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Rating Action:

Moody's affirms American Financial Group (senior at Baa1), outlook changed to negative

09 Jan 2014

New York, January 09, 2014 -- Moody's Investors Service has affirmed the Baa1 senior debt rating for American Financial Group, Inc. (NYSE: AFG), and the A1 insurance financial strength (IFS) ratings of AFG's property and casualty (P&C) operations led by Great American Insurance Company (GAIC) following the announcement that AFG will acquire workers' compensation insurer Summit Holdings Southeast, Inc. and its related companies (unrated; together "Summit") from the Liberty Mutual Group for approximately $250 million. In the same action, Moody's also affirmed the A2 IFS rating of AFG's life insurance subsidiary, Great American Life Insurance Company (GALIC), and the A3 IFS rating of AFG's California workers' compensation subsidiary, Republic Indemnity Insurance Company (Republic). The outlook on the ratings of the holding company, GAIC, and GALIC was changed to negative from stable, reflecting the integration risk associated with a sizable transaction and the higher product risk in a monoline workers' compensation writer. The outlook on Republic remains stable.

Under the terms of the planned transaction, AFG will pay Liberty Mutual Group an estimated $250 million at closing, funded by AFG holding company cash. The purchase price will be subject to adjustment between signing and closing for, among other things, increases in Summit's tangible book value. AFG's total capital investment in Summit will be approximately $400 million, inclusive of an approximately $150 million capital contribution by AFG at closing. The transaction is expected to close in the first or second quarter of 2014, following customary regulatory approvals.

RATINGS RATIONALE

P&C Operations

According to Pano Karambelas, Moody's lead analyst for AFG, "While the transaction broadens the group's market presence as a leading workers' compensation carrier in the Southeast, the negative outlook reflects execution risk associated with a large transaction, as well as the combined group's prospectively greater exposure to long-tail workers' compensation, with potentially higher earnings volatility." On a pro forma basis, AFG's combined workers' compensation reserves will represent 30% of the group's total P&C reserves, versus 18% prior to the acquisition. Moody's noted that AFG's good track record in managing its long-standing California workers' compensation carrier Republic, as well as its Strategic Comp workers compensation segment within GAIC will be of benefit in managing Summit, particularly the use of an opportunistic strategy to manage the cyclical nature of workers' compensation.

The affirmation of AFG's ratings reflects the company's solid financial fundamentals, including consistently strong profitability, good market position in a diverse group of specialty niche businesses, and limited catastrophe exposure. The group has maintained moderate adjusted financial leverage in the low 20% range, with good cash flow and earnings coverage of interest. As an all-cash financed acquisition, the transaction does not impact AFG's financial leverage profile, and Moody's expects that AFG will continue to maintain a strong liquidity profile, including $100-200 million of cash and short-term securities at the holding company.

The A3 IFS rating of AFG's Republic Indemnity is based on Republic's position and focus as a leading writer of California workers' compensation, and its concentration in this historically volatile, limited geographic business line. Moody's expects that Republic will continue to employ an opportunistic strategy, pursuing profitability over revenue growth in step with conditions in the California workers' compensation sector.

Given the outlook of the P&C operations is negative, an upgrade over the near term is unlikely. Factors that could lead to the outlook reverting back to stable include: 1) improved risk-adjusted capitalization (gross underwriting leverage consistently below 5.0x); 2) combined ratios in the mid 90% range; 3) strong and consistent earnings with returns on capital above 10%; and 4) successful integration of the Summit acquisition. The following factors could lead to a downgrade of the P&C ratings: 1) adverse development in excess of 2% of reserves, including the Summit portfolio; 2) material reductions in earnings capacity (returns on capital sustained below 10%); or 3) decline (e.g., due to catastrophes and/or investment losses) in P&C group surplus by more than 10% over a rolling twelve month period.

Life Operations

The affirmation of GALIC's rating and change to a negative outlook reflects the negative outlook on the P&C operation as GALIC's rating is based on the implicit support of the P&C operations. The A2 IFS rating on GALIC, an indirect subsidiary of Great American Financial Resources (GAFRI), reflects its niche position in the tax-deferred annuity business for public and private education employees with significant barriers to entry in the 403(b) market. Other strengths include the company's stable earnings base, improving expense structure, expanding distribution, and implicit support from AFG (reflecting 1-notch of uplift for parental support). Credit weaknesses include the potential for adverse regulation in the company's core 403(b) market, managing growth in the bank fixed annuity market, and significant holdings of non-agency residential mortgage-backed securities (RMBS), although these have been performing well.

