Business Context and Reporting Period
American International Group, Inc. (AIG) filed an unaudited Form 10-Q for the three months ended March 31, 2014. AIG is a global insurance organization operating primarily through AIG Property Casualty, AIG Life and Retirement, Mortgage Guaranty, Global Capital Markets, the Direct Investment Book, Corporate & Other, and Aircraft Leasing. The filing compares the first quarter of 2014 with the first quarter of 2013 and balance-sheet amounts with December 31, 2013.
Key Financial Metrics
| Metric | Q1 2014 | Q1 2013 / Dec. 31, 2013 | Change |
|---|---|---|---|
| Total revenues | $16.112 billion | $16.962 billion | Down 5% |
| Income from continuing operations | $1.659 billion | $2.158 billion | Down 23% |
| Net income attributable to AIG | $1.609 billion | $2.206 billion | Down 27% |
| Diluted EPS | $1.09 | $1.49 | Down $0.40 |
| After-tax operating income attributable to AIG | $1.781 billion | $1.982 billion | Down 10% |
| Net cash provided by operating activities | $763 million | $(149) million | Improved by $912 million |
| Total assets | $547.111 billion | $541.329 billion | Up $5.782 billion |
| Long-term debt | $39.508 billion | $41.693 billion | Down $2.185 billion |
| AIG shareholders’ equity | $103.833 billion | $100.470 billion | Up $3.363 billion |
| Book value per common share | $71.77 | $68.62 | Up 5% |
| Book value per share excluding AOCI | $65.49 | $64.28 | Up 2% |
Net income attributable to AIG represented approximately 10.0% of revenue, compared with approximately 13.0% in the prior-year quarter. Income from continuing operations represented approximately 10.3% of revenue, compared with approximately 12.7% in Q1 2013.
Segment Performance
- AIG Property Casualty: Pre-tax operating income was $1.159 billion, down 26%. The combined ratio increased to 101.2 from 97.3, reflecting higher catastrophe and severe losses and adverse prior-year reserve development. Catastrophe losses were $262 million versus $41 million; adverse prior-year development was $162 million versus $52 million of favorable development.
- AIG Life and Retirement: Pre-tax operating income increased 2% to $1.417 billion, supported by higher fee income and improved spread management. Premiums and deposits rose 28% to $7.129 billion, and net flows improved to $1.016 billion from negative $244 million.
- Mortgage Guaranty: Pre-tax operating income increased 85% to $76 million. The combined ratio improved to 80.8 from 96.4, while new insurance written declined 27% to $7.745 billion.
- Global Capital Markets: Pre-tax operating income declined 87% to $29 million, primarily because of lower gains on the super senior credit default swap portfolio and unfavorable credit valuation adjustments.
- Direct Investment Book: Pre-tax operating income increased 34% to $440 million, driven by fair-value appreciation on ABS CDOs and gains from unwinding positions.
Cash Flow, Debt and Liquidity
- Operating cash flow was $763 million; investing activities provided $3.783 billion; financing activities used $4.289 billion. Cash increased to $2.490 billion from $2.241 billion at year-end.
- AIG reduced total reported debt through approximately $3.1 billion of repayments and redemptions, including $2.2 billion of Direct Investment Book debt. Total debt declined to $39.508 billion, excluding $22.7 billion of ILFC debt classified as held for sale.
- AIG Parent reported $15.611 billion of liquidity sources, consisting of $8.212 billion of cash and short-term investments, $2.952 billion of unencumbered fixed-maturity securities, $3.947 billion of available syndicated credit capacity, and a $500 million contingent liquidity facility.
- AIG Parent received a $1.7 billion dividend from AIG Life and Retirement and no dividend from AIG Property Casualty during the quarter.
- AIG repurchased 17.4 million shares for $867 million and paid a $0.125 per-share dividend. Approximately $537 million remained under the repurchase authorization at March 31, 2014.
