Insurance firm AIG (NYSE:AIG) has highlighted the increasing use of reinsurance transactions as one of the ways it will seek to improve its performance, in order to return capital to shareholders and as it hopes to avoid being broken up.
AIG has been coming under growing pressure in recent months, with activist investors and analysts suggesting that the insurer is broken up as a way to reduce the expected load of being designated as systemically important (SIFI) and to improve the return to shareholders.
In a strategy update published today, AIG said it would seek to return at least $25 billion of capital to shareholders over two years, with an increased use of reinsurance capital one of the ways it expects to improve performance and optimize its business in order to achieve that.
AIG will look to improve the performance of its commercial property & casualty insurance business, a unit that has suffered in recent years. The firm said it will focus on "expanding and optimizing the use of reinsurance" as well as addressing unprofitable clients, and exiting or resolving under-performing segments of its portfolio, all with a goal of improving the accident year loss ratio by 6% by 2017.
That's quite a target and while reinsurance capital can certainly help, AIG may find the capital markets a more efficient source of risk capital that is readily able to help it deal with a number of its books of risk.
AIG has a history of innovating with ILS and catastrophe bonds, so the news that the insurer will look for more reinsurance capacity support could result in more risk flowing to the ILS investor market in future.
Recent examples of AIG's use of the capital markets and ILS include the Bellemeade Re Ltd. (Series 2015-1) mortgage insurance risk securitisation, the one-year parametric Compass Re II Ltd. (Series 2015-1) U.S. wind catastrophe bond and the multi-peril, multi-year Tradewynd series of cat bonds, with Tradewynd Re Ltd. (Series 2014-1) being the most recent.
However it is important that AIG doesn't just seek to offload the areas of its business that aren't performing, through reinsurance transactions with traditional or ILS markets.
But of course, for AIG to be sustainable business in its current guise going forwards it really needs to come down to addressing the under-performing business as well as appeasing the regulator. Both difficult tasks operationally as well as culturally.
AIG also said it will look to "expanding reinsurance utilization for inefficient segments of the U.S. life business" as well, as it also seeks to improve the performance of that side of the business as well.
AIG has also announce a strengthening of its reserves today, with adverse development particularly on longer-tailed risks in U.S. & Canada casualty lines ($2.2B), U.S. & Canada financial lines ($0.6B), and runoff lines ($0.5B), totaling $3.6 billion of reserve strengthening.
As quite a large figure it will be interesting to see whether other insurers, or perhaps reinsurers, are equally concerned about their business in these core longer-tailed lines. The strengthening of reserves could also suggest that an element of offloading of legacy books may benefit AIG.
AIG said that it expects to raise between $4 billion and $5 billion thanks to a number of life reinsurance transactions that are currently in process.
The insurer said that both reinsurance and other risk mitigation strategies would be used more in future, to help it to "enhance capital efficiencies." With AIG certainly agnostic as to form or source of risk capital, the ILS and capital markets no doubt will stand to benefit from some of the expected additional reinsurance activity.
Specifically on the firm's legacy portfolio, an increased use of reinsurance as well as securitization is expected, again both of which could involve the capital markets and ILS players.
However, the insurer notes that were it to be broken up, and life and retirement separated from P&C, it would no longer benefit from diversification to the same degree, resulting in much higher reinsurance costs.
The insurer continues to make its bid to stay whole and today's actions clearly see AIG setting out what it believes is a plan that can allow it to do so. Whether it will appease the likes of Carl Icahn, other activist investors and the analysts remains to be seen.
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