AIG Could See Margins Swell This Quarter

by Trefis Team
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AIG (NYSE:AIG) is expected to announce earnings for the second quarter of 2013 on Thursday, August 1. [1] The insurance company along with Prudential Financial (NYSE:PRU) and GE Capital was recently designated as a systemically important financial institution (SIFI) by the Financial Stability Oversight Council (FSOC). The FSOC will impose higher capital requirements on these non-banking firms which will likely restrict their ability to return capital to shareholders in terms of dividends and share buybacks. [2]

AIG reported a 28% year-on-year increase in after-tax operating income from its insurance operations during the first quarter of 2013, with a 52% year-on-year increase in operating income from property and casualty and a 6% increase in the U.S. life and retirement operating income.

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AIG reported a combined ratio, or the ratio between expenses to premiums, of 97.3% for the first quarter, indicating a negative cost of float used for investment, and an improvement from the combined ratio of 102.1% reported in the first quarter of 2012. Catastrophe related losses were moderate, around $41 million, and the accident loss ratio improved from 66.3% to 63.2%. Barring the Moore tornado in Oklahoma in May, [3] there have been a few catastrophes in the U.S. this year. The Travelers Companies, Inc. (NYSE:TRV), one of AIG’s peers in the U.S. P&C market, recently reported an improvement of 7 basis points in its combined ratio, helped by the lack of catastrophes through the quarter. However, it must be noted that AIG’s base of operations covers nearly the entire globe and the company is vulnerable to disasters in the other regions around the world.

The company will also see improved margins on higher returns from its investment in bonds – the yields from which have shot up in the last few months following speculation that the Federal Reserve’s Quantitative Easing program might be coming to an end. The 10-year Treasury yield has climbed from 1.76% at the end of 2012 to around 2.75%. [4]

Our forecast for margins takes both investment income and the combined ratio into account.

Property And Casualty

Almost 60% of the premiums earned by the P&C division come from the Americas. It is the fifth biggest insurer in the country in terms of direct premiums earned with market share of 4.52%. [5] Although the company reported a 6% decline in premiums from the region, it is still the leading insurer in two of the major insurance lines in the U.S. – workers’ compensation and other liabilities. Each of these lines accounts for around 10% of the U.S. P&C market. AIG is the largest insurer in the other liabilities line of insurance, ahead of Travelers, with market share of 11.5% and is the fourth largest insurer in the workers’ compensation line, with market share of 6.14%. [6]

Both of these insurance lines are expected to see increased demand in the coming years as the U.S. economy recovers from the financial downturn of 2008. 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. [7]

The unemployment rate in the U.S. recently reached a four-year low of 7.5% in April, staying around 7.6% through May and June. [8] We expect the economic recovery to fuel growth in the market in the coming years, which should benefit AIG.

Asian Expectations

Nearly 30% of AIG’s P&C premiums come from Asia. The company has established operations in markets like Japan, China, Korea, Singapore, Vietnam, Thailand, Australia and Indonesia. In the first quarter of 2013, it reported a 7% increase in net premiums written, with a 16% increase from the commercial insurance subdivision and a 5% increase from the consumer subdivision.

AIG is the largest foreign property casualty insurer in Japan, which is the second biggest insurance market outside the U.S. [9] While the life insurance penetration, which is premium as a percentage of GPD, is greater than 8%, the property and casualty market is lagging behind with a penetration of just 2%. [10]  China is one of the biggest markets in the world, with a population of over 1 billion, a GDP annual growth rate around 8%, and P&C penetration of less than 2%. However, regulations have limited the market share that foreign insurers have to around 12%.

Another growth market that AIG is looking to capitalize on is India. The Indian government recently passed a proposal to increase foreign direct investment in the insurance sector from 26% to 49%, allowing non-Indian entities like MetLife (NYSE:MET) and Prudential Financial (NYSE:PRU) to hold up to 49% of equity/share capital in Indian insurance companies. [11] AIG entered the Indian general insurance market in collaboration with TATA. [12]

We expect continued growth from the Asian markets in the coming years.

U.S. Life Operations

AIG also provides life insurance and retirement solutions in the U.S. Premiums and fees from this division account for only 8% of the company’s revenues. AIG is currently the eleventh largest life insurer in the U.S. in terms of direct premiums with market share close to 2%. [13] We expect the market to benefit from the economic recovery in the U.S.

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  2. FSOC Tabs AIG, Prudential, GE Capital For Stricter Oversight, Forbes, June 4, 2012 []
  3. Satellite picture reveals the scar left behind by Moore tornado”. NBC News. Retrieved June 17, 2013 []
  4. Analysis: Higher interest rates? Not a problem for some U.S. stocks, Reuters, July 16 []
  5. NAIC, Property and Casualty Insurance []
  6. Ref: 3 []
  7. Overview and Outlook for the Workers Comp Market: Growth, Performance and the Economic Environment, Insurance Information Institute []
  8. U.S. Department of Labor, Labor Force Statistics from the Current Population Survey []
  9. Swiss Re’s World Insurance []

    AIG is also the largest foreign property and casualty insurer in China. ((Foreign Insurance Companies In China, PWC, December 2012 []

  11. Govt allows 100% FDI in telecom, hikes insurance cap to 49%, Times of India, July 16 []
  12. Tata AIG General Insurance Company: Travel Insurance, Health []
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