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American International Group, Inc. (NYSE:AIG)

Q3 2011 Earnings Call

November 4, 2011 8:00 AM ET

Executives

Liz Werner – Head, Investor Relations

Bob Benmosche – Chief Executive Officer

David Herzog – Chief Financial Officer

Jay Wintrob – EVP, SunAmerica Financial Group

Peter Hancock – EVP, Finance, Risk and Investments

Brian Schreiber – EVP, Treasury and Capital Markets, Treasurer

John Doyle – SVP, Domestic General Insurance and President and CEO, National Union

Analysts

Jay Cohen – Bank of America Merrill Lynch

Ed Spehar – Bank of America Merrill Lynch

Jimmy Bhullar – JP Morgan

Thomas Gallagher – Credit Suisse

Josh Shanker – Deutsche Bank

Michael Nannizzi – Goldman Sachs

Operator

Please standby, we’re about to begin. Good day. And welcome to American International Group’s Third Quarter Financial Results Conference Call. Today’s conference is being recorded.

At this time, I would like to turn the conference over to Ms. Liz Werner, Head of Investor Relations. Please go ahead, ma’am.

Liz Werner

Thank you, and good morning, everyone. Before we get started, I would like to remind you that today’s presentation may contain forward-looking statements, which are based on management’s current expectations and are subject to uncertainty and changes in circumstances.

Any forward-looking statements are not guarantees of future performance or events. Actual performance and events may differ, possibly materially from such forward-looking statements. Factors that could cause this include factors described in our 2010 10-K and subsequent 10-Qs under Management’s Discussion and Analysis under Risk Factors.

AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statements whether as a result of new information, future events or otherwise.

Today’s presentation may contain non-GAAP financial measures. The reconciliations of such measures similar to comparable GAAP figures are included in our financial supplement, which is available on AIG’s website.

With that, let’s begin our call today and I’m going to turn over to Bob Benmosche, our CEO.

Bob Benmosche

Hey. Thanks, Liz. You know, for our company we’re operating as if the Federal Reserve will be our regulator. We don’t know what will happen but it’s important we operate as if the Federal will be our regulator.

As part of that we have to do stress testing and so we constantly look at our company what the issues are and we said, what would happen – what would happen if the equity markets fell apart, what would happen if significantly on the S&P, what would happen if this spreads blew out, serious issues in the fixed income markets especially -- especially mortgages and then we said, what would happen if currency has started to create issues for us and throw on top of that a big hurricane maybe in the Northeast and what would have happened if you have some typhoons running around Asia.

And so that’s we did our stress test we updated all the time and we had the opportunity in the third quarter to see what happens when our stress test becomes somewhat of a reality. And so there is a question about AIG, our strength and how we would handle that kind of perfect storm which is what we just come through and I can assure you that we are in very good shape, our liquidity now is sitting at $15.3 billion, up from the last quarter.

And big concern we have gotten during the road show and for many of you over time is what’s going to happen to FP RemainCo and the assets, I should say, not RemainCo what would happen under these scenarios and clearly, our collateral calls were basically flat. There was no issue whatsoever in terms of cash demand. So, we are in pretty good shape.

So, let’s talk about the $4.8 billion of non-cash losses of three items. I’m going to start with Maiden Lane III. Maiden Lane III, we down $1 billion but the cash flows continue to be strong. So this is just the anomalies of the market at this point in time.

Keep in mind, we’ve gone from $45 billion in the beginning, the fed balance is down to $18 billion. It’s paying down cash flows of about $5 plus billion a year for Maiden Lane III and Maiden Lane II combined. This is Maiden Lane II and III combined in these numbers.

And so, we see 2014 still as a year in which AIG will begin to receive back a $6 billion investment before we begin to put the upside with the fed after that period of time. So, Maiden Lane III does cause some noise in the numbers, no question, but economically we see that is continuing to be strong.

Also AIA we took at $2.3 billion drop in the book -- in the carrying value of AIA marking it to market and keep in mind, as it relates to AIA, the SPV that we have from the AIA ALICO, SPV is now down to $8.3 billion. The collateral against the $8.3 billion is Maiden Lane III, ILFC and AIA.

We also have about $1.5 billion in cash sitting in the SPV from the sale of ALICO to MetLife and that cash again will come out of escrow over the next year, another $1 billion I believe and the rest of it in 2013 leaves a $6.8 billion left on the SPV.

We are taking our time to look at that $6.8 billion and we are deciding what is the best way to handle paying that down, such that we maximize value for the AIG shareholders. So, whether is to sell AIA now or later, whether is to wait for the IPO of ILFC, if it works out in the markets in the future and as you know, ILFC is not core. We’re looking to monetize that at the right time for the right values. So we are going to take our time. And I guess that’s the only way I want to continually stress that time to make sure that we’re maximizing value for the AIG shareholders.

When it comes to ILFC, again a $1.5 was taken as part of our normal routine to look at what’s happening in the manufacturing space, some new announces were made on new aircraft. That puts pressure on some of our older plains and as part of our annual review we’ve decided to take a charge of about $1.5 billion to deal with that issue within the legacy aircraft which we’ve been talking to you about that’s the problem we need to resolve and work on and we know it’s drag but I think this resolves a good part of that drag.

