American International Group, Inc. (AIG) Earnings Call Transcript & Summary

Good morning. I'm Tracy Benguigui. I joined Barclays recently as the new insurance analyst. I am pleased to chat this morning with Peter Zaffino, President and Global Chief Operating Officer; and Mark Lyons, CFO of AIG. Peter and Mark, thank you for being here with us. Just some housekeeping items before we kick off. There's a live polling question list on the left side of your screen. And if asked for user name, just please use Barclays and look for the next button when you move through the polling question. We can see the results in real time. And on the left side of the screen, there's also a Q&A box. So this session's format today is fireside chat. And I think we could start off with Peter. If you could provide us a big picture view of AIG alongside marketplace condition.

Thank you. Good morning, everyone, and thank you, Tracy, for inviting Mark and myself to join you today. It's nice to see you again and congratulations on your new role. I thought I'd provide a few opening remarks, and then we'll turn to questions. 2020 has been an incredible year. We knew coming into it that it would be an important inflection point at AIG, and that was before COVID emerged. These have been very challenging times for everyone. And at AIG, we doubled down on efforts that we had already started to execute on in order to reposition our businesses and make them more strategically relevant in the marketplace as well as to make AIG a world-class organization that delivers value to its clients, shareholders and other stakeholders. I know you, Tracy, and I believe this audience are familiar with the direction we're taking the company in, which we outlined early on as establishing underwriting excellence, investing in world-class talent, fixing the core of AIG, reducing volatility and achieving more predictable outcomes over time across GI and L&R. We made a lot of progress, and we continue to execute with a huge sense of urgency. As you know, I was named President of AIG in December of last year. So on a personal level, 2020 for me was about pivoting to my enterprise-wide role, which is what I initially came in to do at AIG, and taking on oversight of other areas of our company like Life and Retirement, IT and ERM, which recently moved under me. And of course, continuing to spend a lot of time on AIG 200, which is a critical component of shaping the future of AIG and making the company more efficient, technologically advanced and operationally fit for purpose given the various lines of business that we're in. Last month, we announced Dave McElroy as my successor in General Insurance and made other changes to the global leadership team. We've developed a very deep bench in General Insurance in North America as well as in International. I have every confidence that under Dave's leadership, we'll continue to strengthen General Insurance's position in the industry as a market leader. We will also continue to leverage our strong foundation to capitalize on the market dynamics we're seeing play out in Property and Casualty, including growth opportunities; some of our businesses such as Validus, our reinsurance company; our Specialty businesses; Excess & Surplus lines, which is the Lexington; and Financial lines, just to name a few, all which we expect to accelerate throughout the remainder of the year. Thanks to a lot of great work by Mark and his finance team, AIG remains financially sound. The decisive actions we took when COVID first emerged have positioned us well. Our liquidity, capital and balance sheet are all very strong. During our planning for 2020, we never imagined that we'll be dealing with a global pandemic for an extended period of time. However, we were able to pivot and adapt very quickly, and I'm really pleased with where we are, the momentum we continue to build and the resiliency of our workforce. It's been a heavy lift at AIG. We've discussed this at length over the last 3 years as well as things that we absolutely had to accomplish. While there's always more work to be done, we're excited about the future at AIG and remain laser-focused on delivering for our shareholders over the long term. Those are my prepared remarks, Tracy, and I think I'll turn it back to you.

Excellent. So maybe staying on strategic priorities, what is next for AIG? We could touch upon AIG 200 a bit, but how do you envision taking AIG to the next level after spending the last few years on remediation efforts?

Well, as we look forward, it's how we continue to strategically position our businesses to be market leaders in either their geographies or the lines of business that they're in. So I mentioned a few in my opening remarks, such as our Specialty businesses, such as our Excess & Surplus lines capability. With the market conditions, we think there's opportunities to grow reinsurance, and we have a great overseas operation in U.K., Japan and Europe. And so I think I would focus on growth for us and for us finding ways, again, to be more strategically relevant, but also finding ways to grow the top line. I also think there's an evolution on how we position the businesses to have that competitive advantage. So not only is it underwriting expertise, we don't have any restrictions on limit deployment. So there's ways in which we can do more for clients across the world. And then the work that we're doing on the operational side will digitally enable us to do things on the underwriting side much more efficiently. But also, when I think of Japan and other places where we have more interaction with sort of small and medium enterprise brokers or agents, that digital enablement will give us opportunities for growth. The underwriting that we've done has significantly reduced our overall exposure over the past several years and has significantly reduced the volatility. Our reliance on reinsurance will continue to be strategic. But I think as we've repositioned the portfolio, we'll be able to do more things with reinsurance over time without taking more risk, and that will give us opportunities for less spend, perhaps, but more strategic purchasing within reinsurance. So I think capital management over time will be very important. We've got to get through this global pandemic and making sure that we continue to invest in the businesses, so they can be not only growth opportunities, but known as market leaders in everywhere we do business.

