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Morningstar | Headline Numbers Bad for AIG in 4Q, Underlying Results Mixed

Catastrophe losses and weak investment results pushed AIG into the red in the fourth quarter, with the company recording a $622 million loss. AIG took almost $800 million in catastrophe losses in the quarter, a level that is in line with the previous disclosed range. Investment income also fell meaningfully, but this was mostly due to losses on alternative investments, and we view quarter-to-quarter swings in this area as largely irrelevant to the company’s long-term prospects. In assessing the prospects for a turnaround at AIG, we are primarily focused on two factors: the trend in the underlying combined ratio and reserve development. On these fronts, the results were mixed, as the underlying combined ratio improved from recent quarters, but the company did also recognize a modest level of adverse reserve development. We will maintain our $76 fair value estimate and no-moat rating.

The underlying combined ratio (which excludes catastrophe losses and reserve development) came in 98.8% for the quarter, compared with 100.2% last year, and this quarter’s level was the best the company achieved in 2018. Looking across regions, North American results improved from results earlier in the year, while international results deteriorated a bit. We are especially pleased with the progress in North American commercial lines, as we believe this is the area most in need of improvement.

Management reiterated its target of a full-year underwriting profit in 2019, assuming a normal level of catastrophe losses. However, while the company made some progress toward this goal in the fourth quarter, it has much further to go to hit this mark. In our view, AIG’s poor historical underwriting performance primarily reflects poor management and we don't believe AIG faces any major structural issues in its lines. We think CEO Brian Duperreault’s track record inspires confidence that he can drive at least modest improvement, and that AIG can generate double-digit overall returns with underwriting performance that is merely mediocre relative to peers. However, given the nature of insurance, it will take some time to get there.

In our view, the biggest negative in the quarter was the $365 million in adverse reserve development. The amount was fairly modest and reserve development for the full year equated to only 1.5% of earned premiums. Further, management stated the development related to policies written in 2016 and prior years, which is before Duperreault’s tenure. However, AIG has a long history of negative surprises on this front, and we think moving fully past this issue is critical to restoring investor confidence in the franchise. Coming into the quarter, AIG had minimal development and an opportunity for full-year favorable development, a mark it has not hit for a long time.

Life insurance operations saw a 9% dip in net income year over year. However, this area still generated a 10% and 13% adjusted return on equity for the quarter and the year, respectively. We continue to believe the company’s life insurance operations are on a solid footing at this point.

During 2018, AIG repurchased $1.8 billion in shares, and the company increased its repurchase authorization to $2 billion. While this is a healthy level of buybacks relative the company’s market capitalization, it marks a material decrease in buybacks relative to previous years, and the company has completed significant acquisitions since Duperreault took the reins. While we are willing to give him some leeway on capital allocation, we would prefer the company focused on capital return until Duperreault can demonstrate material improvement in the underlying performance of the existing franchise.