So, let me come to capital management really quickly. You saw we raised $2 billion in the quarter and that’s really to make sure that our debt maturities are matching to what it is we have in terms of cash on hand. So, that deals with the some future payments we’re going to have to make. You also saw from the capital management point of view that we’re going to be buying back shares.

Let me be very clear that until we were able to do the re-IPO of the company, we could not do any share repurchase while we had Schedule G here at the company. Being able to launch the re-IPO to be able to terminate Schedule G and close that out had allowed us to begin to think about how do we want to handle capital management going forward.

Our priority and it’s important that you understand our priority is to be able to work with the U.S. Treasury so that we can continue to be buying back shares from their shares which represents overhang on the stock. That is our priority.

On the other hand, if we see in the marketplace that there are certain anomalies with our stock and we feel it’s an opportunity to take advantage what the market has done then the Board of Directors has approved a $1 billion share repurchase, so that in these markets if we choose to go out and buy in the open market we’re able to do that and take advantage of where the markets are today.

That doesn’t change our priority. Our priority is still to begin to think about capital management in the context of the U.S. Treasury shares and what we can do to facilitate taking that overhang off the table.

So, as we think about our results for the quarter, Dave is going to bring you up today and I just want to make a few comments that clearly if you look at what’s happening after that $4.8 billion.

Clearly, we had some storms hit us in the quarter, but Chartis is continuing to make great progress. They’re continuing to focus on how we get a better return for the risk we’re taking and making sure that our combined ratios start to come down as we promised in terms of our aspirational goals. They are making very good progress on that.

SunAmerica continues to do well. They are continuing to see client retention strong, sales continued to be strong and keep in mind, we’re down somewhat which would expect with this low interest rate environment in our fixed annuity business but still strong.

UGC continues to perform well on new business. We got that under control. However, there is still going to be a little pressure yet as we work out some of the legacy book and some of the legacy issues and foreclosures and so on.

And last but not least, ILFC continues to do well on operating basis. We did be able to write down, but they are continuing to get pretty good releasing of the plans that we have available.

So, I’d rather wait to some of your questions to rather get into any more detail, but let me turn it over to David on what the stuff – the issues are specifically in the numbers.

David Herzog

Great, Bob. Thanks and good morning, everyone. Let’s turn to slide seven and will step through the slides and make sure we have plenty of time for Q&A. Third quarter loss as Bob said is $4.1 billion that compares to a loss of $2.5 billion a year ago in our operating income, which is our principal non-GAAP measure was a loss of $3 billion for the quarter versus $114 million a year ago.

Slide eight is highlights of what Bob really covered with the AIA share price decline, the ILFC impairments, the spread widening in the some lower interest rates, the lower liable rate drove some of the loss on ML III and obviously cap losses, so we will move fast, as I think Bob covered that.

On slide nine is the ILFC impairment highlight and again we conduct this review annually. We typically do that in the third quarter and much like we did in the fourth quarter we were – we management judgments were informed by current market event. So the as a result of the review we determined that 95 aircraft were impaired from an accounting standpoint and we took a non-cash charge of a$1.5 billion.

So, again, the – there were number of economic events, aircraft technology announcements, then you have seen credit counter-party issues and other announcements that informed our judgment.

Turning to slide 10, for our consolidated performance, Chartis reported pre-tax operating income of $442 million affected by cap losses of little over $570 million in large part due from Hurricane Irene, which totaled little over $370 million for the quarter, as well as Tropical Storm Lee and Typhoons in Japan. Interestingly that compares to an unusually low level of caps a year ago which was about $72 million.

Turning to SunAmerica, which posted a $444 million of operating income for the third quarter. The results include the $43 million mark-to-model, mark-to-fair value for our Maiden Lane II, investment again due largely to spread widening and the underlying non-agency RMBS securities. The third quarter of 2010, actually had income from Maiden Lane II of a $156 million, so you can see the dramatic swing that that had.

So and also due to the decline in equity markets we increased our provision for guaranteed minimum debt benefits in our variable annuity business and we had higher DAC amortization as a result there as well, though together they were a little over $180 million for the quarter.

The equity market performance in the third quarter of 2010 was actually quite strong and as a result we had positive effects on operating income of about $100 million from our variable annuity business last year, so again fairly dramatic swing.

As Bob mentioned, United Guaranty, our mortgage guaranty business reported an operating loss of $96 million versus a loss of $124 million same quarter a year ago. Overall financial results for United Guaranty were unfavorably affected by continued weakness in the U.S. housing market, as well as the sustained high unemployment rates.

Increased delinquencies in the severity of loss cost on some of the older vintages was only partially offset by recessions. In addition, this third quarter overturns of previously declined a rescinded claims continued at a somewhat elevated rate.

Our other reporting unit reported a loss of $1.5 billion versus income of little over $400 million a year ago due in large parts of mark-to-model loss of roughly $1 billion on Maiden Lane III and also too much lesser extent the wind down AIG FP portfolio. Again cash flows on Maiden Lane III remain quite strong.

Global markets or global capital markets had a loss of $174 million, primarily from credit valuation losses or what we call CVA, on counter-party derivative balances and interest rate hedges. The super senior credit derivative portfolio was stood wider credit spreads and was flat essentially for the quarter.

At the end of the third quarter we had about $26 billion worth of notional in the CDS portfolio, of which $20 billion is – does not require active trading management. The remaining multi-sector book is down to about $5.7 billion notional for which we hold a GAAP liability of roughly $3.1 billion, most of which we’ve already posted collateral against.

