Page Page Forward-Looking Statements 23 Uncertainties 30 Overview 24 Results of Operations 30 Critical Accounting Policies 24 General 30 Liquidity and Capital Resources 25 Income Items 30 Sources of Funds 25 Expense Items 36 Investments 26 Recent Accounting Standards 37

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", "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 and investment activities; 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 could differ materially from those contained in or implied by such forward-looking statements for a variety of factors including:

º changes in financial, political and economic conditions, including changes in interest rates and any extended economic recessions or expansions, performance of securities markets, our ability to estimate accurately the likelihood, magnitude and timing of any losses in connection with investments in the residential mortgage market, especially in the subprime sector, and the availability of capital;
º regulatory actions;
º changes in the legal environment affecting AFG or its customers;
º tax law changes;
º levels of natural catastrophes, terrorist activities (including any nuclear, biological, chemical or radiological events), incidents of war and other major losses;
º development of insurance loss reserves and establishment of other reserves, particularly with respect to amounts associated with asbestos and environmental claims;
º the unpredictability of future litigation if certain settlements do not become effective;
º trends in persistency, mortality and morbidity;
º availability of reinsurance and ability of reinsurers to pay their obligations;
º competitive pressures, including the ability to obtain adequate rates; and
º changes in AFG's credit ratings or the financial strength ratings assigned by major ratings agencies to our operating subsidiaries.

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.

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 best done 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.

Through the operations of its subsidiaries, AFG is engaged primarily in property and casualty insurance, focusing on specialized commercial products for businesses and in the sale of traditional fixed, indexed and variable annuities and a variety of supplemental insurance products.

AFG's net earnings for the third quarter and first nine months of 2008 were $20.9 million ($.18 per share, diluted) and $157.2 million ($1.34 per share, diluted), respectively, compared to $112.7 million ($.93 per share, diluted) and $293.3 million ($2.40 per share, diluted) reported in the same periods of 2007. These results reflect net realized losses on investments in 2008, including other than temporary impairments. In addition, improved earnings in AFG's annuity and supplemental insurance operations and increased investment income were offset by lower property and casualty underwriting profits due in part to an increase in catastrophe losses.

Significant accounting policies are summarized in Note A to the financial statements. The preparation of financial statements 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 make accounting policies critical are as follows:

º the establishment of insurance reserves, especially asbestos and environmental-related reserves,
º the recoverability of reinsurance,
º the recoverability of deferred acquisition costs,
º the establishment of asbestos and environmental reserves of former railroad and manufacturing operations, and
º the valuation of investments, including the determination of "other-than-temporary" impairments.

For a discussion of these policies, see Management's Discussion and Analysis - "Critical Accounting Policies" in AFG's 2007 Form 10-K.

     LIQUIDITY AND CAPITAL RESOURCES

     Ratios AFG's debt to total capital ratio on a consolidated basis is shown
     below (dollars in millions).

                                       September 30,   December 31,
                                               2008    2007    2006
Long-term debt                                $ 952   $ 937   $ 921
Total capital (*)                             4,269   4,108   4,160
Ratio of debt to total capital:
 Including debt secured by real estate         22.3%   22.8%   22.1%
 Excluding debt secured by real estate         21.1%   21.5%   20.9%

(*) Includes long-term debt, minority interest and shareholders' equity (excluding unrealized gains (losses) related to fixed maturity investments).

AFG's ratio of earnings to fixed charges, including annuity benefits as a fixed charge, was 1.73 for the nine months ended September 30, 2008 and 2.40 for the entire year of 2007. Excluding annuity benefits, this ratio was 5.07 and 8.49, respectively. Although the ratio excluding interest on annuities 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.

Parent Holding Company Liquidity Management believes AFG has sufficient resources to meet its liquidity requirements. If funds generated from operations, including dividends and tax payments from subsidiaries, are insufficient to meet fixed charges in any period, AFG would be required to utilize parent company cash and marketable securities or generate cash through borrowings, sales of other assets, or similar transactions.

AFG can borrow up to $500 million under its revolving credit facility, which expires in 2011. AFG had $350 million in borrowings outstanding under this agreement at September 30, 2008, bearing interest at a rate of 4.4%. In October 2008, AFG borrowed an additional $115 million under its credit facility and repurchased $37.3 million of its 7-1/8% Senior Debentures due April 2009 for $37.2 million. At October 31, 2008, AFG (parent) had enough cash and marketable securities to retire the remaining $136 million in Senior Debentures due April 2009.

In July 2008, AFG entered into a 364 day credit facility under which it can borrow up to $120 million at an interest rate of 2.25% over LIBOR. No amounts have been borrowed under this credit facility.

In the second quarter of 2008, AFG paid $189.7 million in cash and issued 2.4 million shares of Common Stock to redeem its Senior Convertible Notes. The cash used in the redemption was funded primarily with borrowings under AFG's revolving credit facility.

In the first nine months of 2008, AFG repurchased approximately 1.8 million shares of its Common Stock for $47.4 million.

