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American International Group (NYSE:AIG)

Q4 2011 Earnings Call

February 24, 2012 08:00 am ET

Executives

Elizabeth Werner – Vice President, Head of Investor Relations

Robert H. Benmosche – President and Chief Executive Officer

David L. Herzog – Executive Vice President and Chief Financial Officer

Peter D. Hancock – Chief Executive Officer, Chartis

Jay S. Wintrob – President and Chief Executive Officer, Domestic Life and Retirement Services

Brian T. Schreiber – Treasurer, Executive Vice President, Treasury and Capital Markets

John Q. Doyle – Chief Executive Officer, Global Commercial Business, Chartis

Analysts

Joshua Shanker – Deutsche Bank Securities

Michael Nannizzi – Goldman Sachs

Edward Spehar – Bank of America/Merrill Lynch

Andrew Kligerman – UBS

Daniel Johnson – Citadel Investments

Josh Stirling – Sanford Bernstein

Gregory Locraft – Morgan Stanley

Operator

Please standby, we’re about to begin. Good day and welcome to the American International Group’s Fourth Quarter Financial Results Conference Call. Today’s call is being recorded.

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

Elizabeth 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 2011 10-K under Management’s Discussion and Analysis and 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 to the most comparable GAAP figures are included in our financial supplement, which is available on AIG’s website.

Thank you. And at this time I’d like to turn it over to our CEO, Bob Benmosche.

Robert H. Benmosche

Thanks, Liz, and good morning everybody. For those of you who were following the presentation online go to page 3 if you would. And we’re going to talk a little bit about 2011 and think about where you were a year ago. For us here, a year ago is probably a decade ago, but it was actually only 12 months.

When we started the year off we had, the whole recapitalization of AIG with the Federal Reserve and the U.S. Treasury. And many of you said, I don’t think they can make it. This just doesn’t seem right. And by the way, we were three years early for what it is we were required to do at that point in time. But in fact, we closed at January of 2011. We had some divestitures to continue to reduce the level of debt in our SPV for AIA and ALICO. And you saw, we sold Star and Edison, a tough sale but we got it done.

Nan Shan in Taiwan, a tough sale, we got it done, as well as selling off the remaining MetLife securities so to bring the SPV down to the level we are today, which is well below the starting point of $26 billion.

We had to strengthen our liquidity during the year, continue to get access to debt markets and other facilities including banks. As you saw, we negotiated our revolving credit facility for $4.5 billion. We did our continued capital note and even ILFC was able to get out there and show its strength in the marketplace to deal with its credit needs.

But one of the conditions of closing if you recall was we had to raise equity capital. That was the condition of closing that we could access the market and we saw in May, we were able to sell a 100 million shares of AIG’s stock alongside the Treasury’s 200 million shares of stock.

That demonstrated our ability to access the capital in markets and in fact we were able to then extinguish the Series G which was bridged to us until we actually made this accomplishment. And still in the second half, we finished the first half and as we started the second half we told all of you that we’re going from saving AIG to building AIG; that our crisis was over.

And so as we focused in the second half of the year some of the things we did that weren’t anticipated until 2012, latter part of 2012 we did our senior debt hybrid exchange.

We also repurchased and have the authorization to repurchase AIG shares for $1 billion. It was just on at the end of the year. So, that shows our beginning to do our capital management as we talked, we're going to be able to do. But, when we think about capital management and where we are one of the things we anticipate is we will be regulated by the Federal Reserve Bank of New York, is our assumption.

And therefore we're doing everything we can to make sure we do, to put in the disciplines and be ready for them when they arrive. One of the things they do require is stress testing. And so, we made our best guess as to how you run the stress test. We don't have all of the information. They haven’t given us direction of what to do. But in attempting to understand what they announced recently we've run a stress test of AIG assuming we've got most of the major pieces correct.

We wanted to understand where our Tier 1 capital was and see if that’s a binding constraint on capital management. What we found is, okay, you have to have 5% minimum and maybe a point and a half on top of that to be [sefi]. We came out in the 8% range of Tier 1 capital, which means we got it right in terms of our interpretation of the rules and we got some other things right in terms of how we attempted to execute it. We could have as much as $10 billion of extra Tier 1 capital in this company. And we said we’re resolving for capital early on because we want to make sure that people understand we are financially strong.

That doesn't mean this $10 billion that we're going to put to work right away; it just says that Tier 1 capital looks like it may not be a bided constraint. What is a bided constraint is the operations of this company. Our ability to generate cash and as you can see, in 2011 we generated almost $3 billion of dividends out of the insurance companies, almost $1 billion in the fourth quarter alone.

So we're continuing to see the cash flows come in. We're comfortable with our capital ratios right now. And so the real challenge is getting operating performance right for this company. You see that in the fourth quarter.

We also had to deploy a lot of cash in 2011 because we had a huge pile of cash beginning of the year because we thought we’re going to buy Maiden Lane II. We have succeeded in putting all of that cash to work throughout the year. You see that in our income in the fourth quarter, so you see the evidence of that money working.

We have been asked a lot of questions about how much of Maiden Lane II did you get? So I might as well just answer it, so that you don't keep asking it. Up until now there is one more tranche to go, but up until now while we’ve added a lot of mortgage backed securities to our asset class that we had for the general account and so on, we’ve only purchased just under $2 billion of the assets coming out of Maiden Lane II.

As we shared with you through the year, we had found that other institutions that want to reduce their risk rated assets; we were able to find some pretty good product, better quality credit and a pretty good yield. So that's what we chose to do instead of competing for pieces of Maiden Lane II.

We felt more comfortable with the whole thing, but if we didn't get the whole thing, we were very careful about what we bought within the Maiden Lane II. So just want to put that to bed if I could.

