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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2016

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

Securities Registered Pursuant to Section 12(b) of the Act:
	Title of Each Class		Name of Each Exchange on Which Registered
	Common Stock		New York Stock Exchange
	6-3/8% Senior Notes due June 12, 2042		New York Stock Exchange
	5-3/4% Senior Notes due August 25, 2042		New York Stock Exchange
	6-1/4% Subordinated Debentures due September 30, 2054		New York Stock Exchange
	6% Subordinated Debentures due November 15, 2055		New York Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 

          Large accelerated filer  þ Accelerated filer  ¨ Non-accelerated filer  ¨ Smaller reporting company  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No þ

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the Registrant’s most recently completed second fiscal quarter: $5.54 billion.

Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of the latest practicable date: 87,014,273 shares (excluding 14.9 million shares owned by subsidiaries) as of February 1, 2017.

________________________________

Documents Incorporated by Reference:

Proxy Statement for 2017 Annual Meeting of Stockholders (portions of which are incorporated by reference into Part III hereof). ________________________________________________________________________________________________________________

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AMERICAN FINANCIAL GROUP, INC.

INDEX TO ANNUAL REPORT ON FORM 10-K

 

			Page
FORWARD-LOOKING STATEMENTS			1
Part I
Item 1	—	Business	2
Item 1A	—	Risk Factors	13
Item 1B	—	Unresolved Staff Comments	none
Item 2	—	Properties	20
Item 3	—	Legal Proceedings	20
Item 4	—	Mine Safety Disclosures	none
Part II
Item 5	—	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	22
Item 6	—	Selected Financial Data	23
Item 7	—	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 7A	—	Quantitative and Qualitative Disclosure About Market Risk	96
Item 8	—	Financial Statements and Supplementary Data	98
Item 9	—	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	none
Item 9A	—	Controls and Procedures	98
Item 9B	—	Other Information	none
Part III
Item 10	—	Directors, Executive Officers and Corporate Governance	S-1
Item 11	—	Executive Compensation	S-1
Item 12	—	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	S-1
Item 13	—	Certain Relationships and Related Transactions, and Director Independence	S-1
Item 14	—	Principal Accounting Fees and Services	S-1
Part IV
Item 15	—	Exhibits, Financial Statement Schedules	S-1

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FORWARD-LOOKING STATEMENTS

The disclosures in this Form 10-K contain certain forward-looking statements that are subject to numerous assumptions, risks or uncertainties. 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 the following and those discussed in Item 1A — Risk Factors.

•	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;

•	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;

•	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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PART I

ITEM 1

Business

Introduction

American Financial Group, Inc. (“AFG” or the “Company”) is a holding company that, through the operations of Great American Insurance Group, is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses, and in the sale of fixed and fixed-indexed annuities in the retail, financial institutions and education markets. Its address is 301 East Fourth Street, Cincinnati, Ohio 45202; its phone number is (513) 579-2121. SEC filings, news releases, AFG’s Code of Ethics applicable to directors, officers and employees and other information may be accessed free of charge through AFG’s Internet site at: www.AFGinc.com. (Information on AFG’s Internet site is not part of this Form 10-K.)

See Note C — “Segments of Operations” to the financial statements for information on AFG’s assets, revenues and earnings before income taxes by segment.

Property and Casualty Insurance Segment

General

AFG’s property and casualty operations provide a wide range of commercial coverages through over 30 niche insurance businesses that make up the Great American Insurance Group. AFG’s property and casualty insurance operations ultimately report to a single senior executive and operate under a business model that allows local decision-making for underwriting, claims and policy servicing in each of the niche operations. Each business is managed by experienced professionals in particular lines or customer groups and operates autonomously but with certain central controls and accountability. The decentralized approach allows each unit the autonomy necessary to respond to local and specialty market conditions while capitalizing on the efficiencies of centralized investment and administrative support functions. AFG’s property and casualty insurance operations employed approximately 6,600 people as of December 31, 2016. These operations are conducted through the subsidiaries listed in the following table, which includes independent financial strength ratings and 2016 gross written premiums (in millions) for each major subsidiary. These ratings are generally based on concerns for policyholders and agents and are not directed toward the protection of investors. AFG believes that maintaining a rating in the “A” category by A.M. Best is important to compete successfully in most lines of business.

	Ratings				Gross Written
	AM Best		S&P		Premiums
Company
Great American Insurance	A+		A+		$	3,873
National Interstate	A		not rated		729
Summit (Bridgefield Casualty and Bridgefield Employers)	A		A+		546
Republic Indemnity	A		A+		263
Neon Lloyd’s Syndicate	A		A+		211
American Empire Surplus Lines	A+		A+		143
Mid-Continent Casualty	A+		A+		129
Other					87
					$	5,981

The primary objectives of AFG’s property and casualty insurance operations are to achieve solid underwriting profitability and provide excellent service to its policyholders and agents. Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses, loss adjustment expenses (“LAE”), underwriting expenses and policyholder dividends to premiums. A combined ratio under 100% indicates an underwriting profit. The combined ratio does not reflect investment income, other income or federal income taxes.

While many costs included in underwriting are readily determined (commissions, administrative expenses and many of the losses on claims reported), the process of determining overall underwriting results is highly dependent upon the use of estimates in the case of losses incurred or expected but not yet reported or developed. Actuarial procedures and projections are

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used to obtain “point estimates” of ultimate losses. While the process is imprecise and develops amounts which are subject to change over time, management believes that the liabilities for unpaid losses and loss adjustment expenses are adequate.

Financial information is reported in accordance with U.S. generally accepted accounting principles (“GAAP”) for shareholder and other investor-related purposes and reported on a statutory basis for U.S. insurance regulatory purposes. Unless indicated otherwise, the financial information presented in the Form 10-K for AFG’s property and casualty insurance operations is presented based on GAAP. Statutory information is only prepared for AFG’s U.S.-based subsidiaries, which represented approximately 95% of AFG’s direct written premiums in 2016, and is provided for industry comparisons or where comparable GAAP information is not readily available.

Major differences for statutory accounting include charging policy acquisition costs to expense as incurred rather than spreading the costs over the periods covered by the policies; reporting investment grade bonds and redeemable preferred stocks at amortized cost rather than fair value; netting of reinsurance recoverables and prepaid reinsurance premiums against the corresponding liabilities rather than reporting such items separately; and charging to surplus certain GAAP assets, such as furniture and fixtures and agents’ balances over 90 days old.

AFG’s statutory combined ratio averaged 92.1% for the period 2014 to 2016 as compared to 98.8% for the property and casualty industry over the same period (Source: “A.M. Best’s Review & Preview Report” — February 2017 Edition). AFG believes that its specialty niche focus, product line diversification and underwriting discipline have contributed to the Company’s ability to consistently outperform the industry’s underwriting results. Management’s philosophy is to refrain from writing business that is not expected to produce an underwriting profit even if it is necessary to limit premium growth to do so.

Property and Casualty Results

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. See Note C — “Segments of Operations” to the financial statements for the reconciliation of AFG’s earnings before income taxes by significant business segment to the statement of earnings.

The following table shows the performance of AFG’s property and casualty insurance operations (dollars in millions):

		2016				2015				2014
Gross written premiums		$	5,981			$	5,832			$	5,477
Ceded reinsurance		(1,595		)		(1,505		)		(1,457		)
Net written premiums		$	4,386			$	4,327			$	4,020
Net earned premiums		$	4,328			$	4,224			$	3,878
Loss and LAE		2,669				2,628				2,470
Special asbestos and environmental (“A&E”) charges		36				67				24
Neon exited lines charge		65				—				—
Underwriting expenses		1,322				1,304				1,172
Underwriting gain		$	236			$	225			$	212
GAAP ratios:
Loss and LAE ratio		63.8		%		63.8		%		64.3		%
Underwriting expense ratio		30.7		%		30.9		%		30.2		%
Combined ratio		94.5		%		94.7		%		94.5		%
Statutory ratios:
Loss and LAE ratio		58.8		%		60.9		%		63.2		%
Underwriting expense ratio		31.4		%		31.7		%		30.4		%
Combined ratio		90.2		%		92.6		%		93.6		%
Industry statutory combined ratio (a)
All lines		100.7		%		98.3		%		97.4		%
Commercial lines		98.2		%		97.5		%		97.1		%

(a)	The source of the industry ratios is “A.M. Best’s Review & Preview Report” (February 2017 Edition).

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As with other property and casualty insurers, AFG’s operating results can be adversely affected by unpredictable catastrophe losses. Certain natural disasters (hurricanes, severe storms, earthquakes, tornadoes, floods, etc.) and other incidents of major loss (explosions, civil disorder, terrorist events, fires, etc.) are classified as catastrophes by industry associations. Losses from these incidents are usually tracked separately from other business of insurers because of their sizable effects on overall operations. Total net losses to AFG’s insurance operations from current accident year catastrophes were $55 million in 2016, $35 million in 2015 and $28 million in 2014 and are included in the table above.

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. AFG’s net exposure to a catastrophic earthquake or windstorm that industry models indicate could occur once in every 500 years (a “500-year event”) is expected to be less than 4% of AFG’s Shareholders’ Equity.

Property and Casualty Insurance Products

AFG is focused on growth opportunities in what it believes to be more profitable specialty businesses where AFG personnel are experts in particular lines of business or customer groups. The following are examples of AFG’s specialty businesses:

Property and Transportation
Inland and Ocean Marine	Provides coverage primarily for builders’ risk, contractors’ equipment, property, motor truck cargo, marine cargo, boat dealers, marina operators/dealers and excursion vessels.
Agricultural-related	Provides federally reinsured multi-peril crop (allied lines) insurance covering most perils as well as crop-hail, equine mortality and other coverages for full-time operating farms/ranches and agribusiness operations on a nationwide basis.
Commercial Automobile	Provides coverage for vehicles (such as buses and trucks) in a broad range of businesses including the moving and storage and transportation industries, and a specialized physical damage product for the trucking industry.
Specialty Casualty
Executive and Professional Liability	Markets coverage for directors and officers of businesses and non-profit organizations; errors and omissions; cyber; and mergers and acquisitions.
Umbrella and Excess Liability	Provides liability coverage in excess of primary layers.
Excess and Surplus	Provides liability, umbrella and excess coverage for unique, volatile or hard to place risks, using rates and forms that generally do not have to be approved by state insurance regulators.
General Liability	Provides coverage for contractor-related businesses, energy development and production risks, and environmental liability risks.
Targeted Programs	Includes coverage (primarily liability and property) for social service agencies, leisure, entertainment and non-profit organizations, customized solutions for other targeted markets and alternative risk programs using agency captives.
Workers’ Compensation	Provides coverage for prescribed benefits payable to employees who are injured on the job.
Specialty Financial
Fidelity and Surety	Provides fidelity and crime coverage for government, mercantile and financial institutions and surety coverage for various types of contractors and public and private corporations.
Lease and Loan Services	Provides coverage for insurance risk management programs for lending and leasing institutions, including equipment leasing and collateral and lender-placed mortgage property insurance.

Management believes specialization is the key element to the underwriting success of these business units. These specialty businesses are opportunistic and their premium volume will vary based on prevailing market conditions. AFG continually evaluates expansion in existing markets and opportunities in new specialty markets that meet its profitability objectives. For example, in April 2014, AFG acquired Summit Holding Southeast, Inc. and its related companies. Summit, which is a leading provider of workers’ compensation solutions in the southeastern United States, generated $540 million in net written premiums

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in 2016. Likewise, AFG will withdraw from markets that do not meet its profit objectives or business strategy, such as Neon’s withdrawal from its UK and international medical malpractice and general liability classes in 2016.

Premium Distribution

The following table shows the net written premiums by sub-segment for AFG’s property and casualty insurance operations for 2016, 2015 and 2014 (in millions):

	2016				2015				2014
Property and transportation	$	1,672			$	1,636			$	1,566
Specialty casualty	2,036				2,052				1,864
Specialty financial	572				540				488
Other	106				99				102
	$	4,386			$	4,327			$	4,020

The geographic distribution of statutory direct written premiums by AFG’s U.S.-based insurers for 2016, 2015 and 2014 is shown below. Approximately 5% of AFG’s direct written premiums in 2016 were derived from non U.S.-based insurers, primarily Neon, a United Kingdom-based Lloyd’s insurer.

		2016			2015			2014					2016			2015			2014
California		14.3	%		14.2	%		13.9	%		Pennsylvania		2.5	%		2.6	%		2.6	%
Florida		9.6	%		9.0	%		8.7	%		North Carolina		2.4	%		2.7	%		2.8	%
New York		6.7	%		6.7	%		6.6	%		Iowa		2.3	%		2.5	%		2.5	%
Texas		6.1	%		6.1	%		6.2	%		Kansas		2.2	%		2.5	%		2.5	%
Illinois		5.3	%		5.7	%		5.8	%		Michigan		2.2	%		2.5	%		2.3	%
Georgia		2.9	%		2.8	%		2.8	%		Arizona		2.1	%		1.1	%		1.1	%
Missouri		2.7	%		2.8	%		2.7	%		Indiana		2.1	%		2.0	%		1.8	%
New Jersey		2.5	%		2.3	%		2.4	%		Other		34.1	%		34.5	%		35.3	%
													100.0	%		100.0	%		100.0	%

Reinsurance

 

Consistent with standard practice of most insurance companies, AFG reinsures a portion of its property and casualty business with other insurance companies and assumes a relatively small amount of business from other insurers. AFG uses reinsurance for two primary purposes: (i) to provide higher limits of coverage than it would otherwise be willing to provide (i.e. large line capacity) and (ii) to protect its business by reducing the impact of catastrophes. The availability and cost of reinsurance are subject to prevailing market conditions, which may affect the volume and profitability of business that is written. AFG is subject to credit risk with respect to its reinsurers, as the ceding of risk to reinsurers does not relieve AFG of its liability to its insureds until claims are fully settled.

The commercial marketplace requires large policy limits ($25 million or more) in several of AFG’s lines of business, including certain executive and professional liability, umbrella and excess liability, and fidelity and surety coverages. Since these limits exceed management’s desired exposure to an individual risk, AFG generally enters into reinsurance agreements to reduce its net exposure under such policies to an acceptable level. Reinsurance continues to be available for this large line capacity exposure with satisfactory pricing and terms.

AFG has taken steps to limit its exposure to wind and earthquake losses by purchasing catastrophe reinsurance. In addition, AFG purchases catastrophe reinsurance for its workers’ compensation businesses. Although the cost of catastrophe reinsurance varies depending on exposure and the level of worldwide loss activity, AFG continues to obtain reinsurance coverage in adequate amounts at acceptable rates due to management’s decision to limit overall exposure to catastrophe losses through individual risk selection (including minimizing coastal and known fault-line exposures).

In addition to traditional reinsurance, AFG had catastrophe coverage through a catastrophe bond structure with Riverfront Re Ltd. from April 1, 2014 through January 6, 2017, which has not been renewed as of February 20, 2017.

In addition to the large line capacity and catastrophe reinsurance programs discussed above, AFG purchases reinsurance on a product-by-product basis. AFG regularly reviews the financial strength of its current and potential reinsurers. These reviews include consideration of credit ratings, available capital, claims paying history and expertise. This process periodically results

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in the transfer of risks to more financially secure reinsurers. Substantially all reinsurance is ceded to companies with investment grade S&P ratings or is secured by “funds withheld” or other collateral. Under “funds withheld” arrangements, AFG retains ceded premiums to fund ceded losses as they become due from the reinsurer. Recoverables from the following companies were individually between 5% and 11% of AFG’s total property and casualty reinsurance recoverable (including prepaid reinsurance premiums and net of payables to reinsurers) at December 31, 2016: Hannover Rueck SE, Munich Reinsurance America, Inc. and Swiss Reinsurance America Corporation. In addition, AFG has a reinsurance recoverable from Ohio Casualty Insurance Company of $147 million related to that company’s purchase of AFG’s commercial lines business in 1998. No other reinsurers exceeded 5% of AFG’s property and casualty reinsurance recoverable.

Reinsurance is provided on one of two bases, facultative or treaty. Facultative reinsurance is generally provided on a risk-by-risk basis. Individual risks are ceded and assumed based on an offer and acceptance of risk by each party to the transaction. AFG purchases facultative reinsurance, both pro rata and excess of loss, depending on the risk and available reinsurance markets. Treaty reinsurance provides for risks meeting prescribed criteria to be automatically ceded and assumed according to contract provisions.

The following table presents (by type of coverage) the amount of each loss above the specified retention covered by treaty reinsurance programs in AFG’s U.S.-based property and casualty insurance operations (in millions) as of January 1, 2017:

						Reinsurance Coverage											AFG
		Primary				Coverage				AFG Participation (a)							Maximum
		Retention				Amount				%			$				Loss (b)
California Workers’ Compensation		$	2			$	148			1	%		$	1			$	3
Other Workers’ Compensation		3				37				—	%		—				3
Commercial Umbrella		1				49				13	%		6				7
Property — General		5				45				—	%		—				5
Property — Catastrophe		15				85				5	%		4				19			(c)

 

(a)	Includes the participation of AFG’s internal reinsurance program.

(b)	Maximum loss for claims up to reinsurance coverage limit.

(c)	AFG expects to purchase additional Property — Catastrophe reinsurance during the first quarter of 2017 to replace the Riverfront Re Ltd. catastrophe bond that matured at the beginning of January 2017.

In addition to the coverage shown above, AFG reinsures a portion of its crop insurance business through the Federal Crop Insurance Corporation (“FCIC”). The FCIC offers both proportional (or “quota share”) and non-proportional coverages. The proportional coverage provides that a fixed percentage of risk is assumed by the FCIC. The non-proportional coverage allows AFG to select desired retention of risk on a state-by-state, county, crop or plan basis. AFG typically reinsures 15% to 25% of gross written premiums with the FCIC. AFG also purchases quota share reinsurance in the private market. This quota share provides for a ceding commission to AFG and a profit sharing provision. During both 2016 and 2015, AFG reinsured 52.5% of premiums not reinsured by the FCIC in the private market and purchased stop loss protection coverage for the remaining portion of the business. AFG expects to utilize similar levels of reinsurance in 2017.

Neon, AFG’s United Kingdom-based Lloyd’s insurer, mitigates its exposure to catastrophe losses through the purchase of reinsurance to cover losses in excess of $5 million. Management expects to increase Neon’s retention to $15 million when the current reinsurance treaties expire in the second quarter of 2017.

The balance sheet caption “recoverables from reinsurers” included approximately $92 million on paid losses and LAE and $2.30 billion on unpaid losses and LAE at December 31, 2016. These amounts are net of allowances of approximately $22 million for doubtful collection of reinsurance recoverables. The collectibility of a reinsurance balance is based upon the financial condition of a reinsurer as well as individual claim considerations.

Reinsurance premiums ceded and assumed are presented in the following table (in millions):

		2016				2015				2014
Reinsurance ceded		$	1,595			$	1,505			$	1,457
Reinsurance ceded, excluding crop		985				899				891
Reinsurance assumed — including involuntary pools and associations		123				119				90

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Loss and Loss Adjustment Expense Reserves

The consolidated financial statements include the estimated liability for unpaid losses and LAE of AFG’s insurance subsidiaries. This liability represents estimates of the ultimate net cost of all unpaid losses and LAE and is determined by using case-basis evaluations, actuarial projections and management’s judgment. These estimates are subject to the effects of changes in claim amounts and frequency and are periodically reviewed and adjusted as additional information becomes known. In accordance with industry practices, such adjustments are reflected in current year operations. Generally, reserves for reinsurance assumed and involuntary pools and associations are reflected in AFG’s results at the amounts reported by those entities. See Note O — “Insurance — Property and Casualty Insurance Reserves” to the financial statements for information on the development of AFG’s liability for unpaid losses and loss adjustment expenses by accident year as well as a progression of the liability on a GAAP basis over the past three years.

The differences between the liability for losses and LAE reported in the annual statements filed with the state insurance departments in accordance with statutory accounting principles (“SAP”) and that reported in the accompanying consolidated financial statements in accordance with GAAP at December 31, 2016 are as follows (in millions):

Liability reported on a SAP basis, net of $103 million of retroactive reinsurance	$	5,517
Reinsurance recoverables, net of allowance	2,302
Other, including reserves of foreign insurers	744
Liability reported on a GAAP basis	$	8,563

Asbestos and Environmental (“A&E”) Reserves   AFG’s property and casualty group, like many others in the industry, has A&E claims arising in most cases from general liability policies written more than twenty-five years ago. The establishment of reserves for such A&E claims presents unique and difficult challenges and is subject to uncertainties significantly greater than those presented by other types of claims. For a discussion of these uncertainties, see Item 7 — Management’s Discussion and Analysis — “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves” and Note M — “Contingencies” to the financial statements.

Management has periodically conducted comprehensive external studies of its asbestos and environmental reserves 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. Charges resulting from these studies and reviews are included in “Incurred losses and LAE” in the table below. As a result of the 2016 internal review, AFG recorded a $36 million pretax special charge in the third quarter of 2016 to increase the property and casualty group’s asbestos reserves by $5 million (net of reinsurance) and its environmental reserves by $31 million (net of reinsurance). Over the past few years, the focus of AFG’s asbestos claims litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty segment’s asbestos reserve increases in recent years. AFG is seeing modestly increasing estimates for indemnity and defense compared to prior studies. Overall, the rate of new asbestos cases received is down modestly. The increase in property and casualty environmental reserves was primarily associated with updated estimates of site investigation costs with respect to existing sites and newly identified sites. AFG is seeing increased legal defense costs in environmental claims generally, as well as a number of claims and sites where the estimated investigation and remediation costs have increased. As in past years, there were no new or emerging broad industry trends that were identified in the review. As a result of the 2015 external study, AFG recorded a $67 million pretax special charge in the third quarter of 2015 to increase the property and casualty group’s asbestos reserves by $25 million (net of reinsurance) and its environmental reserves by $42 million (net of reinsurance). The increase in property and casualty environmental reserves was attributed primarily to AFG’s increased defense costs and a number of claims where the estimated costs of remediation have increased. As a result of the internal review in 2014, AFG recorded a $24 million pretax special charge in the third quarter of 2014 to increase the property and casualty group’s asbestos reserves by $4 million (net of reinsurance) and its environmental reserves by $20 million (net of reinsurance). The increase in environmental reserves was attributed primarily to AFG’s increased defense costs and a number of claims where the estimated costs of remediation have increased.

The following table (in millions) is a progression of the property and casualty group’s A&E reserves.

		2016				2015				2014
Reserves at beginning of year		$	327			$	289			$	301
Incurred losses and LAE		36				67				24
Paid losses and LAE		(26		)		(29		)		(36		)
Reserves at end of year, net of reinsurance recoverable		337				327				289
Reinsurance recoverable, net of allowance		106				99				77
Gross reserves at end of year		$	443			$	426			$	366

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Marketing

The property and casualty insurance group directs its sales efforts primarily through independent insurance agents and brokers, although small portions are written through employee agents. Independent agents and brokers generally receive a commission on the sale of each policy. Some agents and brokers are eligible for a bonus commission based on the overall profitability of policies placed with AFG by the broker or agent in a particular year. The property and casualty insurance group writes insurance through several thousand agents and brokers.

Competition

AFG’s property and casualty insurance businesses compete with other individual insurers, state funds and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. See Item 1A — Risk Factors. They also compete with self-insurance plans, captive programs and risk retention groups. Due to the specialty nature of these coverages, competition is based primarily on service to policyholders and agents, specific characteristics of products offered and reputation for claims handling. Financial strength ratings, price, commissions and profit sharing terms are also important factors. Management believes that sophisticated data analysis for refinement of risk profiles, extensive specialized knowledge and loss prevention service have helped AFG compete successfully.

Annuity Segment

General

AFG sells traditional fixed and fixed-indexed annuities in the retail, financial institutions and education markets through independent producers and through direct relationships with certain financial institutions. The annuity operations employed approximately 600 people at December 31, 2016. These operations are conducted primarily through the subsidiaries listed in the following table, which includes 2016 statutory annuity premiums (in millions), annuity policies in force and independent ratings.

						Annuity
		Annuity				Policies			Ratings
Company		Premiums				In Force			AM Best		S&P
Great American Life Insurance Company		$	4,242			384,000			A		A+
Annuity Investors Life Insurance Company		193				117,500			A		A+

AFG believes that the ratings assigned by independent insurance rating agencies are an important competitive factor because agents, potential policyholders, financial institutions, and school districts often use a company’s rating as an initial screening device in considering annuity products. AFG believes that a rating in the “A” category by at least one rating agency is necessary to successfully compete in its primary annuity markets.

Statutory premiums of AFG’s annuity operations for the last three years were as follows (in millions):

		Premiums
		2016				2015				2014
Financial institutions single premium annuities — indexed		$	1,950			$	1,741			$	1,489
Financial institutions single premium annuities — fixed		468				229				332
Retail single premium annuities — indexed		1,714				1,864				1,533
Retail single premium annuities — fixed		82				70				101
Education market — fixed and indexed annuities		184				194				194
Total fixed annuity premiums		4,398				4,098				3,649
Variable annuities		37				42				47
Total annuity premiums		$	4,435			$	4,140			$	3,696

Annuities are long-term retirement saving instruments that benefit from income accruing on a tax-deferred basis. The issuer of the annuity collects premiums, credits interest or earnings on the policy and pays out a benefit upon death, surrender or annuitization. Single premium annuities are generally issued in exchange for a one-time lump-sum premium payment. Certain annuities, primarily in the education market, have premium payments that are flexible in both amount and timing as determined by the policyholder and are generally made through payroll deductions.

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Annuity contracts are generally classified as either fixed rate (including fixed-indexed) or variable. With a traditional fixed rate annuity, AFG seeks to maintain a desired spread between the yield on its investment portfolio and the rate it credits to policyholders. AFG accomplishes this by: (i) offering crediting rates that it has the option to change after any initial guarantee period (subject to minimum interest rate and other contractual guarantees); (ii) designing annuity products that encourage persistency; and (iii) maintaining an appropriate matching of assets and liabilities.

A fixed-indexed annuity provides policyholders with the opportunity to receive a crediting rate tied, in part, to the performance of an existing market index (generally the S&P 500) while protecting against the related downside risk through a guarantee of principal (excluding surrender charges, market value adjustments, and certain benefit charges). AFG purchases call options designed to substantially offset the effect of the index participation in the liabilities associated with fixed-indexed annuities.

As an ancillary product in its education market, AFG offers a limited amount of variable annuities. With a variable annuity, the earnings credited to the policy vary based on the investment results of the underlying investment options chosen by the policyholder, generally without any guarantee of principal except in the case of death of the insured. Premiums directed to the underlying investment options maintained in separate accounts are invested in funds managed by various independent investment managers. AFG earns a fee on amounts deposited into separate accounts. Subject to contractual provisions, policyholders may also choose to direct all or a portion of their premiums to various fixed-rate options, in which case AFG earns a spread on amounts deposited.

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 spread earned are often presented by annuity businesses to help users of their financial statements better understand the company’s performance. The following table shows the earnings before income taxes, as well as the net spread earned on fixed annuities, for the annuity segment both before and after the impact of fair value accounting for derivatives related to fixed-indexed annuities (“FIAs”) (dollars in millions):

		Year ended December 31,
		2016				2015				2014
Annuity earnings before income taxes — before the impact of derivatives related to FIAs		$	395			$	354			$	362
Impact of derivatives related to FIAs (a)		(27		)		(23		)		(34		)
Annuity segment earnings before income taxes		$	368			$	331			$	328
Net spread earned on fixed annuities — before impact of derivatives related to FIAs		1.39		%		1.35		%		1.56		%
Impact of derivatives related to FIAs		(0.10		%)		(0.09		%)		(0.15		%)
Net spread earned on fixed annuities		1.29		%		1.26		%		1.41		%

(a)

Fixed-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets will generally offset the economic change in the liabilities from the index participation. Both the index-based component of the annuities (fair value of $1.76 billion at December 31, 2016) and the related call options (fair value of $492 million at December 31, 2016) are considered derivatives that must be marked-to-market through earnings each period. 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.

Marketing

AFG sells its single premium annuities, excluding financial institution production (discussed below), primarily through a retail network of approximately 55 national marketing organizations (“NMOs”) and managing general agents (“MGAs”) who, in turn, direct over 1,200 actively producing agents.

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AFG also sells single premium annuities in financial institutions through direct relationships with certain financial institutions and through independent agents and brokers. The table below highlights the percentage of AFG’s total annuity premiums generated through its top five financial institution relationships (ranked based on 2016 premiums):

	2016			2015
Wells Fargo & Company	14.2	%		11.7	%
The PNC Financial Services Group, Inc.	9.7	%		4.4	%
LPL Financial	4.8	%		3.8	%
Regions Financial Corporation	4.8	%		3.8	%
BB&T Corporation	4.5	%		6.0	%

In the education market, schools may allow employees to save for retirement through contributions made on a before-tax basis. Federal income taxes are not payable on pretax contributions or earnings until amounts are withdrawn. AFG sells its education market annuities directly through writing agents rather than through NMOs and MGAs.

AFG is licensed to sell its fixed annuity products in all states except New York; it is licensed to sell its variable products in all states except New York and Vermont. At December 31, 2016, AFG had approximately 500,000 annuity policies in force. The states that accounted for 5% or more of AFG’s annuity premiums in 2016 and the comparable preceding years are shown below:

		2016			2015			2014
California		9.8	%		9.7	%		9.8	%
Florida		8.5	%		9.0	%		9.6	%
Pennsylvania		7.2	%		7.2	%		6.3	%
New Jersey		5.3	%		4.3	%		4.0	%
Ohio		5.2	%		5.7	%		5.8	%

Competition

AFG’s annuity businesses operate in highly competitive markets. They compete with other insurers and financial institutions based on many factors, including: (i) ratings; (ii) financial strength; (iii) reputation; (iv) service to policyholders and agents; (v) product design (including interest rates credited, bonus features and index participation); (vi) commissions; and (vii) number of school districts in which a company has approval to sell. Since most policies are marketed and distributed through independent agents, the insurance companies must also compete for agents.

No single insurer dominates the markets in which AFG’s annuity businesses compete. See Item 1A — Risk Factors. Competitors include (i) individual insurers and insurance groups, (ii) mutual funds and (iii) other financial institutions. In a broader sense, AFG’s annuity businesses compete for retirement savings with a variety of financial institutions offering a full range of financial services. In the financial institution annuity market, AFG’s annuities compete directly against competitors’ annuities, certificates of deposit and other investment alternatives at the point of sale. In addition, over the last few years, several offshore and/or hedge fund companies have made significant acquisitions of annuity businesses, resulting in annuity groups that are larger in size than AFG’s annuity business.

Sales of annuities, including renewal premiums, are affected by many factors, including: (i) competitive annuity products and rates; (ii) the general level and volatility of interest rates, including the slope of the yield curve; (iii) the favorable tax treatment of annuities; (iv) commissions paid to agents; (v) services offered; (vi) ratings from independent insurance rating agencies; (vii) other alternative investments; (viii) performance and volatility of the equity markets; (ix) media coverage of annuities; (x) regulatory developments regarding suitability and the sales process; and (xi) general economic conditions.

Run-off Long-term Care and Life Segment

AFG ceased new sales of long-term care insurance in January 2010 and sold substantially all of its run-off long-term care business in December 2015. See Note B — “Acquisitions and Sale of Businesses” to the financial statements. Renewal premiums on the remaining policies covering approximately 1,600 lives will be accepted unless those policies lapse. At December 31, 2016, AFG’s long-term care insurance reserves were $37 million, net of reinsurance recoverables and excluding the impact of unrealized gains on securities.

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Although AFG no longer actively markets new life insurance products, it continues to service and receive renewal premiums on its in-force block of approximately 116,000 policies and $13.49 billion gross ($3.27 billion net of reinsurance) of life insurance in force at December 31, 2016. Renewal premiums, net of reinsurance, were $18 million in 2016, $28 million in 2015 and $30 million in 2014. At December 31, 2016, AFG’s life insurance reserves were $312 million, net of reinsurance recoverables.

Other Operations

Through subsidiaries, AFG is engaged in a variety of other operations, including commercial real estate operations in Cincinnati (office buildings and The Cincinnatian Hotel), Whitefield, New Hampshire (Mountain View Grand Resort), Chesapeake Bay (Skipjack Cove Yachting Resort and Bay Bridge Marina), Charleston (Charleston Harbor Resort and Marina), Palm Beach (Sailfish Marina and Resort) and greater Chicago (KeyLime Cove Indoor Waterpark Resort). These operations employed approximately 400 full-time employees at December 31, 2016.

Investment Portfolio

General

A summary of AFG’s fixed maturities and equity securities is shown in Note E to the financial statements. For additional information on AFG’s investments, see Item 7 — Management’s Discussion and Analysis — “Investments.” Portfolio yields are shown below:

		2016			2015			2014
Yield on Fixed Maturities (a):
Excluding realized gains and losses		4.5	%		4.7	%		4.9	%
Including realized gains and losses		4.5	%		4.6	%		5.0	%
Yield on Equity Securities (a):
Excluding realized gains and losses		5.3	%		5.4	%		5.4	%
Including realized gains and losses		6.2	%		5.4	%		7.7	%

 

(a)	Based on amortized cost; excludes effects of changes in unrealized gains and losses. Realized losses include impairment charges.

The table below compares total returns, which include changes in fair value, on AFG’s fixed maturities and equity securities to comparable public indices. While there are no directly comparable indices to AFG’s portfolio, the two shown below are widely used benchmarks in the financial services industry.

		2016			2015			2014
Total return on AFG’s fixed maturities		4.7	%		1.5	%		6.9	%
Barclays Capital U.S. Universal Bond Index		3.9	%		0.4	%		5.6	%
Total return on AFG’s equity securities		10.3	%		(3.4	%)		8.7	%
Standard & Poor’s 500 Index		12.0	%		1.4	%		13.7	%

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Fixed Maturity Investments

AFG’s bond portfolio is invested primarily in taxable bonds. The following table shows AFG’s available for sale fixed maturity investments by Standard & Poor’s Corporation or comparable rating as of December 31, 2016 (dollars in millions).

		Amortized				Fair Value
		Cost				Amount				%
S&P or comparable rating
AAA, AA, A		$	21,257			$	21,626			63	%
BBB		8,954				9,149				26	%
Total investment grade		30,211				30,775				89	%
BB		684				691				2	%
B		444				444				1	%
CCC, CC, C		909				1,009				3	%
D		628				678				2	%
Total non-investment grade		2,665				2,822				8	%
Not rated		859				947				3	%
Total		$	33,735			$	34,544			100	%

The National Association of Insurance Commissioners (“NAIC”) has retained third-party investment management firms to assist in the determination of appropriate NAIC designations for mortgage-backed securities (“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. Approximately 15% of AFG’s fixed maturity investments are MBS. At December 31, 2016, 97% (based on statutory carrying value of $33.75 billion) of AFG’s fixed maturity investments held by its insurance companies had a NAIC designation of 1 or 2 (the highest of the six designations).

Equity Investments

At December 31, 2016, AFG held common and perpetual preferred stocks classified as available for sale with a fair value of $1.50 billion.

Regulation

AFG’s insurance company subsidiaries are subject to regulation in the jurisdictions where they do business. In general, the insurance laws of the various states establish regulatory agencies with broad administrative powers governing, among other things, premium rates, solvency standards, licensing of insurers, agents and brokers, trade practices, forms of policies, maintenance of specified reserves and capital for the protection of policyholders, deposits of securities for the benefit of policyholders, investment activities and relationships between insurance subsidiaries and their parents and affiliates. Material transactions between insurance subsidiaries and their parents and affiliates generally must receive prior approval of the applicable insurance regulatory authorities and be disclosed. In addition, while differing from state to state, these regulations typically restrict the maximum amount of dividends that may be paid by an insurer to its shareholders in any twelve-month period without advance regulatory approval. Such limitations are generally based on net earnings or statutory surplus. Under applicable restrictions, the maximum amount of dividends available to AFG in 2017 from its insurance subsidiaries without seeking regulatory approval is approximately $693 million.

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”), among other things, established a Federal Insurance Office (“FIO”) within the U.S. Treasury. Under this law, regulations will need to be created for the FIO to carry out its mandate to focus on systemic risk oversight. The FIO has gathered information regarding the insurance industry and submitted a report to Congress in December 2013. The report concluded that a hybrid approach to regulation, involving a combination of state and federal government action, could improve the U.S. insurance system by attaining uniformity, efficiency and consistency, particularly with respect to solvency and market conduct regulation. AFG cannot predict the extent to which the report’s recommendations might result in changes to the current state-based system of insurance industry regulation or ultimately impact AFG’s operations.

Neon, AFG’s UK-based Lloyd’s insurer, is subject to regulation by the European Union’s executive body, the European Commission. On January 1, 2016, Neon adopted new capital adequacy and risk management regulations known as Solvency II. Because Lloyd’s insurers were already operating under the proposed Solvency II guidelines, implementation was not material to AFG.

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Most states have created insurance guaranty associations that assess solvent insurers to pay claims of insurance companies that become insolvent. Annual guaranty assessments for AFG’s insurance companies have not been material.

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 E.U. 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 operations 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. operations 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. The Company has no knowledge that any coverage it has provided has directly or significantly facilitated or contributed to the Iranian petroleum resources, refined petroleum or petrochemical industry.

For the year ended December 31, 2016, the Company is not aware of any premium apportionment with respect to underwriting insurance or reinsurance activities reportable under Section 13(r). Should any such risks have entered into the stream of commerce covered by these insurance or reinsurance activities, the Company believes that the premiums associated with such business would be immaterial.

ITEM 1A

Risk Factors

In addition to the other information set forth in this report, particularly information under “Forward-Looking Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the following factors could materially affect AFG’s business, financial condition, cash flows or future results. Any one of these factors could cause AFG’s actual results to vary materially from recent results or from anticipated future results. The risks described below are not the only risks facing AFG. Additional risks and uncertainties not currently known to management or that management currently deems to be immaterial also may materially adversely affect AFG’s business, financial condition and/or operating results.

Adverse developments in the financial markets and deterioration in global economic conditions could have a material adverse effect on AFG’s results of operations and financial condition.

Worldwide financial markets have, from time to time, experienced significant and unpredictable disruption. For example, during the financial crisis that started approximately nine years ago, the United States and many other economies experienced a prolonged economic downturn, resulting in heightened credit risk, reduced valuation of certain investments and decreased economic activity. Financial markets may again experience significant and prolonged disruption, including disruption from unanticipated events. In the years following the financial crisis, the federal government has taken steps to stabilize financial markets, but such steps may not be effective.

Changes in financial markets including fluctuations in interest rates, credit conditions, equity prices and many other factors that are unpredictable and beyond AFG’s control can adversely affect the value of investments and the realization of investment income.

A significant majority of the Company’s investment portfolio consists of fixed maturity investments, and changes in global economic conditions, including interest rates, could have a material adverse effect on AFG’s results of operations and financial condition.

As of December 31, 2016, approximately 84% of AFG’s investment portfolio holdings consisted of fixed maturity investments that are sensitive to changes in interest rates. A decline in interest rates may reduce the returns earned on new and floating-rate fixed maturity investments, thereby reducing AFG’s net investment income, while an increase in interest rates may reduce the value of AFG’s existing fixed maturity investments, which primarily have fixed interest rates. The value of AFG’s fixed

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maturity investments is also subject to risk that certain investments may default or become impaired due to deterioration in the financial condition of issuers of those investments. If a decline in the fair value of a specific investment (below its amortized cost) is considered to be other-than-temporary, a provision for impairment would be charged to earnings.

Interest rates have remained at historical lows for an extended period. In addition, central banks in some countries have recently pursued largely unprecedented negative interest rate policies, the consequences of which are uncertain. The continuation of the current low interest rate environment or a deflationary environment with negative interest rates could affect business behavior in ways that are adverse to AFG and could constrict AFG’s net investment income.

As of December 31, 2016, mortgage-backed securities constituted approximately 15% of AFG’s fixed maturity portfolio. In addition to the risks applicable to the entire fixed maturity investment portfolio, changes in interest rates can expose AFG to prepayment risks on mortgage-backed securities. In periods of declining interest rates, mortgage prepayments generally increase and mortgage-backed securities are paid down more quickly, requiring AFG to reinvest the proceeds at the then current market rates, which may be lower than on the securities repaid.

Changes in interest rates could adversely affect the profitability of AFG’s annuity business.

The profitability of AFG’s annuity segment is largely dependent on the spread between what it earns on its investments and the crediting rate it pays on its annuity contracts plus expenses incurred.

Both rising and declining interest rates can negatively affect the Company’s annuity results. Most of AFG’s annuity products have guaranteed minimum crediting rates. Although AFG could reduce the average crediting rate on a substantial portion of its traditional fixed and fixed-indexed deferred annuities during periods of low or falling interest rates, AFG may not be able to fully offset the decline in investment earnings with lower crediting rates.

During periods of rising interest rates, the Company may experience competitive pressure to increase crediting rates to avoid a decline in sales or increased surrenders, thus resulting in lower spreads. In addition, an increase in surrenders could require the sale of investments at a time when the prices of those assets are lower due to the increase in market rates, which may result in realized investment losses.

Intense competition could adversely affect AFG’s results of operations.

The property and casualty insurance segment operates in a highly competitive industry that is affected by many factors that can cause significant fluctuations in its results of operations. The lines of business in this segment compete with other individual insurers, state funds and insurance groups of varying sizes, some of which are mutual insurance companies possessing competitive advantages in that all their profits inure to their policyholders. In addition, certain foreign insurers can write business in the U.S. on a tax-advantaged basis, which may result in a competitive advantage over AFG. The property and casualty insurance segment also competes with self-insurance plans, captive programs and risk retention groups. Competition is based on many factors, including service to policyholders and agents, product design, reputation for claims handling, price, commissions, ratings and financial strength. Peer companies and competitors in some or all of AFG’s specialty lines include the following companies and/or their subsidiaries: Alleghany Corp., American International Group Inc., American National Insurance Company, AmTrust Financial Services, Inc., Arch Capital Group Ltd., Baldwin & Lyons, Inc., Chubb Ltd., Cincinnati Financial Corp., CNA Financial Corp., Fairfax Financial Holdings Ltd. (Zenith National), The Hartford Financial Services Group, Inc., Ironshore Insurance Ltd., Lancer Insurance Company, Liberty Mutual, Markel Corp., Munich Re Group (American Modern Insurance), RLI Corp., The Travelers Companies Inc., Tokio Marine Holdings, Inc. (HCC Insurance, Philadelphia Consolidated), W.R. Berkley Corp., XL Group Plc and Zurich Financial Services Group.

AFG’s annuity segment competes with individual insurers and insurance groups, mutual funds and other financial institutions. In addition, in recent years, offshore and/or hedge fund companies have made significant acquisitions of annuity businesses. Competition is based on numerous factors including reputation, product design, interest crediting rates, performance, scope of distribution, price and perceived financial strength and credit ratings. While generally lower rated, the hedge fund companies are often more aggressive on pricing, which could adversely affect AFG’s annuity segment’s ability to grow its business, as well as its surrender activity. Peer companies and competitors for AFG’s annuity segment include the following companies and/or their subsidiaries: Allianz Life Insurance Company of North America, American Equity Investment Life Holding Company (Eagle Life Insurance Company), American International Group Inc., Athene Holding Ltd, Global Atlantic Financial Group Ltd. (Forethought Life Insurance Company), Lincoln National Corp., MetLife, Inc., Nationwide Mutual Insurance Company, Pacific Life Insurance Company, Sumitomo Life Insurance Company (Symetra Financial Corporation) and Voya Financial.

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Some of AFG’s competitors have more capital and greater resources than AFG, and may offer a broader range of products and lower prices than AFG offers. If competition limits AFG’s ability to write new or renewal business at adequate rates, its results of operations will be adversely affected.

A significant percentage of AFG’s sales of annuity products through financial institutions is concentrated in a small number of institutions.

Annuity premiums generated through financial institutions represented 55% of AFG’s annuity premiums in 2016 and have been a key driver in the growth of AFG’s annuity business. In 2016, two large financial institutions accounted for 44% of AFG’s total sales through financial institutions and 24% of AFG’s overall annuity sales. In the financial institutions annuity market, AFG competes directly against competitors’ annuities, certificates of deposit and other investment alternatives at the point of sale. Loss of a substantial portion of this business coupled with a failure to replace these financial institutions if they significantly reduce sales of AFG annuities could reduce AFG’s future growth.

AFG’s revenues could be adversely affected if it is not able to attract and retain independent agents.

AFG’s reliance on the independent agency market makes it vulnerable to a reduction in the amount of business written by agents. Many of AFG’s competitors also rely significantly on the independent agency market. Accordingly, AFG must compete with other insurance carriers for independent agents’ business. Some of its competitors offer a wider variety of products, lower price for insurance coverage or higher commissions. A reduction in the number of independent agencies marketing AFG’s products, the failure of agencies to successfully market AFG’s products, changes in the strategy or operations of agencies (including agency consolidation) or the choice of agencies to reduce their writings of AFG products could adversely affect AFG’s revenues and profitability.

The inability to obtain reinsurance or to collect on ceded reinsurance could adversely affect AFG’s results of operations.

AFG purchases reinsurance to limit the amount of risk it retains. Market conditions determine the availability and cost of the reinsurance protection AFG purchases, which affects the level of AFG’s business and profitability, as well as the level and types of risk AFG retains. If AFG is unable to obtain sufficient reinsurance at a cost AFG deems acceptable, AFG may opt to reduce the volume of its underwriting. AFG is also subject to credit risk with respect to its reinsurers, as AFG will remain liable to its insureds if any reinsurer is unable to meet its obligations under agreements covering the reinsurance ceded. The collectability of recoverables from reinsurers is subject to uncertainty arising from a number of factors, including a reinsurers’ financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract and changes in market conditions. As of December 31, 2016, recoverables from reinsurances reported on AFG’s Balance Sheet were approximately $2.74 billion.

AFG is subject to comprehensive regulation, and its ability to earn profits may be restricted by these regulations.

AFG is subject to comprehensive regulation by government agencies in the states and countries where its insurance company subsidiaries are domiciled and where these subsidiaries issue policies and handle claims. In addition, the Lloyd’s marketplace sets rules under which its members operate, including AFG’s Neon Lloyd’s syndicate. Most insurance regulations are designed to protect the interests of AFG’s policyholders and third party claimants as opposed to its investors.

The Dodd-Frank Act, enacted in June 2010, mandates changes to the regulation of the financial services industry. Implementation of the Dodd-Frank Act is ongoing. The potential impacts of the Act on the U.S. insurance industry are not clear, but may affect AFG’s operations and governance in ways that could adversely affect AFG’s financial condition and results of operations.

Changes in domestic or foreign tax laws or interpretations of such laws could increase AFG’s corporate taxes and reduce earnings. Additionally, global budget deficits make it possible that governments will seek additional revenue through future tax proposals that may increase AFG’s effective tax rate. However, it remains difficult to predict the timing and effect that future tax law changes could have on AFG’s earnings both in the United States and in foreign jurisdictions.

As a participant in the federal crop insurance program, AFG could also be impacted by regulatory and legislative changes affecting that program. For example, the reinsurance levels that the federal government provides to authorized carriers could be reduced by future legislation. AFG will continue to monitor new and changing federal regulations and their potential impact, if any, on its insurance company subsidiaries.

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On April 6, 2016, the U.S. Department of Labor released a final regulation that substantially expands the range of activities that will be considered fiduciary advice under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of 1986. Implementation is scheduled to phase in beginning April 10, 2017. The new regulation deems advisers, including independent agents, who sell fixed index annuities to IRAs, IRA rollovers or 401(k) plans to be fiduciaries and prohibits them from receiving compensation unless they comply with a prohibited transaction exemption requiring advisers to comply with impartial conduct standards. In addition, AFG may be required to provide enhanced oversight over the sales process. On February 3, 2017, President Trump issued a presidential memorandum directing the Department of Labor to examine the regulation. While the memorandum does not delay the implementation date for the regulation, on February 9, 2017, the Department of Labor filed a notice with the Office of Management and Budget (“OMB”) to delay implementation of the regulation. The OMB is reviewing the notice and, if approved, will send the notice for publication in the Federal Register. Even if delayed or repealed, many financial firms have taken steps to comply with the regulation and may decide to continue to comply. If implemented, compliance with the prohibited transaction exemptions will likely result in increased regulatory burdens, changes to AFG’s product offerings and compensation to agents and increased litigation risk, which could negatively impact AFG’s business, results of operations or financial condition. Management cannot currently predict the effect on AFG’s business if the regulation is not implemented but is partly or substantially followed by some or all its independent agents.

Existing insurance-related laws and regulations may become more restrictive in the future or new restrictive laws may be enacted; it is not possible to predict the potential effects of these laws and regulations. The costs of compliance or the failure to comply with existing or future regulations could impose significant burdens on the Company.

A downgrade or potential downgrade in AFG’s financial strength and/or credit ratings by one or more rating agencies could adversely affect its business, financial condition, results of operations and/or cash flows.

Financial strength ratings are an important factor in establishing the competitive position of insurance companies and may have an effect on an insurance company’s sales. A downgrade out of the “A” category in AFG’s insurers’ claims-paying and financial strength ratings could significantly reduce AFG’s business volumes in certain lines of business, adversely impact AFG’s ability to access the capital markets and increase AFG’s borrowing costs.

