AIG turnaround: The four Rs

As outlined in the first half of our analysis ‘Inside the battle to save AIG’ we identified the four "Rs" new management has taken to turn around AIG. They are explored in depth below.

Recruiting better talent

This type of change is famously challenging for investors. In the absence of competitive business secrets or differentiated products, most insurance companies try to sell their people as their competitive advantage.

And in some ways, this is reasonable. Top talent does tend to have a disproportionate impact on long-term value creation at insurance companies.

Even so, it is incredibly difficult to assess this from the outside, especially for the type of mid-level management and underwriting talent that has a less visible and less measurable track record.

For AIG, the level of personnel change over the last 18 months has been extraordinary.

Industry sources consistently cite the talent recruitment as the most impressive achievement of Duperreault’s tenure to date. For the first time in more than a decade, AIG is widely seen by brokers and competitors as having an “A-team” in place to improve underwriting results.

However, as important as the firm’s emphasis on people is, just as important is what the company is not saying. By placing so much emphasis on its people, AIG has quietly dropped one of its prior management’s biggest bets.

In essence, the firm is betting on people rather than technology to drive its immediate turnaround.

It is true the company still has longer-term bets in place, including its Blackboard and Attune platforms. But its near-term bet is on re-establishing the primacy of underwriters – empowered and enabled by data and analytics – but driven by human decision-making.

Central to this point is the tacit acknowledgement that prior management’s strategy has been a costly failure – a fact the company has never fully admitted in public. Indeed, faced with little scrutiny, the firm appears to have quietly buried this failed investment of hundreds of millions of dollars of shareholders’ money, quietly absorbing some talent and successes into the business units, while seeing notable exits among its “science” leadership team.

In returning to its origins, the firm is truly heading back to the future. 

Re-underwriting

Internally, the company has made clear that AIG’s re-underwriting strategy, put in place by new CUO of general insurance Tom Bolt, is aimed at delivering an underwriting profit in 2019. Nothing else will be considered a successful result, sources told this publication.

Though the re-underwriting drive has many strands, perhaps most notable is the aggressive action AIG has taken on pricing – which should feed through to margin improvement.

Reinsurance market sources said the firm had told casualty reinsurers that it was achieving price increases of around 20 percent in primary commercial auto and close to 10 percent in primary casualty general liability, substantially ahead of internal budgets and at a higher retention level than anticipated.

The firm is also said to be ahead of budget on pricing in Lexington London and excess casualty (albeit at modestly worse retention rates than expected), with Lexington US roughly on target with pricing in the mid-single-digits and retention in the high 70s, sources told this publication.

Together, these businesses represent more than half of the firm’s circa $2bn of auto and general liability casualty insurance premiums. Outside of these units, pricing and retention remain reasonably strong across most casualty lines, reinsurance sources said.

However, as well as pricing, insurance broking sources said AIG has also taken multiple bold steps on re-underwriting that are likely to have a significant impact on both the firm’s underwriting results while also causing ripple effects across the industry.

These include drastically cutting back its appetite for writing large limits and reviewing its attachment points in excess business, as well as spreading its bets away from large complex risks and reducing the complexity of the business it writes in general.

Notably, the firm’s decision to go “all-in” on accounts it likes with big limits on Fortune 500 companies seems to have been reversed in some areas, according to sources. New management is seeking to emphasise portfolio balance, both by building more middle-market exposure, and by playing more across an insured’s tower depending on where the best value lies.

For example, sources suggested the company has walked back on its prior decision to lay down big limits in property akin to FM Global and write single stretches of up to $2.5bn. Broking sources suggested the firm has reined this in and will keep its maximum line somewhere in the $750mn-$1bn range.

And in casualty the firm has made numerous steps across its various business units.

For example, in cat XL the firm has reduced its normal maximum line size to $100mn globally, from $250mn in international and $150mn in the US.  

Further, the insurer is understood to have been reviewing underperforming accounts root and branch, taking notable actions on pricing and/or terms and conditions, including cutting back its lines or restructuring its attachment points.

Similarly, the company is understood to have taken notable steps by industry segment, including limiting its lines for companies exposed to California wildfires, following heavy losses last year.

Additionally, in excess casualty the firm has looked to increase its minimum attachment points, as well as adding more balance to its exposure by participating across multiple layers of programmes with other markets in between, rather than writing single long stretches.

Reinsurance

Management has already clearly signalled its desire to use reinsurance more heavily to reduce the volatility of its underwriting results, and 18 months in, this strategy is starting to take shape.

The most high-profile change to date was the firm’s decision to restructure its catastrophe reinsurance programme to give it more protection for an accumulation of smaller events, including aggregate cat reinsurance cover in the US.

As reported earlier this week, the firm is currently marketing two new casualty reinsurance structures. One is a global excess-of-loss cover providing $75mn of limit excess $25mn, and the other is a 50 percent quota share covering a US casualty portfolio with $1.9bn of subject premiums.

The core programme covers primary auto liability and general liability, including its risk management business, surplus lines insurer Lexington and all excess lines.

Notably, the firm is using its leverage as a new large buyer of reinsurance in a market keen to secure growth.

In addition, sources have said that AIG is pushing reinsurers to participate across all of its reinsurance programmes. Appealing to a broad commercial relationship is likely to be key to AIG’s efforts to gain support for the US casualty treaty given the historically weak performance of the book of business.

Re-establish controls and governance

The final step of the operational plan involves ensuring the above steps are integrated into a consistent, enterprise-wide risk framework and executed in the real world.

Here the firm has to strike a balance between re-empowering frontline underwriters and a centralised black-box approach, but also put in place rigorous process and procedures for how and when underwriting decisions need to be escalated to management.

Management has outlined a new hierarchy for decision-making that involves reining in the organisation’s scope to deploy large limits or requiring reviews of major deals at a senior level.

Similarly, the firm has reduced its delegated underwriting authority for external program administrators, cutting the number roughly in half, according to sources.

Reinsurance sources briefed on the new processes describe an immense amount of detail on new internal management policies designed to create a more rational and ordered company.

Notably, the firm has also emphasised improved management information that allows it to have a single, centralised view on large risk accumulations and limits deployed – something that was unthinkable at the sprawling and unintegrated AIG of the mid-2000s.

Make AIG great again?

For all the operational improvements the firm has been making, one unavoidable critique still remains – one which is likely to come under close scrutiny from analysts and investors this week.

Following its recent acquisitions of Validus for $5.6bn and Glatfelter for an undisclosed sum, AIG now finds itself somewhat constrained on capital and liquidity just as its share price is reaching cyclical lows on valuation.

There is much to be said about the firm’s progress on improving its operations. But it is hard to beat mathematics, and there are few things you can do for the same return or for lower risk than buying back your own stock at a fraction of your net assets.

To put this in context, the cash spent on acquisitions in 2018 alone probably represents around 15-20 percent of the current market capitalisation.

So long as you broadly believe the carrying values of your assets and liabilities, it is hard to make a case against buying back as much stock as you can at these levels, so long as your goal is creating value for shareholders rather than building a great company.

Otherwise there is one inescapable question: if you do not think your stock is undervalued, especially relative to (re)insurers at 1.8x tangible book, why should external investors?