So our crisis is over. We had a good 2011. A lot of people say you made it, but, there is a but. So let's go to page four. What are some of the buts that I keep hearing? But it's a soft market. Try to say (inaudible) in the soft market. Rate is not coming back. You've heard us say throughout the year that we’re now working hard to get, at least there across the capital. Peter has talked very eloquently about risk-adjusted profitability and we’ve got to look at the risk we're writing, and do it in a more holistic way because our new organization allows us to do that.

So you can see we got rate 4% in U.S., Canada, workers comp, and we’ve been talking about issues in workers comp now for the last year and a half. The market is beginning, our competitors are beginning to see the financial effect of that, but when you look at workers comp and property up 8%. So we’re getting rate, but the reserves. We’re concerned about the quality of the reserves, you see in the fourth quarter, we added about $13 million to the reserve, so on a year-to-date basis we added about $195 million to the reserve. When you think about $195 million for the year and again you saw throughout the year, it wasn't a surprised in the fourth quarter.

When you think about that, keep in mind what percentage that is of a $71 billion reserve. It's very infinitesimal, so we're very confident as we look at our reserves, we’re still and many of our products above the central estimate of the outside actuaries; we've got a lot of people focusing on our claims, our claims process and our reserve process. So, I don’t know what more we can do other than give you another year to see that the reserves are in very good shape.

Can we generate cash flow to do capital management? That was a big piece, along with the DTA. So that we have the tax cash flows as we’re in taxable income as well as the dividends and so on. As you can see in here, very strong in the fourth quarter; strong for the year. But the low interest rate environment, you know the equity markets, your franchises were damaged. It’s tough to make money in the low-interest rate environment.

If you look at our ability in SunAmerica they have performed very well. Remember it's not just the portfolio rate. It's what your crediting rates are, and there is going to be some pressure. But it’s not as dramatic as every once and then sales continue, not in the case as they were, because people still need to save their money. They can’t just sit in cash. So look at our numbers, our flows, you can see we had net flows again up $673 million, very strong for the year.

But the housing crisis; the housing crisis is going to drag you down. You’re in a mortgage business, look at the other primary insurers, you got a problem. We have told all of you over the last two years, we have redesigned the way we write business at United Guaranty. They have a multivariate model that is extremely successful. We’re getting better than expected returns and in fact the ROEs on the new business for writings in the 20% range.

So, while we have a housing crisis we see that pretty much behind us and you’re going to see this business, which is now the leader of the industry continue to pull out with really good numbers as we move into 2012 and ’13. And so the last but is, but the DTA. It says that you really are not confident about your future profitability, well we are. And the DTA constituent says we have a clear view now that we could use the tax benefits here within the timeframe that’s allowed for them.

In fact, we think it says that we’re well on our way to our aspirational goals, well on our way. And in fact as we get to 2015 and achieve those aspirational goals we think we’ll probably use up [somewhere] around 65% of this DTA on the way. So, net to us is the fourth quarter is a clear demonstration that this company has not only survived, it's got its strength, its got its key people and we’re moving in the right direction and we're going to continue to build value for our clients, for our shareholders and have a great place for our employees to thrive in.

So on that note let me turn it over to David Herzog who will take you through some of the numbers.

David L. Herzog

Thank you Bob and good morning everyone. This morning, I will go over some of the highlights over the quarter and then Peter and Jay will comment on specifically the results of Chartis and SunAmerica. And I'm going to build on Bob's themes that he set forth. And I would characterize the quarter as pivotal both for what did happen and for what did not happen.

And what did happen as our core insurance businesses made $1.3 billion despite $467 million of cap losses. What did happen is SunAmerica had another solid quarter with strong sales, strong flows and driven by growing distribution. What did happen as Bob referenced is continued capital flows from our operating companies to our holding company for capital management which is a key pillar of our long term aspirational goals.

And what did happen, as Bob mentioned is we completed our assessment of the DTA valuation allowance that we set out in our 10-Q's earlier in the year, where we concluded that it is more likely than not that we're going to realize a substantial portion of our DTA's, based principally on our return to sustainable profitability.

And what did not happen is the need for significant Chartis loss reserve development charge. In fact loss reserve development for the year and for the quarter were benign.

If you turn to slide five, you can see the increase in GAAP net income to $19.8 billion, which included $17.7 billion related to the reversal valuation allowance. Net income per share was $10.43, which included $9.34 per share from the valuation allowance.

After-tax operating income, which is our principal non-GAAP measure was $0.82 per share versus a loss of about $16 a share a year ago that included the reserve strengthening. Importantly, our GAAP book value per share increased 18% to $55.33, reflecting the valuation allowance. And book value per share, excluding AOCI was $52.69.

Also impacting book value in the first quarter of 2012, but to a far lesser extent in the valuation allowance is EITF 09-G. That's the new DAC standard. And in the 10-K we provide the GAAP after-tax impact to book value of 09-G and that's about $3.7 billion or about $1.95 per share, excluding AOCI and that will be recorded in the first quarter. The future earnings impact of 09-G are largely related to the direct marketing activities at Chartis.

Moving to slide six, in core insurance operations Chartis pretax operating income was impacted as I mentioned by $467 million in cat losses including $368 million from the Thailand floods. This was a record cat year for Chartis totaling nearly $3.3 billion. Despite the cat losses for the year Chartis delivered $629 million in dividends to the Parent at the fourth quarter and $1.5 billion for the year.

SunAmerica as I said had another strong quarter with pretax operating income of $931 million. SunAmerica's results included, little over $200 million from a favorable legal settlement, which was offset by little over $100 million from an IBNR reserve increase that Jay will comment on in a minute.

For both Chartis and SunAmerica, alternative investment returns were weak for the quarter compared to a very strong fourth quarter a year ago. Total fourth quarter alternative investment income declined by little over $700 million from a year ago. Last year's fourth quarter alternative investment returns were roughly 14% on an annualized basis making for a tough comparison.

For the full-year alternative investment returns were around 7% versus 9% in 2010. Looking ahead to the first quarter we’d expect the returns to improve sequentially given the fourth quarter performance and the one quarter lag for our private equity investments. We continue to expect an approximate 10% annualized return over the long-term for the alternate investments.