We continue to believe that the actual settlements under these contracts will be less than the GAAP liability and the collateral postings we have, thus giving rise to intrinsic gains. Also during the third-party – during the third quarter, AIG and counter-party spreads widen substantially and those have requisite effects on the mark-to-market, mark-to-model instruments we have in the derivative portfolio.

Our direct investment book had earnings of $119 million, the increase in that from year ago was driven by net increases in the value of the formally AIG FP asset book. And finally, we’ve talked about the AIA mark-to-market, which has already recovered somewhat in the fourth quarter thus far.

Turning to page 11, which shows our after tax operating income reconciliation, the only comment I make is with respect to taxes, we apply a pro forma tax rate to our operating income or operating loss for the quarter. We show the benefit in operating in this case the benefit in the operating loss and we essentially reverse that out for the reconciliation to GAAP net income.

On page 12, there is our capital structure. Our leverage is currently in the low end of our longer term range and we still assume a 20% to 25% debt-to-total capital in our aspirational goals.

And we continue to actively manage our capital structure and cost to capital most recently. We issued debt to refinance some of our national investment program notes and we’ll launch an exchange offer for a portion of our hybrid securities.

Turning to page 14 for a word or two on Chartis. The financial results of Chartis are now reported in accordance with the recent reorganization in the global commercial and global consumer businesses.

Progress continues to be made toward improving our risk-adjusted profitability and changing the mix of our business. Some highlights are as follows, net premiums were up about just shy of 1% from a year ago and excluding the impact of foreign exchange and restructured loss sensitive programs and exiting selected workers compensation business, net premiums were flat for the quarter.

Adverse prior year development was a benign $55 million after considering related additional loss sensitive premiums. We review a portion of the reserves each quarter throughout the year and importantly the accident year loss ratio was $68.4 versus $67 and -- $67.7 in the second quarter and $68.5 a year ago.

The expense ratio was 30.8%, up from 28.2% a year ago. Last year’s quarter included the benefits of negative VOBA amortization related to the acquisition of Fuji Fire & Marine. Fuji DAC amortization this year is higher from new deferrals since the time of acquisition. Excluding FX and the DAC expenses was the – ratio was up about 1%.

Chartis premiums are on page 15. Chartis continues to execute on its strategy to grow higher margin, less capital intensive business and implementing corrective actions on underperforming business lines.

Excluding FX, consumer insurance premiums were down about 1% driven by personal lines, which was a management action to deal with a certain unprofitable warranty program. We see the results of our focus on the growth in higher margins lines.

Turning to commercial insurance premiums, excluding FX we’re down about 2% driven by again a focus on capital management and continued discipline in certain challenging markets.

I think it’s important to note that in U.S. commercial line we’re seeing rate increase overall about 4.1% on renewal business with rate increases led by over 8% in our property line. The trend is accelerating from prior periods.

Our international business is now about 50% of our net premiums and that’s up from about 45% a year ago.

Chartis investment results were on slide 16. Net investment income for Chartis was a $1 billion in 2011, basically flat from a year ago. Chartis continue to reduce its muni bond portfolio, which is now 27% of its invested assets and that’s down from over 35% a year ago.

Turning to SunAmerica on page 18. SunAmerica’s operating income was $444 million for the quarter versus $1 billion a year ago. The decline in operating income reflects much of the market volatility that we talked about with respect to ML II, some partnership investments, as well as the higher guarantee minimum debt benefits, DAC amortization in our VALIC business.

Premium deposits and other considerations totaled $5.7 billion for the quarter that’s up nearly 30% over a year ago, net flows were positive for the third quarter, third consecutive quarter, it’s just shy of $550 million and it’s interesting to note that year-to-date is positive $2.1 billion versus -- year-to-date versus negative $1.6 billion a year ago year-to-date.

SunAmerica’s business remains diverse strong good momentum in sales, deposits and good strong customer retention. Previous deposits, other considerations are on page 19 and I commented on [PDLC] overall. Life sales I would comment were up 14% driven by strong retail life sales.

Let’s turn to slide 20 for SunAmerica’s investment income. Investment income was $2.3 billion down a little over $350 million from a year ago, as I mentioned ML II affected this quarter by negative $43 million, due mainly due to spread widening.

Partnership income was muted this quarter due to private equity in hedge fund investments, which would remind everybody our report one quarter lag. There was also $97 million impairment on equity method investments and trusts that hold leased commercial aircraft, the same factors that gave rise to the ILFC impairment affected these aircraft as well.

Excluding ML II and partnership, and impairments the investment income was essentially flat. Importantly, we’ve redeployed the excess cash we had coming into the year and you can see that in our – in our base yields that are set forth in the financial supplement.

Page 21 has some information about the SunAmerica’s spreads, base spreads excluding the impact of partnerships and other enhancements increased again as we redeployed the excess cash from the beginning of the year.

Looking ahead, if we continue to take capital gains to realize the economic value of our substantial capital loss carry-forwards, again I would just remind everybody that the spreads themselves, the reported spreads could come under some pressure.

Now for a few words on our income taxes on page 23. That’s more fully described in our third quarter 10-Q. We apply a framework for establishing the valuation allowance, among other factors AIG has emerged from its recent cumulative loss and now we need to demonstrate a level of sustained profitability.