In addition to the financial strength ratings of AFG’s principal insurance company subsidiaries, various rating agencies also publish credit ratings for AFG. Credit ratings are indicators of a debt issuer’s ability to meet the terms of debt obligations in a timely manner, are part of AFG’s overall financial profile and affect AFG’s ability to access certain types of capital. A downgrade in AFG’s credit ratings could have a material adverse effect on AFG’s financial condition and results of operations and cash flows in a number of ways, including adversely limiting access to capital markets, potentially increasing the cost of debt or increasing borrowing costs under AFG’s current revolving credit facility.

The continued threat of terrorism and ongoing military and other actions, as well as civil unrest, may adversely affect AFG’s results of operations.

The occurrence of one or more terrorist attacks could cause significant losses from insurance claims that could adversely affect AFG’s profitability. Private sector catastrophe reinsurance is limited and generally unavailable for terrorism losses caused by attacks with nuclear, biological, chemical or radiological weapons. Reinsurance coverage from the federal government under the Terrorism Risk Insurance Program Reauthorization Act of 2015 (“TRIPRA”) is also limited. Although TRIPRA provides benefits for certified acts of terrorism that exceed a certain threshold of industry losses ($120 million in 2016, increasing by $20 million annually to $200 million by 2020), those benefits are subject to a deductible and other limitations. In 2017, AFG would have to sustain losses from terrorism of nearly $650 million to be eligible for reinsurance under the program. In addition, because the interpretation of this law is untested, there is substantial uncertainty as to how it will be applied to specific circumstances. Finally, the program currently expires at the end of 2020, and the elimination or modification of the program, or a failure to extend the program, could adversely affect AFG’s property and casualty business through increased exposure to a catastrophic level of terrorism losses.

AFG may experience difficulties with technology or data security, which could have an adverse effect on its business or reputation.

AFG uses computer systems to store, retrieve, evaluate and utilize company and customer data and information. Systems failures or outages could compromise AFG’s ability to perform business functions in a timely manner, which could harm its ability to conduct business and hurt its relationships with business partners and customers. In the event of a disaster such as a natural catastrophe, an industrial accident, a blackout, a computer virus, a terrorist attack or war, AFG’s systems may be inaccessible to employees, customers or business partners for an extended period of time. Even if AFG’s employees are able to

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report to work, they may be unable to perform their duties for an extended period of time if the Company’s data or systems are disabled or destroyed.

AFG’s computer systems are vulnerable to security breaches due to the sophistication of cyber-attacks, viruses, malware, hackers and other external hazards, as well as inadvertent errors, equipment and system failures, and employee misconduct. In addition, over time, and particularly recently, the sophistication of these threats continues to increase. AFG’s administrative and technical controls as well as other preventative actions used to reduce the risk of cyber incidents and protect AFG’s information may be insufficient to detect or prevent unauthorized access, other physical and electronic break-ins, cyber-attacks or other security breaches to AFG’s computer systems or those of third parties with whom AFG does business.

AFG has increasingly outsourced certain technology and business process functions to third parties and may continue to do so in the future. Outsourcing of certain technology and business process functions to third parties may expose AFG to increased risk related to data security or service disruptions. If AFG does not effectively develop, implement and monitor these relationships, third party providers do not perform as anticipated, technological or other problems are incurred with a transition, or outsourcing relationships relevant to AFG’s business process functions are terminated, AFG may not realize expected productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of business.

The increased risks identified above could expose AFG to data loss, disruption of service, monetary and reputational damages, competitive disadvantage and significant increases in compliance costs and costs to improve the security and resiliency of AFG’s computer systems. The compromise of personal, confidential or proprietary information could also subject AFG to legal liability or regulatory action under evolving cyber-security, data protection and privacy laws and regulations enacted by the U.S. federal and state governments, Canada, the European Union (the “EU”) or other jurisdictions or by various regulatory organizations or exchanges. As a result, AFG’s ability to conduct business and its results of operations might be materially and adversely affected.

Any failure to protect the confidentiality of customer information could adversely affect AFG’s reputation and have a material adverse effect on AFG’s business, financial condition and results of operations.

AFG receives and is required to protect confidential information from customers, vendors and other third parties that may include financial information and, in connection with AFG’s property and casualty insurance operations, medical information. In addition, AFG and certain of its third-party vendors receive and store personal information in connection with AFG’s human resources operations and other aspects of AFG’s business. AFG is subject to numerous federal and state laws regarding the privacy and security of personal information, which laws vary significantly from jurisdiction to jurisdiction. If any disruption or security breach results in a loss or damage to AFG’s data, or inappropriate disclosure of AFG’s confidential information or that of others, it could damage AFG’s reputation, affect its relationships with customers and clients, lead to claims against AFG, result in regulatory action and harm AFG’s business. In addition, AFG may be required to incur significant costs to mitigate the damage caused by any security breach or to protect against future damage.

AFG’s property and casualty reserves may be inadequate, which could have a material adverse effect on AFG’s results of operations.

Liabilities for unpaid losses and loss adjustment expenses do not represent an exact calculation of liability but instead represent management estimates of what the ultimate settlement and administration of claims will cost, supported by actuarial expertise and projection techniques, at a given accounting date. The process of estimating unpaid losses and loss adjustment expense reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as: changes in claims handling procedures, adverse changes in loss cost trends (including inflationary pressures on medical costs), economic conditions (including general inflation), legal trends and legislative changes, and varying judgments and viewpoints of the individuals involved in the estimation process, among others. The impact of many of these items on ultimate costs for unpaid losses and loss adjustment expenses is difficult to estimate. Unpaid losses and loss adjustment expense reserve estimation difficulties also differ significantly by product line due to differences in claim complexity, the volume of claims, the potential severity of individual claims, the determination of an occurrence date for a claim and lags in the time between damage, loss or injury and when a claim is actually reported to the insurer. In addition, the historic development of AFG’s liability for unpaid losses and loss adjustment expenses may not necessarily reflect future trends in the development of these amounts. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on historical information. To the extent that reserves are inadequate and are strengthened, AFG’s profitability would be adversely affected because the amount of any such increase would be treated as a charge to earnings in the period in which the deficiency is recognized.

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AFG’s results of operations could be adversely impacted by severe weather conditions or other catastrophes, both natural and man-made.

Catastrophes can be caused by unpredictable natural events such as hurricanes, windstorms, severe storms, tornadoes, floods, hailstorms, severe winter weather, earthquakes, explosions and fire, and by man-made events, such as terrorist attacks. While not considered a catastrophe by insurance industry standards, droughts can have a significant adverse impact on AFG’s crop insurance results. In addition, extreme weather events that are linked to rising temperatures, changing global weather patterns and fluctuating rain, snow and sea levels could result in increased occurrence and severity of catastrophes. The extent of gross losses from a catastrophe event is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event, potentially mitigated by any reinsurance coverage purchased by AFG’s insurance subsidiaries. In addition, certain catastrophes could result in both property and non-property claims from the same event. A severe catastrophe or a series of catastrophes could result in losses exceeding AFG’s reinsurance protection and may have a material adverse impact on its results of operations or financial condition.

Volatility in crop prices, as a result of weather conditions or otherwise, could adversely impact AFG’s results of operations.

Weather conditions, including too much moisture (flooding or excessive rain) or not enough moisture (droughts), and the level of crop prices in the commodities market heavily impact AFG’s crop insurance business. These factors are inherently unpredictable and could result in significant volatility in the results of the crop insurance business from one year to the next. AFG’s crop results could also be negatively impacted by pests and plant disease. A large decline in the commodity prices of one or more of the major crops that AFG insures could have a material adverse effect on AFG’s results of operations or financial condition.

AFG’s international operations exposes it to investment, political and economic risks, including foreign currency and credit risk.

AFG’s international operations expose AFG to a number of additional risks. These risks include restrictions such as price controls, capital controls, currency exchange limits, ownership limits and other restrictive or anti-competitive governmental actions or requirements, which could have an adverse effect on AFG’s business and reputation. AFG’s business activities outside the United States may also be subject to political and economic risks, including foreign currency and credit risk.

AFG’s business activities outside the United States subject AFG to additional domestic and foreign laws and regulations, including the Foreign Corrupt Practices Act and similar laws in other countries that prohibit the making of improper payments to foreign officials. Although AFG has policies and controls in place that are designed to ensure compliance with these laws, if those controls are ineffective and an employee or intermediary fails to comply with applicable laws and regulations, AFG could suffer civil and criminal penalties and AFG’s business and reputation could be adversely affected. Some countries have laws and regulations that lack clarity and, even with local expertise and effective controls, it can be difficult to determine the exact requirements of, and potential liability under, the local laws. Failure to comply with local laws in a particular market may result in substantial liability and could have a significant and negative effect not only on AFG’s business in that market but also on AFG’s reputation generally.

Exposure to asbestos or environmental claims could materially adversely affect AFG’s results of operations and financial condition.

AFG has asbestos and environmental (“A&E”) exposures arising from its insurance operations and former railroad and manufacturing operations. Uncertainties surrounding the final resolution of these asbestos and environmental liabilities continue, and it is difficult to estimate AFG’s ultimate exposure to such liabilities and related litigation. Establishing A&E liabilities is subject to uncertainties that are significantly greater than those presented by other types of liabilities. Uncertainties include the long delays between exposure and manifestation of any bodily injury or property damage, difficulty in identifying the source of the asbestos or environmental contamination, long reporting delays, the risks inherent in complex litigation and difficulty in properly allocating liability for the asbestos or environmental damage. As a result, A&E liabilities are subject to revision as new information becomes available and as claims are made and develop. Claimants continue to assert new and novel theories of recovery, and from time to time, there is proposed state and federal legislation regarding A&E liability, which would also affect AFG’s exposure. If AFG has not established adequate reserves to cover future claims, AFG’s results of operations and financial condition could be materially adversely affected.

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Variations from the actuarial assumptions used to establish certain assets and liabilities in AFG’s annuity business could adversely affect AFG’s results of operations.

The earnings on AFG’s annuity products depend significantly upon the extent to which actual experience is consistent with the assumptions used in setting reserves and establishing and amortizing deferred policy acquisition costs (“DPAC”). These assumptions relate to investment yields (and spreads over fixed annuity crediting rates), benefit utilization rates, equity market performance, mortality, surrenders, annuitizations and other withdrawals. Developing such assumptions is complex and involves information obtained from company-specific and industry-wide data, as well as general economic information. These assumptions, and therefore AFG’s results of operations, could be negatively impacted by changes in any of the factors listed above.

Changes to existing accounting standards could adversely impact AFG’s reported results of operations.

As a U.S.-based SEC registrant, AFG prepares its financial statements in accordance with GAAP, as promulgated by the Financial Accounting Standards Board, subject to the accounting-related rules and interpretations of the SEC. Changes in accounting standards, particularly those that specifically apply to insurance company operations, may impact AFG’s reported financial results and could cause increased volatility in reported earnings, resulting in other adverse impacts on AFG’s ratings and cost of capital, and decrease the understandability of AFG’s financial results as well as the comparability of AFG’s reported results with other insurers.

As a holding company, AFG is dependent on the operations of its insurance company subsidiaries to meet its obligations and pay future dividends.

AFG is a holding company and a legal entity separate and distinct from its insurance company subsidiaries. As a holding company without significant operations of its own, AFG’s principal sources of funds are dividends and other distributions from its insurance company subsidiaries. State insurance laws differ from state to state but, absent advance regulatory approval, restrict the maximum amount of dividends that may be paid by an insurer to its shareholders in any twelve-month period. AFG’s rights to participate in any distribution of assets of its insurance company subsidiaries are subject to prior claims of policyholders and creditors (except to the extent that its rights, if any, as a creditor are recognized). Consequently, AFG’s ability to pay its debts, expenses and dividends to its shareholders may be limited.

Adverse developments in the financial markets may limit AFG’s access to capital.

Financial markets in the U.S. and elsewhere can experience extreme volatility, which exerts downward pressure on stock prices and limits access to the equity and debt markets for certain issuers, including AFG. AFG can borrow up to $500 million under its revolving credit facility, which expires in June 2021. In addition, AFG’s access to funds through this facility is dependent on the ability of its banks to meet their funding commitments. There were no borrowings outstanding under AFG’s bank credit line or any other parent company short-term borrowing arrangements during 2016. If AFG cannot obtain adequate capital or sources of credit on favorable terms, or at all, its business, operating results and financial condition would be adversely affected.

AFG may suffer losses from litigation, which could materially and adversely affect AFG’s financial condition and business operations.

AFG, primarily in its property and casualty insurance operations and historical operations, is involved in litigation. Litigation by nature is unpredictable, and the outcome of any case is uncertain and could result in liabilities that vary from the amounts AFG has currently recorded. Pervasive or significant changes in the judicial environment relating to matters such as trends in the size of jury awards, developments in the law relating to the liability of insurers or tort defendants, and rulings concerning the availability or amount of certain types of damages could cause AFG’s ultimate liabilities to change from current expectations. Changes in federal or state tort litigation laws or other applicable law could have a similar effect. It is not possible to predict changes in the judicial and legislative environment, including in connection with asbestos and environmental claims. AFG’s business, financial condition, results of operations and liquidity could also be adversely affected if judicial or legislative developments cause AFG’s ultimate liabilities to increase from current expectations.

Recent developments relating to the United Kingdom’s referendum vote in favor of leaving the EU could adversely affect AFG’s London-based property and casualty insurance operations.

The United Kingdom (“UK”) held a referendum on June 23, 2016 in which a majority of voters voted for the UK’s withdrawal from the European Union (“Brexit”). Because of this vote, the terms of the UK’s withdrawal from the EU and the relationship between the UK and EU going forward will have to be negotiated, including the terms of trade between the UK and the EU.

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The ultimate impact of Brexit is uncertain and will depend on any agreements that the UK makes to retain access to EU markets. Brexit could also lead to legal uncertainty and potentially divergent national laws and regulations as the UK determines which EU laws to replace or replicate. These or other adverse consequences from Brexit could adversely affect the operations and business opportunities of Neon, AFG’s London-based Lloyd’s syndicate.

Certain shareholders exercise substantial control over AFG’s affairs, which may impede a change of control transaction.

Carl H. Lindner III and S. Craig Lindner are each Co-Chief Executive Officers and Directors of AFG. Together, Carl H. Lindner III and S. Craig Lindner beneficially own 13.2% of AFG’s outstanding Common Stock as of February 1, 2017. Other members of the Lindner family own, directly or through trusts, a significant number of additional shares of AFG Common Stock. As a result, the Lindner family has the ability to exercise significant influence over AFG’s management, including over matters requiring shareholder approval. Such concentrated ownership could prevent an acquisition of AFG at a price which other shareholders may find attractive.

The price of AFG Common Stock may fluctuate significantly, which may make it difficult for holders to resell common stock when they want or at a price they find attractive.

The price of AFG’s Common Stock, which is listed on the NYSE, constantly changes. During 2016, AFG’s Common Stock traded at prices ranging between $64.87 and $88.54. AFG’s Common Stock price can fluctuate as a result of a variety of factors, many of which are beyond its control. These factors include but are not limited to:

•	actual or anticipated variations in quarterly operating results;

•	actual or anticipated changes in the dividends paid on AFG Common Stock;

•	rating agency actions;

•	recommendations by securities analysts;

•	significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving AFG or its competitors;

•	operating and stock price performance of other companies that investors deem comparable to AFG;

•	news reports relating to trends, concerns and other issues in AFG’s lines of business;

•	general economic conditions, including volatility in the financial markets; and

•	geopolitical conditions such as acts or threats of terrorism or military conflicts.

ITEM 2

Properties

Subsidiaries of AFG own several buildings in downtown Cincinnati. AFG and its affiliates occupy approximately half of the aggregate 675,000 square feet of commercial and office space in these buildings.

AFG and its insurance subsidiaries lease the majority of their office and storage facilities in numerous cities throughout the United States, including the Company’s home offices in Cincinnati. National Interstate occupies approximately 87% of the 164,000 square feet of rentable office space on 17.5 acres of land that it owns in Richfield, Ohio. See Item 1 — Business — “Other Operations” for a discussion of AFG’s other commercial real estate operations.

ITEM 3

Legal Proceedings

AFG and its subsidiaries are involved in litigation from time to time, generally arising in the ordinary course of business. This litigation may include, but is not limited to, general commercial disputes, lawsuits brought by policyholders, employment matters, reinsurance collection matters and actions challenging certain business practices of insurance subsidiaries. Except for the following, management believes that none of the litigation meets the threshold for disclosure under this Item.

On October 7, 2016, a purported shareholder of National Interstate Corporation (“NATL”) filed an action, relating to the proposed merger in which Great American Insurance Company (“GAI”) would acquire the remaining shares of NATL that it does not already own, derivatively and on behalf of a putative class of NATL’s shareholders in the United States District Court for the Northern District of Ohio, Eastern Division, captioned Solak v. Consolino, et al., Case No. 5:16-cv-02470-SL. The Solak action names as defendants NATL, the members of NATL’s board of directors, AFG, GAI and GAIC Alloy, Inc., a wholly-owned subsidiary of GAI formed to effect the merger transaction, alleging class and derivative claims under Sections 13(e), 14(a) and 20(a) of the Securities Exchange Act of 1934 and rules and regulations promulgated thereunder, and breach of

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fiduciary duty claims against the members of NATL’s board of directors and GAI as an alleged controlling shareholder. Defendants in the Solak action filed motions to dismiss on October 12, 2016, and on November 6, 2016, the parties to the Solak lawsuit entered into a memorandum of understanding with respect to a proposed settlement of the lawsuit, pursuant to which the parties agreed, among other things, that NATL would make certain supplemental disclosures related to the proposed merger. The memorandum of understanding contemplated that the parties would enter into a stipulation of settlement, which occurred on February 10, 2017. The stipulation of settlement is subject to customary conditions, including court approval following notice to NATL’s shareholders. A hearing on the proposal settlement, at which the United States District Court for the Northern District of Ohio (Eastern Division) will consider the settlement’s fairness, reasonableness and adequacy is scheduled for May 30, 2017. If the settlement is finally approved by the court, it will resolve and release all claims that were or could have been brought in any actions challenging any aspect of the proposed merger, the merger agreement and any disclosure made in connection therewith. In connection with the settlement, the parties contemplate that plaintiffs’ counsel will file a petition with the court for an award of attorneys’ fees and expenses to be paid by NATL or its successor, which the defendants may oppose. There can be no assurance that the court will approve the settlement.

AFG’s insurance company subsidiaries and its 100%-owned subsidiary, American Premier Underwriters (including its subsidiaries, “American Premier”), are parties to litigation and receive claims alleging injuries and damages from asbestos, environmental and other substances and workplace hazards and have established loss accruals for such potential liabilities. None of such litigation or claims is individually material to AFG; however, the ultimate loss for these claims may vary materially from amounts currently recorded as the conditions surrounding resolution of these claims continue to change.

American Premier is a party or named as a potentially responsible party in a number of proceedings and claims by regulatory agencies and private parties under various environmental protection laws, including the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), seeking to impose responsibility on American Premier for hazardous waste or discharge remediation costs at certain railroad sites formerly owned by its predecessor, Penn Central Transportation Company (“PCTC”), and at certain other sites where hazardous waste or discharge allegedly generated by PCTC’s railroad operations and American Premier’s former manufacturing operations is present. It is difficult to estimate American Premier’s liability for remediation costs at these sites for a number of reasons, including the number and financial resources of other potentially responsible parties involved at a given site, the varying availability of evidence by which to allocate responsibility among such parties, the wide range of costs for possible remediation alternatives, changing technology and the period of time over which these matters develop. Nevertheless, American Premier believes that its accruals for potential environmental liabilities are adequate to cover the probable amount of such liabilities, based on American Premier’s estimates of remediation costs and related expenses and its estimates of the portions of such costs that will be borne by other parties. Such estimates are based on information currently available to American Premier and are subject to future change as additional information becomes available.

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PART II

ITEM 5

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

AFG Common Stock is listed and traded on the New York Stock Exchange under the symbol AFG. The information presented in the table below represents the high and low sales prices per share reported on the NYSE Composite Tape.

		2016								2015
		High				Low				High				Low
First Quarter		$	71.66			$	64.87			$	65.51			$	57.50
Second Quarter		73.95				66.78				66.72				62.98
Third Quarter		76.03				70.82				73.65				65.43
Fourth Quarter		88.54				73.38				75.68				67.39

There were approximately 5,500 shareholders of record of AFG Common Stock at February 1, 2017. AFG declared and paid regular quarterly dividends of $0.28 per share in January, April and July 2016. In August 2016, AFG increased its quarterly dividend to $0.3125 per share and declared and paid its first dividend at that rate in October 2016. In 2015, AFG declared and paid regular quarterly dividends of $0.25 per share in January, April and July and $0.28 per share in October. In November 2016 and December 2015, AFG declared additional special cash dividends of $1.00 per share of AFG Common Stock, which were paid in December 2016 and December 2015, respectively. The ability of AFG to pay dividends will be dependent upon, among other things, the availability of dividends and payments under intercompany tax allocation agreements from its insurance company subsidiaries.

Issuer Purchases of Equity Securities   AFG repurchased shares of its Common Stock during 2016 as follows:

	Total Number of Shares Purchased			Average Price Paid Per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs			Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs (a)
First Nine Months	1,796,009			$	69.11			1,796,009			4,248,805
Fourth Quarter:
October	15,100			74.45				15,100			4,233,705
November	100,867			75.18				100,867			4,132,838
December	—			—				—			4,132,838
Total	1,911,976			$	69.47			1,911,976

 

(a)	Represents the remaining shares that may be repurchased under the Plans authorized by AFG’s Board of Directors in December 2014 and February 2016.

In addition, AFG acquired 28,059 shares of its Common Stock (at an average of $66.97 per share) in the first nine months of 2016, 1,925 shares (at an average of $75.44 per share) in November 2016 and 2,723 shares (at an average of $87.90 per share) in December 2016 in connection with its stock incentive plans.

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ITEM 6

Selected Financial Data

The following table sets forth certain data for the periods indicated (dollars in millions, except per share data).

		2016				2015				2014				2013				2012
Earnings Statement Data:
Total revenues		$	6,498			$	6,145			$	5,733			$	5,103			$	4,982
Earnings before income taxes		787				565				626				689				537
Net earnings, including noncontrolling interests		668				370				406				453				402
Less: Net earnings (loss) attributable to noncontrolling interests		19				18				(46		)		(18		)		(86		)
Net earnings attributable to shareholders		649				352				452				471				488
Earnings attributable to shareholders per Common Share:
Basic — GAAP		$	7.47			$	4.02			$	5.07			$	5.27			$	5.18
Diluted — GAAP		7.33				3.94				4.97				5.16				5.09
Core net operating earnings per share (diluted) (a)		6.03				5.44				4.82				4.22				3.27
Cash dividends paid per share of Common Stock (b)		$	2.1525			$	2.03			$	1.91			$	1.805			$	0.97
Ratio of earnings to fixed charges including annuity benefits (c)		1.85				1.66				1.90				2.15				1.98
Balance Sheet Data:
Cash and investments		$	41,433			$	37,736			$	36,210			$	31,313			$	28,449
Total assets		55,072				49,837				47,513				42,070				39,153
Property and casualty insurance reserves:
Unpaid losses and loss adjustment expenses		8,563				8,127				7,872				6,410				6,845
Unearned premiums		2,171				2,060				1,956				1,757				1,651
Annuity benefits accumulated		29,907				26,622				23,764				20,944				17,609
Life, accident and health reserves		691				705				2,175				2,008				2,059
Long-term debt		1,283				998				1,039				896				935
Shareholders’ equity		4,916				4,592				4,879				4,599				4,578
Less:
Net unrealized gains related to fixed maturities (d)		299				279				604				441				719
Appropriated retained earnings		—				—				(2		)		49				75
Adjusted shareholders’ equity (e)		4,617				4,313				4,277				4,109				3,784
Book value per share		$	56.55			$	52.50			$	55.62			$	51.38			$	51.45
Adjusted book value per share (e)		53.11				49.32				48.76				45.90				42.52

 

(a)

AFG’s net earnings per share (diluted), determined in accordance with GAAP, includes certain items that may not be indicative of its ongoing core operations. AFG believes that its core net operating earnings per share provides management, financial analysts, rating agencies and investors with an understanding of the results from the ongoing operations of the Company by excluding the impact of net realized investment gains and losses and other items that are not necessarily indicative of operating trends. AFG’s management uses core net operating earnings to evaluate financial performance against historical results because it believes this provides a more comparable measure of its continuing business. Core net operating earnings is also used by AFG’s management as a basis for strategic planning and forecasting. Core net operating earnings per share (diluted) is a non-GAAP financial measure. See Item 7 — Management’s Discussion and Analysis — “Results of Operations — General” for additional details, including a reconciliation of core net operating earnings per share (diluted) to net earnings available to shareholders (diluted) computed in accordance with GAAP.

(b)	Includes special cash dividends of $1.00 per share paid in December 2016, 2015, 2014 and 2013 and $0.25 per share paid in December 2012.

(c)

Fixed charges are computed on a “total enterprise” basis. For purposes of calculating the ratios, “earnings” have been computed by adding to pretax earnings the fixed charges and the noncontrolling interests in earnings of subsidiaries having fixed charges and the undistributed equity in earnings or losses of investees. Fixed charges include interest (including annuity benefits as indicated), amortization of debt premium/discount and expense, preferred dividend and distribution requirements of subsidiaries and a portion of rental expense deemed to be representative of the interest factor. The ratio of earnings to fixed charges excluding annuity benefits was 8.62, 6.58, 7.95, 8.86 and 7.16 for 2016, 2015, 2014, 2013 and 2012, respectively. Although the ratio of earnings to fixed charges excluding annuity benefits is not required or encouraged to be disclosed under Securities and Exchange Commission rules, some investors and lenders may not consider interest credited to annuity policyholders’ accounts a borrowing cost for an insurance company, and accordingly, believe this ratio is meaningful.

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(d)	Net unrealized gains related to fixed maturities, which includes net unrealized gains (losses) on cash flow hedges, is part of accumulated other comprehensive income and is shown net of related adjustments to deferred policy acquisition costs and certain liabilities in the annuity, long-term care and life businesses.

(e)

Adjusted shareholders’ equity and adjusted book value per share exclude appropriated retained earnings and net unrealized gains related to fixed maturity securities. Management believes that investors find a measurement of shareholders’ equity excluding these items to be meaningful as (i) the unrealized gains related to fixed maturities fluctuates with changes in interest rates in a way that is primarily only meaningful to AFG if it sells those investments and (ii) appropriated retained earnings represents amounts that will ultimately inure to the debt holders of the collateralized loan obligations managed by AFG (see Note A — “Accounting Policies — Managed Investment Entities” to the financial statements).

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ITEM 7

Management’s Discussion and Analysis of Financial Condition and Results of Operations

INDEX TO MD&A
	Page			Page
General	25		Results of Operations — Fourth Quarter	49
Overview	25		Segmented Statement of Earnings	49
Critical Accounting Policies	26		Property and Casualty Insurance	50
Liquidity and Capital Resources	26		Annuity	59
Ratios	26		Run-off Long-Term Care and Life	66
Condensed Consolidated Cash Flows	27		Holding Company, Other and Unallocated	67
Parent and Subsidiary Liquidity	28		Results of Operations — Full Year	70
Condensed Parent Only Cash Flows	30		Segmented Statement of Earnings	70
Contractual Obligations	31		Property and Casualty Insurance	72
Off-Balance Sheet Arrangements	31		Annuity	82
Investments	31		Run-off Long-Term Care and Life	91
Uncertainties	36		Holding Company, Other and Unallocated	92
Managed Investment Entities	42		Recent and Pending Accounting Standards	95
Results of Operations	47
General	47

GENERAL

Following is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of AFG’s financial condition and results of operations. This discussion should be read in conjunction with the financial statements beginning on page F-1.

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.

At December 31, 2016, AFG (parent) held approximately $260 million in cash and securities and had $500 million available under a bank line of credit, which expires in June 2021.

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 fixed and fixed-indexed annuities in the retail, financial institutions and education markets.

Fourth quarter 2016 net earnings attributable to AFG’s shareholders were $385 million ($4.33 per share, diluted) compared to $129 million ($1.45 per share, diluted) in the fourth quarter of 2015, reflecting:

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

•	higher earnings in the annuity segment,

•	the fourth quarter 2016 tax benefits from the National Interstate merger and Neon restructuring,

•	the fourth quarter 2015 gain on the sale of an apartment property, and

•	net realized gains on securities in the fourth quarter of 2016 compared to net realized losses in the fourth quarter of 2015.

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Full year 2016 net earnings attributable to AFG’s shareholders were $649 million ($7.33 per share, diluted) compared to $352 million ($3.94 per share, diluted) in 2015, reflecting:

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

•	higher earnings in the annuity segment,

•	lower profitability in the run-off long-term care and life segment,

•	net realized gains on securities in 2016 compared to net realized losses on securities in 2015,

•	the 2015 loss on the sale of substantially all of AFG’s run-off long-term care business,

•	the second quarter 2016 gain on the sale of an apartment property, which was less than the second quarter 2015 gain on the sale of a hotel and the fourth quarter 2015 gain on the sale of an apartment property, and

•	the fourth quarter 2016 tax benefits related to the National Interstate merger and Neon restructuring.

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 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.

See “Liquidity and Capital Resources — Uncertainties” for a discussion of insurance reserves, recoverables from reinsurers, and contingencies related to American Premier’s former operations and “Liquidity and Capital Resources — Investments” for a discussion of impairments on investments. Deferred policy acquisition costs (“DPAC”) and certain liabilities related to annuities are amortized in relation to the present value of expected gross profits on the policies. Assumptions considered in determining expected gross profits involve significant judgment and include management’s estimates of interest rates and investment spreads, surrenders, annuitizations, renewal premiums and mortality. Should actual experience require management to change its assumptions (commonly referred to as “unlocking”), a charge or credit would be recorded to adjust DPAC or annuity liabilities to the levels they would have been if the new assumptions had been used from the inception date of each policy.

LIQUIDITY AND CAPITAL RESOURCES

Ratios   AFG’s debt to total capital ratio on a consolidated basis is shown below (dollars in millions). Management intends to maintain the ratio of debt to capital at or below 25% and intends to maintain the capital of its significant insurance subsidiaries at or above levels currently indicated by rating agencies as appropriate for the current ratings.

		December 31,
		2016				2015
Principal amount of long-term debt		$	1,308			$	1,020
Total capital		5,921				5,512
Ratio of debt to total capital:
Including subordinated debt and debt secured by real estate		22.1		%		18.5		%
Excluding subordinated debt and debt secured by real estate		17.0		%		13.1		%

 

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, 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).

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AFG’s ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.85 for the year ended December 31, 2016. Excluding annuity benefits, this ratio was 8.62. 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.

The NAIC’s model law for risk based capital (“RBC”) applies to both life and property and casualty companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. At December 31, 2016, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements.

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):

	Year ended December 31,
	2016				2015				2014
Net cash provided by operating activities	$	1,150			$	1,353			$	1,231
Net cash used in investing activities	(2,981		)		(4,573		)		(3,628		)
Net cash provided by financing activities	2,718				3,097				2,101
Net change in cash and cash equivalents	$	887			$	(123	)		$	(296	)

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. Net cash provided by operating activities was $1.15 billion, $1.35 billion and $1.23 billion in 2016, 2015 and 2014, respectively.

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 products. Net cash used in investing activities was $2.98 billion in 2016 compared to $4.57 billion in 2015, a decrease of $1.59 billion. The $151 million decrease in net cash flows from annuity policyholders in 2016 as compared to 2015 (discussed below under net cash provided by financing activities) decreased the amount of cash available for investment in 2016 compared to 2015. In addition, AFG’s cash on hand increased by $887 million during 2016, primarily in the property and casualty and annuity segments reflecting the timing of investing available cash in those segments. Investing activities also include the purchase and disposal of managed investment entity investments (collateralized loan obligations), which are presented separately in AFG’s Balance Sheet. Net investment activity in the managed investment entities was a $364 million use of cash in 2016 compared to a $675 million use of cash in 2015, accounting for a $311 million decrease in net cash used in investing activities in 2016 compared to 2015. See Note A — “Accounting Policies — Managed Investment Entities” and Note H — “Managed Investment Entities” to the financial statements.

Net cash used in investing activities was $4.57 billion in 2015 compared to $3.63 billion in 2014, an increase of $945 million. The $537 million increase in net cash flows from annuity policyholders in 2015 as compared to 2014 increased the amount of cash available for investment in 2015 compared to 2014. Net investment activity in the managed investment entities was a $675 million use of cash in 2015 compared to a $275 million use of cash in 2014, accounting for a $400 million increase in net cash used in investing activities in 2015 compared to 2014.

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 $2.72 billion in 2016 compared to $3.10 billion in 2015, a decrease of $379 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $2.35 billion in 2016 compared to $2.50 billion in 2015, resulting in a $151 million decrease in net cash provided by financing activities in 2016 compared to 2015. AFG issued $300 million of 3.50% Senior Notes in 2016 and $150 million of 6% Subordinated Debentures in 2015, the

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net proceeds of which contributed $296 million in 2016 and $145 million in 2015 to net cash provided by financing activities. Redemptions of long-term debt was an $18 million use of cash in 2016 and a $192 million use of cash in 2015. During 2016, AFG repurchased $133 million of its Common Stock compared to $126 million repurchased in 2015, which accounted for a $7 million decrease in net cash provided by financing activities in 2016 compared to 2015. Additionally, during the fourth quarter of 2016, $315 million was used to fund the acquisition of the noncontrolling interest in National Interstate Corporation. 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 $693 million in 2016 compared to $890 million in 2015, accounting for a $197 million decrease in net cash provided by financing activities in 2016 compared to 2015. See Note A — “Accounting Policies — Managed Investment Entities” and Note H — “Managed Investment Entities” to the financial statements.

Net cash provided by financing activities was $3.10 billion in 2015 compared to $2.10 billion in 2014, an increase of $996 million. Annuity receipts exceeded annuity surrenders, benefits, withdrawals and transfers by $2.50 billion in 2015 compared to $1.97 billion in 2014, resulting in a $537 million increase in net cash provided by financing activities. Redemptions of long-term debt resulted in a $192 million use of cash in 2015. AFG issued $150 million of 6% Subordinated Debentures in 2015 and $150 million of 6-1/4% Subordinated Debentures in 2014, the net proceeds of each issuance contributed $145 million to net cash provided by financing activities in those years. During 2015, AFG repurchased $126 million of its Common Stock compared to $191 million in 2014, which accounted for a $65 million increase in net cash provided by financing activities in 2015 compared to 2014. Issuances of managed investment entity liabilities exceeded retirements by $890 million in 2015 compared to $306 million in 2014, accounting for a $584 million increase in net cash provided by financing activities in 2015 compared to 2014.

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.

In June 2016, AFG replaced its bank credit facility with a five-year, $500 million revolving credit line. 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 2016.

On November 10, 2016, AFG acquired the 49% of National Interstate Corporation (“NATL”) not previously owned by AFG’s wholly-owned subsidiary, Great American Insurance Company (“GAI”) for $315 million ($32.00 per share) in cash in a merger transaction. In addition, NATL paid a one-time special cash dividend of $0.50 per share to its shareholders immediately prior to the merger closing ($5 million was paid to noncontrolling shareholders). See Note B — “Acquisitions and Sale of Businesses” to the financial statements.

In August 2016, AFG issued $300 million of 3.50% Senior Notes due 2026. AFG used the net proceeds from the offering to fund a portion of the acquisition of NATL mentioned above.

During 2016, AFG repurchased 1.9 million shares of its Common Stock for $133 million. In December 2016, AFG paid a special cash dividend of $1.00 per share of AFG Common Stock totaling approximately $87 million.

In November 2015, AFG issued $150 million of 6% Subordinated Debentures due 2055. In September 2015, AFG redeemed its $132 million of 7% Senior Notes due 2050 at par using cash on hand at the parent company.

During 2015, AFG repurchased 2.0 million shares of its Common Stock for $126 million. In December 2015, AFG paid a special cash dividend of $1.00 per share of AFG Common Stock totaling approximately $88 million.

In April 2014, AFG completed the purchase of Summit Holding Southeast, Inc. and its related companies (“Summit”) from Liberty Mutual Insurance for $259 million using cash on hand at the parent company. In addition, AFG made a capital contribution of approximately $140 million, bringing its capital investment in the Summit business to $399 million. Summit’s results of operations are included in AFG’s consolidated results beginning in April of 2014.

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In September 2014, AFG issued $150 million of 6-1/4% Subordinated Debentures due 2054. During 2014, AFG repurchased 3.3 million shares of its Common Stock for $191 million. In December 2014, AFG paid a special cash dividend of $1.00 per share of AFG Common Stock totaling approximately $88 million.

All debentures and notes issued by AFG are rated investment grade by two nationally recognized rating agencies. Under a currently effective shelf registration statement, AFG can offer additional equity or debt securities. The shelf registration provides AFG with flexibility to access the capital markets from time to time as market and other conditions permit.

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.

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. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. At December 31, 2016, GALIC had $935 million in outstanding advances from the FHLB (included in annuity benefits accumulated), bearing interest at rates ranging from 0.03% to 0.53% over LIBOR (average rate of 1.18% at December 31, 2016). In the fourth quarter of 2016, GALIC extended the terms on advances totaling $200 million by four years. While these advances must be repaid between 2018 and 2021 ($285 million in 2018, $500 million in 2020 and $150 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 December 31, 2016, 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 December 31, 2016, AFG could reduce the average crediting rate on approximately $22 billion of traditional fixed and fixed-indexed annuities without guaranteed withdrawal benefits by approximately 80 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
					at December 31,
	GMIR				2016		2015
	1 — 1.99%				72%		67%
	2 — 2.99%				6%		7%
	3 — 3.99%				12%		14%
	4.00% and above				10%		12%
	Annuity benefits accumulated (in millions)				$29,907		$26,622

AFG’s weighted average cost of funds for newly issued traditional fixed and fixed-indexed annuities was 2.28% for 2016 compared to 2.31% for 2015. In the first half of 2016, AFG lowered the crediting rates on new annuity sales due to the decline in market investment yields experienced during that period. Conversely, AFG raised crediting rates on new annuity sales in the

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latter part of 2016 in response to rising market investment yields. In addition to lowering the cost of funds, AFG reduced certain commission rates and guaranteed withdrawal benefits on annuities sold in 2016.

For statutory accounting purposes, equity securities of non-affiliates and equity call options used in the fixed-indexed annuity business are generally carried at fair value. At December 31, 2016, AFG’s insurance companies owned publicly traded equity securities with a fair value of $1.51 billion and equity call options with a fair value of $492 million. Decreases in market prices could adversely affect the insurance group’s capital, potentially impacting the amount of dividends available or necessitating a capital contribution. Conversely, increases in market prices could have a favorable impact on the group’s dividend-paying capability.

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.

Condensed Parent Only Cash Flows   AFG’s parent holding company only condensed cash flows from operating, investing and financing activities are shown below (in millions):

	Year ended December 31,
	2016				2015				2014
Net cash provided by operating activities	$	555			$	162			$	372
Net cash used in investing activities	(560		)		(33		)		(432		)
Net cash provided by (used in) financing activities	13				(232		)		(171		)
Net change in cash and cash equivalents	$	8			$	(103	)		$	(231	)

Parent Net Cash Provided by Operating Activities   Parent holding company cash flows from operating activities consist primarily of dividends and tax payments received from AFG’s insurance subsidiaries, reduced by tax payments to the IRS and holding company interest and other expenses. Parent holding company net cash provided by operating activities was $555 million in 2016 compared to $162 million in 2015 and $372 million in 2014. Higher dividends received from subsidiaries in 2016 as compared to 2015 were the primary driver of the $393 million increase in net cash provided by operating activities. The $210 million decrease in net cash provided by operating activities in 2015 as compared to 2014 was primarily the result of lower dividends received.

Parent Net Cash Used in Investing Activities   Parent holding company investing activities consist of capital contributions to and returns of capital from subsidiaries and, to a much lesser extent, parent company investment activity. Parent holding company net cash used in investing activities was $560 million in 2016 compared to $33 million in 2015 and $432 million in 2014. The $560 million in net cash used in investing activities in 2016 as compared to the $33 million in 2015 is significantly higher due primarily to increased capital contributions to a subsidiary to fund the acquisition of the noncontrolling interest in National Interstate Corporation. The $33 million of parent holding company net cash used in investing activities in 2015 was significantly lower than the $432 million in net cash used in investing activities in 2014 due primarily to capital contributions made to a subsidiary to fund the $399 million investment in Summit in 2014.

Parent Net Cash Provided by (Used in) Financing Activities   Parent company financing activities consist primarily of repurchases of AFG Common Stock, dividends to shareholders, the issuance and retirement of long-term debt and, to a lesser extent, proceeds from employee stock option exercises. Significant long-term debt and common stock transactions are discussed above under “Parent Holding Company Liquidity.” Parent holding company net cash provided by financing activities was $13 million in 2016 compared to net cash used in financing activities of $232 million in 2015 and $171 million in 2014. The $245 million increase in net cash provided by financing activities in 2016 as compared to 2015 primarily reflects proceeds from additional long-term borrowings. The $61 million increase in net cash used in financing activities in 2015 as compared to 2014 reflects the 2015 redemption of $132 million of 7% Senior Notes due 2050, partially offset by a $65 million decrease in common stock repurchases.

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Contractual Obligations   The following table shows an estimate (based on historical patterns and expected trends) of payments to be made for insurance reserve liabilities, as well as scheduled payments for major contractual obligations (in millions).

		Total				Within One Year				2-3 Years				4-5 Years				More than 5 Years
Annuities (a)		$	34,004			$	2,523			$	5,987			$	7,189			$	18,305
Life, accident and health liabilities (a)		1,545				126				226				215				978
Property and casualty unpaid losses and loss adjustment expenses (b)		8,563				2,300				2,200				1,000				3,063
Long-term debt, including interest		2,797				85				521				119				2,072
Operating leases		388				66				113				82				127
Total		$	47,297			$	5,100			$	9,047			$	8,605			$	24,545

(a)

Amounts presented in the table represent estimated cash payments under such contracts, based on significant assumptions related to mortality, morbidity, lapse, renewal, retirement and annuitization. These assumptions also include interest and index crediting consistent with assumptions used to amortize DPAC and assess loss recognition. All estimated cash payments are undiscounted for the time value of money. As a result, total outflows for all years exceed the corresponding liabilities of $29.91 billion for annuity benefits accumulated and $691 million for life, accident and health reserves included in AFG’s Balance Sheet as of December 31, 2016. Based on the same assumptions, AFG projects reinsurance recoveries related to life, accident and health reserves totaling $769 million as follows: Within 1 year — $81 million; 2-3 years — $129 million; 4-5 years — $110 million; and thereafter — $449 million. Actual payments and their timing could differ significantly from these estimates.

(b)

Dollar amounts and time periods are estimates based on historical net payment patterns applied to the gross reserves and do not represent actual contractual obligations. Based on the same assumptions, AFG projects reinsurance recoveries related to these reserves totaling $2.30 billion as follows: Within 1 year — $600 million; 2-3 years — $600 million; 4-5 years — $300 million; and thereafter — $800 million. Actual payments and their timing could differ significantly from these estimates.

AFG has no material contractual purchase obligations or other long-term liabilities at December 31, 2016.

Off-Balance Sheet Arrangements   See Note P — “Additional Information — Financial Instruments — Unfunded Commitments” to the financial statements.

Investments   AFG attempts to optimize investment income while building the value of its portfolio, placing emphasis upon total long-term performance.

AFG’s investment portfolio at December 31, 2016, contained $34.54 billion in fixed maturity securities and $1.50 billion in equity 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. In addition, $359 million in fixed maturities and $56 million in equity securities were classified as trading with changes in unrealized holding gains or losses included in net investment income.

As detailed in Note E — “Investments — Net Unrealized Gain on Marketable Securities” to the financial statements, unrealized gains and losses on AFG’s fixed maturity and equity securities are included in shareholders’ equity after adjustments for related changes in DPAC and certain liabilities related to annuity, long-term care and life businesses, noncontrolling interests and deferred income taxes. DPAC and certain other balance sheet amounts applicable to annuity, long-term care and life businesses are adjusted for the impact of unrealized gains or losses on investments as if these gains or losses had been realized, with corresponding increases or decreases (net of tax) included in accumulated other comprehensive income in AFG’s Balance Sheet.

Fixed income investment funds are generally invested in securities with intermediate-term maturities with an objective of optimizing total return while allowing flexibility to react to changes in market conditions. At December 31, 2016, the average life of AFG’s fixed maturities was about 6-1/2 years.

 

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 published closing prices. For mortgage-backed securities (“MBS”), which comprise approximately 15% 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 79% are priced using pricing services and the balance is priced primarily by

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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 December 31, 2016 (dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional.

Fair value of fixed maturity portfolio	$	34,903
Percentage impact on fair value of 100 bps increase in interest rates	(5.0		%)
Pretax impact on fair value of fixed maturity portfolio	$	(1,745	)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts	700
Estimated pretax impact on accumulated other comprehensive income	(1,045		)
Deferred income tax	366
Estimated after-tax impact on accumulated other comprehensive income	$	(679	)

 

Approximately 89% of the fixed maturities held by AFG at December 31, 2016, 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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Summarized information for AFG’s MBS (including those classified as trading) at December 31, 2016, 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 4 years, respectively.

		Amortized Cost				Fair Value				Fair Value as % of Cost			Unrealized Gain (Loss)				% Rated Investment Grade
Collateral type
Residential:
Agency-backed		$	243			$	243			100	%		$	—			100	%
Non-agency prime		1,406				1,557				111	%		151				29	%
Alt-A		1,093				1,170				107	%		77				13	%
Subprime		629				669				106	%		40				24	%
Commercial		1,446				1,493				103	%		47				96	%
		$	4,817			$	5,132			107	%		$	315			48	%

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 mortgage-backed securities 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 December 31, 2016, 97% (based on statutory carrying value of $4.75 billion) of AFG’s MBS had an NAIC designation of 1.

Municipal bonds represented approximately 19% of AFG’s fixed maturity portfolio at December 31, 2016. AFG’s municipal bond portfolio is high quality, with 98% of the securities rated investment grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At December 31, 2016, approximately 76% of the municipal bond portfolio was held in revenue bonds, with the remaining 24% held in general obligation bonds. General obligation securities of California, Illinois, Michigan, New Jersey, New York and Puerto Rico collectively represented approximately 1% of this portfolio.

 

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Summarized information for the unrealized gains and losses recorded in AFG’s Balance Sheet at December 31, 2016, is shown in the following table (dollars in millions). Approximately $288 million of available for sale fixed maturity securities and $41 million of available for sale equity securities had no unrealized gains or losses at December 31, 2016.

	Securities With Unrealized Gains				Securities With Unrealized Losses
Available for Sale Fixed Maturities
Fair value of securities	$	24,445			$	9,811
Amortized cost of securities	$	23,391			$	10,056
Gross unrealized gain (loss)	$	1,054			$	(245	)
Fair value as % of amortized cost	105		%		98		%
Number of security positions	3,937				1,242
Number individually exceeding $2 million gain or loss	47				3
Concentration of gains (losses) by type or industry (exceeding 5% of unrealized):
States and municipalities	$	200			$	(69	)
Mortgage-backed securities	330				(15		)
Manufacturing	97				(18		)
Banks, savings and credit institutions	90				(26		)
Gas and electric services	60				(5		)
Asset-backed securities	43				(46		)
Percentage rated investment grade	89		%		91		%
Available for Sale Equity Securities
Fair value of securities	$	1,105			$	356
Cost of securities	$	924			$	386
Gross unrealized gain (loss)	$	181			$	(30	)
Fair value as % of cost	120		%		92		%
Number of security positions	145				47
Number individually exceeding $2 million gain or loss	20				3

The table below sets forth the scheduled maturities of AFG’s available for sale fixed maturity securities at December 31, 2016, 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		21	%		9	%
After five years through ten years		34	%		37	%
After ten years		10	%		21	%
		69	%		68	%
Asset-backed securities (average life of approximately 5 years)		14	%		24	%
Mortgage-backed securities (average life of approximately 4-1/2 years)		17	%		8	%
		100	%		100	%

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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 Basis
Fixed Maturities at December 31, 2016
Securities with unrealized gains:
Exceeding $500,000 (623 securities)		$	7,952			$	625			109	%
$500,000 or less (3,314 securities)		16,493				429				103	%
		$	24,445			$	1,054			105	%
Securities with unrealized losses:
Exceeding $500,000 (136 securities)		$	2,360			$	(118	)		95	%
$500,000 or less (1,106 securities)		7,451				(127		)		98	%
		$	9,811			$	(245	)		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 Basis
Securities with Unrealized Losses at December 31, 2016
Investment grade fixed maturities with losses for:
Less than one year (957 securities)		$	8,018			$	(181	)		98	%
One year or longer (113 securities)		868				(25		)		97	%
		$	8,886			$	(206	)		98	%
Non-investment grade fixed maturities with losses for:
Less than one year (102 securities)		$	633			$	(15	)		98	%
One year or longer (70 securities)		292				(24		)		92	%
		$	925			$	(39	)		96	%
Common equity securities with losses for:
Less than one year (23 securities)		$	215			$	(23	)		90	%
One year or longer (none)		—				—				—	%
		$	215			$	(23	)		90	%
Perpetual preferred equity securities with losses for:
Less than one year (23 securities)		$	135			$	(6	)		96	%
One year or longer (1 security)		6				(1		)		86	%
		$	141			$	(7	)		95	%

 

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. Factors considered and resources used by management include:

a)	whether the unrealized loss is credit-driven or a result of changes in market interest rates,

b)	the extent to which fair value is less than cost basis,

c)	cash flow projections received from independent sources,

d)	historical operating, balance sheet and cash flow data contained in issuer SEC filings and news releases,

e)	near-term prospects for improvement in the issuer and/or its industry,

f)	third party research and communications with industry specialists,

g)	financial models and forecasts,

h)	the continuity of dividend payments, maintenance of investment grade ratings and hybrid nature of certain investments,

i)	discussions with issuer management, and

j)	ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in fair value.

