COMMENT: AIG’s unexpected $4.1bn reserve charge

COMMENT: AIG’s unexpected $4.1bn reserve charge

In the past two-and-half years, AIG executives and every other insurance executive looking to avoid an over-reaction from regulators have hammered home one point time and time again: the troubles at American International Group (AIG) were nothing to do with insurance.
 
This may be true, but it seems that the insurance units are not in as great shape as some people imagined.

The news that AIG expects to report a $4.1bn property/casualty reserve charge to be assigned to Chartis, its general insurance unit, in its fourth-quarter results has raised fresh concerns about the bailed-out firm.

This charge is equivalent to 6% of its carried reserves as of September 30, 2010.

The magnitude of the charge is well out of whack with AIG’s peers.

While underlining its underperform rating on the firm, equity analysts at Keefe, Bruyette & Woods (KBW) noted: “While the charge may be a step towards assuaging concerns regarding old accident years, the charge also raises concerns.
 
“With a charge of this magnitude, investors must also question the ability of the company to accurately set reserves. The company’s major US peers such as Chubb and Travelers have been reporting material favourable reserve development, so they may ask: why can’t AIG get it right?”
 
The breakdown is $1.3bn for asbestos reserves; $1bn for excess casualty reserves; $825m for excess workers’ compensation reserves; $420m for primary workers’ compensation reserves; $820m for commercial risk and national accounts reserves; and $240m in other business lines.

This is offset by $446m of loss reserve discount and loss sensitive premium adjustments.

The good news was that AIG also announced that the charge will be partially offset by a $2bn capital injection from the proceeds of the recently-completed sales of AIG Star Life and AIG Edison Life to Prudential Financial.

Rating agency Fitch was not impressed either, downgrading the financial strength ratings of AIG’s domestic non-life insurance subsidiaries to A- from A.

“The agency views AIG's recent record of adverse reserve development as a significant outlier relative to that of the company's large commercial insurance lines competitors and to the overall non-life insurance market,” said Fitch.

“Fitch believes that this is partially attributable to AIG's larger than its peers' market share in long-duration excess casualty and workers’ compensation business lines which presents significant and unique reserving challenges.

“The agency notes that AIG has reduced these business lines' relative contribution to the company's overall non-life premium base with a goal that this could contribute to more stable reserves going forward.”

It added: “Fitch believes that AIG's domestic non-life insurance subsidiaries' recent history of reporting significant adverse reserve development raises concerns about the companies’ ability to generate consistent run-rate underwriting results commensurate with their previous ratings.

“Fitch notes that while a majority of the reserve charge is attributable to older accident years, reserves for more recent accident years have also developed adversely.”

Other rating agencies were not so harsh. Standard & Poor’s affirmed its A- rating on AIG. It believes Chartis will report a combined ratio in the high 90s for 2011, despite the charge.

However, Standard & Poor’s is uncertain about the future performance of AIG’s core operations – it already had a negative outlook on its ratings.

AM Best affirmed its A financial strength rating on Chartis. Although the rating agency noted this was a “significant increase” it had already baked reserve increases into its expectations.

Perhaps, here, AIG benefited from the turmoil of its recent past lowering expectations – AM Best, too, already had a negative outlook on the ratings.

It is good news for the firm that it can confidently talk about a time when it will not be dependent on US taxpayer funds.

But the question is whether the firm that emerges will be a consistently underperforming insurance company.

The bulk of the reserve charge is for business written in 2005 and before – the time when AIG enjoyed a stellar reputation and stellar ratings. This is a worry.

But perhaps a bigger worry is that AIG is already increasing reserves for business written after 2005. Since the firm's near collapse it has battled against accusations that it was slashing rates to hold onto business.

The firm has confounded the expectations of some by holding onto more business than some expected, but at what cost?

As the KBW analysts noted: “In addition, to the degree that this charge stems from recent accident years and negative loss trends, Chartis’ earnings power appears not to be as strong as previously reported.”

AIG’s former chairman Harvey Golub recently said “longer term, AIG shouldn’t exist”, and called for its life and non-life units to be split.

Shareholders will be hoping the firm is merely being extra conservative and getting its finances in tip-top condition ahead of being granted its independence again.

Michael Loney
mloney@euromoneyny.com

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