10-Q 1 afg-201863010q.htm 10-Q
______________________________________________________________________________________________________
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the Quarterly Period Ended June 30, 2018
Commission File No. 1-13653

AMERICAN FINANCIAL GROUP, INC.

Incorporated under the Laws of Ohio |  | IRS Employer I.D. No. 31-1544320

301 East Fourth Street, Cincinnati, Ohio 45202
(513) 579-2121
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months. Yes þ No ¨
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer ¨ Non-accelerated filer ¨
Smaller reporting company ¨ Emerging growth company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of August 1, 2018, there were 89,087,663 shares of the Registrant’s Common Stock outstanding, excluding 14.9 million shares owned by subsidiaries.
______________________________________________________________________________________________________

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
TABLE OF CONTENTS

| Page
Part I — Financial Information |
Item 1 — Financial Statements: |
Consolidated Balance Sheet | 2
Consolidated Statement of Earnings | 3
Consolidated Statement of Comprehensive Income | 4
Consolidated Statement of Changes in Equity | 5
Consolidated Statement of Cash Flows | 6
Notes to Consolidated Financial Statements | 7
Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations | 34
Item 3 — Quantitative and Qualitative Disclosure about Market Risk | 89
Item 4 — Controls and Procedures | 89
Part II — Other Information |
Item 2 — Unregistered Sales of Equity Securities and Use of Proceeds | 89
Item 5 — Other Information | 89
Item 6 — Exhibits | 90
Signature | 90

Table of Contents
AMERICAN FINANCIAL GROUP, INC. 10-Q
PART I
ITEM I — FINANCIAL STATEMENTS
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET (UNAUDITED)
(Dollars in Millions)

| June 30, 2018 |  | December 31, 2017
Assets: |  |  |
Cash and cash equivalents | $ | 1,810 |  |  | $ | 2,338 |
Investments: |  |  |
Fixed maturities, available for sale at fair value (amortized cost — $39,244 and $37,038) | 39,648 |  |  | 38,379 |
Fixed maturities, trading at fair value | 137 |  |  | 348 |
Equity securities, at fair value | 1,777 |  |  | 1,662 |
Investments accounted for using the equity method | 1,194 |  |  | 999 |
Mortgage loans | 1,147 |  |  | 1,125 |
Policy loans | 179 |  |  | 184 |
Equity index call options | 615 |  |  | 701 |
Real estate and other investments | 272 |  |  | 312 |
Total cash and investments | 46,779 |  |  | 46,048 |
Recoverables from reinsurers | 3,073 |  |  | 3,369 |
Prepaid reinsurance premiums | 645 |  |  | 600 |
Agents’ balances and premiums receivable | 1,266 |  |  | 1,146 |
Deferred policy acquisition costs | 1,582 |  |  | 1,216 |
Assets of managed investment entities | 5,032 |  |  | 4,902 |
Other receivables | 1,048 |  |  | 1,030 |
Variable annuity assets (separate accounts) | 636 |  |  | 644 |
Other assets | 1,574 |  |  | 1,504 |
Goodwill | 199 |  |  | 199 |
Total assets | $ | 61,834 |  |  | $ | 60,658 |
Liabilities and Equity: |  |  |
Unpaid losses and loss adjustment expenses | $ | 9,093 |  |  | $ | 9,678 |
Unearned premiums | 2,539 |  |  | 2,410 |
Annuity benefits accumulated | 34,886 |  |  | 33,316 |
Life, accident and health reserves | 647 |  |  | 658 |
Payable to reinsurers | 721 |  |  | 743 |
Liabilities of managed investment entities | 4,840 |  |  | 4,687 |
Long-term debt | 1,301 |  |  | 1,301 |
Variable annuity liabilities (separate accounts) | 636 |  |  | 644 |
Other liabilities | 2,087 |  |  | 1,887 |
Total liabilities | 56,750 |  |  | 55,324 |
Redeemable noncontrolling interests | — |  |  | 3 |
Shareholders’ equity: |  |  |
Common Stock, no par value — 200,000,000 shares authorized — 89,072,114 and 88,275,460 shares outstanding | 89 |  |  | 88 |
Capital surplus | 1,220 |  |  | 1,181 |
Retained earnings | 3,628 |  |  | 3,248 |
Accumulated other comprehensive income, net of tax | 147 |  |  | 813 |
Total shareholders’ equity | 5,084 |  |  | 5,330 |
Noncontrolling interests | — |  |  | 1 |
Total equity | 5,084 |  |  | 5,331 |
Total liabilities and equity | $ | 61,834 |  |  | $ | 60,658 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF EARNINGS (UNAUDITED)
(In Millions, Except Per Share Data)

| Three months ended June 30, |  | Six months ended June 30,
| 2018 |  | 2017 |  | 2018 |  | 2017
Revenues: |  |  |  |  |  |  |
Property and casualty insurance net earned premiums | $ | 1,161 |  |  | $ | 1,065 |  |  | $ | 2,268 |  |  | $ | 2,087 |
Life, accident and health net earned premiums | 6 |  |  | 5 |  |  | 12 |  |  | 11 |
Net investment income | 530 |  |  | 460 |  |  | 1,025 |  |  | 895 |
Realized gains (losses) on securities (*) | 31 |  |  | 8 |  |  | (62 | ) |  | 11 |
Income (loss) of managed investment entities: |  |  |  |  |  |  |
Investment income | 64 |  |  | 50 |  |  | 122 |  |  | 101 |
Gain (loss) on change in fair value of assets/liabilities | (2 | ) |  | 11 |  |  | (5 | ) |  | 11 |
Other income | 43 |  |  | 47 |  |  | 92 |  |  | 106 |
Total revenues | 1,833 |  |  | 1,646 |  |  | 3,452 |  |  | 3,222 |
Costs and Expenses: |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |
Losses and loss adjustment expenses | 693 |  |  | 635 |  |  | 1,334 |  |  | 1,244 |
Commissions and other underwriting expenses | 400 |  |  | 366 |  |  | 781 |  |  | 705 |
Annuity benefits | 260 |  |  | 224 |  |  | 442 |  |  | 420 |
Life, accident and health benefits | 11 |  |  | 6 |  |  | 22 |  |  | 15 |
Annuity and supplemental insurance acquisition expenses | 50 |  |  | 48 |  |  | 132 |  |  | 101 |
Interest charges on borrowed money | 16 |  |  | 23 |  |  | 31 |  |  | 44 |
Expenses of managed investment entities | 54 |  |  | 51 |  |  | 102 |  |  | 92 |
Other expenses | 89 |  |  | 88 |  |  | 174 |  |  | 173 |
Total costs and expenses | 1,573 |  |  | 1,441 |  |  | 3,018 |  |  | 2,794 |
Earnings before income taxes | 260 |  |  | 205 |  |  | 434 |  |  | 428 |
Provision for income taxes | 52 |  |  | 60 |  |  | 85 |  |  | 128 |
Net earnings, including noncontrolling interests | 208 |  |  | 145 |  |  | 349 |  |  | 300 |
Less: Net earnings (losses) attributable to noncontrolling interests | (2 | ) |  | — |  |  | (6 | ) |  | 2 |
Net Earnings Attributable to Shareholders | $ | 210 |  |  | $ | 145 |  |  | $ | 355 |  |  | $ | 298 |
Earnings Attributable to Shareholders per Common Share: |  |  |  |  |  |  |
Basic | $ | 2.36 |  |  | $ | 1.64 |  |  | $ | 3.99 |  |  | $ | 3.40 |
Diluted | $ | 2.31 |  |  | $ | 1.61 |  |  | $ | 3.92 |  |  | $ | 3.32 |
Average number of Common Shares: |  |  |  |  |  |  |
Basic | 89.0 |  |  | 87.8 |  |  | 88.8 |  |  | 87.5 |
Diluted | 90.7 |  |  | 89.8 |  |  | 90.5 |  |  | 89.6 |
Cash dividends per Common Share | $ | 1.85 |  |  | $ | 1.8125 |  |  | $ | 2.20 |  |  | $ | 2.125 |
________________________________________ |  |  |  |  |  |  |
(*) Consists of the following: |  |  |  |  |  |  |
Realized gains (losses) before impairments | $ | 31 |  |  | $ | 17 |  |  | $ | (61 | ) |  | $ | 26 |
Losses on securities with impairment | — |  |  | (10 | ) |  | (1 | ) |  | (16 | )
Non-credit portion recognized in other comprehensive income (loss) | — |  |  | 1 |  |  | — |  |  | 1 |
Impairment charges recognized in earnings | — |  |  | (9 | ) |  | (1 | ) |  | (15 | )
Total realized gains (losses) on securities | $ | 31 |  |  | $ | 8 |  |  | $ | (62 | ) |  | $ | 11 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (UNAUDITED)
(In Millions)

| Three months ended June 30, |  | Six months ended June 30,
| 2018 |  | 2017 |  | 2018 |  | 2017
Net earnings, including noncontrolling interests | $ | 208 |  |  | $ | 145 |  |  | $ | 349 |  |  | $ | 300 |
Other comprehensive income (loss), net of tax: |  |  |  |  |  |  |
Net unrealized gains (losses) on securities: |  |  |  |  |  |  |
Unrealized holding gains (losses) on securities arising during the period | (148 | ) |  | 115 |  |  | (427 | ) |  | 240 |
Reclassification adjustment for realized gains included in net earnings | (3 | ) |  | (5 | ) |  | (1 | ) |  | (5 | )
Total net unrealized gains (losses) on securities | (151 | ) |  | 110 |  |  | (428 | ) |  | 235 |
Net unrealized gains (losses) on cash flow hedges | (3 | ) |  | 2 |  |  | (14 | ) |  | 1 |
Foreign currency translation adjustments | (4 | ) |  | 4 |  |  | (3 | ) |  | 4 |
Other comprehensive income (loss), net of tax | (158 | ) |  | 116 |  |  | (445 | ) |  | 240 |
Total comprehensive income (loss), net of tax | 50 |  |  | 261 |  |  | (96 | ) |  | 540 |
Less: Comprehensive income (loss) attributable to noncontrolling interests | (2 | ) |  | — |  |  | (6 | ) |  | 2 |
Comprehensive income (loss) attributable to shareholders | $ | 52 |  |  | $ | 261 |  |  | $ | (90 | ) |  | $ | 538 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY (UNAUDITED)
(Dollars in Millions)

|  |  |  | Shareholders’ Equity |  |  |  |  |  | Redeemable
Common Shares |  |  | Common Stock and Capital Surplus |  | Retained Earnings |  | Accumulated Other Comp. Income (Loss) |  | Total |  | Noncon- trolling Interests |  | Total Equity |  | Noncon- trolling Interests
Balance at December 31, 2017 | 88,275,460 |  |  |  | $ | 1,269 |  |  | $ | 3,248 |  |  | $ | 813 |  |  | $ | 5,330 |  |  | $ | 1 |  |  | $ | 5,331 |  |  | $ | 3 |
Cumulative effect of accounting change | — |  |  |  | — |  |  | 225 |  |  | (221 | ) |  | 4 |  |  | — |  |  | 4 |  |  | — |
Net earnings (losses) | — |  |  |  | — |  |  | 355 |  |  | — |  |  | 355 |  |  | (1 | ) |  | 354 |  |  | (5 | )
Other comprehensive loss | — |  |  |  | — |  |  | — |  |  | (445 | ) |  | (445 | ) |  | — |  |  | (445 | ) |  | — |
Dividends on Common Stock | — |  |  |  | — |  |  | (196 | ) |  | — |  |  | (196 | ) |  | — |  |  | (196 | ) |  | — |
Shares issued: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Exercise of stock options | 531,726 |  |  |  | 19 |  |  | — |  |  | — |  |  | 19 |  |  | — |  |  | 19 |  |  | — |
Restricted stock awards | 200,625 |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other benefit plans | 73,676 |  |  |  | 8 |  |  | — |  |  | — |  |  | 8 |  |  | — |  |  | 8 |  |  | — |
Dividend reinvestment plan | 18,006 |  |  |  | 2 |  |  | — |  |  | — |  |  | 2 |  |  | — |  |  | 2 |  |  | — |
Stock-based compensation expense | — |  |  |  | 11 |  |  | — |  |  | — |  |  | 11 |  |  | — |  |  | 11 |  |  | — |
Shares exchanged — benefit plans | (24,310 | ) |  |  | — |  |  | (2 | ) |  | — |  |  | (2 | ) |  | — |  |  | (2 | ) |  | — |
Forfeitures of restricted stock | (3,069 | ) |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other | — |  |  |  | — |  |  | (2 | ) |  | — |  |  | (2 | ) |  | — |  |  | (2 | ) |  | 2 |
Balance at June 30, 2018 | 89,072,114 |  |  |  | $ | 1,309 |  |  | $ | 3,628 |  |  | $ | 147 |  |  | $ | 5,084 |  |  | $ | — |  |  | $ | 5,084 |  |  | $ | — |
Balance at December 31, 2016 | 86,924,399 |  |  |  | $ | 1,198 |  |  | $ | 3,343 |  |  | $ | 375 |  |  | $ | 4,916 |  |  | $ | 3 |  |  | $ | 4,919 |  |  | $ | — |
Net earnings | — |  |  |  | — |  |  | 298 |  |  | — |  |  | 298 |  |  | 2 |  |  | 300 |  |  | — |
Other comprehensive income | — |  |  |  | — |  |  | — |  |  | 240 |  |  | 240 |  |  | — |  |  | 240 |  |  | — |
Dividends on Common Stock | — |  |  |  | — |  |  | (187 | ) |  | — |  |  | (187 | ) |  | — |  |  | (187 | ) |  | — |
Shares issued: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Exercise of stock options | 792,288 |  |  |  | 26 |  |  | — |  |  | — |  |  | 26 |  |  | — |  |  | 26 |  |  | — |
Restricted stock awards | 232,250 |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other benefit plans | 75,381 |  |  |  | 7 |  |  | — |  |  | — |  |  | 7 |  |  | — |  |  | 7 |  |  | — |
Dividend reinvestment plan | 19,516 |  |  |  | 2 |  |  | — |  |  | — |  |  | 2 |  |  | — |  |  | 2 |  |  | — |
Stock-based compensation expense | — |  |  |  | 13 |  |  | — |  |  | — |  |  | 13 |  |  | — |  |  | 13 |  |  | — |
Shares exchanged — benefit plans | (32,509 | ) |  |  | — |  |  | (3 | ) |  | — |  |  | (3 | ) |  | — |  |  | (3 | ) |  | — |
Forfeitures of restricted stock | (4,073 | ) |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (5 | ) |  | (5 | ) |  | — |
Balance at June 30, 2017 | 88,007,252 |  |  |  | $ | 1,246 |  |  | $ | 3,451 |  |  | $ | 615 |  |  | $ | 5,312 |  |  | $ | — |  |  | $ | 5,312 |  |  | $ | — |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
(In Millions)

| Six months ended June 30,
| 2018 |  | 2017
Operating Activities: |  |  |
Net earnings, including noncontrolling interests | $ | 349 |  |  | $ | 300 |
Adjustments: |  |  |
Depreciation and amortization | 106 |  |  | 69 |
Annuity benefits | 442 |  |  | 420 |
Realized (gains) losses on investing activities | 64 |  |  | (28 | )
Net sales of trading securities | 83 |  |  | 31 |
Deferred annuity and life policy acquisition costs | (127 | ) |  | (133 | )
Change in: |  |  |
Reinsurance and other receivables | 72 |  |  | (291 | )
Other assets | (16 | ) |  | (8 | )
Insurance claims and reserves | (268 | ) |  | 275 |
Payable to reinsurers | (22 | ) |  | 47 |
Other liabilities | 55 |  |  | (32 | )
Managed investment entities’ assets/liabilities | 138 |  |  | (72 | )
Other operating activities, net | (53 | ) |  | (4 | )
Net cash provided by operating activities | 823 |  |  | 574 |
Investing Activities: |  |  |
Purchases of: |  |  |
Fixed maturities | (4,549 | ) |  | (5,387 | )
Equity securities | (248 | ) |  | (44 | )
Mortgage loans | (90 | ) |  | (146 | )
Equity index options and other investments | (446 | ) |  | (360 | )
Real estate, property and equipment | (44 | ) |  | (30 | )
Proceeds from: |  |  |
Maturities and redemptions of fixed maturities | 2,283 |  |  | 3,285 |
Repayments of mortgage loans | 68 |  |  | 110 |
Sales of fixed maturities | 203 |  |  | 150 |
Sales of equity securities | 106 |  |  | 50 |
Sales and settlements of equity index options and other investments | 446 |  |  | 360 |
Sales of real estate, property and equipment | 1 |  |  | 53 |
Managed investment entities: |  |  |
Purchases of investments | (1,261 | ) |  | (1,780 | )
Proceeds from sales and redemptions of investments | 1,035 |  |  | 1,738 |
Other investing activities, net | 11 |  |  | 7 |
Net cash used in investing activities | (2,485 | ) |  | (1,994 | )
Financing Activities: |  |  |
Annuity receipts | 2,547 |  |  | 2,556 |
Annuity surrenders, benefits and withdrawals | (1,372 | ) |  | (1,161 | )
Net transfers from variable annuity assets | 21 |  |  | 30 |
Additional long-term borrowings | — |  |  | 345 |
Reductions of long-term debt | — |  |  | (230 | )
Issuances of managed investment entities’ liabilities | 1,572 |  |  | 977 |
Retirements of managed investment entities’ liabilities | (1,461 | ) |  | (835 | )
Issuances of Common Stock | 21 |  |  | 27 |
Cash dividends paid on Common Stock | (194 | ) |  | (185 | )
Other financing activities, net | — |  |  | (4 | )
Net cash provided by financing activities | 1,134 |  |  | 1,520 |
Net Change in Cash and Cash Equivalents | (528 | ) |  | 100 |
Cash and cash equivalents at beginning of period | 2,338 |  |  | 2,107 |
Cash and cash equivalents at end of period | $ | 1,810 |  |  | $ | 2,207 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

INDEX TO NOTES
A. | Accounting Policies |  | H. | Goodwill and Other Intangibles |
B. | Segments of Operations |  | I. | Long-Term Debt |
C. | Fair Value Measurements |  | J. | Redeemable Noncontrolling Interests |
D. | Investments |  | K. | Shareholders’ Equity |
E. | Derivatives |  | L. | Income Taxes |
F. | Deferred Policy Acquisition Costs |  | M. | Contingencies |
G. | Managed Investment Entities |  | N. | Insurance |

A. Accounting Policies
Basis of Presentation The accompanying consolidated financial statements for American Financial Group, Inc. and its subsidiaries (“AFG”) are unaudited; however, management believes that all adjustments (consisting only of normal recurring accruals unless otherwise disclosed herein) necessary for fair presentation have been made. The results of operations for interim periods are not necessarily indicative of results to be expected for the year. The financial statements have been prepared in accordance with the instructions to Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with U.S. generally accepted accounting principles (“GAAP”).
Certain reclassifications have been made to prior periods to conform to the current year’s presentation. All significant intercompany balances and transactions have been eliminated. The results of operations of companies since their formation or acquisition are included in the consolidated financial statements. Events or transactions occurring subsequent to June 30, 2018, and prior to the filing of this Form 10-Q, have been evaluated for potential recognition or disclosure herein.
The preparation of the financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Changes in circumstances could cause actual results to differ materially from those estimates.
Fair Value Measurements Accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants on the measurement date. The standards establish a hierarchy of valuation techniques based on whether the assumptions that market participants would use in pricing the asset or liability (“inputs”) are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect AFG’s assumptions about the assumptions market participants would use in pricing the asset or liability. AFG did not have any significant nonrecurring fair value measurements in the first six months of 2018.
Investments On January 1, 2018, AFG adopted Accounting Standards Update (“ASU”) 2016-01, which requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At December 31, 2017, AFG had $1.60 billion in equity securities classified as “available for sale” under the prior guidance with holding gains and losses included in accumulated other comprehensive income (“AOCI”) instead of net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities included in AOCI was reclassified to retained earnings as the cumulative effect of an accounting change. The cumulative effect of the accounting change also includes the net unrealized gain on AFG’s small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under the new guidance ($4 million net of tax at the date of adoption).
Holding gains and losses on equity securities carried at fair value under ASU 2016-01 are generally recorded in realized gains (losses) on securities. However, prior to the adoption of the new guidance, AFG classified a small portion of its equity securities as “trading” and reported those investments at fair value with holding gains and losses recognized in net investment income. These investments consisted primarily of equity securities held to offset the impact of changes in the stock market on employee benefit plans that are impacted by stock market performance and totaled $62 million at December 31, 2017. Following the adoption of the new guidance, AFG continues to record holding gains and losses on these securities, as well as its small portfolio of limited partnerships and similar investments carried at fair value under the new guidance and certain other securities classified at purchase as “fair value through net investment income” in net investment income.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
Under the new guidance, AFG recorded holding losses of $57 million on equity securities in net earnings during the first six months of 2018 on securities that were still owned at June 30, 2018. Under the prior guidance, these holding losses would have been recorded in AOCI (with the exception of any impairment charge that may have been recorded). Because almost all of the equity securities impacted by the new guidance were carried at fair value through AOCI under the prior guidance, the adoption of the new guidance did not have a material impact on AFG’s financial position.
Fixed maturity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in AOCI in AFG’s Balance Sheet. Fixed maturity securities classified as “trading” are reported at fair value with changes in unrealized holding gains or losses during the period included in net investment income. Mortgage and policy loans are carried primarily at the aggregate unpaid balance.
Premiums and discounts on fixed maturity securities are amortized using the effective interest method. Mortgage-backed securities (“MBS”) are amortized over a period based on estimated future principal payments, including prepayments. Prepayment assumptions are reviewed periodically and adjusted to reflect actual prepayments and changes in expectations.
Limited partnerships and similar investments are generally accounted for using the equity method of accounting. Under the equity method, AFG records its share of the earnings or losses of the investee based on when they are reported by the investee in its financial statements rather than in the period in which the investee declares a dividend. AFG’s share of the earnings or losses from equity method investments is generally recorded on a quarter lag due to the timing of the receipt of the investee’s financial statements. AFG’s equity in the earnings (losses) of limited partnerships and similar investments is included in net investment income.
Gains or losses on fixed maturity securities are determined on the specific identification basis. When a decline in the value of a specific investment is considered to be other-than-temporary at the balance sheet date, a provision for impairment is charged to earnings (included in realized gains (losses) on securities) and the cost basis of that investment is reduced. If management can assert that it does not intend to sell an impaired fixed maturity security and it is not more likely than not that it will have to sell the security before recovery of its amortized cost basis, then the other-than-temporary impairment is separated into two components: (i) the amount related to credit losses (recorded in earnings) and (ii) the amount related to all other factors (recorded in other comprehensive income). The credit-related portion of an other-than-temporary impairment is measured by comparing a security’s amortized cost to the present value of its current expected cash flows discounted at its effective yield prior to the impairment charge. Both components are shown in the statement of earnings. If management intends to sell an impaired security, or it is more likely than not that it will be required to sell the security before recovery, an impairment charge to earnings is recorded to reduce the amortized cost of that security to fair value.
Derivatives Derivatives included in AFG’s Balance Sheet are recorded at fair value. Changes in fair value of derivatives are included in earnings, unless the derivatives are designated and qualify as highly effective cash flow hedges. Derivatives that do not qualify for hedge accounting under GAAP consist primarily of (i) components of certain fixed maturity securities (primarily interest-only MBS) and (ii) the equity-based component of certain annuity products (included in annuity benefits accumulated) and related equity index options designed to be consistent with the characteristics of the liabilities and used to mitigate the risk embedded in those annuity products.
To qualify for hedge accounting, at the inception of a derivative contract, AFG formally documents the relationship between the terms of the hedge and the hedged items and its risk management objective. This documentation includes defining how hedge effectiveness and ineffectiveness will be measured on a retrospective and prospective basis.
Changes in the fair value of derivatives that are designated and qualify as highly effective cash flow hedges are recorded in AOCI and are reclassified into earnings when the variability of the cash flows from the hedged items impacts earnings. Any hedge ineffectiveness is immediately recorded in current period earnings. When the change in the fair value of a qualifying cash flow hedge is included in earnings, it is included in the same line item in the statement of earnings as the cash flows from the hedged item. AFG uses interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities.
For derivatives that are designated and qualify as highly effective fair value hedges, changes in the fair value of the derivative, along with changes in the fair value of the hedged item attributable to the hedged risk, are recognized in current period earnings.
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Goodwill Goodwill represents the excess of cost of subsidiaries over AFG’s equity in their underlying net assets. Goodwill is not amortized, but is subject to an impairment test at least annually. An entity is not required to complete the quantitative annual goodwill impairment test on a reporting unit if the entity elects to perform a qualitative analysis and determines that it is more likely than not that the reporting unit’s fair value exceeds its carrying amount.
Reinsurance Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policies. AFG’s property and casualty insurance subsidiaries report as assets (i) the estimated reinsurance recoverable on paid and unpaid losses, including an estimate for losses incurred but not reported, and (ii) amounts paid or due to reinsurers applicable to the unexpired terms of policies in force. Payable to reinsurers includes ceded premiums due to reinsurers, as well as ceded premiums retained by AFG’s property and casualty insurance subsidiaries under contracts to fund ceded losses as they become due. AFG’s insurance subsidiaries also assume reinsurance from other companies. Earnings on reinsurance assumed is recognized based on information received from ceding companies.
An AFG subsidiary cedes life insurance policies to a third party on a funds withheld basis whereby the subsidiary retains the assets (securities) associated with the reinsurance contract. Interest is credited to the reinsurer based on the actual investment performance of the retained assets. This reinsurance contract is considered to contain an embedded derivative (that must be adjusted to fair value) because the yield on the payable is based on a specific block of the ceding company’s assets, rather than the overall creditworthiness of the ceding company. AFG determined that changes in the fair value of the underlying portfolio of fixed maturity securities is an appropriate measure of the value of the embedded derivative. The securities related to this contract are classified as “trading.” The adjustment to fair value on the embedded derivative offsets the investment income recorded on the adjustment to fair value of the related trading portfolio.
Deferred Policy Acquisition Costs (“DPAC”) Policy acquisition costs (principally commissions, premium taxes and certain underwriting and policy issuance costs) directly related to the successful acquisition or renewal of an insurance contract are deferred. DPAC also includes capitalized costs associated with sales inducements offered to fixed annuity policyholders such as enhanced interest rates and premium and persistency bonuses.
For the property and casualty companies, DPAC is limited based upon recoverability without any consideration for anticipated investment income and is charged against income ratably over the terms of the related policies. A premium deficiency is recognized if the sum of expected claims costs, claims adjustment expenses and unamortized acquisition costs exceed the related unearned premiums. A premium deficiency is first recognized by charging any unamortized acquisition costs to expense to the extent required to eliminate the deficiency. If the premium deficiency is greater than unamortized acquisition costs, a liability is accrued for the excess deficiency and reported with unpaid losses and loss adjustment expenses.
DPAC related to annuities is deferred to the extent deemed recoverable and amortized, with interest, in relation to the present value of actual and expected gross profits on the policies. Expected gross profits consist principally of estimated future investment margin (estimated future net investment income less interest credited on policyholder funds) and surrender, mortality, and other life and annuity policy charges, less death, annuitization and guaranteed withdrawal benefits in excess of account balances and estimated future policy administration expenses. To the extent that realized gains and losses result in adjustments to the amortization of DPAC related to annuities, such adjustments are reflected as components of realized gains (losses) on securities.
DPAC related to traditional life and health insurance is amortized over the expected premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. See “Life, Accident and Health Reserves” below for details on the impact of loss recognition on the accounting for traditional life and health insurance contracts.
DPAC includes the present value of future profits on business in force of annuity and life, accident and health insurance companies acquired (“PVFP”). PVFP represents the portion of the costs to acquire companies that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the date of acquisition. PVFP is amortized with interest in relation to expected gross profits of the acquired policies for annuities and universal life products and in relation to the premium paying period for traditional life and health insurance products.
DPAC and certain other balance sheet amounts related to annuity and life businesses are also adjusted, net of tax, for the change in expense that would have been recorded if the unrealized gains (losses) from securities had actually been realized. These adjustments are included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.
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Managed Investment Entities A company is considered the primary beneficiary of, and therefore must consolidate, a variable interest entity (“VIE”) based primarily on its ability to direct the activities of the VIE that most significantly impact that entity’s economic performance and the obligation to absorb losses of, or receive benefits from, the entity that could potentially be significant to the VIE.
AFG manages, and has investments in, collateralized loan obligations (“CLOs”) that are VIEs (see Note G — “Managed Investment Entities”). AFG has determined that it is the primary beneficiary of the CLOs because (i) its role as asset manager gives it the power to direct the activities that most significantly impact the economic performance of the CLOs and (ii) through its investment in the CLO debt tranches, it has exposure to CLO losses (limited to the amount AFG invested) and the right to receive CLO benefits that could potentially be significant to the CLOs.
Because AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities, the assets and liabilities of the CLOs are shown separately in AFG’s Balance Sheet. AFG has elected the fair value option for reporting on the CLO assets and liabilities to improve the transparency of financial reporting related to the CLOs. The net gain or loss from accounting for the CLO assets and liabilities at fair value is presented separately in AFG’s Statement of Earnings.
The fair values of a CLO’s assets may differ from the separately measured fair values of its liabilities even though the CLO liabilities only have recourse to the CLO assets. AFG has set the carrying value of the CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at a separately measured fair value. CLO earnings attributable to AFG’s shareholders are measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.
Unpaid Losses and Loss Adjustment Expenses The net liabilities stated for unpaid claims and for expenses of investigation and adjustment of unpaid claims represent management’s best estimate and are based upon (i) the accumulation of case estimates for losses reported prior to the close of the accounting period on direct business written; (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of unreported losses (including possible development on known claims) based on past experience; (iv) estimates based on experience of expenses for investigating and adjusting claims; and (v) the current state of the law and coverage litigation. Establishing reserves for asbestos, environmental and other mass tort claims involves considerably more judgment than other types of claims due to, among other things, inconsistent court decisions, an increase in bankruptcy filings as a result of asbestos-related liabilities, novel theories of coverage, and judicial interpretations that often expand theories of recovery and broaden the scope of coverage.
Loss reserve liabilities are subject to the impact of changes in claim amounts and frequency and other factors. Changes in estimates of the liabilities for losses and loss adjustment expenses are reflected in the statement of earnings in the period in which determined. Despite the variability inherent in such estimates, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.
Annuity Benefits Accumulated Annuity receipts and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited are charged to expense and decreases for annuity policy charges are recorded in other income.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, guaranteed withdrawals and excess benefits expected to be paid on future deaths and annuitizations (“EDAR”). The liabilities for EDAR and guaranteed withdrawals are accrued for and modified using assumptions consistent with those used in determining DPAC and DPAC amortization, except that amounts are determined in relation to the present value of total expected assessments. Total expected assessments consist principally of estimated future investment margin, surrender, mortality, and other life and annuity policy charges, and unearned revenues once they are recognized as income.
Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati.
Unearned Revenue Certain upfront policy charges on annuities are deferred as unearned revenue (included in other liabilities) and recognized in net earnings (included in other income) using the same assumptions and estimated gross profits used to amortize DPAC.
Life, Accident and Health Reserves Liabilities for future policy benefits under traditional life, accident and health policies are computed using the net level premium method. Computations are based on the original projections of investment yields, mortality, morbidity and surrenders and include provisions for unfavorable deviations unless a loss recognition event (premium
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deficiency) occurs. Claim reserves and liabilities established for accident and health claims are modified as necessary to reflect actual experience and developing trends.
For long-duration contracts (such as traditional life and long-term care policies), loss recognition occurs when, based on current expectations as of the measurement date, existing contract liabilities plus the present value of future premiums (including reasonably expected rate increases) are not expected to cover the present value of future claims payments and related settlement and maintenance costs (excluding overhead) as well as unamortized acquisition costs. If a block of business is determined to be in loss recognition, a charge is recorded in earnings in an amount equal to the excess of the present value of expected future claims costs and unamortized acquisition costs over existing reserves plus the present value of expected future premiums (with no provision for adverse deviation). The charge is recorded first to reduce unamortized acquisition costs and then as an additional reserve (if unamortized acquisition costs have been reduced to zero).
In addition, reserves for traditional life and long-term care policies are subject to adjustment for loss recognition charges that would have been recorded if the unrealized gains (losses) from securities had actually been realized. This adjustment is included in unrealized gains (losses) on marketable securities, a component of AOCI in AFG’s Balance Sheet.
Debt Issuance Costs Debt issuance costs related to AFG’s outstanding debt are presented in its Balance Sheet as a direct reduction in the carrying value of long-term debt and are amortized over the life of the related debt using the effective interest method as a component of interest expense. Debt issuance costs related to AFG’s revolving credit facilities are included in other assets in AFG’s Balance Sheet.
Variable Annuity Assets and Liabilities Separate accounts related to variable annuities represent the fair value of deposits invested in underlying investment funds on which AFG earns a fee. Investment funds are selected and may be changed only by the policyholder, who retains all investment risk.
AFG’s variable annuity contracts contain a guaranteed minimum death benefit (“GMDB”) to be paid if the policyholder dies before the annuity payout period commences. In periods of declining equity markets, the GMDB may exceed the value of the policyholder’s account. A GMDB liability is established for future excess death benefits using assumptions together with a range of reasonably possible scenarios for investment fund performance that are consistent with DPAC capitalization and amortization assumptions.
Premium Recognition Property and casualty premiums are earned generally over the terms of the policies on a pro rata basis. Unearned premiums represent that portion of premiums written, which is applicable to the unexpired terms of policies in force. On reinsurance assumed from other insurance companies or written through various underwriting organizations, unearned premiums are based on information received from such companies and organizations. For traditional life, accident and health products, premiums are recognized as revenue when legally collectible from policyholders. For interest-sensitive life and universal life products, premiums are recorded in a policyholder account, which is reflected as a liability. Revenue is recognized as amounts are assessed against the policyholder account for mortality coverage and contract expenses.
Noncontrolling Interests For balance sheet purposes, noncontrolling interests represent the interests of shareholders other than AFG in consolidated entities. In the statement of earnings, net earnings and losses attributable to noncontrolling interests represents such shareholders’ interest in the earnings and losses of those entities. Noncontrolling interests that are redeemable at the option of the holder are presented separately in the mezzanine section of the balance sheet (between liabilities and equity).
Income Taxes Deferred income taxes are calculated using the liability method. Under this method, deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases and are measured using enacted tax rates. A valuation allowance is established to reduce total deferred tax assets to an amount that will more likely than not be realized. The effect of a change in tax rates on deferred tax assets and liabilities is recorded in net earnings in the period that includes the enactment date.
AFG recognizes the tax benefits of uncertain tax positions only when the position is more likely than not to be sustained under examination by the appropriate taxing authority. Interest and penalties on AFG’s reserve for uncertain tax positions are recognized as a component of tax expense.
Stock-Based Compensation All share-based grants are recognized as compensation expense on a straight-line basis over their vesting periods based on their calculated fair value at the date of grant. AFG uses the Black Scholes pricing model to measure the fair value of employee stock options. See Note K — “Shareholders’ Equity” for further information.
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AFG records excess tax benefits or deficiencies for share-based payments through income tax expense in the statement of earnings. In addition, AFG accounts for forfeitures of awards when they occur.
Benefit Plans AFG provides retirement benefits to qualified employees of participating companies through the AFG 401(k) Retirement and Savings Plan, a defined contribution plan. AFG makes all contributions to the retirement fund portion of the plan and matches a percentage of employee contributions to the savings fund. Company contributions are expensed in the year for which they are declared. AFG and many of its subsidiaries provide health care and life insurance benefits to eligible retirees. AFG also provides postemployment benefits to former or inactive employees (primarily those on disability) who were not deemed retired under other company plans. The projected future cost of providing these benefits is expensed over the period employees earn such benefits.
Earnings Per Share Although basic earnings per share only considers shares of common stock outstanding during the period, the calculation of diluted earnings per share includes the following adjustments to weighted average common shares related to stock-based compensation plans: second quarter of 2018 and 2017 — 1.7 million and 2.0 million; first six months of 2018 and 2017 — 1.7 million and 2.1 million, respectively.
There were no anti-dilutive potential common shares in the second quarter or first six months of 2018 or 2017.
Statement of Cash Flows For cash flow purposes, “investing activities” are defined as making and collecting loans and acquiring and disposing of debt or equity instruments and property and equipment. “Financing activities” include obtaining resources from owners and providing them with a return on their investments, borrowing money and repaying amounts borrowed. Annuity receipts, surrenders, benefits and withdrawals are also reflected as financing activities. All other activities are considered “operating.” Short-term investments having original maturities of three months or less when purchased are considered to be cash equivalents for purposes of the financial statements.
Revenue Recognition Guidance Effective in 2018 On January 1, 2018, AFG adopted ASU 2014-09, which provides guidance on recognizing revenue when (or as) performance obligations under the contract are satisfied. The new guidance also updates the accounting for certain costs associated with obtaining and fulfilling contracts with customers and requires certain new disclosures. Because revenue recognition for insurance contracts and financial instruments (AFG’s primary sources of revenue) were excluded from the scope of the new guidance, the adoption of ASU 2014-09 did not have a material impact on AFG’s results of operations or financial position.
B. Segments of Operations
AFG manages its business as three segments: (i) Property and casualty insurance, (ii) Annuity and (iii) Other, which includes holding company costs, revenues and costs of AFG’s limited insurance operations outside of property and casualty insurance and annuities, and operations attributable to the noncontrolling interests of the managed investment entities.
AFG reports its property and casualty insurance business in the following Specialty sub-segments: (i) Property and transportation, which includes physical damage and liability coverage for buses, trucks and recreational vehicles, inland and ocean marine, agricultural-related products and other property coverages, (ii) Specialty casualty, which includes primarily excess and surplus, general liability, executive liability, professional liability, umbrella and excess liability, specialty coverage in targeted markets, customized programs for small to mid-sized businesses and workers’ compensation insurance, and (iii) Specialty financial, which includes risk management insurance programs for leasing and financing institutions (including equipment leasing and collateral and lender-placed mortgage property insurance), surety and fidelity products and trade credit insurance. Premiums and underwriting profit included under Other specialty represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments and amortization of deferred gains on retroactive reinsurance transactions related to the sales of businesses in prior years. AFG’s annuity business markets traditional fixed, fixed-indexed and variable-indexed annuities in the retail, financial institutions, registered investment advisor and education markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services. Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior period amounts were reclassified for consistent presentation.
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The following tables (in millions) show AFG’s revenues and earnings before income taxes by segment and sub-segment.