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Based on its analysis of the factors listed above, 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 December 31, 2016. 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    As more fully explained in the following paragraphs, 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.

Property and Casualty Insurance Reserves   Estimating the liability for unpaid losses and loss adjustment expenses (“LAE”) is inherently judgmental and is influenced by factors that are subject to significant variation. Determining the liability is a complex process incorporating input from many areas of the Company including actuarial, underwriting, pricing, claims and operations management.

The estimates of liabilities for unpaid claims and for expenses of investigation and adjustment of unpaid claims are based upon: (i) the accumulation of case estimates for losses reported prior to the close of the accounting periods on direct business written (“case reserves”); (ii) estimates received from ceding reinsurers and insurance pools and associations; (iii) estimates of claims incurred but not reported or “IBNR” (including possible development on known claims); (iv) estimates (based on experience) of expense for investigating and adjusting claims; and (v) the current state of law and coverage litigation.

The process used to determine the total reserve for liabilities involves estimating the ultimate incurred losses and LAE, adjusted for amounts already paid on the claims. The IBNR reserve is derived by first estimating the ultimate unpaid reserve liability and subtracting case reserves for loss and LAE. See Note O — “Insurance — Property and Casualty Insurance Reserves” to the financial statements for a discussion of the factors considered and actuarial methods used in determining management’s best estimate of the ultimate liability for unpaid losses and LAE.

The following table shows (in millions) the breakdown of AFG’s property and casualty reserves between case reserves, IBNR reserves and LAE reserves (estimated amounts required to adjust, record and settle claims, other than the claim payments themselves).

		Gross Loss Reserves at December 31, 2016
		Case				IBNR				LAE				Total Reserve
Statutory Line of Business
Workers’ compensation		$	1,054			$	1,274			$	337			$	2,665
Other liability — occurrence		551				1,473				350				2,374
Other liability — claims made		154				239				183				576
Commercial auto/truck liability/medical		214				272				84				570
Special property (fire, allied lines, inland marine, earthquake)		318				105				32				455
Products liability — occurrence		78				139				130				347
Commercial multi-peril		103				76				66				245
Other lines		123				304				91				518
Total Statutory Reserves		2,595				3,882				1,273				7,750
Adjustments for GAAP:
Reserves of foreign operations		347				414				40				801
Deferred gains on retroactive reinsurance		—				32				—				32
Loss reserve discounting		(10		)		—				—				(10		)
Other		(10		)		—				—				(10		)
Total Adjustments for GAAP		327				446				40				813
Total GAAP Reserves		$	2,922			$	4,328			$	1,313			$	8,563

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While current factors and reasonably likely changes in variable factors are considered in estimating the liability for unpaid losses, there is no method or system that can eliminate the risk of actual ultimate results differing from such estimates.

Following is a discussion of certain critical variables affecting the estimation of loss reserves of the more significant long-tail lines of business (asbestos and environmental liabilities are separately discussed below). Many other variables may also impact ultimate claim costs.

An important assumption underlying reserve estimates is that the cost trends implicitly built into development patterns will continue into the future. However, future results could vary due to an unexpected change in the underlying cost trends. This unexpected change could arise from a variety of sources including a general increase in economic inflation, inflation from social programs, new medical technologies, or other factors such as those listed below in connection with AFG’s largest lines of business. It is not possible to isolate and measure the potential impact of just one of these variables, and future cost trends could be partially impacted by several such variables. However, it is reasonable to address the sensitivity of the reserves to potential impact from changes in these variables by measuring the effect of a possible overall 1% change in future cost trends that may be caused by one or more variables. Utilizing the effect of a 1% change in overall cost trends enables changes greater than 1% to be estimated by extrapolation. Each additional 1% change in the cost trend would increase the effect on net earnings by an amount slightly (about 5%) greater than the effect of the previous 1%. For example, if a 1% change in cost trends in a line of business would change net earnings by $20 million, a 2% change would change net earnings by approximately $41 million.

The estimated cumulative impact that a 1% change in cost trends in AFG’s more significant lines of property and casualty business (exceeding 5% of total reserves) would have on net earnings is shown below (in millions).

Line of business	Effect of 1% Change in Cost Trends
Workers’ compensation	$	63
Other liability — occurrence	28
Commercial auto/truck liability/medical	7
Other liability — claims made	9

The judgments and uncertainties surrounding management’s reserve estimation process and the potential for reasonably possible variability in management’s most recent reserve estimates may also be viewed by looking at how recent historical estimates of reserves have developed. The following table shows (dollars in millions) what the impact on AFG’s net earnings would be on the more significant lines of business if the December 31, 2016, reserves (net of reinsurance) developed at the same rate as the average development of the most recent five years.

		5-yr. Average Development (a)(b)			Net Reserves (b) December 31, 2016				Effect on Net Earnings (b)
Workers’ compensation		(1.3	%)		$	2,228			$	28
Other liability — occurrence		(0.2	%)		969				2
Commercial auto/truck liability/medical		4.0	%		432				(17		)
Other liability — claims made		(3.2	%)		428				14

(a)	Adverse (favorable), net of tax effect.

(b)	Excludes asbestos and environmental liabilities.

The following discussion describes key assumptions and important variables that affect the estimate of the reserve for loss and loss adjustment expenses of the more significant lines of business and explains what caused them to change from assumptions used in the preceding period.

Workers’ Compensation

This long-tail line of business provides coverage to employees who may be injured in the course of employment. Some of the important variables affecting estimation of loss reserves for workers’ compensation include:

•	Legislative actions and regulatory and legal interpretations

•	Future medical cost inflation

•	Economic conditions

•	Timing of claims reporting

•	Medical advances and changes to life expectancies

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In April 2014, AFG acquired Summit Holding Southeast, Inc. and related companies, a leading provider of workers’ compensation solutions in the southeastern United States. The Summit acquisition significantly increased AFG’s volume of workers’ compensation business and improved its geographic diversity. Approximately 24% and 18% of AFG’s workers’ compensation reserves at December 31, 2016 relate to policies written in Florida and California, respectively. Over the past 13 years in both states, there have been numerous revisions to workers’ compensation regulations and operating environments, adding difficulty and uncertainty to the estimation of related liabilities.

AFG recorded favorable prior year reserve development of $85 million in 2016 due to lower than anticipated claim severity and improving claim closure rates. AFG recorded favorable prior year reserve development of $45 million in 2015 due to lower than anticipated claim severity across all regions of the country. AFG recorded favorable prior year reserve development of $7 million in 2014, as favorable reserve development in the business written in California was partially offset by adverse reserve development in other states.

Other Liability — Occurrence

This long-tail line of business consists of coverages protecting the insured against legal liability resulting from negligence, carelessness, or a failure to act causing property damage or personal injury to others. Some of the important variables affecting estimation of loss reserves for other liability — occurrence include:

•	Litigious climate

•	Unpredictability of judicial decisions regarding coverage issues

•	Magnitude of jury awards

•	Outside counsel costs

•	Timing of claims reporting

AFG recorded adverse prior year reserve development of $61 million in 2016 related to its other liability — occurrence coverage due primarily to increased severity in New York contractor claims. AFG recorded favorable prior year reserve development of $7 million in 2015 and $15 million in 2014 as both the frequency and severity of claims in excess and umbrella liability coverages were lower than previously projected.

While management applies the actuarial methods mentioned above, more judgment is involved in arriving at the final reserve to be held. For recent accident years, more weight is given to the Bornhuetter-Ferguson method.

Commercial Auto/Truck Liability/Medical

This line of business is a mix of coverage protecting the insured against legal liability for property damage or personal injury to others arising from the operation of commercial motor vehicles. The property damage liability exposure is usually short-tail with relatively quick reporting and settlement of claims. The bodily injury and medical payments exposures are longer-tailed; although the claim reporting is relatively quick, the final settlement can take longer to achieve. Some of the important variables affecting estimation of loss reserves for commercial auto/truck liability/medical are similar to other liability — occurrence and include:

•	Magnitude of jury awards

•	Unpredictability of judicial decisions regarding coverage issues

•	Litigious climate and trends

•	Change in frequency of severe accidents

•	Health care costs and utilization of medical services by injured parties

AFG recorded adverse prior year reserve development of $28 million in 2016, $20 million in 2015 and $28 million in 2014 for this line of business as claim severity has been significantly higher than expected in accident years 2010 and subsequent.

Other Liability — Claims Made

This long-tail line of business consists mostly of directors’ and officers’ liability (“D&O”). Some of the important variables affecting estimation of loss reserves for other liability — claims made include:

•	Litigious climate

•	Economic conditions

•	Variability of stock prices

•	Magnitude of jury awards

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The general state of the economy and the variability of the stock price of the insured can affect the frequency and severity of shareholder class action suits and other situations that trigger coverage under D&O policies. For example, from 2008 to 2010, economic conditions led to higher frequency of claims, particularly in the D&O policies for small account and not-for-profit organizations. Since then, claim frequency has continually decreased from its peak in 2010, offsetting increased claim severity.

AFG recorded favorable prior year reserve development of $24 million in 2016, $12 million in 2015 and $18 million in 2014 on its D&O business as claim severity was less than expected across several prior accident years.

Reserves of Foreign Operations

Reserves of foreign operations relate primarily to the operations of Neon Underwriting Limited (“Neon”), AFG’s wholly-owned United Kingdom-based Lloyd’s insurer. Historically, the largest line of business written by Neon was non-U.S. medical malpractice, which provides coverage for injuries and damages caused by medical care providers, including but not limited to, hospitals and their physicians. Although Neon offered this product in approximately 30 countries, the majority of the business has been written in the United Kingdom, Australia and Italy. In addition, Neon writes marine, equine, professional indemnity, directors and officers liability, catastrophe and cyber insurance and previously offered general liability policies. Significant variables in estimating the loss reserves include:

•	Litigious environment

•	Magnitude of court awards

•	A slow moving judicial system including varying approaches to medical malpractice claims among courts

•	Trends in claim costs, including medical cost inflation

During the second quarter of 2016, Neon completed a strategic review of its business under a new leadership team. As part of its strategic review, Neon sold and/or exited certain historical lines of business including its medical malpractice and general liability classes. As a result of Neon’s claims review of its exited lines of business, AFG recorded a charge of approximately $65 million, including $57 million to increase loss reserves (adverse development) primarily related to its medical malpractice and general liability lines. In addition to the exited lines charge, Neon recorded adverse prior year reserve development of $21 million in 2016, $44 million in 2015 and $14 million in 2014. The adverse development in 2016 outside of the exited lines charge was attributable to reserve strengthening in several lines of business, including political risk and personal accident. The adverse development in 2015 and 2014 was attributable to reserve strengthening in several lines of business, primarily Dutch hospital medical malpractice, Australian and other general liability and personal accident insurance.

Recoverables from Reinsurers and Availability of Reinsurance   AFG is subject to credit risk with respect to its reinsurers, as reinsurance contracts do not relieve AFG of its liability to policyholders. To mitigate this risk, substantially all reinsurance is ceded to companies with investment grade S&P ratings or is secured by “funds withheld” or other collateral.

The availability and cost of reinsurance are subject to prevailing market conditions, which are beyond AFG’s control and which may affect AFG’s level of business and profitability. Although the cost of certain reinsurance programs may increase, management believes that AFG will be able to maintain adequate reinsurance coverage at acceptable rates without a material adverse effect on AFG’s results of operations. AFG’s gross and net combined ratios are shown in the table below.

See Item 1 — Business — “Property and Casualty Insurance Segment — Reinsurance” for more information on AFG’s reinsurance programs. For additional information on the effect of reinsurance on AFG’s historical results of operations see Note O — “Insurance — Reinsurance” to the financial statements.

The following table illustrates the effect that purchasing property and casualty reinsurance has had on AFG’s combined ratio over the last three years. 

		2016			2015			2014
Before reinsurance (gross)		92.5	%		92.8	%		90.8	%
Effect of reinsurance		2.0	%		1.9	%		3.7	%
Actual (net of reinsurance)		94.5	%		94.7	%		94.5	%

Outside of its property and casualty operations, AFG also has reinsurance recoverables totaling $343 million, including $296 million related to the run-off life business. These recoverables include $254 million directly or indirectly from Hannover Life Reassurance Company of America (rated A+ by A.M. Best).

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Asbestos and Environmental-related (“A&E”) Insurance Reserves   Asbestos and environmental reserves of the property and casualty group consisted of the following (in millions): 

		December 31,
		2016				2015
Asbestos		$	198			$	205
Environmental		139				122
A&E reserves, net of reinsurance recoverable		337				327
Reinsurance recoverable, net of allowance		106				99
Gross A&E reserves		$	443			$	426

Asbestos reserves include claims asserting alleged injuries and damages from exposure to asbestos. Environmental reserves include claims relating to polluted sites.

Asbestos claims against manufacturers, distributors or installers of asbestos products were presented under the products liability section of their policies, which typically had aggregate limits that capped an insurer’s liability. In recent years, a number of asbestos claims are being presented as “non-products” claims, such as those by installers of asbestos products and by property owners or operators who allegedly had asbestos on their property, under the premises or operations section of their policies. Unlike products exposures, these non-products exposures typically had no aggregate limits, creating potentially greater exposure for insurers. Further, in an effort to seek additional insurance coverage, some insureds with installation activities who have substantially eroded their products coverage are presenting new asbestos claims as non-products operations claims or attempting to reclassify previously settled products claims as non-products claims to restore a portion of previously exhausted products aggregate limits. AFG, along with other insurers, is and will be subject to such non-products claims. It is difficult to predict whether insureds will be successful in asserting claims under non-products coverage or whether AFG and other insurers will be successful in asserting additional defenses. Therefore, the future impact of such efforts is uncertain.

Approximately 41% of AFG’s net asbestos reserves relate to policies written directly by AFG subsidiaries. Claims from these policies generally are product-oriented claims with only a limited amount of non-products exposures, and are dominated by small to mid-sized commercial entities that are mostly regional policyholders with few national target defendants. The remainder is assumed reinsurance business that includes exposures for the periods 1954 to 1983. The asbestos and environmental assumed claims are ceded by various insurance companies under reinsurance treaties. A majority of the individual assumed claims have exposures of less than $100,000 to AFG. Asbestos losses assumed include some of the industry known manufacturers, distributors and installers. Pollution losses include industry known insured names and sites.

Establishing reserves for A&E claims relating to policies and participations in reinsurance treaties and former operations is subject to uncertainties that are significantly greater than those presented by other types of claims. For this group of claims, traditional actuarial techniques that rely on historical loss development trends cannot be used and a range of reasonably possible losses cannot be estimated. Case reserves and expense reserves are established by the claims department as specific policies are identified. In addition to the case reserves established for known claims, management establishes additional reserves for claims not yet known or reported and for possible development on known claims. These additional reserves are management’s best estimate based on periodic comprehensive studies and internal reviews adjusted for payments and identifiable changes, supplemented by management’s review of industry information about such claims, with due consideration to individual claim situations.

Management believes that estimating the ultimate liability for asbestos claims presents a unique and difficult challenge to the insurance industry 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. The casualty insurance industry is engaged in extensive litigation over these coverage and liability issues as the volume and severity of claims against asbestos defendants continue to increase. Environmental claims likewise present challenges in prediction, due to uncertainty regarding the interpretation of insurance policies, complexities regarding multi-party involvements at sites, evolving cleanup standards and protracted time periods required to assess the level of cleanup required at contaminated sites.

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The following factors could impact AFG’s reserves and payments:

•	There is a growing interest at the state level to attempt to legislatively address asbestos liabilities and the manner in which asbestos claims are resolved. These developments are fluid and could result in piecemeal state-by-state solutions.

•	The manner by which bankruptcy courts are addressing asbestos liabilities is in flux.

•	AFG’s insureds may make claims alleging significant non-products exposures.

While management believes that AFG’s reserves for A&E claims are a reasonable estimate of ultimate liability for such claims, actual results may vary materially from the amounts currently recorded due to the difficulty in predicting the number of future claims, the impact of recent bankruptcy filings, and unresolved issues such as whether coverage exists, whether policies are subject to aggregate limits on coverage, how claims are to be allocated among triggered policies and implicated years, and whether claimants who exhibit no signs of illness will be successful in pursuing their claims. A 1% variation in loss cost trends, caused by any of the factors previously described, would change net income by approximately $20 million.

AFG tracks its A&E claims by policyholder. The following table shows, by type of claim, the number of policyholders that did not receive any payments in the calendar year separate from policyholders that did receive a payment. Policyholder counts represent policies written by AFG subsidiaries and do not include assumed reinsurance. 

		2016			2015			2014
Number of policyholders with no indemnity payments:
Asbestos		87			122			136
Environmental		107			112			99
		194			234			235
Number of policyholders with indemnity payments:
Asbestos		66			50			45
Environmental		28			25			30
		94			75			75
Total		288			309			310

Amounts paid (net of reinsurance recoveries) for asbestos and environmental claims, including loss adjustment expenses, were as follows (in millions):

		2016				2015				2014
Asbestos		$	12			$	16			$	18
Environmental		14				13				18
Total		$	26			$	29			$	36

The survival ratio is a measure often used by industry analysts to compare A&E reserves strength among companies. This ratio is typically calculated by dividing reserves for A&E exposures by the three-year average of paid losses, and therefore measures the number of years that it would take to pay off current reserves based on recent average payments. Because this ratio can be significantly impacted by a number of factors such as loss payout variability, caution should be exercised in attempting to determine reserve adequacy based simply on the survival ratio. At December 31, 2016, the property and casualty insurance segment’s three-year survival ratios compare favorably with industry survival ratios published by A.M. Best (as of December 31, 2015) as detailed in the following table:

	Property and Casualty Insurance Reserves
	Three-Year Survival Ratio (% Times Paid Losses)
	Asbestos			Environmental			Total A&E
AFG (12/31/2016)	13.1			9.3			11.2
Industry (12/31/2015)	7.7			6.8			7.5

AFG has periodically conducted comprehensive external studies of its asbestos and environmental exposures 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.

An in-depth internal review of AFG’s A&E reserves was completed in the third quarter of 2016 by AFG’s internal A&E claims specialists and actuaries in consultation with specialty outside counsel and an outside consultant. As a result of the review, AFG’s property and casualty insurance segment recorded a $36 million pretax special charge to increase its asbestos reserves by

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$5 million (net of reinsurance) and its environmental reserves by $31 million (net of reinsurance). Over the past few years, the focus of AFG’s asbestos claims litigation has shifted to smaller companies and companies with ancillary exposures. AFG’s insureds with these exposures have been the driver of the property and casualty insurance segment’s asbestos reserve increases in recent years. AFG is seeing modestly increasing estimates for indemnity and defense compared to prior studies. Overall, the rate of new asbestos cases received is down modestly. The increase in property and casualty environmental reserves was primarily associated with updated estimates of site investigation costs with respect to existing sites and newly identified sites. AFG is seeing increased legal defense costs in environmental claims generally, as well as a number of claims and sites where the estimated investigation and remediation costs have increased. As in past years, there were no new or emerging broad industry trends that were identified in the review.

As a result of the comprehensive external study completed in the third quarter of 2015, AFG’s property and casualty insurance segment recorded a $67 million pretax special charge to increase its asbestos reserves by $25 million (net of reinsurance) and its environmental reserves by $42 million (net of reinsurance). The increase in property and casualty asbestos reserves was attributed to increased estimates for indemnity and defense costs. The increase in property and casualty environmental reserves was attributed primarily to increased defense costs and a number of claims where the estimated costs of remediation have increased.

As a result of the in-depth internal review completed in the third quarter of 2014, AFG’s property and casualty insurance segment recorded a $24 million pretax special charge to increase its asbestos reserves by $4 million (net of reinsurance) and its environmental reserves by $20 million (net of reinsurance). The increase in property and casualty environmental reserves was attributed primarily to AFG’s increased defense costs and a number of claims where the estimated costs of remediation have increased.

Contingencies related to Subsidiaries’ Former Operations   The A&E studies and reviews discussed above encompassed reserves for various environmental and occupational injury and disease claims and other contingencies arising out of the railroad operations disposed of by American Premier’s predecessor and certain manufacturing operations disposed of by American Premier and its subsidiaries and by Great American Financial Resources, Inc. Charges resulting from the A&E study and reviews were $5 million in 2016, $12 million in 2015 and $6 million in 2014. For a discussion of the charges recorded for those operations, see “Holding Company, Other and Unallocated — Results of Operations.” Liabilities for claims and contingencies arising from these former railroad and manufacturing operations totaled $86 million at December 31, 2016. For a discussion of the uncertainties in determining the ultimate liability, see Note M — “Contingencies” to the financial statements.

Run-off Long-term Care Insurance   In December 2015, AFG completed the sale of United Teacher Associates Insurance Company and Continental General Insurance Company, the legal entities containing substantially all of its run-off long-term care insurance business, to HC2 Holdings, Inc. (“HC2”) for approximately $13 million in net proceeds. AFG may also receive up to $13 million of additional proceeds from HC2 in the future contingent upon the release of certain statutory-basis liabilities of the legal entities sold by AFG. In connection with obtaining regulatory approval for the transaction, AFG agreed to provide up to an aggregate of $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2 through a five-year capital maintenance agreement. With the completion of this sale, AFG divested substantially all of its long-term care business (96% as measured by net statutory reserves as of November 30, 2015) and retained only a small block of long-term care insurance (1,600 policies) with approximately $37 million of reserves at December 31, 2016. AFG will continue to service and accept renewal premiums on its remaining outstanding policies, which are guaranteed renewable.

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 H — “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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CONDENSED CONSOLIDATING BALANCE SHEET

	Before CLO Consolidation				Managed Investment Entities				Consol. Entries						Consolidated As Reported
December 31, 2016
Assets:
Cash and investments	$	41,649			$	—			$	(216	)		(a)		$	41,433
Assets of managed investment entities	—				4,765				—						4,765
Other assets	8,874				—				—				(a)		8,874
Total assets	$	50,523			$	4,765			$	(216	)				$	55,072
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	10,734			$	—			$	—					$	10,734
Annuity, life, accident and health benefits and reserves	30,598				—				—						30,598
Liabilities of managed investment entities	—				4,760				(211		)		(a)		4,549
Long-term debt and other liabilities	4,272				—				—						4,272
Total liabilities	45,604				4,760				(211		)				50,153
Shareholders’ equity:
Common Stock and Capital surplus	1,198				5				(5		)				1,198
Retained earnings	3,343				—				—						3,343
Accumulated other comprehensive income, net of tax	375				—				—						375
Total shareholders’ equity	4,916				5				(5		)				4,916
Noncontrolling interests	3				—				—						3
Total equity	4,919				5				(5		)				4,919
Total liabilities and equity	$	50,523			$	4,765			$	(216	)				$	55,072
December 31, 2015
Assets:
Cash and investments	$	38,001			$	—			$	(265	)		(a)		$	37,736
Assets of managed investment entities	—				4,047				—						4,047
Other assets	8,055				—				(1		)		(a)		8,054
Total assets	$	46,056			$	4,047			$	(266	)				$	49,837
Liabilities:
Unpaid losses and loss adjustment expenses and unearned premiums	$	10,187			$	—			$	—					$	10,187
Annuity, life, accident and health benefits and reserves	27,327				—				—						27,327
Liabilities of managed investment entities	—				4,027				(246		)		(a)		3,781
Long-term debt and other liabilities	3,772				—				—						3,772
Total liabilities	41,286				4,027				(246		)				45,067
Shareholders’ equity:
Common Stock and Capital surplus	1,301				20				(20		)				1,301
Retained earnings	2,987				—				—						2,987
Accumulated other comprehensive income, net of tax	304				—				—						304
Total shareholders’ equity	4,592				20				(20		)				4,592
Noncontrolling interests	178				—				—						178
Total equity	4,770				20				(20		)				4,770
Total liabilities and equity	$	46,056			$	4,047			$	(266	)				$	49,837

 

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

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CONDENSED CONSOLIDATING STATEMENT OF EARNINGS

	Before CLO Consolidation (a)				Managed Investment Entities				Consol. Entries						Consolidated As Reported
Three months ended December 31, 2016
Revenues:
Insurance net earned premiums	$	1,150			$	—			$	—					$	1,150
Net investment income	437				—				(8		)		(b)		429
Realized gains on securities	51				—				—						51
Income (loss) of managed investment entities:
Investment income	—				49				—						49
Gain (loss) on change in fair value of assets/liabilities	—				6				—				(b)		6
Other income	57				—				(5		)		(c)		52
Total revenues	1,695				55				(13		)				1,737
Costs and Expenses:
Insurance benefits and expenses	1,262				—				—						1,262
Expenses of managed investment entities	—				55				(13		)		(b)(c)		42
Interest charges on borrowed money and other expenses	116				—				—						116
Total costs and expenses	1,378				55				(13		)				1,420
Earnings before income taxes	317				—				—						317
Provision (credit) for income taxes	(71		)		—				—						(71		)
Net earnings, including noncontrolling interests	388				—				—						388
Less: Net earnings attributable to noncontrolling interests	3				—				—						3
Net earnings attributable to shareholders	$	385			$	—			$	—					$	385
Three months ended December 31, 2015
Revenues:
Insurance net earned premiums	$	1,144			$	—			$	—					$	1,144
Net investment income	405				—				11				(b)		416
Realized losses on:
Securities	(21		)		—				—						(21		)
Subsidiaries	(4		)		—				—						(4		)
Income (loss) of managed investment entities:
Investment income	—				43				—						43
Gain (loss) on change in fair value of assets/liabilities	—				—				(18		)		(b)		(18		)
Other income	62				—				(4		)		(c)		58
Total revenues	1,586				43				(11		)				1,618
Costs and Expenses:
Insurance benefits and expenses	1,273				—				—						1,273
Expenses of managed investment entities	—				43				(11		)		(b)(c)		32
Interest charges on borrowed money and other expenses	103				—				—						103
Total costs and expenses	1,376				43				(11		)				1,408
Earnings before income taxes	210				—				—						210
Provision for income taxes	80				—				—						80
Net earnings, including noncontrolling interests	130				—				—						130
Less: Net earnings attributable to noncontrolling interests	1				—				—						1
Net earnings attributable to shareholders	$	129			$	—			$	—					$	129

(a)	Includes a gain of $8 million in the fourth quarter of 2016 and a loss of $11 million in the fourth quarter of 2015, representing the change in fair value of AFG’s CLO investments plus $5 million and $4 million in the fourth quarter of 2016 and 2015, respectively, in CLO management fees earned.

(b)	Elimination of the change in fair value of AFG’s investments in the CLOs, including $8 million and $7 million in the fourth quarter of 2016 and 2015, respectively, in distributions recorded as interest expense by the CLOs.

(c)	Elimination of management fees earned by AFG.

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CONDENSED CONSOLIDATING STATEMENT OF EARNINGS - CONTINUED

	Before CLO Consolidation (a)				Managed Investment Entities				Consol. Entries						Consolidated As Reported
Year ended December 31, 2016
Revenues:
Insurance net earned premiums	$	4,352			$	—			$	—					$	4,352
Net investment income	1,733				—				(37		)		(b)		1,696
Realized gains on:
Securities	19				—				—						19
Subsidiaries	2				—				—						2
Income (loss) of managed investment entities:
Investment income	—				190				—						190
Gain (loss) on change in fair value of assets/liabilities	—				8				7				(b)		15
Other income	241				—				(17		)		(c)		224
Total revenues	6,347				198				(47		)				6,498
Costs and Expenses:
Insurance benefits and expenses	5,130				—				—						5,130
Expenses of managed investment entities	—				197				(46		)		(b)(c)		151
Interest charges on borrowed money and other expenses	430				—				—						430
Total costs and expenses	5,560				197				(46		)				5,711
Earnings before income taxes	787				1				(1		)				787
Provision for income taxes	119				—				—						119
Net earnings, including noncontrolling interests	668				1				(1		)				668
Less: Net earnings attributable to noncontrolling interests	19				—				—						19
Net earnings attributable to shareholders	$	649			$	1			$	(1	)				$	649
Year ended December 31, 2015
Revenues:
Insurance net earned premiums	$	4,328			$	—			$	—					$	4,328
Net investment income	1,627				—				6				(b)		1,633
Realized losses on:
Securities	(19		)		—				—						(19		)
Subsidiaries	(161		)		—				—						(161		)
Income (loss) of managed investment entities:
Investment income	—				155				—						155
Gain (loss) on change in fair value of assets/liabilities	—				2				(36		)		(b)		(34		)
Other income	258				—				(15		)		(c)		243
Total revenues	6,033				157				(45		)				6,145
Costs and Expenses:
Insurance benefits and expenses	5,057				—				—						5,057
Expenses of managed investment entities	—				155				(43		)		(b)(c)		112
Interest charges on borrowed money and other expenses	411				—				—						411
Total costs and expenses	5,468				155				(43		)				5,580
Earnings before income taxes	565				2				(2		)				565
Provision for income taxes	195				—				—						195
Net earnings, including noncontrolling interests	370				2				(2		)				370
Less: Net earnings attributable to noncontrolling interests	18				—				—						18
Net earnings attributable to shareholders	$	352			$	2			$	(2	)				$	352

(a)	Includes a gain of $37 million in 2016 and a loss of $6 million in 2015, representing the change in fair value of AFG’s CLO investments plus $17 million and $15 million in 2016 and 2015, respectively, in CLO management fees earned.

(b)	Elimination of the change in fair value of AFG’s investments in the CLOs, including $29 million and $28 million in 2016 and 2015, respectively, in distributions recorded as interest expense by the CLOs.

(c)	Elimination of management fees earned by AFG.

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CONDENSED CONSOLIDATING STATEMENT OF EARNINGS - CONTINUED

	Before CLO Consolidation (a)				Managed Investment Entities				Consol. Entries						Consolidated As Reported
Year ended December 31, 2014
Revenues:
Insurance net earned premiums	$	3,986			$	—			$	—					$	3,986
Net investment income	1,517				—				(16		)		(b)		1,501
Realized gains on securities	52				—				—						52
Income (loss) of managed investment entities:
Investment income	—				116				—						116
Gain (loss) on change in fair value of assets/liabilities	—				(35		)		(9		)		(b)		(44		)
Other income	147				—				(25		)		(c)		122
Total revenues	5,702				81				(50		)				5,733
Costs and Expenses:
Insurance benefits and expenses	4,671				—				—						4,671
Expenses of managed investment entities	—				130				(48		)		(b)(c)		82
Interest charges on borrowed money and other expenses	354				—				—						354
Total costs and expenses	5,025				130				(48		)				5,107
Earnings before income taxes	677				(49		)		(2		)				626
Provision for income taxes	220				—				—						220
Net earnings, including noncontrolling interests	457				(49		)		(2		)				406
Less: Net earnings (loss) attributable to noncontrolling interests	5				—				(51		)		(d)		(46		)
Net earnings attributable to shareholders	$	452			$	(49	)		$	49					$	452

(a)	Includes $16 million representing the change in fair value of AFG’s CLO investments plus $25 million in CLO management fees earned.

(b)	Elimination of the change in fair value of AFG’s investments in the CLOs, including $23 million in distributions recorded as interest expense by the CLOs.

(c)	Elimination of management fees earned by AFG.

(d)	Allocate losses of CLOs attributable to other debt holders to noncontrolling interests.

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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) and significant tax benefits (charges) related to 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, such as the Neon exited lines and 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 December 31,								Year ended December 31,
	2016				2015				2016				2015				2014
Components of net earnings attributable to shareholders:
Core operating earnings before income taxes	$	266			$	220			$	840			$	762			$	604
Pretax non-core items:
Realized gains (losses) on securities	51				(21		)		19				(19		)		52
Realized gain (loss) on subsidiaries:
Long-term care business	—				(4		)		2				(166		)		—
Other	—				—				—				5				—
Gain on sale of apartment properties and hotel	—				15				32				66				—
Special A&E charges	—				—				(41		)		(79		)		(30		)
Neon exited lines charge	—				—				(65		)		—				—
Loss on retirement of debt	—				—				—				(4		)		—
Earnings before income taxes	317				210				787				565				626
Provision (credit) for income taxes:
Core operating earnings	88				83				290				263				212
Non-core items:
Tax benefit related to National Interstate merger	(66		)		—				(66		)		—				—
Tax benefit related to Neon restructuring	(111		)		—				(111		)		—				—
Other	18				(3		)		6				(68		)		8
Total provision (credit) for income taxes	(71		)		80				119				195				220
Net earnings, including noncontrolling interests	388				130				668				370				406
Less net earnings (loss) attributable to noncontrolling interests:
Core operating earnings	2				1				16				13				(47		)
Non-core items	1				—				3				5				1
Total net earnings (loss) attributable to noncontrolling interests	3				1				19				18				(46		)
Net earnings attributable to shareholders	$	385			$	129			$	649			$	352			$	452
Net earnings:
Core net operating earnings	$	176			$	136			$	534			$	486			$	439
Non-core items	209				(7		)		115				(134		)		13
Net earnings attributable to shareholders	$	385			$	129			$	649			$	352			$	452
Diluted per share amounts:
Core net operating earnings	$	1.98			$	1.52			$	6.03			$	5.44			$	4.82
Realized gains (losses) on securities	0.36				(0.15		)		0.16				(0.12		)		0.36
Realized gain (loss) on subsidiaries:
Long-term care business	—				(0.03		)		0.01				(1.21		)		—
Other	—				—				—				0.04				—
Gain on sale of apartment properties and hotel	—				0.11				0.17				0.40				—
Special A&E charges	—				—				(0.30		)		(0.58		)		(0.21		)
Neon exited lines charge	—				—				(0.73		)		—				—
Loss on retirement of debt	—				—				—				(0.03		)		—
Tax benefit related to National Interstate merger	0.74				—				0.74				—				—
Tax benefit related to Neon restructuring	1.25				—				1.25				—				—
Net earnings attributable to shareholders	$	4.33			$	1.45			$	7.33			$	3.94			$	4.97

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Net earnings attributable to shareholders increased $256 million in the fourth quarter of 2016 compared to the same period in 2015 due primarily to the fourth quarter 2016 tax benefits related to the National Interstate merger and Neon restructuring, net realized gains on securities in the 2016 period compared to net realized losses on securities in the 2015 period and higher core net operating earnings. Core net operating earnings increased $40 million in the fourth quarter of 2016 compared to the same period in 2015 reflecting higher operating earnings in the property and casualty and annuity segments.

Net earnings attributable to shareholders increased $297 million for the full-year of 2016 compared to the same period in 2015 due primarily to the 2016 tax benefits related to the National Interstate merger and Neon restructuring, lower special A&E charges recorded in 2016 compared to 2015, net realized gains on securities in 2016 compared to net realized losses on securities in 2015, the estimated loss on the sale of the subsidiaries containing substantially all of AFG’s run-off long-term care insurance business that was recorded in the first quarter of 2015 and higher core net operating earnings, partially offset by a charge related to the exit of certain lines of business within Neon, and lower gains on the sale of real estate in 2016 compared to 2015. Core net operating earnings increased $48 million in 2016 compared to 2015 reflecting higher underwriting profit and net investment income in the ongoing property and casualty insurance operations and higher earnings in the annuity segment, partially offset by lower profitability in the run-off long-term care and life segment and higher holding company expenses.

Net earnings attributable to shareholders decreased $100 million for the full-year of 2015 compared to the same period in 2014 due primarily to the loss on the sale of substantially all of AFG’s run-off long-term care insurance business, higher special A&E charges and net realized losses on securities in 2015 compared to net realized gains on securities in 2014, partially offset by the gain on the sale of a hotel and an apartment property and higher core net operating earnings. Core net operating earnings increased $47 million for the full-year of 2015 compared to the same period in 2014 due primarily to higher underwriting profit and higher net investment income in the property and casualty insurance segment and improved core operating results in the run-off long-term care and life segment.

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RESULTS OF OPERATIONS — QUARTERS ENDED DECEMBER 31, 2016 AND 2015

Segmented Statement of Earnings   AFG reports its business as four segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity, (iii) Run-off long-term care and life and (iv) Other, which includes holding company costs and income and expenses related to the managed investment entities (“MIEs”).

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 quarters ended December 31, 2016 and 2015 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				Run-off long-term care and life				Consol. MIEs				Holding Co., other and unallocated				Total				Non-core reclass				GAAP Total
Quarter ended December 31, 2016
Revenues:
Property and casualty insurance net earned premiums	$	1,144			$	—			$	—			$	—			$	—			$	1,144			$	—			$	1,144
Life, accident and health net earned premiums	—				—				6				—				—				6				—				6
Net investment income	85				346				6				(8		)		—				429				—				429
Realized gains on securities	—				—				—				—				—				—				51				51
Income (loss) of MIEs:
Investment income	—				—				—				49				—				49				—				49
Gain (loss) on change in fair value of assets/liabilities	—				—				—				6				—				6				—				6
Other income	5				27				—				(5		)		25				52				—				52
Total revenues	1,234				373				12				42				25				1,686				51				1,737
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	729				—				—				—				—				729				—				729
Commissions and other underwriting expenses	305				—				—				—				6				311				—				311
Annuity benefits	—				160				—				—				—				160				—				160
Life, accident and health benefits	—				—				7				—				—				7				—				7
Annuity and supplemental insurance acquisition expenses	—				54				1				—				—				55				—				55
Interest charges on borrowed money	—				—				—				—				21				21				—				21
Expenses of MIEs	—				—				—				42				—				42				—				42
Other expenses	18				27				2				—				48				95				—				95
Total costs and expenses	1,052				241				10				42				75				1,420				—				1,420
Earnings before income taxes	182				132				2				—				(50		)		266				51				317
Provision (credit) for income taxes	65				44				1				—				(22		)		88				(159		)		(71		)
Net earnings, including noncontrolling interests	117				88				1				—				(28		)		178				210				388
Less: Net earnings attributable to noncontrolling interests	2				—				—				—				—				2				1				3
Core Net Operating Earnings	115				88				1				—				(28		)		176
Non-core earnings attributable to shareholders (a):
Realized gains on securities, net of tax and noncontrolling interests	—				—				—				—				32				32				(32		)		—
Tax benefit related to National Interstate merger	66				—				—				—				—				66				(66		)		—
Tax benefit related to Neon restructuring	111				—				—				—				—				111				(111		)		—
Net Earnings Attributable to Shareholders	$	292			$	88			$	1			$	—			$	4			$	385			$	—			$	385

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													Other
	P&C				Annuity				Run-off long-term care and life				Consol. MIEs				Holding Co., other and unallocated				Total				Non-core reclass				GAAP Total
Quarter ended December 31, 2015
Revenues:
Property and casualty insurance net earned premiums	$	1,120			$	—			$	—			$	—			$	—			$	1,120			$	—			$	1,120
Life, accident and health net earned premiums	—				—				24				—				—				24				—				24
Net investment income	74				309				19				11				3				416				—				416
Realized losses on:
Securities	—				—				—				—				—				—				(21		)		(21		)
Subsidiaries	—				—				—				—				—				—				(4		)		(4		)
Income (loss) of MIEs:
Investment income	—				—				—				43				—				43				—				43
Gain (loss) on change in fair value of assets/liabilities	—				—				—				(18		)		—				(18		)		—				(18		)
Other income	2				23				—				(4		)		22				43				15				58
Total revenues	1,196				332				43				32				25				1,628				(10		)		1,618
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	693				—				—				—				—				693				—				693
Commissions and other underwriting expenses	327				—				—				—				6				333				—				333
Annuity benefits	—				189				—				—				—				189				—				189
Life, accident and health benefits	—				—				35				—				—				35				—				35
Annuity and supplemental insurance acquisition expenses	—				20				3				—				—				23				—				23
Interest charges on borrowed money	1				—				—				—				16				17				—				17
Expenses of MIEs	—				—				—				32				—				32				—				32
Other expenses	11				22				5				—				48				86				—				86
Total costs and expenses	1,032				231				43				32				70				1,408				—				1,408
Earnings before income taxes	164				101				—				—				(45		)		220				(10		)		210
Provision for income taxes	64				34				—				—				(15		)		83				(3		)		80
Net earnings, including noncontrolling interests	100				67				—				—				(30		)		137				(7		)		130
Less: Net earnings attributable to noncontrolling interests	1				—				—				—				—				1				—				1
Core Net Operating Earnings	99				67				—				—				(30		)		136
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax and noncontrolling interests	—				—				—				—				(14		)		(14		)		14				—
Loss on subsidiaries, net of tax	—				—				(3		)		—				—				(3		)		3				—
Gain on sale of apartment property, net of tax	10				—				—				—				—				10				(10		)		—
Net Earnings Attributable to Shareholders	$	109			$	67			$	(3	)		$	—			$	(44	)		$	129			$	—			$	129

(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 $182 million in GAAP pretax earnings in the fourth quarter of 2016 compared to $179 million in the fourth quarter of 2015, an increase of $3 million (2%). Property and casualty core pretax earnings were $182 million in the fourth quarter of 2016 compared to $164 million in the fourth quarter of 2015, an increase of

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$18 million (11%). The increase in GAAP and core pretax earnings reflects higher underwriting profit in the Property and transportation and Specialty financial insurance sub-segments and higher net investment income, partially offset by lower underwriting profit in the Specialty casualty sub-segment. GAAP earnings also includes a $15 million pretax gain on the sale of an apartment property in the fourth quarter of 2015.

The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the three months ended December 31, 2016 and 2015 (dollars in millions):

	Three months ended December 31,
	2016				2015				% Change
Gross written premiums	$	1,441			$	1,356			6	%
Reinsurance premiums ceded	(358		)		(300		)		19	%
Net written premiums	1,083				1,056				3	%
Change in unearned premiums	61				64				(5	%)
Net earned premiums	1,144				1,120				2	%
Loss and loss adjustment expenses	729				693				5	%
Commissions and other underwriting expenses	305				327				(7	%)
Underwriting gain	110				100				10	%
Net investment income	85				74				15	%
Other income and expenses, net (*)	(13		)		(10		)		30	%
Core earnings before income taxes	182				164				11	%
Pretax non-core gain on sale of apartment property	—				15				(100	%)
GAAP earnings before income taxes	$	182			$	179			2	%
(*) Excludes the $15 million pretax non-core gain on the sale of an apartment property in the fourth quarter of 2015.
Combined Ratios:
Specialty lines									Change
Loss and LAE ratio	63.7		%		61.8		%		1.9	%
Underwriting expense ratio	26.7		%		29.2		%		(2.5	%)
Combined ratio	90.4		%		91.0		%		(0.6	%)
Aggregate — including exited lines
Loss and LAE ratio	63.7		%		61.8		%		1.9	%
Underwriting expense ratio	26.7		%		29.2		%		(2.5	%)
Combined ratio	90.4		%		91.0		%		(0.6	%)

AFG’s combined ratio has been better than the industry average for 29 of the last 31 years. Management believes that AFG’s insurance operations have performed better than the industry as a result of its specialty niche focus, product line diversification, stringent underwriting discipline and alignment of compensation incentives.

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.

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Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $1.44 billion for the fourth quarter of 2016 compared to $1.36 billion for the fourth quarter of 2015, an increase of $85 million (6%). Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):

	Three months ended December 31,
	2016							2015
	GWP				%			GWP				%			% Change
Property and transportation	$	577			40	%		$	515			38	%		12	%
Specialty casualty	684				47	%		661				49	%		3	%
Specialty financial	180				13	%		179				13	%		1	%
Other specialty	—				—	%		1				—	%		(100	%)
	$	1,441			100	%		$	1,356			100	%		6	%

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 25% of gross written premiums for the fourth quarter of 2016 compared to 22% for the fourth quarter of 2015, an increase of 3 percentage points. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):    

	Three months ended December 31,
	2016							2015							Change in
	Ceded				% of GWP			Ceded				% of GWP			% of GWP
Property and transportation	$	(183	)		32	%		$	(137	)		27	%		5	%
Specialty casualty	(174		)		25	%		(158		)		24	%		1	%
Specialty financial	(26		)		14	%		(27		)		15	%		(1	%)
Other specialty	25							22
	$	(358	)		25	%		$	(300	)		22	%		3	%

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $1.08 billion for the fourth quarter of 2016 compared to $1.06 billion for the fourth quarter of 2015, an increase of $27 million (3%). Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):

	Three months ended December 31,
	2016							2015
	NWP				%			NWP				%			% Change
Property and transportation	$	394			37	%		$	378			36	%		4	%
Specialty casualty	510				47	%		503				48	%		1	%
Specialty financial	154				14	%		152				14	%		1	%
Other specialty	25				2	%		23				2	%		9	%
	$	1,083			100	%		$	1,056			100	%		3	%

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Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $1.14 billion for the fourth quarter of 2016 compared to $1.12 billion for the fourth quarter of 2015, an increase of $24 million (2%). Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):

	Three months ended December 31,
	2016							2015
	NEP				%			NEP				%			% Change
Property and transportation	$	465			41	%		$	442			39	%		5	%
Specialty casualty	510				45	%		515				46	%		(1	%)
Specialty financial	141				12	%		137				12	%		3	%
Other specialty	28				2	%		26				3	%		8	%
	$	1,144			100	%		$	1,120			100	%		2	%

The $85 million increase in gross written premiums in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflects growth in each of the Specialty property and casualty insurance sub-segments. Overall average renewal rates were up 1% in the fourth quarter of 2016.

Property and transportation Gross written premiums increased $62 million (12%) in the fourth quarter of 2016 compared to the fourth quarter of 2015. This increase was due primarily to higher year-over-year gross written premiums in the crop business. Excluding crop, gross written premiums were comparable to the prior year period. Average renewal rates increased approximately 2% for this group in the fourth quarter of 2016, including a 4% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums increased 5 percentage points in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflecting higher cessions in the crop business, primarily related to growth in a rainfall-related product, which is heavily reinsured.

Specialty casualty Gross written premiums increased $23 million (3%) in the fourth quarter of 2016 compared to the fourth quarter of 2015. Higher gross written premiums in the targeted markets and executive liability businesses were partially offset by lower premiums in the excess and surplus lines operations, primarily the result of more stringent underwriting standards related to New York contractors business, as well as lower premiums within the workers’ compensation businesses. Average renewal rates for this group were flat in the fourth quarter of 2016, and include a decrease of approximately 2% in the workers’ compensation business. Excluding the workers’ compensation business, average renewal rates for this group increased approximately 1% during the quarter. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point for the fourth quarter of 2016 compared to the fourth quarter of 2015, reflecting a change in the mix of business.

Specialty financial Gross written premiums increased $1 million (1%) in the fourth quarter of 2016 compared to the fourth quarter of 2015, due primarily to growth in the fidelity and crime, surety and equipment leasing businesses, partially offset by lower premiums in the financial institutions business. Average renewal rates for this group were down approximately 1% in the fourth quarter of 2016. Reinsurance premiums ceded as a percentage of gross written premiums are comparable between periods.

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.

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Combined Ratio

Performance measures such as the combined ratio are often used by property and casualty insurers to help users of their financial statements better understand the company’s performance. The combined ratio is the sum of the loss and loss adjustment expenses (“LAE”) and underwriting expense ratios. These ratios are calculated by dividing each of the respective expenses by net earned premiums. The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment:

	Three months ended December 31,									Three months ended December 31,
	2016			2015			Change			2016				2015
Property and transportation
Loss and LAE ratio	68.6	%		71.7	%		(3.1	%)
Underwriting expense ratio	15.3	%		20.7	%		(5.4	%)
Combined ratio	83.9	%		92.4	%		(8.5	%)
Underwriting profit										$	75			$	34
Specialty casualty
Loss and LAE ratio	68.2	%		61.1	%		7.1	%
Underwriting expense ratio	29.2	%		29.1	%		0.1	%
Combined ratio	97.4	%		90.2	%		7.2	%
Underwriting profit										$	13			$	50
Specialty financial
Loss and LAE ratio	32.4	%		32.8	%		(0.4	%)
Underwriting expense ratio	53.6	%		55.9	%		(2.3	%)
Combined ratio	86.0	%		88.7	%		(2.7	%)
Underwriting profit										$	20			$	15
Total Specialty
Loss and LAE ratio	63.7	%		61.8	%		1.9	%
Underwriting expense ratio	26.7	%		29.2	%		(2.5	%)
Combined ratio	90.4	%		91.0	%		(0.6	%)
Underwriting profit										$	110			$	100
Aggregate — including exited lines
Loss and LAE ratio	63.7	%		61.8	%		1.9	%
Underwriting expense ratio	26.7	%		29.2	%		(2.5	%)
Combined ratio	90.4	%		91.0	%		(0.6	%)
Underwriting profit										$	110			$	100

The Specialty property and casualty insurance operations generated an underwriting profit of $110 million for the fourth quarter of 2016 compared to $100 million in the fourth quarter of 2015, an increase of $10 million (10%). The higher underwriting profit in the fourth quarter of 2016 reflects improved underwriting results in the Property and transportation and Specialty financial sub-segments, partially offset by lower underwriting profit in the Specialty casualty sub-segment. Overall catastrophe losses were $12 million (1.1 points on the combined ratio) in the fourth quarter of 2016 compared to $9 million (0.8 points on the combined ratio) in the fourth quarter of 2015.

