Good day and welcome to AIG Fourth Quarter Financial Results Conference Call. Today's conference 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.
Thank you. Good morning. Before we get started, I'd 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 that 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 the factors described in AIG's third and second quarter Form 10-Q and our 2012 Form 10-K under Management's Discussion and Analysis of Financial Condition and Results of Operations and under Risk Factors, as well as in the same sections within AIG's 2013 Form 10-K when it is filed with the SEC. 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 reconciliation of such measures to the most comparable GAAP figures is included in our financial supplement, which is available on our website, www.aig.com. At this time, I'd like to turn over our earnings call to our CEO, Bob Benmosche. Bob?
Thanks, Liz. Good morning to everybody. If you turn to page three, let me start off with capital management, which is very important. As you saw, we announced a dividend increase, and we've added to our share repurchase another $1 billion, so we're sitting here with about $1.4 billion available for share repurchase at this time. This reflects the strength, not of the fourth quarter, but the entire year and actually the last several years as we look at being able to stress our company to see what would happen under adverse situations and making sure we have the capital and liquidity to meet a stress event and continue to maintain our strong ratings and improve those ratings, in fact, over time. This was in line with that. In addition to that, we continue our debt management, as you've seen.
Most important in the quarter, we were able to sell ILFC and close out the doubt about that transaction. We expect that to close in the second quarter of this year. That will, as you know, be the last major non-core asset that AIG is selling. Peter will talk to you about our Property Casualty business. The underlying results continue to be very strong, in my opinion. This has been a dramatic turnaround from the company and how it was designed in the past to where we are today. He'll take you through the details, but strong top line. Accident year loss ratios continue to improve. Remember, it's not only in your business, it's a zigzag. I know that's a technical term for some of you, but that means it goes up and down and it doesn't go straight.
You'll see that the trends, I feel, are very strong. Our Mortgage Guaranty business continues to do well. A dramatic turnaround from where we were five years ago, but that's part of the strong risk selection model that was put in place, as well as recovery in the market. Jay will talk about our AIG Life and Retirement business. We've had very strong sales. That business is really doing extremely well and continues to do well across all of its product sets. I'll let Jay bring you up to date on the details there. Let me turn it over to David, who will give you the highlights of the financials, and then we'll take you through the other key businesses. David?
Thank you, Bob, and good morning, everyone. As Bob mentioned, we saw strong performance in our insurance operations with operating earnings for the quarter in excess of $2.5 billion. For the full year, our insurance businesses collectively generated in excess of $10 billion of pre-tax operating earnings. Looking ahead to 2014, we'd expect continued progress in expanding our risk-adjusted returns through growth and capital efficiency. The sale of ILFC, as Bob mentioned, to AerCap, is on track for closing in the second quarter. The transaction was valued at $5.4 billion upon announcement using a $24.93 share price for AerCap, and any adjustment in that value on closing will reflect the change in the AerCap share price and will be recorded as a non-operating gain or loss on sale.
Upon closing, AIG will receive net cash of about $2.4 billion, which will be held at the parent company available for general corporate purposes. Our retained 46% interest in AerCap will be held at the holding company and will be accounted for under the equity method of accounting, with the equity earnings from AerCap included in our other segment operating results. The lockup expiration on AerCap shares begins to phase out nine months following the closing date. We will be prudent in maximizing our value, as you have seen in our past dispositions of invested assets. As part of the ongoing focus on capital management, as Bob mentioned, our board approved the 25% increase in our quarterly dividend to $0.125 a share and authorized the repurchase of additional shares with an aggregate purchase price of up to $1 billion. This gives us $1.4 billion of capacity.
Turning to our financials on slide four, net income for the quarter was $2 billion and included several largely offsetting non-operating items detailed on page six of our financial supplement. One such item, footnoted on page six of the financial supplement, relates to an impairment charge on our investment in life settlements totaling about $832 million before tax. This charge was prompted by the continued underperformance relative to our mortality assumptions. Accordingly, we revised our future mortality assumptions and discount rates for valuation purposes. Overall, we expect this $3.6 billion portfolio to have a mid-single digits return. Our operating ROE for the quarter was 7.3%, in line with our full year of about 7.5%. Since our earnings are tax affected for purposes here, and we are not paying taxes to the U.S. government, given our NOLs, our ROE excluding the DTA is about 190 points higher than that.
Book value per share excluding AOCI was $64.28, grew 11% from year-end 2012. Our operating results begin on slide five, and you can see solid growth in our insurance operating income from a year ago, and Peter and Jay will speak to their respective businesses. The direct investment book and global capital markets earnings collectively were strong at a little over $600 million for the quarter and reflect market pricing due to their mark-to-market accounting treatment that can create some volatility from period to period. We expect these earnings to moderate over time as the portfolio winds down and the investments approach their expected recovery values. In addition, we continue to proactively and opportunistically reduce the direct investment book's footprint.
During the fourth quarter of 2013, we repurchased about $466 million worth of DIB-related debt, and during the first quarter of 2014, we reduced the direct investment book debt by a little over $2 billion through both a MACO call that we announced in December and open market purchase transactions. All of this using cash within the direct investment book, specifically allocated for this purpose. At year-end, we had roughly $7.9 billion of net asset value in the direct investment book in global capital markets. Corporate expenses totaled about $213 million for the quarter, down from a year ago due to lower data center restructuring costs and other related expenses on restructuring costs. We expect corporate expenses would run at about $225 million-$250 million quarterly run rate in 2014.