| Three months ended June 30, |  | Six months ended June 30,
| 2018 |  | 2017 |  | 2018 |  | 2017
Revenues |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |
Premiums earned: |  |  |  |  |  |  |
Specialty |  |  |  |  |  |  |
Property and transportation | $ | 374 |  |  | $ | 357 |  |  | $ | 724 |  |  | $ | 699 |
Specialty casualty | 595 |  |  | 537 |  |  | 1,174 |  |  | 1,045 |
Specialty financial | 159 |  |  | 146 |  |  | 308 |  |  | 293 |
Other specialty | 33 |  |  | 25 |  |  | 62 |  |  | 50 |
Total premiums earned | 1,161 |  |  | 1,065 |  |  | 2,268 |  |  | 2,087 |
Net investment income | 115 |  |  | 96 |  |  | 215 |  |  | 182 |
Other income (a) | 2 |  |  | 4 |  |  | 4 |  |  | 20 |
Total property and casualty insurance | 1,278 |  |  | 1,165 |  |  | 2,487 |  |  | 2,289 |
Annuity: |  |  |  |  |  |  |
Net investment income | 412 |  |  | 360 |  |  | 806 |  |  | 707 |
Other income | 27 |  |  | 26 |  |  | 53 |  |  | 53 |
Total annuity | 439 |  |  | 386 |  |  | 859 |  |  | 760 |
Other | 85 |  |  | 87 |  |  | 168 |  |  | 162 |
Total revenues before realized gains (losses) | 1,802 |  |  | 1,638 |  |  | 3,514 |  |  | 3,211 |
Realized gains (losses) on securities | 31 |  |  | 8 |  |  | (62 | ) |  | 11 |
Total revenues | $ | 1,833 |  |  | $ | 1,646 |  |  | $ | 3,452 |  |  | $ | 3,222 |

Earnings Before Income Taxes |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |
Underwriting: |  |  |  |  |  |  |
Specialty |  |  |  |  |  |  |
Property and transportation | $ | 23 |  |  | $ | 21 |  |  | $ | 56 |  |  | $ | 64 |
Specialty casualty | 29 |  |  | 29 |  |  | 70 |  |  | 44 |
Specialty financial | 22 |  |  | 23 |  |  | 37 |  |  | 45 |
Other specialty | (1 | ) |  | — |  |  | 2 |  |  | (1 | )
Other lines | (1 | ) |  | (1 | ) |  | (2 | ) |  | (2 | )
Total underwriting | 72 |  |  | 72 |  |  | 163 |  |  | 150 |
Investment and other income, net (a) | 106 |  |  | 91 |  |  | 199 |  |  | 184 |
Total property and casualty insurance | 178 |  |  | 163 |  |  | 362 |  |  | 334 |
Annuity | 99 |  |  | 85 |  |  | 224 |  |  | 181 |
Other (b) | (48 | ) |  | (51 | ) |  | (90 | ) |  | (98 | )
Total earnings before realized gains (losses) and income taxes | 229 |  |  | 197 |  |  | 496 |  |  | 417 |
Realized gains (losses) on securities | 31 |  |  | 8 |  |  | (62 | ) |  | 11 |
Total earnings before income taxes | $ | 260 |  |  | $ | 205 |  |  | $ | 434 |  |  | $ | 428 |

(a) | Includes income of $13 million (before noncontrolling interest) from the sale of a hotel in the first quarter of 2017.

(b) | Includes holding company interest and expenses, including a $7 million loss on retirement of debt in the second quarter of 2017.

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C. Fair Value Measurements
Accounting standards for measuring fair value are based on inputs used in estimating fair value. The three levels of the hierarchy are as follows:
Level 1 — Quoted prices for identical assets or liabilities in active markets (markets in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis). AFG’s Level 1 financial instruments consist primarily of publicly traded equity securities, highly liquid government bonds for which quoted market prices in active markets are available and short-term investments of managed investment entities.
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar assets or liabilities in inactive markets (markets in which there are few transactions, the prices are not current, price quotations vary substantially over time or among market makers, or in which little information is released publicly); and valuations based on other significant inputs that are observable in active markets. AFG’s Level 2 financial instruments include separate account assets, corporate and municipal fixed maturity securities, asset-backed securities (“ABS”), mortgage-backed securities (“MBS”), non-affiliated common stocks, equity index call options and investments of managed investment entities priced using observable inputs. Level 2 inputs include benchmark yields, reported trades, corroborated broker/dealer quotes, issuer spreads and benchmark securities. When non-binding broker quotes can be corroborated by comparison to similar securities priced using observable inputs, they are classified as Level 2.
Level 3 — Valuations derived from market valuation techniques generally consistent with those used to estimate the fair values of Level 2 financial instruments in which one or more significant inputs are unobservable or when the market for a security exhibits significantly less liquidity relative to markets supporting Level 2 fair value measurements. The unobservable inputs may include management’s own assumptions about the assumptions market participants would use based on the best information available at the valuation date. AFG’s Level 3 is comprised of financial instruments whose fair value is estimated based on non-binding broker quotes or internally developed using significant inputs not based on, or corroborated by, observable market information.
As discussed in Note A — “Accounting Policies — Managed Investment Entities,” AFG has set the carrying value of its CLO liabilities equal to the fair value of the CLO assets (which have more observable fair values) as an alternative to reporting those liabilities at separately measured fair values. As a result, the CLO liabilities are categorized within the fair value hierarchy on the same basis (proportionally) as the related CLO assets. Since the portion of the CLO liabilities allocated to Level 3 is derived from the fair value of the CLO assets, these amounts are excluded from the progression of Level 3 financial instruments.
AFG’s management is responsible for the valuation process and uses data from outside sources (including nationally recognized pricing services and broker/dealers) in establishing fair value. AFG’s internal investment professionals are a group of approximately 25 analysts whose primary responsibility is to manage AFG’s investment portfolio. These professionals monitor individual investments as well as overall industries and are active in the financial markets on a daily basis. The group is led by AFG’s chief investment officer, who reports directly to one of AFG’s Co-CEOs. Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, the Company communicates directly with the pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the service to value specific securities.
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Assets and liabilities measured and carried at fair value in the financial statements are summarized below (in millions):

| Level 1 |  | Level 2 |  | Level 3 |  | Total
June 30, 2018 |  |  |  |  |  |  |
Assets: |  |  |  |  |  |  |
Available for sale (“AFS”) fixed maturities: |  |  |  |  |  |  |
U.S. Government and government agencies | $ | 140 |  |  | $ | 92 |  |  | $ | 8 |  |  | $ | 240 |
States, municipalities and political subdivisions | — |  |  | 6,852 |  |  | 61 |  |  | 6,913 |
Foreign government | — |  |  | 129 |  |  | — |  |  | 129 |
Residential MBS | — |  |  | 2,739 |  |  | 147 |  |  | 2,886 |
Commercial MBS | — |  |  | 878 |  |  | 56 |  |  | 934 |
Asset-backed securities | — |  |  | 7,931 |  |  | 1,004 |  |  | 8,935 |
Corporate and other | 29 |  |  | 18,174 |  |  | 1,408 |  |  | 19,611 |
Total AFS fixed maturities | 169 |  |  | 36,795 |  |  | 2,684 |  |  | 39,648 |
Trading fixed maturities | 38 |  |  | 99 |  |  | — |  |  | 137 |
Equity securities | 1,471 |  |  | 76 |  |  | 230 |  |  | 1,777 |
Equity index call options | — |  |  | 615 |  |  | — |  |  | 615 |
Assets of managed investment entities (“MIE”) | 229 |  |  | 4,780 |  |  | 23 |  |  | 5,032 |
Variable annuity assets (separate accounts) (*) | — |  |  | 636 |  |  | — |  |  | 636 |
Total assets accounted for at fair value | $ | 1,907 |  |  | $ | 43,001 |  |  | $ | 2,937 |  |  | $ | 47,845 |
Liabilities: |  |  |  |  |  |  |
Liabilities of managed investment entities | $ | 220 |  |  | $ | 4,598 |  |  | $ | 22 |  |  | $ | 4,840 |
Derivatives in annuity benefits accumulated | — |  |  | — |  |  | 2,776 |  |  | 2,776 |
Other liabilities — derivatives | — |  |  | 72 |  |  | — |  |  | 72 |
Total liabilities accounted for at fair value | $ | 220 |  |  | $ | 4,670 |  |  | $ | 2,798 |  |  | $ | 7,688 |
December 31, 2017 |  |  |  |  |  |  |
Assets: |  |  |  |  |  |  |
Available for sale fixed maturities: |  |  |  |  |  |  |
U.S. Government and government agencies | $ | 122 |  |  | $ | 112 |  |  | $ | 8 |  |  | $ | 242 |
States, municipalities and political subdivisions | — |  |  | 6,975 |  |  | 148 |  |  | 7,123 |
Foreign government | — |  |  | 127 |  |  | — |  |  | 127 |
Residential MBS | — |  |  | 3,105 |  |  | 122 |  |  | 3,227 |
Commercial MBS | — |  |  | 926 |  |  | 36 |  |  | 962 |
Asset-backed securities | — |  |  | 7,218 |  |  | 744 |  |  | 7,962 |
Corporate and other | 30 |  |  | 17,662 |  |  | 1,044 |  |  | 18,736 |
Total AFS fixed maturities | 152 |  |  | 36,125 |  |  | 2,102 |  |  | 38,379 |
Trading fixed maturities | 44 |  |  | 304 |  |  | — |  |  | 348 |
Equity securities | 1,411 |  |  | 86 |  |  | 165 |  |  | 1,662 |
Equity index call options | — |  |  | 701 |  |  | — |  |  | 701 |
Assets of managed investment entities | 307 |  |  | 4,572 |  |  | 23 |  |  | 4,902 |
Variable annuity assets (separate accounts) (*) | — |  |  | 644 |  |  | — |  |  | 644 |
Total assets accounted for at fair value | $ | 1,914 |  |  | $ | 42,432 |  |  | $ | 2,290 |  |  | $ | 46,636 |
Liabilities: |  |  |  |  |  |  |
Liabilities of managed investment entities | $ | 293 |  |  | $ | 4,372 |  |  | $ | 22 |  |  | $ | 4,687 |
Derivatives in annuity benefits accumulated | — |  |  | — |  |  | 2,542 |  |  | 2,542 |
Other liabilities — derivatives | — |  |  | 35 |  |  | — |  |  | 35 |
Total liabilities accounted for at fair value | $ | 293 |  |  | $ | 4,407 |  |  | $ | 2,564 |  |  | $ | 7,264 |

(*) | Variable annuity liabilities equal the fair value of variable annuity assets.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
Transfers between Level 1 and Level 2 for all periods presented were a result of increases or decreases in observable trade activity.
During the second quarter and first six months of 2018, there were two preferred stocks with an aggregate fair value of $6 million that transferred from Level 1 to Level 2. During the second quarter and first six months of 2017, there were two preferred stocks with an aggregate fair value of $16 million that transferred from Level 2 to Level 1.
Approximately 6% of the total assets carried at fair value at June 30, 2018, were Level 3 assets. Approximately 73% ($2.14 billion) of the Level 3 assets were priced using non-binding broker quotes, for which there is a lack of transparency as to the inputs used to determine fair value. Details as to the quantitative inputs are neither provided by the brokers nor otherwise reasonably obtainable by AFG. Since internally developed Level 3 asset fair values represent approximately 14% of AFG’s Shareholders’ Equity, any justifiable changes in unobservable inputs used to determine internally developed fair values would not have a material impact on AFG’s financial position.
The only significant Level 3 assets or liabilities carried at fair value in the financial statements that were not measured using broker quotes are the derivatives embedded in AFG’s fixed-indexed and variable-indexed annuity liabilities, which are measured using a discounted cash flow approach and had a fair value of $2.78 billion at June 30, 2018. The following table presents information about the unobservable inputs used by management in determining fair value of these embedded derivatives. See Note E — “Derivatives.”

| Unobservable Input |  | Range |
| Adjustment for insurance subsidiary’s credit risk |  | 0.4% – 1.7% over the risk free rate |
| Risk margin for uncertainty in cash flows |  | 0.70% reduction in the discount rate |
| Surrenders |  | 3% – 23% of indexed account value |
| Partial surrenders |  | 2% – 9% of indexed account value |
| Annuitizations |  | 0.1% – 1% of indexed account value |
| Deaths |  | 1.6% – 8.0% of indexed account value |
| Budgeted option costs |  | 2.5% – 3.5% of indexed account value |

The range of adjustments for insurance subsidiary’s credit risk reflects credit spread variations across the yield curve. The range of projected surrender rates reflects the specific surrender charges and other features of AFG’s individual fixed-indexed and variable-indexed annuity products with an expected range of 7% to 11% in the majority of future calendar years (3% to 23% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flow assumptions in the table above would increase the fair value of the fixed-indexed and variable-indexed annuity embedded derivatives, while increasing any of the other unobservable inputs in the table above would decrease the fair value of the embedded derivatives.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
Changes in balances of Level 3 financial assets and liabilities carried at fair value during the second quarter and first six months of 2018 and 2017 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs and $29 million of equity securities transferred into Level 3 in the first quarter of 2018 related to a small number of limited partnerships and similar investments carried at cost under the prior guidance that are carried at fair value through net earnings under new guidance adopted on January 1, 2018, as discussed in Note A — “Accounting Policies — Investments.” All transfers are reflected in the table at fair value as of the end of the reporting period.

|  |  | Total realized/unrealized gains (losses) included in |  |  |  |  |  |  |  |  |  |
Balance at March 31, 2018 |  | Net earnings |  | Other comprehensive income (loss) |  | Purchases and issuances |  | Sales and settlements |  | Transfer into Level 3 |  | Transfer out of Level 3 |  | Balance at June 30, 2018
AFS fixed maturities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government agency | $ | 8 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 8 |
State and municipal | 62 |  |  | — |  |  | (1 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | 61 |
Residential MBS | 115 |  |  | (3 | ) |  | — |  |  | — |  |  | (5 | ) |  | 50 |  |  | (10 | ) |  | 147 |
Commercial MBS | 47 |  |  | — |  |  | — |  |  | 9 |  |  | — |  |  | — |  |  | — |  |  | 56 |
Asset-backed securities | 912 |  |  | — |  |  | (6 | ) |  | 136 |  |  | (20 | ) |  | — |  |  | (18 | ) |  | 1,004 |
Corporate and other | 1,238 |  |  | 1 |  |  | (4 | ) |  | 234 |  |  | (48 | ) |  | — |  |  | (13 | ) |  | 1,408 |
Total AFS fixed maturities | 2,382 |  |  | (2 | ) |  | (11 | ) |  | 379 |  |  | (73 | ) |  | 50 |  |  | (41 | ) |  | 2,684 |
Equity securities | 194 |  |  | 19 |  |  | — |  |  | 16 |  |  | — |  |  | 1 |  |  | — |  |  | 230 |
Assets of MIE | 24 |  |  | (3 | ) |  | — |  |  | 2 |  |  | — |  |  | — |  |  | — |  |  | 23 |
Total Level 3 assets | $ | 2,600 |  |  | $ | 14 |  |  | $ | (11 | ) |  | $ | 397 |  |  | $ | (73 | ) |  | $ | 51 |  |  | $ | (41 | ) |  | $ | 2,937 |
Embedded derivatives (a) | $ | (2,549 | ) |  | $ | (126 | ) |  | $ | — |  |  | $ | (141 | ) |  | $ | 40 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,776 | )
Total Level 3 liabilities (b) | $ | (2,549 | ) |  | $ | (126 | ) |  | $ | — |  |  | $ | (141 | ) |  | $ | 40 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,776 | )

|  |  | Total realized/unrealized gains (losses) included in |  |  |  |  |  |  |  |  |  |
Balance at March 31, 2017 |  | Net earnings |  | Other comprehensive income (loss) |  | Purchases and issuances |  | Sales and settlements |  | Transfer into Level 3 |  | Transfer out of Level 3 |  | Balance at June 30, 2017
AFS fixed maturities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government agency | $ | 8 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 8 |
State and municipal | 143 |  |  | — |  |  | 1 |  |  | — |  |  | (1 | ) |  | — |  |  | — |  |  | 143 |
Residential MBS | 175 |  |  | (3 | ) |  | 2 |  |  | — |  |  | (23 | ) |  | 13 |  |  | (11 | ) |  | 153 |
Commercial MBS | 29 |  |  | 1 |  |  | — |  |  | 15 |  |  | — |  |  | — |  |  | — |  |  | 45 |
Asset-backed securities | 594 |  |  | — |  |  | 2 |  |  | — |  |  | (25 | ) |  | 19 |  |  | (92 | ) |  | 498 |
Corporate and other | 828 |  |  | 4 |  |  | 4 |  |  | 168 |  |  | (27 | ) |  | — |  |  | (24 | ) |  | 953 |
Total AFS fixed maturities | 1,777 |  |  | 2 |  |  | 9 |  |  | 183 |  |  | (76 | ) |  | 32 |  |  | (127 | ) |  | 1,800 |
Equity securities | 173 |  |  | (10 | ) |  | 6 |  |  | 8 |  |  | (3 | ) |  | — |  |  | (6 | ) |  | 168 |
Assets of MIE | 26 |  |  | (5 | ) |  | — |  |  | 2 |  |  | — |  |  | — |  |  | — |  |  | 23 |
Total Level 3 assets | $ | 1,976 |  |  | $ | (13 | ) |  | $ | 15 |  |  | $ | 193 |  |  | $ | (79 | ) |  | $ | 32 |  |  | $ | (133 | ) |  | $ | 1,991 |
Embedded derivatives | $ | (1,963 | ) |  | $ | (112 | ) |  | $ | — |  |  | $ | (80 | ) |  | $ | 26 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,129 | )
Total Level 3 liabilities (b) | $ | (1,963 | ) |  | $ | (112 | ) |  | $ | — |  |  | $ | (80 | ) |  | $ | 26 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,129 | )

(a) | Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the second quarter of 2018.

(b) | As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

|  |  | Total realized/unrealized gains (losses) included in |  |  |  |  |  |  |  |  |  |
Balance at December 31, 2017 |  | Net earnings |  | Other comprehensive income (loss) |  | Purchases and issuances |  | Sales and settlements |  | Transfer into Level 3 |  | Transfer out of Level 3 |  | Balance at June 30, 2018
AFS fixed maturities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government agency | $ | 8 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 8 |
State and municipal | 148 |  |  | — |  |  | (2 | ) |  | — |  |  | (1 | ) |  | — |  |  | (84 | ) |  | 61 |
Residential MBS | 122 |  |  | (7 | ) |  | — |  |  | — |  |  | (11 | ) |  | 57 |  |  | (14 | ) |  | 147 |
Commercial MBS | 36 |  |  | (1 | ) |  | — |  |  | 21 |  |  | — |  |  | — |  |  | — |  |  | 56 |
Asset-backed securities | 744 |  |  | (2 | ) |  | (3 | ) |  | 340 |  |  | (57 | ) |  | — |  |  | (18 | ) |  | 1,004 |
Corporate and other | 1,044 |  |  | 2 |  |  | (18 | ) |  | 472 |  |  | (79 | ) |  | — |  |  | (13 | ) |  | 1,408 |
Total AFS fixed maturities | 2,102 |  |  | (8 | ) |  | (23 | ) |  | 833 |  |  | (148 | ) |  | 57 |  |  | (129 | ) |  | 2,684 |
Equity securities | 165 |  |  | 14 |  |  | — |  |  | 25 |  |  | (4 | ) |  | 30 |  |  | — |  |  | 230 |
Assets of MIE | 23 |  |  | (5 | ) |  | — |  |  | 5 |  |  | — |  |  | — |  |  | — |  |  | 23 |
Total Level 3 assets | $ | 2,290 |  |  | $ | 1 |  |  | $ | (23 | ) |  | $ | 863 |  |  | $ | (152 | ) |  | $ | 87 |  |  | $ | (129 | ) |  | $ | 2,937 |
Embedded derivatives (a) | $ | (2,542 | ) |  | $ | (63 | ) |  | $ | — |  |  | $ | (244 | ) |  | $ | 73 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,776 | )
Total Level 3 liabilities (b) | $ | (2,542 | ) |  | $ | (63 | ) |  | $ | — |  |  | $ | (244 | ) |  | $ | 73 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,776 | )

|  |  | Total realized/unrealized gains (losses) included in |  |  |  |  |  |  |  |  |  |
Balance at December 31, 2016 |  | Net earnings |  | Other comprehensive income (loss) |  | Purchases and issuances |  | Sales and settlements |  | Transfer into Level 3 |  | Transfer out of Level 3 |  | Balance at June 30, 2017
AFS fixed maturities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. government agency | $ | 8 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 8 |
State and municipal | 140 |  |  | — |  |  | 4 |  |  | — |  |  | (1 | ) |  | — |  |  | — |  |  | 143 |
Residential MBS | 190 |  |  | (2 | ) |  | 2 |  |  | 1 |  |  | (31 | ) |  | 20 |  |  | (27 | ) |  | 153 |
Commercial MBS | 25 |  |  | 1 |  |  | — |  |  | 15 |  |  | — |  |  | 4 |  |  | — |  |  | 45 |
Asset-backed securities | 484 |  |  | — |  |  | 2 |  |  | 104 |  |  | (36 | ) |  | 36 |  |  | (92 | ) |  | 498 |
Corporate and other | 712 |  |  | 5 |  |  | 8 |  |  | 288 |  |  | (65 | ) |  | 29 |  |  | (24 | ) |  | 953 |
Total AFS fixed maturities | 1,559 |  |  | 4 |  |  | 16 |  |  | 408 |  |  | (133 | ) |  | 89 |  |  | (143 | ) |  | 1,800 |
Equity securities | 174 |  |  | (16 | ) |  | 13 |  |  | 20 |  |  | (3 | ) |  | — |  |  | (20 | ) |  | 168 |
Assets of MIE | 29 |  |  | (6 | ) |  | — |  |  | 4 |  |  | — |  |  | — |  |  | (4 | ) |  | 23 |
Total Level 3 assets | $ | 1,762 |  |  | $ | (18 | ) |  | $ | 29 |  |  | $ | 432 |  |  | $ | (136 | ) |  | $ | 89 |  |  | $ | (167 | ) |  | $ | 1,991 |
Embedded derivatives | $ | (1,759 | ) |  | $ | (259 | ) |  | $ | — |  |  | $ | (159 | ) |  | $ | 48 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,129 | )
Total Level 3 liabilities (b) | $ | (1,759 | ) |  | $ | (259 | ) |  | $ | — |  |  | $ | (159 | ) |  | $ | 48 |  |  | $ | — |  |  | $ | — |  |  | $ | (2,129 | )

(a) | Total realized/unrealized gains (losses) included in net earnings for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $44 million in the first six months of 2018.

(b) | As previously discussed, these tables exclude the portion of MIE liabilities allocated to Level 3, which are derived from the fair value of the MIE assets.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
Fair Value of Financial Instruments The carrying value and fair value of financial instruments that are not carried at fair value in the financial statements are summarized below (in millions):

| Carrying |  | Fair Value
| Value |  | Total |  | Level 1 |  | Level 2 |  | Level 3
June 30, 2018 |  |  |  |  |  |  |  |  |
Financial assets: |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 1,810 |  |  | $ | 1,810 |  |  | $ | 1,810 |  |  | $ | — |  |  | $ | — |
Mortgage loans | 1,147 |  |  | 1,136 |  |  | — |  |  | — |  |  | 1,136 |
Policy loans | 179 |  |  | 179 |  |  | — |  |  | — |  |  | 179 |
Total financial assets not accounted for at fair value | $ | 3,136 |  |  | $ | 3,125 |  |  | $ | 1,810 |  |  | $ | — |  |  | $ | 1,315 |
Financial liabilities: |  |  |  |  |  |  |  |  |
Annuity benefits accumulated (*) | $ | 34,673 |  |  | $ | 33,204 |  |  | $ | — |  |  | $ | — |  |  | $ | 33,204 |
Long-term debt | 1,301 |  |  | 1,265 |  |  | — |  |  | 1,262 |  |  | 3 |
Total financial liabilities not accounted for at fair value | $ | 35,974 |  |  | $ | 34,469 |  |  | $ | — |  |  | $ | 1,262 |  |  | $ | 33,207 |
December 31, 2017 |  |  |  |  |  |  |  |  |
Financial assets: |  |  |  |  |  |  |  |  |
Cash and cash equivalents | $ | 2,338 |  |  | $ | 2,338 |  |  | $ | 2,338 |  |  | $ | — |  |  | $ | — |
Mortgage loans | 1,125 |  |  | 1,119 |  |  | — |  |  | — |  |  | 1,119 |
Policy loans | 184 |  |  | 184 |  |  | — |  |  | — |  |  | 184 |
Total financial assets not accounted for at fair value | $ | 3,647 |  |  | $ | 3,641 |  |  | $ | 2,338 |  |  | $ | — |  |  | $ | 1,303 |
Financial liabilities: |  |  |  |  |  |  |  |  |
Annuity benefits accumulated (*) | $ | 33,110 |  |  | $ | 32,461 |  |  | $ | — |  |  | $ | — |  |  | $ | 32,461 |
Long-term debt | 1,301 |  |  | 1,354 |  |  | — |  |  | 1,351 |  |  | 3 |
Total financial liabilities not accounted for at fair value | $ | 34,411 |  |  | $ | 33,815 |  |  | $ | — |  |  | $ | 1,351 |  |  | $ | 32,464 |

(*) | Excludes $213 million and $206 million of life contingent annuities in the payout phase at June 30, 2018 and December 31, 2017, respectively.

The carrying amount of cash and cash equivalents approximates fair value. Fair values for mortgage loans are estimated by discounting the future contractual cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. The fair value of policy loans is estimated to approximate carrying value; policy loans have no defined maturity dates and are inseparable from insurance contracts. The fair value of annuity benefits was estimated based on expected cash flows discounted using forward interest rates adjusted for the Company’s credit risk and includes the impact of maintenance expenses and capital costs. Fair values of long-term debt are based primarily on quoted market prices.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
D. Investments
Available for sale fixed maturities at June 30, 2018 and December 31, 2017, consisted of the following (in millions):

| June 30, 2018 |  | December 31, 2017
Amortized Cost |  | Gross Unrealized |  | Net Unrealized |  | Fair Value |  | Amortized Cost |  | Gross Unrealized |  | Net Unrealized |  | Fair Value
Gains |  | Losses |  | Gains |  | Losses
Fixed maturities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
U.S. Government and government agencies | $ | 243 |  |  | $ | 1 |  |  | $ | (4 | ) |  | $ | (3 | ) |  | $ | 240 |  |  | $ | 244 |  |  | $ | 1 |  |  | $ | (3 | ) |  | $ | (2 | ) |  | $ | 242 |
States, municipalities and political subdivisions | 6,804 |  |  | 162 |  |  | (53 | ) |  | 109 |  |  | 6,913 |  |  | 6,887 |  |  | 254 |  |  | (18 | ) |  | 236 |  |  | 7,123 |
Foreign government | 127 |  |  | 2 |  |  | — |  |  | 2 |  |  | 129 |  |  | 124 |  |  | 3 |  |  | — |  |  | 3 |  |  | 127 |
Residential MBS | 2,564 |  |  | 329 |  |  | (7 | ) |  | 322 |  |  | 2,886 |  |  | 2,884 |  |  | 349 |  |  | (6 | ) |  | 343 |  |  | 3,227 |
Commercial MBS | 920 |  |  | 18 |  |  | (4 | ) |  | 14 |  |  | 934 |  |  | 927 |  |  | 36 |  |  | (1 | ) |  | 35 |  |  | 962 |
Asset-backed securities | 8,849 |  |  | 132 |  |  | (46 | ) |  | 86 |  |  | 8,935 |  |  | 7,836 |  |  | 142 |  |  | (16 | ) |  | 126 |  |  | 7,962 |
Corporate and other | 19,737 |  |  | 198 |  |  | (324 | ) |  | (126 | ) |  | 19,611 |  |  | 18,136 |  |  | 638 |  |  | (38 | ) |  | 600 |  |  | 18,736 |
Total fixed maturities | $ | 39,244 |  |  | $ | 842 |  |  | $ | (438 | ) |  | $ | 404 |  |  | $ | 39,648 |  |  | $ | 37,038 |  |  | $ | 1,423 |  |  | $ | (82 | ) |  | $ | 1,341 |  |  | $ | 38,379 |

The non-credit related portion of other-than-temporary impairment charges is included in other comprehensive income. Cumulative non-credit charges taken for securities still owned at June 30, 2018 and December 31, 2017 were $149 million and $158 million, respectively. Gross unrealized gains on such securities at June 30, 2018 and December 31, 2017 were $135 million and $137 million, respectively. Gross unrealized losses on such securities at both June 30, 2018 and December 31, 2017 were $4 million. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and relate primarily to residential MBS.
As discussed in Note A — “Accounting Policies — Investments,” beginning on January 1, 2018, AFG implemented new accounting guidance, which required all equity securities previously classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net earnings. Equity securities reported at fair value consisted of the following at June 30, 2018 (in millions):

|  |  |  |  | Fair Value in
| Actual Cost |  | Fair Value |  | excess of Cost
Common stocks | $ | 1,066 |  |  | $ | 1,180 |  |  | $ | 114 |
Perpetual preferred stocks | 603 |  |  | 597 |  |  | (6 | )
Total equity securities carried at fair value | $ | 1,669 |  |  | $ | 1,777 |  |  | $ | 108 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
The following tables show gross unrealized losses (dollars in millions) on available for sale fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at the following balance sheet dates.

| Less Than Twelve Months |  | Twelve Months or More
Unrealized Loss |  | Fair Value |  | Fair Value as % of Cost |  | Unrealized Loss |  | Fair Value |  | Fair Value as % of Cost
June 30, 2018 |  |  |  |  |  |  |  |  |  |  |
Fixed maturities: |  |  |  |  |  |  |  |  |  |  |
U.S. Government and government agencies | $ | (1 | ) |  | $ | 102 |  |  | 99 | % |  | $ | (3 | ) |  | $ | 99 |  |  | 97 | %
States, municipalities and political subdivisions | (36 | ) |  | 1,957 |  |  | 98 | % |  | (17 | ) |  | 451 |  |  | 96 | %
Foreign government | — |  |  | 26 |  |  | 100 | % |  | — |  |  | — |  |  | — | %
Residential MBS | (2 | ) |  | 157 |  |  | 99 | % |  | (5 | ) |  | 110 |  |  | 96 | %
Commercial MBS | (4 | ) |  | 215 |  |  | 98 | % |  | — |  |  | — |  |  | — | %
Asset-backed securities | (36 | ) |  | 3,738 |  |  | 99 | % |  | (10 | ) |  | 256 |  |  | 96 | %
Corporate and other | (281 | ) |  | 10,673 |  |  | 97 | % |  | (43 | ) |  | 651 |  |  | 94 | %
Total fixed maturities | $ | (360 | ) |  | $ | 16,868 |  |  | 98 | % |  | $ | (78 | ) |  | $ | 1,567 |  |  | 95 | %
December 31, 2017 |  |  |  |  |  |  |  |  |  |  |
Fixed maturities: |  |  |  |  |  |  |  |  |  |  |
U.S. Government and government agencies | $ | — |  |  | $ | 55 |  |  | 100 | % |  | $ | (3 | ) |  | $ | 123 |  |  | 98 | %
States, municipalities and political subdivisions | (8 | ) |  | 825 |  |  | 99 | % |  | (10 | ) |  | 431 |  |  | 98 | %
Foreign government | — |  |  | 4 |  |  | 100 | % |  | — |  |  | — |  |  | — | %
Residential MBS | (1 | ) |  | 118 |  |  | 99 | % |  | (5 | ) |  | 118 |  |  | 96 | %
Commercial MBS | (1 | ) |  | 67 |  |  | 99 | % |  | — |  |  | — |  |  | — | %
Asset-backed securities | (7 | ) |  | 1,195 |  |  | 99 | % |  | (9 | ) |  | 299 |  |  | 97 | %
Corporate and other | (20 | ) |  | 2,031 |  |  | 99 | % |  | (18 | ) |  | 603 |  |  | 97 | %
Total fixed maturities | $ | (37 | ) |  | $ | 4,295 |  |  | 99 | % |  | $ | (45 | ) |  | $ | 1,574 |  |  | 97 | %
Equity securities: |  |  |  |  |  |  |  |  |  |  |
Common stocks | $ | (22 | ) |  | $ | 117 |  |  | 84 | % |  | $ | — |  |  | $ | — |  |  | — | %
Perpetual preferred stocks | — |  |  | 41 |  |  | 100 | % |  | (1 | ) |  | 13 |  |  | 93 | %
Total equity securities | $ | (22 | ) |  | $ | 158 |  |  | 88 | % |  | $ | (1 | ) |  | $ | 13 |  |  | 93 | %

