America’s Improved Giant

AMERICANS are often asked by politicians if they are better off now than they were four years ago. Anyone involved with American International Group (AIG), an insurance company felled by the financial crisis, can safely answer “yes” to that question. In just four years it has freed itself from a $182 billion bail-out; gone from being publicly owned back to the private sector (the Treasury sold the last of its stake in December); and turned itself into a leaner, simpler business. Now that it has successfully shaken off government ownership, AIG’s next task is to prove its worth as a stand-alone, listed company.

That AIG is around at all is remarkable. By piling into what would emerge as the most rotten part of the financial system (insuring investors against losses on securities linked to American subprime mortgages) during the credit bubble, it ended up owing billions of dollars to those holding the other side of its bets. Ben Bernanke, the Federal Reserve’s chairman, famously derided AIG as a hedge-fund attached to a large and stable insurance company.

Today’s AIG is different. The buccaneering financial-products unit, whose need for collateral caused the government to intervene in September 2008, is all but shuttered. Many of AIG’s prized units have been sold to help finance its rescue, notably Alico and AIA, both non-US life-insurance businesses with bright prospects. An aircraft-leasing arm is in the process of being flogged.

The transition back to private ownership has been pretty smooth. Much of the credit for the transformation falls to Bob Benmosche, a former boss of MetLife, an insurance rival, who was pulled out of a retirement spent cultivating grapes in Croatia to take the reins in August 2009. Known for his blunt, speak-your-mind approach (a month into the job, he said he was avoiding “those crazies down in Washington”), he has helped turn a demoralised group with a radioactive brand into a company with a renewed sense of self.

The happy ending to this corporate fairy tale is still some years away, however. What remains of AIG is hardly a world-beating company. Return on equity, at 5%, is just about the lowest of its American peers. Margins are lousy at both the general-insurance division (known as property-casualty, which insures homes, cars and the like) and the life-insurance bit (which offers bank-like savings products).

Mr Benmosche claims AIG now has the right structure and positioning to thrive. “We had to cut some branches off the tree, but the tree is still there and it’s a big trunk,” he says. Even after the cuts, AIG has some 62,000 staff (down from 116,000) in 90 countries. Despite the wild swings of the recent past, it is still America’s largest insurer by market capitalisation (see chart).

With less management time spent fire-fighting and negotiating with politicians, more attention is being lavished on the nuts and bolts of running each unit. The goal is to reach a 10% return on equity by 2015, thus matching its rivals. Mr Benmosche relishes detailing the humdrum measures AIG is taking to get there: consolidating data centres to cut costs, tweaking the product mix towards more profitable lines, offering more tailored pricing by crunching customer data more intelligently. This is a world away from dabbling in credit derivatives, he implies.

Both sides of AIG’s business need nourishing. The general-insurance arm currently pays out slightly more in claims than it receives in premiums, once costs are factored in. Profits come from investing the cash float it holds to pay out claims as they arise, which is not the most lucrative business when interest rates (and thus returns) are at rock bottom. Chronic underinvestment in IT systems has left it trailing rivals—stories abound of AIG units bidding against each other for contracts. Bad luck hasn’t helped. Hurricane Sandy will have dented fourth-quarter profits to the tune of $2 billion before tax, the most of any American insurer (it also flooded AIG’s Wall Street offices).

The good news is that insurance prices in America are rising, and that AIG’s higher-margin international franchise (despite asset disposals, half of the firm’s general-insurance sales are made abroad) is growing fast. More controversially, the company is also cutting reinsurance coverage, which is how insurers offload their own risks. This will juice margins but could lead to AIG shouldering larger one-off losses.

The impact of low interest rates is even greater for its life-insurance and retirement-planning business, which makes up the other half of the group’s earnings. Many of its life products offer customers fixed returns on premiums paid. AIG has limited flexibility to lower the rates it extended in frothier times. In common with rivals, it is now changing its focus towards products which are less sensitive to interest rates. But lower returns and a still-soft economy also has the effect of dampening interest from consumers, who appear keener to squirrel away money into savings products when they feel rich. Profits in this area of the business are expected to be flat for the foreseeable future.

Bits of AIG continue to baffle outsiders. It still holds $158 billion of credit derivatives on its books, a small slice of its pre-crisis $1.8 trillion portfolio but still nearly three times its market capitalisation. The firm also holds more sub-investment-grade securities on its balance-sheet than any of its life-insurance rivals, according to J.P. Morgan. Much of this exposure comes from mortgage-backed securities taken over by the government during the crisis and subsequently repurchased by AIG.

“We have a detailed understanding of these assets,” says Mr Benmosche. Maybe so. His most obvious successor (Mr Benmosche is 68 years old and was diagnosed in 2010 with an unspecified cancer) is Peter Hancock, who now heads the general-insurance division but is famed in financial circles for having pioneered credit derivatives at J.P. Morgan two decades ago. But however well AIG understands itself, many analysts quietly admit that parts of the group’s finances are still hazy to them.

Investors are nonetheless bullish on the shares. That is partly because they trade at just over half AIG’s book value, whereas other insurers are trading closer to or above book value. Investors like the regular recent payouts of excess cash to shareholders, although the firm’s focus is now expected to be on paying down debt to maintain its A- credit rating. Huge accounting losses during the crisis will lower AIG’s tax bill for the next few years, bolstering profits. And although some fret about a tighter regulatory regime, with the Fed likely to impose bank-like “stress tests” from 2014, others see stricter supervisory oversight as a reassuring plus given the group’s recent history.

AIG certainly has a new-found air of confidence. A recent ad campaign featured its employees thanking America for the bail-out, implying that this unpleasant episode is now firmly in its past. The firm has reverted to selling general insurance under the AIG brand, having opted for the generic “Chartis” at the height of the crisis. By any measure, this has been a remarkable comeback. But it will be sealed only when the insurance company that those Washington crazies deemed fit to salvage shows it can compete with rivals who did not benefit from taxpayer largesse.