O. Insurance

Securities owned by U.S.-based insurance subsidiaries having a carrying value of approximately $1.1 billion at December 31, 2012, were on deposit as required by regulatory authorities. At December 31, 2012, AFG and its subsidiaries had $198 million in undrawn letters of credit ($16 million of which was collateralized) supporting the underwriting capacity of its U.K.-based Lloyd’s insurer.

Property and Casualty Insurance Reserves The liability for losses and LAE for long-term scheduled payments under certain workers’ compensation insurance has been discounted at 4.5%, an approximation of long-term investment yields. As a result, the total liability for losses and loss adjustment expenses at December 31, 2012, has been reduced by $22 million.

The following table provides an analysis of changes in the liability for losses and loss adjustment expenses, net of reinsurance (and grossed up), over the past three years (in millions):



	2012			2011			2010
Balance at beginning of period	$	4,282		$	4,164		$	3,899
Provision for losses and LAE occurring in the current year	1,903			1,813			1,615
Net decrease in provision for claims of prior years	(30		)	(69		)	(158		)
Total losses and LAE incurred	1,873			1,744			1,457
Payments for losses and LAE of:
Current year	(841		)	(652		)	(360		)
Prior years	(1,185		)	(969		)	(1,116		)
Total payments	(2,026		)	(1,621		)	(1,476		)
Reserves of businesses acquired	—			—			287
Foreign — currency translation and other	—			(5		)	(3		)
Balance at end of period	4,129			4,282			4,164
Add back reinsurance recoverables, net of allowance	2,716			2,238			2,249
Gross unpaid losses and LAE included in the Balance Sheet	$	6,845		$	6,520		$	6,413

Favorable development in 2012 was due primarily to lower than expected frequency and severity in the homebuilders’ general liability business within the Specialty casualty sub-segment and lower than expected frequency in the crop business within the Property and transportation sub-segment, partially offset by higher frequency and severity in a block of program business in the Specialty casualty sub-segment and the $31 million special charge to increase asbestos and environmental reserves. Favorable development in 2011 was due primarily to lower than expected severity in certain businesses within the Specialty casualty sub-segment and lower than expected frequency in crop business within the Property and transportation sub-segment, partially offset by the $50 million special charge to increase asbestos and environmental reserves. Favorable development in 2010 was primarily in the Specialty casualty and Specialty financial sub-segments.

Closed Block of Long-Term Care Insurance AFG, as well as other companies that sell long-term care products, have accumulated relatively limited claims, lapse and mortality experience, making it difficult to predict future claims. Long-term care claims tend to be much higher in dollar amount and longer in duration than other health care products. In addition, long-term care claims are incurred much later in the life of a policy than most other health products. These factors made it difficult to appropriately price this product and were instrumental in AFG’s decision to stop writing new policies in January 2010. AFG’s outstanding long-term care policies have level premiums and are guaranteed renewable. Premium rates can potentially be increased in reaction to adverse experience; however, any rate increases would require regulatory approval.

In 2012, AFG recorded a $153 million pretax loss recognition charge to write off deferred policy acquisition costs and strengthen reserves on its closed block of long-term care insurance, due primarily to the impact of changes in assumptions related to future investment yields resulting from the continued low interest rate environment, as well as changes in claims, expenses and persistency assumptions. At December 31, 2012, AFG’s long-term care insurance reserves were $755 million, net of reinsurance recoverables.

FHLB Funding Agreements 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. Members are required to purchase stock in the FHLB in addition to maintaining collateral deposits that back any funds advanced. GALIC’s $26 million investment in FHLB capital stock at December 31, 2012, is included in other investments at cost. Membership in the FHLB provides the annuity operations with a substantial additional source of liquidity. In the fourth quarter of 2011, the FHLB advanced GALIC $240 million (included in annuity benefits accumulated at December 31, 2012 and 2011). Interest rates under the various funding agreements on these advances range from 0.02% to 0.03% over LIBOR (average rate of 0.23% at December 31, 2012). These advances must be repaid within 5 to 7 years, but GALIC has the option to prepay all or a portion of the advances on a monthly basis. The advances on these agreements are collateralized by commercial mortgage-backed securities with a fair value of $316 million (included in available for sale fixed maturity securities) at December 31, 2012. Interest credited on the funding agreements, which is included in annuity benefits, was less than $1 million in 2012 and 2011.

Net Investment Income The following table shows (in millions) investment income earned and investment expenses incurred by AFG’s insurance group.



	2012			2011			2010
Insurance group investment income:
Fixed maturities	$	1,215		$	1,142		$	1,112
Equity securities	31			26			11
Other	60			65			61
Total investment income	1,306			1,233			1,184
Insurance group investment expenses (*)	(31		)	(34		)	(25		)
Net investment income	$	1,275		$	1,199		$	1,159

(*) Included primarily in “Other operating and general expenses” in the Statement of Earnings.

Statutory Information AFG’s U.S.-based insurance subsidiaries are required to file financial statements with state insurance regulatory authorities prepared on an accounting basis prescribed or permitted by such authorities (statutory basis). Net earnings (loss) and policyholders’ surplus on a statutory basis for the insurance subsidiaries were as follows (in millions):



	Net Earnings (Loss)						Policyholders’ Surplus
	2012		2011		2010		2012		2011
Property and casualty companies	$	221	$	375	$	624	$	2,015	$	1,976
Life insurance companies	171		190		213		1,343		1,225

Reinsurance In the normal course of business, AFG’s insurance subsidiaries cede reinsurance to other companies to diversify risk and limit maximum loss arising from large claims. To the extent that any reinsuring companies are unable to meet obligations under agreements covering reinsurance ceded, AFG’s insurance subsidiaries would remain liable. The following table shows (in millions) (i) amounts deducted from property and casualty written and earned premiums in connection with reinsurance ceded, (ii) written and earned premiums included in income for reinsurance assumed and (iii) reinsurance recoveries, which represent ceded losses and loss adjustment expenses.



	2012			2011			2010
Direct premiums written	$	4,283		$	4,061		$	3,542
Reinsurance assumed	38			45			47
Reinsurance ceded	(1,372		)	(1,336		)	(1,181		)
Net written premiums	$	2,949		$	2,770		$	2,408

Direct premiums earned	$	4,120		$	4,062		$	3,653
Reinsurance assumed	36			41			45
Reinsurance ceded	(1,309		)	(1,344		)	(1,148		)
Net earned premiums	$	2,847		$	2,759		$	2,550

Reinsurance recoveries	$	1,743		$	770		$	395

AFG has reinsured approximately $14 billion in face amount of life insurance at December 31, 2012 and $16 billion at December 31, 2011. Life written premiums ceded were $42 million, $44 million and $49 million for 2012, 2011 and 2010, respectively.

Variable Annuities At December 31, 2012, the aggregate guaranteed minimum death benefit value (assuming every variable annuity policyholder died on that date) on AFG’s variable annuity policies exceeded the fair value of the underlying variable annuities by $40 million, compared to $63 million at December 31, 2011. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years.