AIG (NYSE:AIG) continued its remarkable turnaround with a seventh consecutive quarter of positive operating income. The insurer reported 17% year-on-year increase in net income with a 21% increase in insurance operating income for the three months ending June. AIG also introduced a $0.10 per share dividend and announced plans to repurchase $1 billion of its common stock.
We are using a modification of the dividend discount model (DDM) to arrive at a price estimate for AIG. In our model, we estimate the total income that can be returned to shareholders through dividends and share repurchases, and discounting this value back to the present. We will shortly update our model based on the recent developments.
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Strong P&C Operations
AIG’s insurance operations can be divided into AIG property and casualty, and AIG life and retirement. Both of these divisions account for roughly half of the company’s insurance income each.
The property and casualty division reported an 18% jump in operating income for the second quarter, helped by strong investment results and a 4% increase in net premiums. Commercial net written premiums, earned from insurance services provided to other businesses, increased 3.6% over the prior year while consumer net written premiums grew 4.7%. The commercial subdivision accounts for 85% of AIG’s P&C operating income.
Almost half of the P&C premiums come from the U.S., where it is the fifth biggest insurer in terms of direct premiums earned with a market share of 4.52%.  AIG is the largest insurer in the other liabilities line of insurance, ahead of The Travelers Companies, Inc. (NYSE:TRV), with a market share of 11.5% and is the fourth largest insurer in the workers’ compensation line, with a market share of 6.14%. Both of these lines account for 10% of the P&C premiums in the country each and are expected to grow as the economy improves. Employment in the manufacturing and construction sectors, which are closely linked with workers ’ compensation, has been strong. Manufacturing employment has increased by 4.3% since 2010 while jobs in the construction industry have increased by 5.4% since the start of 2011. 
AIG delivered a good underwriting performance or the quarter as the combined ratio (expenses to premiums) excluding catastrophes and prior year reserve development improved from 98.3% to 96.5%. However, a loss reserve increase of $142 million related to claims concerning Storm Sandy, meant that the combined ratio increased from 102.4% in the second quarter of 2012 to 102.6% this quarter. The commercial combined ratio was 99.3% while the consumer combined ratio was 97.7%. In the long term, we expect AIG’s combined ratio to fall just below 100%, indicating a negative cost of float.
Life And Retirement
AIG’s life and retirement division reported a 23% increase in operating income and a 24% increase in premiums, driven by strong variable annuity and mutual funds sales. AIG has been capitalizing on MetLife’s (NYSE:MET) exit from the variable annuity market and is now the sixth biggest player in the market, with a market share of 7%.  AIG reported a 65% increase in retirement solutions premiums while MetLife reported a 40% decrease in variable annuity sales through the three months ending June. Variable annuities remain a popular retirement solution product in the U.S. and account for 70% of the annuities market. AIG’s assets under management grew 10% over the prior year, helped by a strong performance by the stable value wrap product.
AIG is currently the eleventh largest life insurer in the U.S. in terms of direct premiums with a market share close to 2%.  We expect it to grow its U.S. life insurance business in the coming years.Notes:
- NAIC, Property and Casualty Insurance [↩]
- Overview and Outlook for the Workers Comp Market: Growth, Performance and the Economic Environment, Insurance Information Institute [↩]
- 2013, LL Global, Inc. SM U.S. Individual Annuity Sales 1st Quarter 2013 [↩]
- NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS LIFE AND FRATERNAL INSURANCE INDUSTRY 2012 TOP 25 GROUPS AND COMPANIES BY COUNTRYWIDE PREMIUM [↩]