At the end of the second quarter, we described that framework for evaluating the reversal of a substantial portion of that valuation allowance as early as the fourth quarter of this year. If the framework is met, the valuation allowance for our net operating loss carry-forward to non-life capital loss carry-forward in the foreign tax credits could be released again as early as the fourth quarter. If the framework isn’t met, obviously, the release would be delayed.

Realized capital gain -- realized capital loss, I’m sorry, carry-forward remains more challenging to us as we’ve talked about in the past and that portion of valuation allowance will be released as the carry-forwards are realized.

We still expect an effective tax rate of roughly 25% to 30% for the rest of the year on our operating income driven by our substantial investment in tax free muni bonds. So from time-to-time other discrete items will affect that rate as well.

Just a couple of other comments then before we turn it over to Q&A, a word or two about the new accounting standard on DAC which is going to be adopted January 1, 2012. We will adopt the standard and there are specific categories of acquisition costs that are no longer deferrable under the new standard and if we adopt the standard retro-respectively this will be – this will reduce our DAC balance by approximately one-thirds. So that’s about $4.5 to $5 billion and it’ll reduce our GAAP shareholders equity by about 3%. But they will have no effect at all on our statutory surplus.

Also during the quarter the parent company received dividends, distribution and other inter-company payments from the operating companies of about $1.6 billion bringing the year-to-date total to $2.5 billion, that’s consistent with our capital management goals and aspirations, and so that remains on track.

Again, looking ahead we would expect some continued choppiness in the equity markets with respect to partnership incomes and we will in fact have some losses on the Thailand floods, but we’re not prepared to quantify that at this time.

Lastly, we remain committed to our long-term aspirational goals that we set forth in our first quarter 10-Q.

Bob, now back to you.

Bob Benmosche

Okay. Liz?

Liz Werner

Yeah. At this time, Operator, we’d like to open the call up for any questions.

Question-and-Answer Session

Operator

Yes. Thank you. (Operator Instructions) And our first question will come from Jay Cohen with Bank of America Merrill Lynch.

Jay Cohen – Bank of America Merrill Lynch

Thank you. A couple of questions, I guess, first on the share repurchase that you mentioned the priority is to buyback from the treasury. It seems it is a situation where they didn’t want to sell below a certain price. Is it possible they might sell to you below that price versus selling to the public or should we just assume that until the price gets up $27, $28, that you won’t be buyback from them?

Bob Benmosche

I can’t speak for the U.S. Treasury. I can only say that if they want to sell it to us below that price, we’d be happy to buy it, but I think they have their view of what the company is and what the company will be. Their goal and our goal is to make sure that the American tax payer gets back all their money plus a profit and that’s their goal as well. So I think that’s clearly up to them.

There is no – the advantage you have, people say, with the U.S. Treasury is not a problem and as far as we’re concerned they have allowed us to run the company, the way we need to run the company. They are very effective shareholder for us and the goal is to sell where they can get a profit for the American tax payer. They are not trying to time the market. They just wanted to make sure that they get out with the profit and time is not of the essence for the U.S. Treasury. They just want to achieve that goal. So, I think, if they chose to sell less than that, they could but that’s not what their interest is.

Jay Cohen – Bank of America Merrill Lynch

I have Ed Spehar too, he is going to ask a question.

Ed Spehar – Bank of America Merrill Lynch

Thanks. Just a couple of quick ones. Could you give us some sense of what you think the free cash flow is for both Chartis and SunAmerica and a kind of normalized sort of basis? And then just a couple of questions on topline, the VALIC deposits were very strong this quarter and you mentioned rollovers. Is that a, is that something that is sustainable and if so why?

And then on the Western National, was the weakness in sales because others didn’t lower crediting rates as fast as you did or is it just that you’re not interested in putting on a lot of fixed business when rates are at such very low levels considering the risk of short lapses if rates start to go up?

Bob Benmosche

Okay. I’ll have David start and then I think when it comes to VALIC and in terms of the ongoing rollover programs, so it’s not a one-time thing, but Jay can talk about the ongoing rollover program that he’d been successful at and also the pricing strategy within Western that deals with making sure that we have the right combination of commissions and price, and that’s really up for the bank and how they want to deal with that in this low rate environment. So, I’ll let Jay handle those two but David, why don’t you want to start?

David Herzog

Yeah. Sure. Thanks, Ed. The – I would first start by saying we are reaffirming the capital flow in our long-term aspirational goal, so while the markets are somewhat volatile, again we were – our expectations are that those dividend flows and capital flows from the operating companies to the holding company, we would reaffirm those expectations.

We had in the quarter about $1.6 billion overall of flows and again the flows come in a number of different shapes and sizes in terms of outright dividends. We have some surplus notes between the holding company and some of the operating companies in SunAmerica and so we are paying interest plus principal on that.

We got the tax payments, so while we are not going to quantify a court free cash flow I would just say that our risk base capital levels remain very strong and the earnings of the operating companies continue to be strong and therefore the dividend flows are in line with our previously discussed expectations.

Again, we got about $1.6 billion this quarter and again, that’s – it’ll bounce around a little bit but that gives you – it won’t be – you can’t take that and annualize it. But, again, I would point you back to our longer term aspirational goals that we set out.

Bob Benmosche

Jay, you want to pick up the other two.

