Business Context and Reporting Period
American International Group, Inc. (AIG) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2011. AIG reported three principal segments: Chartis property and casualty insurance, SunAmerica life and retirement services, and Financial Services, consisting primarily of aircraft leasing and the wind-down of AIG Financial Products derivatives.
The period followed AIG’s January 2011 recapitalization, repayment and termination of the Federal Reserve Bank of New York credit facility, substantial asset dispositions, and the May 2011 common-stock offering. Prior-period amounts were reclassified for discontinued operations and changes in presentation.
Financial Performance and Position
| Metric | Three months ended June 30, 2011 | Three months ended June 30, 2010 | Six months ended June 30, 2011 | Six months ended June 30, 2010 |
|---|---|---|---|---|
| Total revenues | $16.676 billion | $18.314 billion | $34.112 billion | $36.869 billion |
| Pre-tax income from continuing operations | $1.806 billion | $1.501 billion | $426 million | $3.142 billion |
| Income from continuing operations | $2.094 billion | $496 million | $914 million | $2.584 billion |
| Net income attributable to AIG | $1.840 billion | $(2.656) billion | $2.109 billion | $(873) million |
| Net income attributable to common shareholders | $1.840 billion | $(2.656) billion | $1.297 billion | $(176) million |
| Basic EPS from continuing operations | $1.03 | $(0.25) | $(0.18) | $2.11 |
- Second-quarter pre-tax income rose 20% year over year, while six-month pre-tax income fell 86%, primarily because the first half of 2011 included a $3.392 billion loss on extinguishment of debt.
- The second-quarter effective tax rate on continuing operations was negative 15.9%, and the six-month rate was negative 114.6%, reflecting tax benefits, valuation-allowance changes, tax-exempt income, partnership investments, and settlements of uncertain tax positions.
- At June 30, 2011, total assets were $616.798 billion, down from $683.443 billion at December 31, 2010. Total liabilities were $511.593 billion, and total equity was $93.629 billion.
- AIG shareholders’ equity was $92.681 billion, compared with $85.319 billion at year-end 2010. Redeemable noncontrolling interests held by the Department of the Treasury were $11.465 billion.
- Investments totaled $411.813 billion, including $249.360 billion of available-for-sale bonds, $26.968 billion of trading bonds, and $37.688 billion of flight equipment.
Segment Results
| Segment | Q2 2011 revenue | Q2 2011 pre-tax income | Six-month 2011 pre-tax income |
|---|---|---|---|
| Chartis | $10.214 billion | $828 million | $412 million |
| SunAmerica | $3.896 billion | $775 million | $1.715 billion |
| Financial Services | $1.065 billion | $(143) million | $182 million |
| Other operations | $1.639 billion | $317 million | $(1.888) billion |
- Chartis net premiums written increased 18% in the quarter and 19% year to date, substantially reflecting the Fuji acquisition. Its GAAP combined ratio was 104.0% in the quarter and 111.2% year to date, indicating underwriting losses; adjusted combined ratios were 97.7% and 98.2%, respectively.
- Chartis incurred $539 million of second-quarter catastrophe-related charges and $2.266 billion for the first six months, including $1.337 billion related to the Tohoku catastrophe.
- SunAmerica’s pre-tax income increased sharply because of lower realized losses and impairments, although operating income declined 13% in the quarter and 5% year to date. Premiums, deposits and other considerations rose 24% in the quarter and 27% year to date.
- Financial Services included a $160 million second-quarter Capital Markets loss and $87 million of aircraft-leasing income. AIG stated that the active wind-down of the AIGFP derivatives portfolio was completed at the end of the second quarter.
Cash Flow, Debt and Liquidity
- Six-month operating cash flow was $(3.464) billion, compared with $9.771 billion provided in the prior-year period. Continuing operations used $6.139 billion, largely because AIG paid $6.363 billion of accrued FRBNY facility interest and fees, including approximately $4.7 billion of compounded interest.
- Investing activities provided $37.748 billion, while financing activities used $33.714 billion. Cash increased by $599 million to $2.590 billion.
- Total debt declined from $106.461 billion at December 31, 2010 to $79.461 billion at June 30, 2011. The FRBNY facility balance was eliminated; other long-term debt was $79.461 billion on the consolidated balance sheet.
- AIG Parent liquidity sources totaled $13.077 billion, comprising $598 million of cash, $8.797 billion of short-term investments, $3.182 billion of syndicated credit capacity, and $500 million under a contingent liquidity facility.