Other expenses included a severance charge of about $265 million, related primarily to the Property Casualty business, and relates to our migration towards shared service centers, which Peter will speak to in his remarks. Also reported in other were $170 million of gains related to AIG real estate sales transactions. Our reported operating effective tax rate for the quarter was about 32%. Our current outlook for 2014 is an annual operating effective tax rate of somewhere between 31%-32%. Slide six presents a summary of our DTA, which totals a little over $21 billion at year-end, up from just shy of $17 billion a year ago. While our tax attribute related DTAs, i.e., the net operating loss carryforwards and the foreign tax credits, have declined by about a billion through the utilization of the NOLs, our net other DTLs and DTAs increased by almost $6 billion.
The increase relates to the sale of securities with gains, transactions that resulted in tax basis step-up, and a reduction in the unrealized appreciation of our AFS securities. In the fourth quarter, we recognized another $540 million of income related to the release of the valuation allowance on the capital loss carryforwards. In aggregate, we have utilized roughly 86% of the capital loss carryforwards. For the ROE calculation that normalizes for the tax attribute DTA, we subtract about $17 billion from stockholders' equity. Turning to slide seven, you can see the impact of our capital management activity in 2013. During the quarter, we issued $1 billion of 10-year notes at a little over 4% interest, and we repurchased some debt at the parent company in DIB totaling a little over $1 billion that had an average coupon of about 7.5%.
Including the DIB, when you take into account all the things we've done in 2013 with respect to our liability management and maturities, we've reduced our leverage by over $7 billion and reduced our annualized interest expense by roughly $350 million. On the equity side, during the quarter, we distributed about $147 million in dividends to our shareholders and deployed just over $400 million towards the repurchase of 8.3 million shares. While the ILFC transaction impacted how active we were in the market during the quarter, we remain focused on continued execution of our repurchase authorization. We will continue to be opportunistic in the future going forward towards our debt capital management as well.
As you can see on slide eight, our insurance operations remain the source of parental liquidity as they sent $4.3 billion in dividends and distributions to the parent in the quarter, including $90 million of dividends from Mortgage Guaranty, its first dividend since 2010. For the full year, dividends and distributions totaled $8.9 billion, well above our expectation of the 4 to 5 we've talked about in the past. I would point out that the full-year dividends from AIG Life & Retirement included about $800 million related to litigation settlement proceeds received by AIG Life & Retirement that were remitted up to the parent company. Additionally, $1.5 billion in the fourth quarter dividends from AIG Property Casualty resulted largely from some restructuring activities that we've been working on for quite some time.
Our expectation for 2014 to have dividends and distributions from the operating companies somewhere between $5 billion and $6 billion. In addition to these dividends, we expect tax-sharing payments from the insurance companies to parent of approximately $1 billion in 2014 and roughly $2 billion in 2015 as the local insurance company statutory NOL DTAs are utilized. These dividends, combined with our capital management activities I've mentioned earlier, resulting in parent cash short-term investments in unencumbered securities of just over $13 billion as of the end of the quarter. Included in parental liquidity is $5.9 billion related to the direct investment book in global capital markets, which is allocated for its future debt maturities and contingent liquidity stress needs. As we've indicated in the past, nearly 80% of the direct investment book's liability will mature between now and the end of 2018.
With that, I'd like to turn the call over to Peter for comments on property casualty.
Thank you, David, and good morning, everybody. Today, I'd like to discuss the highlights for the quarter and the year as well as our outlook for 2014. Let me begin by saying the year marks significant accomplishments as we believe are indicative of our future direction. Our balanced approach to growth, risk, and profitability drove our business mix shift, our underwriting actions, and our capital management achievements. We're pleased with our progress and look forward to continuing on our path towards increasing returns. Turning to slide nine. In the fourth quarter, net premiums written grew 6% from a year ago on a normalized basis, with growth coming from each of our major business lines. For the full year, net premiums written were over $34 billion or up 4% on a normalized basis. In the quarter, Commercial Line delivered net premiums written growth of 7% with improvement in each product line.
This is the first quarter in 2013 with a comparable top-line comparison to casualty, as there's no longer an impact from the global excess casualty quota share entered into in 2012. Specialty delivered the strongest top-line improvement on a normalized basis from a year ago, with noteworthy growth in the Europe and Asia Pacific regions. Property also developed strong growth both in the fourth quarter and full year. Our global property business is benefiting from significant international growth as we leverage our recently expanded in-house engineering capabilities and execute on our global approach to capital allocation. Looking ahead to 2014, we expect continued growth across our businesses, including casualty, where the re-underwriting of our book is largely complete. We remain focused on retaining our highest quality business and see positive rate increase in the United States. Pricing continued to be positive and largely exceeded loss cost trends.
Global commercial rates increased 2.6% in the quarter. The U.S. market continued to lead rate improvements with a 5% increase in the quarter. U.S. casualty led with a 6.5% increase, followed by U.S. Financial lines, which were up 4.2%, and U.S. property at 3.7%. Continued favorable underwriting trends were offset by increased severe losses in the fourth quarter. Improved underwriting results over the course of the year were the result of our pricing actions, enhanced risk selection, technical underwriting, and investment in claims handling. Severe losses in the third and fourth quarter reflected higher frequency and severity and exposure growth following the low level of severe losses in the first half. Our full-year severe losses were somewhat in excess of our expectations. We accept a modest amount of volatility for the increased returns.
