American International Group, Inc. — Second Quarter 2018 Form 10-Q
Reporting period: Quarterly and six-month periods ended June 30, 2018. The financial statements are unaudited and presented under U.S. GAAP. AIG is a global insurance organization operating in General Insurance, Life and Retirement, Other Operations and a Legacy Portfolio.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Total revenues | $11.6 billion, down 7% | $23.3 billion, down 7% |
| Income from continuing operations | $931 million, down 16% | $1.9 billion, down 19% |
| Net income attributable to AIG | $937 million, down 17% | $1.875 billion, down 19% |
| Diluted earnings per share | $1.02, versus $1.19 | $2.04, versus $2.37 |
| Adjusted pre-tax income | $1.278 billion, versus $2.133 billion | $2.494 billion, versus $4.174 billion |
| Adjusted after-tax income per diluted share | $1.05, versus $1.53 | $2.09, versus $2.88 |
| Net cash from operating activities | Not separately presented | $(340) million, versus $(9.036) billion |
- Revenue drivers: Premiums declined 5% in the quarter and 6% year to date, primarily reflecting the 2017 sale of Fuji Life. Net investment income declined 15% in the quarter and 13% year to date, driven by weaker alternative-investment returns, lower fair-value-option gains and lower invested assets.
- Profit drivers: Results benefited from favorable prior-year loss reserve development, net realized capital gains and gains on divested businesses. These benefits were more than offset by weaker investment returns, lower premiums and higher expenses.
- General Insurance: Adjusted pre-tax income declined 46% in the quarter to $568 million and 49% year to date to $1.078 billion. The combined ratio increased to 101.3% from 97.7% in the quarter and 102.5% from 98.7% year to date.
- Life and Retirement: Adjusted pre-tax income declined 3% in the quarter to $962 million and 2% year to date to $1.854 billion. Life Insurance improved materially, but Individual Retirement declined as a result of higher policyholder benefits, weaker equity-market performance and lower fixed-annuity spreads.
- Catastrophe and reserve activity: General Insurance catastrophe losses were $150 million in the quarter and $526 million year to date. Total favorable prior-year development was $63 million in the quarter and $173 million year to date, compared with unfavorable development of $56 million and $66 million, respectively, in 2017.
- Margins and equity: Adjusted return on equity was 7.6% in the quarter and 7.7% year to date, compared with 10.5% and 10.0% in the comparable 2017 periods. Book value per share was $68.65; excluding AOCI, it was $68.40; adjusted book value per share was $57.34.
- Balance sheet: Total assets were $496.8 billion, total AIG shareholders’ equity was $61.2 billion, and long-term debt was $33.8 billion at June 30, 2018. Accumulated other comprehensive income declined to $230 million from $5.465 billion at year-end 2017, primarily due to unrealized investment losses.
- Liquidity and capital: AIG Parent reported $13.8 billion of liquidity sources, including $9.3 billion of cash, short-term investments and unencumbered fixed-maturity securities, plus $4.5 billion of available syndicated credit capacity. Cash and restricted cash were $2.380 billion at June 30, 2018.
- Capital distributions and financing: AIG repurchased approximately 12 million shares for $646 million and paid $575 million of dividends during the first six months. It issued $3.504 billion of long-term debt and repaid $1.959 billion.
Material changes versus the prior comparable periods
- Net income attributable to AIG decreased 17% in the second quarter and 19% year to date, while adjusted pre-tax income decreased 40% and 40%, respectively.
- Investment performance weakened significantly, particularly in alternative investments and securities measured using the fair value option. Net investment income declined from $3.613 billion to $3.065 billion in the quarter.
- General Insurance underwriting deteriorated: the consolidated combined ratio rose 3.6 points in the quarter and 3.8 points year to date, reflecting higher current accident-year losses, catastrophe losses and expenses.
- Other comprehensive income was a loss of $1.990 billion in the quarter and $4.659 billion year to date, compared with gains in 2017, primarily because of higher interest rates and wider credit spreads.
- Operating cash flow improved substantially from 2017, when cash usage included funding of the NICO adverse-development reinsurance agreement, but remained negative at $340 million year to date.
- Adoption of the new financial-instruments standard moved equity-security fair-value changes into earnings and increased beginning retained earnings by $824 million, with a corresponding reduction in beginning AOCI. AIG also reclassified $248 million from AOCI to retained earnings for Tax Act-related stranded tax effects.
Outlook, commentary, risks and unusual items
- Management cited continued pressure from low, though rising, interest rates; widening credit spreads; catastrophe losses; intense insurance competition; currency volatility; Brexit-related uncertainty; and evolving retirement-product standards of care.
- Approximately 70% of fixed account values in Individual and Group Retirement annuity products were crediting at contractual minimum guaranteed rates, increasing sensitivity to reinvestment yields and spread compression.
- The Tax Cuts and Jobs Act accounting remained provisional. AIG had recorded a provisional net tax charge of approximately $6.7 billion at December 31, 2017 and continued to assess the effects of GILTI, BEAT, insurance-reserve provisions and state taxes.
- AIG disclosed out-of-period adjustments that increased net income attributable to AIG by $116 million in the quarter and $191 million year to date. Management concluded the adjustments were not material to current or previously reported periods.
- On July 18, 2018, AIG completed the acquisition of Validus for approximately $5.5 billion in cash. Validus results were expected to enter General Insurance beginning in the third quarter.
- On July 31, 2018, AIG agreed to sell a 19.9% interest in Fortitude, the holding company for DSA Re, to an affiliate of The Carlyle Group. The transaction was subject to regulatory and other closing conditions; AIG expected to retain an 80.1% interest.
- AIG had $4.7 billion of unrecognized tax benefits and accrued $2.1 billion for related interest and penalties. A potential settlement of cross-border financing tax litigation could require an estimated payment of approximately $1.3 billion, although the settlement was non-binding and timing remained uncertain.
- Key insurance estimates remain sensitive to loss reserves, reinsurance recoverables, annuity guarantees, deferred acquisition costs, fair values, impairments, legal contingencies and deferred tax-asset realizability.
Important facts for investors to verify
- Reconcile GAAP earnings with adjusted pre-tax income and adjusted after-tax income, particularly the effects of reserve development, realized gains, restructuring costs and out-of-period adjustments.
- Assess whether the General Insurance combined ratio and current accident-year loss trends improve after the Validus acquisition and following elevated catastrophe and severe losses.
- Monitor interest-rate and credit-spread effects on AOCI, fixed-maturity securities, annuity guarantees, hedging results and book value.
- Review liquidity after the $5.5 billion Validus cash acquisition, including AIG Parent liquidity, debt issuance, credit-facility availability and regulatory restrictions on subsidiary dividends.
- Evaluate potential tax cash payments and accounting changes related to the Tax Act, cross-border financing litigation, GILTI and BEAT.
- Track the Fortitude/DSA Re transaction, including required approvals, capital-maintenance obligations, adverse-development protections, the $6 billion Carlyle investment commitment and potential loss recognition.
- Review reinsurance recoverable credit exposure, downgrade-related collateral requirements, catastrophe protection and the adequacy of loss reserves.