Given the outlook on GALIC is negative, an upgrade over the near term is unlikely. A return of AFG's and GAIC's outlook to stable would likely result in GALIC's outlook also moving back to stable. Longer term, the following would place upward pressure on GALIC's rating: 1) improved market position in the 403(b) market and better diversification away from fixed indexed annuities; and 2) consistent profitability as measured by return on capital of at least 7%. The following could lead to a downgrade of GALIC's rating: 1) a downgrade of AFG and/or its P&C affiliates; 2) reduction in implicit support from AFG; 3) pre-tax investment losses of greater than $75 million over the next 12 months; and 4) company action level NAIC risk-based capital (RBC) ratio of less than 300%.

Holding Company

Moody's said the affirmation and change in outlook to negative for AFG's debt ratings reflects the negative outlook for the P&C ratings and the announced acquisition of Summit. AFG's debt rating reflects its diversified earnings and cash flows of its P&C and life operations, moderate use of financial leverage, and very good earnings coverage metrics. The holding company's senior debt rating is positioned three notches below the A1 IFS rating of the P&C operations and one notch lower than the stand-alone credit profile of GALIC.

Given the negative outlook on the debt ratings, an upgrade of AFG over the near term is unlikely. The following could lead to the outlook returning to stable : 1) an affirmation of IFS ratings of the P&C and life subsidiaries with a stable outlook; 2) financial leverage in the low 20% range; and 3) earnings coverage at or above 7x. Factors that could lead to a downgrade of the holding company ratings include: 1) a downgrade of the IFS ratings of the P&C and/or life subsidiaries; 2) earnings coverage consistently at or below 6x; and 3) financial leverage consistently in the mid-to-high 20% range.

The following ratings have been affirmed and the outlook changed to negative from stable:

American Financial Group, Inc. -- senior debt at Baa1; senior unsecured shelf at (P)Baa1; subordinated unsecured shelf at (P)Baa2; junior subordinated unsecured shelf at (P)Baa2; preferred stock at (P)Baa3;

American Financial Capital Trust II, III, IV -- preferred securities at (P)Baa2;

American Annuity Capital Trust II -- preferred securities at Baa2(hyb);

Great American Insurance Company -- insurance financial strength at A1;

Great American Alliance Insurance Company -- insurance financial strength at A1;

Great American Assurance Company -- insurance financial strength at A1;

Great American Contemporary Insurance Company -- insurance financial strength at A1;

Great American E&S Insurance Company -- insurance financial strength at A1;

Great American Fidelity Insurance Company -- insurance financial strength at A1;

Great American Insurance Company of New York -- insurance financial strength at A1;

Great American Protection Insurance Company -- insurance financial strength at A1;

Great American Security Insurance Company -- insurance financial strength at A1;

Great American Spirit Insurance Company -- insurance financial strength at A1;

Great American Casualty Insurance Company -- insurance financial strength at A1;

Great American Life Insurance Company -- insurance financial strength at A2.

The following rating has been affirmed with a stable outlook:

Republic Indemnity Company of America -- insurance financial strength at A3.

The principal methodologies used in these ratings were Global Property and Casualty Insurers published in December 2013, and Global Life Insurers published in December 2013. Please see the Credit Policy page on www.moodys.com for a copy of these methodologies.

AFG is an Ohio-based holding company that, through its operating subsidiaries, provides specialty commercial property and casualty insurance, as well as tax-deferred annuities, supplemental and life insurance products through Great American Financial Resources, Inc. (unrated), the indirect holding company of GALIC. For the first nine months of 2013, AFG reported revenues of $3.7 billion and net income of $313 million. Shareholders' equity was approximately $4.7 billion as of Q3 2013.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the rating action on the support provider and in relation to each particular rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this rating action, and whose ratings may change as a result of this rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Pano Karambelas
VP - Senior Credit Officer
Financial Institutions Group
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Robert Riegel
MD - Insurance
Financial Institutions Group
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Releasing Office:
Moody's Investors Service, Inc.
250 Greenwich Street
New York, NY 10007
U.S.A.
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's affirms American Financial Group (senior at Baa1), outlook changed to negative
No Related Data.
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