We expect to continue to see a decline in the accident year loss ratio as a result of our underwriting improvements. Over the last three years, we've continued to manage down our gross exposures to catastrophes and refined our global approach to reinsurance, which has led to consolidation of our reinsurance purchases and a reduction in the number of counterparties and contracts. While we don't disclose all of our reinsurance programs, we'd like to provide a few highlights that illustrate the role reinsurance plays in our business strategy. In our corporate cat program, which we renewed in the fourth quarter, the attachment point is $3 billion and provides significant protection up to $5.5 billion for individual losses in the U.S. and Canada and up to $4 billion for accumulation of losses worldwide. In 2013, we also continued our strategy of accessing the capital markets.
During the year as part of our cat program, we entered into two separate multi-year cat bond transactions, providing combined reinsurance protection of $525 million. Our consumer business, which is presented on slide 11, underwent a transition in 2013 as we increased rates in Japan A&H and personal lines and engaged in further portfolio management in the United States. We continued selective growth in key markets. We experienced a higher level of travel and accident losses in the quarter, which we don't expect to be a sustained issue given the short tail nature of this business. Consumer remains on track for modest improvements in both growth and profitability in 2014. Additionally, the investments we're making in Japan will help provide a more competitive operating platform and a lower cost structure in the long term.
Under Kevin Hogan's new leadership, we look forward to executing on a strategy of targeted growth in markets where we can achieve meaningful scale and applying some of the principles that have worked well in commercial. We look forward to discussing more details of our consumer strategy over the coming months. Two items of note in the quarter are the severance charge that was recorded in AIG's other operations and our reserve actions. The expense savings associated with the $265 million severance charge largely pertain to Property Casualty and will emerge beginning in 2014 and become more significant in 2015. For the full year 2014, investments in the business will result in a relatively flat expense ratio compared to 2013. We began the final phase of the Fuji integration work in the second half of 2013, which will continue into the second half of 2015.
The cost of this initiative, estimated to be approximately $250 million, when combined with our purchase price, still represents a meaningful discount to the fair value of the underlying assets and liabilities acquired. We believe the full integration of our Japanese business, which currently has an 8% market share, will position us well in the second-largest non-life insurance market in the world. Slide 13 presents prior year development for the fourth quarter and full year. We continue to review our reserves quarterly and take timely action to address changes in development trends. In the fourth quarter, we added $225 million to our pre-2004 runoff environmental reserves based on our updated review.
Our analysis of pollution products looked into individual cases which indicated large increases in the value of certain previously reported cases due to new developments, such as the discovery of additional contamination in certain sites, legislative changes, court rulings, expansion of plaintiff damages, and increased costs of remediation technologies. In addition, there was a one-point adverse impact to our current accident year loss ratio related to these multi-year runoff lines of business. In the fourth quarter, we obtained approval from our Pennsylvania regulator to better align payout patterns and mortality assumptions for our excess workers' compensation reserves using our own experience and to utilize a more economic discount rate assumption for our primary workers' compensation reserves. These actions reflect our work with regulators over the course of the year and the significant analysis we completed to better model our runoff excess workers' compensation book.
For the quarter, the total net discount benefit was $325 million, which included a benefit of $647 million on excess workers' compensation reserves and a charge of $322 million on primary workers' compensation reserves. We also expect to record an additional workers' compensation loss reserve discount benefit of approximately $100 million in the first quarter of 2014, associated with the merger of internal pooling arrangements effective January 1st, 2014. In the fourth quarter, we made $2.6 billion of cash dividend payments to the parent company and $4.1 billion for the full year. During 2013, we worked with our regulators to simplify our legal entity structure. We consolidated our U.S. and Bermuda insurance exposures into one U.S. pool to increase our diversification benefits. These restructuring transactions resulted in $1.5 billion in the fourth quarter dividend payments to the parent company and $1.8 billion for the full year.
Turning to slide 14, Mortgage Guaranty's operating performance continues to improve with operating income for the quarter of $48 million. Mortgage Guaranty continues to benefit from its proprietary risk selection model and an improving housing market, with 59% of earned premiums generated by high-quality business written after 2008. Mortgage Guaranty closed the year with a record level of domestic first lien new insurance written of $49.4 billion. The delinquency ratio fell to 5.9% at the end of the quarter, representing the lowest level since the fourth quarter of 2007. UGC continues to be strongly capitalized and holds an investment portfolio that's highly liquid, with 81% of the investments rated A or better. As a leading U.S. mortgage insurer, UGC currently insures 800,000 mortgages across the United States. Now I'd like to turn the call over to Jay to discuss AIG Life and Retirement results.
Thanks a lot, Peter. Good morning, everyone. 2013 was a record year for AIG Life and Retirement. We had our best year in top-line results, generating nearly $29 billion in premiums and deposits, and in delivering on the bottom line with $5.1 billion of pre-tax operating income. Turning to slide 15. Operating income in the fourth quarter was $1.4 billion, up 29% from a year ago, due primarily to fee income growth, active spread management throughout the year, and higher net investment income. Returns on alternative investments were approximately $200 million above expectations and 52% higher than the prior year period, driving much of the increase in our net investment income. These results and our solid capital position enabled AIG Life and Retirement to distribute over $1.3 billion to the holding company this quarter and deliver full-year dividends and loan repayments to AIG of more than $4.4 billion.