At June 30, 2018, the gross unrealized losses on fixed maturities of $438 million relate to 2,043 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 93% of the gross unrealized loss and 96% of the fair value.
AFG analyzes its MBS securities for other-than-temporary impairment each quarter based upon expected future cash flows. Management estimates expected future cash flows based upon its knowledge of the MBS market, cash flow projections (which reflect loan to collateral values, subordination, vintage and geographic concentration) received from independent sources, implied cash flows inherent in security ratings and analysis of historical payment data. In the first six months of 2018, AFG recorded less than $1 million in other-than-temporary impairment charges related to its residential MBS.
In the first six months of 2018, AFG recorded less than $1 million in other-than-temporary impairment charges related to corporate bonds and other fixed maturities.
Management believes AFG will recover its cost basis in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2018. As discussed in Note A — “Accounting Policies — Investments,” effective January 1, 2018, all equity securities previously classified as “available for sale” are required to be carried at fair value through net earnings instead of accumulated other comprehensive income and therefore are no longer evaluated for other-than-temporary impairment.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
A progression of the credit portion of other-than-temporary impairments on fixed maturity securities for which the non-credit portion of an impairment has been recognized in other comprehensive income is shown below (in millions):

| 2018 |  | 2017
Balance at March 31 | $ | 144 |  |  | $ | 146 |
Additional credit impairments on: |  |  |
Previously impaired securities | — |  |  | 1 |
Securities without prior impairments | 1 |  |  | — |
Reductions due to sales or redemptions | (1 | ) |  | (2 | )
Balance at June 30 | $ | 144 |  |  | $ | 145 |
Balance at January 1 | $ | 145 |  |  | $ | 153 |
Additional credit impairments on: |  |  |
Previously impaired securities | — |  |  | 1 |
Securities without prior impairments | 1 |  |  | — |
Reductions due to sales or redemptions | (2 | ) |  | (9 | )
Balance at June 30 | $ | 144 |  |  | $ | 145 |

The table below sets forth the scheduled maturities of available for sale fixed maturities as of June 30, 2018 (dollars in millions). Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.

| Amortized |  | Fair Value
Cost |  | Amount |  | %
Maturity |  |  |  |  |
One year or less | $ | 994 |  |  | $ | 1,003 |  |  | 3 | %
After one year through five years | 7,703 |  |  | 7,764 |  |  | 20 | %
After five years through ten years | 13,386 |  |  | 13,285 |  |  | 33 | %
After ten years | 4,828 |  |  | 4,841 |  |  | 12 | %
| 26,911 |  |  | 26,893 |  |  | 68 | %
ABS (average life of approximately 4-1/2 years) | 8,849 |  |  | 8,935 |  |  | 22 | %
MBS (average life of approximately 4-1/2 years) | 3,484 |  |  | 3,820 |  |  | 10 | %
Total | $ | 39,244 |  |  | $ | 39,648 |  |  | 100 | %

Certain risks are inherent in fixed maturity securities, including loss upon default, price volatility in reaction to changes in interest rates, and general market factors and risks associated with reinvestment of proceeds due to prepayments or redemptions in a period of declining interest rates.
There were no investments in individual issuers that exceeded 10% of shareholders’ equity at June 30, 2018 or December 31, 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
Net Unrealized Gain on Marketable Securities In addition to adjusting fixed maturity securities and equity securities classified as “available for sale” to fair value, GAAP requires that deferred policy acquisition costs and certain other balance sheet amounts related to annuity, long-term care and life businesses be adjusted to the extent that unrealized gains and losses from securities would result in adjustments to those balances had the unrealized gains or losses actually been realized. The following table shows (in millions) the components of the net unrealized gain on securities that is included in AOCI in AFG’s Balance Sheet.

| Pretax |  | Deferred Tax |  | Net
June 30, 2018 |  |  |  |  |
Net unrealized gain on: |  |  |  |  |
Fixed maturities — annuity segment (a) | $ | 310 |  |  | $ | (65 | ) |  | $ | 245 |
Fixed maturities — all other | 94 |  |  | (20 | ) |  | 74 |
Total fixed maturities | 404 |  |  | (85 | ) |  | 319 |
Deferred policy acquisition costs — annuity segment | (124 | ) |  | 26 |  |  | (98 | )
Annuity benefits accumulated | (41 | ) |  | 9 |  |  | (32 | )
Unearned revenue | 3 |  |  | (1 | ) |  | 2 |
Total net unrealized gain on marketable securities | $ | 242 |  |  | $ | (51 | ) |  | $ | 191 |
December 31, 2017 |  |  |  |  |
Net unrealized gain on: |  |  |  |  |
Fixed maturities — annuity segment (a) | $ | 1,082 |  |  | $ | (227 | ) |  | $ | 855 |
Fixed maturities — all other | 259 |  |  | (55 | ) |  | 204 |
Total fixed maturities | 1,341 |  |  | (282 | ) |  | 1,059 |
Equity securities (b) | 279 |  |  | (58 | ) |  | 221 |
Total investments | 1,620 |  |  | (340 | ) |  | 1,280 |
Deferred policy acquisition costs — annuity segment | (433 | ) |  | 91 |  |  | (342 | )
Annuity benefits accumulated | (137 | ) |  | 29 |  |  | (108 | )
Unearned revenue | 13 |  |  | (3 | ) |  | 10 |
Total net unrealized gain on marketable securities | $ | 1,063 |  |  | $ | (223 | ) |  | $ | 840 |

(a) | Net unrealized gains on fixed maturity investments supporting AFG’s annuity benefits accumulated.

(b) | As discussed in Note A — “Accounting Policies — Investments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings.

Net Investment Income The following table shows (in millions) investment income earned and investment expenses incurred.

| Three months ended June 30, |  | Six months ended June 30,
| 2018 |  | 2017 |  | 2018 |  | 2017
Investment income: |  |  |  |  |  |  |
Fixed maturities | $ | 431 |  |  | $ | 397 |  |  | $ | 843 |  |  | $ | 786 |
Equity securities: |  |  |  |  |  |  |
Dividends | 20 |  |  | 17 |  |  | 40 |  |  | 36 |
Change in fair value (*) | 15 |  |  | 2 |  |  | 14 |  |  | 4 |
Equity in earnings of partnerships and similar investments | 41 |  |  | 21 |  |  | 87 |  |  | 31 |
Other | 28 |  |  | 27 |  |  | 51 |  |  | 47 |
Gross investment income | 535 |  |  | 464 |  |  | 1,035 |  |  | 904 |
Investment expenses | (5 | ) |  | (4 | ) |  | (10 | ) |  | (9 | )
Net investment income | $ | 530 |  |  | $ | 460 |  |  | $ | 1,025 |  |  | $ | 895 |

(*) | As discussed in Note A — “Accounting Policies — Investments,” AFG adopted guidance in January 2018 that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. Although the change in the fair value of the majority of AFG’s equity securities is recorded in realized gains (losses) on securities, AFG records holding gains and losses in net investment income on equity

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
securities classified as “trading” under the previous guidance and on a small portfolio of limited partnership and similar investments that do not qualify for the equity method of accounting.
Realized gains (losses) and changes in unrealized appreciation (depreciation) related to fixed maturity and equity security investments are summarized as follows (in millions):

| Three months ended June 30, 2018 |  | Three months ended June 30, 2017
| Realized gains (losses) |  |  |  | Realized gains (losses) |  |
| Before Impairments |  | Impairments |  | Total |  | Change in Unrealized |  | Before Impairments |  | Impairments |  | Total |  | Change in Unrealized
Fixed maturities | $ | 4 |  |  | $ | — |  |  | $ | 4 |  |  | $ | (338 | ) |  | $ | 11 |  |  | $ | (1 | ) |  | $ | 10 |  |  | $ | 262 |
Equity securities | 23 |  |  | — |  |  | 23 |  |  | — |  |  | 8 |  |  | (11 | ) |  | (3 | ) |  | 20 |
Mortgage loans and other investments | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Other (*) | 4 |  |  | — |  |  | 4 |  |  | 147 |  |  | (2 | ) |  | 3 |  |  | 1 |  |  | (112 | )
Total pretax | 31 |  |  | — |  |  | 31 |  |  | (191 | ) |  | 17 |  |  | (9 | ) |  | 8 |  |  | 170 |
Tax effects | (6 | ) |  | — |  |  | (6 | ) |  | 40 |  |  | (6 | ) |  | 3 |  |  | (3 | ) |  | (60 | )
Net of tax | $ | 25 |  |  | $ | — |  |  | $ | 25 |  |  | $ | (151 | ) |  | $ | 11 |  |  | $ | (6 | ) |  | $ | 5 |  |  | $ | 110 |
| Six months ended June 30, 2018 |  | Six months ended June 30, 2017
| Realized gains (losses) |  |  |  | Realized gains (losses) |  |
| Before Impairments |  | Impairments |  | Total |  | Change in Unrealized |  | Before Impairments |  | Impairments |  | Total |  | Change in Unrealized
Fixed maturities | $ | 3 |  |  | $ | (1 | ) |  | $ | 2 |  |  | $ | (937 | ) |  | $ | 16 |  |  | $ | (1 | ) |  | $ | 15 |  |  | $ | 464 |
Equity securities | (72 | ) |  | — |  |  | (72 | ) |  | — |  |  | 10 |  |  | (20 | ) |  | (10 | ) |  | 92 |
Mortgage loans and other investments | — |  |  | — |  |  | — |  |  | — |  |  | 3 |  |  | — |  |  | 3 |  |  | — |
Other (*) | 8 |  |  | — |  |  | 8 |  |  | 395 |  |  | (3 | ) |  | 6 |  |  | 3 |  |  | (195 | )
Total pretax | (61 | ) |  | (1 | ) |  | (62 | ) |  | (542 | ) |  | 26 |  |  | (15 | ) |  | 11 |  |  | 361 |
Tax effects | 13 |  |  | — |  |  | 13 |  |  | 114 |  |  | (9 | ) |  | 5 |  |  | (4 | ) |  | (126 | )
Net of tax | $ | (48 | ) |  | $ | (1 | ) |  | $ | (49 | ) |  | $ | (428 | ) |  | $ | 17 |  |  | $ | (10 | ) |  | $ | 7 |  |  | $ | 235 |

(*) | Primarily adjustments to deferred policy acquisition costs and reserves related to the annuity business.

As discussed in Note A — “Accounting Policies — Investments,” effective January 1, 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. AFG recorded net holding gains (losses) on equity securities during the second quarter and first six months of 2018 on securities that were still owned at June 30, 2018 as follows (in millions):

| Three months ended |  | Six months ended
| June 30, 2018 |  | June 30, 2018
Included in realized gains (losses) | $ | 16 |  |  | $ | (71 | )
Included in net investment income | 15 |  |  | 14 |
| $ | 31 |  |  | $ | (57 | )

Gross realized gains and losses (excluding impairment write-downs and mark-to-market of derivatives) on available for sale fixed maturity investment transactions consisted of the following (in millions):

| Six months ended June 30,
2018 |  | 2017
Fixed maturities: |  |  |
Gross gains | $ | 16 |  |  | $ | 21 |
Gross losses | (8 | ) |  | (2 | )

In the first six months of 2017, AFG recorded gross gains of $15 million and gross losses of $5 million on available for sale equity securities.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
E. Derivatives
As discussed under “Derivatives” in Note A — “Accounting Policies,” AFG uses derivatives in certain areas of its operations.
Derivatives That Do Not Qualify for Hedge Accounting The following derivatives that do not qualify for hedge accounting under GAAP are included in AFG’s Balance Sheet at fair value (in millions):

|  |  |  | June 30, 2018 |  | December 31, 2017
Derivative |  | Balance Sheet Line |  | Asset |  | Liability |  | Asset |  | Liability
MBS with embedded derivatives |  | Fixed maturities |  | $ | 115 |  |  | $ | — |  |  | $ | 105 |  |  | $ | — |
Public company warrants |  | Equity securities |  | 3 |  |  | — |  |  | 4 |  |  | — |
Fixed-indexed and variable-indexed annuities (embedded derivative) |  | Annuity benefits accumulated |  | — |  |  | 2,776 |  |  | — |  |  | 2,542 |
Equity index call options |  | Equity index call options |  | 615 |  |  | — |  |  | 701 |  |  | — |
Equity index put options |  | Other liabilities |  | — |  |  | — |  |  | — |  |  | — |
Reinsurance contracts (embedded derivative) |  | Other liabilities |  | — |  |  | 2 |  |  | — |  |  | 4 |
|  |  |  | $ | 733 |  |  | $ | 2,778 |  |  | $ | 810 |  |  | $ | 2,546 |

The MBS with embedded derivatives consist primarily of interest-only MBS with interest rates that float inversely with short-term rates. AFG records the entire change in the fair value of these securities in earnings. These investments are part of AFG’s overall investment strategy and represent a small component of AFG’s overall investment portfolio.
Warrants to purchase shares of publicly traded companies, which represent a small component of AFG’s overall investment portfolio, are considered to be derivatives that are required to be carried at fair value through earnings.
AFG’s fixed-indexed and variable-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG receives collateral from certain counterparties to support its purchased call option assets (net of collateral required under put option contracts with the same counterparties). This collateral ($353 million at June 30, 2018 and $389 million at December 31, 2017) is included in other assets in AFG’s Balance Sheet with an offsetting liability to return the collateral, which is included in other liabilities. AFG’s strategy is designed so that the change in the fair value of the call and put options will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities and the related call and put options are considered derivatives. Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products.
As discussed under “Reinsurance” in Note A, AFG has a reinsurance contract that is considered to contain an embedded derivative.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
The following table summarizes the gains (losses) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for the second quarter and first six months of 2018 and 2017 (in millions):

|  |  |  | Three months ended June 30, |  | Six months ended June 30,
Derivative |  | Statement of Earnings Line |  | 2018 |  | 2017 |  | 2018 |  | 2017
MBS with embedded derivatives |  | Realized gains (losses) on securities |  | $ | (1 | ) |  | $ | (3 | ) |  | $ | (5 | ) |  | $ | (3 | )
Public company warrants |  | Realized gains (losses) on securities |  | — |  |  | — |  |  | (1 | ) |  | — |
Fixed-indexed and variable-indexed annuities (embedded derivative) (*) |  | Annuity benefits |  | (126 | ) |  | (112 | ) |  | (63 | ) |  | (259 | )
Equity index call options |  | Annuity benefits |  | 90 |  |  | 81 |  |  | 52 |  |  | 222 |
Equity index put options |  | Annuity benefits |  | — |  |  | — |  |  | — |  |  | — |
Reinsurance contract (embedded derivative) |  | Net investment income |  | 1 |  |  | (1 | ) |  | 2 |  |  | (2 | )
|  |  |  | $ | (36 | ) |  | $ | (35 | ) |  | $ | (15 | ) |  | $ | (42 | )

(*) | The change in fair value of the embedded derivative includes losses related to unlocking of actuarial assumptions of $44 million in both the second quarter and first six months of 2018.

Derivatives Designated and Qualifying as Cash Flow Hedges As of June 30, 2018, AFG has entered into eleven interest rate swaps that are designated and qualify as highly effective cash flow hedges to mitigate interest rate risk related to certain floating-rate securities included in AFG’s portfolio of fixed maturity securities. The purpose of each of these swaps is to effectively convert a portion of AFG’s floating-rate fixed maturity securities to fixed rates by offsetting the variability in cash flows attributable to changes in short-term LIBOR.
Under the terms of the swaps, AFG receives fixed-rate interest payments in exchange for variable interest payments based on short-term LIBOR. The notional amounts of the interest rate swaps generally decline over each swap’s respective life (the swaps expire between August 2019 and June 2030) in anticipation of the expected decline in AFG’s portfolio of fixed maturity securities with floating interest rates based on short-term LIBOR. The total outstanding notional amount of AFG’s interest rate swaps was $1.64 billion at June 30, 2018 compared to $1.58 billion at December 31, 2017, reflecting a new swap with an aggregate notional amount at issuance of $130 million entered into in the first quarter of 2018, partially offset by the scheduled amortization discussed above. The fair value of the effective portion of the interest rate swaps in an asset position and included in other assets was zero at June 30, 2018 and less than $1 million at December 31, 2017. The fair value of the effective portion of the interest rate swaps in a liability position and included in other liabilities was $70 million at June 30, 2018 and $31 million at December 31, 2017. The net unrealized gain or loss on cash flow hedges is included in AOCI, net of DPAC and deferred taxes. Amounts reclassified from AOCI (before DPAC and taxes) to net investment income were losses of $2 million and $1 million during the second quarter and first six months of 2018 as compared to income of $1 million and $3 million in the second quarter and first six months of 2017, respectively. There was no ineffectiveness recorded in net earnings during these periods. A collateral receivable supporting these swaps of $116 million at June 30, 2018 and $70 million at December 31, 2017 is included in other assets in AFG’s Balance Sheet.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
F. Deferred Policy Acquisition Costs
A progression of deferred policy acquisition costs is presented below (in millions):

| P&C |  |  | Annuity and Other |  |  |
| Deferred |  |  | Deferred |  | Sales |  |  |  |  |  |  |  |  |  |  | Consolidated
| Costs |  |  | Costs |  | Inducements |  | PVFP |  | Subtotal |  | Unrealized (*) |  | Total |  |  | Total
Balance at March 31, 2018 | $ | 279 |  |  |  | $ | 1,208 |  |  | $ | 97 |  |  | $ | 47 |  |  | $ | 1,352 |  |  | $ | (214 | ) |  | $ | 1,138 |  |  |  | $ | 1,417 |
Additions | 181 |  |  |  | 70 |  |  | 1 |  |  | — |  |  | 71 |  |  | — |  |  | 71 |  |  |  | 252 |
Amortization: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Periodic amortization | (160 | ) |  |  | (66 | ) |  | (5 | ) |  | (2 | ) |  | (73 | ) |  | — |  |  | (73 | ) |  |  | (233 | )
Annuity unlocking | — |  |  |  | 28 |  |  | 1 |  |  | — |  |  | 29 |  |  | — |  |  | 29 |  |  |  | 29 |
Included in realized gains | — |  |  |  | 3 |  |  | — |  |  | — |  |  | 3 |  |  | — |  |  | 3 |  |  |  | 3 |
Foreign currency translation | (2 | ) |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  |  | (2 | )
Change in unrealized | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 116 |  |  | 116 |  |  |  | 116 |
Balance at June 30, 2018 | $ | 298 |  |  |  | $ | 1,243 |  |  | $ | 94 |  |  | $ | 45 |  |  | $ | 1,382 |  |  | $ | (98 | ) |  | $ | 1,284 |  |  |  | $ | 1,582 |
Balance at March 31, 2017 | $ | 243 |  |  |  | $ | 1,137 |  |  | $ | 105 |  |  | $ | 44 |  |  | $ | 1,286 |  |  | $ | (324 | ) |  | $ | 962 |  |  |  | $ | 1,205 |
Additions | 151 |  |  |  | 66 |  |  | 1 |  |  | — |  |  | 67 |  |  | — |  |  | 67 |  |  |  | 218 |
Amortization: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Periodic amortization | (136 | ) |  |  | (36 | ) |  | (4 | ) |  | (2 | ) |  | (42 | ) |  | — |  |  | (42 | ) |  |  | (178 | )
Included in realized gains | — |  |  |  | — |  |  | 1 |  |  | — |  |  | 1 |  |  | — |  |  | 1 |  |  |  | 1 |
Foreign currency translation | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  |  | — |
Change in unrealized | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (90 | ) |  | (90 | ) |  |  | (90 | )
Balance at June 30, 2017 | $ | 258 |  |  |  | $ | 1,167 |  |  | $ | 103 |  |  | $ | 42 |  |  | $ | 1,312 |  |  | $ | (414 | ) |  | $ | 898 |  |  |  | $ | 1,156 |
Balance at December 31, 2017 | $ | 270 |  |  |  | $ | 1,217 |  |  | $ | 102 |  |  | $ | 49 |  |  | $ | 1,368 |  |  | $ | (422 | ) |  | $ | 946 |  |  |  | $ | 1,216 |
Additions | 343 |  |  |  | 127 |  |  | 1 |  |  | — |  |  | 128 |  |  | — |  |  | 128 |  |  |  | 471 |
Amortization: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Periodic amortization | (314 | ) |  |  | (135 | ) |  | (10 | ) |  | (4 | ) |  | (149 | ) |  | — |  |  | (149 | ) |  |  | (463 | )
Annuity unlocking | — |  |  |  | 28 |  |  | 1 |  |  | — |  |  | 29 |  |  | — |  |  | 29 |  |  |  | 29 |
Included in realized gains | — |  |  |  | 6 |  |  | — |  |  | — |  |  | 6 |  |  | — |  |  | 6 |  |  |  | 6 |
Foreign currency translation | (1 | ) |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  |  | (1 | )
Change in unrealized | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 324 |  |  | 324 |  |  |  | 324 |
Balance at June 30, 2018 | $ | 298 |  |  |  | $ | 1,243 |  |  | $ | 94 |  |  | $ | 45 |  |  | $ | 1,382 |  |  | $ | (98 | ) |  | $ | 1,284 |  |  |  | $ | 1,582 |
Balance at December 31, 2016 | $ | 238 |  |  |  | $ | 1,110 |  |  | $ | 110 |  |  | $ | 46 |  |  | $ | 1,266 |  |  | $ | (265 | ) |  | $ | 1,001 |  |  |  | $ | 1,239 |
Additions | 290 |  |  |  | 133 |  |  | 2 |  |  | — |  |  | 135 |  |  | — |  |  | 135 |  |  |  | 425 |
Amortization: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Periodic amortization | (271 | ) |  |  | (78 | ) |  | (10 | ) |  | (4 | ) |  | (92 | ) |  | — |  |  | (92 | ) |  |  | (363 | )
Included in realized gains | — |  |  |  | 2 |  |  | 1 |  |  | — |  |  | 3 |  |  | — |  |  | 3 |  |  |  | 3 |
Foreign currency translation | 1 |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  |  | 1 |
Change in unrealized | — |  |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (149 | ) |  | (149 | ) |  |  | (149 | )
Balance at June 30, 2017 | $ | 258 |  |  |  | $ | 1,167 |  |  | $ | 103 |  |  | $ | 42 |  |  | $ | 1,312 |  |  | $ | (414 | ) |  | $ | 898 |  |  |  | $ | 1,156 |

(*) | Unrealized adjustments to DPAC includes net unrealized gains/losses on securities and net unrealized gains/losses on cash flow hedges.

The present value of future profits (“PVFP”) amounts in the table above are net of $145 million and $141 million of accumulated amortization at June 30, 2018 and December 31, 2017, respectively.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
G. Managed Investment Entities
AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 60.9% of the most subordinate debt tranche of sixteen collateralized loan obligation entities or “CLOs,” which are considered variable interest entities. AFG’s subsidiaries also own portions of the senior debt tranches of certain of these CLOs. Upon formation between 2004 and 2018, these entities issued securities in various senior and subordinate classes and invested the proceeds primarily in secured bank loans, which serve as collateral for the debt securities issued by each particular CLO. None of the collateral was purchased from AFG. AFG’s investments in the subordinate debt tranches of these entities receive residual income from the CLOs only after the CLOs pay expenses (including management fees to AFG) and interest on and returns of capital to senior levels of debt securities. There are no contractual requirements for AFG to provide additional funding for these entities. AFG has not provided and does not intend to provide any financial support to these entities.
AFG’s maximum exposure to economic loss on its CLOs is limited to its investment in the CLOs, which had an aggregate fair value of $192 million (including $134 million invested in the most subordinate tranches) at June 30, 2018, and $215 million at December 31, 2017.
In March 2018 and March 2017, AFG formed new CLOs, which issued $463 million and $408 million face amount of liabilities, respectively (including $31 million and $24 million face amount purchased by subsidiaries of AFG). During the first six months of 2017, AFG subsidiaries also purchased $29 million face amount of senior debt and subordinate tranches of existing CLOs for $29 million. During the first six months of 2018 and 2017, AFG subsidiaries received $45 million and $64 million, respectively, in sale and redemption proceeds from its CLO investments. During both the first six months of 2018 and 2017, one AFG CLO was substantially liquidated, as permitted by the CLO indentures.
The revenues and expenses of the CLOs are separately identified in AFG’s Statement of Earnings, after the elimination of management fees and earnings attributable to shareholders of AFG as measured by the change in the fair value of AFG’s investments in the CLOs. Selected financial information related to the CLOs is shown below (in millions):

| Three months ended June 30, |  | Six months ended June 30,
2018 |  | 2017 |  | 2018 |  | 2017
Investment in CLO tranches at end of period | $ | 192 |  |  | $ | 188 |  |  | $ | 192 |  |  | $ | 188 |
Gains (losses) on change in fair value of assets/liabilities (a): |  |  |  |  |  |  |
Assets | (29 | ) |  | (9 | ) |  | (15 | ) |  | (4 | )
Liabilities | 27 |  |  | 20 |  |  | 10 |  |  | 15 |
Management fees paid to AFG | 4 |  |  | 5 |  |  | 8 |  |  | 9 |
CLO earnings (losses) attributable to AFG shareholders (b) | 4 |  |  | 5 |  |  | 7 |  |  | 11 |

(a) | Included in revenues in AFG’s Statement of Earnings.

(b) | Included in earnings before income taxes in AFG’s Statement of Earnings.

The aggregate unpaid principal balance of the CLOs’ fixed maturity investments exceeded the fair value of the investments by $62 million and $55 million at June 30, 2018 and December 31, 2017, respectively. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $167 million and $118 million at those dates. The CLO assets include loans with an aggregate fair value of $1 million at both June 30, 2018 and December 31, 2017, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of $8 million at both those dates).
H. Goodwill and Other Intangibles
There were no changes in the goodwill balance of $199 million during the first six months of 2018. Included in other assets in AFG’s Balance Sheet is $34 million at June 30, 2018 and $26 million at December 31, 2017 in amortizable intangible assets related to property and casualty insurance acquisitions. These amounts are net of accumulated amortization of $34 million and $30 million, respectively. Amortization of intangibles was $2 million in both the second quarters of 2018 and 2017 and $4 million in both the first six months of 2018 and 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
I. Long-Term Debt
Long-term debt consisted of the following (in millions):

| June 30, 2018 |  | December 31, 2017
| Principal |  | Discount and Issue Costs |  | Carrying Value |  | Principal |  | Discount and Issue Costs |  | Carrying Value
Direct Senior Obligations of AFG: |  |  |  |  |  |  |  |  |  |  |
4.50% Senior Notes due June 2047 | $ | 590 |  |  | $ | (2 | ) |  | $ | 588 |  |  | $ | 590 |  |  | $ | (2 | ) |  | $ | 588 |
3.50% Senior Notes due August 2026 | 425 |  |  | (5 | ) |  | 420 |  |  | 425 |  |  | (5 | ) |  | 420 |
Other | 3 |  |  | — |  |  | 3 |  |  | 3 |  |  | — |  |  | 3 |
| 1,018 |  |  | (7 | ) |  | 1,011 |  |  | 1,018 |  |  | (7 | ) |  | 1,011 |
Direct Subordinated Obligations of AFG: |  |  |  |  |  |  |  |  |  |  |
6-1/4% Subordinated Debentures due September 2054 | 150 |  |  | (5 | ) |  | 145 |  |  | 150 |  |  | (5 | ) |  | 145 |
6% Subordinated Debentures due November 2055 | 150 |  |  | (5 | ) |  | 145 |  |  | 150 |  |  | (5 | ) |  | 145 |
| 300 |  |  | (10 | ) |  | 290 |  |  | 300 |  |  | (10 | ) |  | 290 |
| $ | 1,318 |  |  | $ | (17 | ) |  | $ | 1,301 |  |  | $ | 1,318 |  |  | $ | (17 | ) |  | $ | 1,301 |

AFG has no scheduled principal payments on its long-term debt for the balance of 2018 or in the subsequent five years.
AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. No amounts were borrowed under this facility at June 30, 2018 or December 31, 2017.
J. Redeemable Noncontrolling Interests
Neon Lloyd’s Business On December 29, 2017, AFG completed the sale of an indirect noncontrolling interest in Neon, its United Kingdom-based Lloyd’s insurer, to certain Neon executives for cash equal to the fair value of the interest sold as determined by a third-party valuation firm. This noncontrolling interest is redeemable at the option of the holder and is presented separately in the mezzanine section of the balance sheet, as discussed in Note A — “Accounting Policies — Noncontrolling Interests.”
K. Shareholders’ Equity
AFG is authorized to issue 12.5 million shares of Voting Preferred Stock and 12.5 million shares of Nonvoting Preferred Stock, each without par value.
Accumulated Other Comprehensive Income, Net of Tax (“AOCI”) Comprehensive income is defined as all changes in shareholders’ equity except those arising from transactions with shareholders. Comprehensive income includes net earnings and other comprehensive income, which consists primarily of changes in net unrealized gains or losses on available for sale securities.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
The progression of the components of accumulated other comprehensive income follows (in millions):

|  |  | Other Comprehensive Income (Loss) |  |  |  |
| AOCI Beginning Balance |  | Pretax |  | Tax |  | Net of tax |  | Attributable to noncontrolling interests |  | Attributable to shareholders |  | Other (c) |  | AOCI Ending Balance
Quarter ended June 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net unrealized gains (losses) on securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding losses on securities arising during the period |  |  | $ | (187 | ) |  | $ | 39 |  |  | $ | (148 | ) |  | $ | — |  |  | $ | (148 | ) |  |  |  |  |
Reclassification adjustment for realized (gains) losses included in net earnings (a) |  |  | (4 | ) |  | 1 |  |  | (3 | ) |  | — |  |  | (3 | ) |  |  |  |  |
Total net unrealized gains (losses) on securities (b) | $ | 342 |  |  | (191 | ) |  | 40 |  |  | (151 | ) |  | — |  |  | (151 | ) |  | $ | — |  |  | $ | 191 |
Net unrealized losses on cash flow hedges | (24 | ) |  | (4 | ) |  | 1 |  |  | (3 | ) |  | — |  |  | (3 | ) |  | — |  |  | (27 | )
Foreign currency translation adjustments | (5 | ) |  | (4 | ) |  | — |  |  | (4 | ) |  | — |  |  | (4 | ) |  | — |  |  | (9 | )
Pension and other postretirement plans adjustments | (8 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (8 | )
Total | $ | 305 |  |  | $ | (199 | ) |  | $ | 41 |  |  | $ | (158 | ) |  | $ | — |  |  | $ | (158 | ) |  | $ | — |  |  | $ | 147 |
Quarter ended June 30, 2017 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net unrealized gains on securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding gains on securities arising during the period |  |  | $ | 178 |  |  | $ | (63 | ) |  | $ | 115 |  |  | $ | — |  |  | $ | 115 |  |  |  |  |
Reclassification adjustment for realized (gains) losses included in net earnings (a) |  |  | (8 | ) |  | 3 |  |  | (5 | ) |  | — |  |  | (5 | ) |  |  |  |
Total net unrealized gains on securities | $ | 529 |  |  | 170 |  |  | (60 | ) |  | 110 |  |  | — |  |  | 110 |  |  | $ | — |  |  | $ | 639 |
Net unrealized gains (losses) on cash flow hedges | (8 | ) |  | 4 |  |  | (2 | ) |  | 2 |  |  | — |  |  | 2 |  |  | — |  |  | (6 | )
Foreign currency translation adjustments | (15 | ) |  | 3 |  |  | 1 |  |  | 4 |  |  | — |  |  | 4 |  |  | — |  |  | (11 | )
Pension and other postretirement plans adjustments | (7 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (7 | )
Total | $ | 499 |  |  | $ | 177 |  |  | $ | (61 | ) |  | $ | 116 |  |  | $ | — |  |  | $ | 116 |  |  | $ | — |  |  | $ | 615 |
Six months ended June 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net unrealized gains (losses) on securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding losses on securities arising during the period |  |  | $ | (540 | ) |  | $ | 113 |  |  | $ | (427 | ) |  | $ | — |  |  | $ | (427 | ) |  |  |  |  |
Reclassification adjustment for realized (gains) losses included in net earnings (a) |  |  | (2 | ) |  | 1 |  |  | (1 | ) |  | — |  |  | (1 | ) |  |  |  |  |
Total net unrealized gains (losses) on securities (b) | $ | 840 |  |  | (542 | ) |  | 114 |  |  | (428 | ) |  | — |  |  | (428 | ) |  | $ | (221 | ) |  | $ | 191 |
Net unrealized losses on cash flow hedges | (13 | ) |  | (18 | ) |  | 4 |  |  | (14 | ) |  | — |  |  | (14 | ) |  | — |  |  | (27 | )
Foreign currency translation adjustments | (6 | ) |  | (2 | ) |  | (1 | ) |  | (3 | ) |  | — |  |  | (3 | ) |  | — |  |  | (9 | )
Pension and other postretirement plans adjustments | (8 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (8 | )
Total | $ | 813 |  |  | $ | (562 | ) |  | $ | 117 |  |  | $ | (445 | ) |  | $ | — |  |  | $ | (445 | ) |  | $ | (221 | ) |  | $ | 147 |
Six months ended June 30, 2017 |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Net unrealized gains on securities: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Unrealized holding gains on securities arising during the period |  |  | $ | 369 |  |  | $ | (129 | ) |  | $ | 240 |  |  | $ | — |  |  | $ | 240 |  |  |  |  |
Reclassification adjustment for realized (gains) losses included in net earnings (a) |  |  | (8 | ) |  | 3 |  |  | (5 | ) |  | — |  |  | (5 | ) |  |  |  |
Total net unrealized gains on securities | $ | 404 |  |  | 361 |  |  | (126 | ) |  | 235 |  |  | — |  |  | 235 |  |  | $ | — |  |  | $ | 639 |
Net unrealized gains (losses) on cash flow hedges | (7 | ) |  | 2 |  |  | (1 | ) |  | 1 |  |  | — |  |  | 1 |  |  | — |  |  | (6 | )
Foreign currency translation adjustments | (15 | ) |  | 3 |  |  | 1 |  |  | 4 |  |  | — |  |  | 4 |  |  | — |  |  | (11 | )
Pension and other postretirement plans adjustments | (7 | ) |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (7 | )
Total | $ | 375 |  |  | $ | 366 |  |  | $ | (126 | ) |  | $ | 240 |  |  | $ | — |  |  | $ | 240 |  |  | $ | — |  |  | $ | 615 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(a)The reclassification adjustment out of net unrealized gains (losses) on securities affected the following lines in AFG’s Statement of Earnings:

| OCI component |  | Affected line in the statement of earnings |
| Pretax |  | Realized gains (losses) on securities |
| Tax |  | Provision for income taxes |

(b) | Includes net unrealized gains of $67 million at June 30, 2018 and $68 million at both March 31, 2018 and December 31, 2017 related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.