Moving toward non-core operations, ILFC reported fourth quarter results of $119 million profit versus last year's loss. ILFC is benefiting from managing its fleet aggressively.

In the quarter we reported about $40 million of charges related to airline bankruptcies. As you know, we filed an S1 last September, which is consistent with our view that this is a non-core business. ILFC’s book value was approximately $7.5 billion at the end of 2011.

One thing I want to share with you is the impact on our book value as it might relate to an IPO or a sale of ILFC. It is possible that our book value could be negatively impacted. For example, if we monetize ILFC at its net book value our book value could declined by approximately $2.7 billion or $1.50 per share. Within corporate, we reported a $484 million gain due to the hybrid tender that Bob had referenced.

Turning to slide seven, you can see the breakdown of our deferred tax assets for which we no longer hold a valuation allowance against with the exception of the life insurance capital loss carry forwards for which we hold an approximate $7.2 billion allowance. We are focused on strategies to capture a portion of the value of this asset, but we’re retaining the allowance against this for now.

Going forward we continue to expect an effective tax rate of somewhere between 25% and 30% on our operating income. What is most important about the judgment we made with respect to releasing the valuation allowance is it signifies our view that we have returned to sustainable profitability.

On slide eight, you can see the impact of fourth quarter and the full-year from our capital management activity. In the fourth quarter our capital management activities included ranging an additional $0.5 billion contingent capital facility and renewing a $4.5 billion credit facility.

We also exchanged $2.4 billion in hybrid securities and began our share buyback program. We repurchased $70 million of our stock at an average price of $22.75. We expect to complete the $1 billion authorization in the foreseeable future.

Capital management is a fundamental part of how we will run this company, and with our goal of maximizing investor returns.

Slide nine highlights Parent company liquidity sources of $14 billion at year end. The full year of 2011, our insurance operating companies paid dividends and note repayments to the holding company of over $3 billion and we expect to reach $4 billion to $5 billion this year, supporting our ongoing capital management plans.

And with that I'd like to turn it over to Peter for a discussion of Chartis.

Peter D. Hancock

Thank you, David. Good morning everybody. I've got a couple of Chartis slides in the earnings presentation but they’re just for your reference.

So I'm going to focus on a few notable items from the quarter, and those include catastrophes, reinsurance strategy, reserves, geographic alignment, our growth plans especially in the direct marketing channel.

So overall I was pretty pleased with our performance in the fourth quarter. Excluding catastrophes, actual business results are pretty strong as were some of our key performance indicators, reflecting progress in our strategic initiatives to improve profit, generate growth and better manage our risks.

As David noted, this was a historic year for cat losses. And I must say I'm very proud of how our 11,000 claims professionals worldwide handled this, by working extremely hard to deliver excellent claim service to our customers. And we received a very good feedback on that from both customers and regulators.

We continue to consider our claims organization to be really an important competitive advantage that separates us from the rest of the market. As I reflect on the level of catastrophe losses in 2011, I'm satisfied with how well our efforts to manage our risk appetite resulted in a level of losses inline with the industry if you benchmark it as a proportion of capital and that's Chartis's capital, not AIG's.

The effective management of our catastrophe exposures also clearly recognized by the reinsurance market during our very successful Jan 1 renewal season. Today Chartis has a more efficient blueprint for its reinsurance strategy through a combination of managing our risk appetite, improvements to the structure of our catastrophe reinsurance program, and the issuance of $1.45 billion in multi-year cat bonds over the past two years. That reduces our reliance on traditional reinsurance.

Underwriting results in the quarter included favorable [prior] year reserve development of $13 million and for the full year 2011 Chartis had insignificant net adverse prior year reserve development of $72 million. And our $68 billion in held reserves regularly reviewed by internal and third-party actuaries as part of an enhanced risk management framework.

Similar to others in the industry we experienced increased frequency and severity related to the most recent accident years in primary workers comp. In environmental liability we saw increases from multi-year policies written in prior years. These were offset by improvements in excess casualty and executive liability products.

Excess casualty, workers compensation, specialty workers compensation, and asbestos the four lines with the largest reserve increases in the fourth quarter of 2010 experienced overall net favorable development in the fourth quarter of 2011.

Chartis continues to reduce our writings in these lines of business. They represented 5.1% of our net premiums in the fourth quarter, compared to 6.2% in the comparable period in 2010.

Expense trends were consistent with the increase in higher value added consumer lines, which have higher acquisition cost but lower combined ratios, and from our strategic investments in systems and processes that yield greater expense savings and improve service and efficiency in the long run.

We also expect an additional increase in our expense ratio in 2012 due to our growth in direct marketing. And I'll discuss that a bit more later.

The fourth quarter premium trends are consistent with our emphasis on profitability and capital optimization. Our mix of business demonstrates Chartis' flexibility in deploying capital across businesses and geographies, targeting them where the greatest opportunity for profitable returns exist, given current market conditions and our long term strategic view.

International business was 51% of our total net premiums in the quarter, an increase from 47% in the comparable period the year before. And on the consumer side it represented 43% of net premiums compared to 40% in the comparable period in 2010.

So we're very proud of the leadership we’re demonstrating in the marketplace with respect to rates and terms and conditions. Rates in the U.S. and Canada region increased approximately 4%. Specifically workers compensation and property experienced the most notable increases, and they were needed at approximately 8% increase in both lines.

We recently announced the alignment of our geographic operations within three principal regions, the Americas, Asia Pacific and EMEA. The new alignment promotes greater operational efficiency and allows us to utilize financial and human capital optimally. It also provides greater focus on strategic growth economy countries, such as China, India and Brazil among others that are vital to our growth plans.

With respect to China specifically this has been a very good month for further improving our prospects in a truly extraordinary country. We've established a long term strategic relationship with China, highlighted by the fact that we’re the largest foreign owned insurer in China with more operating licenses and premium than any other insurer based outside the country.

