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AIG AT A GLANCE

P/E ► -0.0723   EV/EBITDA ► -5.85   ROA ► -5% VERY LOW ROE ► -92.2% VERY LOW Debt to Equity ► 10.6 AVG Current Ratio ► 0   Interest Coverage Ratio ► -1.04 LOW

 

 

 

 

 

 

American International Group, Inc. (NYSE:AIG) provides insurance and financial services in both the United States and abroad. One of the largest companies in the world by assets and employee size, AIG was a component of the Dow Jones Industrial Average from April 1, 2004 to September 22, 2008.^[1] Through its subsidiaries, its holdings can be divided into four sections: General Insurance, Life Insurance and Retirement Services, Financial Services, and Asset Management.

Traditionally, AIG’s diversity and international holdings insulated it from poor performance in individual markets. However, weak corporate oversight and risk management combined with unchecked speculative trading in its Financial Services arm brought the company to the brink of bankruptcy. In a historic move, the Federal Reserve granted AIG an $85 billion loan and effectively took control of the company with a 79.9% ownership stake.^[2] As of November 12, 2008, the AIG "rescue" encompasses $152.5 billion in government assistance.^[3]

Despite the government aid received, concerns remain that AIG will still need even more money than they have already received.^[4] Former CEO Edward Liddy (previously of Allstate) stated that he intended to keep AIG running as a "smaller, nimbler" public company. ^[5] In August of 2009, AIG announced that Robert H. Benmosche would succeed Libby as the new CEO of AIG; however, Libby continues to hold his position of Chairman. The decision to find a new CEO was actually Libby's, who felt that having a CEO dedicated to running business operations would allow him to focus more on broader governance issues the company faces.^[6]

For the third quarter of 2009, AIG reported its second straight quarterly profit, posting a net income of $455 million, an enormous turnaround from its quarterly loss of $24.4 billion for the same quarter of 2008.^[7] The second straight quarterly profit was a general result of continued market stabilization, as many of the losses AIG suffered from their derivative positions turned in their favor. As a result, the massive losses AIG was forced to report earlier are now showing up as profits, helping it boost net income.

Company Overview

Aig first went public in 1969, and is based out of New York, New York. AIG is well known for striving to generate an underwriting profit. Although difficult for most insurance companies to achieve, underwriting profit occurs when premiums taken in are greater than claims paid out before considering investment returns. Through its various subsidiaries, AIG offers a wide range of insurance and financial services.

AIG was highly levered to the U.S. housing market, making its success heavily dependent on the housing market. As such, when the U.S. housing market crashed, AIG's earnings did as well. In the fourth quarter of 2008 alone, the firm reported write-offs of $18.6 billion related to their mortgage backed securities (MBS) portfolio.^[8] The nearly $20 billion that AIG has written down from losses on credit derivatives has also led the Securities and Exchange Commission (SEC) and Justice Department to investigate the possible overstating of the value of these credit default swap positions during the process of the revaluations.^[9]

Business and Financial Metrics

Business Segments

AIG breaks its operations into 4 segments: i) General Insurance, ii) Life Insurance, iii) Financial Services, and iv) Asset Management.

General Insurance

AIG's subsidiaries are multiple line companies writing all lines of commercial property and casualty insurance, as well as various personal lines. In 2008, AIG's General Insurance segment had an operating loss of $5.75 billion, compared to its 2007 operating income of $10.53 billion.^[12] This decline is attributed primarily to a 4% decline in net premiums written^[13], a 43% decline in net investment income^[14], and $5.02 billion in net realized capital losses. The 4% decline in net premiums written equates to a $1.8 billion decline, workers compensation made up for $1.7 billion of the decline due to falling employment, lower rates, and increased competition.^[15]

Life Insurance

AIG's Life Insurance segment offers a wide range of insurance and retirement service products and services, including whole and term life insurance, individual and group life insurance, and annuities among others. The vast majority of its revenues and premiums are earned abroad; in 2008, 80.2% of premiums written for this segment came from outside the United States.^[16] Although total premiums written increased in 2008, total revenues fell significantly from $53.6 billion in 2007 to $3.1 billion in 2008 due to a sharp increase in net realized capital losses as well as a decline in net investment income.^[16] As a result, AIG's Life Insurance segment had an operating loss of $37.4 billion compared to its 2007 operating income of $8.2 billion.^[16]

