When AIG announced its fourth quarter earnings after the bell Thursday, the top line sounded great: Net income of $11.2 billion from selling businesses. But the next line killed the enthusiasm of taxpayers ready to pop the cork: The company had an operating loss of $2.2 billion.
The loss was the result of a $4.2 billion charge to increase reserves for its property and casualty subsidiary Chartis. It came at a time when competitors’ reserve pictures were improving, according to KBW analyst Cliff Gallant.
”This charge raises questions regarding AIG’s ability to accurately set reserves and the earnings power of the company,” Gallant wrote in a February 9 report when the charge was announced.
He’s got a point about the earnings power. The company’s fourth quarter profit came from a gain of $17.6 billion on sales of moneymakers AIA and ALICO, the company’s international insurance subsidiaries.
The net premiums at Chartis, by far its biggest business, were down 3.3 percent in the fourth quarter, excluding a boost from its newly-consolidated Japanese unit, Fuji Fire and Marine.
But CEO Robert Benmosche sees the company beginning to emerge from its problems. I caught up with him in a CNBC exclusive right after the earnings hit the wire. His main messages: The business environment is still tough, the company is now properly reserved, it’s poised to make money as an insurance company, and the IPO is full-steam ahead.
He reiterated his estimate that the company could generate between $6 and $8 billion in profit on a long-term basis.
Bottom line, though: AIG’s spacer business is feeling the effects of the recession and Medicare policy changes, according to Benmosche. Insurance products such as worker’s compensation see a rise in claims during a recession.
People are quicker to take disability leave in a downturn. They also stay on it longer, particularly if they don’t have a job to go back to, says Benmosche. In addition, Medicare changed the way it handles their claims, and told insurers they have to pick up more of the cost, Benmosche said.
These factors were part of what led to Chartis’s reserve increase. “As we went through this review we wanted to be careful that we looked at all of the indicators that changed this year vs. last year,” Benmosche said. “We wanted to make sure that we were as strong as we could be in terms of setting those reserves.”
As for the unease this caused in the market: “Unfortunately the consequences of getting the reserves right and making sure they’re sufficient makes one appear that they’re weak,” Benmosche said. “But in fact we have the strongest reserves, I believe, or as strong as any other company out there.”
The reserves may be strong, but AIG’s premium base has shrunk, while its fixed expenses have stayed the same, Benmosche says. Insurers amortize fixed costs—so-called “deferred acquisition charges” related to making a sale—over premium income. From an accounting perspective, it looks as if the fixed costs have risen, but they haven’t changed, says Benmosche. That doesn’t bode well for earnings.
So where will those revenues come from? One place is United Guaranty, AIG’s mortgage insurance business, which is profitable, Benmosche points out. That’s thanks to improving claims generally, as well as better outcomes in their negotiations over banks’ claims.
Given AIG’s businesses and footprint, he reiterated his previous public estimate of $6 to $8 billion as an achievable run rate for the company's consolidated pretax earnings in 2011.
”On a go-forward basis I think you will continue to see us produce good core earnings growth,” Benmosche said. “We’re going to focus on improving our capital position and our ROEs, quite frankly because, they’re low.”
At least all the special charges are about to stop. The last one should come in first quarter results, he says.
Once AIG has paid its final $3 billion prepayment penalty on the federal government’s loan, Benmosche sees nothing standing in the way of the company’s IPO, tentatively scheduled for May. That includes the bumped up reserves at Chartis.
“I do not believe that the charges we took will affect our ability to do an IPO,” Benmosche said. “The quality of our book of business, the quality of our people, the quality of the things we've been doing will determine that, and the belief that we have an earnings engine that will improve over time.”