Why We Expect AIG To Bounce Back After Weak Q3 Earnings

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The recent Atlantic hurricane season resulted in earnings pressure for most U.S. property and casualty (P&C) insurers in the U.S., including AIG (NYSE: AIG), during the third quarter of 2017. AIG’s net income declined by nearly $2.2 billion due to high catastrophe losses, partially offset by increased income from the group retirement and life insurance businesses. Much like other major life insurance companies, AIG derives a majority of its value (approx. 60%) from its investment portfolio. The life and retirement insurance business on its own is an extremely low-margin business, but that is offset by lucrative investments, on which insurers rely. AIG’s investment yields have been low in the last few years due to the low-interest rate environment in the United States. However, we expect AIG’s investment yield to improve going forward due to the recent interest rate hikes by the Fed. Additionally, AIG had increased rates for its P&C insurance offerings, which should improve the margins of AIG’s P&C business in the coming quarters.

See our complete analysis of AIG here

Investment Yield May Improve Following The Interest Rate Hike

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AIG’s investment division invests the income from its premiums and deposits to generate investment income to cover future claims and benefits. Most of AIG’s assets are invested in fixed maturity securities, whose yields are closely tied to the interest rate environment. The investments mostly consist of corporate and municipal bonds, government issuances, common stock, real estate and hedge funds. AIG’s investment yield had declined from 6% in 2013 to about 4% in 2016 due to the low rates in the U.S. However, the Fed has raised rates twice this year, which resulted in an improved 10 year U.S. treasury bond yield in the last three months. Over the last year, AIG has been narrowing its credit spreads, which has resulted in net unrealized gains in the last few quarters. AIG’s net unrealized gains on its available for sale portfolio increased by nearly $1 billion. We expect the improved treasury yields to boost AIG’s investment returns in the coming quarters. Additionally, the reduction in AIG’s hedge fund portfolio and creation of a new business unit, AIG Risk Management, will reduce volatility, and allow yields to increase in a rising rate environment.

AIG’s P&C Division Profitability Should Improve Going Forward

In the recently concluded third quarter earnings, AIG’s total catastrophe losses amounted to nearly $3 billion, of which $2.7 billion were in the P&C division. The division’s performance has not been up to par in the last year and a half. However, we expect AIG’s P&C division to turn things around in the coming quarters as AIG increased rates in the wake of recent hurricanes. The recent hurricane season may also lead more customers to buy property insurance (or increase their current coverage), which could lead to premium growth for AIG.

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