Measuring AIG Going Forward

Bring on TomorrowOver the past number of conference calls management has emphasized debt reduction and interest coverage as the highest priority near term. They are focused on cost reductions, interest expense reductions and improving the interest coverage ratio. “As the year progresses, we will then begin to look at things like could we add a dividend to the stock, and also could we have some kind of a modest stock buyback…But we’re going to wait until we’re very, very sure we’re in great shape, because of what I’ve said, it’s important we retain our ratings, and improve those ratings…”

Bob Benmosche, President and CEO, closed the 4Q12 conference call referring to AIG’s goal to become an investment-grade company and …”and 2015 is our aspirational date, and we’re still marching pretty quickly towards that date and the things we need to achieve for it.”

Anticipating the need for operational improvement after the recapitalization of the company, management developed enterprise wide, long term “aspirational goals” during the 1Q11 for the key operational metrics of the company [Source].

The restructuring is complete, government shares sold, and SIFI requirements should be defined by mid-year. Going forward we’ll monitor the improvement in operations as one of the primary catalyst for the remaining increase in share price we expect. Operationally there is still a lot of work to do.

Later this year, once the Systemically Important Financial Institution (SIFI) requirements are defined, returning capital to shareholders in the form of a dividend and share repurchases will act as a further catalyst to realizing the full value of the company.

Enterprise Goals:

In the 1Q11 10Q on page 92 [Source] the goals are introduced as follows:

Following the completion of the Recapitalization, AIG is developing business plans for its operations in relation to certain long-term aspirational goals. Among the most significant of AIG’s enterprise-wide long-term aspirational goals are the following:

• to increase its ROE to 10 percent or more by the year ended December 31, 2015, from its 6.2 percent normalized ROE as of and for the year ended December 31, 2010; and

• to achieve average annual percentage growth of its EPS in the mid-teens through the year ended December 31, 2015, from normalized EPS of $2.62 for the year ended December 31, 2010.

Return on Equity (ROE):

Goal 1: to increase ROE to 10 percent or more by the year ended December 31, 2015. This is a key metric for our investment thesis because the share price to book value multiple is a function of ROE. We’ll track the quarters ROE annualized and the last twelve months ROE. Calculation: ROE = Annualized net income attributable to AIG divided by average AIG shareholder equity.

ROE Progress r1

Earnings per Share (EPS):

Goal 2: to achieve average annual percentage growth of its EPS in the mid-teens through the year ended December 31, 2015. After-tax operating income (loss) is a measure of the operating performance of the ongoing operations and the underlying profitability. Improving the price to book value multiple relies on consistency and improving performance in EPS.

We’ll use the current quarters annualized after tax operating income (loss) per share (EPS) attributable to AIG’s continuing operations and track it against the last twelve months EPS for an annualized improvement rate of 15% per year.

EPS Progress r1

Operating Goals:

The achievements of these two major enterprise goals are dependent upon the underlying improved performance of AIG’s businesses. AIG developed supporting operating goals with estimates of the impact on ROE.

Property and Casualty Combined Ratio: 

The combined ratio is a measure of insurance underwriting profitability. If it is over 100% claims paid are exceeding the premiums received. Under 100% the underwriting is profitable, risk is being priced appropriately and premiums are exceeding claims.

AIG’s Property and Casualty Company’s goal is a combined ratio of between 90 and 95% by the year ended December 31, 2015 resulting in an un-leveraged return on equity of 10 to 12 percent. AIG uses an adjusted “accident year” combined ratio that exclude catastrophe losses and related reinstatement premiums, prior year development, etc.

Although the accident year combined ratio helps provide clarity for current operation it is too forgiving for previous poor performance that may still need corrected. It essentially shows how well (or bad) the company is doing if you forget the mistakes of the past. In the insurance industry losses will occur but poor underwriting can haunt for years to come. We will show the accident year ratio but follow the unadjusted combined ratio.

P C Combined Progress

Mortgage Guaranty Combined Ratio:  

AIG’s Mortgage Guaranty business providing mortgage insurance for homeowners and will be monitored through the unadjusted combined ratio. The company has not published an aspirational goal for this business. Like the Property and Casualty business we will be looking for something under 100%, the more the better.

Mortgage Guarantee Combined Progress

Life and Retirement:

The aspirational goals are assets under management (AUM) of $320 billion and life insurance in force of 1 trillion by the year ended December 31, 2015 resulting in an un-leveraged return on equity of 9 percent.

These compare to assets under management of $249 billion and life insurance in force of $909 billion at December 31, 2010 and an un-leveraged return on equity of 7.4 percent for the year ended December 31, 2010.

Life insurance is more predictable because underwriting actuarial based. Here the level of float (assets under management) and the return on investment are the important measures of performance. AIG has not published a return on investment goal but we will monitor it along with asset under management growth.

Life AUM and Yield Progress

 

Life Insurance in Force Progress

Disclosure: Long AIG common stock and AIG warrants.

 

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