This past week, I visited with Vice President, Xi Jinping in Washington and thanked him for his commitment to open up mandatory third-party liability insurance for motor vehicles, to foreign invested insurance companies. We’re also able to renew our longstanding relationship with the People's Insurance Company of China in which we hold a 9.9% equity stake.

And third, we celebrated the opening of our new office in Jiangsu Province in China. This is our fifth license in China and the region includes 80 million people with a per capital GDP equivalent to that of a mid-sized European nation. We’re well-positioned in China and we expect to broaden our relationship there including through direct marketing opportunities.

Beyond China, we’re expecting a direct marketing strategy in approximately 50 countries. We’re able to transfer our successful DM strategies in Japan, Korea and Israel to other parts of Asia-Pacific and elsewhere. Even with an increase in our expense ratio due to EITF-09G, which we expect to be a valid point on our combined ratio depending on our marketing costs, we believe that the DM related business offers very attractive risk-adjusted returns and we’re going to continue to grow that channel.

Let me conclude by saying that I believe we're very much on pace to achieve our goals by year-end 2015. We also continue to measure and refine the risk-adjusted profitability of all our businesses and with directing capital and resources to optimize profitability where we see the opportunities. We still have work to do but our people and platform give me great confidence that we’re on the right track.

So next I’d like to hand over to Jay.

Jay S. Wintrob

Thank you, Peter and good morning everybody. SunAmerica delivered a solid fourth quarter with improved year-over-year net flows, sales and base investment spreads. David mentioned the unusual items in the quarter. I just want to add that the IBNR reserve addition of $105 million this quarter reflected new information about the death claim verification procedures disclosed in recently announced settlements with other companies, including longer look back periods and that's what drove that increase.

Taking a look at page 12, compared to last year SunAmerica's fourth quarter earnings were negatively impacted by lower alternative investment returns of approximately 1% in the quarter, versus last year's strong alternative investment returns of approximately 14% annualized as David mentioned earlier and to a lesser extent, call and tender income and the ML II fair value market.

If you just look at those three items alone, the alternative investment change, lesser call and tender and the ML II mark that accounted for a $530 million decline in the prior year.

Looking ahead to 2012, we would expect full-year investment returns to reflect the benefit of last year's cash deployment and base investment spreads to be relatively stable.

Sales were strong across all of our product lines and total net flows as Bob mentioned were positive for the fourth consecutive quarter. We benefited from being reinstated on all distribution platforms and added to some new ones and surrenders remains relatively stable.

Term life and private placement VUL sales delivered strong fourth quarter results leading to retail life sales growth of 9%, and total life sales growth of 24% from a year ago.

With the sustained positive net flows continue to reflect our product diversity, sales of group retirement products increased nearly 27%, as our focus on individual rollover deposits continue to produce results.

However, we do expect sales of individual rollover deposits to slow in the near term due to the low interest rate environment. Variable annuities held by stronger equity markets in the quarter also showed good momentum with fourth quarter sales up 24% year-over-year and this positive trend is continued into the first quarter of this year.

Our discipline in the VA market has served us well. For example our guaranteed benefit writer fees remain about industry averages. And we were the first in the industry to index our living benefit fees to market volatility as measured by the VIX index reducing our exposure to changes in volatility. And just last month we launched our latest iteration of the de-risked product with the volatility control front designed to reduce the impact of market vol on fund performance.

Also in the quarter our mutual fund sales continue to accelerate due to strong fund performance and success of recent product offerings. And while mutual funds are not our highest margin products their modest capital requirements allow them contribute to our returns.

Fields of fixed annuities decelerated in the fourth quarter as expected given the very steep decline in treasury rates between the start of the third and fourth quarters. For example the base crediting rate on bank sold fixed annuities declined between 25 and 45 basis points depending on the product structure from the start of the third quarter to the end of the fourth quarter. And given the current interest rate environment with base crediting rates on new fixed annuities below 2% we would expect weak fixed annuities sales trends to continue.

Despite that we'll continue to actively manage our product pricing, in particular new and renewal crediting rates. We will renew new money rates for fixed annuities weekly and have the flexibility to manage crediting rates on over half of our enforce fixed annuity and universal life enforce account values.

On slide 13, we show the general improvement in base investment yields and base net investment spread throughout the year driven by a redeployment of cash and disciplined new and renewal crediting rate actions.

In the fourth quarter, we saw some impact in base yield from lower interest rates and we would expect additional pressure into next year, all things equal with rates.

On slide 14, we assume a continued low interest rate environment and the implications for operating earnings. Given our current new money rates, our disciplined approach to pricing and active managing of crediting rates, we would expect our pretax earnings to be impacted between really zero and about $10 million this year, solely from low rates, and between $65 million and $80 million next year due to the current low level of rates.

While the macro environment does present challenges, we’ve not changed our view on statutory capital over the next two years, which remains strong, and we expect our product diversity and distribution breadth to provide continued growth opportunities at attractive returns.

And with that I'll turn it back over to David to wrap this up.

David L. Herzog

Thank you, Jay. And turning to slide 15, we consider United Guaranty part of our core insurance business and it continues to be an industry leader in the mortgage insurance market. The company led new business written in the industry, and in the fourth quarter we wrote over $7 billion of new insurance.

United Guaranty's fourth quarter included a $42 million favorable reserve development. I'd like to highlight another sequential decline in delinquencies and the delinquency rate of just under 14% at 13.8%. Reserves remain steady with the reserve for delinquency of 27,000. I think more importantly I would note that we helped over 40,000 families stay in their home.

And finally, we've also provided some additional disclosure on non-core assets in the appendix. I’d like to highlight that as a result of the recent sales of Maiden Lane II securities in February that the Federal Reserve Bank of New York, senior loan will be repaid in March and as a result AIG will begin receiving payments on our Maiden Lane II interest this year.

