Business context and reporting period
American International Group, Inc. (AIG) filed its Form 10-K for the fiscal year ended December 31, 2018. AIG is a global insurer operating in more than 80 countries, with core businesses in General Insurance, Life and Retirement, Other Operations and the Legacy Portfolio. The filing is an annual report, not a quarterly filing, although fourth-quarter information is included.
- General Insurance reported North America and International operating segments.
- Life and Retirement reported Individual Retirement, Group Retirement, Life Insurance and Institutional Markets.
- AIG completed the $5.5 billion cash acquisition of Validus on July 18, 2018, acquired Glatfelter in November, and acquired Ellipse on December 31.
- Fortitude Re was established to consolidate most Legacy insurance run-off reserves; AIG sold a 19.9% interest in Fortitude Holdings to an affiliate of Carlyle while retaining 80.1%.
Key financial metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total revenues | $47.389 billion | $49.520 billion | Down 4% |
| Income from continuing operations before tax | $257 million | $1.466 billion | Down 82% |
| Income from continuing operations | $103 million | $(6.060) billion | Improved from prior-year loss |
| Net income attributable to AIG | $(6) million | $(6.084) billion | Near break-even |
| Adjusted pre-tax income | $1.409 billion | $3.158 billion | Down 55% |
| Adjusted after-tax income attributable to AIG | $1.064 billion | $2.231 billion | Down 52% |
| Adjusted return on equity | 2.1% | 4.1% | Down 2.0 percentage points |
| Book value per common share | $65.04 | $72.49 | Down 10% |
| Adjusted book value per common share | $54.95 | $54.74 | Up slightly |
| Net cash provided by operating activities | $61 million | $(7.818) billion | Improved materially |
| Long-term debt | $34.540 billion | $31.640 billion | Up 9% |
| AIG shareholders’ equity | $56.361 billion | $65.171 billion | Down 14% |
Reported 2018 pre-tax and net margins were approximately 0.5% and 0.1%, respectively. Adjusted pre-tax margin was approximately 3.0%; adjusted measures are non-GAAP and exclude specified items.
- General Insurance net premiums written increased 4% to $26.407 billion. The combined ratio improved to 111.4% from 117.3%, but remained above 100%, indicating an underwriting loss. Adjusted pre-tax loss improved to $469 million from $813 million.
- General Insurance catastrophe losses were $2.885 billion, compared with $4.167 billion in 2017. Prior-year unfavorable development was $362 million, compared with $978 million in 2017.
- Life and Retirement adjusted pre-tax income declined to $3.190 billion from $3.831 billion, primarily because of lower investment returns and unfavorable actuarial assumption updates.
- Net investment income declined 12% to $12.476 billion, reflecting weaker hedge fund performance, lower fair-value-option investment returns and lower invested assets.
- Net realized capital losses improved to $130 million from $1.380 billion.
- Total assets were $491.984 billion and total investments were $314.209 billion at year-end.
- Cash and restricted cash increased to $3.358 billion from $2.737 billion.
Liquidity, capital and cash flow
- AIG Parent reported $8.294 billion of liquidity sources at December 31, 2018, consisting of $3.794 billion of parent liquidity and $4.5 billion of available revolving credit capacity.
- AIG Parent received approximately $4.2 billion of dividends and other payments from subsidiaries and $938 million of tax-sharing payments during 2018.
- AIG issued $2.5 billion of debt in March 2018 and used part of the proceeds to fund the Validus acquisition. Consolidated long-term debt increased to $34.540 billion.
- AIG paid $1.138 billion of common stock dividends and repurchased approximately 36.5 million shares for $1.739 billion. The Board subsequently increased the repurchase authorization, leaving approximately $2.0 billion available as of February 13, 2019.
- All domestic and foreign insurance subsidiaries exceeded minimum statutory capital and surplus requirements, and all domestic insurance subsidiaries exceeded RBC minimums. However, approximately $41.6 billion of statutory capital and surplus was restricted from transfer to AIG Parent without regulatory approval.
- The filing identifies approximately $1.7 billion of potential tax payments, including interest, under non-binding settlement agreements relating to cross-border financing tax disputes; payment was not expected before early 2020 and the final amount and timing remained uncertain.