AIG's acquisitions over the last two decades demonstrate a clear shift from property and casualty insurance towards life insurance. Notably, it’s 2001 acquisition of American General Corp showed that AIG is shifting its focus. The American Life Insurance Company (ALICO) is AIG's mainstay for both domestic and overseas Life Insurance services. AIG has made this shift because life insurance is less cyclical than property and casualty insurance. As such, earnings are less volatile than earnings with property and casualty insurance. Despite the relative stability, there has been turmoil in regard to capital reserves at AIG's life insurance subsidiaries, since many used AIG common stock as capital for required reserves. For instance, in October of 2008 the parent company had to transfer ¥90.7 billion ($854 million) to the Japanese unit of Alico to shore up its capital., which represented a nearly 40% increase in the Japanese unit's capital.^[17]

Financial Services

AIG’s Financial Services division offers a diversified range of products and services, such as aircraft leasing, capital markets, and consumer finance, among others. Despite an 8% increase in revenues from its aircraft leasing subdivision, AIG Financial Services had losses of $40.8 billion, $40.5 billion of which came from the the Capital Markets subdivision in relation to write downs it was forced to make on credit and derivative positions.^[18] The Capital Markets subdivision represents the operations of AIG Financial Products (AIGFP) group, which at one point held over $60 billion in credit default swaps (CDS).^[19]The SEC is now investigating whether or not the AIGFP, which wrote down $28.6 billion from its Collateralized debt obligation (CDO) and Credit Default Swap (CDS) portfolio in 2008^[20], intentionally overstated the value of CDS on mortgage backed securities (MBS).^[21]

In Januray of 2009, AIG hired investment bank Moelis & Company to find a buyer for its aircraft leasing subsidiary, International Lease Finance Corp. (ILFC), hoping to raise cash with the sale.^[22] As of July 15, 2009, a number of potential buyers had submitted second round bids, indicating a finalized sale may be completed soon.^[23] The sale is expected to generate $8-10 billion for AIG.^[24]

Asset Management

AIG's Asset Management segment offers investment products and services to individuals, pension funds, and other institutions. In 2008, this segment had an operating loss of $9.2 billion, compared to an operating income of $1.2 billion in 2007.^[25] This loss was mainly due to write downs on securities, significantly lower fees earned, as well as losses related to falling equities markets and real estate.

In early September 2009, AIG sold a portion of its Asset Management segment for $500 million to Bridge Partners LP, a company owned by Hong Kong private-equity firm Pacific Century Group. Specifically, AIG sold its unit called AIG Investments, which operates in 32 countries and manages $88.7 billion of investments.^[26] The sale fits within the company's plan to slim down and refocus on AIG's core businesses.

Government Rescue

Phase 1 - September 16 2008- Emergency $85 Billion Loan From Fed

The beginning of the AIG's monumental downfall began on September 15, 2008 when its credit rating was downgraded from AAA. The reasons behind the downgrade involve years of poor oversight and risk management, but the actual unwinding of the company did not begin until AIG lost its AAA rating. On September 15, 2008. S&P lowered the firm to A- and Moody's downgraded them to A2.^[27] This crippled AIG, which was already low on cash, because it forced AIG to post an additional $13 billion in capital to its debtors and trading counterparties as a result of its lower credit rating. As its positions were devalued and it lost its AAA rating, its share price fell, making it difficult to sell equity as a way to raise capital. Since there was an ongoing credit crunch, AIG looked to the U.S. government, initially seeking a $40 billion bridge loan from the Federal Reserve to help it sell assets and stem losses.^[28]

There was high systemic risk in the case of an AIG bankruptcy. RBC Capital Markets estimated that an AIG bankruptcy would have cost the financial industry roughly $180 billion in losses. They arrived at this figure by examining AIG's outstanding insurance on debt securities, which was over $441 billion.^[29] The Federal Reserve brought in Goldman Sachs and J.P. Morgan to assess possible options for AIG to avoid bankruptcy. After both firms were unable to come up with a solution, the Fed moved forward with its plan to offer the $85 billion loan to help prevent a systemic failure in the capital markets caused by an AIG bankruptcy.

