To What Degree Were AIG’s Operating Insurance Subsidiaries Sound? (8)

Continuing profitability / Is this strictly an investment problem?

2007 Net Income2008 Net Income2007 Net Operating  Income2008 Net Operating  IncomeSurplus Increase net of Capital Contributions and divsYellow Column less Realized Capital Gains
Total P&C

5,563

733

7,210

654

(353)

Total Life

3,404

(23,218)

7,206

2,819

(29,539)

(1,840)

Total

8,967

(22,485)

14,416

3,473

(29,892)

Net Underwriting Gain 2007Net Underwriting Gain 2008Net Investment Gain 2007Net Investment Gain 2008
Total P&C

2,189

(1,939)

3,783

2,485

Take a look at the above two tables.  For the P&C OISs, investment results were worse in 2008, but the really big swing was in underwriting, where profits were around $4 billion lower than 2007.  My summary figure for core P&C statutory earnings in 2008 is the -$353 million highlighted in green.  That is the surplus increase net of capital contributions and dividends.  I.e., how much did the value of the companies fall as a result of the year operations — $353 million.

For the life companies, I did the same calculation, but netted out realized capital losses, which should not recur, for a core statutory loss of $1.84 billion.  I can’t split that entirely into underwriting and investments, as with P&C, but taking out the realized capital gains approximates it.

My main point here is that 2008 was a bad year for AIG’s OISs even without the investment losses.  Not enough to take any of the main OISs into insolvency by itself, but bad still.

Articles and other issues

More holding company liquidity out of thin air: receiving a $800 million loan from American General Finance, a wholly owned subsidiary, in exchange for giving the subsidiary $600 million in capital to satisfy a debt covenant.  Wonderful, American General Finance is somewhat less creditworthy to bondholders of the firm, and the AIG holding company gets cash.

AIG attempts to raise cash and reduce leverage through the sale of subsidiaries that are in relatively good shape:

The price talk doesn’t look that great.  Counting in Hartford Steam Boiler, premium prices are certainly not being realized.

In general, the simplest units to sell are the simplest ones to value.  They have the easiest models for analyzing likely future free cash flows, or distributable earnings.  I have said before that when a company is in a crisis, and has to sell off assets, that it makes a great deal of difference what kinds of assets they sell off.  If they reach for the dirtier assets, and wish to keep the clean ones, it is usually a sign of confidence in the future.  If they sell the good assets, because that is all they can do, they are just stalling for time, and hoping that a better day arrives.  Hope is not a strategy, but that is what seems to be going on here.

Now, as for Maurice Raymond Greenberg’s claim that he had nothing to do with the wreck of AIG, let me simply say that he should shoulder a lot of the blame.  Most of the increase in leverage occurred under his watch.  AIG was a decidedly more risky investment when he left than in the late 80s, when the balance sheet had virtually no debt.  He encouraged a fear-based culture that was very bottom-line oriented for the quarterly earnings estimate, even to the point of buying finite reinsurance to manipulate the results.  He pushed for an aggressive culture at AIG Financial products, and he got one.  He may not have been there for the worst of it, but he certainly sowed the seeds of future trouble.

Summary

To what degree were AIG’s operating subsidiaries sound? Answer: aside from the mortgage insurers, the P&C subsidiaries were basically sound, though with some issues such as capital stacking, affiliated assets, etc., as mentioned above.  The non-mortgage P&C subsidiaries didn’t have a great 2008, but they would have survived as standalone entities.

The life and mortgage subsidiaries are another matter.  Without the help of the US Government, many of them would have failed.  Even now, given the levels of affiliated assets, capital stacking, deferred tax assets, etc., they are not in great shape now should there be another surprise.  Profitability is likely to be lower in the future than in the banner years of the middle of the 2000s decade.

The US government acted for multiple reasons on AIG.  Among them was to protect the other life insurers of the US from getting surcharged in order to pay for the costs going to the guarantee funds, along with systemic risk issues at AIG Financial Products (which was much bigger).

If AIG did not have AIGFP, and no bailout from the US Government, the company as a whole would have come under severe stress, and some of the life and mortgage subsidiaries would have gone into insolvency, but the company as a whole would probably have survived.

Investment implications

My view of AIG is this: the common stock will go out worthless, or nearly so.  Preferred stakes will be compromised at best.  Beyond that, I am less certain.  I look at two types of debt securities and wonder, though.  I am planning on doing a review of the funding agreement-backed notes, and perhaps a closer look at American General Finance notes after the first quarter is reported.

The tough part is we don’t know what the government will do.  If their main goal was stabilizing AIGFP, and that job is nearly complete, then if the value of AIG as subsidiaries get sold appears to not support the preferred stock, the government might walk, and not throw good money after bad.  At that point, bonds of the holding company would suffer further, because the insurance commissioners will carefully watch any dividending up to the AIG holding company.  They got bailed out once.  They will be watching more closely from now on, because lightning doesn’t often strike twice in the same place.

My basic view is take a conservative posture on AIG securities.  There are many competing interests, some political, some economic, fighting over the corpse of this once great company.  Be wary of investing in the capital structure of AIG.