Material changes versus comparable periods
- Reported net loss attributable to AIG improved substantially from 2017, when a $6.7 billion Tax Act charge caused a large loss. Excluding the Tax Act charge, 2018 operating earnings still declined because of weaker investments, unfavorable Life and Retirement assumption updates and higher expenses.
- General Insurance underwriting performance improved, driven by lower catastrophe losses and lower adverse prior-year reserve development, although current accident-year profitability weakened and the combined ratio remained above 100%.
- General Insurance 2018 included Validus and Glatfelter results, while the comparison period did not include those acquisitions for equivalent periods.
- Life and Retirement results declined, particularly Individual Retirement adjusted pre-tax income, which fell to $1.681 billion from $2.289 billion. The segment recorded a net unfavorable actuarial assumption impact of $98 million, compared with a $284 million favorable impact in 2017.
- Net unrealized gains in the available-for-sale portfolio fell to approximately $3.6 billion from $13.9 billion, primarily because of higher interest rates and wider credit spreads. Other comprehensive income declined by $6.293 billion.
- AIG adopted new financial-instrument accounting in 2018, including recognition of equity securities at fair value through earnings and a $824 million reclassification from AOCI to retained earnings at adoption.
- 2018 results included $77 million of net income-reducing out-of-period adjustments, which management concluded were not material to 2018 or previously reported annual financial statements.
Outlook, management commentary and risks
Management’s stated priorities for 2019 were product diversification and portfolio optimization, technology and cybersecurity investment, leadership and talent, capital efficiency, underwriting excellence and reinsurance optimization. AIG emphasized reducing gross and net property-casualty limits, improving risk selection, integrating underwriting with claims and actuarial functions, and using reinsurance to reduce volatility.
- Market conditions remained challenging because of low interest rates, equity and credit-market volatility, foreign-exchange movements, trade tensions, slowing global growth and Brexit uncertainty.
- Higher interest rates may improve reinvestment yields but can increase annuity surrenders, reduce the value of fixed-income assets and increase guarantee-related volatility. At year-end, 66% of fixed account values in Individual and Group Retirement annuities were crediting at contractual minimum guaranteed rates.
- Reserve adequacy remains a major risk. AIG recorded $1.4 billion of pre-tax General Insurance reserve strengthening in 2018 and identified significant sensitivity to assumptions for excess casualty, financial lines, workers’ compensation and run-off business.
- Catastrophe risk remains material. The filing cites hurricanes, wildfires, typhoons and earthquakes as significant 2018 events and warns that climate change could increase catastrophe frequency, severity and modeling uncertainty.
- Reinsurance reduces exposure but creates counterparty, collectability, collateral and contract-interpretation risk. Reinsurance recoverable assets were $38.2 billion, with $20.2 billion of collateral held from unaffiliated reinsurers.
- Additional risks include investment concentration, credit deterioration, rating downgrades, liquidity stress, cybersecurity and data breaches, legal and regulatory proceedings, changing insurance-capital rules, Brexit, tax litigation and potential restrictions on the use of tax attributes.
- The filing states that AIG’s financial statements and internal control over financial reporting received unqualified audit opinions. Management and the auditor excluded Validus and Glatfelter from the 2018 internal-control assessment because they were acquired during the year.
Most important facts for an investor to verify
- Whether General Insurance can reduce its combined ratio below 100% and prevent further adverse development in long-tail casualty and financial-lines reserves.
- Whether adjusted earnings recover from the 2018 decline despite lower investment returns, rising expenses and Life and Retirement assumption sensitivity.
- The sustainability and accessibility of AIG Parent liquidity, including subsidiary dividends subject to regulatory restrictions and the $4.5 billion revolving facility.
- The impact of the Validus, Glatfelter and Ellipse acquisitions on underwriting profitability, integration costs, goodwill and capital requirements.
- The final amount and timing of the potential approximately $1.7 billion cross-border tax settlement and any related tax-attribute limitations.
- Exposure to interest-rate changes, annuity surrenders, catastrophe losses, reserve sensitivities, reinsurance recoverability and credit-rating triggers.
- The effect of the 2021 long-duration insurance accounting standard and the 2020 expected-credit-loss standard, which management expected could materially affect reported results, capital and disclosures.