Property and transportation Underwriting profit for this group was $75 million for the fourth quarter of 2016 compared to $34 million in the fourth quarter of 2015, an increase of $41 million (121%) reflecting higher underwriting profit in the crop insurance business, primarily the result of favorable growing conditions and relatively stable commodity pricing.

Specialty casualty Underwriting profit for this group was $13 million for the fourth quarter of 2016 compared to $50 million in the fourth quarter of 2015, a decrease of $37 million (74%). This decrease is due primarily to underwriting losses in one of the excess and surplus lines businesses, primarily related to coverage written for New York contractors, and lower profitability in the targeted markets business.

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Specialty financial Underwriting profit for this group was $20 million for the fourth quarter of 2016 compared to $15 million in the fourth quarter of 2015, an increase of $5 million (33%) reflecting higher underwriting profit in the financial institutions, surety and trade credit businesses.

Other specialty Underwriting profit for this group was $2 million for the fourth quarter of 2016 compared to $1 million in the fourth quarter of 2015, an increase of $1 million (100%).

Losses and Loss Adjustment Expenses

AFG’s overall loss and LAE ratio was 63.7% for the fourth quarter of 2016 compared to 61.8% for fourth quarter of 2015, an increase of 1.9 percentage points. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):

	Three months ended December 31,
	Amount								Ratio						Change in
	2016				2015				2016			2015			Ratio
Property and transportation
Current year, excluding catastrophe losses	$	300			$	306			64.4	%		69.2	%		(4.8	%)
Prior accident years development	13				8				3.0	%		1.8	%		1.2	%
Current year catastrophe losses	6				3				1.2	%		0.7	%		0.5	%
Property and transportation losses and LAE and ratio	$	319			$	317			68.6	%		71.7	%		(3.1	%)
Specialty casualty
Current year, excluding catastrophe losses	$	341			$	321			66.9	%		62.3	%		4.6	%
Prior accident years development	3				(7		)		0.5	%		(1.4	%)		1.9	%
Current year catastrophe losses	4				1				0.8	%		0.2	%		0.6	%
Specialty casualty losses and LAE and ratio	$	348			$	315			68.2	%		61.1	%		7.1	%
Specialty financial
Current year, excluding catastrophe losses	$	50			$	46			35.2	%		32.9	%		2.3	%
Prior accident years development	(6		)		(5		)		(4.5	%)		(3.6	%)		(0.9	%)
Current year catastrophe losses	2				5				1.7	%		3.5	%		(1.8	%)
Specialty financial losses and LAE and ratio	$	46			$	46			32.4	%		32.8	%		(0.4	%)
Total Specialty
Current year, excluding catastrophe losses	$	707			$	689			61.7	%		61.4	%		0.3	%
Prior accident years development	10				(5		)		0.9	%		(0.4	%)		1.3	%
Current year catastrophe losses	12				9				1.1	%		0.8	%		0.3	%
Total Specialty losses and LAE and ratio	$	729			$	693			63.7	%		61.8	%		1.9	%
Aggregate — including exited lines
Current year, excluding catastrophe losses	$	707			$	689			61.7	%		61.4	%		0.3	%
Prior accident years development	10				(5		)		0.9	%		(0.4	%)		1.3	%
Current year catastrophe losses	12				9				1.1	%		0.8	%		0.3	%
Aggregate losses and LAE and ratio	$	729			$	693			63.7	%		61.8	%		1.9	%

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 61.7% for the fourth quarter of 2016 compared to 61.4% for the fourth quarter of 2015, an increase of 0.3%.

Property and transportation   The 4.8 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses reflects a decrease in the loss and LAE ratio of the crop business and, to a lesser extent, the equine business and the Singapore branch in the fourth quarter of 2016 compared to the fourth quarter of 2015.

Specialty casualty   The 4.6 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, general liability, excess and surplus and workers’ compensation businesses and at Neon.

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Specialty financial   The 2.3 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 business.

Net prior year reserve development

AFG’s Specialty property and casualty insurance operations recorded net adverse reserve development related to prior accident years of $10 million in the fourth quarter of 2016 compared to net favorable reserve development related to prior accident years of $5 million in the fourth quarter of 2015.

Property and transportation   Net adverse reserve development of $13 million in the fourth quarter of 2016 reflects reserve strengthening at National Interstate and higher than expected claim severity in the ocean marine business. Net adverse reserve development of $8 million in the fourth quarter of 2015 reflects higher than expected claim severity in commercial auto liability insurance at National Interstate and higher than expected claim frequency in the ocean marine business, partially offset by lower than expected claim severity in the property and inland marine business.

Specialty casualty   Net adverse reserve development of $3 million in the fourth quarter of 2016 reflects higher than anticipated severity in New York contractor claims, adverse reserve development at Neon and higher than anticipated claim severity in the targeted programs business, partially offset by lower than anticipated claim frequency and severity in the workers’ compensation businesses. Net favorable reserve development of $7 million in the fourth quarter of 2015 reflects lower than anticipated claim severity in workers’ compensation business, excess liability insurance and directors and officers liability insurance, partially offset by adverse reserve development at Neon.

Specialty financial   Net favorable reserve development of $6 million in the fourth quarter of 2016 reflects lower than expected claim frequency in the financial institutions business and lower than anticipated claim severity in the fidelity and crime business. Net favorable reserve development of $5 million in the fourth quarter of 2015 reflects lower than anticipated claim severity in the fidelity business, lower than expected claim frequency and severity in the surety business and lower than expected claim severity on a run-off block of collateral value insurance, partially offset by higher than expected claim severity in products for financial institutions and in the trade credit business.

Other specialty In addition to the reserve development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $1 million in the fourth quarter of 2015 reflecting amortization of the deferred gain on the retroactive insurance transaction entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.

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, 2016, AFG’s exposure to a catastrophic earthquake or windstorm that industry models indicate could occur once in every 500 years (a “500-year event”) is expected to be less than 4% of AFG’s Shareholders’ Equity. Catastrophe losses of $12 million in the fourth quarter of 2016 resulted primarily from Hurricane Matthew. The $5 million of catastrophe losses in the Specialty financial group in the fourth quarter of 2015 resulted primarily from flooding in the midwestern United States.

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Commissions and Other Underwriting Expenses

AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $305 million in the fourth quarter of 2016 compared to $327 million for the fourth quarter of 2015, a decrease of $22 million (7%). AFG’s underwriting expense ratio, calculated as commissions and other underwriting expenses divided by net premiums earned, was 26.7% for the fourth quarter of 2016 compared to 29.2% for the fourth quarter of 2015, a decrease of 2.5 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 December 31,
	2016							2015							Change in
	U/W Exp				% of NEP			U/W Exp				% of NEP			% of NEP
Property and transportation	$	71			15.3	%		$	91			20.7	%		(5.4	%)
Specialty casualty	149				29.2	%		150				29.1	%		0.1	%
Specialty financial	75				53.6	%		76				55.9	%		(2.3	%)
Other specialty	10				35.4	%		10				36.1	%		(0.7	%)
	$	305			26.7	%		$	327			29.2	%		(2.5	%)

AFG’s overall expense ratio decreased 2.5% in the fourth quarter of 2016 as compared to the fourth quarter of 2015 reflecting an increase in ceding commissions received from reinsurers.

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 5.4 percentage points in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflecting an increase in ceding commissions received from reinsurers in the crop business.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.1 percentage points in the fourth quarter of 2016 compared to the fourth quarter of 2015.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 2.3 percentage points in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflecting an increase in ceding commissions received from reinsurers and the impact of higher premiums on the ratio in the financial institutions business.

Property and Casualty Net Investment Income

Net investment income in AFG’s property and casualty operations was $85 million in the fourth quarter of 2016 compared to $74 million in the fourth quarter of 2015, an increase of $11 million (15%). In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty operations are provided below (dollars in millions):

	Three months ended December 31,
	2016				2015				Change				% Change
Net investment income	$	85			$	74			$	11			15	%
Average invested assets (at amortized cost)	$	9,779			$	9,113			$	666			7	%
Yield (net investment income as a % of average invested assets)	3.48		%		3.25		%		0.23		%
Tax equivalent yield (*)	3.92		%		3.82		%		0.10		%

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

The increase in average invested assets in the property and casualty insurance segment for the fourth quarter of 2016 as compared to the fourth quarter of 2015 is due primarily to growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.48% for the fourth quarter of 2016 compared to 3.25% for the fourth quarter of 2015, an increase of 0.23 percentage points, reflecting a $5 million increase in income from certain investments that are required to be carried at fair value through earnings and an $8 million increase in equity in the earnings of limited partnerships and similar investments, partially offset by slightly higher investment expenses and lower yields available in the financial markets. The 7% increase in average invested assets in the fourth quarter of 2016 compared to the fourth quarter of 2015 reflects a higher average balance in cash and cash equivalents.

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Property and Casualty Other Income and Expenses, Net

GAAP other income and expenses, net for AFG’s property and casualty operations was a net expense of $13 million for the fourth quarter of 2016 compared to net income of $5 million for the fourth quarter of 2015, a decrease of $18 million (360%). Core other income and expenses, net for AFG’s property and casualty operations was a net expense of $13 million in the fourth quarter of 2016 compared to $10 million in the fourth quarter of 2015, an increase of $3 million (30%). The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty operations (in millions):

	Three months ended December 31,
	2016				2015
Other income
Income from the sale of real estate (*)	$	1			$	—
Other	4				2
Total other income	5				2
Other expenses
Amortization of intangibles	2				2
NATL merger expenses	5				—
Other	11				9
Total other expenses	18				11
Interest expense	—				1
Core other income and expenses, net	(13		)		(10		)
Pretax non-core gain on sale of apartment property	—				15
GAAP other income and expenses, net	$	(13	)		$	5

(*)	Excludes the $15 million pretax non-core gain on the sale of an apartment property in the fourth quarter of 2015.

AFG and its consolidated subsidiaries incurred $5 million in transaction expenses in the fourth quarter of 2016 related to GAI’s acquisition of the NATL common stock that it did not already own. These expenses consisted primarily of financial advisory and legal services. See Note B — “Acquisitions and Sale of Businesses” to the financial statements.

Interest expense for AFG’s property and casualty operations includes interest charges on long-term debt within the property and casualty operations.

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Annuity Segment — Results of Operations

AFG’s annuity operations contributed $132 million in pretax earnings in the fourth quarter of 2016 compared to $101 million in the fourth quarter of 2015, an increase of $31 million (31%). AFG’s annuity segment results for the fourth quarter of 2016 as compared to the fourth quarter of 2015 reflect higher investment income from certain investments that are required to be carried at fair value through earnings and an 11% increase in average annuity investments (at amortized cost). In addition, the annuity segment’s earnings in the fourth quarter of 2016 benefitted from the positive impact of a significant increase in interest rates on the fair value accounting for fixed-indexed annuities (“FIAs”). Both periods reflect the positive impact of strong stock market performance on fair value accounting for FIAs. These improved results were partially offset by the impact of lower investment yields due to the run-off of higher yielding investments. AFG’s periodic detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations resulted in a net annuity expense reduction of $1 million in the fourth quarter of 2016 compared to $10 million in the fourth quarter of 2015.

The following table details AFG’s earnings before income taxes from its annuity operations for the three months ended December 31, 2016 and 2015 (dollars in millions):

	Three months ended December 31,
	2016				2015				% Change
Revenues:
Net investment income	$	346			$	309			12	%
Other income:
Guaranteed withdrawal benefit fees	14				12				17	%
Policy charges and other miscellaneous income	13				11				18	%
Total revenues	373				332				12	%
Costs and Expenses:
Annuity benefits (*)	160				189				(15	%)
Acquisition expenses	54				20				170	%
Other expenses	27				22				23	%
Total costs and expenses	241				231				4	%
Earnings before income taxes	$	132			$	101			31	%

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

	Three months ended December 31,
	2016				2015				% Change
Earnings before income taxes — before the impact of derivatives related to FIAs	$	103			$	96			7	%
Impact of derivatives related to FIAs	29				5				480	%
Earnings before income taxes	$	132			$	101			31	%

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

	Three months ended December 31,
	2016				2015				% Change
Interest credited — fixed	$	148			$	138			7	%
Interest credited — fixed component of variable annuities	1				1				—	%
Other annuity benefits:
Change in expected death and annuitization reserve	4				5				(20	%)
Amortization of sales inducements	7				6				17	%
Change in guaranteed withdrawal benefit reserve	20				15				33	%
Change in other benefit reserves	11				5				120	%
Total other annuity benefits	42				31				35	%
Total before impact of derivatives related to FIAs and unlocking	191				170				12	%
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	6				88				(93	%)
Equity option mark-to-market	(60		)		(88		)		(32	%)
Impact of derivatives related to FIAs	(54		)		—				—	%
Unlocking	23				19				21	%
Total annuity benefits	$	160			$	189			(15	%)

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity benefit expense.

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 annuities):

	Three months ended December 31,
	2016				2015				% Change
Average fixed annuity investments (at amortized cost)	$	29,192			$	26,401			11	%
Average fixed annuity benefits accumulated	29,250				26,048				12	%
As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	4.72		%		4.65		%
Interest credited — fixed	(2.02		%)		(2.12		%)
Net interest spread	2.70		%		2.53		%
Policy charges and other miscellaneous income	0.15		%		0.15		%
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees	(0.38		%)		(0.31		%)
Acquisition expenses	(1.06		%)		(0.75		%)
Other expenses	(0.35		%)		(0.32		%)
Change in fair value of derivatives related to fixed-indexed annuities	0.73		%		0.02		%
Unlocking	0.03		%		0.07		%
Net spread earned on fixed annuities	1.82		%		1.39		%

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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 December 31,
	2016			2015
Net spread earned on fixed annuities — before impact of derivatives related to FIAs	1.42	%		1.31	%
Impact of derivatives related to fixed-indexed annuities:
Change in fair value of derivatives	0.73	%		0.02	%
Related impact on amortization of DPAC (*)	(0.31	%)		0.06	%
Related impact on amortization of deferred sales inducements (*)	(0.02	%)		—	%
Net spread earned on fixed annuities	1.82	%		1.39	%

(*)	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 fourth quarter of 2016 was $346 million compared to $309 million for the fourth quarter of 2015, an increase of $37 million (12%). This increase reflects primarily the growth in AFG’s annuity business and higher income from certain investments that are required to be carried at fair value through earnings, 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 0.07 percentage points to 4.72% from 4.65% in the fourth quarter of 2016 compared to the fourth quarter of 2015. This increase in net investment yield reflects higher income from certain investments that are required to be carried at fair value through earnings, 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 2016, $4.0 billion in annuity segment investments with an average yield of 5.51% were redeemed or sold while the investments purchased during 2016 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 4.21%.

Annuity Interest Credited — Fixed

Interest credited — fixed for the fourth quarter of 2016 was $148 million compared to $138 million for the fourth quarter of 2015, an increase of $10 million (7%). The impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, decreased 0.10 percentage points to 2.02% from 2.12% in the fourth quarter of 2016 compared to the fourth quarter of 2015.

Annuity Net Interest Spread

AFG’s net interest spread increased 0.17 percentage points to 2.70% from 2.53% in the fourth quarter of 2016 compared to the same period in 2015 due primarily to the impact of lower crediting rates and higher income from certain investments that are required to be carried at fair value through earnings, partially offset by lower in-force 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 $13 million in the fourth quarter of 2016 compared to $11 million in the fourth quarter of 2015, an increase of $2 million (18%). The fourth quarter of 2016 includes gains of $2 million from the sale of real estate. 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 were 0.15% in both the fourth quarter of 2016 and 2015.

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity policy charges and other miscellaneous income.

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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 fourth quarter of 2016 were $28 million compared to $19 million for the fourth quarter of 2015, an increase of $9 million (47%). As a percentage of average fixed annuity benefits accumulated, these net expenses increased 0.07 percentage points to 0.38% from 0.31% in the fourth quarter of 2016 compared to the fourth quarter of 2015. 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 December 31,
	2016				2015
Change in expected death and annuitization reserve	$	4			$	5
Amortization of sales inducements	7				6
Change in guaranteed withdrawal benefit reserve	20				15
Change in other benefit reserves	11				5
Other annuity benefits	42				31
Offset guaranteed withdrawal benefit fees	(14		)		(12		)
Other annuity benefits, net	$	28			$	19

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.

Annuity Acquisition Expenses

Excluding the impact of unlocking charges (expense reductions) discussed under “Annuity Unlocking” below, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 1.06% for the fourth quarter of 2016 compared to 0.75% for the fourth quarter of 2015 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 the significantly higher than anticipated interest rates and strong stock market performance during the fourth quarter of 2016 on the fair value of derivatives related to fixed-indexed annuities (discussed below) resulted in a partially offsetting acceleration in the amortization of DPAC. During the third quarter of 2015, the deceleration in the amortization of DPAC caused by the negative impact of poor stock market performance on the fair value accounting for derivatives related to fixed-indexed annuities was limited on certain recently issued products. This prior period limitation had a $5 million favorable impact on the amortization of DPAC related to the fair value accounting for those derivatives when the stock market rebounded during the fourth quarter of 2015. This favorable impact is reported in the impact on DPAC of derivatives related to FIAs.

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:

	Three months ended December 31,
	2016			2015
Before the impact of changes in the fair value of derivatives related to fixed-indexed annuities on the amortization of DPAC	0.75	%		0.81	%
Impact of changes in fair value of derivatives related to FIAs on the amortization of DPAC (*)	0.31	%		(0.06	%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	1.06	%		0.75	%

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

Annuity Other Expenses  

Annuity other expenses were $27 million for the fourth quarter of 2016 compared to $22 million for the fourth quarter of 2015, an increase of $5 million (23%). Annuity other expenses represent primarily general and administrative expenses, as well as selling and issuance expenses that are not deferred. The increase in annuity other expenses reflects primarily growth in the business and an increase in the number of sales personnel focused on new initiatives and increased market share within existing financial institutions and retail marketing organizations in the fourth quarter of 2016 compared to the fourth quarter of 2015. As

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a percentage of average fixed annuity benefits accumulated, these expenses increased 0.03 percentage points to 0.35% from 0.32% for the fourth quarter of 2016 as compared to the fourth quarter of 2015.

Change in Fair Value of Derivatives Related to Fixed-Indexed Annuities

AFG’s fixed-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets 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 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 of AFG’s annuity benefits accumulated, see Note D — “Fair Value Measurements” to the financial statements. Excluding the impact of unlocking charges, the net change in fair value of derivatives related to fixed-indexed annuities decreased annuity benefits by $54 million in the fourth quarter of 2016 and had a nominal impact on annuity benefits in the fourth quarter of 2015. The $54 million decrease in annuity benefits in the fourth quarter of 2016 reflects the positive impact of significantly higher than anticipated interest rates and strong market performance on the fair value of these derivatives. As a percentage of average fixed annuity benefits accumulated, this net expense reduction increased 0.71 percentage points to 0.73% in the fourth quarter of 2016 from 0.02% in the fourth quarter of 2015.

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 December 31,
	2016				2015				% Change
Earnings before income taxes — before change in fair value of derivatives related to fixed-indexed annuities	$	103			$	96			7	%
Change in fair value of derivatives related to fixed-indexed annuities	54				—				—	%
Related impact on amortization of DPAC (*)	(25		)		5				(600	%)
Earnings before income taxes	$	132			$	101			31	%

(*)	An estimate of the related acceleration/deceleration of 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 $29 million in the fourth quarter of 2016 and by $5 million in the fourth quarter of 2015.

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity and supplemental insurance acquisition expenses. 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 Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities increased 0.43 percentage points to 1.82% from 1.39% in the fourth quarter of 2016 compared to the same period in 2015 due primarily to the net impact of changes in the fair value of derivatives and related DPAC amortization offset discussed above and the 0.17 percentage points increase in AFG’s net interest spread.

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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 December 31, 2016 and 2015 (in millions):

	Three months ended December 31,
	2016				2015
Beginning fixed annuity reserves	$	28,853			$	25,725
Fixed annuity premiums (receipts)	1,103				1,097
Federal Home Loan Bank advances	—				45
Surrenders, benefits and other withdrawals	(524		)		(515		)
Sale of subsidiaries	—				(261		)
Interest and other annuity benefit expenses:
Interest credited	148				138
Embedded derivative mark-to-market	6				88
Change in other benefit reserves	34				31
Unlocking	27				23
Ending fixed annuity reserves	$	29,647			$	26,371
Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	29,647			$	26,371
Impact of unrealized investment gains	76				64
Fixed component of variable annuities	184				187
Annuity benefits accumulated per balance sheet	$	29,907			$	26,622

Statutory Annuity Premiums

AFG’s annuity operations generated statutory premiums of $1.11 billion in both the fourth quarter of 2016 and 2015. The following table summarizes AFG’s annuity sales (dollars in millions):

	Three months ended December 31,
	2016				2015				% Change
Financial institutions single premium annuities — indexed	$	474			$	462			3	%
Financial institutions single premium annuities — fixed	152				72				111	%
Retail single premium annuities — indexed	415				494				(16	%)
Retail single premium annuities — fixed	22				18				22	%
Education market — fixed and indexed annuities	40				51				(22	%)
Total fixed annuity premiums	1,103				1,097				1	%
Variable annuities	8				10				(20	%)
Total annuity premiums	$	1,111			$	1,107			—	%

AFG continues to implement product and process changes needed to comply with the Department of Labor (“DOL”) fiduciary rule and is proceeding under the premise the DOL rule becomes effective in April 2017 in its current form. There is considerable discussion surrounding the possibility of a delay or other action impacting the rule. On February 9, 2017, the DOL filed a notice with the Office of Management and Budget to delay implementation of the regulation. However, until there is some definitive action impacting the rule, AFG intends to continue to pursue necessary changes.

Assuming the rule becomes effective in its current form, AFG believes the biggest impact will be on insurance-only licensed agents whose sales represented less than 10% of its fourth quarter annuity premium. While AFG’s management continues to believe the adjustments required of AFG and its distribution partners to comply with the rule will impact 2017 annuity premiums, management does not believe the new rule will have a material impact on AFG’s results of operations.

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Annuity Unlocking

In the fourth quarters of 2016 and 2015, AFG conducted a detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations. As a result of these reviews, AFG recorded net expense reductions related to its annuity business of $1 million in 2016 and $10 million in 2015, which impacted AFG’s financial statements as follows (in millions):

		Three months ended December 31,
		2016				2015
Policy charges and other miscellaneous income:
Unearned revenue		$	(1	)		$	(2	)
Total revenues		(1		)		(2		)
Annuity benefits:
Fixed-indexed annuity embedded derivative		17				28
Sales inducements		(4		)		(4		)
Other reserves		10				(5		)
Total annuity benefits		23				19
Annuity and supplemental insurance acquisition expenses:
Deferred policy acquisition costs		(25		)		(31		)
Total costs and expenses		(2		)		(12		)
Net expense reduction		$	1			$	10

The net expense reduction from unlocking annuity assumptions in the fourth quarter of 2016 reflects the favorable impact of an increase in projected net interest spreads on in-force business, substantially offset by the unfavorable impact of (i) changes in projected policyholder annuitization and lapse behavior, (ii) an increase in the risk premium for the uncertainty in the cash flows component of the discount rates used to value the FIA-related embedded derivative and (iii) a slight decrease in projected stock market growth over the next three years. Reinvestment rate assumptions are based primarily on 7-year and 10-year corporate bond yields. For the 2016 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 4.24% in 2017, grading up ratably to an ultimate net reinvestment rate of 5.55% in 2022 and beyond.

The table below compares the reinvestment rate assumed 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 (*)			Achieved
2014		2015		3.75	%		4.27	%
2015		2016		4.05	%		4.27	%
2016		2017		4.42	%		n/a

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

Management believes that these results demonstrate that AFG’s reinvestment rate assumptions are reasonable and prudently conservative. In addition to the reinvestment rates above, actual default rates in 2015 and 2016 were lower than the long-term default rates of 0.18% assumed in the unlocking in each of the periods above.

The 2015 net expense reduction was due primarily to the impact of changes in assumptions to reflect higher than previously projected net interest spreads as well as the impact of higher assets under management and expense discipline. For the 2015 unlocking, AFG assumed a net reinvestment rate (net of default and expense assumptions) of 3.87% in 2016, grading up ratably to an ultimate net reinvestment rate of 5.53% in 2022 and beyond.

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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 December 31, 2016 and 2015 (in millions):

	Three months ended December 31,
	2016				2015
Earnings on fixed annuity benefits accumulated	$	133			$	91
Earnings on investments in excess of fixed annuity benefits accumulated (*)	—				4
Variable annuity earnings (loss)	(1		)		6
Earnings before income taxes	$	132			$	101

(*)	Net investment income (as a % of investments) of 4.72% and 4.65% for the three months ended December 31, 2016 and 2015, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

Run-off Long-Term Care and Life Segment — Results of Operations AFG’s run-off long-term care and life segment reported GAAP pretax earnings of $2 million for the fourth quarter of 2016 compared to a loss of $4 million for the fourth quarter of 2015. Results for the 2015 period include a $4 million pretax non-core realized loss adjustment to the previously recognized $162 million estimated pretax loss on the sale of substantially all of AFG’s run-off long-term care insurance business that was recorded in the first quarter of 2015. See Note B — “Acquisitions and Sale of Businesses” to the financial statements. The following table details AFG’s GAAP and core earnings (loss) before income taxes from its run-off long-term care and life operations for the three months ended December 31, 2016 and 2015 (dollars in millions):

	Three months ended December 31,
	2016				2015				% Change
Revenues:
Net earned premiums:
Long-term care	$	1			$	17			(94	%)
Life operations	5				7				(29	%)
Net investment income	6				19				(68	%)
Total revenues	12				43				(72	%)
Costs and Expenses:
Life, accident and health benefits:
Long-term care	—				24				(100	%)
Life operations	7				11				(36	%)
Acquisition expenses	1				3				(67	%)
Other expenses	2				5				(60	%)
Total costs and expenses	10				43				(77	%)
Core earnings (loss) before income taxes	2				—				—	%
Pretax non-core realized loss on subsidiaries	—				(4		)		(100	%)
GAAP earnings (loss) before income taxes	$	2			$	(4	)		(150	%)

The decrease in long-term care net earned premiums and benefit expense in the fourth quarter of 2016 compared to the fourth quarter of 2015 is due to the sale of subsidiaries containing substantially all of AFG’s run-off long-term care insurance business in December of 2015.

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Holding Company, Other and Unallocated — Results of Operations   AFG’s net pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $50 million for the fourth quarter of 2016 compared to $45 million for the fourth quarter of 2015, an increase of $5 million (11%).

The following table details AFG’s loss before income taxes from operations outside of its insurance operations for three months ended December 31, 2016 and 2015 (dollars in millions):

	Three months ended December 31,
	2016				2015				% Change
Revenues:
Net investment income	$	—			$	3			(100	%)
Other income — P&C fees	17				16				6	%
Other income	8				6				33	%
Total revenues	25				25				—	%
Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	6				6				—	%
Interest charges on borrowed money	21				16				31	%
Other expense — expenses associated with P&C fees	11				10				10	%
Other expenses	37				38				(3	%)
Total costs and expenses	75				70				7	%
Loss before income taxes, excluding realized gains and losses	$	(50	)		$	(45	)		11	%

Holding Company and Other — Net Investment Income

AFG recorded net investment income on investments held outside of its insurance operations of less than $1 million in the fourth quarter of 2016 compared to $3 million in the fourth quarter of 2015.

Holding Company and Other — P&C Fees and Related Expenses

Summit, the workers’ compensation insurance business that AFG acquired in April 2014, 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 businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In the fourth quarter of 2016, AFG collected $17 million in fees for these services compared to $16 million in the fourth quarter of 2015. Management views this fee income, net of the $11 million in the fourth quarter of 2016 and $10 million in the fourth quarter of 2015, 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 $5 million and $4 million in the fourth quarter of 2016 and 2015, 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 insurance operations of $3 million in the fourth quarter of 2016 and $2 million in the fourth quarter of 2015.

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Holding Company and Other — Interest Charges on Borrowed Money

AFG’s holding companies and other operations outside of its insurance operations recorded interest expense of $21 million in the fourth quarter of 2016 compared to $16 million in the fourth quarter of 2015, an increase of $5 million (31%). This increase reflects higher average indebtedness, partially offset by lower average interest rates on outstanding debt. The following table details the principal amount of AFG’s long-term debt balances as of October 1, 2016 compared to October 1, 2015 (dollars in millions):

	October 1, 2016				October 1, 2015
Direct obligations of AFG:
9-7/8% Senior Notes due June 2019	$	350			$	350
3.50% Senior Notes due August 2026	300				—
6-3/8% Senior Notes due June 2042	230				230
5-3/4% Senior Notes due August 2042	125				125
6-1/4% Subordinated Debentures due September 2054	150				150
6% Subordinated Debentures due November 2055	150				—
Other	3				3
Total principal amount of Holding Company Debt	$	1,308			$	858
Weighted Average Interest Rate	6.5		%		7.7		%

The increase in average indebtedness for the fourth quarter of 2016 as compared to the fourth quarter of 2015 reflects the following financing transactions completed by AFG between October 1, 2015 and October 1, 2016:

•	Issued $300 million of 3.50% Senior Notes on August 22, 2016.

•	Issued $150 million of 6% Subordinated Debentures on November 17, 2015.

Holding Company and Other — Other Expenses

AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $37 million in the fourth quarter of 2016 compared to $38 million in the fourth quarter of 2015, a decrease of $1 million (3%).

Consolidated Realized Gains (Losses) on Securities   AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were gains of $51 million in the fourth quarter of 2016 compared to losses of $21 million in the fourth quarter of 2015, an increase of $72 million (343%). Realized gains (losses) on securities consisted of the following (in millions):

	Three months ended December 31,
	2016				2015
Realized gains (losses) before impairments:
Disposals	$	69			$	41
Change in the fair value of derivatives	(9		)		(4		)
Adjustments to annuity deferred policy acquisition costs and related items	—				(2		)
	60				35
Impairment charges:
Securities	(11		)		(60		)
Adjustments to annuity deferred policy acquisition costs and related items	2				4
	(9		)		(56		)
Realized gains (losses) on securities	$	51			$	(21	)

AFG’s impairment charges on securities for the fourth quarter of 2016 consist of $10 million on equity securities and $1 million on fixed maturities compared to $46 million on equity securities, $11 million on fixed maturities and $3 million on other investments in the fourth quarter of 2015. Approximately $7 million in impairment charges in the fourth quarter of 2016 are related to an equity investment in a pharmaceutical company. Approximately $26 million of the charges in the fourth quarter of 2015 are attributable to real estate and mortgage related investments, $12 million are on investments in asset managers and $8 million are on energy related investments.

Consolidated Realized Gains (Losses) on Subsidiaries   The $4 million pretax realized loss on subsidiaries in the fourth quarter of 2015 represents an adjustment to the previously recognized $162 million estimated pretax loss on the sale of substantially all of AFG’s run-off long-term care insurance business that was recorded in the first quarter of 2015.

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Consolidated Income Taxes   AFG’s consolidated provision (credit) for income taxes was a benefit of $71 million for the fourth quarter of 2016 compared to an expense of $80 million in the fourth quarter of 2015, a decrease of $151 million (189%). The following is a reconciliation of income taxes at the statutory rate of 35% to the provision (credit) for income taxes as shown in the segmented statement of earnings (dollars in millions):

	Three months ended December 31,
	2016							2015
	Amount				% of EBT			Amount				% of EBT
Earnings before income taxes (“EBT”)	$	317						$	210
Income taxes at statutory rate	$	110			35	%		$	74			35	%
Effect of:
Tax exempt interest	(6		)		(2	%)		(7		)		(3	%)
Change in valuation allowance	12				4	%		15				7	%
Stock-based compensation	(9		)		(3	%)		—				—	%
Acquisition of noncontrolling interest in NATL	(66		)		(21	%)		—				—	%
Neon restructuring	(111		)		(35	%)		—				—	%
Other	(1		)		—	%		(2		)		(1	%)
Provision (credit) for income taxes	$	(71	)		(22	%)		$	80			38	%

The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Neon Lloyd’s insurance business. Due to the uncertainty concerning the realization of the deferred tax benefits associated with these losses, AFG maintains a full valuation allowance against these deferred tax assets.

As discussed in Note B — “Acquisitions and Sale of Businesses” to the financial statements, AFG acquired the noncontrolling interest in National Interstate Corporation in November 2016. This transaction allowed National Interstate and its subsidiaries to become members of the AFG consolidated tax group, which resulted in a tax benefit of $66 million to AFG during the fourth quarter of 2016.

In connection with the ongoing reorganization of AFG’s Neon Lloyd’s business, in December 2016, AFG undertook a restructuring that included the liquidation for tax purposes of the foreign subsidiary that is the parent of the Neon Lloyd’s operations, resulting in a taxable loss for U.S. tax purposes. AFG reported the $111 million tax benefit associated with this loss in the fourth quarter of 2016. See Note L — “Income Taxes” to the financial statements.

Excluding the tax benefit related to the acquisition of the noncontrolling interest in NATL and the tax benefit related to the Neon restructuring, AFG’s effective tax rate for the three months ended December 31, 2016 was 33%.

Consolidated Noncontrolling Interests   AFG’s consolidated net earnings attributable to noncontrolling interests was $3 million for the fourth quarter of 2016 compared to $1 million for the fourth quarter of 2015.

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RESULTS OF OPERATIONS — YEARS ENDED DECEMBER 31, 2016, 2015 AND 2014

Segmented Statement of Earnings   AFG reports its business as four segments: (i) Property and casualty insurance (“P&C”), (ii) Annuity, (iii) Run-off long-term care and life and (iv) Other, which includes holding company costs and income and expenses related to the managed investment entities (“MIEs”).

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 years ended December 31, 2016, 2015 and 2014 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				Run-off long-term care and life				Consol. MIEs				Holding Co., other and unallocated				Total				Non-core reclass				GAAP Total
Year ended December 31, 2016
Revenues:
Property and casualty insurance net earned premiums	$	4,328			$	—			$	—			$	—			$	—			$	4,328			$	—			$	4,328
Life, accident and health net earned premiums	—				—				24				—				—				24				—				24
Net investment income	350				1,356				21				(37		)		6				1,696				—				1,696
Realized gains on:
Securities	—				—				—				—				—				—				19				19
Subsidiaries	—				—				—				—				—				—				2				2
Income (loss) of MIEs:
Investment income	—				—				—				190				—				190				—				190
Gain (loss) on change in fair value of assets/liabilities	—				—				—				15				—				15				—				15
Other income	19				103				4				(17		)		83				192				32				224
Total revenues	4,697				1,459				49				151				89				6,445				53				6,498
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,669				—				—				—				—				2,669				93				2,762
Commissions and other underwriting expenses	1,322				—				—				—				19				1,341				8				1,349
Annuity benefits	—				800				—				—				—				800				—				800
Life, accident and health benefits	—				—				33				—				—				33				—				33
Annuity and supplemental insurance acquisition expenses	—				181				5				—				—				186				—				186
Interest charges on borrowed money	—				—				—				—				77				77				—				77
Expenses of MIEs	—				—				—				151				—				151				—				151
Other expenses	60				110				9				—				169				348				5				353
Total costs and expenses	4,051				1,091				47				151				265				5,605				106				5,711
Earnings before income taxes	646				368				2				—				(176		)		840				(53		)		787
Provision for income taxes	229				127				1				—				(67		)		290				(171		)		119
Net earnings, including noncontrolling interests	417				241				1				—				(109		)		550				118				668
Less: Net earnings attributable to noncontrolling interests	16				—				—				—				—				16				3				19
Core Net Operating Earnings	401				241				1				—				(109		)		534
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax and noncontrolling interests	—				—				—				—				13				13				(13		)		—
Realized gain on subsidiaries, net of tax	—				—				1				—				—				1				(1		)		—
Gain on sale of apartment property, net of tax and noncontrolling interests	15				—				—				—				—				15				(15		)		—
Special A&E charges, net of tax	(23		)		—				—				—				(3		)		(26		)		26				—
Neon exited lines charge	(65		)		—				—				—				—				(65		)		65				—
Tax benefit related to National Interstate merger	66				—				—				—				—				66				(66		)		—
Tax benefit related to Neon restructuring	111				—				—				—				—				111				(111		)		—
Net Earnings Attributable to Shareholders	$	505			$	241			$	2			$	—			$	(99	)		$	649			$	—			$	649

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													Other
	P&C				Annuity				Run-off long-term care and life				Consol. MIEs				Holding Co., other and unallocated				Total				Non-core reclass				GAAP Total
Year ended December 31, 2015
Revenues:
Property and casualty insurance net earned premiums	$	4,224			$	—			$	—			$	—			$	—			$	4,224			$	—			$	4,224
Life, accident and health net earned premiums	—				—				104				—				—				104				—				104
Net investment income	319				1,224				80				6				4				1,633				—				1,633
Realized losses on:
Securities	—				—				—				—				—				—				(19		)		(19		)
Subsidiaries	—				—				—				—				—				—				(161		)		(161		)
Income (loss) of MIEs:
Investment income	—				—				—				155				—				155				—				155
Gain (loss) on change in fair value of assets/liabilities	—				—				—				(34		)		—				(34		)		—				(34		)
Other income	12				98				4				(15		)		78				177				66				243
Total revenues	4,555				1,322				188				112				82				6,259				(114		)		6,145
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,628				—				—				—				—				2,628				67				2,695
Commissions and other underwriting expenses	1,304				—				—				—				16				1,320				—				1,320
Annuity benefits	—				732				—				—				—				732				—				732
Life, accident and health benefits	—				—				131				—				—				131				—				131
Annuity and supplemental insurance acquisition expenses	—				163				16				—				—				179				—				179
Interest charges on borrowed money	2				—				—				—				73				75				—				75
Expenses of MIEs	—				—				—				112				—				112				—				112
Other expenses	44				96				27				—				153				320				16				336
Total costs and expenses	3,978				991				174				112				242				5,497				83				5,580
Earnings before income taxes	577				331				14				—				(160		)		762				(197		)		565
Provision for income taxes	199				113				5				—				(54		)		263				(68		)		195
Net earnings, including noncontrolling interests	378				218				9				—				(106		)		499				(129		)		370
Less: Net earnings attributable to noncontrolling interests	11				—				—				—				2				13				5				18
Core Net Operating Earnings	367				218				9				—				(108		)		486
Non-core earnings attributable to shareholders (a):
Realized losses on securities, net of tax and noncontrolling interests	—				—				—				—				(12		)		(12		)		12				—
Realized gain (loss) on subsidiaries, net of tax					—				(108		)		—				4				(104		)		104				—
Gain on sale of hotel and apartment property, net of tax and noncontrolling interests	36				—				—				—				—				36				(36		)		—
Special A&E charges, net of tax	(44		)		—				—				—				(8		)		(52		)		52				—
Loss on retirement of debt, net of tax	—				—				—				—				(2		)		(2		)		2				—
Net Earnings Attributable to Shareholders	$	359			$	218			$	(99	)		$	—			$	(126	)		$	352			$	—			$	352

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													Other
	P&C				Annuity				Run-off long-term care and life				Consol. MIEs				Holding Co., other and unallocated				Total				Non-core reclass				GAAP Total
Year ended December 31, 2014
Revenues:
Property and casualty insurance net earned premiums	$	3,878			$	—			$	—			$	—			$	—			$	3,878			$	—			$	3,878
Life, accident and health net earned premiums	—				—				108				—				—				108				—				108
Net investment income	294				1,136				82				(16		)		5				1,501				—				1,501
Realized gains on securities	—				—				—				—				—				—				52				52
Income (loss) of MIEs:
Investment income	—				—				—				116				—				116				—				116
Gain (loss) on change in fair value of assets/liabilities	—				—				—				(44		)		—				(44		)		—				(44		)
Other income	9				97				5				(25		)		36				122				—				122
Total revenues	4,181				1,233				195				31				41				5,681				52				5,733
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,470				—				—				—				—				2,470				24				2,494
Commissions and other underwriting expenses	1,172				—				—				—				—				1,172				—				1,172
Annuity benefits	—				648				—				—				—				648				—				648
Life, accident and health benefits	—				—				164				—				—				164				—				164
Annuity and supplemental insurance acquisition expenses	—				175				18				—				—				193				—				193
Interest charges on borrowed money	4				—				—				—				70				74				—				74
Expenses of MIEs	—				—				—				82				—				82				—				82
Other expenses	55				82				23				—				114				274				6				280
Total costs and expenses	3,701				905				205				82				184				5,077				30				5,107
Earnings before income taxes	480				328				(10		)		(51		)		(143		)		604				22				626
Provision for income taxes	151				112				(3		)		—				(48		)		212				8				220
Net earnings, including noncontrolling interests	329				216				(7		)		(51		)		(95		)		392				14				406
Less: Net earnings (loss) attributable to noncontrolling interests	4				—				—				(51		)		—				(47		)		1				(46		)
Core Net Operating Earnings	325				216				(7		)		—				(95		)		439
Non-core earnings attributable to shareholders (a):
Realized gains on securities, net of tax and noncontrolling interests	—				—				—				—				32				32				(32		)		—
Special A&E charges, net of tax	(15		)		—				—				—				(4		)		(19		)		19				—
Net Earnings Attributable to Shareholders	$	310			$	216			$	(7	)		$	—			$	(67	)		$	452			$	—			$	452

(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 $577 million in GAAP pretax earnings in 2016 compared to $576 million in 2015, an increase of $1 million. Property and casualty core pretax earnings were $646 million in 2016 compared to $577 million in 2015, an increase of $69 million (12%). The increase in GAAP and core pretax earnings reflects improved underwriting results in the Property and transportation group and higher net investment income, partially offset by lower underwriting profit in the Specialty casualty and Specialty financial groups. GAAP pretax earnings also reflect a pretax non-core charge of $65 million in the second quarter of 2016 related to the exit of certain lines of business within Neon and a $32 million pretax non-core gain on the sale of an apartment property in the second quarter of 2016 compared to a $51 million pretax non-core gain on the sale of a hotel in the second quarter of 2015 and a $15 million pretax non-core gain on the sale of an apartment property in the fourth quarter of 2015, as well as non-core special A&E charges of $36 million in 2016 compared to $67 million in 2015.

AFG’s property and casualty insurance operations contributed $576 million in GAAP pretax earnings in 2015 compared to $456 million in 2014, an increase of $120 million (26%). Property and casualty core pretax earnings were $577 million in 2015

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compared to $480 million in 2014, an increase of $97 million (20%). The increase in GAAP and core pretax earnings reflects higher underwriting profit across each of AFG’s property and casualty insurance sub-segments, higher net investment income (due primarily to the investment of cash acquired in the Summit acquisition on April 1, 2014) and lower net expenses. The increase in GAAP pretax earnings in 2015 also reflects pretax non-core gains of $51 million on the sale of a hotel and $15 million on the sale of an apartment property, partially offset by higher non-core special A&E charges in 2015 as compared to 2014.

The following table details AFG’s GAAP and core earnings before income taxes from its property and casualty insurance operations for the years ended December 31, 2016, 2015 and 2014 (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Gross written premiums	$	5,981			$	5,832			$	5,477			3	%		6	%
Reinsurance premiums ceded	(1,595		)		(1,505		)		(1,457		)		6	%		3	%
Net written premiums	4,386				4,327				4,020				1	%		8	%
Change in unearned premiums	(58		)		(103		)		(142		)		(44	%)		(27	%)
Net earned premiums	4,328				4,224				3,878				2	%		9	%
Loss and loss adjustment expenses (a)	2,669				2,628				2,470				2	%		6	%
Commissions and other underwriting expenses (b)	1,322				1,304				1,172				1	%		11	%
Core underwriting gain	337				292				236				15	%		24	%
Net investment income	350				319				294				10	%		9	%
Other income and expenses, net (c)	(41		)		(34		)		(50		)		21	%		(32	%)
Core earnings before income taxes	646				577				480				12	%		20	%
Pretax non-core special A&E charges	(36		)		(67		)		(24		)		(46	%)		179	%
Pretax non-core Neon exited lines charge	(65		)		—				—				—	%		—	%
Pretax non-core gain on sale of apartment properties and hotel	32				66				—				(52	%)		—	%
GAAP earnings before income taxes	$	577			$	576			$	456			—	%		26	%
(a) Excludes pretax non-core special A&E charges of $36 million, $67 million and $24 million in 2016, 2015 and 2014, respectively, and a non-core charge of $57 million related to the exit of certain lines of business within Neon in 2016.
(b) Excludes a non-core charge of $8 million related to the exit of certain lines of business within Neon in 2016.
(c) Excludes pretax non-core gains of $32 million on the sale of an apartment property in 2016 and $51 million on the sale of a hotel and $15 million on the sale of an apartment property in 2015.
													Change
													2016 - 2015			2015 - 2014
Combined Ratios:
Specialty lines
Loss and LAE ratio	61.7		%		62.2		%		63.7		%		(0.5	%)		(1.5	%)
Underwriting expense ratio	30.6		%		30.9		%		30.2		%		(0.3	%)		0.7	%
Combined ratio	92.3		%		93.1		%		93.9		%		(0.8	%)		(0.8	%)
Aggregate — including exited lines
Loss and LAE ratio	63.8		%		63.8		%		64.3		%		—	%		(0.5	%)
Underwriting expense ratio	30.7		%		30.9		%		30.2		%		(0.2	%)		0.7	%
Combined ratio	94.5		%		94.7		%		94.5		%		(0.2	%)		0.2	%

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.

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Gross Written Premiums

Gross written premiums (“GWP”) for AFG’s property and casualty insurance segment were $5.98 billion in 2016 compared to $5.83 billion in 2015, an increase of $149 million (3%). GWP increased $355 million (6%) in 2015 compared to 2014. Detail of AFG’s property and casualty gross written premiums is shown below (dollars in millions):

	Year ended December 31,																					% Change
	2016							2015							2014							2016 - 2015			2015 - 2014
	GWP				%			GWP				%			GWP				%
Property and transportation	$	2,504			42	%		$	2,455			42	%		$	2,342			43	%		2	%		5	%
Specialty casualty	2,792				47	%		2,739				47	%		2,529				46	%		2	%		8	%
Specialty financial	685				11	%		637				11	%		605				11	%		8	%		5	%
Other specialty	—				—	%		1				—	%		1				—	%		(100	%)		—	%
	$	5,981			100	%		$	5,832			100	%		$	5,477			100	%		3	%		6	%

Reinsurance Premiums Ceded

Reinsurance premiums ceded (“Ceded”) for AFG’s property and casualty insurance segment were 27%, 26% and 27% of gross written premiums for the years ended December 31, 2016, 2015 and 2014, respectively. Detail of AFG’s property and casualty reinsurance premiums ceded is shown below (dollars in millions):

	Year ended December 31,																					Change in % of GWP
	2016							2015							2014							2016 - 2015			2015 - 2014
	Ceded				% of GWP			Ceded				% of GWP			Ceded				% of GWP
Property and transportation	$	(832	)		33	%		$	(819	)		33	%		$	(776	)		33	%		—	%		—	%
Specialty casualty	(756		)		27	%		(687		)		25	%		(665		)		26	%		2	%		(1	%)
Specialty financial	(113		)		16	%		(97		)		15	%		(117		)		19	%		1	%		(4	%)
Other specialty	106							98							101
	$	(1,595	)		27	%		$	(1,505	)		26	%		$	(1,457	)		27	%		1	%		(1	%)

Net Written Premiums

Net written premiums (“NWP”) for AFG’s property and casualty insurance segment were $4.39 billion in 2016 compared to $4.33 billion in 2015, an increase of $59 million (1%). NWP increased $307 million (8%) in 2015 compared to 2014. Detail of AFG’s property and casualty net written premiums is shown below (dollars in millions):

	Year ended December 31,																					% Change
	2016							2015							2014							2016 - 2015			2015 - 2014
	NWP				%			NWP				%			NWP				%
Property and transportation	$	1,672			38	%		$	1,636			38	%		$	1,566			39	%		2	%		4	%
Specialty casualty	2,036				46	%		2,052				47	%		1,864				46	%		(1	%)		10	%
Specialty financial	572				13	%		540				12	%		488				12	%		6	%		11	%
Other specialty	106				3	%		99				3	%		102				3	%		7	%		(3	%)
	$	4,386			100	%		$	4,327			100	%		$	4,020			100	%		1	%		8	%

Net Earned Premiums

Net earned premiums (“NEP”) for AFG’s property and casualty insurance segment were $4.33 billion in 2016 compared to $4.22 billion in 2015, an increase of $104 million (2%). NEP increased $346 million (9%) in 2015 compared to 2014. Detail of AFG’s property and casualty net earned premiums is shown below (dollars in millions):

	Year ended December 31,																					% Change
	2016							2015							2014							2016 - 2015			2015 - 2014
	NEP				%			NEP				%			NEP				%
Property and transportation	$	1,662			38	%		$	1,599			38	%		$	1,544			40	%		4	%		4	%
Specialty casualty	2,006				46	%		2,011				48	%		1,765				45	%		—	%		14	%
Specialty financial	557				13	%		517				12	%		469				12	%		8	%		10	%
Other specialty	103				3	%		97				2	%		100				3	%		6	%		(3	%)
	$	4,328			100	%		$	4,224			100	%		$	3,878			100	%		2	%		9	%

The $149 million (3%) increase in gross written premiums in 2016 compared to 2015 reflects growth in the Property and transportation, Specialty casualty and Specialty financial sub-segments. Overall average renewal rates were flat in 2016.

