Shares in American International Group were hit by heavy selling on Monday, ostensibly on the back of a downbeat note issued by BernsteinResearch.
By ‘downbeat’, we mean ‘quite aggressively bearish’. From the note, emphasis FT Alphaville’s:
It appears that AIG’s loss reserves are significantly deficient again, much sooner that we would have forecast 2 years ago.
? Our estimate is about $11bn deficient, +/- a $4bn standard deviation and equal to about 24 points of total 2008 earned premium (35 points for US only). This equals about $10 per fully diluted share after-tax. The majority of the deficiency ($10bn) is concentrated in 3 long-tailed casualty lines: Work Comp ($1.8bn), General Liability ($5.6bn), and Professional Liability ($2.6bn).
? Because this result was so unexpected to us, we conducted numerous independent reasonableness checks on the AIG analysis. In each case, looking at paid/incurred ratios, implied real price adequacy, and empirical loss development factors, it appears at a minimum that AIG’s results are worse than its other large peers, and directionally worse than its booked reserves.
? These results give some credence to long-held views that AIG simply has always been a more aggressive competitor. There is even some support to the idea that discipline was lost after former CEO “Hank” Greenberg left the company. But a more solid analytical reason that may explain the recent deterioration is that AIG’s reinsurance usage has been cut nearly in half since the late 1990s, from 43% cessions in 1999 to 22% in 2008. This fact supports both the idea that AIG’s underwriters never adjusted to the greater need for more “net line” underwriting, as well as the possibility that AIG’s reserves will have a “thicker” tail without so much reinsurance usage.
And it gets worse:
The potential implications of this result for AIG are quite significant. If our analysis is even directionally correct, it implies that AIG shareholders and the Federal Government face considerably more uncertainty than they may have anticipated. At a minimum, if these results are reasonable, AIG would likely have to take some kind of reserve charge before it could sell or IPO its Chartis unit, which would probably greatly increase the difficulty of implementing such a deal in the first place. There is also the possibility for even greater Government scrutiny and penalties, although we have no insight as to what this might be at this point.
But this may also lead to a result that was widely anticipated earlier this year but for the wrong reason, namely continued loss of AIG market share. It was viewed by many that AIG’s weakened state would compel clients and brokers to want to move business. We were skeptical of this view because we felt that clients would instead stay put and wait for the uncertainty to pass before making a major decision. So far, our view is what appears to be playing out. But now, with this loss reserve result, we have a more analytical case to make that AIG may face client flight in the future, driven by fear over its potentially weakened claims-paying ability. That factor seems much more likely to matter to risk managers than what is happening in AIG’s Financial Products unit. It is very difficult to determine if and when any reserving problems will be manifest in AIG’s results, and so if and when competitors will be able to capitalize. But at this point, we now think it is more likely that companies like TRV, CB, ACE, and even CNA will eventually be able to capitalize on the likely uncertainty this will create in AIG’s client base.
The Bernstein analysts, who described the outcome of their study as “a big surprise”, cut their price target on AIG from $20 to $12, adding:
There is now 64% potential downside to our target from AIG’s most recent close. We continue to rate AIG Underperform.
At pixel time, AIG’s shares were trading five dollars lower at $28.25. That Bernstein target price is suddenly in sight.
Related links:
The AIG report – Paul Krugman / NY Times
AIG and Greenberg settle dispute – FT
Is AIG’s Benmosche staying or leaving? Both, maybe – FT Alphaville