Giving effect to these dividends, we still grew shareholders' equity ex-AOCI by 11% to nearly $35 billion. The success of our retail investment product strategy was a key driver of the significant increase in our sales volumes. Our all products, all channels distribution platform continues to generate outstanding results. Retail premiums and deposits grew 88% from the year ago quarter, reflecting growth across all of our investment products. Individual variable annuity sales were $2.3 billion for the quarter and $8.2 billion for the full year. We remain comfortable with this run rate of sales, particularly given the actions we've taken over the years to de-risk this product. Fixed annuity sales increased over 90% in 2013, and sales in the fourth quarter were nearly four times what they were in the year ago period. Consumer demand for fixed annuities has improved from the year ago quarter.
Those sales have moderated somewhat from the third quarter due to interest rates declining from peak levels reached last quarter and our related disciplined pricing actions. We also saw increased premiums and deposits in our institutional businesses, with growth in both group retirement and institutional markets on a year-over-year basis. As of year-end, our assets under management were $318 billion, up 10% from year-end 2012. Over the course of the year, we saw improved net flows across all of our retail investment products, higher separate account balances, and an increase in institutional assets under management. Net flows in 2013 were nearly $4.6 billion, driven by the substantial sales improvement in our retail products that I just discussed. We continued to grow our stable value wrap business in the quarter and saw a year-over-year increase of $14 billion in stable value wrap assets under management.
These sources of AUM growth more than offset the impact of rising rates on our invested asset portfolio, and for the first time in four quarters, we experienced sequential growth in our general account asset balance. Overall, we're pleased with the growth in assets under management we're seeing across our portfolio of businesses. Slide 16 highlights the strong operating income results of our businesses. Retail operating income increased 37% versus the year ago quarter as a result of enhanced spreads, growth in fee income on separate accounts, and higher net investment income. Institutional operating income increased 19% versus the year ago period and similarly benefited from crediting rate actions, higher fee income on separate accounts, and the higher net investment income.
The increases in net investment income were largely attributable to greater partnership returns and appreciation in hybrid securities, non-agency RMBS, and other invested assets accounted for using the fair value method. We also experienced better than expected mortality in our life insurance business, which contributed to the favorable year-over-year performance in the quarter. Our retirement income solutions business continued to grow profitably, with operating income up over 70% from the year ago quarter. We're seeing strong demand for our products, which we believe are differentiated in the market based on the income options we offer and our award-winning customer service. Over the past almost four years, we've redesigned our products to reduce risk to AIG. I think the strategy is paying off.
In our retirement income solutions business, of our $24 billion of variable annuities with guaranteed minimum withdrawal benefits, 71% include benefits with strong de-risking features, such as the fixed indexing of our rider fees, volatility control funds, and required minimum allocations to the fixed account. Given its relative size, we view our variable annuity business as an opportunity to generate attractive returns, especially as competitors reduce their appetite for additional exposure while consumer demand for income solutions remains robust. Slide 17 shows our investment portfolio composition returns and yields. Net investment income benefited from the strong alternative investment returns in the quarter, as I mentioned earlier. Overall, the total portfolio base yield declined four basis points from the year-ago period as we continued to invest premiums, deposits, and cash flow from the portfolio at new money yields below the overall base portfolio yield.
Over the course of 2013, portfolio cash flow included proceeds from asset sales, which generated significant tax gains in our fixed investment portfolio designed to utilize our capital loss carryforwards. Since inception of our gains realization program to utilize those capital loss carryforwards in 2012, our overall portfolio base yield has been negatively impacted by 13 basis points on an annualized basis as a result of the action. It's worth noting, however, that our base yield increased three basis points sequentially, mainly attributable to increased income recorded on residential mortgage-backed securities related to appreciation in the home price index as well as an increase in estimated future cash flows when compared to the prior quarter.
Moving to slide 18, we continue to actively manage crediting rates, which is reflected in the decline in cost of funds for both our fixed annuities and group retirement businesses on both a year-over-year and sequential basis. Net spreads expanded for both fixed annuities and group retirement from the year-ago period and the prior quarter. At year-end, 73% of our fixed annuity and universal account values were at minimum guaranteed crediting rates. In closing, 2013 was a strong year for AIG Life and Retirement, with record sales and profits. This year, we remain focused on executing against our strategic initiatives, which includes growing our distribution organization and increasing the productivity of our wholesalers, affiliated agents, and financial advisors.
Leveraging our strong relationship with distribution partners to increase penetration of our broad retail product portfolio within firms, maintaining a leadership position in offering competitive and profitable retirement income solutions, and continuing to look for opportunities to grow our institutional businesses where we can achieve the most attractive risk-adjusted returns. With that, I'll turn it back to Liz to open up the Q&A.
Thank you, Jay. Operator, can we open up the lines for questions this morning?
Yes, thank you. If you'd like to ask a question, please signal by pressing *1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press *1 to ask a question. We'll go first to Brian Meredith with UBS.
Yeah. Good morning, everybody. A couple quick questions here. First, Peter, I'm just curious, with 2.5% or 2.3% kind of rate increases globally, do you think we can continue to see the magnitude of improvement in your accident year loss ratios here going forward?
Yes, we have a fair degree of confidence that the three-year trend of accident year loss ratio improvement will continue. As you know, a lot of the improvement is baked into this year through renewals, we have a high degree of confidence on that.
Is it coming from maybe just mix instead of absolute rate, and that's why you're still getting the big improvement?