Any proceeds in excess of our principal and interest will be allocated 56 to the Federal Reserve and 16 to AIG. All proceeds from Maiden Lane II for AIG will be used to repay any remaining balance in the AIA, SPV preferred interest. With respect to ML III payments continue to come in as expected and amounted to just over a $1 billion in the fourth quarter.

At this time, I'd like to turn it over to the operator for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we'll take our first question from Josh Shanker with Deutsche Bank.

Joshua Shanker – Deutsche Bank Securities

Hey, good morning everyone. I wanted to first congratulate you on the disclosure on reserves. Its outstanding, it creates a lot more questions, but I think is what you guys need to be doing. Can you talk a little bit about the loss emergence trend, you’ve said in the 10-K that you use a shorter term development pattern to set the reserves for excess casualty. That sounds like a contradiction to me, so maybe you can flush that out. And can you talk a little bit about what's going on in environmental, so we can be confident it's not a recurring event but a one-time event?

Robert H. Benmosche

Hey Josh, it’s Rob Benmosche. Let me start with your question on excess casualty. You might want to rewind back to the fourth quarter of 2010. It was actually in the fourth quarter of 2010 that we shortened the period that we were looking at excess casualty trend. It actually resulted in us increasing our reserves in 2010.

And that was us giving more reliance on the development that we had experienced in the more recent years, as it relates to business that have been written previously. And so, really we’re simply saying we stayed consistent with that time period that we shortened down in 2010. But it's just so happened at the more recent years are showing better results than they did just a year ago.

The next point regarding environmental, I think, I want to highlight a couple of things. There’s two pieces of disclosure in the 10-K that I think people should be making sure they focus on. The first is, the difference between the inputs as best as an environmental and then the environmental line of business that we write. So with respect to that you might want to take a look at pages 93 and 102 of the 10-K, although I'm positive, I know that you have in particular, but I think some other people might benefit by taking a look at that disclosure.

What I would note is that with respect to the disclosure we provide on page 93, we provide a discussion of the fact that we write environmental business through a profit centre referred to as the environmental profit centre that sits inside of our commercial business. You'd note that through the first nine months of the year we experienced some level of adverse development in the environmental book of business. Following that adverse development, we spent a lot of our fourth quarter conducting a ground-up study of the claims in environmental, and our fourth quarter adverse development is the result of a very focused effort to try to make sure that we were really getting at a claim-by-claim evaluation of that exposure.

Historically, we’ve used more traditional actuarial methods. I think that this is an improvement on what we have been doing historically, because in the end the best way to get to this exposure is really on a case-by-case claims review in connection with the work that's being done by the actuaries.

I also want to observe for you that this tends to be from accident years 2003 and prior and that most of that business was business written by this environmental profit center. It was written on a multiyear basis, and so we’re at this point in time dealing with those multiyear policies that were written 2003 and prior.

Joshua Shanker – Deutsche Bank Securities

And then the policy years '08 and '09 which evolved into accident years '09 and '10, a lot of your most sober critics say that they’re worried about the reserves there, and there was a little bit of reserve development on the unfavorable side for those years. Can we just go through those and then I'll disappear into the queue I guess.

Robert H. Benmosche

Yes, no problem Josh. I would say that consistent with what you're seeing from other participants in the marketplace, it's been more or so related to the workers compensation line of business. So it's not something broad-based across all of the businesses that we wrote in 2008, 2009, 2010, but in particular with respect to workers compensation, we’ve done we think a very good job of pushing rates in workers compensation and in managing our exposure on workers compensation. That book of business has continued to shrink and if it plays where we have conducted a lot of work regarding the structural drivers of loss to get our hands around what's actually causing the losses in the first place as well as using predictive modeling to help us do a better job with respect to risk section and we think we'll continue to get better with respect to all aspects of that as we move forward.

Joshua Shanker – Deutsche Bank Securities

Well, thank you. The details much appreciated.

Operator

We'll take our next question from Michael Nannizzi with Goldman Sachs.

Michael Nannizzi – Goldman Sachs

Hi, thank you. I just have got question Peter in Chartis, the expense ratio look like what the, I should say the combined ratio in commercial lines was a bit higher in the fourth quarter. It looks like, the expense ratio was a contributor there particularly within international. I was just trying to understand what happened there? If you could, thanks.

Robert H. Benmosche

Sure. Mike, its Rob Benmosche. I'll comment on that.

Michael Nannizzi – Goldman Sachs

Great.

Robert H. Benmosche

Let me start by making a couple of observations. First, as you know our international commercial business has a much heavier 1/1 renewal date. So, if you actually go back and look at the premium trend one thing you will observe is that the earned premium and the written premium relationship changes throughout the year.

So, for example in the first quarter of the year our written premium outpaced earned premium for commercial international by $700 million. But, by the fourth quarter earned premium outpaced written premium. So, the exact opposite by $400 million, that actually causes a pretty significant change, a swing in our expense ratio and you'll notice that it's almost a 10 point swing in the expense ratio from the first quarter to the fourth quarter.

That’s not unusual for us, that actually if you go back and take a look over time you’ll see that, that same type of relationship existed in the prior year. So, that's one point to make.

The second thing I’ll make observation regarding expenses is, international commercial is really the heartbeat of where a lot of our efforts are going with respect to some improvements that we're making with respect to our infrastructure. So we are in the process of a very large SAP implementation, probably the largest and most complex SAP implementation for a financial services company in the history of the world occurring in Europe as we speak. In addition to that we have Solvency II and a significant legal entity restructuring. So there’s truly some additional expense there as well as typical seasonality.

The last point that I'd make regarding the loss side of the house for International Commercial is that it's largely on the casualty side of the house, and we are continuing to use the same kinds of efforts with respect to International Commercial Casualty as we do with respect to the U.S. Commercial Casualty, which is focused really on predictive modeling, evaluating the structural drivers of losses and pushing for improvement in rate so that we can get the appropriate risk-adjusted profitability. So I think it's really the combination of those three items, focusing in particular on the expense ratio in the quarter.

