How AIG Could Achieve Insurance Greatness

It seems that I can’t escape AIG anymore.  I asked my kids (who are still at home) today, “Of all the jobs I had, where did I get treated the worst?”  The oldest answered “AIG.”  He was born shortly after I left AIG in 1992.

I guess I made some of the wounds obvious enough.  I don’t believe in “payback,” I believe in “Love your enemies,” and “Be honest.”  Thus I find it odd that I am being ever more sought out by reporters on any AIG news.

Granted, I’ve written on underreserving by AIG, the problems they had at their operating insurance subsidiaries during the financial crisis, which got picked up by SIGTARP.

What has prompted recent inquiries, is the sale of stock at $29/share,  at only a 1.6% discount to the prior closing price.  That price was a hodgepodge between what the market would bear, and what would give the government a “profit.”  Bad idea in my opinion; it would have been better to price the deal lower, say $28.50, where the government took a loss, but where the market might have driven the price up.  A 1.6% gap is marginal and would invite sellers. $28.50 would be over 3% and would invite buyers.

Now, some sympathy for Bruce Berkowitz — He saw book value decline by almost $1 today, from $47.32 to $46.35.  I don’t know if he was buying as the largest private shareholder of AIG, but he was certainly disappointed by the company offering shares.  Why offer shares at less than 2/3rds of book?

Easy, because AIG can’t borrow or issue any other security.  But that is a signal to what the company is worth.  I mean at worst, AIG could have procured a secured loan to  provide $3 billion, offering a valuable subsidiary as collateral.  They chose to dilute, which tells you what the stock is likely worth.

Also, with such a large fall in price after the offering the next offering should come at a larger discount to the recent market price.  Those that were burned in this offering will be less willing to step up and take immediate losses.

Now, AIG has two other ways to improve their stock price.  Improve transparency, and improve Return on Equity.  The first of those means eliminate the sense that there could be negative surprises in the future.  That means that reserves have to be modestly conservative, unlike they have been in the past.  That means taking one last reserve strengthening to do so, if needed, even if it temporarily hurts the stock price because of the loss.

But if it can be shown that the loss is likely the last of such losses, and that AIG isn’t going to use its reserves to manipulate earnings any more, the loss in the stock price should be minimal.  After all, a lot of that is buried in the discount to book anyway.

Then comes improving ROE. The CFO Peter Hancock has said, ‘“We are moving away from any kind of top-line targeting,” Hancock said in a call with analysts. “We think that leads you to do business at the margin, which is unattractive.”’

That’s some of the best news I have heard on AIG in some time.  If AIG limits its underwriting, and focuses on profitability, it has a lot of potential for upside, but that would mean:

  • Reducing overhead expenses
  • Compensating line managers on underwriting profitability, conservatively estimated.  Tie their long-term bonuses to aggregate underwriting profits.
  • Eliminating marginal lines of business, including selling off lines where AIG has no sustainable competitive advantage, like investment management, consumer finance, aircraft leasing, and domestic life insurance.  The last of those is the most controversial — I would sell off the domestic life insurers to the highest bidder.  I suspect there would be willing buyers among the big players of the life insurance industry.  Use the proceeds to buy back stock from the government, or to reduce debt.

AIG would do best if it were a pure play P&C insurer.  As I have argued since long before the crisis, the size and complexity of AIG make it unmanageable.  Better management will come through creating a more focused company that does not require having a “superman” like Maurice Greenberg to manage it.

Disclosure: I don’t own any AIG, nor am I short.  The same for my clients.