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The $355 million (6%) increase in gross written premiums in 2015 compared to 2014 reflects $535 million in premiums from Summit (acquired in April 2014) in 2015 compared to $414 million in 2014 as well as significant growth in other businesses within the Specialty casualty and Property and transportation groups. Overall average renewal rates increased approximately 1% in 2015.

Property and transportation Gross written premiums increased $49 million (2%) in 2016 compared to 2015. This increase was the result of higher premiums in the agricultural businesses, growth in the transportation businesses and higher gross written premiums from the Singapore branch, which opened for business in June 2015, partially offset by lower gross written premiums in the property and inland marine businesses. Average renewal rates increased approximately 3% for this group in 2016, including a 5% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in 2016 and 2015.

Gross written premiums increased $113 million (5%) in 2015 compared to 2014. This increase is the result of higher gross written premiums in the transportation businesses due primarily to new accounts, higher gross written premiums in the agricultural businesses and new gross written premiums from the Singapore branch, which opened for business in June 2015, partially offset by lower gross written premiums in the property and inland marine businesses. Average renewal rates were up approximately 4% for this group in 2015, including a 5% increase in National Interstate’s renewal rates. Reinsurance premiums ceded as a percentage of gross written premiums were comparable in 2015 and 2014.

Specialty casualty Gross written premiums increased $53 million (2%) in 2016 compared to 2015. Higher gross written premiums in the excess and surplus, targeted markets and workers’ compensation businesses were partially offset by lower premiums in the general liability business and by Neon’s exit of certain lines of business and implementation of more stringent underwriting standards at Neon. Lower premiums in the general liability business were primarily the result of competitive market conditions, re-underwriting efforts within the Florida homebuilders market and the slowdown within the energy sector. Average renewal rates decreased approximately 1% for this group in 2016, including a decrease of approximately 4% in the workers’ compensation businesses. Excluding the workers’ compensation business, average renewal rates for this group increased approximately 1% during 2016. Reinsurance premiums ceded as a percentage of gross written premiums increased 2 percentage points in 2016 compared to 2015, reflecting the cession of Neon’s UK medical malpractice business and a change in the mix of business at Neon.

Gross written premiums increased $210 million (8%) in 2015 compared to 2014 reflecting $535 million in gross written premiums from Summit (acquired in April 2014) in 2015 compared to $414 million in 2014. Excluding premiums from Summit, gross written premiums increased 4% in 2015 compared to 2014. While most of the businesses in this group reported growth, the workers’ compensation, excess and surplus lines and targeted markets businesses were primary drivers of the higher premiums, partially offset by lower premiums in the general liability business, primarily the result of competitive market conditions, re-underwriting efforts within the Florida homebuilders market and the slowdown within the energy sector. Average renewal rates for this group were down 1% in 2015 due primarily to lower pricing in the workers’ compensation businesses. Excluding the workers’ compensation business, average renewal rates in this group increased 1% during 2015. Reinsurance premiums ceded as a percentage of gross written premiums declined 1 percentage point in 2015 compared to 2014 reflecting the impact of the acquisition of Summit, which cedes only about 1% of its premiums.

Specialty financial Gross written premiums increased $48 million (8%) in 2016 compared to 2015 due primarily to growth in the financial institutions and surety businesses. Average renewal rates for this group decreased approximately 1% in 2016. Reinsurance premiums ceded as a percentage of gross written premiums increased 1 percentage point in 2016 compared to 2015, reflecting higher cessions in the financial institutions business, partially offset by a decline in auto dealer business, which is heavily reinsured.

Gross written premiums increased $32 million (5%) in 2015 compared to 2014 due primarily to higher gross written premiums in the surety, financial institutions and equipment leasing businesses. Average renewal rates for this group were flat in 2015. Reinsurance premiums ceded as a percentage of gross written premiums decreased 4 percentage points in 2015 compared to 2014, reflecting a decline in auto dealer business, which is heavily reinsured.

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.

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Combined Ratio

The table below (dollars in millions) details the components of the combined ratio for AFG’s property and casualty insurance segment for 2016, 2015 and 2014:

	Year ended December 31,									Change						Year ended December 31,
	2016			2015			2014			2016 - 2015			2015 - 2014			2016				2015				2014
Property and transportation
Loss and LAE ratio	67.0	%		72.4	%		74.9	%		(5.4	%)		(2.5	%)
Underwriting expense ratio	23.0	%		24.5	%		23.8	%		(1.5	%)		0.7	%
Combined ratio	90.0	%		96.9	%		98.7	%		(6.9	%)		(1.8	%)
Underwriting profit																$	166			$	48			$	21
Specialty casualty
Loss and LAE ratio	65.8	%		62.9	%		62.7	%		2.9	%		0.2	%
Underwriting expense ratio	30.3	%		29.8	%		29.6	%		0.5	%		0.2	%
Combined ratio	96.1	%		92.7	%		92.3	%		3.4	%		0.4	%
Underwriting profit																$	78			$	146			$	136
Specialty financial
Loss and LAE ratio	32.0	%		29.7	%		33.9	%		2.3	%		(4.2	%)
Underwriting expense ratio	52.9	%		53.4	%		52.6	%		(0.5	%)		0.8	%
Combined ratio	84.9	%		83.1	%		86.5	%		1.8	%		(3.4	%)
Underwriting profit																$	84			$	87			$	64
Total Specialty
Loss and LAE ratio	61.7	%		62.2	%		63.7	%		(0.5	%)		(1.5	%)
Underwriting expense ratio	30.6	%		30.9	%		30.2	%		(0.3	%)		0.7	%
Combined ratio	92.3	%		93.1	%		93.9	%		(0.8	%)		(0.8	%)
Underwriting profit																$	337			$	295			$	237
Aggregate — including exited lines
Loss and LAE ratio	63.8	%		63.8	%		64.3	%		—	%		(0.5	%)
Underwriting expense ratio	30.7	%		30.9	%		30.2	%		(0.2	%)		0.7	%
Combined ratio	94.5	%		94.7	%		94.5	%		(0.2	%)		0.2	%
Underwriting profit																$	236			$	225			$	212

The Specialty property and casualty insurance operations generated an underwriting profit of $337 million in 2016 compared to $295 million in 2015, an increase of $42 million (14%). The higher underwriting profit in 2016 reflects higher underwriting profit in the Property and transportation sub-segment, partially offset by lower underwriting profit in the Specialty casualty and Specialty financial sub-segments. Overall catastrophe losses were $55 million (1.3 points on the combined ratio) in 2016 compared to $35 million (0.8 points on the combined ratio) in 2015.

The Specialty property and casualty insurance operations generated an underwriting profit of $295 million in 2015 compared to $237 million in 2014, an increase of $58 million (24%). The higher underwriting profit in 2015 reflects higher underwriting profit across each of AFG’s property and casualty insurance sub-segments. Overall catastrophe losses were $35 million (0.8 points on the combined ratio) in 2015 compared to $28 million (0.7 points on the combined ratio) in 2014.

Property and transportation Underwriting profit for this group was $166 million in 2016 compared to $48 million in 2015, an increase of $118 million (246%). This improvement reflects higher underwriting profit in the crop insurance business, primarily the result of favorable growing conditions and relatively stable commodity pricing and higher underwriting profits in the transportation and property and inland marine businesses. These improved results were partially offset by an increase of $10 million in catastrophe losses in 2016 compared to 2015.

Underwriting profit for this group was $48 million in 2015 compared to $21 million in 2014, an increase of $27 million (129%). Higher profits in the agricultural operations and improved year-over-year underwriting results at National Interstate, due primarily to lower adverse prior year reserve development, were partially offset by lower profitability in the property and inland marine, ocean marine and other transportation businesses.

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Specialty casualty Underwriting profit for this group was $78 million in 2016 compared to $146 million in 2015, a decrease of $68 million (47%). Higher underwriting profitability in the workers’ compensation businesses, due primarily to higher favorable prior year reserve development, and improved results in the general liability business were more than offset by adverse prior year reserve development in the excess and surplus and targeted markets businesses, current accident year trade credit losses in Neon’s political risk and trade credit business and higher catastrophe losses.

Underwriting profit for this group was $146 million in 2015 compared to $136 million in 2014, an increase of $10 million (7%). This increase is due primarily to higher profitability in the workers’ compensation and targeted markets businesses, partially offset by higher adverse prior year reserve development at Neon and in the general liability and excess and surplus businesses and lower favorable prior year reserve development in the executive liability business.

Specialty financial Underwriting profit for this group was $84 million in 2016 compared to $87 million in 2015, a decrease of $3 million (3%). Higher underwriting profit in the fidelity and crime and surety businesses, primarily the result of higher favorable prior year reserve development, was more than offset by lower underwriting profit in the financial institutions and trade credit businesses, resulting primarily from lower favorable prior year reserve development.

Underwriting profit for this group was $87 million in 2015 compared to $64 million in 2014, an increase of $23 million (36%). This increase was driven by higher favorable prior year reserve development across the group and higher current year underwriting profitability in the fidelity and financial institutions businesses, partially offset by an increase of $6 million in catastrophe losses in 2015 compared to 2014.

Other specialty Underwriting profit for this group was $9 million in 2016 compared to $14 million in 2015, a decrease of $5 million (36%). The decrease is due primarily to lower favorable prior year loss development in the business assumed by AFG’s internal reinsurance program from the operations that make up AFG’s other Specialty sub-segments.

Underwriting profit for this group was $14 million in 2015 compared to $16 million in 2014, a decrease of $2 million (13%).

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Losses and Loss Adjustment Expenses

AFG’s overall loss and LAE ratio was 63.8% in both 2016 and 2015 and 64.3% in 2014. The components of AFG’s property and casualty losses and LAE amounts and ratio are detailed below (dollars in millions):

	Year ended December 31,
	Amount												Ratio									Change in Ratio
	2016				2015				2014				2016			2015			2014			2016 - 2015			2015 - 2014
Property and transportation
Current year, excluding catastrophe losses	$	1,104			$	1,123			$	1,119			66.3	%		70.2	%		72.6	%		(3.9	%)		(2.4	%)
Prior accident years development	(21		)		15				16				(1.2	%)		0.9	%		1.0	%		(2.1	%)		(0.1	%)
Current year catastrophe losses	31				21				20				1.9	%		1.3	%		1.3	%		0.6	%		—	%
Property and transportation losses and LAE and ratio	$	1,114			$	1,159			$	1,155			67.0	%		72.4	%		74.9	%		(5.4	%)		(2.5	%)
Specialty casualty
Current year, excluding catastrophe losses	$	1,323			$	1,272			$	1,110			66.0	%		63.2	%		62.9	%		2.8	%		0.3	%
Prior accident years development	(13		)		(11		)		(7		)		(0.7	%)		(0.5	%)		(0.4	%)		(0.2	%)		(0.1	%)
Current year catastrophe losses	10				4				4				0.5	%		0.2	%		0.2	%		0.3	%		—	%
Specialty casualty losses and LAE and ratio	$	1,320			$	1,265			$	1,107			65.8	%		62.9	%		62.7	%		2.9	%		0.2	%
Specialty financial
Current year, excluding catastrophe losses	$	190			$	175			$	173			34.0	%		33.7	%		36.9	%		0.3	%		(3.2	%)
Prior accident years development	(23		)		(30		)		(17		)		(4.0	%)		(5.7	%)		(3.7	%)		1.7	%		(2.0	%)
Current year catastrophe losses	11				9				3				2.0	%		1.7	%		0.7	%		0.3	%		1.0	%
Specialty financial losses and LAE and ratio	$	178			$	154			$	159			32.0	%		29.7	%		33.9	%		2.3	%		(4.2	%)
Total Specialty
Current year, excluding catastrophe losses	$	2,675			$	2,627			$	2,460			61.8	%		62.2	%		63.5	%		(0.4	%)		(1.3	%)
Prior accident years development	(61		)		(37		)		(19		)		(1.4	%)		(0.8	%)		(0.5	%)		(0.6	%)		(0.3	%)
Current year catastrophe losses	55				35				28				1.3	%		0.8	%		0.7	%		0.5	%		0.1	%
Total Specialty losses and LAE and ratio	$	2,669			$	2,625			$	2,469			61.7	%		62.2	%		63.7	%		(0.5	%)		(1.5	%)
Aggregate — including exited lines
Current year, excluding catastrophe losses	$	2,675			$	2,627			$	2,460			61.8	%		62.2	%		63.5	%		(0.4	%)		(1.3	%)
Prior accident years development	32				33				6				0.7	%		0.8	%		0.1	%		(0.1	%)		0.7	%
Current year catastrophe losses	55				35				28				1.3	%		0.8	%		0.7	%		0.5	%		0.1	%
Aggregate losses and LAE and ratio	$	2,762			$	2,695			$	2,494			63.8	%		63.8	%		64.3	%		—	%		(0.5	%)

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 61.8% in 2016, 62.2% in 2015 and 63.5% in 2014.

Property and transportation   The 3.9 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2016 compared to 2015 reflects a decrease in the loss and LAE ratio of the crop, equine, transportation and property and inland marine businesses and the Singapore branch.

The 2.4 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2015 compared to 2014 reflects higher profitability in the agricultural businesses.

Specialty casualty   The 2.8 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses in 2016 compared to 2015 reflects an increase in current accident year trade credit losses in Neon’s political risk and trade credit business and an increase in the loss and LAE ratio of the targeted markets, general liability and excess and surplus businesses.

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The 0.3 percentage point increase in the loss and LAE ratio for the current year, excluding catastrophe losses in 2015 compared to 2014 reflects the inclusion of Summit following its acquisition in April 2014, which has a higher loss and LAE ratio than AFG’s overall Specialty casualty group.

Specialty financial   The loss and LAE ratio for the current year, excluding catastrophe losses is comparable in 2016 and 2015.

The 3.2 percentage point decrease in the loss and LAE ratio for the current year, excluding catastrophe losses in 2015 compared to 2014 reflects an improvement in the loss and LAE ratio of the financial institutions, fidelity and equipment leasing 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 $61 million in 2016 compared to $37 million in 2015 and $19 million in 2014, an increase of $24 million (65%) and $18 million (95%), respectively.

Property and transportation Net favorable reserve development of $21 million in 2016 reflects lower than expected losses in the crop operations and lower than expected claim severity in the property and inland marine and trucking businesses, partially offset by reserve strengthening at National Interstate and higher than expected claim frequency in the ocean marine business.

Net adverse reserve development of $15 million in 2015 reflects higher than expected claim severity at National Interstate and higher than anticipated claim frequency in the ocean marine business, partially offset by lower than expected claim severity in the property and inland marine business, agricultural operations and a run-off book of homebuilders business.

Net adverse reserve development of $16 million in 2014 reflects higher than expected severity in commercial auto liability losses written in the transportation businesses, partially offset by lower than expected claim frequency and severity in the property and inland marine business and lower than expected claim frequency in the agricultural operations.

Specialty casualty Net favorable reserve development of $13 million in 2016 reflects lower than anticipated claim frequency and severity in workers’ compensation business, lower than expected claim severity in directors and officers liability insurance and lower than expected claim frequency and severity in excess liability business, partially offset by adverse reserve development at Neon, higher than anticipated severity in New York contractor claims, higher than anticipated claim frequency and severity in general liability insurance and higher than expected claim frequency and severity in the targeted markets business.

Net favorable reserve development of $11 million in 2015 includes lower than anticipated claim severity in workers’ compensation business, lower than anticipated claim severity and frequency in excess liability insurance and lower than expected claim severity in directors and officers liability insurance, partially offset by adverse reserve development at Neon.

Net favorable reserve development of $7 million in 2014 reflects lower than expected claim severity in directors and officers liability insurance, lower than expected claim severity and frequency in excess liability insurance and lower than anticipated claim severity in specialty workers’ compensation business, partially offset by higher than expected severity in contractor claims and in a run-off book of casualty business and adverse reserve development at Neon.

Specialty financial Net favorable reserve development of $23 million in 2016 reflects lower than anticipated claim severity in the fidelity and crime business, lower than expected claim frequency and severity in the surety business and lower than anticipated claim frequency in the financial institutions business.

Net favorable reserve development of $30 million in 2015 reflects lower than anticipated claim frequency and severity in the surety business and products for financial institutions and lower than expected claim severity in the fidelity business and run-off collateral value insurance.

Net favorable reserve development of $17 million in 2014 reflects lower than expected claim severity in the surety and fidelity businesses and lower than expected claim frequency and severity in the trade credit business and products for financial institutions.

Other specialty In addition to the reserve development discussed above, total Specialty prior year reserve development includes net favorable reserve development of $4 million in 2016 and $11 million in both 2015 and 2014, reflecting

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amortization of the deferred gain on the retroactive insurance transaction entered into in connection with the sale of businesses in 1998 and 2001 and reserve development associated with AFG’s internal reinsurance program.

Asbestos and environmental reserve charges   As previously discussed under “Uncertainties” — “Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG has established property and casualty reserves for claims related to environmental exposures and asbestos claims. Total charges recorded to increase reserves (net of reinsurance recoverable) for A&E exposures of AFG’s property and casualty group (included in loss and loss adjustment expenses) were $36 million in 2016, $67 million in 2015 and $24 million in 2014.

Neon exited lines charge During the second quarter of 2016, AFG’s specialist Lloyd’s market insurer completed a strategic review of its business under a new leadership team and re-launched as Neon Underwriting Ltd. As part of its strategic review, Neon sold and/or exited certain historical lines of business including its UK and international medical malpractice and general liability classes. As a result of Neon’s claims review of its exited lines of business, AFG recorded a charge of approximately $65 million including $57 million to increase loss reserves primarily related to its medical malpractice and general liability lines. Consistent with the treatment of other items that are not indicative of AFG’s ongoing operations (both favorable and unfavorable), this charge is being treated as non-core because it resulted from a special strategic review of lines of business that Neon no longer writes.

Aggregate Aggregate net prior accident years reserve development for AFG’s property and casualty insurance segment includes the A&E charges and Neon exited lines charge mentioned above and adverse reserve development of $3 million in 2015 and $1 million in 2014 related to business outside of the Specialty 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. Catastrophe losses of $55 million in 2016 resulted primarily from winter storms in the first quarter, storms in Texas in the second quarter, flooding in Louisiana and multiple storms in the southern United States in the third quarter and Hurricane Matthew in the fourth quarter. Catastrophe losses of $35 million in 2015 resulted primarily from winter storms in the first quarter, multiple storms in the midwestern and central United States in the second and third quarters and flooding in the midwestern United States in the fourth quarter. Catastrophe losses of $20 million in the Property and transportation group in 2014 were primarily from winter storms in the month of January and multiple storms in the midwestern and central United States in the second quarter.

Commissions and Other Underwriting Expenses

AFG’s property and casualty commissions and other underwriting expenses (“U/W Exp”) were $1.33 billion in 2016 compared to $1.30 billion in 2015, an increase of $26 million (2%). AFG’s underwriting expense ratio was 30.7% in 2016 compared to 30.9% in 2015, a decrease of 0.2 percentage points.

AFG’s property and casualty U/W Exp were $1.30 billion in 2015 compared to $1.17 billion in 2014, an increase of $132 million (11%). AFG’s underwriting expense ratio was 30.9% in 2015 compared to 30.2% in 2014, an increase of 0.7 percentage points.

Detail of AFG’s property and casualty commissions and other underwriting expenses and underwriting expense ratios is shown below (dollars in millions):

	Year ended December 31,																					Change in % of NEP
	2016							2015							2014							2016 - 2015			2015 - 2014
	U/W Exp				% of NEP			U/W Exp				% of NEP			U/W Exp				% of NEP
Property and transportation	$	382			23.0	%		$	392			24.5	%		$	368			23.8	%		(1.5	%)		0.7	%
Specialty casualty	608				30.3	%		600				29.8	%		522				29.6	%		0.5	%		0.2	%
Specialty financial	295				52.9	%		276				53.4	%		246				52.6	%		(0.5	%)		0.8	%
Other specialty	37				36.5	%		36				36.1	%		36				35.5	%		0.4	%		0.6	%
Total Specialty	1,322				30.6	%		1,304				30.9	%		1,172				30.2	%		(0.3	%)		0.7	%
Neon exited lines charge	8							—							—
Total Aggregate	$	1,330			30.7	%		$	1,304			30.9	%		$	1,172			30.2	%		(0.2	%)		0.7	%

AFG’s overall expense ratio decreased 0.2% in 2016 as compared to 2015.

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The $132 million increase in commissions and other underwriting expenses in 2015 compared to 2014 reflects the acquisition of Summit in April 2014. The overall increase of 0.7% in AFG’s expense ratio in 2015 as compared to 2014 reflects higher profitability-based commissions paid to agents and brokers, partially offset by the impact of higher premiums on the ratio.

Property and transportation   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 1.5 percentage points in 2016 compared to 2015 reflecting an increase in ceding commissions received from reinsurers in the crop business.

Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.7 percentage points in 2015 compared to 2014 reflecting higher profitability-based commissions paid to agents and brokers, partially offset by the impact of higher premiums on the ratio.

Specialty casualty   Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.5 percentage points in 2016 compared to 2015 due primarily to the impact of lower premiums at Neon on the ratio, partially offset by the impact of a charge in the second quarter of 2015 to write off certain previously capitalized project costs.

Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.2 percentage points in 2015 compared to 2014 due primarily to a charge of $6 million in the second quarter of 2015 to write off certain previously capitalized project costs, partially offset by the impact of higher premiums on the ratio.

Specialty financial   Commissions and other underwriting expenses as a percentage of net earned premiums decreased 0.5 percentage points in 2016 compared to 2015 reflecting lower profitability-based commissions paid to agents.

Commissions and other underwriting expenses as a percentage of net earned premiums increased 0.8 percentage points in 2015 compared to 2014 reflecting higher profitability-based commissions paid to agents, partially offset by the impact of higher premiums on the ratio.

Aggregate   Aggregate commissions and other underwriting expenses for AFG’s property and casualty insurance segment includes $8 million of restructuring charges recorded as part of the $65 million non-core charge related to the exit of certain lines of business within Neon, AFG’s Lloyd’s-based insurer recorded in the second quarter of 2016. See “Net prior year reserve development” under “Property and Casualty Insurance Segment — Results of Operations” for the years ended December 31, 2016, 2015 and 2014.

Property and Casualty Net Investment Income

Net investment income in AFG’s property and casualty operations was $350 million in 2016 compared to $319 million in 2015, an increase of $31 million (10%). Net investment income in AFG’s property and casualty operations was $319 million in 2015 compared to $294 million in 2014, an increase of $25 million (9%). In recent years, yields available in the financial markets on fixed maturity securities have generally declined, placing downward pressure on AFG’s investment portfolio yield. The average invested assets and overall yield earned on investments held by AFG’s property and casualty operations are provided below (dollars in millions):

	Year ended December 31,												2016 - 2015							2015 - 2014
	2016				2015				2014				Change				% Change			Change				% Change
Net investment income	$	350			$	319			$	294			$	31			10	%		$	25			9	%
Average invested assets (at amortized cost)	$	9,550			$	8,956			$	7,849			$	594			7	%		$	1,107			14	%
Yield (net investment income as a % of average invested assets)	3.66		%		3.56		%		3.75		%		0.10		%					(0.19		%)
Tax equivalent yield (*)	4.16		%		4.13		%		4.32		%		0.03		%					(0.19		%)

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

The increase in average invested assets in the property and casualty insurance segment in 2016 as compared to 2015 is due primarily to growth in the segment. The $31 million increase in the property and casualty insurance segment’s net investment income reflects a $13 million increase in income from certain investments that are required to be carried at fair value through earnings, an $11 million increase in equity in the earnings of limited partnerships and similar investments and the increase in

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average invested assets, partially offset by slightly higher investment expenses and lower yields available in the financial markets. The property and casualty segment’s overall yield on investments (net investment income as a percentage of average invested assets) was 3.66% in 2016 compared to 3.56% in 2015, reflecting the higher income from investments carried at fair value and partnership earnings discussed above, partially offset by the impact of the lower current market yields discussed above.

The increase in average invested assets and net investment income in the property and casualty insurance segment in 2015 compared to 2014 is due primarily to the investment of cash acquired in the Summit acquisition, which occurred over the two quarters following the April 2014 acquisition, as well as growth in the property and casualty insurance segment. The property and casualty insurance segment’s overall yield on investments was 3.56% in 2015 compared to 3.75% in 2014, a decline of 0.19 percentage points reflecting the impact of lower yields available in the financial markets and lower earnings from other investments.

Property and Casualty Other Income and Expenses, Net

GAAP other income and expenses, net for AFG’s property and casualty operations was a net expense of $9 million in 2016, net income of $32 million in 2015, and a net expense of $50 million in 2014. Core other income and expenses, net for AFG’s property and casualty operations was a net expense of $41 million, $34 million and $50 million in 2016, 2015 and 2014, respectively. The table below details the items included in GAAP and core other income and expenses, net for AFG’s property and casualty operations (in millions):

	Year ended December 31,
	2016				2015				2014
Other income
Income from the sale of real estate (*)	$	1			$	3			$	2
Other	18				9				7
Total other income	19				12				9
Other expenses
Amortization of intangibles	8				8				19
NATL merger/tender offer expenses	10				—				3
Other	42				36				33
Total other expense	60				44				55
Interest expense	—				2				4
Core other income and expenses, net	(41		)		(34		)		(50		)
Pretax non-core gain on sale of hotel and apartment properties	32				66				—
GAAP other income and expenses, net	$	(9	)		$	32			$	(50	)

(*)	Excludes pretax non-core gains of $32 million on the sale of an apartment property in 2016 and $51 million on the sale of a hotel and $15 million on the sale of an apartment property in 2015.

Other income for AFG’s property and casualty operations includes a $4 million death benefit on a life insurance policy received in the second quarter of 2016.

The lower amortization of intangibles in 2015 compared to 2014 reflects the impact of intangible assets related to three acquisitions that became fully amortized in 2014.

AFG and its consolidated subsidiaries incurred $10 million in transaction expenses in 2016 related to GAI’s acquisition of all of the NATL common stock that it did not already own. These expenses consisted primarily of financial advisory and legal services. See Note B — “Acquisitions and Sale of Businesses” to the financial statements.

AFG and its consolidated subsidiaries incurred $3 million in transaction expenses related to the February 2014 tender offer by GAI to acquire all of the NATL common stock that it did not already own. These expenses consisted primarily of financial advisory and legal services. The tender offer was terminated in March 2014.

Interest expense for AFG’s property and casualty operations includes interest charges on long-term debt within the property and casualty operations.

Annuity Segment — Results of Operations

AFG’s annuity operations contributed $368 million in pretax earnings in 2016 compared to $331 million in 2015, an increase of $37 million (11%). The increase in AFG’s annuity segment results in 2016 compared to 2015 reflects higher investment income

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from certain investments that are required to be carried at fair value through earnings and a 12% increase in average annuity investments (at amortized cost), partially offset by lower investment yields due to the run-off of higher yielding investments and higher general and administrative expenses. Included in these results is the change in fair value of derivatives related to FIAs, which had a negative impact of $27 million in 2016 compared to $23 million in 2015. For 2016, the negative impact of a significant drop in interest rates on fair value accounting for FIAs was partially offset by the positive impact of an increase in the stock market. For 2015, fair value accounting for FIAs was negatively impacted by a significant decrease in the stock market and a slightly lower than expected increase in interest rates. AFG’s periodic detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations resulted in a net annuity expense reduction of $1 million in 2016 compared to $10 million in 2015.

AFG’s annuity operations contributed $331 million in pretax earnings in 2015 compared to $328 million in 2014, an increase of $3 million (1%). While AFG’s average annuity investments (at amortized cost) were 12% higher in 2015 as compared to 2014, the benefit of this growth and the impact that fluctuations in interest rates had on the fair value accounting for FIAs was offset by the negative impact that the stock market decrease had on certain annuity reserves in 2015 compared to a stock market increase in 2014, the run-off of higher yielding investments and higher general and administrative expenses in 2015 compared to 2014. Operating earnings also include a net unlocking expense reduction of $10 million in 2015 compared to $1 million in 2014.

The following table details AFG’s earnings before income taxes from its annuity operations for 2016, 2015 and 2014 (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Revenues:
Net investment income	$	1,356			$	1,224			$	1,136			11	%		8	%
Other income:
Guaranteed withdrawal benefit fees	53				43				34				23	%		26	%
Policy charges and other miscellaneous income	50				55				63				(9	%)		(13	%)
Total revenues	1,459				1,322				1,233				10	%		7	%
Costs and Expenses:
Annuity benefits (*)	800				732				648				9	%		13	%
Acquisition expenses	181				163				175				11	%		(7	%)
Other expenses	110				96				82				15	%		17	%
Total costs and expenses	1,091				991				905				10	%		10	%
Earnings before income taxes	$	368			$	331			$	328			11	%		1	%

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

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Earnings before income taxes — before the impact of derivatives related to FIAs	$	395			$	354			$	362			12	%		(2	%)
Impact of derivatives related to FIAs	(27		)		(23		)		(34		)		17	%		(32	%)
Earnings before income taxes	$	368			$	331			$	328			11	%		1	%

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

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Interest credited — fixed	$	574			$	532			$	497			8	%		7	%
Interest credited — fixed component of variable annuities	5				6				6				(17	%)		—	%
Other annuity benefits:
Change in expected death and annuitization reserve	18				19				18				(5	%)		6	%
Amortization of sales inducements	24				26				26				(8	%)		—	%
Change in guaranteed withdrawal benefit reserve	69				63				41				10	%		54	%
Change in other benefit reserves	34				22				12				55	%		83	%
Total other annuity benefits	145				130				97				12	%		34	%
Total before impact of derivatives related to FIAs and unlocking	724				668				600				8	%		11	%
Derivatives related to fixed-indexed annuities:
Embedded derivative mark-to-market	194				(11		)		240				(1,864	%)		(105	%)
Equity option mark-to-market	(141		)		56				(181		)		(352	%)		(131	%)
Impact of derivatives related to FIAs	53				45				59				18	%		(24	%)
Unlocking	23				19				(11		)		21	%		(273	%)
Total annuity benefits	$	800			$	732			$	648			9	%		13	%

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity benefit expense.

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 annuities):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Average fixed annuity investments (at amortized cost)	$	28,223			$	25,174			$	22,391			12	%		12	%
Average fixed annuity benefits accumulated	28,146				24,898				22,119				13	%		13	%
As % of fixed annuity benefits accumulated (except as noted):
Net investment income (as % of fixed annuity investments)	4.77		%		4.83		%		5.03		%
Interest credited — fixed	(2.04		%)		(2.14		%)		(2.25		%)
Net interest spread	2.73		%		2.69		%		2.78		%
Policy charges and other miscellaneous income	0.15		%		0.18		%		0.18		%
Other annuity benefit expenses, net of guaranteed withdrawal benefit fees	(0.33		%)		(0.35		%)		(0.28		%)
Acquisition expenses	(0.70		%)		(0.74		%)		(0.67		%)
Other expenses	(0.38		%)		(0.36		%)		(0.34		%)
Change in fair value of derivatives related to fixed-indexed annuities	(0.19		%)		(0.18		%)		(0.27		%)
Unlocking	0.01		%		0.02		%		0.01		%
Net spread earned on fixed annuities	1.29		%		1.26		%		1.41		%

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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:

	Year ended December 31,
	2016			2015			2014
Net spread earned on fixed annuities — before impact of derivatives related to FIAs	1.39	%		1.35	%		1.56	%
Impact of derivatives related to fixed-indexed annuities:
Change in fair value of derivatives	(0.19	%)		(0.18	%)		(0.27	%)
Related impact on amortization of DPAC (*)	0.09	%		0.08	%		0.11	%
Related impact on amortization of deferred sales inducements (*)	—	%		0.01	%		0.01	%
Net spread earned on fixed annuities	1.29	%		1.26	%		1.41	%

(*)	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 in 2016 was $1.36 billion compared to $1.22 billion in 2015, an increase of $132 million (11%). This increase reflects primarily the growth in AFG’s annuity business and higher income from certain investments that are required to be carried at fair value through earnings, partially offset by the impact of lower in-force investment yields. The overall yield earned on investments in AFG’s annuity operations, calculated as net investment income divided by average investment balances (at amortized cost), decreased by 0.06 percentage points to 4.77% from 4.83% in 2016 compared to 2015. This decline in net investment yield reflects (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, partially offset by higher investment income from certain investments that are required to be carried at fair value through earnings. During 2016, $4.0 billion in annuity segment investments with an average yield of 5.51% were redeemed or sold while the investments purchased during 2016 (with new premium dollars and the redemption/sale proceeds) had an average yield at purchase of 4.21%.

Net investment income in 2015 was $1.22 billion compared to $1.14 billion in 2014, an increase of $88 million (8%). This increase reflects primarily the growth in AFG’s annuity business, partially offset by the run-off of higher yielding investments. The overall yield earned on investments in AFG’s annuity operations declined by 0.20 percentage points to 4.83% from 5.03% in 2015 compared to 2014. This decline in net investment yield reflects (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.

Annuity Interest Credited — Fixed

Interest credited — fixed in 2016 was $574 million compared to $532 million in 2015, an increase of $42 million (8%). The impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn. The average interest rate credited to policyholders, calculated as interest credited divided by average fixed annuity benefits accumulated, decreased 0.10 percentage points to 2.04% from 2.14% in 2016 compared to 2015.

Interest credited — fixed in 2015 was $532 million compared to $497 million in 2014, an increase of $35 million (7%). The impact of growth in the annuity business was partially offset by lower interest crediting rates on new premiums as compared to the crediting rates on policyholder funds surrendered or withdrawn. The average interest rate credited to policyholders decreased 0.11 percentage points to 2.14% from 2.25% in 2015 compared to 2014.

Annuity Net Interest Spread

AFG’s net interest spread increased 0.04 percentage points to 2.73% from 2.69% in 2016 compared to 2015 as the impact of lower in-force investment yields was more than offset by lower crediting rates and higher income from certain investments that are required to be carried at fair value through earnings. In addition, 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 of these items, AFG expects its net interest spread to narrow in the future.

AFG’s net interest spread decreased 0.09 percentage points to 2.69% from 2.78% in 2015 compared to 2014 due primarily to the run-off of higher yielding investments, partially offset by lower crediting rates.

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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 $50 million in 2016 compared to $55 million in 2015, a decrease of $5 million (9%). Other miscellaneous income includes $5 million in income from the sale of real estate in 2016 compared to $6 million in 2015. Excluding the impact of unlocking charges of $1 million in 2016 and $2 million in 2015 related to unearned revenue, annuity policy charges and other miscellaneous income were $51 million in 2016 compared to $57 million in 2015, a decrease of $6 million (11%). As a percentage of average fixed annuity benefits accumulated, annuity policy charges and other miscellaneous income decreased 0.03 percentage points to 0.15% from 0.18% in 2016 compared to 2015.

Annuity policy charges and other miscellaneous income were $55 million in 2015 compared to $63 million in 2014, a decrease of $8 million (13%). Excluding the impact of unlocking charges of $2 million in 2015 and unlocking income of $10 million in 2014 related to unearned revenue, annuity policy charges and other miscellaneous income were $57 million in 2015 and $53 million in 2014, an increase of $4 million (8%). This increase reflects the impact of $6 million in income from the sale of real estate recorded in 2015.

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity policy charges and other miscellaneous income.

Other Annuity Benefits, Net of Guaranteed Withdrawal Benefit Fees

Other annuity benefits, net of guaranteed withdrawal benefit fees (excluding the impact of unlocking) were $92 million in 2016, $87 million in 2015 and $63 million in 2014, representing an increase of $5 million (6%) in 2016 compared to 2015 and an increase of $24 million (38%) in 2015 compared to 2014. As a percentage of average fixed annuity benefits accumulated, these net expenses decreased 0.02 percentage points to 0.33% from 0.35% in 2016 compared to 2015 and increased 0.07 percentage points to 0.35% from 0.28% in 2015 compared to 2014. 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):

	Year ended December 31,
	2016				2015				2014
Change in expected death and annuitization reserve	$	18			$	19			$	18
Amortization of sales inducements	24				26				26
Change in guaranteed withdrawal benefit reserve	69				63				41
Change in other benefit reserves	34				22				12
Other annuity benefits	145				130				97
Offset guaranteed withdrawal benefit fees	(53		)		(43		)		(34		)
Other annuity benefits, net	$	92			$	87			$	63

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 is 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.

The $5 million increase in other annuity benefits, net of guaranteed withdrawal benefit fees in 2016 compared to 2015 primarily reflects growth in the business.

The $24 million increase in other annuity benefits, net of guaranteed withdrawal benefit fees in 2015 compared to 2014 reflects higher expenses related to products with guaranteed withdrawal benefit features.

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity benefits expense.

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Annuity Acquisition Expenses

Excluding the impact of unlocking charges (expense reductions) discussed under “Annuity Unlocking” below, AFG’s amortization of DPAC and commission expenses as a percentage of average fixed annuity benefits accumulated was 0.70% in 2016 compared to 0.74% in 2015 and 0.67% in 2014 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 negative impact of significantly lower than anticipated interest rates during 2016, the significant stock market decrease in 2015 and slightly lower than anticipated interest rates during 2014 on the fair value of derivatives related to fixed-indexed annuities (discussed below) resulted in a partially offsetting deceleration in 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:

	Year ended December 31,
	2016			2015			2014
Before the impact of changes in the fair value of derivatives related to fixed-indexed annuities on the amortization of DPAC	0.79	%		0.82	%		0.78	%
Impact of changes in fair value of derivatives related to FIAs on the amortization of DPAC (*)	(0.09	%)		(0.08	%)		(0.11	%)
Annuity acquisition expenses as a % of fixed annuity benefits accumulated	0.70	%		0.74	%		0.67	%

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

See “Annuity Unlocking” below for a discussion of the impact that the periodic review of actuarial assumptions had on annuity and supplemental insurance acquisition expenses. 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 $110 million in 2016, $96 million in 2015 and $82 million in 2014, representing an increase of $14 million (15%) in 2016 compared to 2015 and an increase of $14 million (17%) in 2015 compared to 2014. 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 increased 0.02 percentage points to 0.38% from 0.36% in 2016 compared to 2015 and 0.02 percentage points to 0.36% from 0.34% in 2015 compared to 2014. The increase in annuity other expenses in 2016 compared to 2015 primarily reflects growth in the business as well as an increase in the number of sales personnel focused on new initiatives and increased market share within existing financial institutions and retail marketing associations. The increase in annuity other expenses in 2015 compared to 2014 primarily reflects higher expenses related to professional services and employee compensation plans in 2015. Annuity other expenses for 2014 includes the favorable impact of settling certain accrued expenses at a lower cost than previously estimated.

Change in Fair Value of Derivatives Related to Fixed-Indexed Annuities

AFG’s fixed-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets 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 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 of AFG’s annuity benefits accumulated, see Note D — “Fair Value Measurements” to the financial statements. Excluding the impact of unlocking charges, the net change in fair value of derivatives related to fixed-indexed annuities increased annuity benefits by $53 million in 2016, $45 million in 2015 and $59 million in 2014. The increase in 2016 is due primarily to significantly lower than expected interest rates, partially offset by the impact of an increase in the stock market. The increase in 2015 reflects the negative impact of the decline in the stock market and lower than anticipated interest rates on these derivatives. The increase in 2014 is due primarily to the impact of lower than anticipated interest rates on these derivatives. As a percentage of average fixed annuity benefits accumulated, this net expense increased 0.01 percentage points to 0.19% from 0.18% in 2016 compared to 2015, and decreased 0.09 percentage points to 0.18% from 0.27% in 2015 compared to 2014.

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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):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Earnings before income taxes — before change in fair value of derivatives related to fixed-indexed annuities	$	395			$	354			$	362			12	%		(2	%)
Change in fair value of derivatives related to fixed-indexed annuities	(53		)		(45		)		(59		)		18	%		(24	%)
Related impact on amortization of DPAC (*)	26				22				25				18	%		(12	%)
Earnings before income taxes	$	368			$	331			$	328			11	%		1	%

(*)	An estimate of the related acceleration/deceleration of 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 decreased the annuity segment’s earnings before income taxes by $27 million, $23 million and $34 million in 2016, 2015 and 2014, respectively.

Annuity Net Spread Earned on Fixed Annuities

AFG’s net spread earned on fixed annuities increased 0.03 percentage points to 1.29% from 1.26% in 2016 compared to 2015 due primarily to the 0.04 percentage point increase in AFG’s net interest spread.

AFG’s net spread earned on fixed annuities decreased 0.15 percentage points to 1.26% from 1.41% in 2015 compared to 2014 due primarily to the 0.09 percentage points decrease in AFG’s net interest spread, the impact of the decline in the stock market on guaranteed withdrawal benefit reserves, and higher general and administrative expenses, partially offset by income from the sale of real estate recorded primarily in the first quarter of 2015.

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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 2016, 2015 and 2014 (in millions):

	Year ended December 31,
	2016				2015				2014
Beginning fixed annuity reserves	$	26,371			$	23,462			$	20,679
Fixed annuity premiums (receipts)	4,398				4,098				3,649
Federal Home Loan Bank advances	150				345				—
Surrenders, benefits and other withdrawals	(2,189		)		(1,932		)		(1,673		)
Sale of subsidiaries	—				(261		)		—
Interest and other annuity benefit expenses:
Interest credited	574				532				497
Embedded derivative mark-to-market	194				(11		)		240
Change in other benefit reserves	122				115				81
Unlocking	27				23				(11		)
Ending fixed annuity reserves	$	29,647			$	26,371			$	23,462
Reconciliation to annuity benefits accumulated per balance sheet:
Ending fixed annuity reserves (from above)	$	29,647			$	26,371			$	23,462
Impact of unrealized investment gains	76				64				111
Fixed component of variable annuities	184				187				191
Annuity benefits accumulated per balance sheet	$	29,907			$	26,622			$	23,764

Statutory Annuity Premiums

AFG’s annuity operations generated statutory premiums of $4.44 billion in 2016, $4.14 billion in 2015 and $3.70 billion in 2014, an increase of $295 million (7%) in 2016 compared to 2015 and an increase of $444 million (12%) in 2015 compared to 2014. The following table summarizes AFG’s annuity sales (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Financial institutions single premium annuities — indexed	$	1,950			$	1,741			$	1,489			12	%		17	%
Financial institutions single premium annuities — fixed	468				229				332				104	%		(31	%)
Retail single premium annuities — indexed	1,714				1,864				1,533				(8	%)		22	%
Retail single premium annuities — fixed	82				70				101				17	%		(31	%)
Education market — fixed and indexed annuities	184				194				194				(5	%)		—	%
Total fixed annuity premiums	4,398				4,098				3,649				7	%		12	%
Variable annuities	37				42				47				(12	%)		(11	%)
Total annuity premiums	$	4,435			$	4,140			$	3,696			7	%		12	%

Management believes the 7% increase in annuity premiums in 2016 compared to 2015 is consistent with overall growth in the annuity industry, as sales of traditional fixed and fixed-indexed annuities have increased while sales of variable annuities have decreased. In addition, the increase reflects new products, additional staffing, and increased market share within existing financial institutions. This growth slowed in the second half of 2016 as a result of AFG’s reduction in crediting rates on its annuities in 2016 due to the decline in market interest rates; these crediting rate reductions were made to maintain appropriate returns on new business.

Management attributes the 12% increase in annuity premiums in 2015 compared to 2014 to the significant rise of interest rates during the second quarter of 2015 from first quarter 2015 lows, allowing AFG to raise the crediting rates on its annuities and become more competitive in its markets.

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Annuity Unlocking

In 2016, 2015 and 2014, AFG conducted its detailed review (“unlocking”) of the major actuarial assumptions underlying its annuity operations. As a result of these reviews, AFG recorded net expense reductions related to its annuity business of $1 million in 2016, $10 million in 2015 and $1 million in 2014, which impacted AFG’s financial statements as follows (in millions):

		Year ended December 31,
		2016				2015				2014
Policy charges and other miscellaneous income:
Unearned revenue		$	(1	)		$	(2	)		$	10
Total revenues		(1		)		(2		)		10
Annuity benefits:
Fixed-indexed annuities embedded derivative		17				28				(58		)
Sales inducements		(4		)		(4		)		—
Other reserves		10				(5		)		47
Total annuity benefits		23				19				(11		)
Annuity and supplemental insurance acquisition expenses:
Deferred policy acquisition costs		(25		)		(31		)		20
Total costs and expenses		(2		)		(12		)		9
Net expense reduction		$	1			$	10			$	1

See “Results of Operations — Quarters ended December 31, 2016 and 2015 — Annuity Segment — Results of Operations — Annuity Unlocking” for a discussion of the overall net expense reduction from the periodic review of actuarial assumptions in 2016 and 2015.

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 2016, 2015 and 2014 (in millions):

	Year ended December 31,
	2016				2015				2014
Earnings on fixed annuity benefits accumulated	$	363			$	313			$	312
Earnings on investments in excess of fixed annuity benefits accumulated (*)	4				13				14
Variable annuity earnings	1				5				2
Earnings before income taxes	$	368			$	331			$	328

(*)	Net investment income (as a % of investments) of 4.77%, 4.83% and 5.03% in 2016, 2015 and 2014, respectively, multiplied by the difference between average fixed annuity investments (at amortized cost) and average fixed annuity benefits accumulated in each period.

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Run-off Long-Term Care and Life Segment — Results of Operations AFG’s run-off long-term care and life segment incurred GAAP pretax earnings of $4 million in 2016 compared to losses of $152 million and $10 million in 2015 and 2014, respectively. Results for 2015 include a $166 million pretax non-core realized loss on the sale of the subsidiaries containing substantially all of AFG’s run-off long-term care insurance business. See Note B — “Acquisitions and Sale of Businesses” to the financial statements. The following table details AFG’s GAAP and core earnings (loss) before income taxes from its run-off long-term care and life operations in 2016, 2015 and 2014 (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Revenues:
Net earned premiums:
Long-term care	$	3			$	73			$	74			(96	%)		(1	%)
Life operations	21				31				34				(32	%)		(9	%)
Net investment income	21				80				82				(74	%)		(2	%)
Other income	4				4				5				—	%		(20	%)
Total revenues	49				188				195				(74	%)		(4	%)
Costs and Expenses:
Life, accident and health benefits:
Long-term care	5				91				119				(95	%)		(24	%)
Life operations	28				40				45				(30	%)		(11	%)
Acquisition expenses	5				16				18				(69	%)		(11	%)
Other expenses	9				27				23				(67	%)		17	%
Total costs and expenses	47				174				205				(73	%)		(15	%)
Core earnings (loss) before income taxes	2				14				(10		)		(86	%)		(240	%)
Pretax non-core realized gain (loss) on subsidiaries	2				(166		)		—				(101	%)		—	%
GAAP earnings (loss) before income taxes	$	4			$	(152	)		$	(10	)		(103	%)		1,420	%

The decrease in long-term care net earned premiums and benefit expense in 2016 compared to 2015 is due to the sale of subsidiaries containing substantially all of AFG’s run-off long-term care insurance business in December of 2015.

Substantially all of the core earnings before income taxes in AFG’s run-off long-term care and life segment in 2015 represent earnings from AFG’s long-term care business and reflect the impact of improved claims experience, rate increases, and lower persistency. The 2014 GAAP and core pretax loss includes a $5 million loss on the commutation of a reinsurance agreement.

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Holding Company, Other and Unallocated — Results of Operations   AFG’s net GAAP pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $181 million in 2016 compared to compared to $176 million in 2015, an increase of $5 million (3%). AFG’s net core pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $176 million in 2016 compared to $160 million in 2015, an increase of $16 million (10%).

AFG’s net GAAP pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $176 million in 2015 compared to $149 million in 2014, an increase of $27 million (18%). AFG’s net core pretax loss outside of its insurance operations (excluding realized gains and losses) totaled $160 million in 2015 compared to $143 million in 2014, an increase of $17 million (12%).

The following table details AFG’s GAAP and core loss before income taxes from operations outside of its insurance operations in 2016, 2015 and 2014 (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
Revenues:
Net investment income	$	6			$	4			$	5			50	%		(20	%)
Other income — P&C fees	60				54				—				11	%		—	%
Other income	23				24				36				(4	%)		(33	%)
Total revenues	89				82				41				9	%		100	%
Costs and Expenses:
Property and casualty insurance — commissions and other underwriting expenses	19				16				—				19	%		—	%
Interest charges on borrowed money	77				73				70				5	%		4	%
Other expense — expenses associated with P&C fees	41				38				—				8	%		—	%
Other expenses (*)	128				115				114				11	%		1	%
Total costs and expenses	265				242				184				10	%		32	%
Core loss before income taxes, excluding realized gains and losses	(176		)		(160		)		(143		)		10	%		12	%
Pretax non-core special A&E charges	(5		)		(12		)		(6		)		(58	%)		100	%
Pretax non-core loss on retirement of debt	—				(4		)		—				(100	%)		—	%
GAAP loss before income taxes, excluding realized gains and losses	$	(181	)		$	(176	)		$	(149	)		3	%		18	%

(*)	Excludes pretax non-core special A&E charges of $5 million, $12 million and $6 million in 2016, 2015 and 2014, respectively, and a pretax non-core loss on retirement of debt of $4 million in 2015.