(c) | On January 1, 2018, AFG adopted new guidance that requires all equity securities other than those accounted for under the equity method to be reported at fair value with holding gains and losses recognized in net earnings. At the date of adoption, the $221 million net unrealized gain on equity securities classified as available for sale (with unrealized holding gains and losses reported in AOCI) under the prior guidance was reclassified from AOCI to retained earnings as the cumulative effect of an accounting change.

Stock Incentive Plans Under AFG’s stock incentive plans, employees of AFG and its subsidiaries are eligible to receive equity awards in the form of stock options, stock appreciation rights, restricted stock awards, restricted stock units and stock awards. In the first six months of 2018, AFG issued 200,625 shares of restricted Common Stock (fair value of $112.86 per share) under the Stock Incentive Plan. In addition, AFG issued 45,804 shares of Common Stock (fair value of $115.49 per share) in the first quarter of 2018 under the Equity Bonus Plan. AFG did not grant any stock options in the first six months of 2018.
Total compensation expense related to stock incentive plans of AFG and its subsidiaries was $6 million in both the second quarters of 2018 and 2017 and $11 million and $17 million in the first six months of 2018 and 2017, respectively.
L. Income Taxes
The following is a reconciliation of income taxes at the statutory rate (21% in 2018 and 35% in 2017) to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):

| Three months ended June 30, |  | Six months ended June 30,
| 2018 |  | 2017 |  | 2018 |  | 2017
| Amount |  | % of EBT |  | Amount |  | % of EBT |  | Amount |  | % of EBT |  | Amount |  | % of EBT
Earnings before income taxes (“EBT”) | $ | 260 |  |  |  |  | $ | 205 |  |  |  |  | $ | 434 |  |  |  |  | $ | 428 |  |  |
Income taxes at statutory rate | $ | 54 |  |  | 21 | % |  | $ | 72 |  |  | 35 | % |  | $ | 91 |  |  | 21 | % |  | $ | 150 |  |  | 35 | %
Effect of: |  |  |  |  |  |  |  |  |  |  |  |  |  |  |
Stock-based compensation | (2 | ) |  | (1 | %) |  | (7 | ) |  | (3 | %) |  | (7 | ) |  | (2 | %) |  | (13 | ) |  | (3 | %)
Tax exempt interest | (4 | ) |  | (2 | %) |  | (6 | ) |  | (3 | %) |  | (7 | ) |  | (2 | %) |  | (12 | ) |  | (3 | %)
Dividends received deduction | (1 | ) |  | — | % |  | (2 | ) |  | (1 | %) |  | (2 | ) |  | — | % |  | (4 | ) |  | (1 | %)
Employee Stock Ownership Plan dividends paid deduction | (1 | ) |  | — | % |  | (2 | ) |  | (1 | %) |  | (1 | ) |  | — | % |  | (2 | ) |  | — | %
Foreign operations | — |  |  | — | % |  | — |  |  | — | % |  | 3 |  |  | 1 | % |  | 6 |  |  | 1 | %
Nondeductible expenses | 2 |  |  | 1 | % |  | 1 |  |  | — | % |  | 4 |  |  | 1 | % |  | 3 |  |  | 1 | %
Change in valuation allowance | 2 |  |  | 1 | % |  | 2 |  |  | 1 | % |  | 2 |  |  | — | % |  | — |  |  | — | %
Other | 2 |  |  | — | % |  | 2 |  |  | 1 | % |  | 2 |  |  | 1 | % |  | — |  |  | — | %
Provision for income taxes as shown in the statement of earnings | $ | 52 |  |  | 20 | % |  | $ | 60 |  |  | 29 | % |  | $ | 85 |  |  | 20 | % |  | $ | 128 |  |  | 30 | %

The Tax Cuts and Jobs Act of 2017 (“TCJA”), which was enacted on December 22, 2017, lowered the U.S corporate tax rate to 21% and made other widespread changes to the U.S. tax code effective in 2018. Because the TCJA was enacted in December 2017, AFG recorded the $83 million decrease in its net deferred tax asset resulting from the changes in the tax code (primarily the lower corporate tax rate applicable to 2018 and future years) in the fourth quarter of 2017.
The TCJA is subject to further clarification and interpretation by the U.S. Treasury Department and the Internal Revenue Service. For example, the TCJA changes the way that companies calculate their insurance claims and reserves for tax purposes,
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
including revaluing those tax basis liabilities as of January 1, 2018, based on a methodology and discount factors that have not been published. The resulting transitional deferred tax liability (taxes payable over eight years under the TCJA) and offsetting increase in AFG’s insurance claims and reserves deferred tax assets, were recorded at December 31, 2017 using reasonable estimates based on available information and should be considered provisional in accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 118 (“SAB 118”). Because the established transition liability was completely offset by an increase in related deferred tax assets, any adjustment to the provisional amount will not impact AFG’s effective tax rate. In accordance with SAB 118, the insurance claims and reserves transitional deferred tax liability (and offsetting adjustment to the related deferred tax assets) and any other changes in deferred taxes resulting from clarification and interpretation of the TCJA provided during 2018 (none through June 30, 2018) will be recorded in the period in which the guidance is published.
The favorable impact of stock-based compensation on AFG’s effective tax rate in the second quarters and first six months of 2018 and 2017 reflects the high volume of employee stock option exercises during that period and the increase in the market price of AFG Common Stock.
Approximately $19 million of AFG’s net operating loss carryforwards (“NOL”) subject to separate return limitation year (“SRLY”) tax rules will expire unutilized at December 31, 2018. Since AFG maintains a full valuation allowance against its SRLY NOLs, the expiration of these loss carryforwards will be offset by a corresponding reduction in the valuation allowance and will have no overall impact on AFG’s income tax expense or results of operations.
M. Contingencies
There have been no significant changes to the matters discussed and referred to in Note M — “Contingencies” of AFG’s 2017 Form 10-K, which covers property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims and environmental and occupational injury and disease claims of former subsidiary railroad and manufacturing operations, as well as contingencies related to the sale of substantially all of AFG’s run-off long-term care insurance business.
N. Insurance
Property and Casualty Insurance Reserves The following table provides an analysis of changes in the liability for losses and loss adjustment expenses during the first six months of 2018 and 2017 (in millions):

| Six months ended June 30,
| 2018 |  | 2017
Balance at beginning of year | $ | 9,678 |  |  | $ | 8,563 |
Less reinsurance recoverables, net of allowance | 2,957 |  |  | 2,302 |
Net liability at beginning of year | 6,721 |  |  | 6,261 |
Provision for losses and LAE occurring in the current period | 1,434 |  |  | 1,294 |
Net increase (decrease) in the provision for claims of prior years | (100 | ) |  | (50 | )
Total losses and LAE incurred | 1,334 |  |  | 1,244 |
Payments for losses and LAE of: |  |  |
Current year | (294 | ) |  | (253 | )
Prior years | (975 | ) |  | (953 | )
Total payments | (1,269 | ) |  | (1,206 | )
Reserves of business disposed (*) | (319 | ) |  | — |
Foreign currency translation and other | (4 | ) |  | 24 |
Net liability at end of period | 6,463 |  |  | 6,323 |
Add back reinsurance recoverables, net of allowance | 2,630 |  |  | 2,407 |
Gross unpaid losses and LAE included in the balance sheet at end of period | $ | 9,093 |  |  | $ | 8,730 |

(*) | Reflects the reinsurance to close transaction at Neon discussed below.

The net decrease in the provision for claims of prior years during the first six months of 2018 reflects (i) lower than expected losses in the crop business and lower than expected claim severity in the transportation businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in the workers’ compensation businesses
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED
(within the Specialty casualty sub-segment), and (iii) lower than expected claim frequency and severity in the surety business and lower than expected claim severity in the fidelity business (all within the Specialty financial sub-segment).
The net decrease in the provision for claims of prior years during the first six months of 2017 reflects (i) lower than expected losses in the crop and equine operations and lower than expected claim severity in the property and inland marine business (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in the workers’ compensation businesses and at Neon (all within the Specialty casualty sub-segment) and (iii) lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business (all within the Specialty financial sub-segment). This favorable development was partially offset by (i) higher than expected claim severity in the ocean marine business (within the Property and transportation sub-segment), (ii) higher than anticipated claim severity in the targeted markets and general liability business (all within the Specialty casualty sub-segment) and (iii) an adjustment to the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998 (included in Other specialty sub-segment).
In December 2017, the Neon Lloyd’s syndicate entered into a reinsurance to close transaction for the 2015 and prior years of account with StarStone Underwriting Limited, a subsidiary of Enstar Group Limited, which was effective as of December 31, 2017 (the transaction settled in early 2018). In the Lloyd’s market, a reinsurance to close transaction transfers the responsibility for discharging all of the liabilities that attach to the transferred year of account plus the right to any income due to the closing year of account in return for a premium. This transaction provided Neon with finality on its legacy business.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
ITEM 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations

INDEX TO MD&A
| Page |  |  | Page
Forward-Looking Statements | 34 |  | Results of Operations — Second Quarter | 48
Overview | 35 |  | Segmented Statement of Earnings | 48
Critical Accounting Policies | 35 |  | Property and Casualty Insurance | 49
Liquidity and Capital Resources | 36 |  | Annuity | 58
Ratios | 36 |  | Holding Company, Other and Unallocated | 66
Condensed Consolidated Cash Flows | 36 |  | Results of Operations — First Six Months | 69
Parent and Subsidiary Liquidity | 37 |  | Segmented Statement of Earnings | 69
Investments | 38 |  | Property and Casualty Insurance | 70
Uncertainties | 42 |  | Annuity | 78
Managed Investment Entities | 42 |  | Holding Company, Other and Unallocated | 85
Results of Operations | 46 |  | Recent and Pending Accounting Standards | 87
General | 46 |  |  |

FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. Some of the forward-looking statements can be identified by the use of words such as “anticipates”, “believes”, “expects”, “projects”, “estimates”, “intends”, “plans”, “seeks”, “could”, “may”, “should”, “will” or the negative version of those words or other comparable terminology. Such forward-looking statements include statements relating to: expectations concerning market and other conditions and their effect on future premiums, revenues, earnings, investment activities, and the amount and timing of share repurchases; recoverability of asset values; expected losses and the adequacy of reserves for asbestos, environmental pollution and mass tort claims; rate changes; and improved loss experience.
Actual results and/or financial condition could differ materially from those contained in or implied by such forward-looking statements for a variety of reasons including but not limited to:

• | changes in financial, political and economic conditions, including changes in interest and inflation rates, currency fluctuations and extended economic recessions or expansions in the U.S. and/or abroad;

• | performance of securities markets, including the cost of equity index call options used in the fixed-indexed and variable-indexed annuity business;

• | new legislation or declines in credit quality or credit ratings that could have a material impact on the valuation of securities in AFG’s investment portfolio;

• | the availability of capital;

• | regulatory actions (including changes in statutory accounting rules);

• | changes in the legal environment affecting AFG or its customers;

• | tax law and accounting changes, including the impact of recent changes in U.S. corporate tax law;

• | levels of natural catastrophes and severe weather, terrorist activities (including any nuclear, biological, chemical or radiological events), incidents of war or losses resulting from civil unrest and other major losses;

• | development of insurance loss reserves and establishment of other reserves, particularly with respect to amounts associated with asbestos and environmental claims;

• | availability of reinsurance and ability of reinsurers to pay their obligations;

• | trends in persistency and mortality;

• | competitive pressures;

• | the ability to obtain adequate rates and policy terms;

• | changes in AFG’s credit ratings or the financial strength ratings assigned by major ratings agencies to AFG’s operating subsidiaries; and

• | the impact of the conditions in the international financial markets and the global economy (including those associated with the United Kingdom’s expected withdrawal from the European Union, or “Brexit”) relating to AFG’s international operations.

The forward-looking statements herein are made only as of the date of this report. The Company assumes no obligation to publicly update any forward-looking statements.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
OVERVIEW
Financial Condition
AFG is organized as a holding company with almost all of its operations being conducted by subsidiaries. AFG, however, has continuing cash needs for administrative expenses, the payment of principal and interest on borrowings, shareholder dividends, and taxes. Therefore, certain analyses are most meaningfully presented on a parent only basis while others are best done on a total enterprise basis. In addition, because most of its businesses are financial in nature, AFG does not prepare its consolidated financial statements using a current-noncurrent format. Consequently, certain traditional ratios and financial analysis tests are not meaningful.
Results of Operations
Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of traditional fixed, fixed-indexed and variable-indexed annuities in the retail, financial institutions, broker-dealer, registered investment advisor and education markets.
Net earnings attributable to AFG’s shareholders for the second quarter and first six months of 2018 were $210 million ($2.31 per share, diluted) and $355 million ($3.92 per share, diluted), respectively, compared to $145 million ($1.61 per share, diluted) and $298 million ($3.32 per share, diluted) reported in the same periods of 2017, reflecting:

• | higher earnings in the annuity segment,

• | higher net investment income in the property and casualty insurance segment,

• | higher underwriting profit in the property and casualty insurance segment in the first six months of 2018 compared to the first six months of 2017,

• | lower interest charges on borrowed money,

• | a lower corporate income tax rate,

• | realized losses on securities in the first six months of 2018 compared to realized gains in the first six months of 2017 and higher realized gains on securities in the second quarter of 2018 compared to the second quarter of 2017. Both periods in 2018 reflect the change in the fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018, and

• | lower income from the sale of real estate in the first six months of 2018 compared to the first six months of 2017.

CRITICAL ACCOUNTING POLICIES
Significant accounting policies are summarized in Note A — “Accounting Policies” to the financial statements. The preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that can have a significant effect on amounts reported in the financial statements. As more information becomes known, these estimates and assumptions change and, thus, impact amounts reported in the future. The areas where management believes the degree of judgment required to determine amounts recorded in the financial statements is most significant are as follows:

• | the establishment of insurance reserves, especially asbestos and environmental-related reserves,

• | the recoverability of reinsurance,

• | the recoverability of deferred acquisition costs,

• | the establishment of asbestos and environmental reserves of former railroad and manufacturing operations, and

• | the valuation of investments, including the determination of other-than-temporary impairments.

For a discussion of these policies, see Management’s Discussion and Analysis — “Critical Accounting Policies” in AFG’s 2017 Form 10-K.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
LIQUIDITY AND CAPITAL RESOURCES
Ratios AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions):

|  | June 30, 2018 |  | December 31,
2017 |  | 2016
Principal amount of long-term debt |  | $ | 1,318 |  |  | $ | 1,318 |  |  | $ | 1,308 |
Total capital |  | 6,211 |  |  | 6,033 |  |  | 5,921 |
Ratio of debt to total capital: |  |  |  |  |  |
Including subordinated debt |  | 21.2 | % |  | 21.8 | % |  | 22.1 | %
Excluding subordinated debt |  | 16.4 | % |  | 16.9 | % |  | 17.0 | %

The ratio of debt to total capital is a non-GAAP measure that management believes is useful for investors, analysts and independent ratings agencies to evaluate AFG’s financial strength and liquidity and to provide insight into how AFG finances its operations. In addition, maintaining a ratio of debt, excluding subordinated debt and debt secured by real estate (if any), to total capital of 35% or lower is a financial covenant in AFG’s bank credit facility. The ratio is calculated by dividing the principal amount of AFG’s long-term debt by its total capital, which includes long-term debt, noncontrolling interests and shareholders’ equity (excluding unrealized gains (losses) on fixed maturity investments).
AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.82 for the six months ended June 30, 2018 and 1.72 for the year ended December 31, 2017. Excluding annuity benefits, this ratio was 10.40 and 7.67, respectively. Although the ratio excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, it is presented because interest credited to annuity policyholder accounts is not always considered a borrowing cost for an insurance company.
Condensed Consolidated Cash Flows AFG’s principal sources of cash include insurance premiums, income from its investment portfolio and proceeds from the maturities, redemptions and sales of investments. Insurance premiums in excess of acquisition expenses and operating costs are invested until they are needed to meet policyholder obligations or made available to the parent company through dividends to cover debt obligations and corporate expenses, and to provide returns to shareholders through share repurchases and dividends. Cash flows from operating, investing and financing activities as detailed in AFG’s Consolidated Statement of Cash Flows are shown below (in millions):

| Six months ended June 30,
| 2018 |  | 2017
Net cash provided by operating activities | $ | 823 |  |  | $ | 574 |
Net cash used in investing activities | (2,485 | ) |  | (1,994 | )
Net cash provided by financing activities | 1,134 |  |  | 1,520 |
Net change in cash and cash equivalents | $ | (528 | ) |  | $ | 100 |

Net Cash Provided by Operating Activities AFG’s property and casualty insurance operations typically produce positive net operating cash flows as premiums collected and investment income exceed policy acquisition costs, claims payments and operating expenses. AFG’s net cash provided by operating activities is impacted by the level and timing of property and casualty premiums, claim and expense payments and recoveries from reinsurers. AFG’s annuity operations typically produce positive net operating cash flows as investment income exceeds acquisition costs and operating expenses. Interest credited on annuity policyholder funds is a non-cash increase in AFG’s annuity benefits accumulated liability and annuity premiums, benefits and withdrawals are considered financing activities due to the deposit-type nature of annuities. Cash flows provided by operating activities also include the activity of AFG’s managed investment entities (collateralized loan obligations) other than those activities included in investing or financing activities. The changes in the assets and liabilities of the managed investment entities included in operating activities increased cash flows from operating activities by $138 million during the first six months of 2018 and reduced cash flows from operating activities by $72 million in the first six months of 2017, accounting for a $210 million increase in cash flows from operating activities in the 2018 period compared to the 2017 period. As discussed in Note A — “Accounting Policies — Managed Investment Entities” to the financial statements, AFG has no right to use the CLO assets and no obligation to pay the CLO liabilities and such assets and liabilities are shown separately in AFG’s Balance Sheet. Excluding the impact of the managed investment entities, net cash provided by operating activities was $685 million in the first six months of 2018 compared to $646 million in the first six months of 2017, an increase of $39 million.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Net Cash Used in Investing Activities AFG’s investing activities consist primarily of the investment of funds provided by its property and casualty and annuity businesses. Net cash used in investing activities was $2.49 billion for the first six months of 2018 compared to $1.99 billion in the first six months of 2017, an increase of $491 million. While the $229 million decrease in net cash flows from annuity policyholders in the first six months of 2018 as compared to the 2017 period (discussed below under net cash provided by financing activities) reduced the amount of cash available for investment in the first six months of 2018 compared to the same 2017 period, this reduction was more than offset by the investment of AFG’s overall cash held at December 31, 2017 during the first six months of 2018. In addition to the investment of funds provided by the insurance operations, investing activities also include the purchase and disposal of managed investment entity investments, which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $226 million use of cash in the first six months of 2018 compared to a $42 million use of cash in the 2017 period, accounting for a $184 million increase in net cash used in investing activities in the first six months of 2018 compared to the same 2017 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note G — “Managed Investment Entities” to the financial statements.
Net Cash Provided by Financing Activities AFG’s financing activities consist primarily of transactions with annuity policyholders, issuances and retirements of long-term debt, repurchases of common stock and dividend payments. Net cash provided by financing activities was $1.13 billion for the first six months of 2018 compared to $1.52 billion in the first six months of 2017, a decrease of $386 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $1.20 billion in the first six months of 2018 compared to $1.43 billion in the first six months of 2017, accounting for a $229 million decrease in net cash provided by financing activities in the 2018 period compared to the 2017 period. In June 2017, AFG issued $350 million of 4.50% Senior Notes due 2047, the net proceeds of which contributed $345 million to net cash provided by financing activities in the first six months of 2017. Redemptions of long-term debt were a $230 million use of cash in the first six months of 2017. Financing activities also include issuances and retirements of managed investment entity liabilities, which are nonrecourse to AFG and presented separately in AFG’s Balance Sheet. Issuances of managed investment entity liabilities exceeded retirements by $111 million in the first six months of 2018 compared to $142 million in the first six months of 2017, accounting for a $31 million decrease in net cash provided by financing activities in the 2018 period compared to the 2017 period. See Note A — “Accounting Policies — Managed Investment Entities” and Note G — “Managed Investment Entities” to the financial statements.
Parent and Subsidiary Liquidity
Parent Holding Company Liquidity Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends, tax payments and borrowings from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to utilize parent company cash and marketable securities or to generate cash through borrowings, sales of other assets, or similar transactions.
AFG can borrow up to $500 million under its revolving credit facility which expires in June 2021. Amounts borrowed under this agreement bear interest at rates ranging from 1.00% to 1.875% (currently 1.375%) over LIBOR based on AFG’s credit rating. There were no borrowings under this agreement, or under any other parent company short-term borrowing arrangements, during 2017 or the first six months of 2018.
In May 2018, AFG paid a special cash dividend of $1.50 per share of AFG Common Stock totaling $134 million. In 2017, AFG paid special cash dividends of $3.50 per share of AFG Common Stock ($1.50 per share in May and $2.00 per share in November) totaling approximately $308 million.
In June 2017, AFG issued $350 million of 4.50% Senior Notes due June 2047. Net proceeds from the offering were used to redeem AFG’s $230 million outstanding principal amount of 6-3/8% Senior Notes due June 2042, at par value in June 2017 and AFG’s $125 million outstanding principal amount of 5-3/4% Senior Notes due August 2042 at par value in August 2017.
In November 2017, AFG issued an additional $240 million of 4.50% Senior Notes due in 2047 and $125 million of 3.50% Senior Notes due in 2026. The net proceeds of the offering were used to redeem AFG’s $350 million outstanding principal amount of 9-7/8% Senior Notes due in June 2019 for $388 million (including a make-whole premium of $38 million) in December 2017.
Under a tax allocation agreement with AFG, its 80%-owned U.S. subsidiaries generally pay taxes to (or recover taxes from) AFG based on each subsidiary’s contribution to amounts due under AFG’s consolidated tax return.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Subsidiary Liquidity Great American Life Insurance Company (“GALIC”), a wholly-owned annuity subsidiary, is a member of the Federal Home Loan Bank of Cincinnati (“FHLB”). The FHLB makes advances and provides other banking services to member institutions, which provides the annuity operations with an additional source of liquidity. At June 30, 2018, GALIC had $871 million in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.03% to 0.22% over LIBOR (average rate of 2.25% at June 30, 2018). While these advances must be repaid between 2018 and 2021 ($40 million in 2018, $345 million in 2019, $150 million in 2020 and $336 million in 2021), GALIC has the option to prepay all or a portion of the advances. GALIC has invested the proceeds from the advances in fixed maturity securities with similar expected lives as the advances for the purpose of earning a spread over the interest payments due to the FHLB. At June 30, 2018, GALIC estimated that it had additional borrowing capacity of approximately $300 million from the FHLB.
The liquidity requirements of AFG’s insurance subsidiaries relate primarily to the liabilities associated with their products as well as operating costs and expenses, payments of dividends and taxes to AFG and contributions of capital to their subsidiaries. Historically, cash flows from premiums and investment income have generally provided more than sufficient funds to meet these requirements. Funds received in excess of cash requirements are generally invested in additional marketable securities. In addition, the insurance subsidiaries generally hold a significant amount of highly liquid, short-term investments.
The excess cash flow of AFG’s property and casualty group allows it to extend the duration of its investment portfolio somewhat beyond that of its claim reserves.
In the annuity business, where profitability is largely dependent on earning a spread between invested assets and annuity liabilities, the duration of investments is generally maintained close to that of liabilities. In a rising interest rate environment, significant protection from withdrawals exists in the form of temporary and permanent surrender charges on AFG’s annuity products. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to contractually guaranteed minimum interest rates (“GMIRs”). AFG began selling policies with GMIRs below 2% in 2003; almost all new business since late 2010 has been issued with a 1% GMIR. At June 30, 2018, AFG could reduce the average crediting rate on approximately $27 billion of traditional fixed annuities and fixed-indexed and variable-indexed annuities without guaranteed withdrawal benefits by approximately 109 basis points (on a weighted average basis). Annuity policies are subject to GMIRs at policy issuance. The table below shows the breakdown of annuity reserves by GMIR. The current interest crediting rates on substantially all of AFG’s annuities with a GMIR of 3% or higher are at their minimum.

|  |  |  |  | % of Reserves |
|  |  |  |  | June 30, |  | December 31, |
| GMIR |  |  |  | 2018 |  | 2017 |  | 2016 |
| 1 — 1.99% |  |  |  | 78% |  | 76% |  | 72% |
| 2 — 2.99% |  |  |  | 4% |  | 5% |  | 6% |
| 3 — 3.99% |  |  |  | 9% |  | 10% |  | 12% |
| 4.00% and above |  |  |  | 9% |  | 9% |  | 10% |
| Annuity benefits accumulated (in millions) |  | $34,886 |  | $33,316 |  | $29,907 |

AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses. In addition, these subsidiaries have sufficient capital to meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. Nonetheless, changes in statutory accounting rules, significant declines in the fair value of the insurance subsidiaries’ investment portfolios or significant ratings downgrades on these investments, could create a need for additional capital.
Investments AFG’s investment portfolio at June 30, 2018, includes $39.65 billion in fixed maturity securities classified as available for sale and carried at fair value with unrealized gains and losses included in a separate component of shareholders’ equity on an after-tax basis and $137 million in fixed maturities classified as trading with changes in unrealized holding gains or losses included in net investment income. In addition, AFG’s investment portfolio includes $1.62 billion in equity securities carried at fair value with holding gains and losses included in realized gains (losses) on securities and $160 million in equity securities carried at fair value with unrealized holding gains and losses included in net investment income.
Fair values for AFG’s portfolio are determined by AFG’s internal investment professionals using data from nationally recognized pricing services as well as non-binding broker quotes. Fair values of equity securities are generally based on
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 10% of AFG’s fixed maturities, prices for each security are generally obtained from both pricing services and broker quotes. For the remainder of AFG’s fixed maturity portfolio, approximately 73% are priced using pricing services and the balance is priced primarily by using non-binding broker quotes. When prices obtained for the same security vary, AFG’s internal investment professionals select the price they believe is most indicative of an exit price.
The pricing services use a variety of observable inputs to estimate fair value of fixed maturities that do not trade on a daily basis. Based upon information provided by the pricing services, these inputs include, but are not limited to, recent reported trades, benchmark yields, issuer spreads, bids or offers, reference data, and measures of volatility. Included in the pricing of MBS are estimates of the rate of future prepayments and defaults of principal over the remaining life of the underlying collateral. Due to the lack of transparency in the process that brokers use to develop prices, valuations that are based on brokers’ prices are classified as Level 3 in the GAAP hierarchy unless the price can be corroborated, for example, by comparison to similar securities priced using observable inputs.
Valuation techniques utilized by pricing services and prices obtained from external sources are reviewed by AFG’s internal investment professionals who are familiar with the securities being priced and the markets in which they trade to ensure the fair value determination is representative of an exit price. To validate the appropriateness of the prices obtained, these investment managers consider widely published indices (as benchmarks), recent trades, changes in interest rates, general economic conditions and the credit quality of the specific issuers. In addition, AFG communicates directly with pricing services regarding the methods and assumptions used in pricing, including verifying, on a test basis, the inputs used by the services to value specific securities.
In general, the fair value of AFG’s fixed maturity investments is inversely correlated to changes in interest rates. The following table demonstrates the sensitivity of such fair values to reasonably likely changes in interest rates by illustrating the estimated effect on AFG’s fixed maturity portfolio and accumulated other comprehensive income that an immediate increase of 100 basis points in the interest rate yield curve would have at June 30, 2018 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.

Fair value of fixed maturity portfolio | $ | 39,785 |
Percentage impact on fair value of 100 bps increase in interest rates | (4.5 | %)
Pretax impact on fair value of fixed maturity portfolio | $ | (1,790 | )
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts | 750 |
Estimated pretax impact on accumulated other comprehensive income | (1,040 | )
Deferred income tax | 218 |
Estimated after-tax impact on accumulated other comprehensive income | $ | (822 | )

Approximately 90% of the fixed maturities held by AFG at June 30, 2018, were rated “investment grade” (credit rating of AAA to BBB) by nationally recognized rating agencies. Investment grade securities generally bear lower yields and lower degrees of risk than those that are unrated and non-investment grade. Management believes that the high quality investment portfolio should generate a stable and predictable investment return.
MBS are subject to significant prepayment risk due to the fact that, in periods of declining interest rates, mortgages may be repaid more rapidly than scheduled as borrowers refinance higher rate mortgages to take advantage of lower rates. Although interest rates have been low in recent years, tighter lending standards have resulted in fewer buyers being able to refinance the mortgages underlying much of AFG’s non-agency residential MBS portfolio.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Summarized information for AFG’s MBS (including those classified as trading) at June 30, 2018, is shown in the table below (dollars in millions). Agency-backed securities are those issued by a U.S. government-backed agency; Alt-A mortgages are those with risk profiles between prime and subprime. The average life of the residential and commercial MBS is approximately 4-1/2 years and 5 years, respectively.

|  | Amortized Cost |  | Fair Value |  | Fair Value as % of Cost |  | Unrealized Gain (Loss) |  | % Rated Investment Grade
Collateral type |  |  |  |  |  |  |  |  |  |
Residential: |  |  |  |  |  |  |  |  |  |
Agency-backed |  | $ | 189 |  |  | $ | 185 |  |  | 98 | % |  | $ | (4 | ) |  | 100 | %
Non-agency prime |  | 1,076 |  |  | 1,231 |  |  | 114 | % |  | 155 |  |  | 28 | %
Alt-A |  | 891 |  |  | 1,015 |  |  | 114 | % |  | 124 |  |  | 14 | %
Subprime |  | 410 |  |  | 457 |  |  | 111 | % |  | 47 |  |  | 28 | %
Commercial |  | 920 |  |  | 934 |  |  | 102 | % |  | 14 |  |  | 94 | %
|  | $ | 3,486 |  |  | $ | 3,822 |  |  | 110 | % |  | $ | 336 |  |  | 44 | %

The National Association of Insurance Commissioners (“NAIC”) assigns creditworthiness designations on a scale of 1 to 6 with 1 being the highest quality and 6 being the lowest quality. The NAIC retains third-party investment management firms to assist in the determination of appropriate NAIC designations for MBS based not only on the probability of loss (which is the primary basis of ratings by the major ratings firms), but also on the severity of loss and statutory carrying value. At June 30, 2018, 97% (based on statutory carrying value of $3.44 billion) of AFG’s MBS had an NAIC designation of 1.
Municipal bonds represented approximately 17% of AFG’s fixed maturity portfolio at June 30, 2018. AFG’s municipal bond portfolio is high quality, with 99% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At June 30, 2018, approximately 77% of the municipal bond portfolio was held in revenue bonds, with the remaining 23% held in general obligation bonds. AFG does not own general obligation bonds issued by Puerto Rico.
Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at June 30, 2018, is shown in the following table (dollars in millions). Approximately $607 million of available for sale fixed maturity securities had no unrealized gains or losses at June 30, 2018.

| Securities With Unrealized Gains |  | Securities With Unrealized Losses
Available for Sale Fixed Maturities |  |  |
Fair value of securities | $ | 20,606 |  |  | $ | 18,435 |
Amortized cost of securities | $ | 19,764 |  |  | $ | 18,873 |
Gross unrealized gain (loss) | $ | 842 |  |  | $ | (438 | )
Fair value as % of amortized cost | 104 | % |  | 98 | %
Number of security positions | 3,212 |  |  | 2,043 |
Number individually exceeding $2 million gain or loss | 53 |  |  | 6 |
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized): |  |  |
Mortgage-backed securities | $ | 347 |  |  | $ | (11 | )
States and municipalities | 162 |  |  | (53 | )
Asset-backed securities | 132 |  |  | (46 | )
Banks, savings and credit institutions | 43 |  |  | (87 | )
Manufacturing | 32 |  |  | (53 | )
Insurance companies | 20 |  |  | (40 | )
Percentage rated investment grade | 86 | % |  | 96 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at June 30, 2018, based on their fair values. Securities with sinking funds are reported at average maturity. Actual maturities may differ from contractual maturities because certain securities may be called or prepaid by the issuers.

| Securities With Unrealized Gains |  | Securities With Unrealized Losses
Maturity |  |  |
One year or less | 4 | % |  | 1 | %
After one year through five years | 22 | % |  | 17 | %
After five years through ten years | 24 | % |  | 45 | %
After ten years | 12 | % |  | 13 | %
| 62 | % |  | 76 | %
Asset-backed securities (average life of approximately 4-1/2 years) | 22 | % |  | 22 | %
Mortgage-backed securities (average life of approximately 4-1/2 years) | 16 | % |  | 2 | %
| 100 | % |  | 100 | %

The table below (dollars in millions) summarizes the unrealized gains and losses on fixed maturity securities by dollar amount:

|  | Aggregate Fair Value |  | Aggregate Unrealized Gain (Loss) |  | Fair Value as % of Cost
Fixed Maturities at June 30, 2018 |  |  |  |  |  |
Securities with unrealized gains: |  |  |  |  |  |
Exceeding $500,000 (457 securities) |  | $ | 5,797 |  |  | $ | 534 |  |  | 110 | %
$500,000 or less (2,755 securities) |  | 14,809 |  |  | 308 |  |  | 102 | %
|  | $ | 20,606 |  |  | $ | 842 |  |  | 104 | %
Securities with unrealized losses: |  |  |  |  |  |
Exceeding $500,000 (235 securities) |  | $ | 4,529 |  |  | $ | (213 | ) |  | 96 | %
$500,000 or less (1,808 securities) |  | 13,906 |  |  | (225 | ) |  | 98 | %
|  | $ | 18,435 |  |  | $ | (438 | ) |  | 98 | %

The following table (dollars in millions) summarizes the unrealized losses for all securities with unrealized losses by issuer quality and the length of time those securities have been in an unrealized loss position:

|  | Aggregate Fair Value |  | Aggregate Unrealized Loss |  | Fair Value as % of Cost
Securities with Unrealized Losses at June 30, 2018 |  |  |  |  |  |
Investment grade fixed maturities with losses for: |  |  |  |  |  |
Less than one year (1,649 securities) |  | $ | 16,260 |  |  | $ | (344 | ) |  | 98 | %
One year or longer (249 securities) |  | 1,353 |  |  | (63 | ) |  | 96 | %
|  | $ | 17,613 |  |  | $ | (407 | ) |  | 98 | %
Non-investment grade fixed maturities with losses for: |  |  |  |  |  |
Less than one year (95 securities) |  | $ | 608 |  |  | $ | (16 | ) |  | 97 | %
One year or longer (50 securities) |  | 214 |  |  | (15 | ) |  | 93 | %
|  | $ | 822 |  |  | $ | (31 | ) |  | 96 | %