The historic agreement was unveiled on September 17, 2008. AIG would receive an emergency $85 billion credit facility secured by all of AIG's assets, and the company would in turn pledge 79.9% ownership through warrants in effectively a debt-for-equity swap.^[30] The loan was structured as a two year floating rate note. The Fed structured the payment from AIG to be the benchmark 3-Month Libor plus 8.5%.^[31] The Fed also obtained the right to suspend dividends and has the right of first refusal, which means that AIG cannot sell assets unless the proceeds are remitted to the government.^[32] The obvious implication from the "punitive" interest rate (as described by Unicredit Group analyst Marco Annuziata) was that the Fed did not intend for this to be financing for the firm to continue its operations. This was a loan for a single purpose- for AIG to sell assets and pay off its obligations in the two year time frame.

Phase 2 - October 8 - Additional $37.8 Billion Secured Credit Facility (Total $122.8 Billion)

A mere three weeks after the Federal Reserve lent AIG $85 billion, the firm was in the midst of another liquidity crisis. This second collapse was the result of the firm's securities lending program.^[33] AIG lent out securities, and lost a great deal of the cash collateral when the securities it lent fell in value. AIG lent out equities, bonds, and CDOs to firms in return for cash collateral and a borrowing fee. AIG suffered significant losses as its holdings, especially CDS, continued to decline in value and additional collateral was required. At the same time, firms that borrowed securities from AIG are redeeming and requesting their posted cash collateral back.

Thus, AIG has again sought the Fed's assistance as the lender of last resort. This additional secured credit facility was actually structured as a loan from AIG to the Federal Reserve. The New York Fed borrowed $37.8 billion worth of investment grade (BBB or better) fixed income securities, and in exchange posted the same amount of cash collateral to AIG.^[34]

Phase 3 - November 10 - Purchase of Preferreds/MBS and Restructured Credit (Total $152.5 Billion)

As AIG's prospects continued to dim in tandem with the global financial markets, it became clear that the original loan package would cripple AIG. On November 10, the firm reported a third quarter loss of $24.5 billion. Even planned asset sales were falling apart as potential buyers had difficulty attaining financing and shrinking valuations decreased their proceeds. Newly appointed CEO Edward Liddy commented on the situation: "It was obvious to me from day one that the terms of that arrangement were really quite punitive in terms of the interest rate and the commitment fee and the shortness of it...I started really about a week after I got here trying to renegotiate."^[35] Once Congress had passed the Troubled Assets Relief Program (TARP), there was a new opportunity for capital infusion into the company. Now, the Treasury had the authority to purchase securities or equity from these beleaguered financial companies. Rather than push AIG into complete nationalization or bankruptcy with the nearly $130 billion loan that had an interest rate of over 10% and only two year maturity, the Fed and the Treasury collaborated to help stem the actual source of the losses.

The new deal was structured in three branches:

Secured Credit Facility ($60 billion)

As Liddy pointed out, the original loan was unlikely to be paid off. As a result, the Treasury restructured the Fed's secured credit facility to a much more favorable agreement for AIG. This time, the firm was offered increased liquidity through equity and asset purchases. The new agreement reduced the amount of the loan from $85 billion to $60 billion, lowered the interest rate from 3-Month Libor plus 8.5% on the entire facility to 3-Month Libor plus 3% on drawn funds and plus 0.75% on the unused balance, and extended the life of the loan from two to five years.^[36][37][38]

Senior Preferred Stock ($40 billion)

The second part of the Treasury's restructured package was to utilize the TARP program to purchase $40 billion of senior preferred stock. AIG used this new capital to pay down funds drawn from the initial secured credit facility. The Treasury also placed limitations on executive compensation and put a freeze on the bonus pool of the top 70 company executives. ^[39]

New Lending Facilities for MBS and CDS ($52.5 billion)

The final piece of the restructured agreement attempts to attack the source of the problem - AIG's overexposure to mortgage-backed securities and credit default swaps. The Federal Reserve and AIG worked together to create two new limited liability companies (LLC) to move the toxic assets off of AIG's balance sheet. The first was created with a $22.5 billion credit facility from the Fed and was used to purchase residential MBS from AIG. The firm would post $1 billion of its own capital to the LLC and bear the risk of the first billion in losses. The second LLC has a $30 billion facility from the Fed to purchase CDOs that AIG had written credit default swaps on. This was effectively used to unwind the CDS that AIG had written. AIG contributed $5 billion of its own capital and would be accountable for the first losses as well. These LLCs would only be guaranteed by the assets they possess, rather than all of AIG's assets, and will be repaid by the cash flows of the underlying assets.^[40]

Sale of Various AIG Units

AIG has hired Wall Street titan Blackstone Group to advise the firm on its disposal of insurance businesses and assets.^[41] There are a number of units that AIG has sold or plans to sell as part of its strategy going forward. Many of these sales are under duress, as AIG desperately needs cash to repay government loans and maintain capital stock. As such, most of the sales were at much lower prices than if AIG were to sell them when market conditions were better.