Michael Nannizzi – Goldman Sachs

Great. And so, we’re at 99.4 for Chartis overall on a full-year underlying combined. Thinking about 09-G, I'm guessing that's 50 basis points to 100 basis points on total Chartis. Thinking about the migration of the business towards consumer lines, some investments in technology, the better pricing that you’ve kind of talked about and any loss trends in '11, like how should we think about that basket of attributes? As we look at profitability from Chartis from here is it sort of a J, in terms of the profitability declining and then starting to pick up or how should we think about that?

Robert H. Benmosche

I'll reiterate the overall observation that Peter made, which is that we certainly believe we continue to be on pace for our 2015 goals. That will result in different, sort of dimensions to the solution. But first with respect to expenses, you can expect our expense ratio to improve more in 2013, 2014 as we complete some of our efforts with respect to the investments that I described for you just a moment ago in the international commercial business.

And with respect to losses, I think you should continue to expect that we'll be making ongoing progress. And we're really focused heavily on using the tools and the technical pricing expertise that we are focused on heavily these days to make sure that they are a continual area of progress.

I think what I would look at if I were you is I'd look at, are they making continual progress on the underlying loss ratio, understanding that we think we have very strong plans and a very determined view that we will achieve our expense goals by 2015.

David L. Herzog

Rob, I'd just add a little bit, just on the direct marketing, the pace of growth there. Our current course and speed would add about 0.8 to the combined ratio, but I would love to deliver you the news that the expense ratio impact would be twice that because we have the bandwidth to grow faster than that because the prospective ROE on that business is very, very attractive, well above our cost of capital.

And so I think that we can demonstrate that through greater disclosures going forward if and when we accelerate the pace of our DM spend. But our current course and speed would be just under a point on the combine from the DM. But I think that our way of thinking about that business is economics, not accounting.

Michael Nannizzi – Goldman Sachs

And what would be the loss ratio on that same basis? What would be the loss ratio impact if you're getting 80 points of deterioration on the expense side, what's the offsetting impact on the loss side?

David L. Herzog

The combined ratio of that business is in the high 80s, depending on the country. So it's very attractive business. The issue is bandwidth and how much of it you can do how fast? And so, we are expanding in 50 countries, prioritizing about a dozen, and we have extensive experience in terms of persistency, cross-sell, and up-sell ratios from our experience in Japan, Korea and Israel over the last dozen years.

So we have a good framework that applies in many countries. But I think that we can give you more disclosure on that going forward as we fine-tune the pace. But, right now our current pace of growth in that business would add about 0.8 to the expense ratio under the new EITF 09-G.

Robert H. Benmosche

I'd like to add that one of the things that I've said before and I want to repeat now is that we have not invested enough in technology to really do the predictive data mining and so on that we need to do. And so, we are going to continue to see that number flow through the expense ratio, and our issue here is to really position us well for the future. For example, we have 27 million claim records in our workers comp area that we never extensively studied.

We are now working with Johns Hopkins University to really understand those claims, what they say, what they mean and how we use that as a standard for processing claims and understanding claims going forward.

So we're investing heavily around this, so that you will continue to see the pattern of expenses from now and before continuing. But we did say, we would get to a $1 billion, say by the time we get to 2015 and we're on track to do that. But expenses are not a driver. What Peter talked about is having the right growth and the right risk-adjusted profitability of that growth, and being able to explain to you, if the numbers because if the accounting come out a little different than before, we'll make sure you’re used to what that is.

But this is about growing smartly and still leveraging technologies as we do it, which as Rob said is going to cost us some money and that's not our driver.

Michael Nannizzi – Goldman Sachs

All right, thank you all very much.

Operator

We'll take our next question from Jay Cohen with BofA Merrill Lynch.

Edward Spehar – Bank of America/Merrill Lynch

Thank you. It's Ed Spehar and then I think Jay will have one question as well. I'm wondering if you could talk a little bit about why you weren't more aggressive with the share buyback in the fourth quarter?

And sort of related question on capital generation, cash flow. The $4 billion to $5 billion of subsidiary dividends that you see, could you tell us just approximately how that would break down between Chartis and Sun, and again remind us about the uses of cash at the holding company? Thanks.

Robert H. Benmosche

Go ahead Brian.

Brian T. Schreiber

Sure. It's Brian Schreiber. How are you doing, Ed? On the first question about the share repurchase, keep in mind that the authorization was in November, so we had a very short window. We were also subject to volume limitations on how much we could participate in daily volume. And it was our intention to not be very heavy in the stock on low volume days.

So that I hope answers that first question. In terms of the question on the uses of the parental liquidity, there are several. Obviously we won a variety of stress tests and try and maintain a level of parental liquidity sufficient to meet those stress tests. We also have a variety of obligations, short-term maturities as debt service that we have to meet, and we also have a plan to reduce contingent liquidity risk at the company and take down the level of repose and funding arrangements that could result in additional liquidity needs. So we keep adequate reserves for that and again make sure that we do have adequate resources for our planned and anticipated capital management activities.

Unidentified Company Representative

Ed, I guess your other part of the question is with respect to the 2012 dividends. About $2.5 billion to $4.5 billion might come from Chartis and we'd expect somewhere around $2 billion from SunAmerica.

Edward Spehar – Bank of America/Merrill Lynch

Okay and can you talk about just numbers on uses of the holding company beyond the sort of contingent liquidity, just the normal uses of cash at the holding company?

Unidentified Company Representative

Debt service is roughly $400 million.

Edward Spehar – Bank of America/Merrill Lynch

Per quarter?

Unidentified Company Representative

Per quarter. Parental holding company expense is roughly $250 or so per quarter.

Unidentified Company Representative

Okay, I think Jay has a question.