When a decline in the value of a specific investment is considered to be other-than-temporary, a provision for impairment is charged to earnings (accounted for as a realized loss) and the cost basis of that investment is reduced by the amount of the charge. The determination of whether unrealized losses are other-than-temporary requires judgment based on subjective as well as objective factors as detailed in AFG’s 2017 Form 10-K under Management’s Discussion and Analysis — “Investments.”
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Based on its analysis, management believes AFG will recover its cost basis in the securities with unrealized losses and that AFG has the ability to hold the securities until they recover in value and had no intent to sell them at June 30, 2018. Although AFG has the ability to continue holding its investments with unrealized losses, its intent to hold them may change due to deterioration in the issuers’ creditworthiness, decisions to lessen exposure to a particular issuer or industry, asset/liability management decisions, market movements, changes in views about appropriate asset allocation or the desire to offset taxable realized gains. Should AFG’s ability or intent change with regard to a particular security, a charge for impairment would likely be required. While it is not possible to accurately predict if or when a specific security will become impaired, charges for other-than-temporary impairment could be material to results of operations in future periods. Significant declines in the fair value of AFG’s investment portfolio could have a significant adverse effect on AFG’s liquidity. For information on AFG’s realized gains (losses) on securities, including charges for other-than-temporary impairment, see “Results of Operations — Consolidated Realized Gains (Losses) on Securities.”
Uncertainties Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. See Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” in AFG’s 2017 Form 10-K. In addition to its ongoing internal monitoring of asbestos and environmental exposures, AFG has periodically conducted comprehensive external studies of its asbestos and environmental reserves relating to the run-off operations of its property and casualty insurance segment and exposures related to its former railroad and manufacturing operations with the aid of specialty actuarial, engineering and consulting firms and outside counsel, generally every two years, with an in-depth internal review during the intervening years. AFG has scheduled its 2018 internal review of these liabilities to be completed in the third quarter of 2018.
MANAGED INVESTMENT ENTITIES
Accounting standards require AFG to consolidate its investments in collateralized loan obligation (“CLO”) entities that it manages and owns an interest in (in the form of debt). See Note A — “Accounting Policies — Managed Investment Entities” and Note G — “Managed Investment Entities” to the financial statements. The effect of consolidating these entities is shown in the tables below (in millions). The “Before CLO Consolidation” columns include AFG’s investment and earnings in the CLOs on an unconsolidated basis.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
CONDENSED CONSOLIDATING BALANCE SHEET

| Before CLO Consolidation |  | Managed Investment Entities |  | Consol. Entries |  |  |  | Consolidated As Reported
June 30, 2018 |  |  |  |  |  |  |  |  |
Assets: |  |  |  |  |  |  |  |  |
Cash and investments | $ | 46,970 |  |  | $ | — |  |  | $ | (191 | ) |  | (a) |  | $ | 46,779 |
Assets of managed investment entities | — |  |  | 5,032 |  |  | — |  |  |  |  | 5,032 |
Other assets | 10,024 |  |  | — |  |  | (1 | ) |  | (a) |  | 10,023 |
Total assets | $ | 56,994 |  |  | $ | 5,032 |  |  | $ | (192 | ) |  |  |  | $ | 61,834 |
Liabilities: |  |  |  |  |  |  |  |  |
Unpaid losses and loss adjustment expenses and unearned premiums | $ | 11,632 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 11,632 |
Annuity, life, accident and health benefits and reserves | 35,533 |  |  | — |  |  | — |  |  |  |  | 35,533 |
Liabilities of managed investment entities | — |  |  | 5,032 |  |  | (192 | ) |  | (a) |  | 4,840 |
Long-term debt and other liabilities | 4,745 |  |  | — |  |  | — |  |  |  |  | 4,745 |
Total liabilities | 51,910 |  |  | 5,032 |  |  | (192 | ) |  |  |  | 56,750 |
Redeemable noncontrolling interests | — |  |  | — |  |  | — |  |  |  |  | — |
Shareholders’ equity: |  |  |  |  |  |  |  |  |
Common Stock and Capital surplus | 1,309 |  |  | — |  |  | — |  |  |  |  | 1,309 |
Retained earnings | 3,628 |  |  | — |  |  | — |  |  |  |  | 3,628 |
Accumulated other comprehensive income, net of tax | 147 |  |  | — |  |  | — |  |  |  |  | 147 |
Total shareholders’ equity | 5,084 |  |  | — |  |  | — |  |  |  |  | 5,084 |
Noncontrolling interests | — |  |  | — |  |  | — |  |  |  |  | — |
Total equity | 5,084 |  |  | — |  |  | — |  |  |  |  | 5,084 |
Total liabilities and equity | $ | 56,994 |  |  | $ | 5,032 |  |  | $ | (192 | ) |  |  |  | $ | 61,834 |
December 31, 2017 |  |  |  |  |  |  |  |  |
Assets: |  |  |  |  |  |  |  |  |
Cash and investments | $ | 46,262 |  |  | $ | — |  |  | $ | (214 | ) |  | (a) |  | $ | 46,048 |
Assets of managed investment entities | — |  |  | 4,902 |  |  | — |  |  |  |  | 4,902 |
Other assets | 9,709 |  |  | — |  |  | (1 | ) |  | (a) |  | 9,708 |
Total assets | $ | 55,971 |  |  | $ | 4,902 |  |  | $ | (215 | ) |  |  |  | $ | 60,658 |
Liabilities: |  |  |  |  |  |  |  |  |
Unpaid losses and loss adjustment expenses and unearned premiums | $ | 12,088 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 12,088 |
Annuity, life, accident and health benefits and reserves | 33,974 |  |  | — |  |  | — |  |  |  |  | 33,974 |
Liabilities of managed investment entities | — |  |  | 4,902 |  |  | (215 | ) |  | (a) |  | 4,687 |
Long-term debt and other liabilities | 4,575 |  |  | — |  |  | — |  |  |  |  | 4,575 |
Total liabilities | 50,637 |  |  | 4,902 |  |  | (215 | ) |  |  |  | 55,324 |
Redeemable noncontrolling interests | 3 |  |  | — |  |  | — |  |  |  |  | 3 |
Shareholders’ equity: |  |  |  |  |  |  |  |  |
Common Stock and Capital surplus | 1,269 |  |  | — |  |  | — |  |  |  |  | 1,269 |
Retained earnings | 3,248 |  |  | — |  |  | — |  |  |  |  | 3,248 |
Accumulated other comprehensive income, net of tax | 813 |  |  | — |  |  | — |  |  |  |  | 813 |
Total shareholders’ equity | 5,330 |  |  | — |  |  | — |  |  |  |  | 5,330 |
Noncontrolling interests | 1 |  |  | — |  |  | — |  |  |  |  | 1 |
Total equity | 5,331 |  |  | — |  |  | — |  |  |  |  | 5,331 |
Total liabilities and equity | $ | 55,971 |  |  | $ | 4,902 |  |  | $ | (215 | ) |  |  |  | $ | 60,658 |

(a) | Elimination of the fair value of AFG’s investment in CLOs and related accrued interest.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS

| Before CLO Consolidation (a) |  | Managed Investment Entities |  | Consol. Entries |  |  |  | Consolidated As Reported
Three months ended June 30, 2018 |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |
Insurance net earned premiums | $ | 1,167 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 1,167 |
Net investment income | 534 |  |  | — |  |  | (4 | ) |  | (b) |  | 530 |
Realized gains on securities | 31 |  |  | — |  |  | — |  |  |  |  | 31 |
Income (loss) of managed investment entities: |  |  |  |  |  |  |  |  |
Investment income | — |  |  | 64 |  |  | — |  |  |  |  | 64 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | — |  |  | (2 | ) |  | (b) |  | (2 | )
Other income | 47 |  |  | — |  |  | (4 | ) |  | (c) |  | 43 |
Total revenues | 1,779 |  |  | 64 |  |  | (10 | ) |  |  |  | 1,833 |
Costs and Expenses: |  |  |  |  |  |  |  |  |
Insurance benefits and expenses | 1,414 |  |  | — |  |  | — |  |  |  |  | 1,414 |
Expenses of managed investment entities | — |  |  | 64 |  |  | (10 | ) |  | (b)(c) |  | 54 |
Interest charges on borrowed money and other expenses | 105 |  |  | — |  |  | — |  |  |  |  | 105 |
Total costs and expenses | 1,519 |  |  | 64 |  |  | (10 | ) |  |  |  | 1,573 |
Earnings before income taxes | 260 |  |  | — |  |  | — |  |  |  |  | 260 |
Provision for income taxes | 52 |  |  | — |  |  | — |  |  |  |  | 52 |
Net earnings, including noncontrolling interests | 208 |  |  | — |  |  | — |  |  |  |  | 208 |
Less: Net earnings (loss) attributable to noncontrolling interests | (2 | ) |  | — |  |  | — |  |  |  |  | (2 | )
Net earnings attributable to shareholders | $ | 210 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 210 |
Three months ended June 30, 2017 |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |
Insurance net earned premiums | $ | 1,070 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 1,070 |
Net investment income | 465 |  |  | — |  |  | (5 | ) |  | (b) |  | 460 |
Realized gains on securities | 8 |  |  | — |  |  | — |  |  |  |  | 8 |
Income (loss) of managed investment entities: |  |  |  |  |  |  |  |  |
Investment income | — |  |  | 50 |  |  | — |  |  |  |  | 50 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | 21 |  |  | (10 | ) |  | (b) |  | 11 |
Other income | 52 |  |  | — |  |  | (5 | ) |  | (c) |  | 47 |
Total revenues | 1,595 |  |  | 71 |  |  | (20 | ) |  |  |  | 1,646 |
Costs and Expenses: |  |  |  |  |  |  |  |  |
Insurance benefits and expenses | 1,279 |  |  | — |  |  | — |  |  |  |  | 1,279 |
Expenses of managed investment entities | — |  |  | 71 |  |  | (20 | ) |  | (b)(c) |  | 51 |
Interest charges on borrowed money and other expenses | 111 |  |  | — |  |  | — |  |  |  |  | 111 |
Total costs and expenses | 1,390 |  |  | 71 |  |  | (20 | ) |  |  |  | 1,441 |
Earnings before income taxes | 205 |  |  | — |  |  | — |  |  |  |  | 205 |
Provision for income taxes | 60 |  |  | — |  |  | — |  |  |  |  | 60 |
Net earnings, including noncontrolling interests | 145 |  |  | — |  |  | — |  |  |  |  | 145 |
Less: Net earnings (loss) attributable to noncontrolling interests | — |  |  | — |  |  | — |  |  |  |  | — |
Net earnings attributable to shareholders | $ | 145 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 145 |

(a) | Includes income of $4 million and $5 million in the second quarter of 2018 and 2017, respectively, representing the change in fair value of AFG’s CLO investments plus $4 million and $5 million in the second quarter of 2018 and 2017, respectively, in CLO management fees earned.

(b) | Elimination of the change in fair value of AFG’s investments in the CLOs, including $6 million and $15 million in the second quarter of 2018 and 2017, respectively, in distributions recorded as interest expense by the CLOs.

(c) | Elimination of management fees earned by AFG.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS

| Before CLO Consolidation (a) |  | Managed Investment Entities |  | Consol. Entries |  |  |  | Consolidated As Reported
Six months ended June 30, 2018 |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |
Insurance net earned premiums | $ | 2,280 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 2,280 |
Net investment income | 1,032 |  |  | — |  |  | (7 | ) |  | (b) |  | 1,025 |
Realized losses on securities | (62 | ) |  | — |  |  | — |  |  |  |  | (62 | )
Income (loss) of managed investment entities: |  |  |  |  |  |  |  |  |
Investment income | — |  |  | 122 |  |  | — |  |  |  |  | 122 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | (1 | ) |  | (4 | ) |  | (b) |  | (5 | )
Other income | 100 |  |  | — |  |  | (8 | ) |  | (c) |  | 92 |
Total revenues | 3,350 |  |  | 121 |  |  | (19 | ) |  |  |  | 3,452 |
Costs and Expenses: |  |  |  |  |  |  |  |  |
Insurance benefits and expenses | 2,711 |  |  | — |  |  | — |  |  |  |  | 2,711 |
Expenses of managed investment entities | — |  |  | 121 |  |  | (19 | ) |  | (b)(c) |  | 102 |
Interest charges on borrowed money and other expenses | 205 |  |  | — |  |  | — |  |  |  |  | 205 |
Total costs and expenses | 2,916 |  |  | 121 |  |  | (19 | ) |  |  |  | 3,018 |
Earnings before income taxes | 434 |  |  | — |  |  | — |  |  |  |  | 434 |
Provision for income taxes | 85 |  |  | — |  |  | — |  |  |  |  | 85 |
Net earnings, including noncontrolling interests | 349 |  |  | — |  |  | — |  |  |  |  | 349 |
Less: Net earnings (loss) attributable to noncontrolling interests | (6 | ) |  | — |  |  | — |  |  |  |  | (6 | )
Net earnings attributable to shareholders | $ | 355 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 355 |
Six months ended June 30, 2017 |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |
Insurance net earned premiums | $ | 2,098 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 2,098 |
Net investment income | 906 |  |  | — |  |  | (11 | ) |  | (b) |  | 895 |
Realized gains on securities | 11 |  |  | — |  |  | — |  |  |  |  | 11 |
Income (loss) of managed investment entities: |  |  |  |  |  |  |  |  |
Investment income | — |  |  | 101 |  |  | — |  |  |  |  | 101 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | 21 |  |  | (10 | ) |  | (b) |  | 11 |
Other income | 115 |  |  | — |  |  | (9 | ) |  | (c) |  | 106 |
Total revenues | 3,130 |  |  | 122 |  |  | (30 | ) |  |  |  | 3,222 |
Costs and Expenses: |  |  |  |  |  |  |  |  |
Insurance benefits and expenses | 2,485 |  |  | — |  |  | — |  |  |  |  | 2,485 |
Expenses of managed investment entities | — |  |  | 122 |  |  | (30 | ) |  | (b)(c) |  | 92 |
Interest charges on borrowed money and other expenses | 217 |  |  | — |  |  | — |  |  |  |  | 217 |
Total costs and expenses | 2,702 |  |  | 122 |  |  | (30 | ) |  |  |  | 2,794 |
Earnings before income taxes | 428 |  |  | — |  |  | — |  |  |  |  | 428 |
Provision for income taxes | 128 |  |  | — |  |  | — |  |  |  |  | 128 |
Net earnings, including noncontrolling interests | 300 |  |  | — |  |  | — |  |  |  |  | 300 |
Less: Net earnings (loss) attributable to noncontrolling interests | 2 |  |  | — |  |  | — |  |  |  |  | 2 |
Net earnings attributable to shareholders | $ | 298 |  |  | $ | — |  |  | $ | — |  |  |  |  | $ | 298 |

(a) | Includes income of $7 million and $11 million in the first six months of 2018 and 2017, respectively, representing the change in fair value of AFG’s CLO investments plus $8 million and $9 million in the first six months of 2018 and 2017, respectively, in CLO management fees earned.

(b) | Elimination of the change in fair value of AFG’s investments in the CLOs, including $11 million and $21 million in the first six months of 2018 and 2017, respectively, in distributions recorded as interest expense by the CLOs.

(c) | Elimination of management fees earned by AFG.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
RESULTS OF OPERATIONS
General AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. For example, core net operating earnings excludes realized gains (losses) on securities because such gains and losses are influenced significantly by financial markets, interest rates and the timing of sales. Similarly, significant gains and losses from the sale of real estate are excluded from core earnings as they are influenced by the timing of sales and realized gains (losses) on subsidiaries are excluded because such gains and losses are largely the result of the changing business strategy and market opportunities. In addition, special charges related to coverage that AFG no longer writes for asbestos and environmental exposures are excluded from core earnings. The following table (in millions, except per share amounts) identifies non-core items and reconciles net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure. AFG believes core net operating earnings is a useful tool for investors and analysts in analyzing ongoing operating trends and for management to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business.

| Three months ended June 30, |  | Six months ended June 30,
2018 |  | 2017 |  | 2018 |  | 2017
Components of net earnings attributable to shareholders: |  |  |  |  |  |  |
Core operating earnings before income taxes | $ | 229 |  |  | $ | 204 |  |  | $ | 496 |  |  | $ | 424 |
Pretax non-core items: |  |  |  |  |  |  |
Realized gains (losses) on securities | 31 |  |  | 8 |  |  | (62 | ) |  | 11 |
Loss on retirement of debt | — |  |  | (7 | ) |  | — |  |  | (7 | )
Earnings before income taxes | 260 |  |  | 205 |  |  | 434 |  |  | 428 |
Provision (credit) for income taxes: |  |  |  |  |  |  |
Core operating earnings | 46 |  |  | 59 |  |  | 98 |  |  | 126 |
Non-core items | 6 |  |  | 1 |  |  | (13 | ) |  | 2 |
Total provision for income taxes | 52 |  |  | 60 |  |  | 85 |  |  | 128 |
Net earnings, including noncontrolling interests | 208 |  |  | 145 |  |  | 349 |  |  | 300 |
Less net earnings (losses) attributable to noncontrolling interests: |  |  |  |  |  |  |
Core operating earnings (losses) | (2 | ) |  | — |  |  | (6 | ) |  | 2 |
Non-core items | — |  |  | — |  |  | — |  |  | — |
Total net earnings (losses) attributable to noncontrolling interests | (2 | ) |  | — |  |  | (6 | ) |  | 2 |
Net earnings attributable to shareholders | $ | 210 |  |  | $ | 145 |  |  | $ | 355 |  |  | $ | 298 |
Net earnings: |  |  |  |  |  |  |
Core net operating earnings | $ | 185 |  |  | $ | 145 |  |  | $ | 404 |  |  | $ | 296 |
Non-core items | 25 |  |  | — |  |  | (49 | ) |  | 2 |
Net earnings attributable to shareholders | $ | 210 |  |  | $ | 145 |  |  | $ | 355 |  |  | $ | 298 |
Diluted per share amounts: |  |  |  |  |  |  |
Core net operating earnings | $ | 2.04 |  |  | $ | 1.61 |  |  | $ | 4.46 |  |  | $ | 3.29 |
Realized gains (losses) on securities | 0.27 |  |  | 0.05 |  |  | (0.54 | ) |  | 0.08 |
Loss on retirement of debt | — |  |  | (0.05 | ) |  | — |  |  | (0.05 | )
Net earnings attributable to shareholders | $ | 2.31 |  |  | $ | 1.61 |  |  | $ | 3.92 |  |  | $ | 3.32 |

Net earnings attributable to shareholders increased $65 million in the second quarter of 2018 compared to the same period in 2017 due to higher core net operating earnings, higher net realized gains on securities in the 2018 period compared to the 2017 period and a loss on retirement of debt in the second quarter of 2017. Core net operating earnings increased $40 million in the second quarter of 2018 compared to the same period in 2017, reflecting higher earnings in the annuity segment, higher net investment income in the property and casualty segment, lower interest charges on borrowed money and a lower corporate income tax rate. Realized gains on securities in the second quarter of 2018 includes the increase in fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Net earnings attributable to shareholders increased $57 million in the first six months of 2018 compared to the same period in 2017 due primarily to higher core net operating earnings in the 2018 period and a loss on retirement of debt in the 2017 period, partially offset by net realized losses on securities in the 2018 period compared to net realized gains on securities in the 2017 period. Core net operating earnings increased $108 million in the first six months of 2018 compared to the same period in 2017, reflecting higher earnings in the annuity segment, higher underwriting profit and net investment income in the property and casualty insurance segment, lower interest charges on borrowed money and a lower corporate income tax rate. Realized losses on securities in the first six months of 2018 includes the decline in fair value of equity securities that are required to be carried at fair value through net earnings under new accounting guidance adopted on January 1, 2018.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
RESULTS OF OPERATIONS — QUARTERS ENDED JUNE 30, 2018 AND 2017
Segmented Statement of Earnings AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).
Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the three months ended June 30, 2018 and 2017 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):

|  |  |  |  | Other |  |  |  |  |  |
| P&C |  | Annuity |  | Consol. MIEs |  | Holding Co., other and unallocated |  | Total |  | Non-core reclass |  | GAAP Total
Three months ended June 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance net earned premiums | $ | 1,161 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 1,161 |  |  | $ | — |  |  | $ | 1,161 |
Life, accident and health net earned premiums | — |  |  | — |  |  | — |  |  | 6 |  |  | 6 |  |  | — |  |  | 6 |
Net investment income | 115 |  |  | 412 |  |  | (4 | ) |  | 7 |  |  | 530 |  |  | — |  |  | 530 |
Realized gains on securities | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 31 |  |  | 31 |
Income (loss) of MIEs: |  |  |  |  |  |  |  |  |  |  |  |  |
Investment income | — |  |  | — |  |  | 64 |  |  | — |  |  | 64 |  |  | — |  |  | 64 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | — |  |  | (2 | ) |  | — |  |  | (2 | ) |  | — |  |  | (2 | )
Other income | 2 |  |  | 27 |  |  | (4 | ) |  | 18 |  |  | 43 |  |  | — |  |  | 43 |
Total revenues | 1,278 |  |  | 439 |  |  | 54 |  |  | 31 |  |  | 1,802 |  |  | 31 |  |  | 1,833 |
Costs and Expenses: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss adjustment expenses | 693 |  |  | — |  |  | — |  |  | — |  |  | 693 |  |  | — |  |  | 693 |
Commissions and other underwriting expenses | 396 |  |  | — |  |  | — |  |  | 4 |  |  | 400 |  |  | — |  |  | 400 |
Annuity benefits | — |  |  | 260 |  |  | — |  |  | — |  |  | 260 |  |  | — |  |  | 260 |
Life, accident and health benefits | — |  |  | — |  |  | — |  |  | 11 |  |  | 11 |  |  | — |  |  | 11 |
Annuity and supplemental insurance acquisition expenses | — |  |  | 49 |  |  | — |  |  | 1 |  |  | 50 |  |  | — |  |  | 50 |
Interest charges on borrowed money | — |  |  | — |  |  | — |  |  | 16 |  |  | 16 |  |  | — |  |  | 16 |
Expenses of MIEs | — |  |  | — |  |  | 54 |  |  | — |  |  | 54 |  |  | — |  |  | 54 |
Other expenses | 11 |  |  | 31 |  |  | — |  |  | 47 |  |  | 89 |  |  | — |  |  | 89 |
Total costs and expenses | 1,100 |  |  | 340 |  |  | 54 |  |  | 79 |  |  | 1,573 |  |  | — |  |  | 1,573 |
Earnings before income taxes | 178 |  |  | 99 |  |  | — |  |  | (48 | ) |  | 229 |  |  | 31 |  |  | 260 |
Provision for income taxes | 37 |  |  | 21 |  |  | — |  |  | (12 | ) |  | 46 |  |  | 6 |  |  | 52 |
Net earnings, including noncontrolling interests | 141 |  |  | 78 |  |  | — |  |  | (36 | ) |  | 183 |  |  | 25 |  |  | 208 |
Less: Net earnings (loss) attributable to noncontrolling interests | (2 | ) |  | — |  |  | — |  |  | — |  |  | (2 | ) |  | — |  |  | (2 | )
Core Net Operating Earnings | 143 |  |  | 78 |  |  | — |  |  | (36 | ) |  | 185 |  |  |  |  |
Non-core earnings attributable to shareholders (a): |  |  |  |  |  |  |  |  |  |  |  |  |
Realized gains on securities, net of tax | — |  |  | — |  |  | — |  |  | 25 |  |  | 25 |  |  | (25 | ) |  | — |
Net Earnings Attributable to Shareholders | $ | 143 |  |  | $ | 78 |  |  | $ | — |  |  | $ | (11 | ) |  | $ | 210 |  |  | $ | — |  |  | $ | 210 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

|  | Other |  |  |  |  |  |
| P&C |  | Annuity |  | Consol. MIEs |  | Holding Co., other and unallocated |  | Total |  | Non-core reclass |  | GAAP Total
Three months ended June 30, 2017 |  |  |  |  |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance net earned premiums | $ | 1,065 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 1,065 |  |  | $ | — |  |  | $ | 1,065 |
Life, accident and health net earned premiums | — |  |  | — |  |  | — |  |  | 5 |  |  | 5 |  |  | — |  |  | 5 |
Net investment income | 96 |  |  | 360 |  |  | (5 | ) |  | 9 |  |  | 460 |  |  | — |  |  | 460 |
Realized gains on securities | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 8 |  |  | 8 |
Income (loss) of MIEs: |  |  |  |  |  |  |  |  |  |  |  |  |
Investment income | — |  |  | — |  |  | 50 |  |  | — |  |  | 50 |  |  | — |  |  | 50 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | — |  |  | 11 |  |  | — |  |  | 11 |  |  | — |  |  | 11 |
Other income | 4 |  |  | 26 |  |  | (5 | ) |  | 22 |  |  | 47 |  |  | — |  |  | 47 |
Total revenues | 1,165 |  |  | 386 |  |  | 51 |  |  | 36 |  |  | 1,638 |  |  | 8 |  |  | 1,646 |
Costs and Expenses: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss adjustment expenses | 635 |  |  | — |  |  | — |  |  | — |  |  | 635 |  |  | — |  |  | 635 |
Commissions and other underwriting expenses | 358 |  |  | — |  |  | — |  |  | 8 |  |  | 366 |  |  | — |  |  | 366 |
Annuity benefits | — |  |  | 224 |  |  | — |  |  | — |  |  | 224 |  |  | — |  |  | 224 |
Life, accident and health benefits | — |  |  | — |  |  | — |  |  | 6 |  |  | 6 |  |  | — |  |  | 6 |
Annuity and supplemental insurance acquisition expenses | — |  |  | 47 |  |  | — |  |  | 1 |  |  | 48 |  |  | — |  |  | 48 |
Interest charges on borrowed money | — |  |  | — |  |  | — |  |  | 23 |  |  | 23 |  |  | — |  |  | 23 |
Expenses of MIEs | — |  |  | — |  |  | 51 |  |  | — |  |  | 51 |  |  | — |  |  | 51 |
Other expenses | 9 |  |  | 30 |  |  | — |  |  | 42 |  |  | 81 |  |  | 7 |  |  | 88 |
Total costs and expenses | 1,002 |  |  | 301 |  |  | 51 |  |  | 80 |  |  | 1,434 |  |  | 7 |  |  | 1,441 |
Earnings before income taxes | 163 |  |  | 85 |  |  | — |  |  | (44 | ) |  | 204 |  |  | 1 |  |  | 205 |
Provision for income taxes | 52 |  |  | 30 |  |  | — |  |  | (23 | ) |  | 59 |  |  | 1 |  |  | 60 |
Net earnings, including noncontrolling interests | 111 |  |  | 55 |  |  | — |  |  | (21 | ) |  | 145 |  |  | — |  |  | 145 |
Less: Net earnings attributable to noncontrolling interests | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | — |
Core Net Operating Earnings | 111 |  |  | 55 |  |  | — |  |  | (21 | ) |  | 145 |  |  |  |  |
Non-core earnings attributable to shareholders (a): |  |  |  |  |  |  |  |  |  |  |  |  |
Realized gains on securities, net of tax | — |  |  | — |  |  | — |  |  | 5 |  |  | 5 |  |  | (5 | ) |  | — |
Loss on retirement of debt, net of tax | — |  |  | — |  |  | — |  |  | (5 | ) |  | (5 | ) |  | 5 |  |  | — |
Net Earnings Attributable to Shareholders | $ | 111 |  |  | $ | 55 |  |  | $ | — |  |  | $ | (21 | ) |  | $ | 145 |  |  | $ | — |  |  | $ | 145 |

(a) | See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

Property and Casualty Insurance Segment — Results of Operations Performance measures such as underwriting profit or loss and related combined ratios are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses and loss adjustment expenses, and commissions and other underwriting expenses to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect net investment income, other income, other expenses or federal income taxes.
AFG’s property and casualty insurance operations contributed $178 million in pretax earnings in the second quarter of 2018 compared to $163 million in the second quarter of 2017, an increase of $15 million (9%). The increase in pretax earnings reflects higher net investment income due primarily to higher earnings from limited partnerships and similar investments. These high returns should not necessarily be expected to repeat in future periods.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the three months ended June 30, 2018 and 2017 (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Gross written premiums | $ | 1,665 |  |  | $ | 1,503 |  |  | 11 | %
Reinsurance premiums ceded | (408 | ) |  | (373 | ) |  | 9 | %
Net written premiums | 1,257 |  |  | 1,130 |  |  | 11 | %
Change in unearned premiums | (96 | ) |  | (65 | ) |  | 48 | %
Net earned premiums | 1,161 |  |  | 1,065 |  |  | 9 | %
Loss and loss adjustment expenses | 693 |  |  | 635 |  |  | 9 | %
Commissions and other underwriting expenses | 396 |  |  | 358 |  |  | 11 | %
Underwriting gain | 72 |  |  | 72 |  |  | — | %
Net investment income | 115 |  |  | 96 |  |  | 20 | %
Other income and expenses, net | (9 | ) |  | (5 | ) |  | 80 | %
Earnings before income taxes | $ | 178 |  |  | $ | 163 |  |  | 9 | %
Combined Ratios: |  |  |  |  |
Specialty lines |  |  |  |  | Change
Loss and LAE ratio | 59.7 | % |  | 59.5 | % |  | 0.2 | %
Underwriting expense ratio | 34.0 | % |  | 33.7 | % |  | 0.3 | %
Combined ratio | 93.7 | % |  | 93.2 | % |  | 0.5 | %
Aggregate — including exited lines |  |  |  |  |
Loss and LAE ratio | 59.7 | % |  | 59.7 | % |  | — | %
Underwriting expense ratio | 34.0 | % |  | 33.7 | % |  | 0.3 | %
Combined ratio | 93.7 | % |  | 93.4 | % |  | 0.3 | %

AFG reports the underwriting performance of its Specialty property and casualty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.
To understand the overall profitability of particular lines, the timing of claims payments and the related impact of investment income must be considered. Certain “short-tail” lines of business (primarily property coverages) generally have quick loss payouts, which reduce the time funds are held, thereby limiting investment income earned thereon. In contrast, “long-tail” lines of business (primarily liability coverages and workers’ compensation) generally have payouts that are either structured over many years or take many years to settle, thereby significantly increasing investment income earned on related premiums received.
Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.67 billion for the second quarter of 2018 compared to $1.50 billion for the second quarter of 2017, an increase of $162 million (11%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  |
| GWP |  | % |  | GWP |  | % |  | % Change
Property and transportation | $ | 615 |  |  | 37 | % |  | $ | 573 |  |  | 38 | % |  | 7 | %
Specialty casualty | 858 |  |  | 52 | % |  | 756 |  |  | 50 | % |  | 13 | %
Specialty financial | 192 |  |  | 11 | % |  | 174 |  |  | 12 | % |  | 10 | %
| $ | 1,665 |  |  | 100 | % |  | $ | 1,503 |  |  | 100 | % |  | 11 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 25% of gross written premiums for both the second quarter of 2018 and the second quarter of 2017. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | Change in
| Ceded |  | % of GWP |  | Ceded |  | % of GWP |  | % of GWP
Property and transportation | $ | (193 | ) |  | 31 | % |  | $ | (180 | ) |  | 31 | % |  | — | %
Specialty casualty | (219 | ) |  | 26 | % |  | (195 | ) |  | 26 | % |  | — | %
Specialty financial | (33 | ) |  | 17 | % |  | (25 | ) |  | 14 | % |  | 3 | %
Other specialty | 37 |  |  |  |  | 27 |  |  |  |  |
| $ | (408 | ) |  | 25 | % |  | $ | (373 | ) |  | 25 | % |  | — | %

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.26 billion for the second quarter of 2018 compared to $1.13 billion for the second quarter of 2017, an increase of $127 million (11%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  |
| NWP |  | % |  | NWP |  | % |  | % Change
Property and transportation | $ | 422 |  |  | 33 | % |  | $ | 393 |  |  | 35 | % |  | 7 | %
Specialty casualty | 639 |  |  | 51 | % |  | 561 |  |  | 50 | % |  | 14 | %
Specialty financial | 159 |  |  | 13 | % |  | 149 |  |  | 13 | % |  | 7 | %
Other specialty | 37 |  |  | 3 | % |  | 27 |  |  | 2 | % |  | 37 | %
| $ | 1,257 |  |  | 100 | % |  | $ | 1,130 |  |  | 100 | % |  | 11 | %

Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.16 billion for the second quarter of 2018 compared to $1.07 billion for the second quarter of 2017, an increase of $96 million (9%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  |
| NEP |  | % |  | NEP |  | % |  | % Change
Property and transportation | $ | 374 |  |  | 32 | % |  | $ | 357 |  |  | 34 | % |  | 5 | %
Specialty casualty | 595 |  |  | 51 | % |  | 537 |  |  | 50 | % |  | 11 | %
Specialty financial | 159 |  |  | 14 | % |  | 146 |  |  | 14 | % |  | 9 | %
Other specialty | 33 |  |  | 3 | % |  | 25 |  |  | 2 | % |  | 32 | %
| $ | 1,161 |  |  | 100 | % |  | $ | 1,065 |  |  | 100 | % |  | 9 | %