Spinoff of The American Life Insurance Company (ALICO)

In an apparent misnomer, The American Life Insurance Company (ALICO) only provides life and health insurance outside of the United States. The company currently operate in 54 countries^[42], although more than half of its revenues are generated in Japan.^[43] This segment has had capital problems, as a large portion of its reserves were in AIG common shares. In October of 2008, AIG had to transfer ¥90.7 billion ($854 million) to ALICO to help shore up its capital.^[44]

While originally the plan was to sell ALICO, AIG ultimately decided to "spinoff the unit as its own business. In July of 2009, AIG announced it was speeding up efforts for an ALICO initial public offering (IPO) after multiple bidders dropped out of the picture.^[45] During the week of September 8, 2009, AIG interviewed numerous investment banks, including Deutsche Bank AG (DB), Credit Suisse Group (CS), UBS AG (UBS), Citigroup (C), and Goldman Sachs Group (GS) about the IPO of ALICO, which could fetch up to $5.0 billion.^[43]

Nan Shan Life Insurance Co.

On October 15, 2009 AIG sold its Taiwan life insurance unit, the Nan Shan Life Insurance Co. for $2.15 billion, incurring approximately a $1.4 billion loss on the sale.^[46] This sale follows the trend of AIG selling off many of its units at steep discounts as the pressure to repay the government loans increases.

Trends and Forces

Accuracy of risk models

As with any insurance company, risk modeling is a primary factor in AIG’s performance. Since the level of risk determines insurance premiums, insurers consider every available quantifiable factor to develop profiles of high and low insurance risk. Due to the impracticability of determining insurance on a case-by-case basis, this general profile of high and low insurance risk is applied in the form of an algorithm to sort all clients between the two categories. Just like other algorithms that are used to simplify complex systems, insurance models suffer from a lack of scope. Situations that would have a large impact on risk but are nearly impossible to predict (natural disasters, terrorist attacks, etc…) can create difficulties in determining an appropriate premium. However, in more conventional situations, the profit or loss of insurance companies is determined by their accuracy in sorting high-risk clients from low-risk ones.

This being said, AIG also faces low obsolescence risk - that is, there is little chance of the company's services becoming obsolete due to a lack of market demand. So long as the company continues to diversify the insurance products it offers in accordance with the current industry trends, there is also little chance of competitors offering substantially different risk models that undercut AIG's. Essentially, the company will remain at about the same level of demand so long as it remains in the insurance industry.

Government regulation risk

Insurance companies in the United States are regulated primarily by the individual states as there is no nationwide federal regulatory agency that oversees insurance companies. Insurance companies are required to meet certain financial requirements and to demonstrate periodically (at least annually) to a state's Department of Insurance that they continue to meet or exceed the minimum financial requirements. The Department of Insurance can take various actions against an insurance company that fails to conduct its business in a financially sound manner, including causing the company to cease operations in the state.

Strength in foreign markets

AIG's foreign roots took hold in China in 1919 and Japan in 1946, and it is now the top foreign insurer in both nations. Despite the entrance of American and European competitors, AIG's head start in the region should help continue its dominance among the foreign insurers. Whether or not AIG can become more than a niche player compared to the existing Chinese and Japanese insurers is an open question. The company has made efforts to adapt to the local market by offering SARS-related insurance, implementing stricter control on overhead, and earning top ratings from credit companies (a major selling point in regions with iffy insurers, like China).

While its presence in China and Japan is strong, AIG faces stiff competition from Prudential and state-backed insurers in India. The South East Asian market continues to expand, and while AIG has holdings in Vietnam, Thailand, and South Korea, none are as dominant as its Chinese and Japanese holdings. As a whole, Asia accounted for about a third of AIG's revenue.

In other regions, AIG has significant life insurance holdings in the EU, which provide a big lead over the competition there.

