Lower Investment Income Pressures AIG’s Earnings

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AIG (NYSE:AIG) reported lower than expected earnings for the fourth quarter of 2014, with a 67% year-over-year (y-o-y) decline in net income of $655 million. [1] During the quarter, the company recorded a loss on extinguishment of debt of $824 million on an after-tax basis. Reductions in workers’ compensation discount as well as adverse prior year reserve development led the company’s operating income for the quarter to drop to $1.4 billion from $1.7 billion a year ago. The company’s quarterly earnings also took a hit from a decline in returns on investments due to the low interest rate environment. [2]

On a full year basis, the company’s net income decreased from $9.1 billion in 2013 to $7.5 billion in 2014. After-tax operating income remained largely flat at $6.8 billion in 2014. The company’s total general operating expenses also declined by over 5% in 2014 compared to the prior year. The company is targeting a 3-5% annual reduction in expenses through 2017.

In this note we discuss in detail AIG’s performance in the fourth quarter of 2014. We have a price estimate of $56 for AIG’s stock, which is about in line with the current market price.

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See our complete analysis of AIG here

Property And Casualty Underwriting Improves

During the fourth quarter, AIG reported a 27% y-o-y improvement in pre-tax operating income from its property and casualty operations in the U.S. This was largely due to better underwriting performance on the back of lower catastrophe-related losses, but higher unfavorable prior year loss reserve development and lower returns on investments partially erased those gains. [3] The combined ratio, the ratio of claims to premiums, improved by 5.3 points over Q4 2013 to 103.4% for the fourth quarter of 2014. But it is still over 100%, thus implying underwriting losses for the company. Underwriting losses, however, decreased sharply by 62% y-o-y in the fourth quarter. The net investment income in the division decreased 7% y-o-y in the fourth quarter.

Growth In Japan, But Lower Investment Returns In Life And Retirement

Japan is a major market for AIG. It accounts for close to a third of overall premiums in the life insurance segment. Growth in premiums in Japan resulted in overall life insurance premiums increasing to $1.25 billion from $1.23 billion in Q4 2013. However, a decline in net investment income during the quarter offset the growth in premiums. Pre-tax operating income registered a significant decline of $135 million to $80 million during the fourth quarter compared to a year ago, largely due to a $104 million increase in estimated reserves for incurred but not reported death claims.

In the retirement services division, AIG’s assets under management (AUM) increased by nearly $7 billion in 2014 to $224 billion. [4] The increase came on the back of strong growth in the variable annuity business. However, net outflows in fixed annuities and group retirement solutions, along with the low interest rate environment and the loss of large group plans, adversely affected the growth in the segment. Reduced retail mutual fund sales also affected growth in premiums during the fourth quarter, while lower interest rates affected deposits. Overall premiums and deposits declined by 11% y-o-y in the fourth quarter to $6 billion.

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Notes:
  1. AIG Reports Fourth Quarter 2014 Net Income of $655 Million and Diluted Earnings Per Share of $0.46, AIG Press Release []
  2. American International Group’s CEO Peter Hancock on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha []
  3. 2014 Fourth Quarter Results, Presentation, AIG Investor Relations []
  4. SEC 8-K Filing, February 12 2015 []