American International Group unveiled strategic plans this week that are good enough to stave off — for now — demands by activist investor Carl Icahn for the breakup of the insurance giant. But AIG is unlikely to convince critics that it is doing enough to match the underwriting results and return on equity (ROE) by peers such as Travelers Cos. and the newly reconstituted Chubb Group.
Topping the list of short-term remedies offered by New York–based AIG is a promise to return at least $25 billion of capital to shareholders over the next two years and to cut costs by $1.6 billion, also by the end of 2017. AIG will sell off up to 19.9 percent of its mortgage insurance arm, United Guaranty Corp., at an undisclosed date as a first step toward an eventual spin-off. AIG Advisor Group, its independent broker-dealer network, will be sold to private equity firm Lightyear Capital and Canadian pension manager PSP Investments. Though no prices were disclosed by AIG, analysts estimate the two sales could total $1.5 billion. AIG promised other divestitures in subsequent years and a reorganization of the massive company into more transparent business units.
“With these actions, AIG has taken another major step in simplifying our organization to a leaner, more profitable insurer, while continuing to return capital to shareholders and improve shareholder returns,” asserted CEO Peter Hancock in a written statement announcing the new strategic plan.
“This isn’t really revolutionary — just a more aggressive response to underperformance,” says Meyer Shields, Baltimore-based analyst for Keefe, Bruyette & Woods. Highlighting the underperformance is a dreadful combined ratio — which measures costs and claims as a proportion of premiums in property and casualty (P&C) insurance. A combined ratio greater than 100 percent indicates a loss in underwriting operations. In the third quarter of 2015, AIG was at 102.7 percent. In the same period, Travelers, ACE and Chubb (before the last two merged into the new Chubb) all reported combined ratios of less than 87 percent. The poor underwriting results are the primary reason for AIG’s mediocre operating ROE, which was only 7.1 percent in the first nine months of 2015, compared with the 12 to 15 percent at its three peers.
AIG has targeted a 9 percent ROE by 2017. “Shareholders have to wonder why they wouldn’t rather invest in Chubb, which is already delivering an ROE in the teens,” says Joshua Stirling, a Boston–based analyst at Sanford C. Bernstein & Co.
Another major concern voiced by Icahn and his allies is that AIG’s future profitability will be further compromised unless it cuts down in size enough to shed its designation by the Treasury Department as a systemically important financial institution, or SIFI. AIG is one of three U.S. insurers, also including MetLife and Prudential Insurance Co. of America, in the SIFI category, which requires these insurers to hold additional regulatory capital.
Earlier this January, MetLife announced it would divest substantial parts of its life insurance operations to evade the SIFI label. The move puts further pressure on AIG to follow suit by splitting its P&C and life insurance businesses in two, as demanded by dissident shareholders. But AIG insists such a move would force it to forgo up to a third of the $15 billion in deferred tax benefits gained as a result of the 2008–’09 financial crisis. The insurer also argues that a breakup might endanger the diversification credit it gets from its life insurance operations as a balance to its poor P&C results.
“So, while strategically it doesn’t make sense to keep the company together, financially it does,” says Jay Gelb, a New York–based analyst for Barclays Capital.
AIG has endured more difficult battles than its current jousts with dissidents. It survived the financial crisis, thanks to a record $182 billion government bailout. Under CEO Robert Benmosche, who came out of retirement in 2009 to save the insurer, AIG slashed its $1 trillion precrisis balance sheet almost in half, sold off some of its more valuable assets and eventually repaid the U.S. Treasury along with more than $22 billion in profits to taxpayers. That still leaves AIG as the world’s sixth-largest insurer, with a $68.3 billion market cap. Net income for the first nine months of 2015 was $4.03 billion, a 41.3 percent decline from the $6.87 billion earned in the same period the year before.
Benmosche, who died last year, brought Hancock into the firm in 2010 and groomed him as his successor after stepping down in late 2014. Hancock, now 57, was a banker and derivatives specialist with no previous insurance experience. He has overseen AIG investments in technology, in research and development and in direct marketing. But these are ten-year payback investments that may have taken focus away from basic P&C underwriting. And dramatic improvements in underwriting results “will be tough to achieve, especially in a soft P&C market,” says Gelb.
This prediction doesn’t necessarily mean paralysis. Rather than lopping off its life business and becoming a standalone P&C insurer in one fell swoop, AIG could slowly sell off subsidiaries. “If they come to that conclusion, then the most important thing for management and the board is to decide, business by business, what is possible to repair and what should be sold,” says Bernstein’s Stirling.