Great. I do want to circle back on your reinsurance utilization, but just staying on the theme of strategic priorities. For AIG 200, how important is this project now? And will the timetable change given everything else going on?

I think it's very important because there's just some fundamental things that we need to do in IT modernization, how we look at operations, what we're doing to use data better within the underwriting businesses, and so having a data architecture and making sure that the underwriters are able to use that data to our advantage. So I think it's very important. When we went to a work remote environment, it actually allowed us to accelerate a lot of that. So we're meeting with more frequency. We're able to get more than 40,000 people within weeks to work remotely. So we looked at our KPIs. We're at or at better levels than pre-COVID. And we've really been able to accelerate much of what we were doing on the AIG 200 operational side. And I think that that's going to position us well for 2021 and 2022 to achieve the objectives that we outlined in prior earnings calls.

Great. So it sounds like you feel good about all the underwriting actions as you approach 2021, and you could retrench a bit on your reinsurance utilization. And you've mentioned you do not have restrictions on limit deployment. One of your peers once related to me that they don't like sharing profits with reinsurers. So just given where we are with the hardening REIT market, in very simplistic terms, should we expect AIG to meaningfully keep less premiums? Or is this retransmit or nuance in that?

Well, I don't think anybody intentionally wants to cede off profit. But I think it really goes to more of a strategic relationship that you have with reinsurers. And so the strategy in terms of how we look at reinsurance doesn't change. What does change, what you mentioned at the beginning of the call, is just the incredible progress that we've made on the underwriting side. And it's not just limits deployment, it's how we actually position the businesses, whether it's on the Property side, the Casualty side, our Global Specialty businesses, our global multinational business. We're just better positioned because of the excellent underwriting transformation that's taken place. And I think that the reinsurance has to reflect the book of business that you have at the time. So I think 2021 is going to be very important for us to look at reinsurance. So examples would be, we don't deploy as much gross limit on Casualty. We don't perhaps need as much in terms of up to $100 million limits. With the work that we've done on Syndicate 2019, the overall core CAT exposure in peak zones for AIG has decreased along with the excellent underwriting that we've done in terms of reducing billions of dollars of limits. So I think our philosophy remains the same, which is to have high-quality global reinsurers that trade across multiple lines of business in the portfolio. We look at it as a partnership. There's an evolution process of how one approaches structuring reinsurance to make sure that you're not taking more volatility. And I also think, just taking a look at the index of the market, doesn't really reflect AIG. We're a big company. We buy reinsurance across multiple lines, and reinsurers partner with us because they choose the company, they choose the underwriters and they choose us as an insurance company in terms of how they want to deploy capital. So I think all of that will evolve next year to reflect the book we have. And I think our reinsurance will be revised accordingly.

Okay. Excellent. Just because you mentioned Syndicate 2019 and all the actions to reduce your CAT and property aggregates, given all the leg work you've been doing already, can you frame out what type of risk you would be potentially sharing with capital partners? And it will be helpful to also understand the profile of ideal capital partners.