The $162 million (11%) increase in gross written premiums for the second quarter of 2018 compared to the second quarter of 2017 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates increased approximately 1% in the second quarter of 2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.
Property and transportation Gross written premiums increased $42 million (7%) in the second quarter of 2018 compared to the second quarter of 2017. This increase was the result of new business opportunities in the property and inland marine business and higher premiums in the transportation businesses, which included a 5% average renewal rate increase in National Interstate’s business. Average renewal rates increased approximately 4% for this group in the second quarter of 2018. Reinsurance premiums ceded as a percentage of gross written premiums are comparable between periods.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Specialty casualty Gross written premiums increased $102 million (13%) in the second quarter of 2018 compared to the second quarter of 2017 due primarily to growth at Neon. Higher gross written premiums in the general liability, executive liability and excess and surplus lines businesses also contributed to the year-over-year growth, partially offset by lower gross written premiums in the workers’ compensation businesses. Average renewal rates were flat for this group in the second quarter of 2018. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 3%. Reinsurance premiums ceded as a percentage of gross written premiums reflect higher cessions to AFG’s internal reinsurance program, which is included in Other specialty, offset by lower cessions at Neon.
Specialty financial Gross written premiums increased $18 million (10%) in the second quarter of 2018 compared to the second quarter of 2017 due primarily to higher premiums in the financial institutions business. Average renewal rates for this group increased approximately 5% in the second quarter of 2018. Reinsurance premiums ceded as a percentage of gross written premiums increased 3 percentage points for the second quarter of 2018 compared to the second quarter of 2017, reflecting higher cessions in the financial institutions and equipment leasing businesses.
Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $10 million (37%) in the second quarter of 2018 compared to the second quarter of 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.
Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:

| Three months ended June 30, |  |  |  | Three months ended June 30,
| 2018 |  | 2017 |  | Change |  | 2018 |  | 2017
Property and transportation |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 63.8 | % |  | 64.9 | % |  | (1.1 | %) |  |  |  |
Underwriting expense ratio | 30.1 | % |  | 29.3 | % |  | 0.8 | % |  |  |  |
Combined ratio | 93.9 | % |  | 94.2 | % |  | (0.3 | %) |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 23 |  |  | $ | 21 |
Specialty casualty |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 63.4 | % |  | 63.1 | % |  | 0.3 | % |  |  |  |
Underwriting expense ratio | 31.7 | % |  | 31.6 | % |  | 0.1 | % |  |  |  |
Combined ratio | 95.1 | % |  | 94.7 | % |  | 0.4 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 29 |  |  | $ | 29 |
Specialty financial |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 33.9 | % |  | 33.1 | % |  | 0.8 | % |  |  |  |
Underwriting expense ratio | 51.7 | % |  | 51.3 | % |  | 0.4 | % |  |  |  |
Combined ratio | 85.6 | % |  | 84.4 | % |  | 1.2 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 22 |  |  | $ | 23 |
Total Specialty |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 59.7 | % |  | 59.5 | % |  | 0.2 | % |  |  |  |
Underwriting expense ratio | 34.0 | % |  | 33.7 | % |  | 0.3 | % |  |  |  |
Combined ratio | 93.7 | % |  | 93.2 | % |  | 0.5 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 73 |  |  | $ | 73 |
Aggregate — including exited lines |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 59.7 | % |  | 59.7 | % |  | — | % |  |  |  |
Underwriting expense ratio | 34.0 | % |  | 33.7 | % |  | 0.3 | % |  |  |  |
Combined ratio | 93.7 | % |  | 93.4 | % |  | 0.3 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 72 |  |  | $ | 72 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The Specialty property and casualty insurance operations generated an underwriting profit of $73 million in both the second quarter of 2018 and the second quarter of 2017, reflecting strong results in both periods. Higher underwriting profit in the Property and transportation sub-segment was offset by lower underwriting profits in the Specialty financial sub-segment.
Property and transportation Underwriting profit for this group was $23 million for the second quarter of 2018 compared to $21 million in the second quarter of 2017, an increase of $2 million (10%). These results include higher year-over-year underwriting profits in the transportation businesses and improved results in the ocean marine operations and lower underwriting profitability in the property and inland marine and equine businesses.
Specialty casualty Underwriting profit for this group was $29 million for both the second quarter of 2018 and the second quarter of 2017. Higher underwriting profitability in the targeted markets businesses was offset by lower profitability in the excess and surplus lines businesses.
Specialty financial Underwriting profit for this group was $22 million for the second quarter of 2018 compared to $23 million in the second quarter of 2017, a decrease of $1 million (4%). Lower underwriting profits in the fidelity and surety businesses were offset by higher underwriting profits in the financial institutions business.
Other specialty This group reported an underwriting loss of $1 million in the second quarter of 2018 compared to an underwriting profit of less than $1 million in the second quarter of 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 59.7% for both the second quarter of 2018 and the second quarter of 2017. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):

| Three months ended June 30, |  |
| Amount |  | Ratio |  | Change in
| 2018 |  | 2017 |  | 2018 |  | 2017 |  | Ratio
Property and transportation |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 250 |  |  | $ | 232 |  |  | 66.7 | % |  | 65.0 | % |  | 1.7 | %
Prior accident years development | (21 | ) |  | (11 | ) |  | (5.6 | %) |  | (3.1 | %) |  | (2.5 | %)
Current year catastrophe losses | 10 |  |  | 11 |  |  | 2.7 | % |  | 3.0 | % |  | (0.3 | %)
Property and transportation losses and LAE and ratio | $ | 239 |  |  | $ | 232 |  |  | 63.8 | % |  | 64.9 | % |  | (1.1 | %)
Specialty casualty |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 392 |  |  | $ | 342 |  |  | 65.8 | % |  | 63.6 | % |  | 2.2 | %
Prior accident years development | (15 | ) |  | (5 | ) |  | (2.5 | %) |  | (0.9 | %) |  | (1.6 | %)
Current year catastrophe losses | 1 |  |  | 2 |  |  | 0.1 | % |  | 0.4 | % |  | (0.3 | %)
Specialty casualty losses and LAE and ratio | $ | 378 |  |  | $ | 339 |  |  | 63.4 | % |  | 63.1 | % |  | 0.3 | %
Specialty financial |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 59 |  |  | $ | 52 |  |  | 37.3 | % |  | 35.2 | % |  | 2.1 | %
Prior accident years development | (8 | ) |  | (8 | ) |  | (5.4 | %) |  | (5.4 | %) |  | — | %
Current year catastrophe losses | 3 |  |  | 5 |  |  | 2.0 | % |  | 3.3 | % |  | (1.3 | %)
Specialty financial losses and LAE and ratio | $ | 54 |  |  | $ | 49 |  |  | 33.9 | % |  | 33.1 | % |  | 0.8 | %
Total Specialty |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 721 |  |  | $ | 639 |  |  | 62.2 | % |  | 60.0 | % |  | 2.2 | %
Prior accident years development | (45 | ) |  | (23 | ) |  | (3.9 | %) |  | (2.2 | %) |  | (1.7 | %)
Current year catastrophe losses | 16 |  |  | 18 |  |  | 1.4 | % |  | 1.7 | % |  | (0.3 | %)
Total Specialty losses and LAE and ratio | $ | 692 |  |  | $ | 634 |  |  | 59.7 | % |  | 59.5 | % |  | 0.2 | %
Aggregate — including exited lines |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 721 |  |  | $ | 639 |  |  | 62.2 | % |  | 60.0 | % |  | 2.2 | %
Prior accident years development | (44 | ) |  | (22 | ) |  | (3.9 | %) |  | (2.0 | %) |  | (1.9 | %)
Current year catastrophe losses | 16 |  |  | 18 |  |  | 1.4 | % |  | 1.7 | % |  | (0.3 | %)
Aggregate losses and LAE and ratio | $ | 693 |  |  | $ | 635 |  |  | 59.7 | % |  | 59.7 | % |  | — | %

Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.2% for the second quarter of 2018 compared to 60.0% for the second quarter of 2017, an increase of 2.2 percentage points.
Property and transportation The 1.7 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio in the property and inland marine and equine businesses for the second quarter of 2018 compared to the second quarter of 2017.
Specialty casualty The 2.2 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio in the excess and surplus, workers’ compensation and targeted markets businesses.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Specialty financial The 2.1 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the financial institutions and trade credit businesses.
Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $45 million in the second quarter of 2018 compared to $23 million in the second quarter of 2017, an increase of $22 million (96%).
Property and transportation Net favorable reserve development of $21 million in the second quarter of 2018 reflects lower than expected losses in the crop business and lower than expected claim severity in the transportation businesses. Net favorable reserve development of $11 million in the second quarter of 2017 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine businesses, partially offset by higher than expected claim severity in the ocean marine business.
Specialty casualty Net favorable reserve development of $15 million in the second quarter of 2018 includes lower than anticipated claim frequency and severity in workers’ compensation business. Net favorable reserve development of $5 million in the second quarter of 2017 reflects lower than anticipated claim severity in the workers’ compensation businesses and at Neon, partially offset by higher than anticipated claim severity in the targeted markets and general liability businesses.
Specialty financial Net favorable reserve development of $8 million in the second quarter of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than anticipated claim severity in the financial institutions business. Net favorable reserve development of $8 million in the second quarter of 2017 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $1 million in the second quarter of 2018 and net adverse reserve development of $1 million in the second quarter of 2017, reflecting amortization of the deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $1 million in both the second quarters of 2018 and 2017 related to business outside of the Specialty insurance group that AFG no longer writes.
Catastrophe losses
AFG generally seeks to reduce its exposure to catastrophes through individual risk selection, including minimizing coastal and known fault-line exposures, and the purchase of reinsurance. Based on data available at December 31, 2017, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate should statistically occur once in every 100, 250 or 500 years as a percentage of AFG’s Shareholders’ Equity is shown below:

|  |  | Impact of modeled loss on AFG’s |
| Industry Model |  | Shareholders’ Equity |
| 100-year event |  | Less than 1% |
| 250-year event |  | Less than 2% |
| 500-year event |  | Less than 4% |

AFG maintains comprehensive catastrophe reinsurance coverage, including a $15 million per occurrence net retention for its U.S.-based property and casualty insurance operations for losses up to $100 million and a separate $15 million per occurrence retention for Neon for losses up to $200 million ($225 million for U.S. catastrophe events). AFG’s property and casualty insurance operations further maintain supplemental fully collateralized reinsurance coverage up to 95% of $200 million for catastrophe losses in excess of $100 million of traditional catastrophe reinsurance through a catastrophe bond.
Catastrophe losses of $16 million in the second quarter of 2018 resulted primarily from storms and flooding in several regions of the United States. Catastrophe losses of $18 million in the second quarter of 2017 resulted primarily from storms and tornadoes in several regions of the United States.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $396 million in the second quarter of 2018 compared to $358 million for the second quarter of 2017, an increase of $38 million (11%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 34.0% for the second quarter of 2018 compared to 33.7% for the second quarter of 2017, an increase of 0.3 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | Change in
| U/W Exp |  | % of NEP |  | U/W Exp |  | % of NEP |  | % of NEP
Property and transportation | $ | 112 |  |  | 30.1 | % |  | $ | 104 |  |  | 29.3 | % |  | 0.8 | %
Specialty casualty | 188 |  |  | 31.7 | % |  | 169 |  |  | 31.6 | % |  | 0.1 | %
Specialty financial | 83 |  |  | 51.7 | % |  | 74 |  |  | 51.3 | % |  | 0.4 | %
Other specialty | 13 |  |  | 36.8 | % |  | 11 |  |  | 36.3 | % |  | 0.5 | %
| $ | 396 |  |  | 34.0 | % |  | $ | 358 |  |  | 33.7 | % |  | 0.3 | %

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8 percentage points in the second quarter of 2018 compared to the second quarter of 2017, reflecting a change in the mix of business.
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.1 percentage points in the second quarter of 2018 compared to the second quarter of 2017, reflecting growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group.
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.4 percentage points in the second quarter of 2018 compared to the second quarter of 2017, reflecting higher profitability-based commissions paid to agents in the financial institutions business.
Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $115 million in the second quarter of 2018 compared to $96 million in the second quarter of 2017, an increase of $19 million (20%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):

| Three months ended June 30, |  |  |  |
| 2018 |  | 2017 |  | Change |  | % Change
Net investment income | $ | 115 |  |  | $ | 96 |  |  | $ | 19 |  |  | 20 | %
Average invested assets (at amortized cost) | $ | 10,346 |  |  | $ | 9,947 |  |  | $ | 399 |  |  | 4 | %
Yield (net investment income as a % of average invested assets) | 4.45 | % |  | 3.86 | % |  | 0.59 | % |  |  |
Tax equivalent yield (*) | 4.62 | % |  | 4.32 | % |  | 0.30 | % |  |

(*) Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.
The property and casualty insurance segment’s increase in net investment income for the second quarter of 2018 as compared to the second quarter of 2017 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 4.45% for the second quarter of 2018 compared to 3.86% for the second quarter of 2017, an increase of 0.59 percentage points, due primarily to the higher earnings from limited partnerships and similar investments.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $9 million for the second quarter of 2018 compared to $5 million in the second quarter of 2017, an increase of $4 million (80%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):

| Three months ended June 30,
| 2018 |  | 2017
Other income |  |  |
Income from the sale of real estate | $ | — |  |  | $ | 3 |
Other | 2 |  |  | 1 |
Total other income | 2 |  |  | 4 |
Other expenses |  |  |
Amortization of intangibles | 2 |  |  | 2 |
Other | 9 |  |  | 7 |
Total other expenses | 11 |  |  | 9 |
Other income and expenses, net | $ | (9 | ) |  | $ | (5 | )

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Annuity Segment — Results of Operations
AFG’s annuity operations contributed $99 million in pretax earnings in the second quarter of 2018 compared to $85 million in the second quarter of 2017, an increase of $14 million (16%). AFG’s annuity segment results for the second quarter of 2018 as compared to the second quarter of 2017 reflect a 10% increase in average investments (at amortized cost), higher earnings from limited partnerships and similar investments and the favorable impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”), partially offset by an unlocking charge in the second quarter of 2018 and the impact of lower investment yields due to the run-off of higher yielding investments. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The fair value of derivatives related to FIAs was favorably impacted by higher than anticipated interest rates in the second quarter of 2018 compared to the negative impact of lower than anticipated interest rates in the second quarter of 2017, partially offset in the 2018 period by the negative impacts of higher interest on the embedded derivative (from growth in the FIA business and higher interest rates) and higher than expected option costs. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment of actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018, resulting in a net charge to earnings of $27 million.
The following table details AFG’s earnings before income taxes from its annuity operations for the three months ended June 30, 2018 and 2017 (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Revenues: |  |  |  |  |
Net investment income | $ | 412 |  |  | $ | 360 |  |  | 14 | %
Other income: |  |  |  |  |
Guaranteed withdrawal benefit fees | 16 |  |  | 14 |  |  | 14 | %
Policy charges and other miscellaneous income | 11 |  |  | 12 |  |  | (8 | %)
Total revenues | 439 |  |  | 386 |  |  | 14 | %
Costs and Expenses: |  |  |  |  |
Annuity benefits (*) | 260 |  |  | 224 |  |  | 16 | %
Acquisition expenses | 49 |  |  | 47 |  |  | 4 | %
Other expenses | 31 |  |  | 30 |  |  | 3 | %
Total costs and expenses | 340 |  |  | 301 |  |  | 13 | %
Earnings before income taxes | $ | 99 |  |  | $ | 85 |  |  | 16 | %

Detail of annuity earnings before income taxes (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Earnings before income taxes — before the impact of unlocking and derivatives related to FIAs | $ | 123 |  |  | $ | 101 |  |  | 22 | %
Unlocking | (27 | ) |  | — |  |  | — | %
Impact of derivatives related to FIAs | 3 |  |  | (16 | ) |  | (119 | %)
Earnings before income taxes | $ | 99 |  |  | $ | 85 |  |  | 16 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

(*) | Annuity benefits consisted of the following (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Interest credited — fixed | $ | 173 |  |  | $ | 157 |  |  | 10 | %
Interest credited — fixed component of variable annuities | 2 |  |  | 2 |  |  | — | %
Other annuity benefits: |  |  |  |  |
Change in expected death and annuitization reserve | 4 |  |  | 4 |  |  | — | %
Amortization of sales inducements | 5 |  |  | 4 |  |  | 25 | %
Change in guaranteed withdrawal benefit reserve | 19 |  |  | 17 |  |  | 12 | %
Change in other benefit reserves | 11 |  |  | 9 |  |  | 22 | %
Total other annuity benefits | 39 |  |  | 34 |  |  | 15 | %
Total before impact of derivatives related to FIAs and unlocking | 214 |  |  | 193 |  |  | 11 | %
Derivatives related to fixed-indexed annuities: |  |  |  |  |
Embedded derivative mark-to-market | 82 |  |  | 112 |  |  | (27 | %)
Equity option mark-to-market | (90 | ) |  | (81 | ) |  | 11 | %
Impact of derivatives related to FIAs | (8 | ) |  | 31 |  |  | (126 | %)
Unlocking | 54 |  |  | — |  |  | — | %
Total annuity benefits | $ | 260 |  |  | $ | 224 |  |  | 16 | %

See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in the second quarter of 2018.
The profitability of a fixed annuity business is largely dependent on the ability of a company to earn income on the assets supporting the business in excess of the amounts credited to policyholder accounts plus expenses incurred (earning a “spread”). Performance measures such as net interest spread and net spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance.
Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of these spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Average fixed annuity investments (at amortized cost) | $ | 33,935 |  |  | $ | 30,988 |  |  | 10 | %
Average fixed annuity benefits accumulated | 34,165 |  |  | 31,212 |  |  | 9 | %
As % of fixed annuity benefits accumulated (except as noted): |  |  |  |  |  |  |
Net investment income (as % of fixed annuity investments) | 4.83 | % |  | 4.62 | % |  |
Interest credited — fixed | (2.02 | %) |  | (2.01 | %) |  |
Net interest spread | 2.81 | % |  | 2.61 | % |  |
Policy charges and other miscellaneous income | 0.10 | % |  | 0.12 | % |  |
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees | (0.27 | %) |  | (0.27 | %) |  |
Acquisition expenses | (0.89 | %) |  | (0.58 | %) |  |
Other expenses | (0.35 | %) |  | (0.38 | %) |  |
Change in fair value of derivatives related to fixed-indexed annuities | 0.10 | % |  | (0.39 | %) |  |
Unlocking | (0.32 | %) |  | — | % |  |
Net spread earned on fixed annuities | 1.18 | % |  | 1.11 | % |  |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:

| Three months ended June 30,
| 2018 |  | 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs | 1.46 | % |  | 1.32 | %
Unlocking | (0.32 | %) |  | — | %
Impact of derivatives related to fixed-indexed annuities: |  |  |
Change in fair value of derivatives | 0.10 | % |  | (0.39 | %)
Related impact on amortization of deferred policy acquisition costs (*) | (0.06 | %) |  | 0.18 | %
Related impact on amortization of deferred sales inducements (*) | — | % |  | — | %
Net spread earned on fixed annuities | 1.18 | % |  | 1.11 | %

(*) | An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

Annuity Net Investment Income
Net investment income for the second quarter of 2018 was $412 million compared to $360 million for the second quarter of 2017, an increase of $52 million (14%). This increase reflects the growth in AFG’s annuity business and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), increased by 0.21 percentage points to 4.83% from 4.62% in the second quarter of 2018 compared to the second quarter of 2017. This increase in net investment yield reflects higher earnings from limited partnerships and similar investments, partially offset by (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. During 2017, $4.9 billion in annuity segment investments with an average yield of 5.14% were redeemed or sold while the investments purchased during 2017 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.94%.
Annuity Interest Credited — Fixed
Interest credited — fixed for the second quarter of 2018 was $173 million compared to $157 million for the second quarter of 2017, an increase of $16 million (10%). This increase reflects the impact of growth in the annuity business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, increased 0.01 percentage points to 2.02% in the second quarter of 2018 from 2.01% in the second quarter of 2017.
Annuity Net Interest Spread
AFG’s net interest spread increased 0.20 percentage points to 2.81% from 2.61% in the second quarter of 2018 compared to the same period in 2017 due primarily to higher earnings from limited partnerships and similar investments, partially offset by lower investment yields. Features included in current annuity product offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.
Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate were $11 million for the second quarter of 2018 compared to $12 million for the second quarter of 2017, a decrease of $1 million (8%). Excluding the impact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2018, annuity policy charges and other miscellaneous income were $12 million for both the second quarter of 2018 and the second quarter of 2017. Excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income as a percentage of average fixed annuity benefits accumulated, decreased 0.02 percentage points to 0.10% from 0.12% in the second quarter of 2018 compared to the second quarter of 2017.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking), for the second quarter of 2018 were $23 million compared to $20 million for the second quarter of 2017, an increase of $3 million (15%). As a percentage of average fixed annuity benefits accumulated, these net expenses were 0.27% in both the second quarter of 2018 and the second quarter of 2017. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):

| Three months ended June 30,
| 2018 |  | 2017
Change in expected death and annuitization reserve | $ | 4 |  |  | $ | 4 |
Amortization of sales inducements | 5 |  |  | 4 |
Change in guaranteed withdrawal benefit reserve | 19 |  |  | 17 |
Change in other benefit reserves | 11 |  |  | 9 |
Other annuity benefits | 39 |  |  | 34 |
Offset guaranteed withdrawal benefit fees | (16 | ) |  | (14 | )
Other annuity benefits, net | $ | 23 |  |  | $ | 20 |

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefits expense in the second quarter of 2018.
Annuity Acquisition Expenses
Annuity acquisition expenses for the second quarter of 2018 were $49 million compared to $47 million for the second quarter of 2017, an increase of $2 million (4%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarter of 2018, annuity acquisition expenses were $77 million for the second quarter of 2018, an increase of $30 million (64%) compared to the second quarter of 2017, reflecting the acceleration/deceleration of DPAC amortization related to changes in the fair value of derivatives related to FIAs and growth in the business. Excluding the impact of the 2018 unlocking charge, AFG’s amortization of deferred policy acquisition costs (“DPAC”) and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.89% for the second quarter of 2018 compared to 0.58% for the second quarter of 2017 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during the second quarter of 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipated interest rates during the second quarter of 2017 on the fair value of derivatives related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.
The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated (excluding the impact of unlocking):

| Three months ended June 30,
| 2018 |  | 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC | 0.83 | % |  | 0.76 | %
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*) | 0.06 | % |  | (0.18 | %)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated | 0.89 | % |  | 0.58 | %

(*) | An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in the second quarter of 2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to future write-offs of DPAC or the present value of future profits on business in force of companies acquired (“PVFP”).
Annuity Other Expenses
Annuity other expenses were $31 million for the second quarter of 2018 compared to $30 million for the second quarter of 2017, an increase of $1 million (3%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses were 0.35% for the second quarter of 2018 and 0.38% for the second quarter of 2017. This decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is due primarily to growth in the business.
Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable-indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-based component (embedded derivative) of AFG’s annuity benefits accumulated, see Note C — “Fair Value Measurements” to the financial statements.
Excluding the impact of the 2018 unlocking charge, the net change in fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $8 million in the second quarter of 2018 and increased annuity benefits by $31 million in the second quarter of 2017. During the second quarter of 2018, the positive impact of higher than expected interest rates and strong market performance on the fair value of these derivatives was partially offset by the negative impact of higher than expected option costs. During the second quarter of 2017, the positive impact of strong stock market performance on the fair value of these derivatives was more than offset by the negative impact of lower than expected interest rates. As a percentage of average fixed annuity benefits accumulated, this net expense improved 0.49 percentage points to a net expense reduction of 0.10% in the second quarter of 2018 from a net expense of 0.39% in the second quarter of 2017.
Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Earnings before income taxes — before unlocking and change in fair value of derivatives related to FIAs | $ | 123 |  |  | $ | 101 |  |  | 22 | %
Unlocking | (27 | ) |  | — |  |  | — | %
Impact of derivatives related to fixed-indexed annuities: |  |  |  |  |
Change in fair value of derivatives related to FIAs | 8 |  |  | (31 | ) |  | (126 | %)
Related impact on amortization of DPAC (*) | (5 | ) |  | 15 |  |  | (133 | %)
Earnings before income taxes | $ | 99 |  |  | $ | 85 |  |  | 16 | %

(*) | An estimate of the related acceleration/deceleration of the amortization of deferred sales inducements and deferred policy acquisition costs.

As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC, increased the annuity segment’s earnings before income taxes by $3 million in the second quarter of 2018 and decreased the annuity segment’s earnings before income taxes by $16 million in the second quarter of 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Interest on the embedded derivative liability | $ | (8 | ) |  | $ | (4 | ) |  | 100 | %
Changes in interest rates higher (lower) than expected | 12 |  |  | (17 | ) |  | (171 | %)
Change in the stock market, including volatility | 6 |  |  | 5 |  |  | 20 | %
Renewal option costs lower (higher) than expected | (3 | ) |  | 1 |  |  | (400 | %)
Other, including the impact of actual versus expected lapses | (4 | ) |  | (1 | ) |  | 300 | %
Impact of derivatives related to FIAs | $ | 3 |  |  | $ | (16 | ) |  | (119 | %)

See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on the change in the fair value of the embedded derivative liability in the second quarter of 2018.
Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.07 percentage points to 1.18% from 1.11% in the second quarter of 2018 compared to the same period in 2017 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.20 percentage points increase in AFG’s net interest spread, partially offset by the unlocking of actuarial assumptions discussed below.
Annuity Benefits Accumulated
Annuity premiums received and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited and other benefits are charged to expense and decreases for surrender and other policy charges are credited to other income.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the three months ended June 30, 2018 and 2017 (in millions):

| Three months ended June 30,
| 2018 |  | 2017
Beginning fixed annuity reserves | $ | 33,652 |  |  | $ | 30,719 |
Fixed annuity premiums (receipts) | 1,393 |  |  | 1,258 |
Surrenders, benefits and other withdrawals | (706 | ) |  | (571 | )
Interest and other annuity benefit expenses: |  |  |
Interest credited | 173 |  |  | 157 |
Embedded derivative mark-to-market | 82 |  |  | 112 |
Change in other benefit reserves | 29 |  |  | 29 |
Unlocking | 55 |  |  | — |
Ending fixed annuity reserves | $ | 34,678 |  |  | $ | 31,704 |
Reconciliation to annuity benefits accumulated per balance sheet: |  |  |
Ending fixed annuity reserves (from above) | $ | 34,678 |  |  | $ | 31,704 |
Impact of unrealized investment related gains | 32 |  |  | 128 |
Fixed component of variable annuities | 176 |  |  | 182 |
Annuity benefits accumulated per balance sheet | $ | 34,886 |  |  | $ | 32,014 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $1.40 billion in the second quarter of 2018 compared to $1.27 billion in the second quarter of 2017, an increase of $133 million (11%). The following table summarizes AFG’s annuity sales (dollars in millions):

| Three months ended June 30, |  |
2018 |  | 2017 |  | % Change
Financial institutions single premium annuities — indexed | $ | 448 |  |  | $ | 500 |  |  | (10 | %)
Financial institutions single premium annuities — fixed | 131 |  |  | 215 |  |  | (39 | %)
Retail single premium annuities — indexed | 378 |  |  | 265 |  |  | 43 | %
Retail single premium annuities — fixed | 23 |  |  | 19 |  |  | 21 | %
Broker dealer single premium annuities — indexed | 355 |  |  | 209 |  |  | 70 | %
Broker dealer single premium annuities — fixed | 4 |  |  | 3 |  |  | 33 | %
Education market — fixed and indexed annuities | 54 |  |  | 47 |  |  | 15 | %
Total fixed annuity premiums | 1,393 |  |  | 1,258 |  |  | 11 | %
Variable annuities | 6 |  |  | 8 |  |  | (25 | %)
Total annuity premiums | $ | 1,399 |  |  | $ | 1,266 |  |  | 11 | %

Management attributes the 11% increase in annuity premiums in the second quarter of 2018 compared to the second quarter of 2017 to the introduction of new products and an improving interest rate environment in the first half of 2018.
On June 21, 2018, the United States Fifth Circuit Court of Appeals (“Fifth Circuit”) issued a mandate of its decision vacating the Department of Labor (“DOL”) Fiduciary Rule in its entirety. The Fifth Circuit’s order to vacate the DOL Fiduciary Rule applies nationwide. The law regarding fiduciary status is once again the law in effect prior to the DOL Fiduciary Rule.
On April 18, 2018, the U.S. Securities and Exchange Commission released a package of regulatory proposals to enhance standards of conduct, including a proposal to enhance the standard of conduct owed by broker-dealers to their clients known as Regulation Best Interest. If adopted as proposed, the Regulation Best Interest would heighten the standard that registered representatives need to meet when making a recommendation by requiring them to act in the best interest of the retail customer at the time of the recommendation. Regulation Best Interest further proposes that satisfying this duty would require (i) disclosing to the customer the key facts about the relationship, (ii) exercising reasonable diligence, care, skill and prudence in recommending a product that is in the client’s best interest, and (iii) disclosing, mitigating or eliminating conflicts of interests arising from financial incentives and disclosing other conflicts.
Although approximately 70-75% of AFG’s premiums come through registered representatives associated with broker-dealers, neither traditional fixed annuities nor fixed-indexed annuities are securities. Based on AFG’s initial assessment, if the proposals are adopted as is, the new requirements would not be expected to have a material impact on AFG’s premiums.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Annuity Unlocking
AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment or actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free interest rates), AFG unlocked its assumptions for option costs, interest rates and policyholder lapse behavior in the second quarter of 2018. AFG will continue its practice of conducting detailed reviews of its assumptions (including option costs and interest rates) in the fourth quarter each year, including 2018.
The unlocking of the major actuarial assumptions underlying AFG’s annuity operations in the second quarter of 2018 resulted in a net charge related to its annuity business of $27 million, which impacted AFG’s financial statements as follows (in millions):

|  | Three months ended June 30,
|  | 2018 |  | 2017
Policy charges and other miscellaneous income: |  |  |  |
Unearned revenue |  | $ | (1 | ) |  | $ | — |
Total revenues |  | (1 | ) |  | — |
Annuity benefits: |  |  |  |
Fixed-indexed annuity embedded derivative |  | 44 |  |  | — |
Sales inducements |  | (1 | ) |  | — |
Other reserves |  | 11 |  |  | — |
Total annuity benefits |  | 54 |  |  | — |
Annuity and supplemental insurance acquisition expenses: |  |  |  |
Deferred policy acquisition costs |  | (28 | ) |  | — |
Total costs and expenses |  | 26 |  |  | — |
Net charge |  | $ | (27 | ) |  | $ | — |

The net charge from unlocking annuity assumptions in the second quarter of 2018 is due primarily to the unfavorable impact of higher projected option costs, partially offset by the favorable impact of an increase in projected net interest spreads on in-force business (due primarily to higher than previously anticipated reinvestment rates). Reinvestment rate assumptions are based primarily on 7-year and 10-year corporate bond yields. For the 2018 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 4.44% in the second half of 2018, grading up ratably to an ultimate net reinvestment rate of 5.55% in 2022 and beyond.
The table below compares the reinvestment rate assumed on assets purchased to directly support “fixed annuity benefits accumulated” in AFG’s fourth quarter unlockings for the next calendar year to the actual reinvestment rate achieved in that period (both net of investment expenses):

|  | First |  |  |  |
Unlocking |  | Investment |  | Reinvestment Rate
Year |  | Period |  | Assumed (a) |  | Achieved
2014 |  | 2015 |  | 3.75 | % |  | 4.27 | %
2015 |  | 2016 |  | 4.05 | % |  | 4.27 | %
2016 |  | 2017 |  | 4.42 | % |  | 3.95 | %
2017 |  | 2018 (b) |  | 4.17 | % |  | 4.43 | %
2018 |  | July 2018 |  | 4.62 | % |  | n/a |

(a) | Assumed reinvestment rates exclude default rates of 0.18% in each period.

(b) | Reinvestment rate achieved is for the six months ended June 30, 2018.

Management believes that these results over the last several years demonstrate that AFG’s investment rate assumptions are reasonable and prudent. During 2017, long-term interest rates were lower than anticipated and credit spreads narrowed, resulting in a lower achieved reinvestment rate than assumed in the 2016 unlocking. In addition to the reinvestment rates above, actual default rates in the first six months of 2018 and in 2017, 2016 and 2015 were lower than the long-term default rates of 0.18% assumed in the unlocking in each of the periods above.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the three months ended June 30, 2018 and 2017 (in millions):

| Three months ended June 30,
| 2018 |  | 2017
Earnings on fixed annuity benefits accumulated | $ | 101 |  |  | $ | 87 |
Earnings impact of investments in excess of fixed annuity benefits accumulated (*) | (3 | ) |  | (3 | )
Variable annuity earnings | 1 |  |  | 1 |
Earnings before income taxes | $ | 99 |  |  | $ | 85 |

(*) | Net investment income (as a % of investments) of 4.83% and 4.62% for the three months ended June 30, 2018 and 2017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Holding Company, Other and Unallocated — Results of Operations AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $48 million in the second quarter of 2018 compared to $51 million in the second quarter of 2017, a decrease of $3 million (6%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $48 million in the second quarter of 2018 compared to $44 million in the second quarter of 2017, an increase of $4 million (9%).
The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the three months ended June 30, 2018 and 2017 (dollars in millions):

| Three months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Revenues: |  |  |  |  |
Life, accident and health net earned premiums | $ | 6 |  |  | $ | 5 |  |  | 20 | %
Net investment income | 7 |  |  | 9 |  |  | (22 | %)
Other income — P&C fees | 15 |  |  | 15 |  |  | — | %
Other income | 3 |  |  | 7 |  |  | (57 | %)
Total revenues | 31 |  |  | 36 |  |  | (14 | %)
Costs and Expenses, excluding interest charges on borrowed money |  |  |  |  |
Property and casualty insurance — commissions and other underwriting expenses | 4 |  |  | 8 |  |  | (50 | %)
Life, accident and health benefits | 11 |  |  | 6 |  |  | 83 | %
Life, accident and health acquisition expenses | 1 |  |  | 1 |  |  | — | %
Other expense — expenses associated with P&C fees | 11 |  |  | 7 |  |  | 57 | %
Other expenses (*) | 36 |  |  | 35 |  |  | 3 | %
Costs and expenses, excluding interest charges on borrowed money | 63 |  |  | 57 |  |  | 11 | %
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money | (32 | ) |  | (21 | ) |  | 52 | %
Interest charges on borrowed money | 16 |  |  | 23 |  |  | (30 | %)
Core loss before income taxes, excluding realized gains and losses | (48 | ) |  | (44 | ) |  | 9 | %
Pretax non-core loss on retirement of debt | — |  |  | (7 | ) |  | (100 | %)
GAAP loss before income taxes, excluding realized gains and losses | $ | (48 | ) |  | $ | (51 | ) |  | (6 | %)

(*) | Excludes a pretax non-core loss on retirement of debt of $7 million in the second quarter of 2017.