It's a combination of all the initiatives we've made to make sure that we have re-underwritten the books that were causing problems. The U.S. casualty book has been substantially re-underwritten, getting rate where we needed rate, investment in much tighter claims to reduce claims leakage. It's a whole combination of factors which have been underway for 2 years and are now starting to come through as the actuaries start to believe in the trends that have been established.
Great.
Brian, it's John Boyle.
Yeah.
I'd add that we expect to see continued good growth in our commercial business in Latin America, in Asia, ex-Japan, as well as the Middle East and Africa. That business continues to perform quite well from a loss ratio point of view. We've also rolled out some new products around the world that will continue to contribute to an improved mix of business. We expect the underwriting results on a normalized basis to continue to improve next year.
Great, thanks. Just quickly on capital management for David. As I look at your common equity this year, it was up a little over $2.5 billion. If you exclude AOCI, it was up close to $8 billion. I'm just kind of curious, why aren't we seeing more capital management, more share buyback? Is that something we may be able to expect on the horizon at kind of a faster pace than we've seen?
Yeah, sure. Thanks, Brian. As we said before, listen, we've remained and do remain committed to the $25 billion-$30 billion of overall capital management. To date, we've done about 20, I don't know, 16 or so of that's in common equity buybacks. We've done some debt. We're increasing the dividend. I think the overall approach is to be prudent, to be deliberate and orderly about the pace at which we go. We want to be in the long-term scheme of things do this in an orderly way. We're balancing the perspectives of many different stakeholders at the table. The fact that we're increasing our dividend, increasing or getting an additional share repurchase authorization, I think you should take as a sign of our confidence, our board's confidence in the underlying financial underpinnings of the company.
As I said, we remain committed to the $25 billion-$30 billion of capital management between 2011 and 2015. We're going at a pace we think is appropriate. Bob, if you want to add any commentary to that, I'd welcome that at this time.
No, I think David said it exactly right. Keep in mind that considering where we've been and we have a clear direction, we want to make sure we do this in a very thoughtful, routine, and prudent way.
Great. Thanks for the answers.
Thank you. We'll go next to Mark Finkelstein with Evercore.
Good morning. Peter, can you elaborate on the A&H losses and Private Client Group losses in consumer, please?
I think I'll ask Kevin Hogan to handle that one. Kevin, why don't you discuss that?
Yeah, sure. Mark, these are primarily related to some wholesale travel business in the fourth quarter. There were some severe losses, some travel delays. In the AIG Private Client Group also, there were a handful of losses associated with the severe weather.
We've taken appropriate underwriting actions across the portfolio, in the U.S., throughout 2013, we anticipate this to be a short-term impact on the results.
Okay, perfect. I guess also staying there, just thinking about the expense ratio, you've kind of had the severance charges, but the outlook for the expense ratio in 2014 is relatively flat, I think, if I heard those comments correctly. I know in the past you've talked about expense ratio staying high through 2014 and into 2015. What is the current thinking on when we'll start to see some of the infrastructure and the IT spend moderate and start to see the actual expense ratio coming down?
Well, the big expenditure in 2014 relates to Japan. As I mentioned, we're spending about $250 million in fully integrating the Fuji acquisition into our AIU operation. That's a spend that really started in July of last year and will last through July of 2015, really peaks this year as we make some very major investments in infrastructure and branch rationalization in Japan. That's the big item. Offsetting that is a continuation of the process we started in 2011 of integrating the property casualty business into one seamless AIG as opposed to a number of separate profit centers with duplicative infrastructure. This year, we will be really streamlining, removing excess layers of management in areas where they're duplicative so that we can be as responsive to customers and grow and redeploy people and capital where the opportunity is the greatest.
I think that the expense ratio has been affected by a combination of these investments as well as the reduced denominator of the shrinkage in the U.S. casualty business. A bit of negative operating leverage occurring, which as I mentioned, has really stopped. We're getting top-line growth again as we have reunderwritten the casualty books. I think that we feel good about the outlook on the expense front. I don't think there's going to be a dramatic change until 2015.
Okay. Real-
Can I just add to that? I know we're all focused on the expense ratio, you need to focus on the accident year loss ratio and the growth of this business. I think one thing that, as Peter's talked about over the last year or two, is that we've invested heavily in an engineering center, which will improve our ability to assess risk, invest in huge amounts of money and time so we have better data around our underwriting intuition and do a better job there. That's adding to the expense ratio. When you look at monies we're spending to put in the fraud unit, the subrogation units in our claims area, all this is adding expense and the beneficiary of that is an improved and reliable, and consistent accident year loss ratio.
You really have to think about the strategic work that he's talked about over the last two years and how you're seeing that benefit across the entire combined ratio. Also, it takes a while to earn into the benefits of what we're talking. You just mentioned earlier today that the actuaries have to see the trends, and it takes a long time for trends to emerge. I think you'll see this continue to progress over the next several years.
Okay. All very fair points. Just one very quick one, if I may, which is the increase in the statutory dividend that you're assuming for 2014 over 2013. Is that all from improvement in earnings, or is there more capital efficiency improvements at P&C or any other items that are helping to improve that number?
Mark, it's David. It's a combination of continued strength in earnings. We're continuing to generate the deployable capital, there is some amount, they haven't quantified it publicly, there is some amount that we're moving some higher than needed capital in some of the operating companies up to the holding company. We're continuing to evaluate the amount of capital that we're holding in the operating companies. We want to make sure that we've got plenty of capital for our ratings, plenty of capital to maintain our competitive positioning and to fund growth. The businesses are continuing to generate very substantial capital, and we will migrate some of the capital ratios down a bit over time as we said we would do.