Well, if I start with Syndicate 2019, that was designed to put together an innovative capital structure to address our high net worth business where we think we have a very good market position and see opportunities for growth. The growth is largely in peak zones. And so when you look at our commercial portfolio, our Japanese book, we already have a lot of peak zone exposure. So it would be heavily reliant on reinsurance for its growth. We decided to partner with Lloyd's John Neal, and the leadership group there have been terrific in terms of looking at this as a partnership. We've been able to bring in top global reinsurers to be partners with us because they like the portfolio a lot and see opportunities for product innovation and for top line growth. And then we brought in Hudson Structured Capital, a capital markets group, that wanted to make an investment and also take risk on the portfolio. So we're all aligned in terms of risk sharing. We have multiple partners that have different backgrounds, if you will, with the -- looking at Lloyd's and then looking at traditional reinsurers to do whole account quota shares and then having a capital markets group come in. All of that really was quite strategic. And now we can grow top line because everyone's taking a piece of the peak zone exposure, not the entire exposure. When I think about other capital market opportunities, we have AlphaCat, which is an ILS fund that has north of $4 billion of AUM. That came with the Validus acquisition. We have high hopes to grow that over time and measure it by AUM and think that there will be a lot of demand for AlphaCat at January 1. But there's other ways to set things up similar to that that might address retro capacity or may address other needs in the marketplace that we're going to be very nimble with investors because we originate risk, we have excellent underwriting capabilities and that capital markets wants to find risk that has excellent underwriting and modeling, and we think that's us.

Okay. So you've mentioned AlphaCat and Syndicate 2019. Just on a mechanical question, so AlphaCat is a sidecar. And how would you characterize the Syndicate 2019? Is the inspiration to be structured like an unaffiliated, reciprocal exchange or essentially Talbot would earn a management fee with a built-in profit margin in exchange for a policy and claims administration? Or does it look more like an AlphaCat where it's a sidecar?

No. It's different. I mean like AlphaCat -- look AlphaCat can take single limits that would not reflect the sidecar. So they can deploy capital that's underwritten, that hits the return thresholds of the investors to be deployed as a collateralized reinsurer. So it has flexibility beyond just taking a line with Validus just to create capacity. So it has multiple capabilities. I think on the Syndicate, you just think about it as, Talbot's the Lloyd's Syndicate. They will be doing underwriting under the same discipline as they would be doing when they put their business plans into Lloyd's at year-end. They're going to oversee the underwriting and work with U.S. colleagues as well as all of the different stakeholders to make sure that everything that we've outlined to Lloyd's that we're doing on the underwriting side and then we would look to do a lot more common account reinsurance on behalf of the Syndicate. And that's what we're doing as we approach year-end. So I find them to be actually quite different, both strategic, both trying to solve issues for clients and also going after markets where we think risk-adjusted returns will be attractive over time.

Tracy, if I could, I would just add to Peter's pretty comprehensive view of that is, from my angle, it changes the revenue model. So you have more fee income coming in the door, which really drops down to the bottom line. I don't have to put a loss reserve against it, as an example. The catastrophe risk is not that spread, I think, in a very intelligent fashion, which then reduces the profile of CAT from an AIG Group perspective on a go-forward basis. So it's got a lot of benefits that accrue.

Great. I have to talk about CAT, just given how active this quarter has been. It seems to be shaping up to be the second heaviest third quarter dollar-wise over the last 10 years, just after Harvey or memory in the third quarter of 2017. And I'm not just talking about the impact of Laura, and now we're seeing -- which wasn't as bad as what everyone anticipated. And Hurricane Paulette is making a direct hit on Bermuda this morning. Could you share some early insights of your catastrophe experience so far this quarter?

Well, maybe I'll start and then Mark can add on to anything that he would like to share. But yes, it's been an active CAT quarter. I don't think -- I haven't seen anything. We're still looking through it on a gross and net basis in terms of what the activity is in claims, but there's nothing that I see at this point that would be an outlier. I think it will be all managed within our expectations. I mean as we've talked about at length, I won't go into it, we have very comprehensive occurrence and aggregate reinsurance to protect the company from a lot of frequency or a lot of severity. But as you said, there's still a lot of activity. I mean we have 5 active storms with 2 hurricanes, 1 tropical storm and 2 tropical depressions in the Atlantic at the moment. And yes, it has been very active. But again, this is what we planned the overall gross limits and making sure that we manage peak zones and making sure we have reinsurance to respond to quarters like this where there's a lot of activity. I don't know, Mark, if there's anything you want to add.

Actually, no. I mean what I would have just said is really what you said, which is the -- at this point, we don't see any of those being outliers for us. And reinsurance has both vertical and horizontal components. So we feel pretty good about it.