Jay Wintrob

Yes. Good morning. On the VALIC question, Ed. We did a very strong quarter on the individual rollovers, I think that will continue the exact numbers and such obviously can’t predict.

I think the reasons for that are probably threefold, we’ve had an increased emphasis on focusing on rollover sales for sometime in our recruitment of financial advisors, our focus on doing more financial plans for prospective customers.

Secondly, we have rolled out a series of new products more focused on that market something we called PD advantage which is for people rolling over from our core portfolio director product at the end of their service. We’ve added a new contemporary guaranteed living benefit writer called IncomeLOCK Plus that’s available for non-flowing customers.

And then finally, we also rolled out a new variable annuity for the rollover market we call Equity Director those have all been picking up momentum and share starting this quarter. And then the last thing I would say is, in addition to our core VALIC field of financial advisors we do have a growing independent distribution organization that is licensed with VALIC and of large part of their sales have been focused on the rollover market.

So, I think that you’ll see continued progress here and continues to be a point of emphasis in VALIC. In western, see the reasons for the decline sequentially in fixed annuity sales and I think we still had an increased year-over-year kind of three different reasons for there. First on the positive front, we are now back in Wells Fargo, which had historically been our largest distributor that just came online in June.

We’re also back in SunTrust that just came online in August. So, we continue to get reinstatements and we’ll be building back our presence in those organizations in the quarters to come, but in the last quarter with the absolute level of interest rates declining that was a meaningful contributor to our reduction in sales sequentially. We did see a few new competitors come in to our market. We’ve seen that over the years, that’s fine, didn’t want to compete in a couple of cases.

The fact is we got, I think something like 21 proprietary arrangements now going through our banks where we are trading off crediting rate to the customer for lower commissions. So, we feel like we are very well positioned. And the last thing I’d say is that in the last quarter the second quarter we hit our highest market share of the fixed annuities through banks that we have ever hit, I think north of 40% as recorded by [Kehrer] or Limra.

And I’m expecting this quarter we will be back in what is our more typical market share which just not will meet target but just where we end up probably somewhere between 25% and 30% of the market and still far away the largest. So, those would be three reasons for the sequential change in Western National and our fixed annuities sales through banks.

Ed Spehar – Bank of America Merrill Lynch

Jay, just one quick follow-up. Do you worry at all even if you are getting your spread today, do you worry at all about the risk of writing business with rates this low and kind of shock lapses if rates start to go up at some point?

Jay Wintrob

We do worry about that. We worry about in all environments and our -- the major litigant there is very careful matching of our assets and liabilities. Our pricing is very disciplined, our guaranteed minimum rates are down to 1% on all products, it have been for some time.

The yield curve is still reasonably steep, so we’re still able to price and get reasonable spreads, but the main thing will be the continued matching of our asset and liability durations, not only initially at purchase, but monitoring that very closely on a regular basis. But, yes, we worry about that in the sense that we got constantly match those duration?

Bob Benmosche

And keep in mind that what you have here and the way they have designed the product in many cases has been trade off of communication to raid and so when you look at disinter-mediation is what you got left, you haven’t amortize that we have looked to amortize then the shock laps are on as own risk, as you might have on what traditional fixed annuity commission product so it’s -- there’s lot of contributing factors to make this we’re watching it and Jay is watching it very carefully, but it’s not as Barry you might think, if you think just normal fixed annuities.

Ed Spehar – Bank of America Merrill Lynch

Thank you.

Operator

Okay. And next we will hear from Jimmy Bhullar with JP Morgan.

Jimmy Bhullar – JP Morgan

Good morning. I had a few questions the first one for Bob. You mentioned that you would be opened -- or you would preferred to buy stock back from the treasury, but also would consider buying and if -- in the open market if the treasury is one. So may be if you could give us some sense of the timing of completion of your share repurchase plan that end you mentioned ILFC was non-core, wondering if you can share that’s what your talks are as it relates to AIA?

And then finally for Peter on -- in the P&C business just talk a little bit more about pricing you mentioned commercial property lines getting little better, but may be more details on the causality side and personal lines and related to that frequencies towards to end the Chartis, obviously results were affected by high cat losses this quarter, but if you look at the combined ratio ex-cats and development, it’s still been up from third quarter last year from the second quarter this year. So what’s you’re seeing there and your comfort level with your long-term combined ratio?

David Herzog

Let me start with the timing of the buyback. We’re going to, we’ve got the authorization and the team will take a look at what the opportunities are and we’ll begin to do it what we think makes the more sense based upon where the markets are. I don’t have a goal to say we’re going to be done in a month, two months or three months. We’re just going to be prudent and see what makes the more sense. So I don’t want to give you that answer when it’s over.

As far as ILFC not being core of about AIA, AIA is -- this is the third interest in Asia and the question becomes looking at the value of that position over time and where the markets are and what the opportunity we would have, if were to monetize that and sell it, the question is what would we do with the cash. And obviously you’d say how about buying back AIG shares, we’ll look at that as one of the capital management opportunities. There could be others.

But whatever we do we’d take a look at what the market says that property is worth and what else we could with the money that would give us the better return over time and that’s, it’s just a consideration we have to make as we go forward. Right now, we’re going to stand pat from what we see, but that doesn’t mean that won’t change over time. And so, I would then turn it over to -- I think that covered my piece of it and turn it over to Peter and go with that Peter, if you will.

