American International Group, Inc. — Q3 2018 Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018; unaudited interim financial statements. AIG is a global insurer operating in more than 80 countries, with General Insurance, Life and Retirement, Other Operations and Legacy Portfolio businesses.
Business context and material transactions
- AIG completed the acquisition of Validus Holdings on July 18, 2018 for approximately $5.5 billion in cash. Validus contributed $756 million of revenue and reduced AIG net income by $105 million during the third quarter and nine-month period. The acquisition added approximately $2.0 billion of goodwill and integration and transaction costs of $91 million.
- Fortitude Re was established in February 2018 to consolidate approximately $36 billion of Legacy insurance reserves. AIG agreed to sell Carlyle-related entities a 19.9% interest in Fortitude Holdings, subject to closing conditions and regulatory approvals.
- AIG continued organizational simplification, expense-reduction and portfolio-rationalization initiatives. The company repurchased approximately 18.5 million common shares for $994 million during the first nine months.
Financial performance
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Total revenues | $11.486 billion | $11.751 billion | $34.829 billion | $36.885 billion |
| Income from continuing operations before tax | $(1.527) billion | $(2.803) billion | $952 million | $591 million |
| Net income attributable to AIG | $(1.259) billion | $(1.739) billion | $616 million | $576 million |
| Diluted EPS attributable to AIG | $(1.41) | $(1.91) | $0.67 | $0.60 |
| Adjusted pre-tax income | $(416) million | $(1.856) billion | $2.078 billion | $2.318 billion |
| Net cash from operating activities | Not separately provided for the quarter | Not separately provided for the quarter | $(38) million | $(8.862) billion |
Quarterly results improved primarily because of substantially lower catastrophe losses, lower unfavorable prior-year reserve development and lower realized capital losses. These benefits were partly offset by unfavorable actuarial assumption updates and higher operating expenses, including Validus-related costs.
- General Insurance: Adjusted pre-tax loss was $825 million in Q3 versus $2.933 billion in Q3 2017; nine-month adjusted pre-tax income was $253 million versus a $826 million loss. The combined ratio improved to 124.4% from 157.1% for the quarter and was 110.2% for the nine months versus 118.5%.
- Life and Retirement: Adjusted pre-tax income was $713 million in Q3 versus $1.158 billion and $2.567 billion for the nine months versus $3.049 billion. Results were pressured by lower fixed-annuity spreads, lower investment returns and unfavorable actuarial assumption changes.
- Investments: Net investment income declined 1% to $3.396 billion in Q3 and 9% to $9.722 billion for the nine months. Net realized capital losses improved to $511 million in Q3 and $365 million for the nine months, compared with $922 million and $1.106 billion, respectively, in 2017.
- Comprehensive income: AIG reported comprehensive losses attributable to AIG of $2.025 billion in Q3 and $4.809 billion for the nine months, driven largely by unrealized investment depreciation.
Balance sheet, debt and liquidity
- Total assets were $504.860 billion at September 30, 2018, compared with $498.301 billion at December 31, 2017. Total liabilities were $445.683 billion and total equity was $59.177 billion.
- AIG shareholders’ equity decreased to $58.586 billion from $65.171 billion, primarily reflecting a $5.425 billion decline in accumulated other comprehensive income. Book value per common share was $66.23; excluding AOCI, $66.83; adjusted book value, excluding AOCI and specified deferred tax assets, $55.58.
- Long-term debt increased to $34.594 billion from $31.640 billion. AIG issued $4.059 billion of debt and repaid $2.885 billion during the nine months.
- Cash and restricted cash increased to $3.123 billion from $2.737 billion at year-end. AIG Parent reported $4.514 billion of cash, short-term investments and unencumbered securities, plus $4.5 billion of available capacity under its syndicated credit facility, for total liquidity sources of $9.014 billion.
- AIG paid $858 million of common dividends during the first nine months and declared an additional $0.32 per share dividend payable in December 2018.
Material changes versus the prior comparable period
- Quarterly net loss attributable to AIG narrowed by $480 million, while nine-month net income increased by $40 million.
- General Insurance underwriting improved substantially as catastrophe charges declined to $1.567 billion in Q3 2018 from $3.016 billion, although 2018 still included significant catastrophe losses.
- Net unrealized investment losses were significant: investment depreciation was $951 million in Q3 and $8.917 billion for the nine months, versus investment appreciation of $1.078 billion and $4.257 billion in the comparable 2017 periods.
- The 2018 adoption of financial-instrument accounting moved equity securities to fair value through earnings and produced an $824 million increase to beginning retained earnings and corresponding decrease to beginning AOCI.
- Results included out-of-period adjustments that reduced Q3 net income by $205 million and nine-month net income by $28 million. Management stated these adjustments were not material to the current or prior periods.
Outlook, commentary and risks
- Management highlighted rising interest rates, widening credit spreads, foreign-exchange volatility, catastrophic events, competitive pricing, Brexit, regulatory changes affecting annuity and investment-product sales, and slowing global economic growth as important operating factors.
- Low rates continue to pressure reinvestment yields, annuity spreads and long-tail casualty economics. Rising rates may improve reinvestment returns but could increase policy surrenders and reduce the fair value of fixed-income assets.
- AIG identified unfavorable reserve development in U.S. Excess Casualty, including a $1.3 billion gross strengthening before the 80% NICO cession, and adverse activity in European Casualty and Financial Lines.
- The company’s NICO adverse-development reinsurance agreement covers 80% of specified U.S. commercial long-tail losses above a $25 billion attachment point, subject to a $20 billion NICO liability limit. Covered paid losses remained below the attachment point at September 30, 2018.
- AIG estimated that a downgrade of specified senior debt ratings could result in up to approximately $49 million of additional collateral calls and termination payments under derivative contracts. Broader collateral requirements may vary with market conditions.
- AIG faces pending tax litigation related to foreign tax credits. Non-binding settlement terms could require approximately $1.7 billion of payments, although the amount, timing and completion of any settlement remain uncertain.
- Unrecognized tax benefits were $4.7 billion, with accrued interest and penalties of $2.2 billion. Management stated that unrecognized tax benefits could decrease by as much as $3.9 billion within the following 12 months.
- The company expects the 2021 long-duration insurance contract accounting standard to have a significant effect on financial condition, results, cash flows, disclosures, systems and controls.
Important facts for investors to verify
- Validate the sustainability of General Insurance underwriting improvement, particularly the 110.2% nine-month combined ratio and exposures to Excess Casualty, Financial Lines and catastrophes.
- Assess Validus integration, the effect of its acquired reserves and assets, related guarantees and the ultimate purchase-price allocation.
- Monitor investment portfolio unrealized losses, credit quality, below-investment-grade exposure, alternative-asset performance and sensitivity to further rate or spread changes.
- Review Life and Retirement actuarial assumptions, guaranteed living benefit liabilities, surrender trends and the effect of lower reinvestment yields on spreads.
- Evaluate parent-company liquidity, debt maturities, ratings-trigger collateral requirements and restrictions on dividends from insurance subsidiaries.
- Follow the Fortitude Re transaction, capital maintenance obligations, potential reserve development reimbursement and the planned $6 billion Carlyle investment commitment.
- Track tax litigation, provisional Tax Act accounting, deferred-tax-asset realizability and possible tax settlement payments.
- Reconcile reported GAAP results with adjusted pre-tax income and adjusted after-tax measures, which exclude significant realized gains and losses, reserve effects, actuarial items and transaction costs.