I mean one thing I would add, and this has been the case over the past several quarters of CAT is that the excellent job we've done reunderwriting the commercial book, that really hasn't been a big contributor to a lot of the CATs we've seen in the past, wildfires or perhaps win for Private Client Group or the typhoons in Japan. But I think we've done a really good job on the commercial side with the reunderwriting and doing that at pace. That -- peak zone exposures for the commercial, they still exist, but they're much more manageable and the reinsurance reflects, again, the book that we have today there.

Okay. Maybe moving on to COVID-19 reserve adequacy, and maybe I'll turn the question to you, Mark. So far, AIG has reported $730 million of pretax COVID-19 losses. And since we just spoke about catastrophes, well, it's not apples-to-apples, $730 million doesn't feel like the worst 2 quarters of CAT experience. In your opening remarks, you mentioned that COVID-19 would be more of like an earnings event, not a capital event. Are you just as bearish now as you were at the start of the pandemic? Or are these losses just take more time to manifest?

Well, it's a good question. And the -- I think what you got to think about is that you really can't put up a reserve on your books for everything that will occur. This is an ongoing event. It affects your gross views, it affects your ceded views as to what's recoverable. So it's very complex. So what do we do, as of any balance sheet date, we put up management's best estimate based upon claims that have occurred at that point in time, taking due consideration to triggers and individual coverage parts and so forth. So we can't really reach forward and do that because that is in direct conflict with the unearned premium reserve. And therefore, you'd be overlapped and be redundant. So I think, to some extent, there's some misunderstanding of that. But I think that that intro is really going to the conclusion that every quarter we look at what's emerged, what are the characteristics, what lines of business are affected? And you always do a retrospective look back to 1Q and 2Q. Were the original assumptions still hold water? Does the emergence against those still hold water? And that's the ongoing process. So that's what we would expect to continue to emerge.

Great. So maybe I'm being a little [ cued ] here. But should we add an E to IBNR and make it essentially incurred, but not enough reported? Let me unpack that a little bit. I understand that the accounting standards for putting up IBNR based on 2 criteria points, losses have to be estimatable and probable. And a pandemic like this has not been tested in modern times. So Mark, you described some of the complexities, but how would you describe the new reserve path in the COVID-19 world?

Well, some of it, I think, is similar to the answer I just gave, but it is a bit different, and that is continuing and ongoing. And we know there's going to be creative plaintiff bar approaches. And in some lines of business, you -- like in some areas, first responders can come up, you've got some regulatory direction on that. You don't really see that on the GL side, for example. So I think what we've got to do is continually look at what kind of claims are emerging because that could really shift lines of business as we go deeper and deeper in. I know there's been some thoughts that the GL policies could be tapped for a business interruption cousin, if you will. And that's really not going to happen. That -- you got the CCC, care, custody and control exclusion. You don't really have first-party coverages and property damages. It's a nice theoretical idea. We may have to expend defense costs associated with it. But it's really not anything that's going to really hold water. So we actually expect on the GL side to have more defense cost issues than indemnity issues on the roll forward. But hopefully, that gives you some of what you're looking for.

Yes. On GL, I actually heard what may be tested is the employer liability, which should be excluded from GL. But it -- again, that's a coverage that hasn't been tested. Is that what you're referring to?

Well, there's that, but there's also, sticking on GL for a minute, I mean that's a third-party cover, right? So on the bodily injury side, I think a good example might be a restaurant, right? So if a patron to or diner to a restaurant got sick and they didn't follow established protocols that have come out, there's some liability that could accrue. But in concept, but how to prove that when they're exposed across the board that it came from there as opposed to the restaurant they went the day before or the -- it's very complex, hence, for defense costs.

Okay. Just my last question here on the COVID-19 scale risk. My math, AIG has put up about 30% of its reserves for long tail lines, working back from the comment you guys made at another conference. Given these losses make more time to manifest on the liability side, how did you get comfortable with the 30%?

Well, some of it is kind of what we just talked about, which was the fact that we expect the complexion really of those longer tail lines to be different, more on the defense cost side, I think, firstly. And secondly, I kind of look at that a little different than the 30% that you talked about. I look at it more as to what proportion is case reserve versus IBNR. And at the end of second quarter, it was roughly 28 -- 20 case IBNR, but that's biased. That's biased towards the very short report. You've got travel in there, you've got A&H in there, so there's been cancellation. When you control for those that I think anybody would realize our quick pay areas, it skews a lot more to IBNR, which is one of the real -- closer to the 90% range, which is how you get the comfort.