Under tax allocation agreements 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 In December 2007, National Interstate, a 53%-owned property and casualty insurance subsidiary, entered into a five-year unsecured credit agreement under which it can borrow up to $75 million, subject to certain conditions. Amounts borrowed bear interest at rates ranging from .45% to .9% (currently .65%) over LIBOR based on National Interstate's credit rating. In May 2008, National Interstate borrowed $15 million under the credit agreement to redeem its subordinated debentures at par.

In June 2008, GAFRI used cash on hand to redeem its $28.5 million in 6-7/8% notes at maturity.

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 provided more than sufficient funds to meet these requirements without requiring a sale of investments or contributions from AFG. 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. With declining rates, AFG receives some protection (from spread compression) due to the ability to lower crediting rates, subject to guaranteed minimums. 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.

AFG believes its insurance subsidiaries maintain sufficient liquidity to pay claims and benefits and operating expenses, as well as meet commitments in the event of unforeseen events such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies.

Investments AFG's investment portfolio at September 30, 2008, contained $14.6 billion in "Fixed maturities" classified as available for sale and $516.4 million in "Equity securities," all carried at fair value with unrealized gains and losses included in a separate component of shareholders' equity on an after-tax basis.

Management responsible for the valuation of AFG's portfolio uses data from pricing services and non-binding broker quotes in determining fair value. Prices obtained from these sources are reviewed by internal investment professionals who are familiar with the securities being priced and the markets in which they trade. Equity securities are generally priced using closing prices obtained from pricing services. For mortgage-backed securities, which comprise about one-third of AFG's fixed maturities, prices are generally obtained from two or three of these sources. If the prices vary, AFG's investment professionals select the price they believe most appropriate based on their knowledge of the market. For the other two-thirds of AFG's fixed maturities, 93% are priced using a pricing service and the balance is priced internally or by using a non-binding broker quote. Prices obtained from a broker or pricing service are adjusted only in cases where they are deemed not to be representative of an appropriate exit price (fewer than 1% of the securities).

Increasing turmoil in the global financial markets has caused credit spreads (the difference in rates between U.S. government bonds and other fixed maturities) to widen significantly during the third quarter of 2008. These wider spreads were the primary cause of AFG's pretax net unrealized loss on fixed maturities rising from $472 million at June 30, 2008, to $1.2 billion at September 30, 2008.

Approximately 94% of the fixed maturities held by AFG at September 30, 2008, 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 noninvestment grade. Management believes that a high quality investment portfolio should generate a stable and predictable investment return.

AFG's $5.6 billion investment in mortgage-backed securities ("MBSs") represented approximately one-third of its fixed maturities at September 30, 2008. MBSs 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. Approximately 97% of AFG's mortgage-backed securities are rated "AAA" or "AA." At September 30, 2008, AFG owned approximately $437 million (representing 3% of AFG's total fixed maturity portfolio) of mortgage-backed securities in which the underlying collateral is subprime mortgages. At that date, the net unrealized loss on these securities was approximately $68 million. The securities are collateralized by substantially all fixed-rate mortgages and have an overall average life of approximately 4 years. At September 30, 2008, AFG owned approximately $1.0 billion in Alt-A securities (risk profile between prime and subprime) with an average life of approximately 5 years, the vast majority of which are backed by fixed rate mortgages. The unrealized loss on Alt-A securities was $124 million at September 30, 2008. Based on current information, management does not believe that AFG's ultimate loss on the subprime or Alt-A securities will be material to its financial condition.

At September 30, 2008, AFG owned approximately $778 million in securities with credit enhancement provided by bond insurers, including $546 million of insured municipal bonds, $111 million in insured subprime securities
(included in the $437 million in total subprime exposure discussed above)
and $99 million in insured corporate bonds. Approximately 92% of the insured municipal bonds carry an explicit underlying rating (i.e. without credit enhancement) with an average of A+, and 63% of the corporate bonds carry an explicit underlying rating with an average of A-. None of the insured subprime securities carry an explicit underlying rating. Management does not believe the risk of loss on the securities without underlying credit ratings is material to AFG's financial condition.

Summarized information for the unrealized gains and losses recorded in AFG's Balance Sheet at September 30, 2008, is shown in the following table (dollars in millions). Approximately $299 million of available for sale "Fixed maturities" and $145 million of "Equity securities" had no unrealized gains or losses at September 30, 2008.

                                                    Securities  Securities
                                                         With        With
                                                    Unrealized  Unrealized
                                                        Gains      Losses
       Available for Sale Fixed Maturities
        Fair value of securities                        $3,213     $11,133
        Amortized cost of securities                    $3,125     $12,406
        Gross unrealized gain (loss)                     $  88    ($ 1,273)
        Fair value as % of amortized cost                  103%         90%
        Number of security positions                     1,029       1,850
        Number individually exceeding
         $2 million gain or loss                             3         165
        Concentration of gains (losses) by type or
         industry (exceeding 5% of unrealized):
          Mortgage-backed securities                    $ 34.3    ($ 515.1)
          Banks, savings and credit institutions           2.2      (367.2)
          States and municipalities                        5.5       (16.0)
          Gas and electric services                        5.3       (37.4)
          Direct obligations of the U.S. Government       13.3         (.1)
        Percentage rated investment grade                   97%         94%