- Debt maturities for the four quarters following June 30, 2011 totaled $10.875 billion. Total contractual obligations were $682.266 billion, including $446.732 billion of insurance and investment contract liabilities, $94.932 billion of loss reserves, and $77.142 billion of borrowings.
- Management stated that AIG had sufficient liquidity to meet future requirements and reasonably foreseeable contingencies, while noting exposure to collateral calls, reserve strengthening, catastrophe losses, policy surrenders, downgrades, market deterioration, and regulatory restrictions.
Material Changes Versus the Prior Comparable Period
- AIG completed the January 14, 2011 recapitalization, repaid approximately $21 billion to the FRBNY, exchanged preferred stock for common stock, and recorded a $3.3 billion pre-tax debt-extinguishment charge.
- AIG sold AIG Star and AIG Edison for $4.8 billion and recognized a $2.0 billion pre-tax gain in discontinued operations. A proposed $2.16 billion sale of Nan Shan had received regulatory approvals and was expected to close in the third quarter.
- AIG completed the $9.6 billion MetLife securities disposition and used $6.6 billion to repay government-held SPV preferred interests. It also issued 100 million common shares for approximately $2.9 billion of net proceeds; the Department of the Treasury sold an additional 200 million shares.
- Revenue declined because AIA was deconsolidated in late 2010, although premiums excluding that effect increased 15% in the quarter and 13% year to date.
- Chartis results deteriorated because of catastrophe losses and unfavorable reserve development, while SunAmerica benefited from materially lower realized losses and impairments.
- Chartis entered into retroactive reinsurance with National Indemnity Company covering most U.S. asbestos liabilities, paying approximately $1.67 billion and receiving approximately $1.82 billion of assumed liabilities. A $150 million deferred gain was recorded.
- AIG’s Capital Markets super-senior CDS net notional exposure fell from $59.850 billion at year-end 2010 to $29.114 billion at June 30, 2011, primarily through terminations, maturities, and amortization.
Guidance, Outlook, Risks and Unusual Items
- Management’s priorities included strengthening operating businesses, repaying Department of the Treasury SPV preferred interests, improving systems and controls, restructuring operations, managing capital efficiently, and increasing investment income.
- Chartis expected a challenging 2011 underwriting environment but cited improving U.S. rates, stabilizing exposures, growth in selected international markets, and continued corrective actions in underperforming businesses.
- ILFC expected continued aircraft sales and potential additional impairments, and AIG was considering a sale, spinoff, or initial public offering of ILFC.
- AIG expected a large release of its U.S. deferred-tax-asset valuation allowance could occur in the fourth quarter of 2011 if projected taxable income and emergence from cumulative losses were achieved. The year-end 2010 valuation allowance was $23.8 billion; no release was recognized at June 30.
- Material judgment areas included insurance reserves, life settlement valuations, aircraft recoverability, deferred acquisition costs, fair-value estimates for Maiden Lane interests and derivatives, tax assets, impairments, and legal contingencies.
- At June 30, 2011, AIG had $40.343 billion of recurring Level 3 assets and $5.483 billion of Level 3 liabilities. Fair values of Maiden Lane interests and super-senior CDS remained sensitive to market spreads, collateral performance, discount rates, and cash-flow assumptions.
- Legal and regulatory matters included securities, ERISA, workers’ compensation, insurance-practices, mortgage-guaranty, and derivative litigation. Several matters could be material, but the filing states that potential losses could not be reasonably estimated.
- Notable accrued or potential obligations included a $725 million proposed 2004 securities litigation settlement, a proposed $450 million workers’ compensation premium-reporting settlement, up to $274 million claimed in employment litigation, and $350 million sought in a securities-lending arbitration. The filing states that outcomes remain uncertain.
Investor Verification Checklist
- Verify the sustainability of reported earnings excluding the debt-extinguishment charge, asset-sale gains, AIA fair-value gains, tax benefits, and other fair-value volatility.
- Reconcile Chartis’s reported combined ratios with catastrophe losses, reserve development, the NICO reinsurance transaction, and future asbestos and casualty reserve changes.
- Assess the timing and conditions for any deferred-tax-asset valuation-allowance release and its potential effect on earnings and comprehensive income.
- Review AIG Parent liquidity, upcoming debt maturities, credit-facility covenants, collateral requirements, and the sensitivity of liquidity to rating downgrades.
- Evaluate the remaining Capital Markets CDS exposure, Level 3 valuation assumptions, collateral calls, and potential losses under adverse credit and market scenarios.
- Monitor the Nan Shan disposition, remaining asset-sale indemnities and escrow arrangements, Treasury ownership and repayment obligations, and pending litigation settlements.