Peter Hancock

Yeah. So, Jimmy in terms of pricing, I think we are seeing some hardening as David already mentioned both in the property and in the causality space. He mentioned specifically overall in the U.S. over 4% year-on-year rate increase. And this is a trend that really started for us, as early as the first quarter of this year and it’s just a progression of year-on-year rate increase since then.

So, I think that we’re leading the industry by about a quarter in terms of rate and on the property side, on the causality side our workers comp year-on-year in the quarter is up about 6.3% and again that’s a trend that actually was initiated earlier then the property and really as early as early middle of last year. So, we feel good about the pricing trends and on the U.S. side.

On the international and on the commercial, consumer lines the news really is Japan, which is the vast bulk of our consumer business and the fact that since the beginning of this year we got a relief from the regulatory block on incremental rate increases that have been existence for three years until January this year. I think it was not just us, it’s across the whole industry.

And so each quarter we’ve seen incremental pricing improvement in Japan, which we expect to continue and has been matched with increased flows as well. So we feel good about trends in Japan, although obviously somewhat distorted by events in the first quarter and both in terms of losses from the tsunami and the earthquake, but also the disruption to new business flows in the second quarter. But rate and demand in Japan is looking good.

Jimmy Bhullar – JP Morgan

And just your views on your, like margins?

Peter Hancock

Sorry, yes. Your point on the combined, as we laid out in the road show last year’s combined on an accident year basis 103.6. We set out a target to get that number to 90 to 95 by 2015. That’s a roughly two point improvement per annum and if you look at the projection for this year on a normalized basis, normalizing out the extraordinary CATS, we are right on track for that two point per annum improvement in accident year combined, though we’re feeling very good about our long-term aspirational plans on improving the combined.

Jimmy Bhullar – JP Morgan

Okay. And lastly, does the loss in the third quarter, heard your ability to reduce the valuation loans against the DTA or could you just still do it if the earnings bounce back in the fourth quarter?

David Herzog

Jimmy, it’s David. The -- we had -- you point to what happened in the third quarter, it’s a factor, but there is still very real possibility that if we -- that we can hit framework and that we can still release the allowance in the fourth quarter again. That will be determined by the performance of the company, one of the critical factors was the falling way of the three-year cumulative loss that’s done.

And we’ll just evaluate the specs and circumstances in the fourth quarter, particularly as they relate or solely as they relate to the U.S. member taxable income for the U.S. member company, so again I think there is still a possibility -- very real possibility of that happening in the fourth quarter.

Jimmy Bhullar – JP Morgan

Thank you.

Peter Hancock

But, it’s very complex. There is a lot of judgment and we want to make sure that everybody who oversees these kinds of activities is regulating entities, all understand what they are, it’s not simply saying well, but looks like we’re going to be profitable in future, let’s just do it.

There is a lot of rules and regulations about how this works and a lot of complexity and lot of judgment and so, it’s not quite so simple to generalize what it means and we’re going through all of those steps very carefully to make sure that what we do is we’re not in a hurry.

We just wanted to make sure when we do it, we want to make sure it’s right and it’s got to be very clearly right and something that’s very great.

Jimmy Bhullar – JP Morgan

And obviously what you do on the balance sheet doesn’t affect the economics of how you use it, right?

Peter Hancock

That’s correct.

Jimmy Bhullar – JP Morgan

Okay. Thanks.

Operator

We will now hear from Thomas Gallagher with Credit Suisse.

Thomas Gallagher – Credit Suisse

Good morning. I guess the first one is just for Bob or David, in terms of the little bit less than $7 billion that’s owed on the SPB, is there a fuse on that meaning would you have to make a decision to monetize either a AIA, ILFC or come up with the cash in another way by certain point in time?

Bob Benmosche

One, the fuse is you got to make sure you do what’s right for the shareholders and there is one shareholder that has 77% of the stock and they want to make sure we maximize their value.

So, that’s the fuse. If for example, we were pushed to pay it down, we’ve already developed a strategy and plan about what we would do, if we chose not to sell any of the assets that will collateralize right now. So they are free of the collateral.

So, at this stage of the game, our primary shareholder is looking to maximize our value, that’s what we want and make sure that we can sell as soon as possible and so that’s the only constraint we have.

Thomas Gallagher – Credit Suisse

Got it. Okay. And then can you talk a little bit, I guess it should be for David, can you talk a bit about your overall capital position today. I see you have north of $15 billion of liquidity resources at the holding company, but can you talk a bit about aside from the stakes in AIA and ILFC which I realized are, at least I think about them as residual asset values that could be monetize into capital.

But as it relates to capital levels that the insurance companies, is there any excess -- and I guess the other side question I had for that is the $11.6 billion of cash and short-term at the holding company. There is a footnote in your Q that said $8.7 billion in reverse repos is used to reduce unsecured exposures. I’m just not sure what that means, if you could elaborate. Thanks.

David Herzog

Sure, I’ll cover a parts of it and I’ll ask Brian Schreiber our Treasurer to comment on your last part there with respect to the reverse repos and the strategy behind that and that the use of those. How we think about the capital management, you’re right we’ve grew our cash and short-term and financial resource at the holding company to adjust north of $15 billion in the quarter.

Again we’ve renewed the bank facility had a terrific stable of banks participating. We were very pleased with that participation we also announced that we’ve been put in place an additional contingent capital facility again building up contingent capital and contingent resources in order to again allow us the greatest degree of financial flexibility.