Jay Cohen – Bank of America/Merrill Lynch

Just really quickly on the commercial pricing, obviously good to hear that you're getting momentum in the fourth quarter. Can you talk about what you saw in January? I assume a fairly active January season on the commercial side. Can you talk at least qualitatively about the direction of pricing? Do they continue to accelerate?

Peter D. Hancock

I think that the trend is certainly continuing. But perhaps John Doyle, you want to give a little bit more color on that?

John Q. Doyle

Sure, Peter. Yeah, Jay, we saw no slowdown in the momentum in January. We continue to be encouraged by where retention stands relative to the prices we’ve been pushing.

Rob mentioned, Europe 1/1 is a particularly big day for our business there and retention was certainly below expectation but rates were ahead of expectation, so we felt good about that. So there is decent momentum and we’re continuing to push and lead the way.

Operator

And we'll take our next question from Andrew Kligerman with UBS.

Andrew Kligerman – UBS

Great, good morning. Couple of quick questions, on your capital position, Bob you threw around a lot of numbers earlier. What would you estimate to be redeployable capital, and would an opportunity, say an equity offering be a viable situation where you could deploy it?

Unidentified Company Representative

There is a combination of what's available now, so something happens in the next two weeks is one availability. The other is, dealing with the sale of assets, recognizing we have the SPV here. It has to be paid down as a priority, so we are looking at that priority.

So I would say that until such time as we clear up the balance remaining on the ALICO AIA SPV, there isn't a whole lot of cash based upon what we can do from sales and so on until that's done.

So we're working through that constraint. Brian and his team have given a lot of thought to that. That's why we said we were looking forward to the IPO of ILFC, but the markets really are not welcoming right at this time, so we’re still seeing that as a delay till things improve in the airline industry as well as in the market.

So I would say it's kind of limited in terms of what we really have in the short-term.

Unidentified Company Representative

As we explained where we were on the road for the equity offering last year, it was that the bulk of the initial capital management activities would be funded by the monetization of core assets and then the remaining portion through dividends from the operating companies.

And again, we set an expectation that capital management wouldn't really start in earnest until 2013. I mean you're seeing evidence now that we are a bit ahead of plan. But again, it's the value of those non-core assets when they get monetized will provide the bulk of the resources for capital management.

Andrew Kligerman – UBS

Got it. And then just quickly, it's a nice opportunity there to get a gain on the debt extinguishment. Do you see any near-term opportunities there, maybe with some of the hybrid securities?

Unidentified Company Representative

At the current time we don't have any plans for additional hybrid exchanges.

Andrew Kligerman – UBS

Okay, and then just lastly, with regard to the international commercial operations, so you had an expense ratio in the fourth quarter of 40.1%. It was 43.4%, and it looks like in past years you were kind of low mid-30s. I think you mentioned 2013, 2014. Do we sort of see this elevated level of close to 40% through 2012? And then where should we expect it to come down to, low to mid-30s?

Robert H. Benmosche

Jay, it's Rob. On the international commercial, what I want to give you a flavor of is timing with respect to those expense initiatives. So we're doing a very significant legal entity restructuring in preparation for Solvency II. We expect the vast majority of that will be completed at the end of 2012, certainly by the beginning of 2013. We are in the process separately, we are in the process of implementing SAP as I described.

We have a very significant roll-out of SAP occurring in the month of March. But we'll continue to roll that out across the rest of continental Europe through 2012 and all the way through 2013. So the timing for the backbone infrastructure work that we're doing will take us all the way through at least the end of 2013 before we start to see improvements in that area of the world.

Andrew Kligerman – UBS

At which time we would probably see a significant drop-off in the expense ratio may be down to low mid-30s at that point?

Unidentified Company Representative

What ends up happening is, as you know we can’t get the benefits until we actually put the technology in place. So we're doing both a complete change in our target operating model structure in Europe, taking our geographies in which we're doing a lot of our efforts down from 20 different places down to a handful of different places and that will create significant benefits, but we’re not going to get that until we actually can roll the technology out in 2013. So you’re right, generally speaking you’ll start to see that and we hope it's, we plan for it to be pretty significant in 2014, 2015.

Andrew Kligerman – UBS

Thanks a lot.

Operator

And we'll take our next question from Dan Johnson at Citadel.

Daniel Johnson – Citadel Investments

Great, thank you very much. Most have already been asked and answered. So I’ll just go with a clarification on the ILFC valuation. I think you’ve mentioned that there is book value differences that I think you said at book value sale for ILFC that’s got a $2.7 billion difference, very simply this is linear that is end up selling ILFC for $1 billion less than their carrying book value that the $2.7 billion goes to $3.7 billion whereas something else we need to consider?

David L. Herzog

Yeah, Dan its David. It's not exactly linear gets a little bit smaller. But, I think you have that just out of because you can, the driver of that is obviously the difference between book and tax.

Daniel Johnson – Citadel Investments

Yeah, understood. And then maybe just for Peter I have a broad question just to given that you've got almost 20% of those business in traditional Europe would love just to hear some comments of what you folks are seeing on the ground in terms of how the economic conditions there impacting the business currently and talk on how it might impact it? And it also remains us for the rest of the year? And thank you very much.

Peter D. Hancock

All right, I think that in the short-term the uncertainty in the Eurozone is helping us. Some of our competitors' especially local competitors have experienced significant down grades in their credit-rating while we've had stable to stronger credit outlook. And so it's a bit of fly to quality to us. I take small joy in that even though there is some short-term gains from that growth because I think it's a symptom of a longer-term deeper malaise in the European economy and that can't be good in terms of ultimate demand.

So, short-term share gains and I'd see even (inaudible) where we have seen a pickup in our volume at very attractive rate. It's to me a symptom of fly to quality. But I do, I'm concerned about the long-term growth rate in Europe and as things stabilize. But there is, I think some light at the end of that tunnel, I'm pleased by the results from last two weeks in terms of policy at the macro level. But, it's an important part of our commercial franchise, I think that like the U.S. market its mature, we need to choose our shots, we need to manage the cycles well, keep our eye on the expenses, so that we don't feel we have to write that business to cover our fixed costs, and we need to use our capital sparingly and targeted at the more attractive growth economies.

