- AIG announced its CEO Bob Benmosche will retire on September 1 after helping to turn the company around in the wake of the financial crisis.
- Peter Hancock, who has helped to de-risk the Property Casualty unit, will be the new CEO and will continue to take a disciplined approach to risk.
- Still, I expect Life Insurance to be the main driver of results thanks to growing assets and eventually rising rates.
- Even with new management, shares are poised to reach book value of $65 within 12 months, and I would be a buyer here.
On Tuesday afternoon, American International Group (NYSE:AIG) announced that CEO Bob Benmosche will be stepping down on September 1 (press release available here). Benmosche's departure has been well telegraphed, though I was expecting him to leave closer to the end of 2014. He has done a tremendous job in turning AIG around since taking over after it was forced to accept $180 billion in federal bailout funds. Under his watch, AIG sold non-core assets, de-risked its balance sheet, and improved underwriting standards. AIG has since paid back all of the money it owes the government and is solidly profitable with $100 billion in common equity (all financial and operating data available here).
Benmosche did a fantastic job, coming in as an outsider and turning around a business that the previous management had virtually run into insolvency. While AIG may never return to a pre-crisis share price (a split adjusted $1,400) due to the extremely dilutive nature of the bailout, it is making money and poised to grow book value and earnings methodically over time. Losing a fantastic CEO is inevitable and never good news, but I continue to believe AIG can thrive under new CEO, Peter Hancock.
Hancock is currently the head of AIG's Property and Casualty unit, which has been slowly improving its underwriting combined ratio, though there is still room for improvement. Adjusting for catastrophes, it came in at 97.3 in the most recent quarter, slightly worse than last year's 97.2. However, AIG has slowly been moving towards less risky policies under Hancock and while legacy policies are still dragging, the unit has been solidly profitable under Mr. Hancock. His low-risk approach should help generate consistent returns for shareholders.
Now, the bull case for AIG rests mainly on its dramatically growing life insurance business, and that unit will remain under the same management. As a consequence, I expect Life to continue to deliver blockbuster results. Last quarter, assets under management at its Life unit increased to $324 billion, up 9% year-over-year. This increase was powered by a 28% jump in deposits and premiums to $7.13 billion. Thanks to a growing asset base, pre-tax income reached a record of $1.42 billion. Life insurance is the ultimate bet on rising interest rates. Customers pay premiums to AIG every month for years, and when they die many years down the road, their beneficiaries can make a claim. This future claim is a liability. As rates rise, the present value of these claims falls. At the same time, AIG can invest the cash premiums in long-term bonds, meaning income increases as interest rates rise. Rising rates increase investment income, while cutting the present value of liabilities. This is a double benefit that makes life insurance a great business to get into as rates are about to rise.
Admittedly, over the past few months, the 10 years' rates have stayed surprisingly low, even with the Federal Reserve tapering its bond purchases. While I cannot say when rates will rise, I do believe that an increase in yields is inevitable as the Fed steps away and begins to increase its overnight rate. With some inflation and positive growth, the 10-year yield and eventually even the Fed funds rate have to increase. This increase in yields is not just a short-term benefit, but a long-term theme that will increase AIG's earnings power over several years. Last quarter, the base investment yield was 5.3%, and a 1% increase in the Fed funds rate will gradually increase AIG's EPS by around $1.50.
AIG's momentum in life insurance should continue after Benmosche leaves, ensuring strong results for investors. AIG is also well capitalized and has been able to buy back shares below book value. Last week, the company was able to authorize another $2 billion, and I expect it to repurchase shares at a roughly $750 million per quarter pace. Shares still trade at a $10 discount to its book value of $65.49. With growing capital returns and improving results mainly from Life, I expect shares to trade towards book value within 12 months. While investors should always be concerned when a great CEO retires, Benmosche has set AIG up to thrive past his departure. I would continue to buy AIG here and on any dips.