Okay. Thank you.
You're welcome.
Thank you. We'll go next to Jay Cohen with Bank of America Merrill Lynch.
Yes. Thank you. Two questions. One is, you had mentioned the accident year loss ratio being negatively impacted by some multiple year contracts. I didn't quite get that. I think it was one point. Secondly, with your stock trading below book value, with the capital that you'll generate from the ILFC sale, should we assume that share repurchase will be a primary use of that capital?
Jay, I'll start on the first point, and I'm going to probably enlist James Bracken's help if I flub the GAAP accounting treatment. Basically, these are contracts, these are policies written pre-2004.
That were multi-year in nature where, because they're multi-year and we're receiving premiums still, means that as claims get made, they appear in the current accident year. This is a discontinued business from pre-2004 that appears in the current accident year as a new normal.
Just one clarification. They're being earned in, we've received all of the premium, think of them as multi-year claims made policies. They run for a number of years. We've still got a bit to earn out, you'll still see some revenue recorded in the NPE line of the segment, they attach some loss activity to them, it relates to run-off business.
Was that one point on the entire?
It's one point in the entire.
One point to the total company for-
Yeah, one point of accident year loss ratio for the entire company.
Right.
As far as capital management's concerned, what we've said all along is that our first priority is our credit ratings, because that speaks for our ability to live up to the promises we make. We're worried about coverage ratio, debt management, and so on. We said that we want to have some dividends to flow back to our shareholders. The primary goal after those two have been achieved is share buybacks. When ILFC closes, we will make a determination at that time, and we'll continue to evaluate our capital management program around our stress testing of the company, which is right now, we do one starting in November, and we do another one around May.
We take a look at where the company is, where we think the issues are in the marketplace, and then we present to the board what we think is appropriate capital actions based upon what we see at that time. As we get to the point, as David pointed out, with $25 billion-$30 billion, we can see the dividends coming up to the holding company. We can see the DTA beginning to get modified. Our priorities continue to maintain a strong company, while at the same time giving what makes sense to the shareholders as quickly as we can.
Got it. Thank you.
Thank you. We'll go next to Paul Newsome with Sandler O'Neill.
I want to talk, sorry, a little bit more about the expense in Property Casualty, but I think maybe I'd like to ask it in a big picture perspective. If you go back to AIG before its problems, this was a company that had a relatively low expense ratio and a pretty average loss ratio, and that was kind of how they made their money by having a lower expense ratio than their peers. Today, we're looking at a loss ratio, which is much improved and actually kind of looks a lot like its peers, broadly speaking. It's an expense ratio that's higher. Ultimately, are we talking about a company that wants to make its competitive advantage once again in expenses?
I think you should think of us having a very competitive combined ratio, both loss ratio and expense ratio. I think that's what Peter's working towards. You need to look at the loss ratio, and look at it on an accident year basis historically. If I go back to our releases and information we provided you, I don't know that the accident year loss ratio for those prior years looked at from this year would be what you saw. I think there's a difference. If you would factor in, which is what you need to do, prior year development, and if you look at the prior year development over the last several years and look at what we've had to do, you can see that the accident years were pretty high.
What you're going to see is continued improvement in the loss ratio, continued improvement in underwriting and systems around underwriting, continued investment in technology. We have a very strong bulletproof processing capability here at AIG that's state-of-the-art. Then you'll see your expense ratio start to come down and still see improvements in loss ratio. We need to continue to invest in a lot of tools to make sure that that loss ratio five years from now is what we said was in the loss pick or slightly better. We're building this company not only for 2014, but for 2018 and 2020. We really have to have a strong foundation for the future, and that's what we're building in.
To try to interpret your comments, it sounds to me like your competitive advantage, if you achieve your goals, will ultimately be a very competitive a better loss ratio than most and an expense ratio that's maybe in line with your peers. Is that kind of the idea, big picture, long term?
I don't view either of these ratios as a source of competitive advantage. They are outcomes of what we do for our customers. Our competitive advantage comes by the expertise that we have in the risks that we take ourselves or help our customers to manage if they choose to retain them. The investments that we're making are to become true experts in the risks that we've chosen to specialize in around the world and to use the relationships that we've developed over decades with customers, both large, medium, and small in the consumer and commercial space. As a result of that, we are investing in what it takes to be expert
That will lead to a higher expense ratio than was the case historically. Those historical expense ratios were also somewhat flattered by reinsurance strategies with large ceding commissions, which we don't do on the same scale anymore. The other thing is, as Bob says, you've got to look at those restated accident year loss ratios 1998 to 2003, which were way above industry averages, and we never want to return to those sorts of underwriting standards. We're really sharpening up how we manage our risks so that we have a competitive combined ratio, as Bob says, and in a sustainable way through the cycle. The other thing we're really focused on is a better trade-off between profitability growth and risk, so we don't feel we're forced to grow top-line in a soft market. We want to get our fixed costs down.
We're focused on the mix between fixed costs and variable costs so that we have the ability to scale back volume in a soft market so we manage the cycle better in the future.
Perfect. Thank you for the call and congratulations on the quarter.
Thank you. We'll go next to Josh Stirling with Sanford Bernstein.