I think we’ve talk quite a bit about historically the capital maintenance agreement that we put in place with all of our operating companies, those agreements, I would say continue to operate as designed, that the capital flows are coming to the holding company in accordance with what we -- what our expectations were with those capital levels.

We don’t report -- or Hammond reported yet the RBC levels of the companies, but it’s a wiser to say our domestic life retirement savings companies remain very strong and in line with where they were at year end which was upwards of 500% RBC. The capital maintenance agreement levels were in the 350% range and I would expect Chartis likewise to be at or above its capital maintenance agreement threshold.

So, again the underlying capital positions of our operating companies remains very strong. Again, I won’t quantify “excess capital” but you get a feel for that where we are there. Brian, you want to comment on the short-term investments and the use of the reverse reports?

Brian Schreiber

Sure. A key component of our capital and liquidity plan has been to reduce contingent liquidity risk at AIG. And as you know, AIG in the past had issued debt in foreign currencies and swapped that debt back to dollars. That exposed us to contingent liquidity risk from a strengthening dollar.

We have net assets and we’re long capital in many of the currencies in which we have issued the debt. So, we have been able to unwind the swaps, eliminate the contingent liquidity risk and effectively invest short-term in those currencies to defies that debt.

So, we are economically hedged and we have eliminated the contingent liquidity risk. We have chosen to go in reverse repos because it offers the best sort of risk adjusted returns for the company from a short-term investment standpoint, so I hope that address your question.

Thomas Gallagher – Credit Suisse

It does. Just a follow-up Brian. So, should I be thinking about $8.7 billion still available, fully utilizable by our whole co. or is there some level of -- those funds encumbered in some way shaper form. Like, I just want to understand how to think about it? I hear the technical explanation, but I just want to know practically speaking is, are those funds there for you or there is some level of that those are encumbered?

Brian Schreiber

The cash impaired is not encumbered it is a fundable asset that can be utilized how the parent company sees fit.

Thomas Gallagher – Credit Suisse

Okay. Thanks.

Operator

We will now here from Josh Shanker with Deutsche Bank.

Josh Shanker – Deutsche Bank

Yeah. Good morning, everyone. I wanted to just follow up little bit on the CVS book back at the time the road show the maximum capital call was about $1.6 billion, I realized mark-to-markets are not capital calls, but you had $1.6 billion in marks over the past two quarters. I wanted to outlook as changed on that law, in terms of the maximum capital call you could have from the book at this time?

David Herzog

No in fact the -- we continue to wine down the portfolio and reduce our exposure to contingent liquidity and as you saw, we’ve further reduced the impact of the down grade AIG or ATE risk is gone down. And every quarter that continued liquidity risk you is being brought down. So I hope that -- we don’t disclose a specific number for the overall contingent liquidity risk, but again it remains on trajectory downward.

Josh Shanker – Deutsche Bank

And -- yeah, go ahead Bob.

Bob Benmosche

So, let me make comment. Keep in mind that we have the holding company a lot more latitude in focusing on economic value instead of just mark to the market and the consequences to capital ratios and so on. So, we feel pretty confident that while you’re looking at various market anomalies that we’re focusing on the economic value when the stuff comes due, so I think that’s what you’ll see that we’re not worried. It’s a matter of what do we think is intrinsic and when we’re going to achieve intrinsic.

David Herzog

Brian, I think maybe also comment the effects of what happened in the quarter with respect to capital calls and the like and on the wind down book.

Brian Schreiber

Yeah. Essentially as Bob mentioned earlier with the volatility we’ve seen in rates, spreads equity market and FX, we had effectively zero postings in the quarter and again it’s a result of actions that we’ve taken over the last year plus again to reduce our exposure be it by terminating trades, by intermediating trades that I just described on the last question about again taking off swaps where we are effectively economically hedged.

Josh Shanker – Deutsche Bank

And then on the upside you made this comment back at the road show that you can future would be probably $1.2 billion in upside from that book. And now we would get $1.6 billion or down. So, does that mean you still think there is $2.8 billion or has the current to market changed your outlook for the value of the upside associated with that?

David Herzog

No, we believe the intrinsic value of those assets remains and we still believe there is a significant amount of upside consistent flow we’ve articulated earlier.

Bob Benmosche

The trouble is nobody will sell us this stuff at this price.

David Herzog

Yeah.

Josh Shanker – Deutsche Bank

I understand.

Bob Benmosche

Yeah. That’s right. That’s why we’re all sitting and waiting and we can afford to wait.

Josh Shanker – Deutsche Bank

Thank you.

Operator

We’ll now go to Michael Nannizzi with Goldman Sachs.

Michael Nannizzi – Goldman Sachs

Thanks. I’m just trying to square a couple of things, so rates were up 4% on average it sound like U.S. commercial, but premiums were down 8% obviously you had some actions you took that impact of premiums, but excluding those actions can you help us understand -- what happened to exposures there?

Peter Hancock

Yeah. This is Peter speaking, to look at the topline, first thing you will do is strip our foreign exchange that’s about a 4.2% adjustment so if you look at the topline adjustment for foreign exchange it’s down 3.5%. The biggest driver of that reduction which it was about 3.4% was caused by us changing the policy form of certain policies in the U.S. along the lines that David alluded to, the law sensitive business is just simply rebooked in a way that reduces the topline has zero impact on the bottom line, it’s actually slightly positive because it reduces the premium tax.