       Equity Securities
        Fair value of securities                         $ 159      $  212
        Cost of securities                               $  67      $  278
        Gross unrealized gain (loss)                     $  92      ($  66)
        Fair value as % of cost                            237%         76%
        Number of security positions                        31         117
        Number of individually exceeding
         $2 million gain or loss                             1           6

The table below sets forth the scheduled maturities of AFG's available for sale fixed maturity securities at September 30, 2008, based on their fair values. Asset-backed securities and other 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  Securities
                                                     With        With
                                                Unrealized  Unrealized
                                                    Gains      Losses
           Maturity
            One year or less                           8%          2%
            After one year through five years         56          19
            After five years through ten years        10          33
            After ten years                            2           5
                                                      76          59
            Mortgage-backed securities (average
             life of 5-1/2 years)                     24          41
                                                     100%        100%

                      AMERICAN FINANCIAL GROUP, INC. 10-Q

                      Management's Discussion and Analysis

          of Financial Condition and Results of Operations - Continued



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


                                                                     Fair
                                        Aggregate    Aggregate   Value as
                                             Fair   Unrealized  % of Cost
                                            Value  Gain (Loss)      Basis
Fixed Maturities at September 30, 2008

Securities with unrealized gains:
 Exceeding $500,000 (32 issues)            $  409        $  32        108%
 Less than $500,000 (997 issues)            2,804           56        102
                                          $ 3,213        $  88        103%

Securities with unrealized losses:
 Exceeding $500,000 (600 issues)          $ 6,400      ($1,107)        85%
 Less than $500,000 (1,250 issues)          4,733         (166)        97
                                          $11,133      ($1,273)        90%

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

                                                                            Fair
                                             Aggregate     Aggregate    Value as
                                                  Fair    Unrealized   % of Cost
                                                 Value          Loss       Basis
Securities with Unrealized
 Losses at September 30, 2008

Investment grade fixed maturities with
losses for:
 Less than one year (1,356 issues)             $ 8,432        ($ 749)         92%
 One year or longer (296 issues)                 2,043          (411)         83
                                               $10,475       ($1,160)         90%

Non-investment grade fixed maturities with
losses for:
 Less than one year (116 issues)                $  356        ($  44)         89%
 One year or longer (82 issues)                    302           (69)         81
                                                $  658        ($ 113)         85%

Common equity securities with losses for:
 Less than one year (42 issues)                 $  111        ($  16)         87%
 One year or longer (6 issues)                       6            (2)         78
                                                $  117        ($  18)         87%

Perpetual preferred equity securities with
losses for:
 Less than one year (32 issues)                  $  70        ($  30)         70%
 One year or longer (37 issues)                     25           (18)         58
                                                 $  95        ($  48)         66%

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. The determination of whether unrealized losses are "other than temporary" requires judgment based on subjective as well as objective factors. A listing of factors considered and resources used is contained in the discussion of "Investments" under Management's Discussion and Analysis in AFG's 2007 Form 10-K. With respect to the perpetual preferred equity securities with unrealized losses shown separately in the table above, management considered the hybrid nature of these investments, the fact that they continue to pay dividends and that they have maintained their investment grade ratings in concluding that the impairment was temporary.

Based on its analysis, management believes (i) AFG will recover its cost basis in the securities with unrealized losses and (ii) that AFG has the ability and intent to hold the securities until they recover in value. 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. Management believes it is not likely that future impairment charges will have a significant effect on AFG's liquidity.

Uncertainties Management believes that the areas posing the greatest risk of material loss are the adequacy of its insurance reserves and contingencies arising out of its former railroad and manufacturing operations. See Management's Discussion and Analysis - "Uncertainties" in AFG's 2007 Form 10-K.

General Results of operations as shown in the accompanying financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP").

AFG reported operating earnings before income taxes of $28.0 million for the third quarter of 2008 and $183.2 million for the 2007 third quarter. The decrease is primarily due to $150 million in realized losses on investments in the 2008 period. The results also reflect higher earnings from annuity and supplemental insurance operations and higher investment income, both of which were offset by a $32.9 million decline in Specialty property and casualty underwriting results (due primarily to catastrophe losses).

Nine month pretax operating earnings decreased $235.3 million in 2008 compared to 2007, reflecting (i) realized losses on investments of $293.5 million recorded in 2008, (ii) a $55.3 million decline in Specialty property and casualty operations, (iii) an increase in investment income of $72.8 million and (iv) a reduction of $72.2 million in asbestos and environmental charges.

Property and Casualty Insurance - Underwriting AFG reports its Specialty insurance business in the following sub-segments: (i) Property and transportation, (ii) Specialty casualty, (iii) Specialty financial and
(iv) California workers' compensation.

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" for the detail of AFG's operating profit by significant business segment.

Underwriting profitability is measured by the combined ratio, which is a sum of the ratios of losses, loss adjustment expenses, underwriting expenses and policyholder dividends to premiums. A combined ratio under 100% is indicative of an underwriting profit. The combined ratio does not reflect investment income, other income or federal income taxes.

                      AMERICAN FINANCIAL GROUP, INC. 10-Q
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