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $6 million and related benefits and acquisition expenses of $12 million in the second quarter of 2018 compared to net earned premiums of $5 million and related benefits and acquisition expenses of $7 million in the second quarter of 2017. The $5 million (83%) increase in life, accident and health benefits reflects higher claims in the run-off life business.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $7 million in the second quarter of 2018 compared to $9 million in the second quarter of 2017, a decrease of $2 million (22%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities decreased in value by $1 million in the second quarter of 2018 compared to an increase in value by $1 million in the second quarter of 2017.
Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In both the second quarter of 2018 and 2017, AFG collected $15 million in fees for these services. Management views this fee income, net of the $11 million in the second quarter of 2018 and $7 million in the second quarter of 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.
Holding Company and Other — Other Income
Other income in the table above includes $4 million in the second quarter of 2018 and $5 million in the second quarter of 2017, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” AFG recorded a $2 million loss on the disposal of equipment in the second quarter of 2018. Excluding amounts eliminated in consolidation and the loss on the disposal of equipment, AFG recorded other income outside of its property and casualty insurance and annuity operations of $1 million in the second quarter of 2018 compared to $2 million in the second quarter of 2017.
Holding Company and Other — Other Expenses
Excluding the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $36 million in the second quarter of 2018 compared to $35 million in the second quarter of 2017, an increase of $1 million (3%). The second quarter of 2018 reflects lower holding company expenses related to employee benefit plans that are tied to stock market performance, offset by a $5 million charge to increase liabilities related to the environmental exposures of AFG’s former railroad and manufacturing operations.
Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of $16 million in the second quarter of 2018 compared to $23 million in the second quarter of 2017, a decrease of $7 million (30%) due primarily to a lower weighted average interest rate on AFG’s outstanding debt. The following table details the principal amount of AFG’s long-term debt balances as of April 1, 2018 compared to April 1, 2017 (dollars in millions):

| April 1, 2018 |  | April 1, 2017
Direct obligations of AFG: |  |  |
4.50% Senior Notes due June 2047 | $ | 590 |  |  | $ | — |
3.50% Senior Notes due August 2026 | 425 |  |  | 300 |
9-7/8% Senior Notes due June 2019 | — |  |  | 350 |
6-3/8% Senior Notes due June 2042 | — |  |  | 230 |
5-3/4% Senior Notes due August 2042 | — |  |  | 125 |
6-1/4% Subordinated Debentures due September 2054 | 150 |  |  | 150 |
6% Subordinated Debentures due November 2055 | 150 |  |  | 150 |
Other | 3 |  |  | 3 |
Total principal amount of Holding Company Debt | $ | 1,318 |  |  | $ | 1,308 |
Weighted Average Interest Rate | 4.6 | % |  | 6.5 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The decrease in the weighted average interest rate for the second quarter of 2018 as compared to the second quarter of 2017 reflects the following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:

• | Issued $350 million of 4.50% Senior Notes on June 2, 2017

• | Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017

• | Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017

• | Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017

• | Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017

• | Redeemed $350 million of 9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $7 million related to the redemption of its $230 million outstanding 6-3/8% Senior Notes due 2042 at par value in June 2017.
Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were a net gain of $31 million in the second quarter of 2018 compared to $8 million in the second quarter of 2017, an increase of $23 million (288%). Realized gains (losses) on securities consisted of the following (in millions):

| Three months ended June 30,
2018 |  | 2017
Realized gains (losses) before impairments: |  |  |
Disposals | $ | 5 |  |  | $ | 22 |
Change in the fair value of equity securities (*) | 23 |  |  | — |
Change in the fair value of derivatives | (1 | ) |  | (3 | )
Adjustments to annuity deferred policy acquisition costs and related items | 4 |  |  | (2 | )
| 31 |  |  | 17 |
Impairment charges: |  |  |
Securities | — |  |  | (12 | )
Adjustments to annuity deferred policy acquisition costs and related items | — |  |  | 3 |
| — |  |  | (9 | )
Realized gains on securities | $ | 31 |  |  | $ | 8 |

(*) | As discussed in Note A — “Accounting Policies — Investments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includes a $16 million net gain on securities that were still held at June 30, 2018.

The $23 million net realized gain from the change in the fair value of equity securities in the second quarter of 2018 includes gains of $10 million on real estate investment trusts, $8 million on health care-related investments and losses of $7 million from investments in banks and financing companies. AFG’s $12 million in impairment charges for the second quarter of 2017 related primarily to equity security investments in a pharmaceutical company and an energy-related business.
Consolidated Income Taxes AFG’s consolidated provision for income taxes was $52 million for the second quarter of 2018 compared to $60 million for the second quarter of 2017, a decrease of $8 million (13%). See Note L — “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.
Consolidated Noncontrolling Interests AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $2 million for the second quarter of 2018 related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
RESULTS OF OPERATIONS — SIX MONTHS ENDED JUNE 30, 2018 AND 2017
Segmented Statement of Earnings AFG reports its business as three segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity and (iii) Other, which includes run-off long-term care and life, holding company costs and income and expenses related to the managed investment entities (“MIEs”).
Effective January 1, 2018, the results of AFG’s run-off long-term care and life businesses are included in the “Other” segment instead of as a separate reportable segment based on the immaterial size of the remaining operations. Prior periods amounts were reclassified for consistent presentation.
AFG’s net earnings attributable to shareholders, determined in accordance with GAAP, include certain items that may not be indicative of its ongoing core operations. The following tables for the six months ended June 30, 2018 and 2017 identify such items by segment and reconcile net earnings attributable to shareholders to core net operating earnings, a non-GAAP financial measure that AFG believes is a useful tool for investors and analysts in analyzing ongoing operating trends (in millions):

|  |  |  |  | Other |  |  |  |  |  |
| P&C |  | Annuity |  | Consol. MIEs |  | Holding Co., other and unallocated |  | Total |  | Non-core reclass |  | GAAP Total
Six months ended June 30, 2018 |  |  |  |  |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance net earned premiums | $ | 2,268 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 2,268 |  |  | $ | — |  |  | $ | 2,268 |
Life, accident and health net earned premiums | — |  |  | — |  |  | — |  |  | 12 |  |  | 12 |  |  | — |  |  | 12 |
Net investment income | 215 |  |  | 806 |  |  | (7 | ) |  | 11 |  |  | 1,025 |  |  | — |  |  | 1,025 |
Realized losses on securities | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | (62 | ) |  | (62 | )
Income (loss) of MIEs: |  |  |  |  |  |  |  |  |  |  |  |  |
Investment income | — |  |  | — |  |  | 122 |  |  | — |  |  | 122 |  |  | — |  |  | 122 |
Gain (loss) on change in fair value of assets/liabilities | — |  |  | — |  |  | (5 | ) |  | — |  |  | (5 | ) |  | — |  |  | (5 | )
Other income | 4 |  |  | 53 |  |  | (8 | ) |  | 43 |  |  | 92 |  |  | — |  |  | 92 |
Total revenues | 2,487 |  |  | 859 |  |  | 102 |  |  | 66 |  |  | 3,514 |  |  | (62 | ) |  | 3,452 |
Costs and Expenses: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss adjustment expenses | 1,334 |  |  | — |  |  | — |  |  | — |  |  | 1,334 |  |  | — |  |  | 1,334 |
Commissions and other underwriting expenses | 771 |  |  | — |  |  | — |  |  | 10 |  |  | 781 |  |  | — |  |  | 781 |
Annuity benefits | — |  |  | 442 |  |  | — |  |  | — |  |  | 442 |  |  | — |  |  | 442 |
Life, accident and health benefits | — |  |  | — |  |  | — |  |  | 22 |  |  | 22 |  |  | — |  |  | 22 |
Annuity and supplemental insurance acquisition expenses | — |  |  | 130 |  |  | — |  |  | 2 |  |  | 132 |  |  | — |  |  | 132 |
Interest charges on borrowed money | — |  |  | — |  |  | — |  |  | 31 |  |  | 31 |  |  | — |  |  | 31 |
Expenses of MIEs | — |  |  | — |  |  | 102 |  |  | — |  |  | 102 |  |  | — |  |  | 102 |
Other expenses | 20 |  |  | 63 |  |  | — |  |  | 91 |  |  | 174 |  |  | — |  |  | 174 |
Total costs and expenses | 2,125 |  |  | 635 |  |  | 102 |  |  | 156 |  |  | 3,018 |  |  | — |  |  | 3,018 |
Earnings before income taxes | 362 |  |  | 224 |  |  | — |  |  | (90 | ) |  | 496 |  |  | (62 | ) |  | 434 |
Provision for income taxes | 74 |  |  | 46 |  |  | — |  |  | (22 | ) |  | 98 |  |  | (13 | ) |  | 85 |
Net earnings, including noncontrolling interests | 288 |  |  | 178 |  |  | — |  |  | (68 | ) |  | 398 |  |  | (49 | ) |  | 349 |
Less: Net earnings (loss) attributable to noncontrolling interests | (6 | ) |  | — |  |  | — |  |  | — |  |  | (6 | ) |  | — |  |  | (6 | )
Core Net Operating Earnings | 294 |  |  | 178 |  |  | — |  |  | (68 | ) |  | 404 |  |  |  |  |
Non-core earnings attributable to shareholders (a): |  |  |  |  |  |  |  |  |  |  |  |  |
Realized losses on securities, net of tax | — |  |  | — |  |  | — |  |  | (49 | ) |  | (49 | ) |  | 49 |  |  | — |
Net Earnings Attributable to Shareholders | $ | 294 |  |  | $ | 178 |  |  | $ | — |  |  | $ | (117 | ) |  | $ | 355 |  |  | $ | — |  |  | $ | 355 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

|  |  |  |  | Other |  |  |  |  |  |
| P&C |  | Annuity |  | Consol. MIEs |  | Holding Co., other and unallocated |  | Total |  | Non-core reclass |  | GAAP Total
Six months ended June 30, 2017 |  |  |  |  |  |  |  |  |  |  |  |  |
Revenues: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance net earned premiums | $ | 2,087 |  |  | $ | — |  |  | $ | — |  |  | $ | — |  |  | $ | 2,087 |  |  | $ | — |  |  | $ | 2,087 |
Life, accident and health net earned premiums | — |  |  | — |  |  | — |  |  | 11 |  |  | 11 |  |  | — |  |  | 11 |
Net investment income | 182 |  |  | 707 |  |  | (11 | ) |  | 17 |  |  | 895 |  |  | — |  |  | 895 |
Realized gains on securities | — |  |  | — |  |  | — |  |  | — |  |  | — |  |  | 11 |  |  | 11 |
Income of MIEs: |  |  |  |  |  |  |  |  |  |  |  |  |
Investment income | — |  |  | — |  |  | 101 |  |  | — |  |  | 101 |  |  | — |  |  | 101 |
Gain on change in fair value of assets/liabilities | — |  |  | — |  |  | 11 |  |  | — |  |  | 11 |  |  | — |  |  | 11 |
Other income | 20 |  |  | 53 |  |  | (9 | ) |  | 42 |  |  | 106 |  |  | — |  |  | 106 |
Total revenues | 2,289 |  |  | 760 |  |  | 92 |  |  | 70 |  |  | 3,211 |  |  | 11 |  |  | 3,222 |
Costs and Expenses: |  |  |  |  |  |  |  |  |  |  |  |  |
Property and casualty insurance: |  |  |  |  |  |  |  |  |  |  |  |  |
Losses and loss adjustment expenses | 1,244 |  |  | — |  |  | — |  |  | — |  |  | 1,244 |  |  | — |  |  | 1,244 |
Commissions and other underwriting expenses | 693 |  |  | — |  |  | — |  |  | 12 |  |  | 705 |  |  | — |  |  | 705 |
Annuity benefits | — |  |  | 420 |  |  | — |  |  | — |  |  | 420 |  |  | — |  |  | 420 |
Life, accident and health benefits | — |  |  | — |  |  | — |  |  | 15 |  |  | 15 |  |  | — |  |  | 15 |
Annuity and supplemental insurance acquisition expenses | — |  |  | 99 |  |  | — |  |  | 2 |  |  | 101 |  |  | — |  |  | 101 |
Interest charges on borrowed money | — |  |  | — |  |  | — |  |  | 44 |  |  | 44 |  |  | — |  |  | 44 |
Expenses of MIEs | — |  |  | — |  |  | 92 |  |  | — |  |  | 92 |  |  | — |  |  | 92 |
Other expenses | 18 |  |  | 60 |  |  | — |  |  | 88 |  |  | 166 |  |  | 7 |  |  | 173 |
Total costs and expenses | 1,955 |  |  | 579 |  |  | 92 |  |  | 161 |  |  | 2,787 |  |  | 7 |  |  | 2,794 |
Earnings before income taxes | 334 |  |  | 181 |  |  | — |  |  | (91 | ) |  | 424 |  |  | 4 |  |  | 428 |
Provision for income taxes | 107 |  |  | 62 |  |  | — |  |  | (43 | ) |  | 126 |  |  | 2 |  |  | 128 |
Net earnings, including noncontrolling interests | 227 |  |  | 119 |  |  | — |  |  | (48 | ) |  | 298 |  |  | 2 |  |  | 300 |
Less: Net earnings attributable to noncontrolling interests | 2 |  |  | — |  |  | — |  |  | — |  |  | 2 |  |  | — |  |  | 2 |
Core Net Operating Earnings | 225 |  |  | 119 |  |  | — |  |  | (48 | ) |  | 296 |  |  |  |  |
Non-core earnings attributable to shareholders (a): |  |  |  |  |  |  |  |  |  |  |  |  |
Realized gains on securities, net of tax | — |  |  | — |  |  | — |  |  | 7 |  |  | 7 |  |  | (7 | ) |  | — |
Loss on retirement of debt, net of tax | — |  |  | — |  |  | — |  |  | (5 | ) |  | (5 | ) |  | 5 |  |  | — |
Net Earnings Attributable to Shareholders | $ | 225 |  |  | $ | 119 |  |  | $ | — |  |  | $ | (46 | ) |  | $ | 298 |  |  | $ | — |  |  | $ | 298 |

(a) | See the reconciliation of core earnings to GAAP net earnings under “Results of Operations — General” for details on the tax and noncontrolling interest impacts of these reconciling items.

Property and Casualty Insurance Segment — Results of Operations AFG’s property and casualty insurance operations contributed $362 million in pretax earnings in the first six months of 2018 compared to $334 million in the first six months of 2017, an increase of $28 million (8%). The increase in pretax earnings reflects higher underwriting profit in the Specialty casualty insurance sub-segment and higher net investment income, due primarily to higher earnings from limited partnerships and similar investments, partially offset by lower underwriting profits in the Property and transportation and Specialty financial insurance sub-segments and lower income from the sale of real estate in the first six months of 2018 compared to the first six months of 2017. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The following table details AFG’s earnings before income taxes from its property and casualty insurance operations for the six months ended June 30, 2018 and 2017 (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Gross written premiums | $ | 3,123 |  |  | $ | 2,827 |  |  | 10 | %
Reinsurance premiums ceded | (764 | ) |  | (670 | ) |  | 14 | %
Net written premiums | 2,359 |  |  | 2,157 |  |  | 9 | %
Change in unearned premiums | (91 | ) |  | (70 | ) |  | 30 | %
Net earned premiums | 2,268 |  |  | 2,087 |  |  | 9 | %
Loss and loss adjustment expenses | 1,334 |  |  | 1,244 |  |  | 7 | %
Commissions and other underwriting expenses | 771 |  |  | 693 |  |  | 11 | %
Underwriting gain | 163 |  |  | 150 |  |  | 9 | %
Net investment income | 215 |  |  | 182 |  |  | 18 | %
Other income and expenses, net | (16 | ) |  | 2 |  |  | (900 | %)
Earnings before income taxes | $ | 362 |  |  | $ | 334 |  |  | 8 | %
Combined Ratios: |  |  |  |  |
Specialty lines |  |  |  |  | Change
Loss and LAE ratio | 58.8 | % |  | 59.5 | % |  | (0.7 | %)
Underwriting expense ratio | 34.0 | % |  | 33.2 | % |  | 0.8 | %
Combined ratio | 92.8 | % |  | 92.7 | % |  | 0.1 | %
Aggregate — including exited lines |  |  |  |  |
Loss and LAE ratio | 58.8 | % |  | 59.6 | % |  | (0.8 | %)
Underwriting expense ratio | 34.0 | % |  | 33.2 | % |  | 0.8 | %
Combined ratio | 92.8 | % |  | 92.8 | % |  | — | %

AFG reports the underwriting performance of its Specialty property and casualty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty and (iii) Specialty financial.
Gross Written Premiums
Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $3.12 billion for the first six months of 2018 compared to $2.83 billion for the first six months of 2017, an increase of $296 million (10%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  |
| GWP |  | % |  | GWP |  | % |  | % Change
Property and transportation | $ | 1,041 |  |  | 33 | % |  | $ | 989 |  |  | 35 | % |  | 5 | %
Specialty casualty | 1,711 |  |  | 55 | % |  | 1,500 |  |  | 53 | % |  | 14 | %
Specialty financial | 371 |  |  | 12 | % |  | 338 |  |  | 12 | % |  | 10 | %
| $ | 3,123 |  |  | 100 | % |  | $ | 2,827 |  |  | 100 | % |  | 10 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Reinsurance Premiums Ceded
Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 24% of gross written premiums for both the first six months of 2018 and the first six months of 2017. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | Change in
| Ceded |  | % of GWP |  | Ceded |  | % of GWP |  | % of GWP
Property and transportation | $ | (295 | ) |  | 28 | % |  | $ | (272 | ) |  | 28 | % |  | — | %
Specialty casualty | (478 | ) |  | 28 | % |  | (399 | ) |  | 27 | % |  | 1 | %
Specialty financial | (64 | ) |  | 17 | % |  | (48 | ) |  | 14 | % |  | 3 | %
Other specialty | 73 |  |  |  |  | 49 |  |  |  |  |
| $ | (764 | ) |  | 24 | % |  | $ | (670 | ) |  | 24 | % |  | — | %

Net Written Premiums
Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $2.36 billion for the first six months of 2018 compared to $2.16 billion for the first six months of 2017, an increase of $202 million (9%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  |
| NWP |  | % |  | NWP |  | % |  | % Change
Property and transportation | $ | 746 |  |  | 32 | % |  | $ | 717 |  |  | 33 | % |  | 4 | %
Specialty casualty | 1,233 |  |  | 52 | % |  | 1,101 |  |  | 51 | % |  | 12 | %
Specialty financial | 307 |  |  | 13 | % |  | 290 |  |  | 13 | % |  | 6 | %
Other specialty | 73 |  |  | 3 | % |  | 49 |  |  | 3 | % |  | 49 | %
| $ | 2,359 |  |  | 100 | % |  | $ | 2,157 |  |  | 100 | % |  | 9 | %

Net Earned Premiums
Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $2.27 billion for the first six months of 2018 compared to $2.09 billion for the first six months of 2017, an increase of $181 million (9%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  |
| NEP |  | % |  | NEP |  | % |  | % Change
Property and transportation | $ | 724 |  |  | 32 | % |  | $ | 699 |  |  | 33 | % |  | 4 | %
Specialty casualty | 1,174 |  |  | 52 | % |  | 1,045 |  |  | 50 | % |  | 12 | %
Specialty financial | 308 |  |  | 13 | % |  | 293 |  |  | 14 | % |  | 5 | %
Other specialty | 62 |  |  | 3 | % |  | 50 |  |  | 3 | % |  | 24 | %
| $ | 2,268 |  |  | 100 | % |  | $ | 2,087 |  |  | 100 | % |  | 9 | %

The $296 million (10%) increase in gross written premiums for the first six months of 2018 compared to the first six months of 2017 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates increased approximately 1% in the first six months of 2018. Excluding the workers’ compensation business, renewal pricing increased approximately 3%.
Property and transportation Gross written premiums increased $52 million (5%) in the first six months of 2018 compared to the first six months of 2017. This increase was the result of new business opportunities in the property and inland marine businesses and higher premiums in the transportation businesses, which included a 5% average renewal rate increase in National Interstate’s business. Average renewal rates increased approximately 4% for this group in the first six months of 2018. Reinsurance premiums ceded as a percentage of gross written premiums are comparable between periods.
Specialty casualty Gross written premiums increased $211 million (14%) in the first six months of 2018 compared to the first six months of 2017 due primarily to growth at Neon. Higher gross written premiums in the general liability, executive liability and excess and surplus lines businesses also contributed to the year-over-year growth. Average renewal rates decreased
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
approximately 1% for this group in the first six months of 2018. Excluding rate decreases in the workers’ compensation businesses, renewal rates for this group increased approximately 2%. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point for the first six months of 2018 compared to the first six months of 2017, reflecting higher cessions to AFG’s internal reinsurance program, which is included in Other specialty.
Specialty financial Gross written premiums increased $33 million (10%) in the first six months of 2018 compared to the first six months of 2017 due primarily to higher premiums in the financial institutions and equipment leasing businesses. Average renewal rates for this group increased approximately 4% in the first six months of 2018. Reinsurance premiums ceded as a percentage of gross written premiums increased 3 percentage points for the first six months of 2018 compared to the first six months of 2017, reflecting higher cessions in the financial institutions and equipment leasing businesses.
Other specialty The amounts shown as reinsurance premiums ceded represent business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty property and casualty insurance sub-segments. Reinsurance premiums assumed increased $24 million (49%) in the first six months of 2018 compared to the first six months of 2017, reflecting an increase in premiums retained, primarily from businesses in the Specialty casualty sub-segment.
Combined Ratio
The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty segment:

| Six months ended June 30, |  |  |  | Six months ended June 30,
| 2018 |  | 2017 |  | Change |  | 2018 |  | 2017
Property and transportation |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 63.4 | % |  | 62.8 | % |  | 0.6 | % |  |  |  |
Underwriting expense ratio | 28.8 | % |  | 27.9 | % |  | 0.9 | % |  |  |  |
Combined ratio | 92.2 | % |  | 90.7 | % |  | 1.5 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 56 |  |  | $ | 64 |
Specialty casualty |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 61.5 | % |  | 64.1 | % |  | (2.6 | %) |  |  |  |
Underwriting expense ratio | 32.5 | % |  | 31.7 | % |  | 0.8 | % |  |  |  |
Combined ratio | 94.0 | % |  | 95.8 | % |  | (1.8 | %) |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 70 |  |  | $ | 44 |
Specialty financial |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 37.0 | % |  | 34.4 | % |  | 2.6 | % |  |  |  |
Underwriting expense ratio | 50.9 | % |  | 50.4 | % |  | 0.5 | % |  |  |  |
Combined ratio | 87.9 | % |  | 84.8 | % |  | 3.1 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 37 |  |  | $ | 45 |
Total Specialty |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 58.8 | % |  | 59.5 | % |  | (0.7 | %) |  |  |  |
Underwriting expense ratio | 34.0 | % |  | 33.2 | % |  | 0.8 | % |  |  |  |
Combined ratio | 92.8 | % |  | 92.7 | % |  | 0.1 | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 165 |  |  | $ | 152 |
Aggregate — including exited lines |  |  |  |  |  |  |  |  |
Loss and LAE ratio | 58.8 | % |  | 59.6 | % |  | (0.8 | %) |  |  |  |
Underwriting expense ratio | 34.0 | % |  | 33.2 | % |  | 0.8 | % |  |  |  |
Combined ratio | 92.8 | % |  | 92.8 | % |  | — | % |  |  |  |
Underwriting profit |  |  |  |  |  |  | $ | 163 |  |  | $ | 150 |

The Specialty property and casualty insurance operations generated an underwriting profit of $165 million for the first six months of 2018 compared to $152 million for the first six months of 2017, an increase of $13 million (9%). Higher underwriting profit in the Specialty casualty insurance sub-segment was partially offset by lower underwriting profits in the Property and transportation and Specialty financial insurance sub-segments.
Property and transportation Underwriting profit for this group was $56 million for the first six months of 2018 compared to $64 million for the first six months of 2017, a decrease of $8 million (13%). Higher underwriting profit in the crop business and
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
improved results in the ocean marine operations were more than offset by lower underwriting profits in the property and inland marine and equine businesses.
Specialty casualty Underwriting profit for this group was $70 million for the first six months of 2018 compared to $44 million for the first six months of 2017, an increase of $26 million (59%). Higher underwriting profits in the workers’ compensation businesses due primarily to higher favorable prior year reserve development and improved results in the targeted markets businesses were partially offset by higher underwriting losses at Neon.
Specialty financial Underwriting profit for this group was $37 million for the first six months of 2018 compared to $45 million for the first six months of 2017, a decrease of $8 million (18%) due primarily to lower underwriting profitability in the fidelity and surety businesses.
Other specialty This group reported an underwriting profit of $2 million for the first six months of 2018 compared to an underwriting loss of $1 million in the first six months of 2017, a change of $3 million (300%). This improvement is due primarily to a $6 million charge recorded in 2017 to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998, partially offset by adverse prior year reserve development in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments in the first six months of 2018 compared to favorable reserve development in the first six months of 2017.
Losses and Loss Adjustment Expenses
AFG’s overall loss and LAE ratio was 58.8% for the first six months of 2018 compared to 59.6% for the first six months of 2017, a decrease of 0.8 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):

| Six months ended June 30, |  |
| Amount |  | Ratio |  | Change in
| 2018 |  | 2017 |  | 2018 |  | 2017 |  | Ratio
Property and transportation |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 483 |  |  | $ | 452 |  |  | 66.7 | % |  | 64.6 | % |  | 2.1 | %
Prior accident years development | (39 | ) |  | (28 | ) |  | (5.4 | %) |  | (4.0 | %) |  | (1.4 | %)
Current year catastrophe losses | 15 |  |  | 16 |  |  | 2.1 | % |  | 2.2 | % |  | (0.1 | %)
Property and transportation losses and LAE and ratio | $ | 459 |  |  | $ | 440 |  |  | 63.4 | % |  | 62.8 | % |  | 0.6 | %
Specialty casualty |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 767 |  |  | $ | 678 |  |  | 65.2 | % |  | 64.8 | % |  | 0.4 | %
Prior accident years development | (50 | ) |  | (11 | ) |  | (4.2 | %) |  | (1.0 | %) |  | (3.2 | %)
Current year catastrophe losses | 6 |  |  | 3 |  |  | 0.5 | % |  | 0.3 | % |  | 0.2 | %
Specialty casualty losses and LAE and ratio | $ | 723 |  |  | $ | 670 |  |  | 61.5 | % |  | 64.1 | % |  | (2.6 | %)
Specialty financial |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 119 |  |  | $ | 112 |  |  | 38.7 | % |  | 38.2 | % |  | 0.5 | %
Prior accident years development | (11 | ) |  | (17 | ) |  | (3.6 | %) |  | (5.8 | %) |  | 2.2 | %
Current year catastrophe losses | 6 |  |  | 6 |  |  | 1.9 | % |  | 2.0 | % |  | (0.1 | %)
Specialty financial losses and LAE and ratio | $ | 114 |  |  | $ | 101 |  |  | 37.0 | % |  | 34.4 | % |  | 2.6 | %
Total Specialty |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 1,405 |  |  | $ | 1,269 |  |  | 62.0 | % |  | 60.8 | % |  | 1.2 | %
Prior accident years development | (102 | ) |  | (52 | ) |  | (4.5 | %) |  | (2.5 | %) |  | (2.0 | %)
Current year catastrophe losses | 29 |  |  | 25 |  |  | 1.3 | % |  | 1.2 | % |  | 0.1 | %
Total Specialty losses and LAE and ratio | $ | 1,332 |  |  | $ | 1,242 |  |  | 58.8 | % |  | 59.5 | % |  | (0.7 | %)
Aggregate — including exited lines |  |  |  |  |  |  |  |  |
Current year, excluding catastrophe losses | $ | 1,405 |  |  | $ | 1,269 |  |  | 62.0 | % |  | 60.8 | % |  | 1.2 | %
Prior accident years development | (100 | ) |  | (50 | ) |  | (4.5 | %) |  | (2.4 | %) |  | (2.1 | %)
Current year catastrophe losses | 29 |  |  | 25 |  |  | 1.3 | % |  | 1.2 | % |  | 0.1 | %
Aggregate losses and LAE and ratio | $ | 1,334 |  |  | $ | 1,244 |  |  | 58.8 | % |  | 59.6 | % |  | (0.8 | %)

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Current accident year losses and LAE, excluding catastrophe losses
The current accident year loss and LAE ratio, excluding catastrophe losses for AFG’s Specialty property and casualty insurance operations was 62.0% for the first six months of 2018 compared to 60.8% for the first six months of 2017, an increase of 1.2 percentage points.
Property and transportation The 2.1 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the property and inland marine and equine businesses in the first six months of 2018 compared to the first six months of 2017.
Specialty casualty The 0.4 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the targeted markets businesses.
Specialty financial The 0.5 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses reflects an increase in the loss and LAE ratio of the trade credit business.
Net prior year reserve development
AFG’s Specialty property and casualty insurance operations recorded net favorable reserve development related to prior accident years of $102 million in the first six months of 2018 compared to $52 million in the first six months of 2017, an increase of $50 million (96%).
Property and transportation Net favorable reserve development of $39 million in the first six months of 2018 reflects lower than expected losses in the crop business and lower than expected claim severity in the transportation businesses. Net favorable reserve development of $28 million in the first six months of 2017 reflects lower than expected losses in the crop and equine businesses and lower than expected claim severity in the property and inland marine business, partially offset by higher than expected claim severity in the ocean marine business.
Specialty casualty Net favorable reserve development of $50 million in the first six months of 2018 reflects lower than anticipated claim frequency and severity in the workers’ compensation businesses. Net favorable reserve development of $11 million in the first six months of 2017 reflects lower than expected claim severity in the workers’ compensation businesses and at Neon, partially offset by higher than expected claim severity in the targeted markets and general liability businesses.
Specialty financial Net favorable reserve development of $11 million in the first six months of 2018 reflects lower than expected claim frequency and severity in the surety business and lower than expected claim severity in the fidelity business. Net favorable reserve development of $17 million in the first six months of 2017 reflects lower than anticipated claim severity in the fidelity business and lower than expected claim frequency and severity in the surety business.
Other specialty In addition to the development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $2 million in the first six months of 2018 and net adverse reserve development of $4 million in the first six months of 2017. The favorable development in the first six months of 2018 reflects amortization of the deferred gains on the retroactive reinsurance transactions entered into in connection with the sale of businesses in 1998 and 2001, partially offset by adverse reserve development associated with AFG’s internal reinsurance program. The adverse reserve development in the first six months of 2017 reflects a $6 million charge to adjust the deferred gain on the retroactive reinsurance transaction entered into in connection with the sale of businesses in 1998, partially offset by the amortization of deferred gains on retroactive reinsurance and favorable reserve development associated with AFG’s internal reinsurance program.
Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes net adverse reserve development of $2 million in both the first six months of 2018 and the first six months of 2017 related to business outside the Specialty group that AFG no longer writes.
Catastrophe losses
Catastrophe losses of $29 million in the first six months of 2018 resulted primarily from storms and flooding in several regions of the United States and mudslides in California. Catastrophe losses of $25 million in the first six months of 2017 resulted primarily from storms and tornadoes in several regions of the United States.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Commissions and Other Underwriting Expenses
AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $771 million in the first six months of 2018 compared to $693 million for the first six months of 2017, an increase of $78 million (11%). AFG’s underwriting expense ratio was 34.0% for the first six months of 2018 compared to 33.2% for the first six months of 2017, an increase of 0.8 percentage points. Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | Change in
| U/W Exp |  | % of NEP |  | U/W Exp |  | % of NEP |  | % of NEP
Property and transportation | $ | 209 |  |  | 28.8 | % |  | $ | 195 |  |  | 27.9 | % |  | 0.9 | %
Specialty casualty | 381 |  |  | 32.5 | % |  | 331 |  |  | 31.7 | % |  | 0.8 | %
Specialty financial | 157 |  |  | 50.9 | % |  | 147 |  |  | 50.4 | % |  | 0.5 | %
Other specialty | 24 |  |  | 38.0 | % |  | 20 |  |  | 37.1 | % |  | 0.9 | %
Total Specialty | $ | 771 |  |  | 34.0 | % |  | $ | 693 |  |  | 33.2 | % |  | 0.8 | %

Property and transportation Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.9 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting a change in the mix of business, partially offset by higher profitability-based commissions received from reinsurers in the crop business.
Specialty casualty Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting growth at Neon, which has a higher expense ratio than AFG’s overall Specialty casualty group.
Specialty financial Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.5 percentage points in the first six months of 2018 compared to the first six months of 2017, reflecting higher profitability-based commissions paid to agents in the financial institutions business.
Property and Casualty Net Investment Income
Net investment income in AFG’s property and casualty insurance operations was $215 million in the first six months of 2018 compared to $182 million in the first six months of 2017, an increase of $33 million (18%). The average invested assets and overall yield earned on investments held by AFG’s property and casualty insurance operations are provided below (dollars in millions):

| Six months ended June 30, |  |  |  |
| 2018 |  | 2017 |  | Change |  | % Change
Net investment income | $ | 215 |  |  | $ | 182 |  |  | $ | 33 |  |  | 18 | %
Average invested assets (at amortized cost) | $ | 10,395 |  |  | $ | 9,872 |  |  | $ | 523 |  |  | 5 | %
Yield (net investment income as a % of average invested assets) | 4.14 | % |  | 3.69 | % |  | 0.45 | % |  |  |
Tax equivalent yield (*) | 4.32 | % |  | 4.16 | % |  | 0.16 | % |  |  |

(*) | Adjusts the yield on equity securities and tax-exempt bonds to the fully taxable equivalent yield.

The property and casualty insurance segment’s increase in net investment income for the first six months of 2018 as compared to the first six months of 2017 reflects growth in the property and casualty insurance segment and very strong earnings from limited partnerships and similar investments. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 4.14% for the first six months of 2018 compared to 3.69% for the first six months of 2017, an increase of 0.45 percentage points due primarily to the higher earnings from limited partnerships and similar investments.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Property and Casualty Other Income and Expenses, Net
Other income and expenses, net for AFG’s property and casualty insurance operations was a net expense of $16 million for the first six months of 2018 compared to net earnings of $2 million for the first six months of 2017, a change of $18 million (900%). The table below details the items included in other income and expenses, net for AFG’s property and casualty insurance operations (in millions):

| Six months ended June 30,
| 2018 |  | 2017
Other income |  |  |
Income from the sale of real estate | $ | — |  |  | $ | 16 |
Other | 4 |  |  | 4 |
Total other income | 4 |  |  | 20 |
Other expenses |  |  |
Amortization of intangibles | 4 |  |  | 4 |
Other | 16 |  |  | 14 |
Total other expense | 20 |  |  | 18 |
Other income and expenses, net | $ | (16 | ) |  | $ | 2 |

Income from the sale of real estate includes $13 million related to the sale of a hotel property in 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Annuity Segment — Results of Operations
AFG’s annuity operations contributed $224 million in pretax earnings in the first six months of 2018 compared to $181 million in the first six months of 2017, an increase of $43 million (24%). AFG’s annuity segment results for the first six months of 2018 compared to the first six months of 2017 reflect a 10% increase in average annuity investments (at amortized cost), higher earnings from limited partnerships and similar investments and the favorable impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”), partially offset by an unlocking charge in the first six months of 2018 and the impact of lower investment yields due to the run-off of higher yielding investments. The high returns on limited partnerships and similar investments should not necessarily be expected to repeat in future periods. The fair value of derivatives related to FIAs was favorably impacted by higher than anticipated interest rates in the first six months of 2018 compared to the negative impact of lower than anticipated interest rates in the first six months of 2017, partially offset in the 2018 period by the negative impacts of higher interest on the embedded derivative (from growth in the FIA business and higher interest rates) and higher than expected option costs. AFG monitors the major actuarial assumptions underlying its annuity operations throughout the year and conducts detailed reviews (“unlocking”) of its assumptions in the fourth quarter of each year. If changes in the economic environment of actual experience would cause material revisions to future estimates, these assumptions are updated (unlocked) in an interim quarter. Due to continued higher FIA option costs (resulting primarily from higher than expected risk-free rates), AFG unlocked its assumptions for option costs and interest rates in the second quarter of 2018, resulting in a net charge to earnings of $27 million.
The following table details AFG’s earnings before income taxes from its annuity operations for the six months ended June 30, 2018 and 2017 (dollars in millions).