Holding Company and Other — Net Investment Income

AFG recorded net investment income on investments held outside of its insurance operations of $6 million, $4 million and $5 million in 2016, 2015 and 2014, respectively.

Holding Company and Other — P&C Fees and Related Expenses

Summit, the workers’ compensation insurance business that AFG acquired in April 2014, 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 businesses collect fees from customers for ancillary services such as workplace safety programs and premium financing. In 2016, AFG collected $60 million in fees for these services compared to $54 million in 2015. Management views this fee income, net of the $41 million in 2016 and $38 million in 2015, 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. Beginning with the first quarter of 2015, these fees are shown in other income and the related expenses are shown in other expenses in AFG’s Statement of Earnings.

Holding Company and Other — Other Income

Other income in the table above includes $17 million, $15 million and $25 million in 2016, 2015 and 2014, respectively in management fees paid to AFG by the AFG-managed CLOs (AFG’s consolidated managed investment entities). The $25 million of management fees in 2014 includes $13 million of incentive management fees earned in connection with the liquidation of three CLOs. The management fees are eliminated in consolidation — see the other income line in the Consolidated MIEs column under “Results of Operations — Segmented Statement of Earnings.” Excluding amounts eliminated in consolidation,

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AFG recorded other income outside of its insurance operations of $6 million in 2016, $9 million in 2015 and $11 million in 2014.

Holding Company and Other — Interest Charges on Borrowed Money

AFG’s holding companies and other operations outside of its insurance operations recorded interest expense of $77 million in 2016 compared to $73 million in 2015, an increase of $4 million (5%). This increase reflects higher average indebtedness during 2016 compared to 2015, partially offset by a lower weighted average interest rate on outstanding debt and the favorable impact of the interest rate swap on the 9-7/8% Senior Notes due June 2019 that was entered into in June 2015.

The increase in average indebtedness for 2016 as compared to 2015 reflects the following financing transactions completed by AFG between January 1, 2015 and December 31, 2016:

•	Issued $300 million of 3.50% Senior Notes in August 2016,

•	Issued $150 million of 6% Subordinated Debentures in November 2015,

•	Redeemed $132 million of 7% Senior Notes in September 2015.

AFG’s holding companies and other operations outside of its insurance operations recorded interest expense of $73 million in 2015 compared to $70 million in 2014, an increase of $3 million (4%). This increase reflects higher average indebtedness during 2015 compared to 2014, partially offset by a lower weighted average interest rate on outstanding debt and the favorable impact of the interest rate swap entered into in June 2015.

The increase in average indebtedness for 2015 as compared to 2014 reflects the following financing transactions completed by AFG between January 1, 2014 and December 31, 2015:

•	Issued $150 million of 6% Subordinated Debentures in November 2015,

•	Redeemed $132 million of 7% Senior Notes in September 2015,

•	Issued $150 million of 6-1/4% Subordinated Debentures in September 2014.

Holding Company and Other — A&E Charges

As a result of the internal reviews and comprehensive external study of A&E exposures discussed under “Uncertainties — Asbestos and Environmental-related (“A&E”) Insurance Reserves,” AFG’s holding companies and other operations outside of its insurance operations recorded non-core special charges of $5 million in 2016, $12 million in 2015 and $6 million in 2014 to increase liabilities related to the A&E exposures of AFG’s former railroad and manufacturing operations. The charge in 2016 is due to relatively small movements across several sites that primarily reflect changes in the scope and costs of investigation. The charges in 2015 and 2014 related to slightly higher estimated costs at sites where remediation is underway, coupled with higher estimated cleanup costs at a limited number of sites. Total charges recorded to increase liabilities for A&E exposures of AFG’s former railroad and manufacturing operations (included in other expenses) were $20 million in 2016, $22 million in 2015 and $13 million in 2014.

Holding Company and Other — Loss on Retirement of Debt

AFG wrote off unamortized debt issuance costs of $4 million related to the redemption of its $132 million outstanding 7% Senior Notes due 2050 at par value on September 30, 2015.

Holding Company and Other — Other Expenses

Excluding the non-core special A&E charges and the non-core loss on retirement of debt discussed above, AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $128 million in 2016 compared to $115 million in 2015, an increase of $13 million (11%). This increase reflects higher holding company expenses related to employee benefit plans that are tied to stock market performance, a $5 million donation to the University of Cincinnati College of Business in 2016 and higher expenses related to AFG’s former railroad and manufacturing operations. AFG’s holding companies and other operations outside of its insurance operations recorded other expenses of $115 million in 2015 compared to $114 million in 2014, an increase of $1 million (1%).

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Consolidated Realized Gains (Losses) on Securities   AFG’s consolidated realized gains (losses) on securities, which are not allocated to segments, were gains of $19 million in 2016 compared to losses of $19 million in 2015, an increase of $38 million (200%). AFG’s consolidated realized losses on securities were $19 million in 2015 compared to gains of $52 million in 2014, a decrease of $71 million (137%). Realized gains (losses) on securities consisted of the following (in millions):

	Year ended December 31,
	2016				2015				2014
Realized gains (losses) before impairments:
Disposals	$	151			$	122			$	89
Change in the fair value of derivatives	(9		)		(11		)		1
Adjustments to annuity deferred policy acquisition costs and related items	(7		)		(5		)		(2		)
	135				106				88
Impairment charges:
Securities	(131		)		(140		)		(41		)
Adjustments to annuity deferred policy acquisition costs and related items	15				15				5
	(116		)		(125		)		(36		)
Realized gains (losses) on securities	$	19			$	(19	)		$	52

AFG’s impairment charges on securities in 2016 consist of $93 million on equity securities and $38 million on fixed maturities. Approximately $70 million in impairment charges in 2016 are related to financial institutions, $19 million are on energy related investments and $7 million relates to a pharmaceutical company.

AFG’s impairment charges on securities in 2015 consist of $94 million on equity securities, $43 million on fixed maturities and $3 million on other investments. Approximately $41 million of the charges are on real estate and mortgage related investments, $38 million are on energy related investments and $12 million are on investments in asset managers.

Consolidated Realized Gains (Losses) on Subsidiaries   In 2015, AFG recorded a pretax realized loss of $166 million on the sale of subsidiaries containing substantially all of AFG’s run-off long-term care insurance business. In the second quarter of 2016, AFG received additional proceeds based on the final closing balance sheet and adjusted certain accrued expense estimates associated with the sale, resulting in a $2 million pretax favorable adjustment to the loss recorded in 2015. See Note B — “Acquisitions and Sale of Businesses” to the financial statements. In addition, AFG recorded a $5 million pretax realized gain in 2015 representing an adjustment to the previously recognized loss on a small property and casualty subsidiary sold several years ago.

Consolidated Income Taxes   AFG’s consolidated provision for income taxes was $119 million in 2016 compared to $195 million in 2015, a decrease of $76 million (39%). AFG’s consolidated provision for income taxes was $195 million in 2015 compared to $220 million in 2014, a decrease of $25 million (11%). 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 (loss) attributable to noncontrolling interests was earnings of $19 million in 2016 compared to $18 million in 2015, an increase of $1 million (6%). AFG’s consolidated net earnings (loss) attributable to noncontrolling interests was earnings of $18 million in 2015 compared to a net loss of $46 million in 2014, an improvement of $64 million (139%). The following table details net earnings (loss) in consolidated subsidiaries attributable to holders other than AFG (dollars in millions):

	Year ended December 31,												% Change
	2016				2015				2014				2016 - 2015			2015 - 2014
National Interstate	$	15			$	10			$	5			50	%		100	%
Managed Investment Entities	—				—				(51		)		—	%		(100	%)
Other	4				8				—				(50	%)		—	%
Earnings (loss) attributable to noncontrolling interests	$	19			$	18			$	(46	)		6	%		(139	%)

Other noncontrolling interests includes $4 million related to the gain on the sale of an apartment property in the second quarter of 2016 and $6 million related to the gain on the sale of a hotel in the second quarter of 2015. Both properties were owned by an 80%-owned subsidiary of GAI.

The losses of Managed Investment Entities in 2014 represent CLO losses that ultimately inure to holders of the CLO debt. See Note A — “Accounting Policies — Managed Investment Entities” to the financial statements for a discussion of accounting

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guidance adopted in 2015 that affects the measurement of the fair value of CLO liabilities. Under the new guidance, there are no longer any CLO earnings or losses to be attributed to noncontrolling interests in AFG’s Statement of Earnings.

RECENTLY ADOPTED ACCOUNTING STANDARDS

See Note A — “Accounting Policies — Managed Investment Entities” to the financial statements for a discussion of accounting guidance adopted on January 1, 2016, which impacts the consolidation of collateralized financing entities such as CLOs, as well as limited partnerships and similar investments.

See Note A — “Accounting Policies — Debt Issuance Costs” to the financial statements for a discussion of accounting guidance adopted on January 1, 2016, which impacted the presentation of debt issuance costs.

See Note A — “Accounting Policies — Stock-Based Compensation” to the financial statements for a discussion of accounting guidance adopted in the fourth quarter of 2016 (effective January 1, 2016), which impacted the accounting for share-based payment transactions.

See Note B — “Acquisitions and Sale of Businesses” to the financial statements for a discussion of accounting guidance adopted on January 1, 2015 that impacts the determination of when a component of an entity qualifies for presentation as a discontinued operation.

See Note O — “Insurance — Property and Casualty Insurance Reserves” to the financial statements for a discussion of accounting guidance adopted for annual reporting beginning in 2016, which requires additional disclosures about the liability for unpaid losses and loss adjustment expenses (including accident year information).

ACCOUNTING STANDARDS TO BE ADOPTED

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities 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 income, 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. AFG will be required to adopt the updated guidance effective January 1, 2018 (early adoption is not permitted). Although recording changes in the fair value of investments in equity securities in net income will result in more volatility in AFG’s Statement of Earnings, it is not expected to have a material effect on the carrying value of AFG’s investments or on overall shareholders’ equity as AFG’s investments in equity securities are currently carried at fair value through accumulated other comprehensive income.

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 guidance effective January 1, 2019 (when it is required). The guidance will require the earliest comparative period presented to include the measurement and recognition of existing leases with an adjustment to shareholders’ equity as if the updated guidance had always been applied. 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

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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.

ITEM 7A

Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the potential economic loss arising from adverse changes in the fair value of financial instruments. AFG’s exposures to market risk relate primarily to its investment portfolio and annuity contracts, which are exposed to interest rate risk and, to a lesser extent, equity price risk. To a much lesser extent, AFG’s long-term debt is also exposed to interest rate risk.

Fixed Maturity Portfolio   In general, the fair value of AFG’s fixed maturity portfolio is directly impacted by changes in market interest rates. AFG’s fixed maturity portfolio is comprised of primarily fixed-rate investments with intermediate-term maturities. This practice is designed to allow flexibility in reacting to fluctuations of interest rates. The portfolios of AFG’s insurance operations are managed with an attempt to achieve an adequate risk-adjusted return while maintaining sufficient liquidity to meet policyholder obligations. AFG’s annuity and run-off long-term care and life operations attempt to align the duration of their invested assets to the projected cash flows of policyholder liabilities.

Consistent with the discussion in Item 7 — Management’s Discussion and Analysis — “Investments,” the following table demonstrates the sensitivity of the fair value of AFG’s fixed maturity portfolio 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 December 31 (based on the duration of the portfolio, dollars in millions). Effects of increases or decreases from the 100 basis points illustrated would be approximately proportional. 

		2016				2015
Fair value of fixed maturity portfolio		$	34,903			$	32,538
Percentage impact on fair value of 100 bps increase in interest rates		(5.0		%)		(5.0		%)
Pretax impact on fair value of fixed maturity portfolio		$	(1,745	)		$	(1,627	)
Offsetting adjustments to deferred policy acquisition costs and other balance sheet amounts		700				700
Estimated pretax impact on accumulated other comprehensive income		(1,045		)		(927		)
Deferred income tax		366				325
Noncontrolling interests		—				13
Estimated after-tax impact on accumulated other comprehensive income		$	(679	)		$	(589	)

Municipal bonds represented approximately 19% of AFG’s fixed maturity portfolio at December 31, 2016. AFG’s municipal bond portfolio is high quality, with 98% of the securities rated investment-grade at that date. The portfolio is well diversified across the states of issuance and individual issuers. At December 31, 2016, approximately 76% of the municipal bond portfolio was held in revenue bonds, with the remaining 24% held in general obligation bonds. General obligation securities of California, Illinois, Michigan, New Jersey, New York and Puerto Rico collectively represented approximately 1% of this portfolio.

Certain European countries, including the so-called “peripheral countries” (Greece, Portugal, Ireland, Italy and Spain) have been experiencing varying degrees of financial stress over the past few years and there remains uncertainty as to future developments and the impact on global financial markets. At December 31, 2016, less than 5% of AFG’s cash and investments consisted of European debt and AFG owned no sovereign debt issued by the peripheral countries.

Annuity Contracts   Substantially all of AFG’s fixed rate annuity contracts permit AFG to change crediting rates (subject to minimum interest rate guarantees as determined by applicable law) enabling management to react to changes in market interest rates. In 2003, AFG began issuing products with guaranteed minimum interest rates (“GMIRs”) of less than 2% in states where required approvals have been received. The GMIR on virtually all new product sales since 2010 is 1%. At December 31, 2016, AFG could reduce the average crediting rate on approximately $22 billion of traditional fixed and fixed-indexed annuities without guaranteed withdrawal benefits by approximately 80 basis points (on a weighted average basis).

As presented in Item 7 — Management’s Discussion and Analysis — “Results of Operations — Years ended December 31, 2016, 2015 and 2014” — “Net Spread on Fixed Annuities,” the interest credited rate as a percent of fixed annuity benefits

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accumulated on AFG’s in-force block of fixed annuities was 2.04% for the year ended December 31, 2016. Management estimates that the interest credited rate on this in-force business will range from 2.00% to 2.10% over the next five years. This rate reflects actuarial assumptions as to (i) expected investment spreads, (ii) deaths, (iii) annuitizations, (iv) surrenders and other withdrawals and (v) renewal premiums. Actual experience and changes in actuarial assumptions may result in different effective crediting rates than those above.

Actuarial assumptions used to estimate DPAC and certain annuity liabilities, as well as AFG’s ability to maintain spread, could be impacted if a low interest rate environment continues for an extended period, or if increases in interest rates cause policyholder behavior to differ significantly from current expectations.

Projected payments (in millions) in each of the subsequent five years and for all years thereafter on AFG’s fixed annuity liabilities at December 31 were as follows. 

		First				Second				Third				Fourth				Fifth				Thereafter				Total				Fair Value (*)
2016		$	2,523			$	2,856			$	3,131			$	3,442			$	3,747			$	18,305			$	34,004			$	28,932
2015		2,070				2,380				2,710				2,817				3,035				19,268				32,280				25,488

 

(*)	Fair value of annuity benefits accumulated excluding life contingent annuities in the payout phase (carrying value of $204 million at December 31, 2016 and $200 million at December 31, 2015).

AFG’s fixed-indexed annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG’s strategy is designed so that the change in the fair value of the call option assets 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 options are considered derivatives that must be adjusted for changes in fair value through earnings each period. See Note D — “Fair Value Measurements” and Note F — “Derivatives” to the financial statements for a discussion of these derivatives.

Long-Term Debt   The following table shows scheduled principal payments on fixed-rate long-term debt of AFG and its subsidiaries and related weighted average interest rates for each of the subsequent five years and for all years thereafter (dollars in millions):

			December 31, 2016									December 31, 2015
			Scheduled Principal Payments				Rate					Scheduled Principal Payments				Rate
	2017		$	—			—	%		2016		$	—			—	%
	2018		—				—	%		2017		—				—	%
	2019		350				9.9	%	(*)	2018		—				—	%
	2020		—				—	%		2019		350				9.9	%	(*)
	2021		—				—	%		2020		—				—	%
	Thereafter		958				5.3	%		Thereafter		658				6.2	%
	Total		$	1,308			6.5	%		Total		$	1,008			7.5	%
	Fair Value		$	1,356						Fair Value		$	1,108

(*)	In June 2015, AFG entered into an interest rate swap that effectively converts its 9-7/8% Senior Notes due 2019 to a floating rate of three-month LIBOR plus 8.099% (9.0624% at December 31, 2016). The 9-7/8% Senior Notes appear in the table above (at the contractual 9-7/8% interest rate) because the notes themselves are fixed-rate obligations.

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ITEM 8

Financial Statements and Supplementary Data

 

	Page
Report of Independent Registered Public Accounting Firm	F-1
Consolidated Balance Sheet as of December 31, 2016 and 2015	F-2
Consolidated Statement of Earnings for the years ended December 31, 2016, 2015 and 2014	F-3
Consolidated Statement of Comprehensive Income for the years ended December 31, 2016, 2015 and 2014	F-4
Consolidated Statement of Changes in Equity for the years ended December 31, 2016, 2015 and 2014	F-5
Consolidated Statement of Cash Flows for the years ended December 31, 2016, 2015 and 2014	F-6
Notes to Consolidated Financial Statements	F-7

Selected Quarterly Financial Data has been included in Note N to the Consolidated Financial Statements.

ITEM 9A

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 fourth fiscal quarter of 2016 that materially affected, or are reasonably likely to materially affect, AFG’s internal control over financial reporting.

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

AFG’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Securities Exchange Act Rules 13a-15(f). Under the supervision and with the participation of management, including AFG’s Co-Chief Executive Officers and Chief Financial Officer, AFG conducted an evaluation of the effectiveness of internal control over financial reporting as of December 31, 2016, based on the criteria set forth in “Internal Control — Integrated Framework” issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commission.

There are inherent limitations to the effectiveness of any system of internal controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective internal controls and procedures can only provide reasonable assurance of achieving their control objectives.

Based on AFG’s evaluation, management concluded that internal control over financial reporting was effective as of December 31, 2016. The attestation report of AFG’s independent registered public accounting firm on AFG’s internal control over financial reporting as of December 31, 2016, is set forth on the next page.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Board of Directors and Shareholders

American Financial Group, Inc.

We have audited American Financial Group, Inc. and subsidiaries’ (the Company’s) internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). The Company’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, American Financial Group, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of American Financial Group, Inc. and subsidiaries as of December 31, 2016 and 2015, and the related consolidated statements of earnings, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2016, and our report dated February 24, 2017, expressed an unqualified opinion thereon.

 

		/s/ ERNST & YOUNG LLP
Cincinnati, Ohio
February 24, 2017

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

American Financial Group, Inc.

We have audited the accompanying consolidated balance sheets of American Financial Group, Inc. and subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of earnings, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American Financial Group, Inc. and subsidiaries at December 31, 2016 and 2015 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), American Financial Group, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 24, 2017 expressed an unqualified opinion thereon.

		/s/ ERNST & YOUNG LLP
Cincinnati, Ohio
February 24, 2017

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(Dollars in Millions)

	December 31,
	2016				2015
Assets:
Cash and cash equivalents	$	2,107			$	1,220
Investments:
Fixed maturities, available for sale at fair value (amortized cost — $33,735 and $31,565)	34,544				32,284
Fixed maturities, trading at fair value	359				254
Equity securities, available for sale at fair value (cost — $1,351 and $1,469)	1,502				1,553
Equity securities, trading at fair value	56				166
Mortgage loans	1,147				1,067
Policy loans	192				201
Equity index call options	492				241
Real estate and other investments	1,034				750
Total cash and investments	41,433				37,736
Recoverables from reinsurers	2,737				2,636
Prepaid reinsurance premiums	539				480
Agents’ balances and premiums receivable	997				937
Deferred policy acquisition costs	1,239				1,184
Assets of managed investment entities	4,765				4,047
Other receivables	908				820
Variable annuity assets (separate accounts)	600				608
Other assets	1,655				1,190
Goodwill	199				199
Total assets	$	55,072			$	49,837
Liabilities and Equity:
Unpaid losses and loss adjustment expenses	$	8,563			$	8,127
Unearned premiums	2,171				2,060
Annuity benefits accumulated	29,907				26,622
Life, accident and health reserves	691				705
Payable to reinsurers	634				591
Liabilities of managed investment entities	4,549				3,781
Long-term debt	1,283				998
Variable annuity liabilities (separate accounts)	600				608
Other liabilities	1,755				1,575
Total liabilities	50,153				45,067
Shareholders’ equity:
Common Stock, no par value — 200,000,000 shares authorized — 86,924,399 and 87,474,452 shares outstanding	87				87
Capital surplus	1,111				1,214
Retained earnings	3,343				2,987
Accumulated other comprehensive income, net of tax	375				304
Total shareholders’ equity	4,916				4,592
Noncontrolling interests	3				178
Total equity	4,919				4,770
Total liabilities and equity	$	55,072			$	49,837

See notes to consolidated financial statements.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EARNINGS

(In Millions, Except Per Share Data)

	Year ended December 31,
	2016				2015				2014
Revenues:
Property and casualty insurance net earned premiums	$	4,328			$	4,224			$	3,878
Life, accident and health net earned premiums	24				104				108
Net investment income	1,696				1,633				1,501
Realized gains (losses) on:
Securities (*)	19				(19		)		52
Subsidiaries	2				(161		)		—
Income (loss) of managed investment entities:
Investment income	190				155				116
Gain (loss) on change in fair value of assets/liabilities	15				(34		)		(44		)
Other income	224				243				122
Total revenues	6,498				6,145				5,733
Costs and Expenses:
Property and casualty insurance:
Losses and loss adjustment expenses	2,762				2,695				2,494
Commissions and other underwriting expenses	1,349				1,320				1,172
Annuity benefits	800				732				648
Life, accident and health benefits	33				131				164
Annuity and supplemental insurance acquisition expenses	186				179				193
Interest charges on borrowed money	77				75				74
Expenses of managed investment entities	151				112				82
Other expenses	353				336				280
Total costs and expenses	5,711				5,580				5,107
Earnings before income taxes	787				565				626
Provision for income taxes	119				195				220
Net earnings, including noncontrolling interests	668				370				406
Less: Net earnings (loss) attributable to noncontrolling interests	19				18				(46		)
Net Earnings Attributable to Shareholders	$	649			$	352			$	452
Earnings Attributable to Shareholders per Common Share:
Basic	$	7.47			$	4.02			$	5.07
Diluted	$	7.33			$	3.94			$	4.97
Average number of Common Shares:
Basic	86.9				87.6				89.0
Diluted	88.5				89.4				91.0
Cash dividends per Common Share	$	2.1525			$	2.03			$	1.91
________________________________________
(*) Consists of the following:
Realized gains before impairments	$	135			$	106			$	88
Losses on securities with impairment	(115		)		(125		)		(36		)
Non-credit portion recognized in other comprehensive income (loss)	(1		)		—				—
Impairment charges recognized in earnings	(116		)		(125		)		(36		)
Total realized gains (losses) on securities	$	19			$	(19	)		$	52

See notes to consolidated financial statements.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(In Millions)

 

	Year ended December 31,
	2016				2015				2014
Net earnings, including noncontrolling interests	$	668			$	370			$	406
Other comprehensive income (loss), net of tax:
Net unrealized gains (losses) on securities:
Unrealized holding gains (losses) on securities arising during the period	80				(406		)		216
Reclassification adjustment for realized (gains) losses included in net earnings	(12		)		9				(33		)
Reclassification for unrealized gains of subsidiaries sold	—				(22		)		—
Total net unrealized gains (losses) on securities	68				(419		)		183
Net unrealized gains (losses) on cash flow hedges	(8		)		1				—
Foreign currency translation adjustments	7				(14		)		(9		)
Pension and other postretirement plans adjustments	—				1				(4		)
Other comprehensive income (loss), net of tax	67				(431		)		170
Total comprehensive income (loss), net of tax	735				(61		)		576
Less: Comprehensive income (loss) attributable to noncontrolling interests	24				10				(43		)
Comprehensive income (loss) attributable to shareholders	$	711			$	(71	)		$	619

See notes to consolidated financial statements.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

(Dollars in Millions)

					Shareholders’ Equity
	Common				Common Stock and Capital				Retained Earnings								Accumulated Other Comp.								Noncon- trolling				Total
	Shares				Surplus				Approp.				Unapprop.				Inc. (Loss)				Total				Interests				Equity
Balance at December 31, 2013	89,513,386				$	1,213			$	49			$	2,777			$	560			$	4,599			$	170			$	4,769
Net earnings	—				—				—				452				—				452				(46		)		406
Other comprehensive income	—				—				—				—				167				167				3				170
Allocation of losses of managed investment entities	—				—				(51		)		—				—				(51		)		51				—
Dividends on Common Stock	—				—				—				(169		)		—				(169		)		—				(169		)
Shares issued:
Exercise of stock options	1,262,313				36				—				—				—				36				—				36
Restricted stock awards	102,330				—				—				—				—				—				—				—
Other benefit plans	140,339				8				—				—				—				8				—				8
Dividend reinvestment plan	27,238				2				—				—				—				2				—				2
Stock-based compensation:
Expense	—				19				—				—				—				19				—				19
Excess tax benefits	—				9				—				—				—				9				—				9
Shares acquired and retired	(3,303,639	)			(46		)		—				(145		)		—				(191		)		—				(191		)
Shares exchanged — benefit plans	(33,174	)			(1		)		—				(1		)		—				(2		)		—				(2		)
Other	—				—				—				—				—				—				(3		)		(3		)
Balance at December 31, 2014	87,708,793				$	1,240			$	(2	)		$	2,914			$	727			$	4,879			$	175			$	5,054
Cumulative effect of accounting change	—				—				2				—				—				2				—				2
Net earnings	—				—				—				352				—				352				18				370
Other comprehensive loss	—				—				—				—				(423		)		(423		)		(8		)		(431		)
Dividends on Common Stock	—				—				—				(178		)		—				(178		)		—				(178		)
Shares issued:
Exercise of stock options	1,475,202				47				—				—				—				47				—				47
Restricted stock awards	171,130				—				—				—				—				—				—				—
Other benefit plans	111,681				7				—				—				—				7				—				7
Dividend reinvestment plan	26,167				2				—				—				—				2				—				2
Stock-based compensation:
Expense	—				21				—				—				—				21				—				21
Excess tax benefits	—				12				—				—				—				12				—				12
Shares acquired and retired	(1,955,186	)			(27		)		—				(99		)		—				(126		)		—				(126		)
Shares exchanged — benefit plans	(45,765	)			(1		)		—				(2		)		—				(3		)		—				(3		)
Forfeitures of restricted stock	(17,570	)			—				—				—				—				—				—				—
Other	—				—				—				—				—				—				(7		)		(7		)
Balance at December 31, 2015	87,474,452				$	1,301			$	—			$	2,987			$	304			$	4,592			$	178			$	4,770
Net earnings	—				—				—				649				—				649				19				668
Other comprehensive income	—				—				—				—				62				62				5				67
Dividends on Common Stock	—				—				—				(187		)		—				(187		)		—				(187		)
Shares issued:
Exercise of stock options	958,344				32				—				—				—				32				—				32
Restricted stock awards	318,940				—				—				—				—				—				—				—
Other benefit plans	95,875				7				—				—				—				7				—				7
Dividend reinvestment plan	25,516				2				—				—				—				2				—				2
Stock-based compensation expense	—				22				—				—				—				22				—				22
Shares acquired and retired	(1,911,976	)			(29		)		—				(104		)		—				(133		)		—				(133		)
Shares exchanged — benefit plans	(32,707	)			—				—				(2		)		—				(2		)		—				(2		)
Forfeitures of restricted stock	(4,045	)			—				—				—				—				—				—				—
Acquisition of noncontrolling interests	—				(137		)		—				—				9				(128		)		(187		)		(315		)
Other	—				—				—				—				—				—				(12		)		(12		)
Balance at December 31, 2016	86,924,399				$	1,198			$	—			$	3,343			$	375			$	4,916			$	3			$	4,919

See notes to consolidated financial statements.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS

(In Millions)

	Year ended December 31,
	2016				2015				2014
Operating Activities:
Net earnings, including noncontrolling interests	$	668			$	370			$	406
Adjustments:
Depreciation and amortization	134				134				144
Annuity benefits	800				732				648
Realized (gains) losses on investing activities	(61		)		100				(58		)
Net (purchases) sales of trading securities	79				10				(109		)
Deferred annuity and life policy acquisition costs	(230		)		(224		)		(198		)
Change in:
Reinsurance and other receivables	(315		)		(10		)		(199		)
Other assets	(467		)		(13		)		(87		)
Insurance claims and reserves	533				451				587
Payable to reinsurers	43				(54		)		134
Other liabilities	265				12				(63		)
Managed investment entities’ assets/liabilities	(279		)		(190		)		2
Other operating activities, net	(20		)		35				24
Net cash provided by operating activities	1,150				1,353				1,231
Investing Activities:
Purchases of:
Fixed maturities	(7,537		)		(7,201		)		(6,846		)
Equity securities	(207		)		(570		)		(471		)
Mortgage loans	(341		)		(213		)		(450		)
Other investments and equity index call options	(738		)		(534		)		(312		)
Real estate, property and equipment	(49		)		(102		)		(47		)
Businesses	—				—				(267		)
Proceeds from:
Maturities and redemptions of fixed maturities	4,713				3,333				2,988
Repayments of mortgage loans	262				265				116
Sales of fixed maturities	641				321				287
Sales of equity securities	348				364				155
Sales and settlements of other investments and equity index call options	319				374				369
Sales of real estate, property and equipment	55				117				14
Sales of businesses	—				7				—
Cash and cash equivalents of businesses acquired (sold)	—				(49		)		1,078
Managed investment entities:
Purchases of investments	(2,254		)		(1,530		)		(1,692		)
Proceeds from sales and redemptions of investments	1,890				855				1,417
Other investing activities, net	(83		)		(10		)		33
Net cash used in investing activities	(2,981		)		(4,573		)		(3,628		)
Financing Activities:
Annuity receipts	4,585				4,485				3,696
Annuity surrenders, benefits and withdrawals	(2,275		)		(2,025		)		(1,773		)
Net transfers from variable annuity assets	42				43				43
Additional long-term borrowings	302				145				145
Reductions of long-term debt	(18		)		(192		)		(2		)
Issuances of managed investment entities’ liabilities	2,293				1,026				1,400
Retirements of managed investment entities’ liabilities	(1,600		)		(136		)		(1,094		)
Issuances of Common Stock	35				61				47
Repurchases of Common Stock	(133		)		(126		)		(191		)
Cash dividends paid on Common Stock	(185		)		(176		)		(167		)
Acquisition of noncontrolling interests in subsidiary	(315		)		—				—
Other financing activities, net	(13		)		(8		)		(3		)
Net cash provided by financing activities	2,718				3,097				2,101
Net Change in Cash and Cash Equivalents	887				(123		)		(296		)
Cash and cash equivalents at beginning of year	1,220				1,343				1,639
Cash and cash equivalents at end of year	$	2,107			$	1,220			$	1,343

See notes to consolidated financial statements.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

INDEX TO NOTES
A.	Accounting Policies		I.	Goodwill and Other Intangibles
B.	Acquisitions and Sale of Businesses		J.	Long-Term Debt
C.	Segments of Operations		K.	Shareholders’ Equity
D.	Fair Value Measurements		L.	Income Taxes
E.	Investments		M.	Contingencies
F.	Derivatives		N.	Quarterly Operating Results (Unaudited)
G.	Deferred Policy Acquisition Costs		O.	Insurance
H.	Managed Investment Entities		P.	Additional Information

A.     Accounting Policies

Basis of Presentation   The consolidated financial statements include the accounts of American Financial Group, Inc. and its subsidiaries (“AFG”). Certain reclassifications have been made to prior years 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 December 31, 2016, and prior to the filing of this Form 10-K, have been evaluated for potential recognition or disclosure herein.

The preparation of the financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) 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. Other than the fair value measurements used in recording the loss on the sale of substantially all of its long-term care business in 2015 (see Note B — “Acquisitions and Sale of Businesses”), AFG did not have any significant nonrecurring fair value measurements of nonfinancial assets and liabilities in 2016 or 2015.

Investments   Fixed maturity and equity securities classified as “available for sale” are reported at fair value with unrealized gains and losses included in accumulated other comprehensive income (“AOCI”) in AFG’s Balance Sheet. Fixed maturity and equity 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.

In January 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-01, which, among other things, will require all equity securities currently classified as “available for sale” to be reported at fair value, with holding gains and losses recognized in net income, instead of AOCI. AFG will be required to adopt this guidance effective January 1, 2018.

Premiums and discounts on fixed maturity securities are amortized using the 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.

Gains or losses on 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

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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 call 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. AFG has entered into an interest rate swap that qualifies as a highly effective fair value hedge to mitigate the interest rate risk associated with fixed-rate long-term debt by economically converting certain fixed-rate debt obligations to floating-rate obligations. Since the terms of the swap match the terms of the hedged debt, changes in the fair value of the swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate.

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.

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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, long-term care 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.

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 H — “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.

On January 1, 2016, AFG adopted ASU 2015-02, which amended certain consolidation accounting guidance, including the VIE guidance that applies to collateralized financing entities such as CLOs. The new guidance affects how fee arrangements with CLO asset managers impact the determination of the primary beneficiary of those entities. Due to the significance of AFG’s investments in the CLOs that it manages, the new guidance did not impact the consolidation of AFG’s currently outstanding CLOs. The new guidance also impacted the consolidation analysis that applies to limited partnerships and similar entities, but did not result in a change to the accounting for AFG’s existing investments in those entities.

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.

Effective January 1, 2015, AFG adopted (on a modified retrospective basis) ASU 2014-13, which addresses the diversity in practice regarding the accounting for assets and liabilities of a consolidated collateralized financing entity (such as a CLO)

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when an election has been made to account for that entity’s assets and liabilities at fair value. 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. Under the new guidance, AFG elected to 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 continue to be measured by the change in the fair value of AFG’s investments in the CLOs and management fees earned.

Prior to the adoption of ASU 2014-13, measuring both the CLO assets and CLO liabilities at separately determined fair values resulted in a difference between the carrying value of the CLO assets and the carrying value of the CLO liabilities that was not attributable to AFG’s ownership interest in the CLOs and CLO earnings (losses) that were not attributable to AFG’s shareholders. This difference was recorded as “appropriated retained earnings — managed investment entities” in AFG’s Balance Sheet and the earnings (losses) that were not attributable to AFG’s shareholders were included in net earnings (loss) attributable to noncontrolling interests in AFG’s Statement of Earnings. In accordance with the guidance adopted in 2015, the amount reported as “appropriated retained earnings — managed investment entities” at December 31, 2014 was reclassified to “liabilities of managed investment entities” on January 1, 2015 as the cumulative effect of an accounting change.

At December 31, 2016, assets and liabilities of managed investment entities included $23 million in assets and $18 million in liabilities of a temporary warehousing entity that was established in connection with the formation of a new CLO that is expected to close in the first half of 2017. Upon closing, all warehoused assets are expected to be transferred to the new CLO and the liabilities will be repaid.

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 policy charges are credited to 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 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 amortized over the life of the related debt using the effective interest method. Effective January 1, 2016, AFG adopted (on a retrospective basis) ASU 2015-03, which requires debt issuance costs to be presented in the balance sheet as a direct reduction in the carrying value of long-term debt (consistent with the treatment of debt discounts) with the periodic amortization of such costs included in interest expense. Debt issuance costs related to AFG’s revolving credit facilities will continue to be included in other assets in AFG’s Balance Sheet. Prior to AFG’s adoption of ASU 2015-03, AFG reported unamortized debt issuance costs as a deferred charge asset (included in other assets) in AFG’s Balance Sheet and the periodic amortization was included in other expenses in AFG’s Statement of Earnings. The updated guidance did not affect the overall recognition and measurement guidance for debt issuance costs. Accordingly, the guidance did not have an overall impact on AFG’s Shareholders’ Equity or results of operations.

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 represents 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.

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.

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.

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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.

In the fourth quarter of 2016, AFG early adopted ASU 2016-09, which, among other things, requires excess tax benefits or deficiencies for share-based payments to be recorded through income tax expense in the statement of earnings instead of directly to capital surplus (as required under the previous guidance). As a result, AFG’s Statement of Earnings for 2016 includes a tax benefit of $9 million that under the previous guidance would have been recorded directly to capital surplus. In addition, the new guidance allows entities to elect to account for forfeitures of awards when they occur rather than accruing expense based on an estimate of expected forfeitures (as required under the previous guidance). AFG has elected to account for forfeitures as they occur. The resulting cumulative effect of accounting change of less than $1 million was recorded directly to retained earnings.

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: 2016 – 1.6 million, 2015 – 1.8 million and 2014 – 2.0 million.

AFG’s weighted average diluted shares outstanding excludes the following anti-dilutive potential common shares related to stock compensation plans: 2016 – 0.4 million, 2015 – 1.1 million and 2014 – 1.0 million. Adjustments to net earnings attributable to shareholders in the calculation of diluted earnings per share were nominal in the 2016, 2015 and 2014 periods.

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.

Effective October 1, 2016, AFG early adopted (on a retrospective basis) ASU 2016-15, which addresses the diversity in practice in how certain cash receipts and cash payments are presented in the statement of cash flows. Among other things, this guidance requires proceeds received from the settlement of corporate-owned life insurance policies to be classified as cash inflows from investing activities and allows premiums paid for policies to be reported as cash outflows either from investing activities or operating activities. AFG has elected to show all corporate-owned life insurance activity in investing activities. Prior to adoption of this guidance, AFG accounted for these transactions as operating activities. In addition, ASU 2016-15 clarifies when distributions received from investees accounted under the equity method should be accounted for as a cash inflow from operating activities or as a cash inflow from investing activities. AFG had previously accounted for all distributions from investments accounted for under the equity method as investing activities. The new guidance solely related to the presentation of certain transactions in the statement of cash flows. Accordingly, adoption of this guidance did not impact AFG’s results of operations or financial position.

Revenue Recognition Guidance Effective in 2018 In May 2014, the FASB issued ASU 2014-09, which requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Revenue is recognized when (or as) the entity satisfies a performance obligation under the contract. The new guidance also updates the accounting for certain costs associated with obtaining and fulfilling contracts with customers and requires disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. Revenue recognition for insurance contracts and financial instruments, which are AFG’s primary sources of revenue, is excluded from the scope of the new guidance. AFG will adopt the new guidance effective January 1, 2018. Because the new guidance does not apply to the vast majority of AFG’s business, management does not expect the adoption of this guidance to have a material impact on AFG’s results of operations or

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financial position. Based on implementation efforts to date, management believes that the new standard will only apply to 2% of AFG’s consolidated revenues.

B.     Acquisitions and Sale of Businesses

Acquisition of Noncontrolling Interest in National Interstate Corporation   On November 10, 2016, AFG acquired the 49% of National Interstate Corporation (“NATL”) not previously owned by AFG’s wholly-owned subsidiary, Great American Insurance Company (“GAI”) for $315 million ($32.00 per share) in a merger transaction. In addition, NATL paid a one-time special cash dividend of $0.50 per share to its shareholders immediately prior to the merger closing ($5 million was paid to noncontrolling shareholders). Expenses related to the merger were approximately $10 million and were expensed as incurred.

Because NATL was already a consolidated subsidiary of AFG prior to the merger, the acquisition was accounted for as an equity transaction. As a result, the excess of the consideration paid over the carrying value of the noncontrolling interest acquired was recorded as a $137 million reduction in AFG’s Capital Surplus. In addition, the merger allowed NATL and its subsidiaries to become members of the AFG consolidated tax group, which resulted in a tax benefit of $66 million in the fourth quarter of 2016.

Acquisition of Summit Holding Southeast, Inc.   In April 2014, AFG acquired Summit Holding Southeast, Inc. and its related companies (“Summit”), from Liberty Mutual Insurance for $259 million using cash on hand at the parent company. Immediately following the acquisition, AFG made a capital contribution of $140 million, bringing its total capital investment in the Summit business to $399 million. Summit is based in Lakeland, Florida and is a leading provider of specialty workers’ compensation solutions in the southeastern United States. Summit continues to operate under the Summit brand as a member of AFG’s Great American Insurance Group. Summit is included in the Specialty casualty sub-segment and generated $540 million and $529 million in net earned premiums in 2016 and 2015, respectively, and $410 million in net earned premiums during the nine months subsequent to AFG’s acquisition in 2014.

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Expenses related to the acquisition were less than $1 million and were expensed as incurred. The purchase price was allocated to the acquired assets and liabilities of Summit based on management’s best estimate of fair value as of the acquisition date. The allocation of the purchase price is shown in the table below (in millions):

	April 1, 2014
Total purchase price					$	259
Tangible assets acquired:
Cash and cash equivalents	$	1,078
Fixed maturities, available for sale	92
Recoverables from reinsurers	116
Agents’ balances and premiums receivable	41
Deferred tax assets, net (*)	67
Other receivables	21
Other assets	11
Total tangible assets acquired					1,426
Liabilities acquired:
Unpaid losses and loss adjustment expenses	1,142
Unearned premiums	3
Payable to reinsurers	3
Other liabilities	66
Total liabilities acquired					1,214
Net tangible assets acquired, at fair value					212
Excess purchase price over net tangible assets acquired					$	47
Allocation of excess purchase price:
Intangible assets acquired (*)					$	47
Deferred tax on intangible assets acquired (*)					(16		)
Goodwill					16
					$	47

(*)	Included in Other assets in AFG’s Balance Sheet.

Acquisition of Renewal Rights In March 2014, AFG completed a renewal rights agreement with Selective Insurance Company of America to acquire Selective’s pooled public entity book of business for $8 million. At the acquisition date, this book of business had approximately $38 million in in-force gross written premiums. The acquired business generated $34 million in gross written premiums and $16 million in net written premiums in 2016.

Sale of Long-term Care Business In December 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business (which was included in the run-off long-term care and life segment) to HC2 Holdings, Inc. (“HC2”) for an initial payment of $7 million in cash and HC2 securities with a fair value of $11 million. AFG may also receive up to $13 million of additional proceeds from HC2 in the future contingent upon the release of certain statutory-basis liabilities of the legal entities sold by AFG. In connection with obtaining regulatory approval for the transaction, AFG agreed to provide up to an aggregate of $35 million of capital support for the insurance companies, on an as-needed basis to maintain specified surplus levels, subject to immediate reimbursement by HC2 through a five-year capital maintenance agreement. The legal entities involved in the transaction, United Teacher Associates Insurance Company (“UTA”) and Continental General Insurance Company (“CGIC”), contained substantially all of AFG’s long-term care insurance reserves (96% as measured by net statutory reserves as of November 30, 2015), as well as smaller blocks of annuity and life insurance business. Following the sale of these subsidiaries, AFG has only a small block of long-term care insurance (1,600 policies) with approximately $37 million in reserves at December 31, 2016. AFG had ceased new sales of long-term care insurance in January 2010, but continued to service and accept renewal premiums on its outstanding policies, which are guaranteed renewable.

In addition to the $18 million in cash and securities received at closing and the $13 million of potential additional proceeds in the future from the release of statutory liabilities, AFG received a total of $97 million in tax benefits in 2016 related to the sale

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through reduced estimated tax payments and a tax refund resulting from the carryback of the tax-basis capital loss. The receivables for these tax benefits were reflected in AFG’s financial statements at December 31, 2015.

Based on the status of ongoing negotiations at the end of the first quarter of 2015, management determined that the potential sale of the run-off long-term care insurance business met the GAAP “held for sale” criteria as of March 31, 2015. Accordingly, AFG recorded a $162 million pretax loss ($105 million loss after tax) in the first quarter of 2015 to establish a liability equal to the excess of the net carrying value of the assets and liabilities to be disposed over the estimated net sale proceeds. At the closing date, the loss was adjusted to $166 million ($108 million loss after tax) based on the actual proceeds received and the final carrying value of the net assets disposed. In the second quarter of 2016, AFG received additional proceeds based on the final closing balance sheet and adjusted certain accrued expense estimates associated with the sale, resulting in a $2 million pretax gain. At March 31, 2015 and at the sale date, the carrying value of the assets and liabilities disposed represented approximately 4% of both AFG’s assets and liabilities.

Under accounting guidance effective in January 2015, only disposals of components of an entity that represent a strategic shift and that have a major effect on a reporting entity’s operations and financial results are reported as discontinued operations. Due to the run-off nature of the business and the immaterial expected impact on AFG’s results of operations, the sale of AFG’s long-term care insurance business has not been reported as a discontinued operation.

The impact of the sale of the run-off long-term care insurance business is shown below (in millions):

	December 24, 2015
Net sale proceeds (*)					$	13
Assets of businesses sold:
Cash and investments	$	1,334
Recoverables from reinsurers	630
Deferred policy acquisition costs	16
Other receivables	16
Other assets	(4		)
Goodwill	2
Total assets					1,994
Liabilities of businesses sold:
Annuity benefits accumulated	261
Life, accident and health reserves	1,525
Other liabilities	7
Total liabilities					1,793
Reclassify net unrealized gain on marketable securities					22
Net assets of businesses sold					179
Loss on subsidiaries, pretax					(166		)
Tax benefit					58
Loss on subsidiaries, net of tax					$	(108	)

(*)	Includes the fair value of the potential additional consideration and capital maintenance agreement and is shown net of estimated expenses.

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Revenues, costs and expenses, and earnings before income taxes for the subsidiaries sold were (in millions):

	Year ended December 31,
	2015				2014
Life, accident and health net earned premiums:
Long-term care	$	73			$	74
Life operations	11				11
Net investment income	73				75
Realized gains (losses) on securities and other income	(11		)		(6		)
Total revenues	146				154
Annuity benefits	8				7
Life, accident and health benefits:
Long-term care	91				119
Life operations	11				11
Annuity and supplemental insurance acquisition expenses	12				11
Other expenses	16				14
Total costs and expenses	138				162
Earnings before income taxes	$	8			$	(8	)

Other In addition to the loss on the sale of substantially all of AFG’s run-off long-term care insurance business (discussed above), AFG recorded a $5 million pretax realized gain in the third quarter of 2015 representing an adjustment to a previously recognized realized loss on a small property and casualty subsidiary sold several years ago.

C.    Segments of Operations

AFG manages its business as four segments: (i) Property and casualty insurance, (ii) Annuity, (iii) Run-off long-term care and life and (iv) Other, which includes holding company assets and costs, and the assets 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 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 and fixed-indexed annuities in the retail, financial institutions and education markets. AFG’s reportable segments and their components were determined based primarily upon similar economic characteristics, products and services.

Sales of property and casualty insurance outside of the United States represented 4% of AFG’s revenues in 2016 and 2015 and 5% of AFG’s revenues in 2014.

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The following tables (in millions) show AFG’s assets, revenues and earnings before income taxes by segment and sub-segment.

	2016				2015				2014
Assets
Property and casualty insurance (a)	$	15,574			$	14,689			$	14,069
Annuity	33,409				29,865				27,317
Run-off long-term care and life (b)	752				772				2,489
Other	5,337				4,511				3,638
Total assets	$	55,072			$	49,837			$	47,513

Revenues
Property and casualty insurance:
Premiums earned:
Specialty
Property and transportation	$	1,662			$	1,599			$	1,544
Specialty casualty	2,006				2,011				1,765
Specialty financial	557				517				469
Other specialty	103				97				100
Total premiums earned	4,328				4,224				3,878
Net investment income	350				319				294
Other income (c)	51				78				9
Total property and casualty insurance	4,729				4,621				4,181
Annuity:
Net investment income	1,356				1,224				1,136
Other income	103				98				97
Total annuity	1,459				1,322				1,233
Run-off long-term care and life (b)	49				188				195
Other	240				194				72
Total revenues before realized gains (losses)	6,477				6,325				5,681
Realized gains (losses) on securities	19				(19		)		52
Realized gains (losses) on subsidiaries	2				(161		)		—
Total revenues	$	6,498			$	6,145			$	5,733

(a)	Not allocable to sub-segments.

(b)	AFG sold substantially all of its run-off long-term care insurance business in December 2015.

(c)	Includes pretax income of $32 million (before noncontrolling interest) from the sale of an apartment property in the second quarter of 2016, $51 million (before noncontrolling interest) from the sale of a hotel in the second quarter of 2015 and $15 million from the sale of an apartment property in the fourth quarter of 2015.

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	2016				2015				2014
Earnings Before Income Taxes
Property and casualty insurance:
Underwriting:
Specialty
Property and transportation	$	166			$	48			$	21
Specialty casualty	78				146				136
Specialty financial	84				87				64
Other specialty	9				14				16
Other lines (a)	(101		)		(70		)		(25		)
Total underwriting	236				225				212
Investment and other income, net (b)	341				351				244
Total property and casualty insurance	577				576				456
Annuity	368				331				328
Run-off long-term care and life (c)	2				14				(10		)
Other (d)	(181		)		(176		)		(200		)
Total earnings before realized gains (losses) and income taxes	766				745				574
Realized gains (losses) on securities	19				(19		)		52
Realized gains (losses) on subsidiaries	2				(161		)		—
Total earnings before income taxes	$	787			$	565			$	626

(a)	Includes a special charge of $65 million related to the exit of certain lines of business within AFG’s Lloyd’s-based insurer, Neon, in the second quarter of 2016 and special charges to increase asbestos and environmental (“A&E”) reserves of $36 million, $67 million and $24 million in 2016, 2015 and 2014, respectively.