Competition

Source: JP Morgan

Due to its various holdings, AIG has a very eclectic group of competitors. In the life insurance industry, AIG already possesses the largest share of the United States market, even as it brings more of its assets and capital to bear. Since AIG has the security of a diverse investment portfolio, it can afford to leave risky rates and pursue the rarer, better ones, unlike one-dimensional companies that are forced to pursue all leads as to stay afloat. Therefore, much as it did earlier in property and causal insurance, AIG will be able to maximize its holdings in life insurance.

Generally, AIG is outperforming its major competitors. In the United States, AIG has the largest individual company share of the life insurance market, at 11% overall. Combined with its strong overseas performance in the EU, China, and Japan AIG has a stranglehold on the international life insurance market.

References

1. ↑ Yahoo Finance
2. ↑ Wall Street Journal
3. ↑ Wall Street Journal
4. ↑ AIG shares fall on fears more government cash needed, Reuters, 2/3/2009
5. ↑ http://online.wsj.com/article/SB122177593394254125.html
6. ↑ A.I.G. Appoints a New Chief Executive. The New York Times.
7. ↑ AIG posts profit of $499.3m. SkyNews.
8. ↑ AIG 10-K 2008 Item 7 Pg. 63
9. ↑ Wall Street Journal
10. ↑ ^{10.0 10.1 10.2} AIG 10-K 2008 Item 8 Pg. 194
11. ↑ AIG 10-Q 2009 Item 1 Pg. 5
12. ↑ AIG 10-K 2008 Item 7 Pg. 75
13. ↑ AIG 10-K 2008 Item 7 Pg. 72
14. ↑ AIG 10-K 2008 Item 7 Pg. 73
15. ↑ AIG 10-K 2008 Item 7 Pg. 76
16. ↑ ^{16.0 16.1 16.2} AIG 10-K 2008 Item 7 Pg. 100
17. ↑ Michael Kitchen. AIG shores up Alico Japan unit with $854 million. Marketwatch
18. ↑ AIG 10-K 2008 Item 7 Pg. 116
19. ↑ http://www.propublica.org/article/article-aigs-downward-spiral-1114
20. ↑ AIG 10-K 2008 Item 7 Pg. 117
21. ↑ Wall Street Journal
22. ↑ Colin Keatinge. AIG Hires Ken Moelis to Find Buyer for ILFC, Telegraph Reports. Bloomberg.
23. ↑ AIG Investment bidder drops out. Dealscape. Thedeal.com
24. ↑ http://www.bloomberg.com/apps/news?pid=20601102&sid=a8FlztakYVY0&refer=uk
25. ↑ AIG 10-K 2008 Item 7 Pg. 120
26. ↑ Lavonne Kuykendall. AIG to Sell Asset-Management Unit. The Wall Street Journal.
27. ↑ http://thismatter.com/money/bonds/bond_ratings_and_credit_risk.htm
28. ↑ http://www.bloomberg.com/apps/news?pid=20601087&sid=amE9cvUPd30A&refer=home
29. ↑ http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=a6QAz6YiyRAI
30. ↑ AIG 8-K
31. ↑ http://www.federalreserve.gov/newsevents/press/other/20080916a.htm
32. ↑ http://www.rgemonitor.com/globalmacro-monitor/254309/the_black_hole_gets_bigger_aig_back_for_yet_another_bailout
33. ↑ http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aoj_ojzEcu9w
34. ↑ Press Release. Board of Governors of the Federal Reserve System.
35. ↑ http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aoj_ojzEcu9w
36. ↑ http://www.bloomberg.com/apps/news?pid=20601087&refer=home&sid=aoj_ojzEcu9w
37. ↑ http://www.nytimes.com/2008/11/11/business/economy/11aig.html?_r=1
38. ↑ http://www.federalreserve.gov/newsevents/press/other/20081110a.htm
39. ↑ http://www.ustreas.gov/press/releases/hp1261.htm
40. ↑ Press Release. November 10, 2008. Board of Governors of the Federal Reserve System.
41. ↑ http://www.bloomberg.com/apps/news?pid=20601102&sid=a8FlztakYVY0&refer=uk
42. ↑ http://web.aig.com/UI/ALICO/Country_Splash_Page.html
43. ↑ ^{43.0 43.1} Paritosh Bansal. AIG interviewing banks on Alico IPO. Reuters.
44. ↑ Marketwatch
45. ↑ Alistair Barr. AIG says Alico unit to seeking New York listing. MarketWatch.
46. ↑ Alistair Barr. AIG to lose $1.4 billion on Nan Shan sale. MarketWatch.