Hey, good morning. Thank you for taking the call, and congratulations on a lot of progress this year. A question, I think, for Peter and John, perhaps, or one of the two. When I look at the commercial business and I do some adjustments for severe losses, and I think normalizing for the higher expenses in the quarter from incentives and stuff, I get to something like an underlying accident year x cat combined in commercial of maybe as low as a 92%, which looks like a very nice improvement from last year and a lot of progress in total. I'm kind of curious just where are we going to get to on this number? When I look at peers, you can often see sort of high 80s% x cat accident year combined ratio underlying numbers.
I think that's what you would need to get to your low 90s% all-in calendar year target. Is that a realistic end goal for this story?
Hey, Josh, it's John. We expect to continue to see, in 2014, accident year loss ratio improvement, again normalized. Peter talked a bit about the severe losses on the quarter. They were slightly elevated relative to our expectations for the full year. A bit better than expected in the first half of the year and higher than expected. That contributed to a slightly higher 2013 accident year result than what we expect. We've talked about expenses. We do expect to see an improvement in the expense ratio over time, as Peter pointed out. We didn't mention shared service centers, right? We have some redundant work going on as we build out our shared service capabilities in different parts of the world, in Europe and Asia, in Colombia as well. Yes, we do expect to continue to see an improvement in the combined ratio results for commercial.
All right, great. If I can ask a different question for Kevin, and welcome back to the company. I think we're all happy to have you here. I want to talk about the consumer business. I know there's a lot of things going on, and we've talked about Japan, but in aggregate, results have been flat in the past couple of quarters on the loss ratio side, I think been a bit of a disappointment. I'm wondering if you can just sort of, you referenced some things you're doing sort of more tactically, rewriting some repricing. I wonder if you can give us some color on some specifics and the magnitude of actions you're taking to drive margins over the next year or two. Thank you.
Okay. Thanks, Josh. Well, the reality is that, A, as you've done a terrific job in the commercial underwriting area in the last couple of years and are a little bit ahead of some of the disciplines that we're adopting in the consumer area. The focus is on the large portfolio. In Japan, we have reviewed and taken rate on some of the large auto portfolios as well as the core A&H businesses. In the U.S. as well, we're taking a hard look at the Private Client Group business state by state and have filed a number of rate adjustments in both the homeowners and the automobile businesses there.
We are also in the process of introducing similar tools to what's been used in commercials in terms of the global raters and focusing on rate adequacies in the various portfolios including those which are the strategic business expansion areas where we're introducing the appropriate technical skills from the get-go in our greenfield operations. Growth is an important aspect of the consumer business as we try to generate a customer insight-driven business. We are doing it with the appropriate underwriting disciplines, and that is a very important part of our renewed focus.
That's great. Thanks, Kevin. If I could just sneak one quick one in. A couple of times now we've heard from management suggesting the actuaries are lagging in recognizing the underwriting results improvement from underwriting and claims. I'm wondering, Charlie, if you'd give us some color on how you're doing the analysis, and are you using the more faster risk report methods, or are you kind of looking at lagging methods like the Bornhuetter-Ferguson and expected loss ratio? How much more would you characterize of margin improvement has yet to actually work through its income statement? Thanks.
Josh, I think Peter's comments earlier really relate to a lot of the investments, especially in the claims area, and we've talked about in workers' compensation. One of the key difficulties the actuaries have is that settlement patterns are changing, paid and incurred are changing, and we're getting much better case reserve information. What Peter's talking about is it's very difficult sometimes to distinguish between that case reserve strengthening and what's really going on in the business. We're certainly using a whole wide range of techniques that look forward and try to give appropriate credit for all the investments that the claims team is making in those initiatives. I think with more track record on the pays and the incurreds, the confidence in that increases. Really, that's what Peter's talking about.
The statistical credibility that you give to the one or two years of emergence will be better. The only other statistic I'd give you is that we've reached today an inflection point where the last two years, if you consider the re-underwriting of the casualty book, we now have just over 50% of our reserves are coming from the better underwriting that Peter and John talked about earlier. As that increases, I think you'll also see a natural improvement in future periods as the quality of the underwriting comes through and becomes a higher percentage of overall reserves.
Great. Thanks, guys. Keep up the good work.
Thank you. We'll go next to Jimmy Bhullar with J.P. Morgan.
Hi, good morning. First question for David, maybe if you could just talk about where you are on your interest coverage ratio now and what your aspiration is. Second, for Peter, on the accident year loss ratio, maybe if you could discuss the reasons for the deterioration in the loss ratio this quarter. You mentioned the one point because of the 2004 and 304 business, but even with that, it would have been worse than previously. I'm not sure if you quantified the benefit of the cost savings plan and the severance plan that you just announced, but if you could maybe just talk about how much you expect to save on that once it starts to fully reflect in your results this year or next year.
Okay, Jimmy. Thanks, and appreciate the question. I think there are three things I'd want to sort of leave you with respect to our debt capital management as it ties into our focus on coverage ratios. One is we did achieve the goals we had set out for 2013 vis-a-vis the coverage ratio and interest expense run rate savings. Again, we did it opportunistically and again, struck a balance of being able to allocate capital to share buyback dividends as well as share repurchase. Again, point one, 2013 goals met. Secondly, with respect to the direct investment book and the liability management that Brian Schreiber and the team are overseeing, we funded that with cash that was allocated in the DIB very specifically for that purpose.