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Revenues: |  |  |  |  |
Net investment income | $ | 806 |  |  | $ | 707 |  |  | 14 | %
Other income: |  |  |  |  |
Guaranteed withdrawal benefit fees | 32 |  |  | 28 |  |  | 14 | %
Policy charges and other miscellaneous income | 21 |  |  | 25 |  |  | (16 | %)
Total revenues | 859 |  |  | 760 |  |  | 13 | %
Costs and Expenses: |  |  |  |  |
Annuity benefits (*) | 442 |  |  | 420 |  |  | 5 | %
Acquisition expenses | 130 |  |  | 99 |  |  | 31 | %
Other expenses | 63 |  |  | 60 |  |  | 5 | %
Total costs and expenses | 635 |  |  | 579 |  |  | 10 | %
Earnings before income taxes | $ | 224 |  |  | $ | 181 |  |  | 24 | %

Detail of annuity earnings before income taxes (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Earnings before income taxes — before the impact of unlocking and derivatives related to FIAs | $ | 235 |  |  | $ | 199 |  |  | 18 | %
Unlocking | (27 | ) |  | — |  |  | — | %
Impact of derivatives related to FIAs | 16 |  |  | (18 | ) |  | (189 | %)
Earnings before income taxes | $ | 224 |  |  | $ | 181 |  |  | 24 | %

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued

(*) | Annuity benefits consisted of the following (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Interest credited — fixed | $ | 339 |  |  | $ | 309 |  |  | 10 | %
Interest credited — fixed component of variable annuities | 3 |  |  | 3 |  |  | — | %
Other annuity benefits: |  |  |  |  |
Change in expected death and annuitization reserve | 8 |  |  | 8 |  |  | — | %
Amortization of sales inducements | 10 |  |  | 10 |  |  | — | %
Change in guaranteed withdrawal benefit reserve | 42 |  |  | 33 |  |  | 27 | %
Change in other benefit reserves | 19 |  |  | 20 |  |  | (5 | %)
Total other annuity benefits | 79 |  |  | 71 |  |  | 11 | %
Total before impact of derivatives related to FIAs and unlocking | 421 |  |  | 383 |  |  | 10 | %
Derivatives related to fixed-indexed annuities: |  |  |  |  |
Embedded derivative mark-to-market | 19 |  |  | 259 |  |  | (93 | %)
Equity option mark-to-market | (52 | ) |  | (222 | ) |  | (77 | %)
Impact of derivatives related to FIAs | (33 | ) |  | 37 |  |  | (189 | %)
Unlocking | 54 |  |  | — |  |  | — | %
Total annuity benefits | $ | 442 |  |  | $ | 420 |  |  | 5 | %

See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.
Net Spread on Fixed Annuities (excludes variable annuity earnings)
The table below (dollars in millions) details the components of the spreads for AFG’s fixed annuity operations (including fixed-indexed and variable-indexed annuities):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Average fixed annuity investments (at amortized cost) | $ | 33,469 |  |  | $ | 30,522 |  |  | 10 | %
Average fixed annuity benefits accumulated | 33,747 |  |  | 30,698 |  |  | 10 | %
As % of fixed annuity benefits accumulated (except as noted): |  |  |  |  |
Net investment income (as % of fixed annuity investments) | 4.79 | % |  | 4.60 | % |  |
Interest credited — fixed | (2.01 | %) |  | (2.01 | %) |  |
Net interest spread | 2.78 | % |  | 2.59 | % |  |
Policy charges and other miscellaneous income | 0.10 | % |  | 0.13 | % |  |
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees | (0.28 | %) |  | (0.29 | %) |  |
Acquisition expenses | (0.91 | %) |  | (0.62 | %) |  |
Other expenses | (0.36 | %) |  | (0.38 | %) |  |
Change in fair value of derivatives related to fixed-indexed annuities | 0.19 | % |  | (0.24 | %) |  |
Unlocking | (0.16 | %) |  | — | % |  |
Net spread earned on fixed annuities | 1.36 | % |  | 1.19 | % |  |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s net spread earned on fixed annuities:

| Six months ended June 30,
| 2018 |  | 2017
Net spread earned on fixed annuities — before the impact of unlocking and derivatives related to FIAs | 1.43 | % |  | 1.31 | %
Unlocking | (0.16 | %) |  | — | %
Impact of derivatives related to fixed-indexed annuities: |  |  |
Change in fair value of derivatives | 0.19 | % |  | (0.24 | %)
Related impact on amortization of deferred policy acquisition costs (*) | (0.10 | %) |  | 0.12 | %
Related impact on amortization of deferred sales inducements (*) | — | % |  | — | %
Net spread earned on fixed annuities | 1.36 | % |  | 1.19 | %

(*) | An estimate of the related acceleration/deceleration of the amortization of deferred policy acquisition costs and deferred sales inducements.

Annuity Net Investment Income
Net investment income for the first six months of 2018 was $806 million compared to $707 million for the first six months of 2017, an increase of $99 million (14%). This increase reflects the growth in AFG’s annuity business and higher earnings from limited partnerships and similar investments, partially offset by the impact of lower investment yields. The overall yield earned on investments in AFG’s fixed annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), increased by 0.19 percentage points to 4.79% from 4.60% for the first six months of 2018 compared to the first six months of 2017. This increase in net investment yield reflects higher earnings from limited partnerships and similar investments, partially offset by (i) the investment of new premium dollars at lower yields as compared to the existing investment portfolio and (ii) the impact of the reinvestment of proceeds from maturity and redemption of higher yielding investments at the lower yields available in the financial markets. During 2017, $4.9 billion in annuity segment investments with an average yield of 5.14% were redeemed or sold while the investments purchased during 2017 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 3.94%.
Annuity Interest Credited — Fixed
Interest credited — fixed for the first six months of 2018 was $339 million compared to $309 million for the first six months of 2017, an increase of $30 million (10%). This increase reflects the impact of growth in the annuity business. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, was 2.01% in both the first six months of 2018 and the first six months of 2017.
Annuity Net Interest Spread
AFG’s net interest spread increased 0.19 percentage points to 2.78% from 2.59% in the first six months of 2018 compared to the same period in 2017 due primarily to higher earnings from limited partnerships and similar investments, partially offset by lower investment yields. Features included in current annuity offerings allow AFG to achieve its desired profitability at a lower net interest spread than historical product offerings. As a result, AFG expects its net interest spread to narrow in the future.
Annuity Policy Charges and Other Miscellaneous Income
Annuity policy charges and other miscellaneous income, which consist primarily of surrender charges, amortization of deferred upfront policy charges (unearned revenue) and income from sales of real estate, were $21 million for the first six months of 2018 compared to $25 million for the first six months of 2017, a decrease of $4 million (16%). Excluding the impact of a $1 million unlocking charge related to unearned revenue in the second quarter of 2018, annuity policy charges and other miscellaneous income were $22 million in 2018 compared to $25 million in 2017, a decrease of $3 million (12%). The first six months of 2017 includes $1 million from the sale of real estate. As a percentage of average fixed annuity benefits accumulated, excluding the impact of unlocking charges related to unearned revenue, annuity policy charges and other miscellaneous income decreased 0.03 percentage points to 0.10% from 0.13% in the first six months of 2018 compared to the first six months of 2017.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity policy charges and other miscellaneous income in 2018.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees
Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking), for the first six months of 2018 were $47 million compared to $43 million for the first six months of 2017, an increase of $4 million (9%). As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.01 percentage points to 0.28% from 0.29% in the first six months of 2018 compared to the first six months of 2017. In addition to interest credited to policyholders’ accounts and the change in fair value of derivatives related to fixed-indexed annuities, annuity benefits expense also includes the following expenses (in millions, net of guaranteed withdrawal benefit fees):

| Six months ended June 30,
| 2018 |  | 2017
Change in expected death and annuitization reserve | $ | 8 |  |  | $ | 8 |
Amortization of sales inducements | 10 |  |  | 10 |
Change in guaranteed withdrawal benefit reserve | 42 |  |  | 33 |
Change in other benefit reserves | 19 |  |  | 20 |
Other annuity benefits | 79 |  |  | 71 |
Offset guaranteed withdrawal benefit fees | (32 | ) |  | (28 | )
Other annuity benefits, net | $ | 47 |  |  | $ | 43 |

As discussed under “Annuity Benefits Accumulated” in Note A — “Accounting Policies” to the financial statements, guaranteed withdrawal benefit reserves are accrued for and modified using assumptions similar to those used in establishing and amortizing deferred policy acquisition costs. The guaranteed withdrawal benefit reserve related to FIAs can be inversely impacted by the calculated FIA embedded derivative reserve as the value to policyholders of the guaranteed withdrawal benefits decreases when the benefit of stock market participation increases.
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity benefit expense in 2018.
Annuity Acquisition Expenses
Annuity acquisition expenses for the first six months of 2018 were $130 million compared to $99 million for the first six months of 2017, an increase of $31 million (31%). Excluding the $28 million favorable impact on amortization of DPAC from the unlocking recorded in the second quarter of 2018, annuity acquisition expenses were $158 million for the first six months of 2018, an increase of $59 million (60%) compared to the first six months of 2017, reflecting the acceleration/deceleration of DPAC amortization related to changes in the fair value of derivatives related to FIAs and growth in the business. Excluding the impact of the 2018 unlocking charge, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.91% for the first six months of 2018 compared to 0.62% for the first six months of 2017 and has generally ranged between 0.75% and 0.85%. Variances from the general range relate primarily to the impact of (i) material changes in interest rates or the stock market on AFG’s fixed-indexed annuity business, and (ii) differences in actual experience from actuarially projected estimates and assumptions. For example, the positive impact of higher than anticipated interest rates during the first six months of 2018 on the fair value of derivatives related to FIAs (discussed below) resulted in a partially offsetting acceleration of the amortization of DPAC. In contrast, the negative impact of lower than anticipated interest rates during the first six months of 2017 on the fair value of derivatives related to FIAs resulted in a partially offsetting deceleration of the amortization of DPAC.
The table below illustrates the estimated impact of fair value accounting for derivatives related to fixed-indexed annuities on annuity acquisition expenses as a percentage of average fixed annuity benefits accumulated (excluding the impact of unlocking):

| Six months ended June 30,
| 2018 |  | 2017
Before the impact of changes in the fair value of derivatives related to FIAs on the amortization of DPAC | 0.81 | % |  | 0.74 | %
Impact of changes in fair value of derivatives related to FIAs on amortization of DPAC (*) | 0.10 | % |  | (0.12 | %)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated | 0.91 | % |  | 0.62 | %

(*) | An estimate of the acceleration/deceleration of the amortization of deferred policy acquisition costs resulting from fair value accounting for derivatives related to fixed-indexed annuities.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on annuity and supplemental insurance acquisition expenses in 2018. Unanticipated spread compression, decreases in the stock market, adverse mortality experience, and higher than expected lapse rates could lead to write-offs of DPAC or PVFP in the future.
Annuity Other Expenses
Annuity other expenses were $63 million for the first six months of 2018 compared to $60 million for the first six months of 2017, an increase of $3 million (5%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. As a percentage of average fixed annuity benefits accumulated, these expenses were 0.36% for the first six months of 2018 and 0.38% for the first six months of 2017. This decrease in annuity other expenses as a percentage of average fixed annuity benefits accumulated is due primarily to growth in the business.
Change in Fair Value of Derivatives Related to Fixed-Indexed (Including Variable-Indexed) Annuities
AFG’s fixed-indexed (including variable indexed) annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market or other financial index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase and sale of call and put options on the appropriate index. AFG’s strategy is designed so that the net change in the fair value of the call option assets and put option liabilities will generally offset the economic change in the net liability from the index participation. Both the index-based component of the annuities (an embedded derivative) and the related call and put options are considered derivatives that must be adjusted for changes in fair value through earnings each period. The fair values of these derivatives are impacted by actual and expected stock market performance and interest rates as well as other factors. For a list of other factors impacting the fair value of the index-based component (embedded derivative) of AFG’s annuity benefits accumulated, see Note C — “Fair Value Measurements” to the financial statements.
Excluding the impact of the 2018 unlocking charge, the net change in fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $33 million in the first six months of 2018 and increased annuity benefits by $37 million in the first six months of 2017. During the first six months of 2018, the positive impact of higher than expected interest rates on the fair value of these derivatives was partially offset by the negative impact of higher than expected option costs. During the first six months of 2017, the positive impact of strong market performance on the fair value of these derivatives was more than offset by the negative impact of lower than anticipated interest rates. As a percentage of average fixed annuity benefits accumulated, this net expense improved 0.43 percentage points to a net expense reduction of 0.19% in the first six months of 2018 from a net expense of 0.24% in the first six months of 2017.
Fluctuations in interest rates and the stock market, among other factors, can cause volatility in the periodic measurement of fair value of the embedded derivative that management believes can be inconsistent with the long-term economics of these products. The table below illustrates the impact of fair value accounting for derivatives related to fixed-indexed annuities on the annuity segment’s earnings before income taxes (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Earnings before income taxes — before unlocking and change in fair value of derivatives related to fixed-indexed annuities | $ | 235 |  |  | $ | 199 |  |  | 18 | %
Unlocking | (27 | ) |  | — |  |  | — | %
Impact of derivatives related to fixed-indexed annuities: |  |  |  |  |
Change in fair value of derivatives related to fixed-indexed annuities | 33 |  |  | (37 | ) |  | (189 | %)
Related impact on amortization of DPAC (*) | (17 | ) |  | 19 |  |  | (189 | %)
Earnings before income taxes | $ | 224 |  |  | $ | 181 |  |  | 24 | %

(*) | An estimate of the related acceleration/deceleration of amortization of deferred sales inducements and deferred policy acquisition costs.

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
As illustrated in the table above, the change in fair value of derivatives related to fixed-indexed annuities, including the related impact on amortization of DPAC increased the annuity segment’s earnings before income taxes by $16 million in the first six months of 2018 and decreased the annuity segment’s earnings before income taxes by $18 million in the first six months of 2017. The following table provides analysis of the primary factors impacting the change in the fair value of derivatives related to FIAs. Each factor is presented net of the estimated related impact on amortization of DPAC (dollars in millions).

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Interest on the embedded derivative liability | $ | (15 | ) |  | $ | (7 | ) |  | 114 | %
Changes in interest rates higher (lower) than expected | 39 |  |  | (28 | ) |  | (239 | %)
Change in the stock market, including volatility | 4 |  |  | 14 |  |  | (71 | %)
Renewal option costs lower (higher) than expected | (7 | ) |  | 3 |  |  | (333 | %)
Other, including the impact of actual versus expected lapses | (5 | ) |  | — |  |  | — | %
Impact of derivatives related to FIAs | $ | 16 |  |  | $ | (18 | ) |  | (189 | %)

See “Annuity Unlocking” below for a discussion of the impact that the unlocking of actuarial assumptions had on the change in the fair value of the embedded derivative liability in 2018.
Annuity Net Spread Earned on Fixed Annuities
AFG’s net spread earned on fixed annuities increased 0.17 percentage points to 1.36% from 1.19% in the first six months of 2018 compared to the same period in 2017 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.19 percentage points increase in AFG’s net interest spread, partially offset by the impact of the unlocking of actuarial assumptions discussed below.
Annuity Benefits Accumulated
Annuity premiums received and benefit payments are recorded as increases or decreases in annuity benefits accumulated rather than as revenue and expense. Increases in this liability for interest credited and other benefits are charged to expense and decreases for surrender and other policy charges are credited to other income.
For certain products, annuity benefits accumulated also includes reserves for accrued persistency and premium bonuses, excess benefits expected to be paid on future deaths and annuitizations (“EDAR”) and guaranteed withdrawal benefits. Annuity benefits accumulated also includes amounts advanced from the Federal Home Loan Bank of Cincinnati. The following table is a progression of AFG’s annuity benefits accumulated liability for the six months ended June 30, 2018 and 2017 (in millions):

| Six months ended June 30,
| 2018 |  | 2017
Beginning fixed annuity reserves | $ | 33,005 |  |  | $ | 29,647 |
Fixed annuity premiums (receipts) | 2,534 |  |  | 2,541 |
Surrenders, benefits and other withdrawals | (1,333 | ) |  | (1,110 | )
Interest and other annuity benefit expenses: |  |  |
Interest credited | 339 |  |  | 309 |
Embedded derivative mark-to-market | 19 |  |  | 259 |
Change in other benefit reserves | 59 |  |  | 58 |
Unlocking | 55 |  |  | — |
Ending fixed annuity reserves | $ | 34,678 |  |  | $ | 31,704 |
Reconciliation to annuity benefits accumulated per balance sheet: |  |  |
Ending fixed annuity reserves (from above) | $ | 34,678 |  |  | $ | 31,704 |
Impact of unrealized investment gains | 32 |  |  | 128 |
Fixed component of variable annuities | 176 |  |  | 182 |
Annuity benefits accumulated per balance sheet | $ | 34,886 |  |  | $ | 32,014 |

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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Statutory Annuity Premiums
AFG’s annuity operations generated statutory premiums of $2.55 billion in the first six months of 2018 compared to $2.56 billion in the first six months of 2017, a decrease of $9 million. The following table summarizes AFG’s annuity sales (dollars in millions):

| Six months ended June 30, |  |
2018 |  | 2017 |  | % Change
Financial institutions single premium annuities — indexed | $ | 861 |  |  | $ | 987 |  |  | (13 | %)
Financial institutions single premium annuities — fixed | 236 |  |  | 477 |  |  | (51 | %)
Retail single premium annuities — indexed | 672 |  |  | 532 |  |  | 26 | %
Retail single premium annuities — fixed | 44 |  |  | 37 |  |  | 19 | %
Broker dealer single premium annuities — indexed | 614 |  |  | 411 |  |  | 49 | %
Broker dealer single premium annuities — fixed | 7 |  |  | 5 |  |  | 40 | %
Education market — fixed and indexed annuities | 100 |  |  | 92 |  |  | 9 | %
Total fixed annuity premiums | 2,534 |  |  | 2,541 |  |  | — | %
Variable annuities | 13 |  |  | 15 |  |  | (13 | %)
Total annuity premiums | $ | 2,547 |  |  | $ | 2,556 |  |  | — | %

While annuity premiums were comparable in the first six months of 2018 and the first six months of 2017, annuity premiums in the second quarter of 2018 represent an increase of 22% compared to the first quarter of 2018, reflecting growth in all fixed annuity product lines and channels.
Annuity Unlocking
In the second quarter of 2018, AFG recorded a $27 million net charge related to its annuity business as a result of unlocking certain actuarial assumptions underlying its annuity operations, which impacted AFG’s financial statements as follows (in millions):

|  | Six months ended June 30,
|  | 2018 |  | 2017
Policy charges and other miscellaneous income: |  |  |  |
Unearned revenue |  | $ | (1 | ) |  | $ | — |
Total revenues |  | (1 | ) |  | — |
Annuity benefits: |  |  |  |
Fixed-indexed annuities embedded derivative |  | 44 |  |  | — |
Sales inducements |  | (1 | ) |  | — |
Other reserves |  | 11 |  |  | — |
Total annuity benefits |  | 54 |  |  | — |
Annuity and supplemental insurance acquisition expenses: |  |  |  |
Deferred policy acquisition costs |  | (28 | ) |  | — |
Total costs and expenses |  | 26 |  |  | — |
Net charge |  | $ | (27 | ) |  | $ | — |

See “Annuity Unlocking” under “Annuity Segment — Results of Operations” for the quarters ended June 30, 2018 and 2017 for a discussion of the charge from the unlocking of actuarial assumptions in the second quarter of 2018.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Annuity Earnings before Income Taxes Reconciliation
The following table reconciles the net spread earned on AFG’s fixed annuities to overall annuity pretax earnings for the six months ended June 30, 2018 and 2017 (in millions):

| Six months ended June 30,
| 2018 |  | 2017
Earnings on fixed annuity benefits accumulated | $ | 229 |  |  | $ | 183 |
Earnings impact of investments in excess of fixed annuity benefits accumulated (*) | (7 | ) |  | (4 | )
Variable annuity earnings | 2 |  |  | 2 |
Earnings before income taxes | $ | 224 |  |  | $ | 181 |

(*) | Net investment income (as a % of investments) of 4.79% and 4.60% for the six months ended June 30, 2018 and 2017, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Holding Company, Other and Unallocated — Results of Operations AFG’s net GAAP pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gains and losses) totaled $90 million in the first six months of 2018 compared to $98 million in the first six months of 2017, a decrease of $8 million (8%). AFG’s net core pretax loss outside of its property and casualty insurance and annuity operations (excluding realized gain and losses) totaled $90 million in the first six months of 2018 compared to $91 million in the first six months of 2017, a decrease of $1 million (1%).
The following table details AFG’s GAAP and core loss before income taxes from operations outside of its property and casualty insurance and annuity operations for the six months ended June 30, 2018 and 2017 (dollars in millions):

| Six months ended June 30, |  |
| 2018 |  | 2017 |  | % Change
Revenues: |  |  |  |  |
Life, accident and health net earned premiums | $ | 12 |  |  | $ | 11 |  |  | 9 | %
Net investment income | 11 |  |  | 17 |  |  | (35 | %)
Other income — P&C fees | 32 |  |  | 29 |  |  | 10 | %
Other income | 11 |  |  | 13 |  |  | (15 | %)
Total revenues | 66 |  |  | 70 |  |  | (6 | %)
Costs and Expenses, excluding interest charges on borrowed money: |  |  |  |  |
Property and casualty insurance — commissions and other underwriting expenses | 10 |  |  | 12 |  |  | (17 | %)
Life, accident and health benefits | 22 |  |  | 15 |  |  | 47 | %
Life, accident and health acquisition expenses | 2 |  |  | 2 |  |  | — | %
Other expense — expenses associated with P&C fees | 22 |  |  | 17 |  |  | 29 | %
Other expenses (*) | 69 |  |  | 71 |  |  | (3 | %)
Costs and expenses, excluding interest charges on borrowed money | 125 |  |  | 117 |  |  | 7 | %
Core loss before income taxes, excluding realized gains and losses and interest charges on borrowed money | (59 | ) |  | (47 | ) |  | 26 | %
Interest charges on borrowed money | 31 |  |  | 44 |  |  | (30 | %)
Core loss before income taxes, excluding realized gains and losses | (90 | ) |  | (91 | ) |  | (1 | %)
Pretax non-core loss on retirement of debt | — |  |  | (7 | ) |  | (100 | %)
GAAP loss before income taxes, excluding realized gains and losses | $ | (90 | ) |  | $ | (98 | ) |  | (8 | %)

(*) | Excludes a pretax non-core loss on retirement of debt of $7 million in the second quarter of 2017.

Holding Company and Other — Life, Accident and Health Premiums, Benefits and Acquisition Expenses
AFG’s run-off long-term care and life insurance operations recorded net earned premiums of $12 million and related benefits and acquisition expenses of $24 million in the first six months of 2018 compared to net earned premiums of $11 million and related benefits and acquisition expenses of $17 million in the first six months of 2017. The $7 million (47%) increase in life, accident and health benefits reflects higher claims in the run-off life business.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Holding Company and Other — Net Investment Income
AFG recorded net investment income on investments held outside of its property and casualty insurance and annuity operations of $11 million in the first six months of 2018 compared to $17 million in the first six months of 2017, a decrease of $6 million (35%). The parent company holds a small portfolio of securities that are carried at fair value through net investment income. These securities decreased in value by $2 million in the first six months of 2018 compared to an increase in value by $3 million in the first six months of 2017.
Holding Company and Other — P&C Fees and Related Expenses
Summit, a workers’ compensation insurance subsidiary, collects fees from a small group of unaffiliated insurers for providing underwriting, policy administration and claims services. In addition, certain of AFG’s property and casualty insurance businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the first six months of 2018, AFG collected $32 million in fees for these services compared to $29 million in the first six months of 2017. Management views this fee income, net of the $22 million in the first six months of 2018 and $17 million in the first six months of 2017, in expenses incurred to generate such fees, as a reduction in the cost of underwriting its property and casualty insurance policies. Consistent with internal management reporting, these fees and the related expenses are netted and recorded as a reduction of commissions and other underwriting expenses in AFG’s segmented results.
Holding Company and Other — Other Income
Other income in the table above includes $8 million and $9 million in the first six months of 2018 and 2017, respectively, in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The management fees are eliminated in consolidation — see the other income line in the Consolidate MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation, AFG recorded other income outside of its property and casualty insurance and annuity operations of $3 million in the first six months of 2018 and $4 million the first six months of 2017.
Holding Company and Other — Other Expenses
Excluding the non-core loss on retirement of debt discussed below, AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded other expenses of $69 million in the first six months of 2018 compared to $71 million in the first six months of 2017, a decrease of $2 million (3%). This decrease reflects the impact of lower holding company expenses related to certain incentive compensation plans and employee benefit plans that are tied to stock market performance in the first six months of 2018 compared to the first six months of 2017, partially offset by a $5 million charge to increase liabilities related to the environmental exposures of AFG’s former railroad and manufacturing operations in the first six months of 2018.
Holding Company and Other — Interest Charges on Borrowed Money
AFG’s holding companies and other operations outside of its property and casualty insurance and annuity operations recorded interest expense of $31 million in the first six months of 2018 compared to $44 million in the first six months of 2017, a decrease of $13 million (30%), due primarily to a lower weighted average interest rate on AFG’s outstanding debt.
The decrease in the weighted average interest rate for the first six months of 2018 as compared to the first six months of 2017 reflects the following financing transactions completed by AFG between April 1, 2017 and December 31, 2017:

• | Issued $350 million of 4.50% Senior Notes on June 2, 2017

• | Redeemed $230 million of 6-3/8% Senior Notes on June 26, 2017

• | Redeemed $125 million of 5-3/4% Senior Notes on August 25, 2017

• | Issued an additional $125 million of 3.50% Senior Notes on November 9, 2017

• | Issued an additional $240 million of 4.50% Senior Notes on November 9, 2017

• | Redeemed $350 million of 9-7/8% Senior Notes on December 11, 2017

Holding Company and Other — Loss on Retirement of Debt
AFG wrote off unamortized debt issuance costs of $7 million related to the redemption of its $230 million outstanding 6-3/8% Senior Notes due 2042 at par value in June 2017.
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
Consolidated Realized Gains (Losses) on Securities AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were a net loss of $62 million in the first six months of 2018 compared to a net gain of $11 million in the first six months of 2017, a decrease of $73 million (664%). Realized gains (losses) on securities consisted of the following (in millions):

| Six months ended June 30,
2018 |  | 2017
Realized gains (losses) before impairments: |  |  |
Disposals | $ | 9 |  |  | $ | 32 |
Change in the fair value of equity securities (*) | (72 | ) |  | — |
Change in the fair value of derivatives | (6 | ) |  | (3 | )
Adjustments to annuity deferred policy acquisition costs and related items | 8 |  |  | (3 | )
| (61 | ) |  | 26 |
Impairment charges: |  |  |
Securities | (1 | ) |  | (21 | )
Adjustments to annuity deferred policy acquisition costs and related items | — |  |  | 6 |
| (1 | ) |  | (15 | )
Realized gains (losses) on securities | $ | (62 | ) |  | $ | 11 |

(*) | As discussed in Note A — “Accounting Policies — Investments,” beginning in January 2018, all equity securities other than those accounted for under the equity method are carried at fair value through net earnings. This amount includes a $71 million net loss on securities that were still held at June 30, 2018.

The $72 million net realized loss from the change in the fair value of equity securities in the first six months of 2018 includes losses of $15 million on investments in real estate investment trusts, $31 million related to banks and financing companies and $15 million on investments in media companies. AFG’s $21 million in impairment charges for the first six months of 2017 consist of $20 million on equity securities and $1 million on fixed maturities. Approximately $10 million in impairment charges in the first six months of 2017 are related to pharmaceutical companies and $5 million are on energy-related investments.
Consolidated Income Taxes AFG’s consolidated provision for income taxes was $85 million for the first six months of 2018 compared to $128 million for the first six months of 2017, a decrease of $43 million (34%). See Note L — “Income Taxes” to the financial statements for an analysis of items affecting AFG’s effective tax rate.
Consolidated Noncontrolling Interests AFG’s consolidated net earnings (losses) attributable to noncontrolling interests was a net loss of $6 million for the first six months of 2018 compared to net earnings of $2 million for the first six months of 2017. Losses attributable to noncontrolling interests for the first six months of 2018 are related to losses at Neon, AFG’s United Kingdom-based Lloyd’s insurer. Earnings attributable to noncontrolling interests in the first six months of 2017 are related to the gain on the sale of a hotel property, which was owned by an 80%-owned subsidiary of Great American Insurance.
RECENTLY ADOPTED ACCOUNTING STANDARDS
Effective December 31, 2017, AFG adopted ASU 2018-02, which allowed the reclassification of amounts stranded in accumulated other comprehensive income from accounting for the Tax Cuts and Jobs Act of 2017 to retained earnings.
See Note A — “Accounting Policies — Investments” to the financial statements for a discussion of accounting guidance adopted on January 1, 2018, which, among other things, requires equity investments that are not accounted for under the equity method of accounting to be measured at fair value with changes in fair value recognized in net earnings, clarifies that the need for a valuation allowance on a deferred tax asset related to available for sale securities should be evaluated with other deferred tax assets and modifies disclosure requirements for financial instruments.
ACCOUNTING STANDARDS TO BE ADOPTED
In February 2016, the FASB issued ASU 2016-02, Leases, which requires entities that lease assets for terms longer than one year to recognize the assets and liabilities for the rights and obligations created by those leases on the balance sheet based on the present value of cash flows. Qualitative and quantitative disclosures of the amount, timing and uncertainty of cash flows arising from leases will also be required. Although the guidance allows for early adoption, AFG expects to adopt the updated
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AMERICAN FINANCIAL GROUP, INC. 10-Q
Management’s Discussion and Analysis of Financial Condition and Results of Operations — Continued
guidance effective January 1, 2019 (when it is required). Although the guidance will result in higher assets and higher liabilities from the recognition of assets and liabilities related to operating leases, it does not change the manner in which lease expense is recognized in the statement of earnings. Although management is currently evaluating the impact of this guidance, AFG does not expect it to have a material effect on its results of operations or financial position.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments, which provides a new credit loss model for determining credit-related impairments for financial instruments measured at amortized cost (e.g. mortgage loans or reinsurance recoverables) and requires an entity to estimate the credit losses expected over the life of an exposure or pool of exposures. The estimate of expected credit losses considers historical information, current information, as well as reasonable and supportable forecasts, including estimates of prepayments. The expected credit losses, and subsequent increases or decreases in such losses, will be recorded immediately through realized gains (losses) as an allowance that is deducted from the amortized cost basis of the financial asset, with the net carrying value of the financial asset presented on the balance sheet at the amount expected to be collected. The updated guidance also amends the current other-than-temporary impairment model for available for sale debt securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. Subsequent increases or decreases in expected credit losses will be recorded immediately in the income statement through realized gains (losses). AFG will be required to adopt this guidance effective January 1, 2020. AFG cannot estimate the impact that the updated guidance will have on its results of operations, financial position or liquidity until the updated guidance is adopted.
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ITEM 3
Quantitative and Qualitative Disclosure about Market Risk
As of June 30, 2018, there were no material changes to the information provided in Item 7A — Quantitative and Qualitative Disclosures about Market Risk of AFG’s 2017 Form 10-K.
ITEM 4
Controls and Procedures
AFG’s management, with participation of its Co-Chief Executive Officers and its Chief Financial Officer, has evaluated AFG’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15) as of the end of the period covered by this report. Based on that evaluation, AFG’s Co-CEOs and CFO concluded that the controls and procedures are effective. There have been no changes in AFG’s internal control over financial reporting during the second fiscal quarter of 2018 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.
In the ordinary course of business, AFG and its subsidiaries routinely enhance their information systems by either upgrading current systems or implementing new systems. There has been no change in AFG’s business processes and procedures during the second fiscal quarter of 2018 that has materially affected, or is reasonably likely to materially affect, AFG’s internal control over financial reporting.
PART II
OTHER INFORMATION
ITEM 2
Unregistered Sales of Equity Securities and Use of Proceeds
Issuer Purchases of Equity Securities AFG did not repurchase any shares of its Common Stock during the first six months of 2018. There are 4,132,838 remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014 and February 2016.
AFG acquired 23,882 shares of its Common Stock (at an average of $112.04 per share) in the first quarter of 2018, 32 shares (at $111.83 per share) in May 2018 and 396 shares (at $107.23 per share) in June 2018 in connection with its stock incentive plans.
ITEM 5
Other Information
Disclosure of Certain Activities Under Section 13(r) of the Securities Exchange Act of 1934 Section 13(r) of the Securities Exchange Act of 1934, as amended (“Section 13(r)”), requires a registrant to disclose in its annual or quarterly reports whether it or an affiliate knowingly engaged in certain activities, transactions or dealings related to Iran during the period covered by the report. Many of the activities, transactions and dealings that are required to be reported under Section 13(r) were previously subject to U.S. sanctions or prohibited by applicable local law. On January 16, 2016, the United States and the European Union eased sanctions against Iran pursuant to the Joint Comprehensive Plan of Action, and many of the reportable activities, transactions and dealings under Section 13(r) are no longer subject to U.S. sanctions and no longer prohibited by applicable local law.
Certain of the Company’s subsidiaries located outside the United States subscribe to insurance policies that provide insurance coverage to vessels owned by international shipping and marine entities with vessels that travel worldwide. As a result, the insurance policies may be called upon to respond to claims involving or that have exposure to Iranian petroleum resources, refined petroleum, and petrochemical industries. For example, certain of the Company’s non-U.S. subsidiaries participate in global marine hull and war policies that provide coverage for damage to vessels navigating into and out of ports worldwide, which could include Iran.
For the six months ended June 30, 2018, the Company is not aware of any additional premium with respect to underwriting insurance or reinsurance activities reportable under Section 13(r). Should any such risks have entered into the stream of
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commerce covered by these insurance or reinsurance activities, the Company believes that the premiums associated with such business would be immaterial.
ITEM 6
Exhibits

Number |  | Exhibit Description |  |
12 |  | Computation of ratios of earnings to fixed charges. |  |
31(a) |  | Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002. |  |
31(b) |  | Certification of Co-Chief Executive Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002. |  |
31(c) |  | Certification of Chief Financial Officer pursuant to section 302(a) of the Sarbanes-Oxley Act of 2002. |  |
32 |  | Certification of Co-Chief Executive Officers and Chief Financial Officer pursuant to section 906 of the Sarbanes-Oxley Act of 2002. |  |
101 |  | The following financial information from American Financial Group’s Form 10-Q for the quarter ended June 30, 2018, formatted in XBRL (Extensible Business Reporting Language): |  |
|  | (i) Consolidated Balance Sheet |  |
|  | (ii) Consolidated Statement of Earnings |  |
|  | (iii) Consolidated Statement of Comprehensive Income |  |
|  | (iv) Consolidated Statement of Changes in Equity |  |
|  | (v) Consolidated Statement of Cash Flows |  |
|  | (vi) Notes to Consolidated Financial Statements |  |

Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

| American Financial Group, Inc.
August 3, 2018 | By: |  | /s/ Joseph E. (Jeff) Consolino
|  |  | Joseph E. (Jeff) Consolino
|  |  | Executive Vice President and Chief Financial Officer

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