Material Changes and Unusual Items
- Net realized capital losses were $213 million versus $300 million of gains in Q1 2013. The change was principally related to fair-value losses on embedded derivatives associated with variable annuity guarantees and lower gains from investment sales.
- Other comprehensive income was $2.725 billion, primarily reflecting a $3.939 billion increase in unrealized investment appreciation. AOCI increased to $9.085 billion from $6.360 billion.
- AIG recognized a $954 million decrease in the deferred tax asset valuation allowance associated with AIG Life and Retirement capital-loss carryforwards and unrealized tax losses; $62 million affected continuing-operations income and $892 million was recorded in other comprehensive income.
- AIG recorded a $238 million loss on extinguishment of debt, compared with $340 million in Q1 2013.
- ILFC remained classified as held for sale. AIG expected the AerCap transaction to close in the second quarter of 2014 for approximately $3.0 billion in cash plus approximately 97.6 million AerCap shares; ILFC assets and liabilities held for sale totaled $30.767 billion and $25.815 billion, respectively.
- ILFC had commitments to purchase 322 aircraft with approximately $21 billion of remaining payments, plus commitments for 13 spare engines. These commitments relate to the held-for-sale business.
Guidance, Outlook, Commentary and Risks
Management did not provide a single consolidated earnings forecast in the filing. Its 2014 priorities were customer focus, profitable growth in core insurance operations, improving investment yield while preserving credit quality, more efficient capital deployment, completion of the ILFC transaction, regulatory engagement, and expense reduction.
- Management expects low interest rates, currency volatility, economic uncertainty, and property-casualty industry overcapacity to continue pressuring investment income and pricing.
- AIG Property Casualty expects continued focus on underwriting discipline, risk selection, claims analytics, expense control, reinsurance optimization, and growth in selected markets. The Terrorism Risk Insurance Program was scheduled to expire December 31, 2014, creating potential exposure if not renewed.
- AIG Life and Retirement expects continued opportunity in variable annuities, fixed annuities, mutual funds, and retirement products, but prolonged low interest rates could reduce spreads, investment returns, and the profitability of guaranteed products.
- Material risks include catastrophe losses, adverse reserve development, policyholder surrenders, interest-rate and credit-spread movements, equity-market declines, foreign-exchange movements, investment impairment, derivative collateral calls, credit-rating downgrades, regulatory restrictions on subsidiary dividends, and tax-asset recoverability.
- At March 31, 2014, a one-notch downgrade scenario could require additional collateral postings and termination payments; the filing estimated approximately $61 million under one stated downgrade scenario and $139 million under a further downgrade scenario, although actual amounts could differ significantly.
- Significant legal and regulatory matters remained outstanding, including securities litigation, ERISA litigation, the Starr International Treasury Action, Caremark-related litigation, regulatory inquiries involving insurance practices, and tax litigation. Certain potential losses could not be reasonably estimated.
Investor Verification Checklist
- Verify whether the AerCap transaction closed on the expected terms and how AIG monetized or retained the AerCap shares.
- Reconcile reported net income with after-tax operating income, realized investment losses, debt-extinguishment losses, tax valuation allowance releases, and discontinued operations.
- Monitor Property Casualty loss-reserve development, catastrophe frequency, severe losses, and whether the 101.2 combined ratio improves.
- Assess Life and Retirement spread performance, surrender rates, variable-annuity guarantee exposure, hedging effectiveness, and sensitivity to interest rates and credit spreads.
- Review liquidity after debt repayments, share repurchases, dividends, collateral requirements, and subsidiary dividend restrictions.
- Evaluate investment concentration and valuation risk, including $284.655 billion of fixed-maturity securities, $41.964 billion of below-investment-grade fixed-maturity securities, and $48.518 billion of recurring Level 3 assets.
- Track unresolved litigation, regulatory proceedings, tax contingencies, aircraft purchase commitments, guarantees, and other off-balance-sheet exposures.