Those proceeds or the funds we used for that had no effect essentially on cash or capital we have available for share buyback or other forms of equity capital management. Again, we'll continue to look to optimize the value of the direct investment book over time. As I said, 80% of it's gone at the end of 2018. If we can accelerate that without sacrificing value, we certainly will. Thirdly, the point being we continue to generate deployable capital again, five to six plus the tax sharing payments. I would look for us to continue to very opportunistically focus on debt capital management as it presents itself. I think I would expect we would continue to make progress on our coverage ratio, primarily through earnings improvements.
Also from time to time, we will look at capital management, debt buybacks, et cetera, as they present themselves. As Bob said, we're focused on our ratings, and we'll strike an appropriate balance. We haven't set any specific targets for 2014. I think, again, we're in a pretty solid place based on what we did in 2013.
It doesn't seem like you're done buying, reducing your debt. Maybe not as much as before, but do you still expect to reduce that a little bit?
I think we'll continue to be opportunistic in how we think about it. I wouldn't give you any specific targets of what we will do or won't do. Again, we'll be opportunistic. We want to focus on continued improvement in the coverage ratio again, and I think we can do that primarily through earnings, but we'll look at other ways to approach that. I'll kick it over to Peter.
Jimmy, thanks for the question. I think that I will just give you a quick answer on the timing of expense saves that are related to the severance, which is that we really have not disclosed the precise savings that we expect in the calendar year 2014 because we want to be extremely thoughtful about the way we execute what is effectively around an organizational streamlining to better serve our customers where we're not approaching this with a finite set of deadlines during the course of the year. We want to make absolutely sure that we execute this in a way that
Makes us better serve our customers. We'll be quite thoughtful about the execution. We have a broad range of ideas, and I think sufficient to say that we think that we will maintain an expense ratio that's fairly stable this year. We're not disclosing precise numbers nor quarterly schedule of savings. On the, accident year loss ratio, as Bob says, this is a business that zigs and zags. To understand which of those zigs and zags are noise and which ones are signal, you need to sort of dig a little bit under the surface to normalize severe storms and so on quarter-to-quarter. I think that's probably best done offline in a follow-up discussion with James.
Sure. Maybe if I could just ask one more quick question. On the AerCap stock, obviously it's gone up a lot in value. Have you thought about hedging your position, and are there any limitations on you doing that if you wanted to?
Jimmy, we're not going to talk about ILFC. Once it closes, we'll be glad to talk about what the options are, but let's get to closing, then we'll know what we can talk about.
Okay, thank you.
Operator, I think we can take just one more question, and then we'll have to call it a day.
Okay. Our last question today will come from Tom Gallagher with Credit Suisse.
Good morning. Just a quick one for David. The $5 billion-$6 billion of annual dividends that you're expecting out of the insurance companies now, I guess the run rate had been $4 billion-$5 billion. We should expect that for the next two years from a visibility standpoint, is that the goal? You would add on the DTA utilization on top of that. If those numbers are correct, the high end of that would be $8 billion by 2015. Is that the right math?
Yeah. I think I'll limit my remarks to 2014. That's the commentary that I want to share with you in the investment community, because that's the line of sight that we want to provide. As I said before, again, as we continue to generate deployable capital, we want to maintain, I think, first and foremost, strong capital positions in our operating companies. As they continue to generate capital, we'll give you as much insight to that as possible. Again, I think, the DTA payments, as I've said, is roughly $1 billion in 2014 and $2 billion in 2015, and it'll go from there. There'll be a very substantial cash flow to the holding company. Again, the $4 billion-$5 billion is what we said back in 2011 when we reintroduced the company. That's a very sound foundation.
We see opportunities to redeploy some capital that's above and beyond the levels we need to hold at those operating companies. Again, that's what we want to do, get it up to the holding company so that it's most fungible at that level.
Got it. Then was just a little confused about the $4 billion or so of dividends that were taken up in 4Q from the insurance companies. Can you just reconcile where the $4 billion went? Because if I look at Holdco cash and investments, they were up by a small fraction of that. Where did the full $4 billion go?
Yeah, sure. Very fair question. One of the things we did was, we improved the diversification of the capital in a couple of our operating companies through some internal restructurings we did with the life settlement portfolio. We accelerated some cash out of the opcos. We used that cash to improve the diversification of some of the capital. Punchline is it had no effect on the level of capital or cash we had available at the holding company for capital management or other general corporate purposes. That's really where it went. About a little, almost $2 billion of it went for that. It was some internal improvements we made.
Okay, thanks. Then one last one from me for Kevin. Just on the comments on increasing rates in Japan A&H and auto, can you just comment on what's happening there? I just want to know, is this to keep pace with loss cost trends? You obviously had some elevation of, you had cited travel and accident. I don't know if that's specifically related to it, or should we expect the rate you're getting to actually improve margin?
Well, thanks, Tom. The actions that we're taking in Japan are really related to an overall portfolio review. Fuji Fire and Marine, a relatively recent acquisition. We've taken an extensive review, and this is really a primary area where we have improved our selection parameters and rate. We have seen an improvements in the overall profile of the results as a result. In terms of the A&H business, it's more of a reflection of responding to some changing trends in the underlying results in the marketplace. I believe that what we will see is an improved underwriting result going forward.
Okay, thanks.
Okay. Thank you everyone for joining us this morning, and we'll certainly be happy to take all your other follow-up questions. We're all here, so please feel free to reach out. Thank you.
Again, ladies and gentlemen, thank you for your participation. This will conclude today's conference.