Daniel Johnson – Citadel Investments

Understood, great. Thank you, very much.

Operator

And we'll take our next question from Josh Stirling with Sanford Bernstein.

Josh Stirling – Sanford Bernstein

Hi, good morning. Thank you for taking the call, and congratulations on a good quarter. So, I wanted to expand the conversation little bit about some of the capital threshold, how much excess you would have overtime in some of the underlying drivers there? And specifically, I wanted to get a little bit more color around some of the other key capital and liquidity cash beyond the Tier 1 ratio you [flat]. So, if you could give us a sense of what the ratings agency coverage ratios? You think that are being help to us or for the holding company liquidity versus debt service, you recently, I think have put in place the capital maintenance agreement such as minimum RBC levels, it will be helpful to know.

And then also, if you could just walk us through technically how we should think about that DTA, the new valuation allowance playing through into capital under various measures. That I think would be a big help as we do our modeling in the future.

David L. Herzog

Okay, Josh, its David, I’ll take the last question first on the DTA ahead of think about. As Bob mentioned, as we think about between now and 2015 we'll use about two-thirds of the total NOLs or the FTCs in combination. In those cash flows will actually come to the parent company by way of tax sharing arrangements or treaties that have been in placed for a very long period of time.

So those cash flows will ultimately flow to the holding company will be a part of the parent company cash flow. As you think about the cash that will come, it's the dividends, the after-tax dividends from the operating companies, which we've talked a lot about, the tax sharing payments that will come through the tax sharing treaties. And as Brian mentioned the monetization of the non-core assets and we've laid some things out in the appendix pages 17 to 19 and [that] you can give a pretty good sense of what those cash flows might ultimately be.

And it's the combination of all of the above, it gives us the confidence and why we’re committed to our long-term aspirational goals. It gives us the funding that we need. And also the capital resources to fund the business growth as Peter and Jay have talked about.

So that’s maybe the last part of your comments. I think and others can certainly time in with respect to the capital hurdles. There really aren’t any new constraints that we are coming across. I think we've laid those out fairly clearly. Bob talked about the capital requirements with respect to perhaps fed oversight, but again there are other things with respect to the rating agencies, all ratings are very important we place a very high degree of importance on that that's an important consideration. So it’s the coverage ratios and the leverage ratios are not any different for us than they are for any other similarly rated company. So for a single A company, I think the coverage ratio is in the five to eight times range. Or again, they are no different for us than they are for others.

And leverage ratio, again I think this ties back to comments Bob made. Leverage ratios, we've got plenty of headroom. Again, when we did the recap we called over (inaudible) for capital and that's not a constraint, although it’s a consideration and we’re mindful of that over time. So hopefully that's helpful to you.

Josh Stirling – Sanford Bernstein

Great, great. And so if I take from all this that that sort of interior you guys can forward some substantial capital excess in the future, but at the moment combination of liquidity and things sort of makes it a much more modest number.

Unidentified Company Representative

I think maybe just to cover again, I would say we are and remain committed to our long term aspirational goals as we laid out for the world on our recent offering last year. So again, I think the pacing that will be driven by, again the framework that I laid out, but as well as monetizaion, importantly monetization of non-core assets and how that plays into considerations of our fed readiness and where and when we become, if we become regulated by the Federal Reserve.

Josh Stirling – Sanford Bernstein

Now I think that all makes sense. Of course we just on the business are trying to figure out the timing of all that. And just a follow-up question. And related to I think Brian’s comment about sort of the slow pace of share repurchases, I mean obviously slow to consideration. In order to make all these repurchases at any meaningful level, presumably you'd have to be negotiating with the government.

I'm wondering if you can give us a sense of what, to the extent that they have shared any vision, any view on sort of how they think about exiting the remainder of the [position] and obviously that’s a huge concern or opportunity for investors today.

Unidentified Company Representative

Yeah, that's a question you probably have to address to the U.S. Treasury. We're focused on operating the business and don't engage in discussions about that. So really, what I can say?

Josh Stirling – Sanford Bernstein

Okay, thank you.

Unidentified Company Representative

You may take one more question.

Elizabeth Werner

Operator, this would be our last question.

Operator

Okay, we'll take our last question from Greg Locraft with Morgan Stanley.

Gregory Locraft – Morgan Stanley

Hi, guys thanks for squeezing me in. Just wanted to clarify one quick thing. It's pretty much everything I needed, but just the ROE aspirational goal of '10 and '015, which book value do I use for that? Is it the 55, and grow that forward or is it some other book value I should be using? I'm trying to tie it to an earnings number.

Unidentified Company Representative

Yes, we assume that aspirational goal that the DTA was not part of that calculus.

Gregory Locraft – Morgan Stanley

Okay, so can you just do the math for me? So what should I be doing to the 55 bucks? Should I take it to something different?

Unidentified Company Representative

Yeah, it's a good question. We announced why we put it in the financial supplement, both with and without. So we've done the math for you. Without, for the quarter we were 7.2, with, 6.9 I believe is the number that's in the financial supplement.

Elizabeth Werner

It's on the page five.

Unidentified Company Representative

Page five of the financial supplement.

Gregory Locraft – Morgan Stanley

Yeah, okay. Great, thank you very much.

Unidentified Company Representative

Thank you.

Operator

Bob, I will open up to you for any closing remarks.

Robert H. Benmosche

I just want to say that this is another quarter and we got more to go and I think what you see here is, the foundation is extremely strong. The company is extremely strong. Our clients have been with us all the way through it and are very confident in us. And so look forward to talking to you at the end of the first quarter. Thank you all very much.

Operator

And that does conclude today's conference. Thank you, for your participation.

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