But it’s really dramatic effect on the use of statutory capital. And one example of where our focus on risk adjusted return and capital efficiency is motivating our behavior as opposed to targeting topline per se that been said we’re absolutely committed to a strategy of profitable growth.

And so, we are shifting the mix of business activities that have long-term sustainable growth. And so, in our road show we talked about topline growth expectations of 3% to 6% over the five year period, we still expect that, but at any given quarter you’ll see some topline reductions as a result of exiting certain areas.

One other area was the excess workers comp which contributed about 0.3 of the reduction of the topline and that’s something which we’ve talked about before as a business that we have exited.

Michael Nannizzi – Goldman Sachs

Right now, I guess I’m just focusing specifically on U.S. commercial where premiums were down to 8%. So, U.S. commercial earnings I imagine should be lot of FX in there and you’d said I think Bob had said in prepared or maybe David said in the comment upfront that rates were up 4% in U.S. commercials.

So I’m just trying to understand just U.S. commercial, what happened and I get it’s about $300 million from the change in form that you had mentioned but I’m just trying to understand what’s happening to exposures in the U.S., are they down to relative to rate and that’s why premiums looked to be about flat, that’s what I’m trying to get to.

Peter Hancock

So, first of all I was talking about aggregate total topline commercial consumer and global. As you know roughly 50% of our business is international and roughly 60% of it is commercial. So, secondly I’ve made it very clear in all of our discussions that we are seeking to grow international faster than domestic and to grow consumer faster than commercial.

So the math works out that we are shrinking U.S. commercial where we feel we’re not getting adequately rewarded and so, the reductions there are quite substantial in order to get that net number on a global basis. So that’s as far as our goal to come over that.

Michael Nannizzi – Goldman Sachs

Okay. And can you talk about regarding the U.S. -- can you talk about pricing versus loss trend or how pricing is tracking to your expectations at the beginning of the year? Can you talk about that?

Peter Hancock

I’ll ask, John Doyle, to comment on that.

John Doyle

Hey Michael, it’s John.

Michael Nannizzi – Goldman Sachs

Hey, John.

John Doyle

I would add to Peter to the response to your last question that we continue to reduce our exposure in the U.S. to cap property to work comp, Peter mentioned excess comp, but also to primary guarantee cost comp and to excess causality. Rates continue to trend more favorably.

They are slightly ahead of what our expectations were in the beginning of the year and we did increase our loss picks for some U.S. commercial lines at the beginning of the year that accounts for some of the year-over-year change in the loss ratio, but obviously we had planned for that when we went on the road in the second quarter.

So, the pricing trends are bit ahead of what we expected and I would add that September pricing was better than August and August was better than July. So, well, we still have some work to do to get where we want to go. Trends continue to move in the right direction.

Michael Nannizzi – Goldman Sachs

And any difference between large case and small case and maybe if you could touch a little bit on professional lines in particular D&O and kind of what you’re seeing there? Thanks.

John Doyle

Yeah. Our rates in professional liability were down about a half a point in the third quarter that’s better than where we were in the first and second quarter. The business there continues to run off very well, so we’re certainly confident in our portfolio there and have certainly read about lots of other markets talking about the competition there.

I would say that -- we’re primarily a lead writer, I mean in the market and I think it can get a bit more competitive as you move up above the lead layers, so we continue to be confident where we headed it there.

David Herzog

I want Rob to just clarify something. Did you mention that you thought that our commercial was that 8%?

Michael Nannizzi – Goldman Sachs

Well, if I’m looking U.S. commercials suggest so in your supplement, you break out commercial lines by geography. So, as looking at -- I guess it’s 3.8 to 3.5 roughly and net written premiums from 3Q ‘10 to 3Q ‘11 so I think that’s about 8%. And as I understand about $300 million of that maybe -- a decent chunk of that is the rate actions we took in the third quarter or the on…

David Herzog

Yes.

Michael Nannizzi – Goldman Sachs

But I guess

David Herzog

That’s principle explained by what I told about the law sensitive business that we have changed the policy form of.

Michael Nannizzi – Goldman Sachs

Right. But still as rates are up 4% even if premiums are flat I would mean, I guess it exposure to down 4% I mean is that how we should thinking about it?

Bob Benmosche

I mean exposures were down in comp in excess casualty and in property and they are down more than 4% in that area and we’d written the less new business year-over-year from quarter to quarter because new business pricing it has been attractive as we like it today.

Michael Nannizzi – Goldman Sachs

Great. Thank you. That helps a lot. Thanks.

Liz Werner

We’re unfortunately we’re out of time and so to those you we didn’t able to get to I apologize for that. But give us a call and we’ll do we can answer your questions. I want to close on a very important statement and that is fact that we have come to this point, we have shown the strength and our resilience in this organization going forward and as it relates to AIA, I want to repeat again because I know there’s been a lot of speculation and sometime people say I’m not clear so I’m working on my clarity skills.

The lockup has allowed us to sell the shares, but our timing and decisions have nothing to do with the lock-up it has to do with making sure we do the right think for the share holders of AIG and at the right time. And so on that note I thank you all and look forward to hearing from you all next quarter.

Operator

Thank you. That was concludes today teleconference. We do thank you all for your participation.

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