(b)	Includes pretax income of $32 million (before noncontrolling interest) from the sale of an apartment property in the second quarter of 2016, $51 million (before noncontrolling interest) from the sale of a hotel in the second quarter of 2015 and $15 million from the sale of an apartment property in the fourth quarter of 2015.

(c)	AFG sold substantially all of its run-off long-term care insurance business in December 2015.

(d)

Primarily holding company interest and expenses, including a $4 million loss on retirement of debt in the third quarter of 2015, and special charges to increase A&E reserves related to AFG’s former railroad and manufacturing operations ($5 million in 2016, $12 million in 2015 and $6 million in 2014) and losses of managed investment entities attributable to noncontrolling interests ($51 million in 2014). Following the adoption of new guidance in the first quarter of 2015, there are no longer earnings (losses) of managed investment entities that are attributable to noncontrolling interests. See Note A — “Accounting Policies — Managed Investment Entities.”

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

D.    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 and 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, mortgage-backed securities (“MBS”) 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 in the circumstances. 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, and prior to 2015 certain liabilities of the CLOs.

Under new guidance adopted in the first quarter of 2015, discussed in Note A — “Accounting Policies — Managed Investment Entities,” AFG has elected to 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 separately measured fair values. Following the adoption of the new guidance, 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.

In December 2015, AFG completed the sale of substantially all of its run-off long-term care insurance business. As discussed in Note B — “Acquisitions and Sale of Businesses,” AFG recorded a loss in the first quarter of 2015 to write down the net carrying value of the assets and liabilities to be disposed to the estimated net sale proceeds (estimated fair value less costs to sell). The estimate of fair value used to determine that loss was derived using significant unobservable inputs (Level 3). At the closing date, approximately $11 million (excluding cash) of the net proceeds was measured at fair value. These fair value measurements are categorized in the fair value hierarchy as follows: Level 1 — $5 million; Level 2 — $2 million and Level 3 — $4 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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
December 31, 2016
Assets:
Available for sale (“AFS”) fixed maturities:
U.S. Government and government agencies	$	133			$	174			$	8			$	315
States, municipalities and political subdivisions	—				6,641				140				6,781
Foreign government	—				136				—				136
Residential MBS	—				3,445				190				3,635
Commercial MBS	—				1,468				25				1,493
Asset-backed securities (“ABS”)	—				5,475				484				5,959
Corporate and other	29				15,484				712				16,225
Total AFS fixed maturities	162				32,823				1,559				34,544
Trading fixed maturities	30				329				—				359
Equity securities — AFS and trading	1,305				79				174				1,558
Assets of managed investment entities (“MIE”)	380				4,356				29				4,765
Variable annuity assets (separate accounts) (*)	—				600				—				600
Equity index call options	—				492				—				492
Other assets — derivatives	—				1				—				1
Total assets accounted for at fair value	$	1,877			$	38,680			$	1,762			$	42,319
Liabilities:
Liabilities of managed investment entities	$	363			$	4,158			$	28			$	4,549
Derivatives in annuity benefits accumulated	—				—				1,759				1,759
Derivatives in long-term debt	—				(1		)		—				(1		)
Other liabilities — derivatives	—				30				—				30
Total liabilities accounted for at fair value	$	363			$	4,187			$	1,787			$	6,337
December 31, 2015
Assets:
Available for sale fixed maturities:
U.S. Government and government agencies	$	100			$	192			$	15			$	307
States, municipalities and political subdivisions	—				6,767				89				6,856
Foreign government	—				154				—				154
Residential MBS	—				3,305				224				3,529
Commercial MBS	—				2,148				39				2,187
Asset-backed securities	—				4,464				470				4,934
Corporate and other	50				13,634				633				14,317
Total AFS fixed maturities	150				30,664				1,470				32,284
Trading fixed maturities	13				241				—				254
Equity securities — AFS and trading	1,362				217				140				1,719
Assets of managed investment entities	309				3,712				26				4,047
Variable annuity assets (separate accounts) (*)	—				608				—				608
Equity index call options	—				241				—				241
Other assets — derivatives	—				2				—				2
Total assets accounted for at fair value	$	1,834			$	35,685			$	1,636			$	39,155
Liabilities:
Liabilities of managed investment entities	$	289			$	3,468			$	24			$	3,781
Derivatives in annuity benefits accumulated	—				—				1,369				1,369
Derivatives in long-term debt	—				(2		)		—				(2		)
Other liabilities — derivatives	—				8				—				8
Total liabilities accounted for at fair value	$	289			$	3,474			$	1,393			$	5,156

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

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The transfers between Level 1 and Level 2 for the years ended December 31, 2016, 2015 and 2014 are reflected in the table below at fair value as of the end of the reporting period (dollars in millions):

	Level 2 To Level 1 Transfers																					Level 1 To Level 2 Transfers
	# of Transfers									Fair Value												# of Transfers									Fair Value
	2016			2015			2014			2016				2015				2014				2016			2015			2014			2016				2015				2014
Perpetual preferred stocks	6			5			14			$	35			$	19			$	96			7			7			13			$	28			$	31			$	83
Common stocks	3			7			—			—				80				—				2			—			7			—				—				26
Redeemable preferred stocks	—			2			1			—				11				5				—			—			—			—				—				—

Transfers between Level 1 and Level 2 for all periods presented were a result of increases or decreases in observable trade activity.

Approximately 4% of the total assets carried at fair value on December 31, 2016, were Level 3 assets. Approximately 78% ($1.37 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 less than 10% 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 annuity liabilities, which are measured using a discounted cash flow approach and had a fair value of $1.76 billion at December 31, 2016. The following table presents information about the unobservable inputs used by management in determining fair value of these embedded derivatives. See Note F — “Derivatives.”

	Unobservable Input		Range
	Adjustment for insurance subsidiary’s credit risk		0.4% – 2.9% over the risk free rate
	Risk margin for uncertainty in cash flows		0.68% reduction in the discount rate
	Surrenders		3% – 21% of indexed account value
	Partial surrenders		2% – 10% of indexed account value
	Annuitizations		0.1% – 1% of indexed account value
	Deaths		1.5% – 8.0% of indexed account value
	Budgeted option costs		2.4% – 3.6% 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 annuity products with an expected range of 6% to 10% in the majority of future calendar years (3% to 21% over all periods). Increasing the budgeted option cost or risk margin for uncertainty in cash flows assumptions in the table above would increase the fair value of the fixed-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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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Changes in balances of Level 3 financial assets and liabilities carried at fair value during 2016, 2015 and 2014 are presented below (in millions). The transfers into and out of Level 3 were due to changes in the availability of market observable inputs. 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 December 31, 2015				Net income				Other comprehensive income (loss)				Purchases and issuances				Sales and settlements				Transfer into Level 3				Transfer out of Level 3				Balance at December 31, 2016
AFS fixed maturities:
U.S. government agency	$	15			$	(8	)		$	1			$	—			$	—			$	—			$	—			$	8
State and municipal	89				—				(4		)		57				(2		)		—				—				140
Residential MBS	224				(4		)		(2		)		8				(28		)		34				(42		)		190
Commercial MBS	39				(1		)		—				—				(7		)		—				(6		)		25
Asset-backed securities	470				(1		)		1				50				(52		)		60				(44		)		484
Corporate and other	633				—				(10		)		176				(100		)		30				(17		)		712
Total AFS fixed maturities	1,470				(14		)		(14		)		291				(189		)		124				(109		)		1,559
Equity securities	140				(12		)		35				44				(28		)		15				(20		)		174
Assets of MIE	26				(9		)		—				12				—				—				—				29
Total Level 3 assets	$	1,636			$	(35	)		$	21			$	347			$	(217	)		$	139			$	(129	)		$	1,762
Embedded derivatives (a)	$	(1,369	)		$	(211	)		$	—			$	(277	)		$	98			$	—			$	—			$	(1,759	)
Total Level 3 liabilities (b)	$	(1,369	)		$	(211	)		$	—			$	(277	)		$	98			$	—			$	—			$	(1,759	)

(a)	Total realized/unrealized gains (losses) included in net income for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $17 million in 2016.

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

									Total realized/unrealized gains (losses) included in
	Bal. at Dec. 31, 2014				Impact of accounting change (b)				Net income				Other comprehensive income (loss)				Purchases and issuances				Sales and settlements				Transfer into Level 3				Transfer out of Level 3				Sale of subsidiaries				Bal. at Dec. 31, 2015
AFS fixed maturities:
U.S. government agency	$	15			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	15
State and municipal	100				—				—				(1		)		34				(1		)		2				(39		)		(6		)		89
Residential MBS	300				—				(11		)		(1		)		—				(34		)		86				(88		)		(28		)		224
Commercial MBS	44				—				(1		)		(1		)		—				(2		)		4				(1		)		(4		)		39
Asset-backed securities	226				—				1				(7		)		265				(56		)		53				(10		)		(2		)		470
Corporate and other	546				—				(5		)		(9		)		161				(90		)		41				(5		)		(6		)		633
Total AFS fixed maturities	1,231				—				(16		)		(19		)		460				(183		)		186				(143		)		(46		)		1,470
Equity securities	93				—				(4		)		(9		)		77				—				—				(17		)		—				140
Assets of MIE	31				—				(11		)		—				6				—				—				—				—				26
Total Level 3 assets	$	1,355			$	—			$	(31	)		$	(28	)		$	543			$	(183	)		$	186			$	(160	)		$	(46	)		$	1,636
Liabilities of MIE	$	(2,701	)		$	2,701			$	—			$	—			$	—			$	—			$	—			$	—			$	—			$	—
Embedded derivatives (a)	(1,160		)		—				(17		)		—				(257		)		65				—				—				—				(1,369		)
Total Level 3 liabilities	$	(3,861	)		$	2,701			$	(17	)		$	—			$	(257	)		$	65			$	—			$	—			$	—			$	(1,369	)

(a)	Total realized/unrealized gains (losses) included in net income for the embedded derivatives reflects losses related to the unlocking of actuarial assumptions of $28 million in 2015.

(b)	The impact of implementing new guidance adopted in 2015, as discussed above and in Note A — “Accounting Policies — Managed Investment Entities.”

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

					Total realized/unrealized gains (losses) included in
	Balance at December 31, 2013				Net income				Other comprehensive income (loss)				Purchases and issuances				Sales and settlements				Transfer into Level 3				Transfer out of Level 3				Balance at December 31, 2014
AFS fixed maturities:
U.S. government agency	$	15			$	—			$	—			$	—			$	—			$	—			$	—			$	15
State and municipal	61				(1		)		—				30				—				10				—				100
Residential MBS	316				4				3				13				(31		)		111				(116		)		300
Commercial MBS	28				(1		)		—				—				—				17				—				44
Asset-backed securities	75				3				(2		)		99				(39		)		117				(27		)		226
Corporate and other	335				2				13				102				(73		)		172				(5		)		546
Total AFS fixed maturities	830				7				14				244				(143		)		427				(148		)		1,231
Equity securities	31				1				2				62				(9		)		22				(16		)		93
Assets of MIE	30				(3		)		—				6				(2		)		—				—				31
Total Level 3 assets	$	891			$	5			$	16			$	312			$	(154	)		$	449			$	(164	)		$	1,355
Liabilities of MIE (a)	$	(2,411	)		$	22			$	—			$	(817	)		$	505			$	—			$	—			$	(2,701	)
Embedded derivatives (b)	(804		)		(182		)		—				(221		)		47				—				—				(1,160		)
Total Level 3 liabilities	$	(3,215	)		$	(160	)		$	—			$	(1,038	)		$	552			$	—			$	—			$	(3,861	)

(a)	Total realized/unrealized gains (losses) included in net income includes gains of $50 million related to liabilities outstanding as of December 31, 2014. See Note H — “Managed Investment Entities.”

(b)	Total realized/unrealized gains (losses) included in net income for the embedded derivatives reflects gains related to the unlocking of actuarial assumptions of $58 million in 2014.

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 at December 31 are summarized below (in millions):

	Carrying				Fair Value
	Value				Total				Level 1				Level 2				Level 3
2016
Financial assets:
Cash and cash equivalents	$	2,107			$	2,107			$	2,107			$	—			$	—
Mortgage loans	1,147				1,146				—				—				1,146
Policy loans	192				192				—				—				192
Total financial assets not accounted for at fair value	$	3,446			$	3,445			$	2,107			$	—			$	1,338
Financial liabilities:
Annuity benefits accumulated (*)	$	29,703			$	28,932			$	—			$	—			$	28,932
Long-term debt	1,284				1,356				—				1,353				3
Total financial liabilities not accounted for at fair value	$	30,987			$	30,288			$	—			$	1,353			$	28,935
2015
Financial assets:
Cash and cash equivalents	$	1,220			$	1,220			$	1,220			$	—			$	—
Mortgage loans	1,067				1,074				—				—				1,074
Policy loans	201				201				—				—				201
Total financial assets not accounted for at fair value	$	2,488			$	2,495			$	1,220			$	—			$	1,275
Financial liabilities:
Annuity benefits accumulated (*)	$	26,422			$	25,488			$	—			$	—			$	25,488
Long-term debt	1,000				1,120				—				1,105				15
Total financial liabilities not accounted for at fair value	$	27,422			$	26,608			$	—			$	1,105			$	25,503

(*)	Excludes $204 million and $200 million of life contingent annuities in the payout phase at December 31, 2016 and 2015, respectively.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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.

E.    Investments

Available for sale fixed maturities and equity securities at December 31 consisted of the following (in millions): 

	2016																				2015
	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	$	315			$	3			$	(3	)		$	—			$	315			$	305			$	5			$	(3	)		$	2			$	307
States, municipalities and political subdivisions	6,650				200				(69		)		131				6,781				6,642				249				(35		)		214				6,856
Foreign government	131				5				—				5				136				147				7				—				7				154
Residential MBS	3,367				281				(13		)		268				3,635				3,236				308				(15		)		293				3,529
Commercial MBS	1,446				49				(2		)		47				1,493				2,111				77				(1		)		76				2,187
Asset-backed securities	5,962				43				(46		)		(3		)		5,959				4,961				25				(52		)		(27		)		4,934
Corporate and other	15,864				473				(112		)		361				16,225				14,163				422				(268		)		154				14,317
Total fixed maturities	$	33,735			$	1,054			$	(245	)		$	809			$	34,544			$	31,565			$	1,093			$	(374	)		$	719			$	32,284
Equity Securities:
Common stocks	$	879			$	160			$	(23	)		$	137			$	1,016			$	1,051			$	146			$	(79	)		$	67			$	1,118
Perpetual preferred stocks	472				21				(7		)		14				486				418				23				(6		)		17				435
Total equity securities	$	1,351			$	181			$	(30	)		$	151			$	1,502			$	1,469			$	169			$	(85	)		$	84			$	1,553

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 December 31, 2016 and December 31, 2015, respectively, were $189 million and $205 million. Gross unrealized gains on such securities at December 31, 2016 and December 31, 2015 were $130 million and $134 million, respectively. Gross unrealized losses on such securities at December 31, 2016 and December 31, 2015 were $3 million and $6 million, respectively. These amounts represent the non-credit other-than-temporary impairment charges recorded in AOCI adjusted for subsequent changes in fair values and relate to residential MBS.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The following tables show gross unrealized losses (dollars in millions) on fixed maturities and equity securities by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2016 and 2015.

		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
	2016
	Fixed maturities:
	U.S. Government and government agencies	$	(1	)		$	153			99	%		$	(2	)		$	8			80	%
	States, municipalities and political subdivisions	(64		)		2,289				97	%		(5		)		44				90	%
	Residential MBS	(7		)		502				99	%		(6		)		162				96	%
	Commercial MBS	(2		)		121				98	%		—				—				—	%
	Asset-backed securities	(29		)		1,737				98	%		(17		)		634				97	%
	Corporate and other	(93		)		3,849				98	%		(19		)		312				94	%
	Total fixed maturities	$	(196	)		$	8,651			98	%		$	(49	)		$	1,160			96	%
	Equity securities:
	Common stocks	$	(23	)		$	215			90	%		$	—			$	—			—	%
	Perpetual preferred stocks	(6		)		135				96	%		(1		)		6				86	%
	Total equity securities	$	(29	)		$	350			92	%		$	(1	)		$	6			86	%
	2015
	Fixed maturities:
	U.S. Government and government agencies	$	(1	)		$	112			99	%		$	(2	)		$	15			88	%
	States, municipalities and political subdivisions	(33		)		1,419				98	%		(2		)		50				96	%
	Residential MBS	(7		)		438				98	%		(8		)		201				96	%
	Commercial MBS	—				95				100	%		(1		)		28				97	%
	Asset-backed securities	(42		)		2,706				98	%		(10		)		455				98	%
	Corporate and other	(229		)		4,661				95	%		(39		)		165				81	%
	Total fixed maturities	$	(312	)		$	9,431			97	%		$	(62	)		$	914			94	%
	Equity securities:
	Common stocks	$	(79	)		$	509			87	%		$	—			$	—			—	%
	Perpetual preferred stocks	(3		)		91				97	%		(3		)		22				88	%
	Total equity securities	$	(82	)		$	600			88	%		$	(3	)		$	22			88	%

At December 31, 2016, the gross unrealized losses on fixed maturities of $245 million relate to 1,242 securities. Investment grade securities (as determined by nationally recognized rating agencies) represented approximately 84% of the gross unrealized loss and 91% of the fair value.

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The determination of whether unrealized losses are “other-than-temporary” requires judgment based on subjective as well as objective factors. Factors considered and resources used by management include:

a)	whether the unrealized loss is credit-driven or a result of changes in market interest rates,

b)	the extent to which fair value is less than cost basis,

c)	cash flow projections received from independent sources,

d)	historical operating, balance sheet and cash flow data contained in issuer SEC filings and news releases,

e)	near-term prospects for improvement in the issuer and/or its industry,

f)	third party research and communications with industry specialists,

g)	financial models and forecasts,

h)	the continuity of dividend payments, maintenance of investment grade ratings and hybrid nature of certain investments,

i)	discussions with issuer management, and

j)	ability and intent to hold the investment for a period of time sufficient to allow for anticipated recovery in 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. During 2016, AFG recorded $3 million in other-than-temporary impairment charges related to its residential MBS.

In 2016, AFG recorded approximately $23 million and $12 million in other-than-temporary impairment charges related to corporate bonds and other fixed maturities, respectively.

AFG recorded $89 million in other-than-temporary impairment charges on common stocks in 2016. At December 31, 2016, the gross unrealized losses on common stocks of $23 million relate to 23 securities, none of which has been in an unrealized loss position for more than 12 months.

AFG recorded $4 million in other-than-temporary impairment charges on preferred stock in 2016. At December 31, 2016, the gross unrealized losses on preferred stocks of $7 million relate to 24 securities. Only one preferred stock has been in an unrealized loss position for 12 months or more and it has an investment grade rating.

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 December 31, 2016.

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):

	2016				2015				2014
Balance at January 1	$	160			$	170			$	194
Additional credit impairments on:
Previously impaired securities	2				1				—
Securities without prior impairments	1				2				—
Reductions due to:
Sales or redemptions	(10		)		(9		)		(24		)
Sale of subsidiaries	—				(4		)		—
Balance at December 31	$	153			$	160			$	170

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

The table below sets forth the scheduled maturities of available for sale fixed maturities as of December 31, 2016 (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	$	1,120			$	1,136			3	%
After one year through five years	5,609				5,866				17	%
After five years through ten years	11,744				11,921				35	%
After ten years	4,487				4,534				13	%
	22,960				23,457				68	%
ABS (average life of approximately 5 years)	5,962				5,959				17	%
MBS (average life of approximately 4.5 years)	4,813				5,128				15	%
Total	$	33,735			$	34,544			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 December 31, 2016 or 2015.

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Net Unrealized Gain on Marketable Securities   In addition to adjusting equity securities and fixed maturity 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 and Amounts  Attributable to Noncontrolling Interests				Net
December 31, 2016
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	640			$	(224	)		$	416
Fixed maturities — all other	169				(59		)		110
Total fixed maturities	809				(283		)		526
Equity securities	151				(53		)		98
Total investments	960				(336		)		624
Deferred policy acquisition costs — annuity segment	(273		)		96				(177		)
Annuity benefits accumulated	(78		)		27				(51		)
Unearned revenue	13				(5		)		8
Total net unrealized gain on marketable securities	$	622			$	(218	)		$	404
December 31, 2015
Net unrealized gain on:
Fixed maturities — annuity segment (*)	$	523			$	(183	)		$	340
Fixed maturities — all other	196				(72		)		124
Total fixed maturities	719				(255		)		464
Equity securities	84				(30		)		54
Total investments	803				(285		)		518
Deferred policy acquisition costs — annuity segment	(233		)		82				(151		)
Annuity benefits accumulated	(64		)		22				(42		)
Unearned revenue	11				(4		)		7
Total net unrealized gain on marketable securities	$	517			$	(185	)		$	332

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

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

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

	2016				2015				2014
Investment income:
Fixed maturities	$	1,510			$	1,461			$	1,352
Equity securities	81				76				66
Equity in earnings of partnerships and similar investments	44				27				18
Other	81				87				77
Gross investment income	1,716				1,651				1,513
Investment expenses	(20		)		(18		)		(12		)
Net investment income	$	1,696			$	1,633			$	1,501

Realized gains (losses) and changes in unrealized appreciation (depreciation) related to fixed maturity and equity security investments are summarized as follows (in millions):

	2016																2015
	Realized gains (losses)																Realized gains (losses)
	Before Impairments				Impairments				Total				Change in Unrealized				Before Impairments				Impairments				Total				Change in Unrealized
Fixed maturities	$	36			$	(38	)		$	(2	)		$	90			$	19			$	(43	)		$	(24	)		$	(941	)
Equity securities	106				(93		)		13				67				94				(94		)		—				(134		)
Mortgage loans and other investments	—				—				—				—				(2		)		(3		)		(5		)		—
Other (*)	(7		)		15				8				(52		)		(5		)		15				10				430
Total pretax	135				(116		)		19				105				106				(125		)		(19		)		(645		)
Tax effects	(48		)		41				(7		)		(37		)		(38		)		45				7				226
Noncontrolling interests	(2		)		3				1				4				(2		)		2				—				8
Net of tax and noncontrolling interests	$	85			$	(72	)		$	13			$	72			$	66			$	(78	)		$	(12	)		$	(411	)

									2014
									Realized gains (losses)
									Before Impairments				Impairments				Total				Change in Unrealized
Fixed maturities									$	36			$	(15	)		$	21			$	570
Equity securities									53				(26		)		27				26
Mortgage loans and other investments									1				—				1				—
Other (*)									(2		)		5				3				(314		)
Total pretax									88				(36		)		52				282
Tax effects									(32		)		13				(19		)		(99		)
Noncontrolling interests									(2		)		1				(1		)		(3		)
Net of tax and noncontrolling interests									$	54			$	(22	)		$	32			$	180

(*)	Primarily adjustments to deferred policy acquisition costs and reserves related to annuities and long-term care business.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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

	2016				2015				2014
Fixed maturities:
Gross gains	$	55			$	38			$	36
Gross losses	(10		)		(7		)		(2		)
Equity securities:
Gross gains	110				99				53
Gross losses	(4		)		(5		)		—

F.    Derivatives

As discussed under “Derivatives” in Note A — “Accounting Policies” to the financial statements, 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):

				December 31, 2016								December 31, 2015
Derivative		Balance Sheet Line		Asset				Liability				Asset				Liability
MBS with embedded derivatives		Fixed maturities		$	107			$	—			$	130			$	—
Public company warrants		Equity securities		4				—				4				—
Fixed-indexed annuities (embedded derivative)		Annuity benefits accumulated		—				1,759				—				1,369
Equity index call options		Equity index call options		492				—				241				—
Reinsurance contracts (embedded derivative)		Other liabilities		—				8				—				7
				$	603			$	1,767			$	375			$	1,376

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 annuities provide policyholders with a crediting rate tied, in part, to the performance of an existing stock market index. AFG attempts to mitigate the risk in the index-based component of these products through the purchase of call options on the appropriate index. AFG receives collateral from its counterparties to support its purchased call option assets. This collateral ($380 million at December 31, 2016 and $211 million at December 31, 2015) 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 option assets 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 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 to the financial statements, certain reinsurance contracts are considered to contain embedded derivatives.

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The following table summarizes the gain (loss) included in AFG’s Statement of Earnings for changes in the fair value of derivatives that do not qualify for hedge accounting for 2016, 2015 and 2014 (in millions):

Derivative		Statement of Earnings Line		2016				2015				2014
MBS with embedded derivatives		Realized gains on securities		$	(9	)		$	(16	)		$	3
Public company warrants		Realized gains on securities		—				—				—
Interest rate swaptions		Realized gains on securities		—				—				(2		)
Fixed-indexed annuities (embedded derivative) (*)		Annuity benefits		(211		)		(17		)		(182		)
Equity index call options		Annuity benefits		141				(56		)		181
Reinsurance contracts (embedded derivative)		Net investment income		(1		)		6				(3		)
				$	(80	)		$	(83	)		$	(3	)

(*)	The change in fair value of the embedded derivative includes losses related to unlocking of actuarial assumptions of $17 million in 2016 compared to losses of $28 million in 2015 and gains related to unlocking of actuarial assumptions of $58 million in 2014.

Derivatives Designated and Qualifying as Cash Flow Hedges   As of December 31, 2016, AFG has entered into seven 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 amortize down 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 increased to $1.08 billion at December 31, 2016 compared to $604 million at December 31, 2015, reflecting four new swaps with an aggregate notional amount at issuance of $610 million entered into in 2016, 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 $1 million at December 31, 2016 and $2 million at December 31, 2015. The fair value of the effective portion of interest rate swaps in a liability position and included in other liabilities was $22 million at December 31, 2016 and less than $1 million at December 31, 2015. 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 $7 million and $6 million in 2016 and 2015, respectively. There was no ineffectiveness recorded in net earnings during these periods. A collateral receivable supporting these swaps of $60 million at December 31, 2016 and $14 million at December 31, 2015 is included in other assets in AFG’s Balance Sheet.

Derivative Designated and Qualifying as a Fair Value Hedge   In June 2015, AFG entered into an interest rate swap to mitigate the interest rate risk associated with its fixed-rate 9-7/8% Senior Notes due June 2019 by effectively converting the interest rate on those notes to a floating rate of three-month LIBOR plus 8.099% (9.0624% at December 31, 2016). Since the terms of the interest rate swap match the terms of the hedged debt, changes in the fair value of the interest rate swap are offset by changes in the fair value of the hedged debt attributable to changes in interest rates. The fair value of the interest rate swap (asset of $1 million and $2 million at December 31, 2016 and December 31, 2015, respectively) and the offsetting adjustment to the carrying value of the 9-7/8% Senior Notes are both included in long-term debt on AFG’s Balance Sheet. Accordingly, the net impact on AFG’s current period earnings is that the interest expense associated with the hedged debt is effectively recorded at the floating rate. The net reduction in interest expense from the swap for 2016 and 2015 was $3 million and $2 million, respectively.

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G.    Deferred Policy Acquisition Costs

A progression of deferred policy acquisition costs is presented below (in millions): 

	P&C					Annuity and Run-off Long-term Care and Life
	Deferred					Deferred				Sales																					Consolidated
	Costs					Costs				Inducements				PVFP				Subtotal				Unrealized				Total					Total
Balance at December 31, 2013	$	211				$	875			$	149			$	85			$	1,109			$	(345	)		$	764				$	975
Additions	497					198				8				—				206				—				206					703
Amortization:
Periodic amortization	(485		)			(130		)		(26		)		(11		)		(167		)		—				(167		)			(652		)
Annuity unlocking	—					(20		)		—				—				(20		)		—				(20		)			(20		)
Included in realized gains	—					2				1				—				3				—				3					3
Foreign currency translation	(2		)			—				—				—				—				—				—					(2		)
Change in unrealized	—					—				—				—				—				(186		)		(186		)			(186		)
Balance at December 31, 2014	221					925				132				74				1,131				(531		)		600					821
Additions	519					224				11				—				235				—				235					754
Amortization:
Periodic amortization	(511		)			(162		)		(26		)		(11		)		(199		)		—				(199		)			(710		)
Annuity unlocking	—					31				4				—				35				—				35					35
Included in realized gains	—					8				1				—				9				—				9					9
Sale of subsidiaries	—					(8		)		(3		)		(8		)		(19		)		—				(19		)			(19		)
Foreign currency translation	(3		)			—				—				—				—				—				—					(3		)
Change in unrealized	—					—				—				—				—				297				297					297
Balance at December 31, 2015	226					1,018				119				55				1,192				(234		)		958					1,184
Additions	535					230				9				—				239				—				239					774
Amortization:
Periodic amortization	(520		)			(169		)		(24		)		(9		)		(202		)		—				(202		)			(722		)
Annuity unlocking	—					25				4				—				29				—				29					29
Included in realized gains	—					6				2				—				8				—				8					8
Foreign currency translation	(3		)			—				—				—				—				—				—					(3		)
Change in unrealized	—					—				—				—				—				(31		)		(31		)			(31		)
Balance at December 31, 2016	$	238				$	1,110			$	110			$	46			$	1,266			$	(265	)		$	1,001				$	1,239

The present value of future profits (“PVFP”) amounts in the table above are net of $134 million and $125 million of accumulated amortization at December 31, 2016 and 2015, respectively. During each of the next five years, the PVFP is expected to decrease at a rate of approximately one-sixth of the balance at the beginning of each respective year.

H.    Managed Investment Entities

AFG is the investment manager and its subsidiaries have investments ranging from 15.0% to 64.4% of the most subordinate debt tranche of fifteen 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 2016, 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.

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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 $216 million (including $144 million invested in the most subordinate tranches) at December 31, 2016, and $266 million at December 31, 2015.

In 2016, AFG formed two new CLOs, which issued an aggregate of $866 million face amount of liabilities (including $64 million face amount purchased by subsidiaries of AFG). During 2016, AFG subsidiaries also purchased $24 million face amount of senior debt and subordinate tranches of existing CLOs for $17 million. During 2016, AFG subsidiaries received $115 million in sale and redemption proceeds from its CLO investments. In 2015, AFG formed two new CLOs, which issued an aggregate of $869 million face amount of liabilities (including $81 million face amount purchased by subsidiaries of AFG). During 2015, AFG subsidiaries also received $77 million in redemption proceeds from its CLO investments. In 2014, AFG formed two new CLOs, which issued an aggregate of $917 million face amount of liabilities (including $94 million face amount purchased by subsidiaries of AFG). During 2014, AFG subsidiaries also purchased $13 million face amount of senior debt tranches of existing CLOs for $13 million and received $81 million in redemption proceeds from its CLO investments. In 2014, four AFG CLOs were 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. See Note A — “Accounting Policies — Managed Investment Entities,” for a discussion of accounting guidance adopted on January 1, 2015 that impacts the measurement of the fair value of CLO liabilities. Selected financial information related to the CLOs is shown below (in millions): 

	Year ended December 31,
	2016				2015				2014
Investment in CLO tranches	$	216			$	266			$	289
Gains (losses) on change in fair value of assets/liabilities (a):
Assets	131				(116		)		(66		)
Liabilities	(116		)		82				22
Management fees paid to AFG	17				15				25
CLO earnings (losses) attributable to (b):
AFG shareholders	37				(6		)		16
Noncontrolling interests	—				—				(51		)

(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 $75 million and $214 million at December 31, 2016 and 2015. The aggregate unpaid principal balance of the CLOs’ debt exceeded its carrying value by $159 million and $205 million at those dates. The CLO assets include $1 million in loans at both December 31, 2016 and December 31, 2015, for which the CLOs are not accruing interest because the loans are in default (aggregate unpaid principal balance of $10 million at both of those dates).

I.    Goodwill and Other Intangibles

Changes in the carrying value of goodwill during 2014, 2015 and 2016, by reporting segment, are presented in the following table (in millions):

	Property and Casualty				Annuity				Total
Balance at January 1, 2014	$	152			$	33			$	185
Acquisition of subsidiary in 2014	16				—				16
Balance at December 31, 2014	168				33				201
Sale of subsidiaries in 2015	—				(2		)		(2		)
Balance at December 31, 2015 and December 31, 2016	$	168			$	31			$	199

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Goodwill increased by $16 million in the second quarter of 2014 due to the purchase of Summit and decreased by $2 million in the fourth quarter of 2015 due to the sale of UTA and CGIC as discussed in Note B — “Acquisitions and Sale of Businesses.”

Included in other assets in AFG’s Balance Sheet is $34 million at December 31, 2016 and $41 million at December 31, 2015 of amortizable intangible assets related to property and casualty insurance acquisitions, primarily the acquisition of Summit in 2014. These amounts are net of accumulated amortization of $25 million and $18 million, respectively. Amortization of intangibles was $8 million in 2016 and 2015 and $19 million in 2014. Future amortization of intangibles (weighted average amortization period of 4 years) is estimated to be $8 million per year in each of 2017 through 2020 and $2 million in 2021.

J.    Long-Term Debt

Long-term debt consisted of the following at December 31 (in millions): 

	2016												2015
	Principal				Discount and Issue Costs				Carrying Value				Principal				Discount and Issue Costs				Carrying Value
Direct Senior Obligations of AFG:
9-7/8% Senior Notes due June 2019	$	350			$	(1	)		$	349			$	350			$	(1	)		$	349
3.50% Senior Notes due August 2026	300				(3		)		297				—				—				—
6-3/8% Senior Notes due June 2042	230				(7		)		223				230				(7		)		223
5-3/4% Senior Notes due August 2042	125				(4		)		121				125				(4		)		121
Other	3				—				3				3				—				3
	1,008				(15		)		993				708				(12		)		696
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
Subsidiaries:
National Interstate bank credit facility	—				—				—				12				—				12
	$	1,308			$	(25	)		$	1,283			$	1,020			$	(22	)		$	998

To achieve a desired balance between fixed and variable rate debt, AFG entered into an interest rate swap in June 2015, which effectively converts its 9-7/8% Senior Notes to a floating rate of three-month LIBOR plus 8.099% (9.0624% at December 31, 2016 and 8.6110% at December 31, 2015). The fair value of the interest rate swap (asset of $1 million and $2 million at December 31, 2016 and December 31, 2015, respectively) and the offsetting adjustment to the carrying value of the notes are both included in the carrying value of the 9-7/8% Senior Notes in the table above.

At December 31, 2016, scheduled principal payments on debt for the subsequent five years and thereafter were as follows: 2017 — none; 2018 — none; 2019 — $350 million; 2020 — none; 2021 — none and thereafter — $958 million.

As shown below at December 31 (principal amount, in millions), the majority of AFG’s long-term debt is unsecured obligations of the holding company and its subsidiaries:

	2016				2015
Senior unsecured obligations	$	1,008			$	720
Subordinated unsecured obligations	300				300
	$	1,308			$	1,020

 

In August 2016, AFG issued $300 million in 3.50% Senior Notes due in 2026 at a price of 99.608%. The net proceeds of the offering were used to fund a portion of the November 10, 2016 acquisition of the noncontrolling interest in NATL (discussed in Note B — “Acquisitions and Sale of Businesses”). At the acquisition date, the $18 million outstanding under NATL’s bank credit facility, including $6 million borrowed in September 2016, was repaid and the credit agreement was terminated.

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In June 2016, AFG replaced its existing credit facility with a new five-year, $500 million 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 December 31, 2016 or AFG’s previous credit facility at December 31, 2015.

In September 2015, AFG used cash on hand to redeem the $132 million in outstanding AFG 7% Senior Notes due September 2050 at par value. In November 2015, AFG issued $150 million in 6% Subordinated Debentures due in 2055. During 2015, subsidiaries of AFG repaid all of the outstanding notes secured by real estate.

In September 2014, AFG issued $150 million in 6-1/4% Subordinated Debentures due 2054.

Cash interest payments on long-term debt were $75 million in 2016, $75 million in 2015 and $72 million in 2014. In 2016 and 2015, AFG received $3 million and $2 million, respectively, in interest under the interest rate swap discussed above.

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.

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. At December 31, 2016, there were 9.3 million shares of AFG Common Stock reserved for issuance under AFG’s stock incentive plans.

The restricted Common Stock that AFG has granted generally vests over a three or four year period. Data relating to grants of restricted stock is presented below:

	Shares			Average Grant Date Fair Value
Outstanding at January 1, 2016	505,698			$	51.43
Granted	318,940			$	67.00
Vested	(141,598	)		$	40.73
Forfeited	(4,165	)		$	64.08
Outstanding at December 31, 2016	678,875			$	60.90

AFG issued 40,336 shares of Common Stock (fair value of $71.05 per share) in the first quarter of 2016 and 54,732 shares (fair value of $62.55 per share) in the first quarter of 2015 under its Equity Bonus Plan.

AFG did not grant any stock options in 2016. Options granted in years prior to 2016 have an exercise price equal to the market price of AFG Common Stock at the date of grant. Options generally become exercisable at the rate of 20% per year commencing one year after grant and expire ten years after the date of grant.

Data for stock options issued under AFG’s stock incentive plans is presented below:

	Shares			Average Exercise Price				Average Remaining Contractual Term		Aggregate Intrinsic Value (in millions)
Outstanding at January 1, 2016	5,516,090			$	41.46
Exercised	(958,344	)		$	33.56
Forfeited/Cancelled	(52,645	)		$	51.91
Outstanding at December 31, 2016	4,505,101			$	43.02			5.4 years		$	203
Options exercisable at December 31, 2016	2,908,200			$	36.95			4.4 years		$	149

The total intrinsic value of options exercised during 2016, 2015 and 2014 was $38 million, $52 million and $38 million, respectively. During 2016, 2015 and 2014, AFG received $32 million, $47 million and $35 million, respectively, in cash from the exercise of stock options. The total tax benefit related to the exercises was $11 million, $16 million and $12 million

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(including $12 million and $9 million credited directly to capital surplus in 2015 and 2014, respectively) during those years, respectively.

AFG used the Black-Scholes option pricing model to calculate the fair value of its option grants issued during 2015 and 2014 (no options were granted in 2016). The expected dividend yield is based on AFG’s current dividend rate. To determine expected volatility, AFG considers its daily historical volatility as well as implied volatility on traded options. The expected term was estimated based on historical exercise patterns and post vesting cancellations. The risk-free rate for periods associated with the expected term is based upon the U.S. Treasury yield curve in effect on the grant date.

	2015				2014
Exercise price	$	63.15			$	56.47
Expected dividend yield	1.6		%		1.6		%
Expected volatility	25		%		26		%
Expected term (in years)	7.25				7.25
Risk-free rate	1.88		%		2.20		%
Grant date fair value	$	15.29			$	14.66

Total compensation expense related to stock incentive plans of AFG and its subsidiaries for 2016, 2015 and 2014 was $28 million, $27 million and $25 million, respectively. AFG’s provision for income tax includes tax benefits of $19 million in 2016 and $8 million in 2015 and 2014 related to AFG’s stock incentive plans. The $19 million tax benefit in 2016 includes $9 million that under previous guidance would have been credited to capital surplus. At December 31, 2016, there was $16 million and $24 million of unrecognized compensation expense related to nonvested stock options and restricted stock awards, respectively. Both of these amounts are expected to be recognized over a weighted average of 2.3 years.

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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. The progression of the components of accumulated other comprehensive income follows (in millions):

					Other Comprehensive Income
	AOCI Beginning Balance				Pretax				Tax				Net of tax				Attributable to noncontrolling interests				Attributable to shareholders				Other (c)				AOCI Ending Balance
Year ended December 31, 2016
Net unrealized gains on securities:
Unrealized holding gains (losses) on securities arising during the period					$	124			$	(44	)		$	80			$	(4	)		$	76
Reclassification adjustment for realized (gains) losses included in net earnings (a)					(19		)		7				(12		)		(1		)		(13		)
Total net unrealized gains on securities (b)	$	332			105				(37		)		68				(5		)		63				$	9			$	404
Net unrealized gains (losses) on cash flow hedges	1				(12		)		4				(8		)		—				(8		)		—				(7		)
Foreign currency translation adjustments	(22		)		6				1				7				—				7				—				(15		)
Pension and other postretirement plans adjustments	(7		)		—				—				—				—				—				—				(7		)
Total	$	304			$	99			$	(32	)		$	67			$	(5	)		$	62			$	9			$	375
Year ended December 31, 2015
Net unrealized gains (losses) on securities:
Unrealized holding gains (losses) on securities arising during the period					$	(625	)		$	219			$	(406	)		$	9			$	(397	)
Reclassification adjustment for realized (gains) losses included in net earnings (a)					14				(5		)		9				(1		)		8
Reclassification for unrealized gains of subsidiaries sold					(34		)		12				(22		)		—				(22		)
Total net unrealized gains (losses) on securities (b)	$	743			(645		)		226				(419		)		8				(411		)		$	—			$	332
Net unrealized gains on cash flow hedges	—				1				—				1				—				1				—				1
Foreign currency translation adjustments	(8		)		(9		)		(5		)		(14		)		—				(14		)		—				(22		)
Pension and other postretirement plans adjustments	(8		)		1				—				1				—				1				—				(7		)
Total	$	727			$	(652	)		$	221			$	(431	)		$	8			$	(423	)		$	—			$	304
Year ended December 31, 2014
Net unrealized gains on securities:
Unrealized holding gains on securities arising during the period					$	334			$	(118	)		$	216			$	(4	)		$	212
Reclassification adjustment for realized (gains) losses included in net earnings (a)					(52		)		19				(33		)		1				(32		)
Total net unrealized gains on securities (b)	$	563			282				(99		)		183				(3		)		180				$	—			$	743
Foreign currency translation adjustments	1				(8		)		(1		)		(9		)		—				(9		)		—				(8		)
Pension and other postretirement plans adjustments	(4		)		(6		)		2				(4		)		—				(4		)		—				(8		)
Total	$	560			$	268			$	(98	)		$	170			$	(3	)		$	167			$	—			$	727

 

(a)	The reclassification adjustment out of net unrealized gains 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
	Attributable to noncontrolling interests		Net earnings (loss) attributable to noncontrolling interests

(b)	Includes net unrealized gains of $52 million at December 31, 2016 compared to net unrealized gains of $51 million and $58 million at December 31, 2015 and 2014, related to securities for which only the credit portion of an other-than-temporary impairment has been recorded in earnings.

(c)	Other represents the impact on AOCI of the November 2016 acquisition of the noncontrolling interest in NATL (see Note B — “Acquisitions and Sale of Businesses”).

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L.    Income Taxes

The following is a reconciliation of income taxes at the statutory rate of 35% to the provision for income taxes as shown in AFG’s Statement of Earnings (dollars in millions):

	2016							2015							2014
	Amount				% of EBT			Amount				% of EBT			Amount				% of EBT
Earnings before income taxes (“EBT”)	$	787						$	565						$	626
Income taxes at statutory rate	$	275			35	%		$	198			35	%		$	219			35	%
Effect of:
Tax exempt interest	(24		)		(3	%)		(27		)		(5	%)		(25		)		(4	%)
Change in valuation allowance	52				7	%		23				4	%		7				1	%
Stock-based compensation	(9		)		(1	%)		1				—	%		1				—	%
Subsidiaries not in AFG’s tax return	3				—	%		2				1	%		1				—	%
Acquisition of noncontrolling interest in NATL	(66		)		(8	%)		—				—	%		—				—	%
Neon restructuring	(111		)		(14	%)		—				—	%		—				—	%
Losses of managed investment entities	—				—	%		—				—	%		18				3	%
Other	(1		)		(1	%)		(2		)		—	%		(1		)		—	%
Provision for income taxes as shown in the statement of earnings	$	119			15	%		$	195			35	%		$	220			35	%

The changes in valuation allowance in the table above are primarily increases in the valuation allowance on tax benefits related to losses in the Neon Lloyd’s insurance business. AFG maintains a full valuation allowance against the deferred tax benefits associated with losses related to Neon.

As discussed in Note B — “Acquisitions and Sale of Businesses,” AFG acquired the noncontrolling interest in NATL in November 2016. This transaction allowed NATL and its subsidiaries to become members of the AFG consolidated tax group, which resulted in a tax benefit of $66 million to AFG during the fourth quarter of 2016.

In January 2008, AFG paid $75 million in cash to acquire approximately 67% of Neon Underwriting Limited (“Neon”, formerly known as Marketform Group Limited), a United Kingdom-based Lloyd’s insurer. During 2012, AFG acquired the then-remaining shares of Neon that it did not already own for $17 million. Neon has recorded underwriting losses in each period from the date of AFG’s initial investment, including adverse prior year reserve development related to Italian public hospital medical malpractice business which Neon ceased writing in 2008, as well as other lines of business. AFG’s investment in Neon includes the cost of acquiring the company as well as additional capital provided to Neon since the date of acquisition.

In 2011, cumulative losses at Neon across multiple lines of business resulted in uncertainty concerning the realization of the deferred tax benefits associated with the losses. Consequently, AFG began maintaining a full valuation allowance against the deferred tax assets related to the Lloyd’s insurance business in 2011.

In connection with the ongoing reorganization of the Neon Lloyd’s business, in December 2016, AFG undertook a restructuring that included the liquidation for tax purposes of the foreign subsidiary that is the parent of the Neon Lloyd’s operations, resulting in a taxable loss for U.S. tax purposes. AFG reported the $111 million tax benefit associated with this loss in the fourth quarter of 2016. Approximately $29 million of the $111 million tax benefit reduced current taxes payable while the remaining tax benefit will be received from the carry-back of the tax-basis capital loss to offset capital gains in prior tax years.

Excluding a $65 million charge related to the exit of certain lines of business within Neon and the tax benefits related to the acquisition of the noncontrolling interest in NATL and the Neon restructuring, AFG’s effective tax rate for the year ended December 31, 2016, was 35%.

AFG’s 2012 — 2016 tax years remain subject to examination by the IRS.

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Total earnings before income taxes include losses subject to tax in foreign jurisdictions of $160 million in 2016, $66 million in 2015 and $4 million in 2014.

The total income tax provision (credit) consists of (in millions):

	2016				2015				2014
Current taxes:
Federal	$	299			$	216			$	265
State	12				8				8
Deferred taxes:
Federal	(192		)		(29		)		(53		)
Provision for income taxes	$	119			$	195			$	220

For income tax purposes, AFG and its subsidiaries had the following carryforwards available at December 31, 2016 (in millions):

	Expiring		Amount
Operating Loss – U.S.	2017 - 2022		$	143
Operating Loss – United Kingdom	indefinite		139			(*)
Capital Loss – U.S.	2021		237

(*)	£112 million

Deferred income tax assets and liabilities reflect temporary differences between the carrying amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. The significant components of deferred tax assets and liabilities included in AFG’s Balance Sheet at December 31 were as follows (in millions):

	2016												2015
	Excluding Unrealized Gains				Impact of Unrealized Gains				Total				Excluding Unrealized Gains				Impact of Unrealized Gains				Total
Deferred tax assets:
Federal net operating loss carryforwards	$	50			$	—			$	50			$	50			$	—			$	50
Foreign underwriting losses	120				—				120				77				—				77
Capital loss carryforwards	83				—				83				32				—				32
Insurance claims and reserves	774				27				801				691				22				713
Employee benefits	131				—				131				115				—				115
Other, net	40				(5		)		35				33				(4		)		29
Total deferred tax assets before valuation allowance	1,198				22				1,220				998				18				1,016
Valuation allowance against deferred tax assets	(173		)		—				(173		)		(130		)		—				(130		)
Total deferred tax assets	1,025				22				1,047				868				18				886
Deferred tax liabilities:
Subsidiaries not in AFG’s tax return	—				—				—				(63		)		—				(63		)
Investment securities	29				(336		)		(307		)		23				(281		)		(258		)
Deferred policy acquisition costs	(448		)		96				(352		)		(418		)		82				(336		)
Total deferred tax liabilities	(419		)		(240		)		(659		)		(458		)		(199		)		(657		)
Net deferred tax asset (liability)	$	606			$	(218	)		$	388			$	410			$	(181	)		$	229

AFG’s net deferred tax asset at December 31, 2016 and 2015 is included in other assets in AFG’s Balance Sheet.

The likelihood of realizing deferred tax assets is reviewed periodically; any adjustments required to the valuation allowance are made in the period during which developments requiring an adjustment become known.

“Foreign underwriting losses” in the table above include the net operating loss carryforward and other deferred tax assets related to the Neon Lloyd’s insurance business. Due to uncertainty concerning the realization of the deferred tax benefits

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associated with these losses, AFG maintains a full valuation allowance of $120 million against these deferred tax assets at December 31, 2016. In addition to the valuation allowance related to the Neon Lloyd’s insurance business, the gross deferred tax asset has also been reduced by a $50 million valuation allowance related to a portion of AFG’s net operating loss carryforwards (“NOL”) subject to the separate return limitation year (“SRLY”) tax rules. A SRLY NOL can be used only by the entity that created it and only in years that both it and the consolidated group have taxable income.

“Subsidiaries not in AFG’s tax return” in the table above represents a deferred tax liability related to AFG’s investment in NATL during the time that it was a less than 80%-owned subsidiary of AFG. In November 2016, AFG completed the acquisition of the noncontrolling interest in NATL. This transaction allowed NATL and its subsidiaries to become members of AFG’s consolidated tax group, which enabled AFG to release the deferred tax liability ($66 million at the transaction date) associated with its investment in NATL.

AFG increased its liability for uncertain tax positions by $1 million in 2015 due to uncertainty in state taxation of its surplus lines insurance subsidiaries.

In July 2014, AFG finalized a settlement with the IRS related to tax years 2008 and 2009. As a result, AFG’s uncertain tax positions were effectively settled, allowing AFG to reduce its liability for previously uncertain tax positions by $19 million in the third quarter of 2014. Although AFG agreed to pay $11 million to the IRS, the majority of the reduction in this liability resulted in offsetting adjustments to AFG’s deferred tax liability and did not impact AFG’s effective tax rate. The portion of the reduction in this liability that favorably impacted the effective tax rate was approximately $4 million including interest. The reduction of the liability for previously uncertain tax positions includes $17 million related to the timing of recognition of investment income on certain debt securities and $2 million related to the deductibility of certain financing expenses.

A progression of the liability for uncertain tax positions, excluding interest and penalties, follows (in millions):

	2016				2015				2014
Balance at January 1	$	1			$	—			$	19
Additions for tax positions of prior years	—				1				—
Reductions for tax positions of prior years	—				—				(8		)
Additions for tax positions of current year	—				—				—
Settlements	—				—				(11		)
Balance at December 31	$	1			$	1			$	—

AFG’s provision for income taxes included an expense of less than $1 million in 2016 and 2015 and a benefit of $1 million in 2014 of interest (net of federal benefit or expense). AFG’s liability for interest related to unrecognized tax benefits was less than $1 million at December 31, 2016 and December 31, 2015 (net of federal benefit); no interest was accrued at December 31, 2014. AFG’s provision for income taxes in 2016 included an expense of less than $1 million for penalties; no penalties were recorded in 2015 or 2014. AFG’s liability for penalties related to unrecognized tax benefits was less than $1 million at December 31, 2016; no penalties were accrued at December 31, 2015 or December 31, 2014.

Cash payments for income taxes, net of refunds, were $308 million, $234 million and $347 million for 2016, 2015 and 2014, respectively.

M.     Contingencies

Establishing property and casualty insurance reserves for claims related to environmental exposures, asbestos and other mass tort claims is subject to uncertainties that are significantly greater than those presented by other types of claims. For this group of claims, traditional actuarial techniques that rely on historical loss development trends cannot be used and a range of reasonably possible losses cannot be estimated. In addition, accruals (included in other liabilities) have been recorded for various environmental and occupational injury and disease claims and other contingencies arising out of the railroad operations disposed of by American Premier’s predecessor, Penn Central Transportation Company (“PCTC”) and its subsidiaries, prior to its bankruptcy reorganization in 1978 and certain manufacturing operations disposed of by American Premier and Great American Financial Resources, Inc. (“GAFRI”).

AFG completed an in-depth internal review of its asbestos and environmental (“A&E”) exposures in the third quarter of 2016. The review resulted in special A&E charges of $36 million for the property and casualty group and $5 million for the former

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railroad and manufacturing operations. AFG completed a comprehensive external study of its A&E exposures in the third quarter of 2015 with the aid of specialty actuarial, engineering and consulting firms and outside counsel. The study resulted in special A&E charges of $67 million for the property and casualty group and $12 million for the former railroad and manufacturing operations. AFG completed an in-depth internal review of its A&E exposures in the third quarter of 2014, which resulted in special A&E charges of $24 million for the property and casualty group and $6 million for the former railroad and manufacturing operations.

The property and casualty group’s liability for asbestos and environmental reserves was $443 million at December 31, 2016; related recoverables from reinsurers (net of allowances for doubtful accounts) at that date were $106 million.

At December 31, 2016, American Premier and its subsidiaries had liabilities for environmental and personal injury claims and other contingencies aggregating $77 million. The environmental claims consist of a number of proceedings and claims seeking to impose responsibility for hazardous waste remediation costs related to certain sites formerly owned or operated by the railroad and manufacturing operations. Remediation costs are difficult to estimate for a number of reasons, including the number and financial resources of other potentially responsible parties, the range of costs for remediation alternatives, changing technology and the time period over which these matters develop. The personal injury claims and other contingencies include pending and expected claims, primarily by former employees of PCTC, for injury or disease allegedly caused by exposure to excessive noise, asbestos or other substances in the workplace and other labor disputes.

At December 31, 2016, GAFRI had a liability of approximately $9 million for environmental costs and certain other matters associated with the sales of its former manufacturing operations.

See Note B — “Acquisitions and Sale of Businesses” for a discussion of the five-year capital maintenance agreement that AFG entered into in connection with obtaining regulatory approval for the sale of substantially all of its run-off long-term care insurance business in December 2015.

While management believes AFG has recorded adequate reserves for the items discussed above in this note, the outcome is uncertain and could result in liabilities that may vary from amounts AFG has currently recorded. Such amounts could have a material effect on AFG’s future results of operations and financial condition.

In addition, AFG and its subsidiaries are involved in litigation from time to time, generally arising in the ordinary course of business. This litigation may include, but is not limited to, general commercial disputes, lawsuits brought by policyholders, employment matters, reinsurance collection matters and actions challenging certain business practices of insurance subsidiaries. None of these matters are expected to have a material adverse impact on AFG’s results of operations or financial condition.

N.     Quarterly Operating Results (Unaudited)

The operations of certain AFG business segments are seasonal in nature. While insurance premiums are recognized on a relatively level basis, claim losses related to adverse weather (snow, hail, hurricanes, severe storms, tornadoes, etc.) may be seasonal. The profitability of AFG’s crop insurance business is primarily recognized during the second half of the year as crop prices and yields are determined. Quarterly results necessarily rely heavily on estimates. These estimates and certain other factors, such as the discretionary sales of assets, cause the quarterly results not to be necessarily indicative of results for longer periods of time.

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The following are quarterly results of consolidated operations for the two years ended December 31, 2016 (in millions, except per share amounts). Quarterly earnings per share do not add to year-to-date amounts due to changes in shares outstanding.

		1st Quarter				2nd Quarter				3rd Quarter				4th Quarter				Total Year
2016
Revenues		$	1,475			$	1,581			$	1,705			$	1,737			$	6,498
Net earnings, including noncontrolling interests		104				63				113				388				668
Net earnings attributable to shareholders		101				54				109				385				649
Earnings attributable to shareholders per Common Share:
Basic		$	1.16			$	0.63			$	1.25			$	4.43			$	7.47
Diluted		1.14				0.62				1.23				4.33				7.33
Average number of Common Shares:
Basic		86.9				86.8				86.9				86.9				86.9
Diluted		88.5				88.4				88.5				88.8				88.5
2015
Revenues		$	1,297			$	1,543			$	1,687			$	1,618			$	6,145
Net earnings, including noncontrolling interests		25				149				66				130				370
Net earnings attributable to shareholders		19				141				63				129				352
Earnings attributable to shareholders per Common Share:
Basic		$	0.22			$	1.60			$	0.72			$	1.48			$	4.02
Diluted		0.21				1.57				0.71				1.45				3.94
Average number of Common Shares:
Basic		87.6				87.7				87.5				87.4				87.6
Diluted		89.4				89.5				89.3				89.2				89.4

Pretax realized gains on subsidiaries and securities (including other-than-temporary impairments) and favorable (adverse) prior year development of AFG’s liability for losses and loss adjustment expenses (“LAE”) were as follows (in millions):

		1st Quarter				2nd Quarter				3rd Quarter				4th Quarter				Total Year
Realized Gains (Losses) on Securities and Subsidiaries
2016		$	(18	)		$	(14	)		$	2			$	51			$	21
2015		(143		)		(1		)		(11		)		(25		)		(180		)
Prior Year Development Favorable (Adverse)
2016		$	28			$	(28	)		$	(22	)		$	(10	)		$	(32	)
2015		7				10				(55		)		5				(33		)

Realized losses on subsidiaries in 2015 include a $166 million realized loss (consisting of an initial loss estimate of $162 million recorded in the first quarter and a $4 million loss adjustment in the fourth quarter) related to the impact of the sale of two subsidiaries, which contained substantially all of AFG’s long-term care insurance business. See Note B — “Acquisitions and Sale of Businesses.”

During the second quarter of 2016, AFG recorded a pretax charge of $65 million related to Neon’s claims review of its exited lines of business, including $57 million to increase loss reserves primarily related to its medical malpractice and general liability classes. Adverse prior year development for the third quarters of 2016 and 2015 include pretax special charges of $36 million and $67 million, respectively, to strengthen property and casualty insurance A&E reserves.

Results include pretax gains (included in other income) of $32 million from the sale of an apartment property in the second quarter of 2016, $51 million from the sale of a hotel in the second quarter of 2015 and $15 million from the sale of an apartment property in the fourth quarter of 2015.

Results for the third quarter of 2016 and 2015 include pretax special charges of $5 million and $12 million, respectively, to strengthen reserves for A&E exposures related to AFG’s former railroad and manufacturing operations.

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Net earnings in the fourth quarter of 2016 includes $177 million in tax benefits related to the NATL merger and Neon restructuring. See Note L — “Income Taxes.”

O.     Insurance

Cash and securities owned by U.S.-based insurance subsidiaries, having a carrying value of approximately $1.00 billion at December 31, 2016, were on deposit as required by regulatory authorities. In addition, $215 million was on deposit in support of AFG’s underwriting activities at Lloyd’s. At December 31, 2016, AFG and its subsidiaries had $332 million in undrawn letters of credit (none of which was collateralized) supporting the underwriting capacity of its U.K.-based Lloyd’s insurer, Neon.

Property and Casualty Insurance Reserves   Estimating the liability for unpaid losses and loss adjustment expenses (“LAE”) is inherently judgmental and is influenced by factors that are subject to significant variation. Determining the liability is a complex process incorporating input from many areas of the Company including actuarial, underwriting, pricing, claims and operations management.

The process used to determine the total reserve for liabilities involves estimating the ultimate incurred losses and LAE, adjusted for amounts already paid on the claims. The IBNR reserve is derived by first estimating the ultimate unpaid reserve liability and subtracting case reserves for loss and LAE.

In determining management’s best estimate of the ultimate liability, management (with the assistance of Company actuaries) considers items such as the effect of inflation on medical, hospitalization, material, repair and replacement costs, the nature and maturity of lines of insurance, general economic trends and the legal environment. In addition, historical trends adjusted for changes in underwriting standards, policy provisions, product mix and other factors are analyzed using actuarial reserve development techniques. Weighing all of the factors, the management team determines a single or “point” estimate that it records as its best estimate of the ultimate liability. Ranges of loss reserves are not developed by Company actuaries. This reserve analysis and review is completed each quarter and for almost every business within AFG’s property and casualty sub-segments.

Each review includes in-depth analysis of several hundred subdivisions of the business, employing multiple actuarial techniques. For each subdivision, actuaries use informed, professional judgment to adjust these techniques as necessary to respond to specific conditions in the data or within the business.

Some of the standard actuarial methods employed for the quarterly reserve analysis may include (but may not be limited to):

•	Case Incurred Development Method

•	Paid Development Method

•	Bornhuetter-Ferguson Method

•	Incremental Paid LAE to Paid Loss Methods

Management believes that each method has particular strengths and weaknesses and that no single estimation method is most accurate in all situations. When applied to a particular group of claims, the relative strengths and weaknesses of each method can change over time based on the facts and circumstances. Ultimately, the estimation methods chosen are those which management believes produce the most reliable indication for the particular liabilities under review.

The period of time from the occurrence of a loss through the settlement of the liability is referred to as the “tail”. Generally, the same actuarial methods are considered for both short-tail and long-tail lines of business because most of them work properly for both. The methods are designed to incorporate the effects of the differing length of time to settle particular claims. For short-tail lines, management tends to give more weight to the Case Incurred and Paid Development methods, although the various methods tend to produce similar results. For long-tail lines, more judgment is involved, and more weight may be given to the Bornhuetter-Ferguson method. Liability claims for long-tail lines are more susceptible to litigation and can be significantly affected by changing contract interpretation and the legal environment. Therefore, the estimation of loss reserves for these classes is more complex and subject to a higher degree of variability.

The level of detail in which data is analyzed varies among the different lines of business. Data is generally analyzed by major product or by coverage within product, using countrywide data; however, in some situations, data may be reviewed by state or region. Appropriate segmentation of the data is determined based on data credibility, homogeneity of development patterns, mix of business, and other actuarial considerations.

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Supplementary statistical information is also reviewed to determine which methods are most appropriate to use or if adjustments are needed to particular methods. Such information includes:

•	Open and closed claim counts

•	Average case reserves and average incurred on open claims

•	Closure rates and statistics related to closed and open claim percentages

•	Average closed claim severity

•	Ultimate claim severity

•	Reported loss ratios

•	Projected ultimate loss ratios

•	Loss payment patterns

Within each business, results of individual methods are reviewed, supplementary statistical information is analyzed, and data from underwriting, operating and claim management are considered in deriving management’s best estimate of the ultimate liability. This estimate may be the result of one method, a weighted average of several methods, or a judgmental selection as the management team determines is appropriate.

The liability for losses and LAE for a very limited number of claims with long-term scheduled payments under certain workers’ compensation policies has been discounted at 4.5% at both December 31, 2016 and 2015, which represents an approximation of long-term investment yields. Because of the limited amount of claims involved, the net impact of discounting did not materially impact AFG’s total liability for unpaid losses and loss adjustment expenses (net reductions from discounting of $16 million and $18 million at December 31, 2016 and 2015, respectively).

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

	2016				2015				2014
Balance at beginning of period	$	8,127			$	7,872			$	6,410
Less reinsurance recoverables, net of allowance	2,201				2,227				2,122
Net liability at beginning of period	5,926				5,645				4,288
Provision for losses and LAE occurring in the current year	2,730				2,662				2,488
Net increase (decrease) in the provision for claims of prior years:
Special A&E charges	36				67				24
Neon exited lines charge	57				—				—
Other	(61		)		(34		)		(18		)
Total losses and LAE incurred	2,762				2,695				2,494
Payments for losses and LAE of:
Current year	(841		)		(828		)		(789		)
Prior years	(1,512		)		(1,575		)		(1,340		)
Total payments	(2,353		)		(2,403		)		(2,129		)
Reserves of businesses acquired (disposed) (*)	(40		)		—				1,028
Foreign currency translation and other	(34		)		(11		)		(36		)
Net liability at end of period	6,261				5,926				5,645
Add back reinsurance recoverables, net of allowance	2,302				2,201				2,227
Gross unpaid losses and LAE included in the balance sheet	$	8,563			$	8,127			$	7,872

(*)	Reflects the November 2016 reinsurance to close transaction at Neon (discussed below) and the acquisition of Summit in April 2014 (discussed in Note B — “Acquisitions and Sale of Businesses”).

The net increase in the provision for claims of prior years in 2016 reflects (i) reserve strengthening at National Interstate (within the Property and transportation sub-segment), (ii) adverse reserve development at Neon and higher than anticipated severity in New York contractor claims (within the Specialty casualty sub-segment), (iii) the $57 million special charge to increase loss reserves related to Neon’s exit of its UK and international medical malpractice and general liability lines of business, and (iv) the $36 million special charge to increase asbestos and environmental reserves. This adverse development was partially offset by (i) lower than expected losses in crop operations and lower than expected claim severity in the property and inland marine and trucking businesses (all within the Property and transportation sub-segment), (ii) lower than anticipated claim frequency and severity in workers’ compensation business, lower than expected claim severity in directors and officers liability insurance and lower than expected claim frequency and severity in excess liability business (all within the Specialty casualty

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sub-segment), and (iii) lower than anticipated claim severity in the fidelity and crime business and lower than expected claim frequency and severity in the surety business (within the Specialty financial sub-segment).

The net increase in the provision for claims of prior years in 2015 reflects (i) higher than expected claim severity at National Interstate and higher than anticipated claim frequency in the ocean marine business (all within the Property and transportation sub-segment), (ii) adverse reserve development at Neon (within the Specialty casualty sub-segment), and (iii) the $67 million special charge to increase asbestos and environmental reserves. This adverse development was partially offset by (i) lower than expected claim severity in the property and inland marine business, agricultural operations and a run-off book of homebuilders business (all within the Property and transportation sub-segment), (ii) lower than anticipated claim severity in workers’ compensation business, lower than anticipated claim severity and frequency in excess liability insurance and lower than expected claim severity in directors and officers liability insurance (all within the Specialty casualty sub-segment), and (iii) lower than anticipated claim frequency and severity in the surety business and products for financial institutions and lower than expected claim severity in the fidelity business and run-off collateral value insurance (all within the Specialty financial sub-segment).

Net adverse reserve development in 2014 reflects higher than expected severity in commercial auto liability losses written in the transportation businesses (within the Property and transportation sub-segment), higher than expected claims severity in contractor claims and in a run-off book of casualty business and adverse reserve development at Neon (all within the Specialty casualty sub-segment), and the $24 million special charge to increase asbestos and environmental reserves. This adverse reserve development was offset by (i) lower than expected claim severity in directors and officers liability insurance, lower than expected claim severity and frequency in excess liability insurance and lower than anticipated claim severity in specialty workers’ compensation business (all within the Specialty casualty sub-segment), and (ii) lower than expected claim severity in the surety and fidelity businesses and lower than expected claim frequency and severity in the foreign credit business and products for financial institutions (all within the Specialty financial sub-segment).

In November 2016, the Neon Lloyd’s syndicate completed a reinsurance to close transaction for its 2007 year of account with StarStone Underwriting Limited, a subsidiary of Enstar Group Limited. The transaction included a quota share of the Italian public hospital business written in Neon’s 2008 year of account and represents Neon’s complete exit from the Italian public hospital medical malpractice business. 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.

In May 2015, the FASB issued ASU 2015-09, Financial Services-Insurance: Disclosures about Short-Duration Contracts. The ASU requires insurance entities to disclose incurred and paid claims development information by accident year, net of reinsurance. All of AFG’s material short-duration insurance contracts are written in its property and casualty insurance segment. The development tables and the associated disclosures are aggregated in the following Specialty sub-segments: Property and transportation, Specialty casualty, Specialty financial and Other specialty. See Note C — “Segments of Operations” to the financial statements for a discussion of these sub-segments.

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A reconciliation of incurred and paid claims development information to the aggregate carrying amount of the liability for unpaid losses and LAE, with separate disclosure of reinsurance recoverables on unpaid claims is shown below (in millions):

	2016				2015
Unpaid losses and allocated LAE, net of reinsurance:
Specialty
Property and transportation	$	1,020			$	971
Specialty casualty	3,356				3,170
Specialty financial	228				219
Other specialty	240				240
Total Specialty (excluding foreign reserves)	4,844				4,600
Other reserves
Reserves for foreign operations	710				648
A&E reserves	337				327
Unallocated LAE	310				296
Other	60				55
Total other reserves	1,417				1,326
Total reserves, net of reinsurance	6,261				5,926
Add back reinsurance recoverables, net of allowance	2,302				2,201
Gross unpaid losses and LAE included in the balance sheet	$	8,563			$	8,127

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The following claims development tables and associated disclosures related to short-duration insurance contracts are prepared by sub-segment within the property and casualty insurance business for the most recent 10 accident years. AFG determines its claim counts at the claimant or policy feature level depending on the particular facts and circumstances of the underlying claim. While the methodology is generally consistent within each sub-segment, there are minor differences between and within the sub-segments. The methods used to summarize claim counts have not changed significantly over the time periods reported in the tables below.

Property and transportation
(Dollars in Millions)
		Incurred Claims and Allocated LAE, Net of Reinsurance																																								As of December 31, 2016
		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)																																								Total IBNR Plus Expected Development on Reported Claims				Cumulative Number of Reported Claims
Accident Year		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016
2007		$	657			$	595			$	577			$	572			$	572			$	569			$	569			$	568			$	568			$	568			$	1			126,900
2008						923				871				852				853				856				854				855				856				854				3				157,173
2009										526				506				523				516				511				511				508				508				4				140,530
2010														702				662				668				676				679				679				683				10				140,614
2011																		830				816				831				845				856				868				16				140,408
2012																						890				884				897				909				922				27				146,584
2013																										911				898				902				908				40				142,139
2014																														868				852				841				67				137,214
2015																																		840				802				106				134,407
2016																																						760				250				109,187
																																		Total				$	7,714

		Cumulative Paid Claims and Allocated LAE, Net of Reinsurance
Accident Year		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)
		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016				% (a)
2007		$	284			$	450			$	492			$	523			$	539			$	553			$	559			$	562			$	563			$	564			99.3	%
2008						352				706				761				799				824				835				846				846				847				99.2	%
2009										229				348				413				456				479				493				497				499				98.2	%
2010														328				505				556				618				649				660				665				97.4	%
2011																		373				679				742				787				821				840				96.8	%
2012																						582				725				793				841				868				94.1	%
2013																										449				721				784				831				91.5	%
2014																														337				646				711				84.5	%
2015																																		367				594				74.1	%
2016																																						296				38.9	%
																																		Total				$	6,715
																		Unpaid losses and LAE — years 2007 through 2016																				999
						Unpaid losses and LAE — 11th year and prior (excluding unallocated LAE)																																21
						Unpaid losses and LAE, net of reinsurance (excluding unallocated LAE)																																$	1,020

		Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Supplementary Information and Unaudited)
		Year 1			Year 2			Year 3			Year 4			Year 5			Year 6			Year 7			Year 8			Year 9			Year 10
Annual		46.5	%		29.5	%		7.9	%		6.1	%		3.6	%		2.1	%		1.0	%		0.3	%		0.1	%		0.2	%
Cumulative		46.5	%		76.0	%		83.9	%		90.0	%		93.6	%		95.7	%		96.7	%		97.0	%		97.1	%		97.3	%

(a)	Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2016).

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Specialty casualty
(Dollars in Millions)
		Incurred Claims and Allocated LAE, Net of Reinsurance																																								As of December 31, 2016
		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)																																								Total IBNR Plus Expected Development on Reported Claims				Cumulative Number of Reported Claims
Accident Year		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016
2007		$	1,036			$	957			$	892			$	852			$	828			$	821			$	818			$	794			$	802			$	803			$	40			62,676
2008						905				891				874				860				871				856				855				849				855				48				59,886
2009										864				867				845				826				816				811				812				807				58				53,097
2010														847				863				864				842				856				846				845				74				52,771
2011																		831				831				819				828				814				808				89				50,635
2012																						874				865				859				859				855				124				49,732
2013																										938				921				915				910				159				49,239
2014																														1,011				984				984				263				51,808
2015																																		1,057				1,023				380				52,001
2016																																						1,105				636				47,436
																																		Total				$	8,995

		Cumulative Paid Claims and Allocated LAE, Net of Reinsurance
Accident Year		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)
		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016				% (a)
2007		$	166			$	357			$	477			$	563			$	623			$	664			$	692			$	708			$	724			$	733			91.3	%
2008						162				355				490				588				653				702				727				751				768				89.8	%
2009										160				366				494				575				636				673				698				713				88.4	%
2010														179				393				539				623				676				712				734				86.9	%
2011																		165				369				506				595				643				674				83.4	%
2012																						163				368				495				596				658				77.0	%
2013																										171				377				530				638				70.1	%
2014																														182				398				556				56.5	%
2015																																		170				398				38.9	%
2016																																						181				16.4	%
																																		Total				$	6,053
																		Unpaid losses and LAE — years 2007 through 2016																				2,942
						Unpaid losses and LAE — 11th year and prior (excluding unallocated LAE)																																414
						Unpaid losses and LAE, net of reinsurance (excluding unallocated LAE)																																$	3,356

		Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Supplementary Information and Unaudited)
		Year 1			Year 2			Year 3			Year 4			Year 5			Year 6			Year 7			Year 8			Year 9			Year 10
Annual		19.0	%		23.7	%		16.1	%		11.0	%		7.0	%		4.7	%		3.0	%		2.2	%		2.0	%		1.1	%
Cumulative		19.0	%		42.7	%		58.8	%		69.8	%		76.8	%		81.5	%		84.5	%		86.7	%		88.7	%		89.8	%

(a)	Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2016).

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Specialty financial
(Dollars in Millions)
		Incurred Claims and Allocated LAE, Net of Reinsurance																																								As of December 31, 2016
		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)																																								Total IBNR Plus Expected Development on Reported Claims				Cumulative Number of Reported Claims
Accident Year		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016
2007		$	170			$	165			$	159			$	149			$	145			$	144			$	142			$	141			$	140			$	136			$	1			21,643
2008						190				207				212				209				203				199				198				197				198				1				27,287
2009										193				193				187				184				188				186				187				186				1				27,438
2010														139				146				133				133				135				133				130				3				21,921
2011																		140				158				157				155				148				146				14				16,364
2012																						164				163				151				139				137				15				21,029
2013																										141				145				137				131				15				28,220
2014																														146				157				156				22				28,814
2015																																		156				159				36				35,880
2016																																						179				75				29,464
																																		Total				$	1,558

		Cumulative Paid Claims and Allocated LAE, Net of Reinsurance
Accident Year		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)
		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016				% (a)
2007		$	82			$	114			$	126			$	133			$	134			$	135			$	135			$	135			$	136			$	135			99.3	%
2008						103				153				185				189				189				191				193				194				194				98.0	%
2009										112				145				157				166				171				182				185				186				100.0	%
2010														61				93				104				122				133				131				128				98.5	%
2011																		59				113				116				124				131				132				90.4	%
2012																						71				104				109				117				121				88.3	%
2013																										70				100				107				114				87.0	%
2014																														62				108				125				80.1	%
2015																																		72				109				68.6	%
2016																																						87				48.6	%
																																		Total				$	1,331
																		Unpaid losses and LAE — years 2007 through 2016																				227
						Unpaid losses and LAE — 11th year and prior (excluding unallocated LAE)																																1
						Unpaid losses and LAE, net of reinsurance (excluding unallocated LAE)																																$	228

		Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Supplementary Information and Unaudited)
		Year 1			Year 2			Year 3			Year 4			Year 5			Year 6			Year 7			Year 8			Year 9			Year 10
Annual		49.9	%		25.3	%		7.7	%		6.1	%		3.3	%		1.4	%		0.1	%		0.3	%		0.4	%		(0.7	%)
Cumulative		49.9	%		75.2	%		82.9	%		89.0	%		92.3	%		93.7	%		93.8	%		94.1	%		94.5	%		93.8	%

(a)	Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2016).

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Other specialty
(Dollars in Millions)
		Incurred Claims and Allocated LAE, Net of Reinsurance																																								As of December 31, 2016
		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)																																								Total IBNR Plus Expected Development on Reported Claims				Cumulative Number of Reported Claims (a)
Accident Year		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016
2007		$	45			$	42			$	42			$	42			$	40			$	39			$	36			$	36			$	33			$	30			$	10			—
2008						49				49				49				49				48				46				45				45				44				4				—
2009										41				41				41				40				37				37				36				38				11				—
2010														36				39				40				39				40				40				40				4				—
2011																		39				43				42				43				43				44				5				—
2012																						42				40				39				40				41				10				—
2013																										46				47				46				47				6				—
2014																														58				57				59				21				—
2015																																		59				60				27				—
2016																																						61				44				—
																																		Total				$	464

		Cumulative Paid Claims and Allocated LAE, Net of Reinsurance
Accident Year		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)
		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016				% (b)
2007		$	6			$	10			$	12			$	15			$	17			$	18			$	19			$	20			$	21			$	21			70.0	%
2008						10				16				23				31				35				37				37				37				38				86.4	%
2009										8				12				15				19				22				22				24				26				68.4	%
2010														8				14				21				24				27				33				35				87.5	%
2011																		12				20				25				28				34				36				81.8	%
2012																						8				17				21				25				28				68.3	%
2013																										7				16				22				34				72.3	%
2014																														13				21				30				50.8	%
2015																																		10				26				43.3	%
2016																																						9				14.8	%
																																		Total				$	283
																		Unpaid losses and LAE — years 2007 through 2016																				181
						Unpaid losses and LAE — 11th year and prior (excluding unallocated LAE)																																59
						Unpaid losses and LAE, net of reinsurance (excluding unallocated LAE)																																$	240

		Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Supplementary Information and Unaudited)
		Year 1			Year 2			Year 3			Year 4			Year 5			Year 6			Year 7			Year 8			Year 9			Year 10
Annual		19.9	%		16.9	%		12.1	%		12.6	%		8.7	%		5.5	%		3.4	%		2.9	%		2.8	%		—	%
Cumulative		19.9	%		36.8	%		48.9	%		61.5	%		70.2	%		75.7	%		79.1	%		82.0	%		84.8	%		84.8	%

(a)	The amounts shown in Other specialty 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. Accordingly, the liability for incurred claims and allocated LAE represents additional reserves held on claims counted in the tables provided for the other sub-segments (above).

(b)	Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2016).

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

Total Specialty Group
(Dollars in Millions)
		Incurred Claims and Allocated LAE, Net of Reinsurance																																								As of December 31, 2016
		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)																																								Total IBNR Plus Expected Development on Reported Claims				Cumulative Number of Reported Claims
Accident Year		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016
2007		$	1,908			$	1,759			$	1,670			$	1,615			$	1,585			$	1,573			$	1,565			$	1,539			$	1,543			$	1,537			$	52			211,219
2008						2,067				2,018				1,987				1,971				1,978				1,955				1,953				1,947				1,951				56				244,346
2009										1,624				1,607				1,596				1,566				1,552				1,545				1,543				1,539				74				221,065
2010														1,724				1,710				1,705				1,690				1,710				1,698				1,698				91				215,306
2011																		1,840				1,848				1,849				1,871				1,861				1,866				124				207,407
2012																						1,970				1,952				1,946				1,947				1,955				176				217,345
2013																										2,036				2,011				2,000				1,996				220				219,598
2014																														2,083				2,050				2,040				373				217,836
2015																																		2,112				2,044				549				222,288
2016																																						2,105				1,005				186,087
																																		Total				$	18,731

		Cumulative Paid Claims and Allocated LAE, Net of Reinsurance
Accident Year		For the Years Ended (2007–2015 is Supplementary Information and Unaudited)
		2007				2008				2009				2010				2011				2012				2013				2014				2015				2016				% (a)
2007		$	538			$	931			$	1,107			$	1,234			$	1,313			$	1,370			$	1,405			$	1,425			$	1,444			$	1,453			94.5	%
2008						627				1,230				1,459				1,607				1,701				1,765				1,803				1,828				1,847				94.7	%
2009										509				871				1,079				1,216				1,308				1,370				1,404				1,424				92.5	%
2010														576				1,005				1,220				1,387				1,485				1,536				1,562				92.0	%
2011																		609				1,181				1,389				1,534				1,629				1,682				90.1	%
2012																						824				1,214				1,418				1,579				1,675				85.7	%
2013																										697				1,214				1,443				1,617				81.0	%
2014																														594				1,173				1,422				69.7	%
2015																																		619				1,127				55.1	%
2016																																						573				27.2	%
																																		Total				$	14,382
																		Unpaid losses and LAE — years 2007 through 2016																				4,349
						Unpaid losses and LAE — 11th year and prior (excluding unallocated LAE)																																495
						Unpaid losses and LAE, net of reinsurance (excluding unallocated LAE)																																$	4,844

		Average Annual Percentage Payout of Incurred Claims by Age, Net of Reinsurance (Supplementary Information and Unaudited)
		Year 1			Year 2			Year 3			Year 4			Year 5			Year 6			Year 7			Year 8			Year 9			Year 10
Annual		33.0	%		26.1	%		11.8	%		8.5	%		5.3	%		3.4	%		2.0	%		1.3	%		1.1	%		0.6	%
Cumulative		33.0	%		59.1	%		70.9	%		79.4	%		84.7	%		88.1	%		90.1	%		91.4	%		92.5	%		93.1	%

(a)	Represents the cumulative percentage paid of incurred claims and allocated LAE (net of reinsurance, as estimated at December 31, 2016).

Closed Block of Long-Term Care Insurance Following the completion of the sale of substantially all of its run-off long-term care insurance business in December 2015, AFG’s remaining long-term care insurance reserves were $37 million at December 31, 2016 and $34 million at December 31, 2015, net of reinsurance recoverables and excluding the impact of unrealized gains on securities. AFG’s remaining 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.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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 $44 million investment in FHLB capital stock at December 31, 2016, is included in other investments at cost. Membership in the FHLB provides the annuity operations with an additional source of liquidity. These advances further the FHLB’s mission of improving access to housing by increasing liquidity in the residential mortgage-backed securities market. In 2016, the FHLB advanced GALIC $150 million, increasing the total amount advanced to $935 million (included in annuity benefits accumulated) at December 31, 2016. In the fourth quarter of 2016, GALIC extended the terms on advances totaling $200 million by four years. Interest rates under the various funding agreements on these advances range from 0.03% to 0.53% over LIBOR (average rate of 1.18% at December 31, 2016). While these advances must be repaid between 2018 and 2021 ($285 million in 2018, $500 million in 2020 and $150 million in 2021), GALIC has the option to prepay all or a portion of the advances. The advances on these agreements are collateralized by mortgage-backed securities, which have a total fair value of $1.08 billion (included in available for sale fixed maturity securities) at December 31, 2016 and which have similar expected lives as the advances. Interest credited on the funding agreements, which is included in annuity benefits, was $8 million in 2016, $3 million in 2015 and $1 million in 2014.

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 and capital and surplus on a statutory basis for the insurance subsidiaries were as follows (in millions):

	Net Earnings												Capital and Surplus
	2016				2015				2014				2016				2015
Property and casualty companies	$	461			$	408			$	318			$	2,939			$	2,488
Life insurance companies	167				399				349				1,976				1,721

The National Association of Insurance Commissioners’ (“NAIC”) model law for risk based capital (“RBC”) applies to both life and property and casualty insurance companies. RBC formulas determine the amount of capital that an insurance company needs so that it has an acceptable expectation of not becoming financially impaired. Companies below specific trigger points or ratios are subject to regulatory action. At December 31, 2016 and 2015, the capital ratios of all AFG insurance companies substantially exceeded the RBC requirements. AFG’s insurance companies did not use any prescribed or permitted statutory accounting practices that differed from the NAIC statutory accounting practices at December 31, 2016 or 2015.

Payments of dividends by AFG’s insurance companies are subject to various state laws that limit the amount of dividends that can be paid. Under applicable restrictions, the maximum amount of dividends available to AFG in 2017 from its insurance subsidiaries without seeking regulatory approval is $693 million. Additional amounts of dividends require regulatory approval.

AFG paid common stock dividends to shareholders totaling $187 million, $178 million and $169 million in 2016, 2015 and 2014, respectively. Currently, there are no regulatory restrictions on AFG’s retained earnings or net income that materially impact its ability to pay dividends. Based on shareholders’ equity at December 31, 2016, AFG could pay dividends in excess of $1 billion without violating its most restrictive debt covenant. However, the payment of future dividends will be at the discretion of AFG’s Board of Directors and will be dependent on many factors including AFG’s financial condition and results of operations, the capital requirements of its insurance subsidiaries, and rating agency commitments.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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.

	2016				2015				2014
Direct premiums written	$	5,858			$	5,713			$	5,387
Reinsurance assumed	123				119				90
Reinsurance ceded	(1,595		)		(1,505		)		(1,457		)
Net written premiums	$	4,386			$	4,327			$	4,020
Direct premiums earned	$	5,745			$	5,613			$	5,195
Reinsurance assumed	118				105				75
Reinsurance ceded	(1,535		)		(1,494		)		(1,392		)
Net earned premiums	$	4,328			$	4,224			$	3,878
Reinsurance recoveries	$	810			$	936			$	895

In March 2014, AFG’s property and casualty insurance operations entered into a reinsurance agreement to obtain additional catastrophe protection through a catastrophe bond structure with Riverfront Re Ltd. (“Riverfront”). The reinsurance agreement provided supplemental reinsurance coverage for catastrophe losses occurring between April 1, 2014 and January 6, 2017. In connection with the reinsurance agreement, Riverfront issued notes to unrelated investors for the full amount of coverage provided under the reinsurance agreement. At the time of the agreement, AFG concluded that Riverfront is a variable interest entity, but that it did not have a variable interest in the entity because the variability in Riverfront’s results was expected to be absorbed entirely by the investors in Riverfront. Accordingly, Riverfront is not consolidated in AFG’s financial statements and the reinsurance agreement is accounted for as ceded reinsurance. AFG’s cost for this coverage was approximately $5 million per year.

AFG has reinsured approximately $10.22 billion of its $13.49 billion in face amount of life insurance at December 31, 2016 compared to $11.19 billion of its $14.67 billion in face amount of life insurance at December 31, 2015. Life written premiums ceded were $31 million, $40 million and $41 million for 2016, 2015 and 2014, respectively. Reinsurance recoveries on ceded life policies were $41 million, $50 million and $59 million for 2016, 2015 and 2014, respectively.

Fixed Annuities   For certain products, the liability for “annuity benefits accumulated” includes reserves for excess benefits expected to be paid on future deaths and annuitizations (“EDAR”), guaranteed withdrawal benefits and accrued persistency and premium bonuses. The liabilities included in AFG’s Balance Sheet for these benefits, excluding the impact of unrealized gains on securities, were as follows at December 31 (in millions):

	2016				2015
Expected death and annuitization	$	223			$	214
Guaranteed withdrawal benefits	278				203
Accrued persistency and premium bonuses	6				11

Variable Annuities   At December 31, 2016, 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 $20 million, compared to $27 million at December 31, 2015. Death benefits paid in excess of the variable annuity account balances were less than $1 million in each of the last three years.

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

P.     Additional Information

AFG’s aggregate allowance for uncollectible reinsurance recoverables was $22 million at both December 31, 2016 and 2015. AFG reviews the allowance quarterly and adjusts it as necessary to reflect changes in estimates of uncollectible balances. In 2016 and 2015, AFG recorded net expense reductions of less than $1 million and $3 million, respectively, against the allowance. In 2014, AFG recorded a charge of $4 million against the allowance (included in losses and loss adjustment expenses). In 2014, the allowance was reduced by reinsurance recoverable write-offs of $6 million.

Operating Leases   Total rental expense for various leases of office space and equipment was $67 million in 2016, $70 million in 2015 and $65 million in 2014. Future minimum rentals, related principally to office space, required under operating leases having initial or remaining noncancelable lease terms in excess of one year at December 31, 2016, were as follows: 2017 – $66 million; 2018 – $60 million; 2019 – $53 million; 2020 – $45 million; 2021 – $37 million; and $128 million thereafter.

Financial Instruments — Unfunded Commitments   On occasion, AFG and its subsidiaries have entered into financial instrument transactions that may present off-balance-sheet risks of both a credit and market risk nature. These transactions include commitments to fund loans, loan guarantees and commitments to purchase and sell securities or loans. At December 31, 2016, AFG and its subsidiaries had commitments to fund credit facilities and contribute capital to limited partnerships and limited liability corporations of approximately $377 million.

Benefit Plans   AFG expensed approximately $43 million in 2016, $34 million in 2015 and $30 million in 2014 for its retirement and employee savings plans.

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PART III

The information required by the following Items will be included in AFG’s definitive Proxy Statement for the 2017 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year and is incorporated herein by reference.

ITEM 10	Directors, Executive Officers of the Registrant and Corporate Governance
ITEM 11	Executive Compensation
ITEM 12	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
ITEM 13	Certain Relationships and Related Transactions, and Director Independence
ITEM 14	Principal Accountant Fees and Services

PART IV

ITEM 15

Exhibits and Financial Statement Schedules

(a)	Documents filed as part of this Report:
	1.	Financial Statements are included in Part II, Item 8.
	2.	Financial Statement Schedules:
		A.	Selected Quarterly Financial Data is included in Note N to the Consolidated Financial Statements.
		B.	Schedules filed herewith for 2016, 2015 and 2014:
						Page
			II — Condensed Financial Information of Registrant			S-2
			III — Supplementary Insurance Information			S-4
			All other schedules for which provisions are made in the applicable regulation of the Securities and Exchange Commission have been omitted as they are not applicable, not required, or the information required thereby is set forth in the Financial Statements or the notes thereto.
	3.	Exhibits — See Exhibit Index on page E-1.

S-1

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AMERICAN FINANCIAL GROUP, INC. — PARENT ONLY

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF REGISTRANT

(In Millions)

Condensed Balance Sheet

	December 31,
	2016				2015
Assets:
Cash and cash equivalents	$	197			$	189
Investment in securities	63				63
Investment in subsidiaries (a)	5,989				5,439
Other investments	2				2
Other assets	136				84
Total assets	$	6,387			$	5,777
Liabilities and Equity:
Long-term debt	$	1,283			$	986
Other liabilities	188				199
Shareholders’ equity	4,916				4,592
Total liabilities and equity	$	6,387			$	5,777

Condensed Statement of Earnings

	Year ended December 31,
	2016				2015				2014
Revenues:
Dividends from subsidiaries	$	643			$	311			$	480
Equity in undistributed earnings of subsidiaries	286				386				332
Investment and other income	7				4				5
Total revenues	936				701				817
Costs and Expenses:
Interest charges on intercompany borrowings	9				9				10
Interest charges on other borrowings	77				73				70
Other expenses	82				72				65
Total costs and expenses	168				154				145
Earnings before income taxes	768				547				672
Provision for income taxes	119				195				220
Net Earnings Attributable to Shareholders	$	649			$	352			$	452

Condensed Statement of Comprehensive Income

Net earnings attributable to shareholders	$	649			$	352			$	452
Other comprehensive income (loss), net of tax	62				(423		)		167
Total comprehensive income (loss), net of tax	$	711			$	(71	)		$	619

________________________

(a)	Investment in subsidiaries includes intercompany receivables and payables.

S-2

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AMERICAN FINANCIAL GROUP, INC. — PARENT ONLY

SCHEDULE II — CONDENSED FINANCIAL INFORMATION OF REGISTRANT — CONTINUED

(In Millions)

Condensed Statement of Cash Flows

	Year ended December 31,
	2016				2015				2014
Operating Activities:
Net earnings attributable to shareholders	$	649			$	352			$	452
Adjustments:
Equity in net earnings of subsidiaries	(638		)		(451		)		(545		)
Dividends from subsidiaries	611				280				451
Other operating activities, net	(67		)		(19		)		14
Net cash provided by operating activities	555				162				372
Investing Activities:
Capital contributions to subsidiaries	(560		)		(27		)		(431		)
Returns of capital from subsidiaries	—				1				—
Purchases of investments, property and equipment	(1		)		(10		)		(1		)
Proceeds from maturities and redemptions of investments	1				—				—
Proceeds from sales of investments, property and equipment	—				3				—
Net cash used in investing activities	(560		)		(33		)		(432		)
Financing Activities:
Additional long-term borrowings	296				145				145
Reductions of long-term debt	—				(132		)		—
Issuances of Common Stock	35				57				42
Repurchases of Common Stock	(133		)		(126		)		(191		)
Cash dividends paid on Common Stock	(185		)		(176		)		(167		)
Net cash provided by (used in) financing activities	13				(232		)		(171		)
Net Change in Cash and Cash Equivalents	8				(103		)		(231		)
Cash and cash equivalents at beginning of year	189				292				523
Cash and cash equivalents at end of year	$	197			$	189			$	292

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AMERICAN FINANCIAL GROUP, INC. AND SUBSIDIARIES

SCHEDULE III — SUPPLEMENTARY INSURANCE INFORMATION

THREE YEARS ENDED DECEMBER 31, 2016

(IN MILLIONS)

Segment		Deferred policy acquisition costs				Reserves for future policy benefits, claims and unpaid losses and LAE				Unearned premiums				Net earned premiums				Net investment income				Benefits, claims, losses and settlement expenses				Amortization of deferred policy acquisition costs				Other operating expenses				Net written premiums (excluding life)
2016
Property and casualty insurance		$	238			$	8,563			$	2,171			$	4,328			$	350			$	2,762			$	520			$	870			$	4,386
Annuity		981				29,907				—				—				1,356				800				149				142				—
Run-off long-term care and life		20				691				—				24				21				33				4				10				3
Other		—				—				—				—				(31		)		—				—				421				—
Total		$	1,239			$	39,161			$	2,171			$	4,352			$	1,696			$	3,595			$	673			$	1,443			$	4,389
2015
Property and casualty insurance		$	226			$	8,127			$	2,060			$	4,224			$	319			$	2,695			$	511			$	839			$	4,327
Annuity		934				26,622				—				—				1,224				732				136				123				—
Run-off long-term care and life		24				705				—				104				80				131				6				37				73
Other		—				—				—				—				10				—				—				370				—
Total		$	1,184			$	35,454			$	2,060			$	4,328			$	1,633			$	3,558			$	653			$	1,369			$	4,400
2014
Property and casualty insurance		$	221			$	7,872			$	1,956			$	3,878			$	294			$	2,494			$	485			$	746			$	4,020
Annuity		564				23,764				—				—				1,136				648				155				102				—
Run-off long-term care and life		36				2,175				—				108				82				164				6				35				74
Other		—				—				—				—				(11		)		—				—				272				—
Total		$	821			$	33,811			$	1,956			$	3,986			$	1,501			$	3,306			$	646			$	1,155			$	4,094

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Table of Contents

Signatures

Pursuant to the requirements of Section 13 or 15(d) 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.
February 24, 2017	By:		/s/ Joseph E. (Jeff) Consolino
			Joseph E. (Jeff) Consolino
			Executive Vice President and Chief Financial Officer

__________________________________________________________________________________________

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:

Signature		Capacity		Date
/s/ Carl H. Lindner III		Co-Chief Executive Officer and Director		February 24, 2017
Carl H. Lindner III		(Principal Executive Officer)
/s/ S. Craig Lindner		Co-Chief Executive Officer and Director		February 24, 2017
S. Craig Lindner		(Principal Executive Officer)
/s/ Joseph E. (Jeff) Consolino		Executive Vice President, Chief Financial Officer and Director		February 24, 2017
Joseph E. (Jeff) Consolino		(Principal Financial and Accounting Officer)
/s/ Kenneth C. Ambrecht		Director		February 24, 2017
Kenneth C. Ambrecht
/s/ John B. Berding		Director		February 24, 2017
John B. Berding
/s/ Virginia (Gina) C. Drosos		Director*		February 24, 2017
Virginia (Gina) C. Drosos
/s/ James E. Evans		Director		February 24, 2017
James E. Evans
/s/ Terry S. Jacobs		Director*		February 24, 2017
Terry S. Jacobs
/s/ Gregory G. Joseph		Director*		February 24, 2017
Gregory G. Joseph
/s/ William W. Verity		Director		February 24, 2017
William W. Verity
/s/ John I. Von Lehman		Director*		February 24, 2017
John I. Von Lehman
* Member of the Audit Committee

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Table of Contents

INDEX TO EXHIBITS

AMERICAN FINANCIAL GROUP, INC.

Number		Exhibit Description
2		Agreement and Plan of Merger dated July 25, 2016 by and among Great American Insurance Company and National Interstate Corporation, filed as Exhibit 2.1 to AFG’s Form 8-K on July 25, 2016.				(*)
3(a)		Amended and Restated Articles of Incorporation, filed as Exhibit 3(a) to AFG’s Form 10-K for 1997.				(*)
3(b)		Amended and Restated Code of Regulations, filed as Exhibit 3 to AFG’s Form 8-K filed on August 16, 2012.				(*)
4		Instruments defining the rights of security holders.	Registrant has no outstanding debt issues exceeding 10% of the assets of Registrant and consolidated subsidiaries.
		Material Contracts:
10(a)		Amended and Restated Non-Employee Directors Compensation Plan, filed as Exhibit 10 to the Form S-8 Registration Statement (File No. 333-181913) filed by AFG on November 13, 2012.				(*)
10(b)		Amended and Restated Deferred Compensation Plan, filed as Exhibit 10(b) to AFG’s Form 10-K for 2008.				(*)
10(c)		2011 Equity Bonus Plan (formerly known as the 2011 Co-CEO Equity Bonus Plan), filed as Exhibit 10 to the Form S-8 Registration Statement (File No. 333-184915) filed by AFG on November 13, 2012.				(*)
10(d)		2011 Annual Senior Executive Bonus Plan, filed as Annex B to AFG’s Proxy statement filed on March 30, 2011.				(*)
10(e)		Amended and restated Nonqualified Auxiliary RASP, filed as Exhibit 10(f) to AFG’s Form 10-K for 2008.				(*)
10(f)		2005 Stock Incentive Plan Exhibit 10 to the Form S-8 Registration Statement (File No. 333-184914) filed by AFG on November 13, 2012.				(*)
10(g)		2015 Stock Incentive Plan filed as Exhibit 10(g) to AFG’s Form 10-K for 2015.				(*)
10(h)		Credit Agreement dated June 2, 2016, among American Financial Group, Inc., Bank of America, N.A., as Administrative Agent, and several lenders, filed as Exhibit 10.1 to AFG’s Form 8-K filed on June 2, 2016.				(*)
10(i)		Stock Purchase Agreement dated January 9, 2014 by and between Liberty Mutual Group Inc. and Great American Holding, Inc. (Summit Holdings Southeast, Inc.), filed as Exhibit 10(h) to AFG’s Form 10-K for 2013.				(*)
12		Computation of ratios of earnings to fixed charges.
21		Subsidiaries of the Registrant.
23		Consent of independent registered public accounting firm.
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-K for the year ended December 31, 2016, 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
		(vii)  Financial Statement Schedules
(*) Incorporated herein by reference.

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