Let's move on to the next session. Very pleased to have two key members of AIG's management team with us today, President and COO, Peter Zaffino, and Chief Financial Officer, Mark Lyons. Together, they have about 70 years of industry experience, and both have great track records with previous companies of value creation. The pace of change at AIG has always been elevated. I feel like today it's at supersonic speeds. The company has a great sense of urgency. It's taking dramatic action to improve results. Obviously, most of you saw the results this morning. I saw the results. I did not listen to the call because I was up here hosting. I might ask some questions you guys have addressed publicly, but it might be a good opportunity for you to expand on it anyway.
Sure.
Peter, I don't know if you want to start, maybe just some big-picture comments to open up.
Thanks for having us, first of all. We did release earnings this morning. I guess really the highlights are, and that we're really pleased with, we put out guidance about one year ago that we were going to make dramatic improvements within the underwriting portfolio and deliver underwriting profit. While it's a big milestone for us in terms of crossing under 100, I think what we try to impress in the detail of the earnings call is just what's really happening in the underlying portfolio. We talked about some of the businesses that have reshaped the most dramatically, some of the limits that we've been shedding, and still offer quite a bit of limits, we can talk about that, and relevance to brokers and clients. The portfolio we inherited had way too much outsized risk in it.
We talked about reinsurance, which is appropriate at January 1st because so much of the renewals come up. We outlined, we've been talking for the last couple of quarters around AIG 200, and what does that transformational change mean? How are we actually going to improve the company? More details, more financial guidance. I gave some overviews. Mark unpacked it in more detail. Then Mark just talked through reserving and got a little bit deeper on the calendar year results, all which we were very pleased with, and then provided some high-level guidance for 2020. I think in a lot of the questions, Jay, we'll probably go into it in more detail.
Yeah. Did anything surprise you about 2019? As you executed on this plan, you saw the results, were there any notable surprises?
Well, when you look at the year, at least from my perspective, is that the first half was a little slower. Not necessarily for AIG, but I think the market, and we knew what we needed to do. The brokers, I think if you asked the large brokers, they haven't been through a market like this in a long time. I think it took a little bit of time, probably a quarter or two, for them to really calibrate to the market we were in. I think that under no set of circumstances did we think that when we started the year, every quarter would have sequential improvement in rate, and it would be broad-based in terms of product, it would be broad-based across geographies. It's not what we led with.
I think you heard with the last panelist that underwriting is the most important, how we reposition the portfolio, underwrite terms and conditions, structure, and then price. I think that's probably one surprise this year is how much the price accelerated as we got in the back half of the year.
Yeah. Of course, the ending point was kind of where you had hoped it would be, right?
Well, it exceeded. I don't think we ever forecast we were going to be getting low double-digit across the world. You don't usually see.
In margin goes, though.
In margin, yes.
Yeah.
When you unpack the margin, it wasn't going to be one component. It takes a while to earn through on the underwriting side, but we had underwriting improvement, we had expense ratio improvement, we had very successful integration of acquisitions, and we had significant discipline on expenses. We took a half a billion out in General Insurance during late 2018 and 2019, and that sustained and kept the ratios relatively flat while the premium was decreasing, reflecting the changes we were making in underwriting.
As Peter has always talked about on the calls, I'm here 18 months, I guess. You just can't believe the volatility of the book. The figuring out, the resculpting, the change in the front end, the reinsurance structures, it was a lot of sweat equity, and now it's bearing fruit.
I guess I was very surprised. I think, Peter, one of your first calls when you talked about the limits that you had been offering and where you were going to, it was a dramatic drop. One, I was surprised the limits were that big. The question I have is: are you done with that process? Is there still more de-risking that needs to be done in 2020 and 2021?
There's still more to do, but I would say the majority of it's largely done. We had to go through a couple of cycles. We inherited some of, particularly in the property portfolio, a lot of long-term arrangements that had multi-year contracts that just took us a little bit of time to bend the curve, which we will do in 2020. I cited on the call just this year we shed $150 billion of property aggregate in North America, which is staggering when you think about it, and drove, again, rates started to pick up in the back half on the portfolio. The property will have a little bit more. The excess and surplus lines will have a little bit more. Some of the casualty and financial lines. I would say the majority of the reduction in limits has taken place.
It has to earn through in 2020. On a written basis, I think the predominant amount's been addressed.
John Pearce, a property example I could just add. The second, Jay, is, you kind of mentioned on the call, I was using Lexington as the call that you will hear.
Okay.
Using Lexington as the case study example. All that shedded limit on the retail side, household name companies, and gigantic limits and huge nets, and the transformation to opening up the wholesale channel for true E&S, probably 90% of that business needs $25 million or under in limit. They don't need these gargantuan limits, so it changes the whole complexion of the book. Then informs and changes the reinsurance that you have behind it. It's an ever-evolving thing.
That was my other question on the ceded reinsurance program, which really changed quite material as well, in 2019. Do you foresee material changes in 2020 and 2021, or is that program where you want it to be?
For the portfolio we have, we like the structure that we have, with the improvement in limits management and peak zone management, we expect that will continue to get refined as we enter into 2021 and 2022. Part of it is the high net worth business has a lot of peak zone exposure. When we worked with Lloyd's to form Syndicate 2019, bifurcating that will take us this year in terms of what we do on the front end of the written premium, also in terms of the reinsurance structure. We bifurcated the CAT at 1/1, there's other things that we need to do in order to de-risk that. You start to see that evolve. Then I think the refinement of the core property CAT and property per risk will continue to get refined.
Got it. There's a lot of moving pieces. We've got our earnings model. We're trying to forecast things like premium. North American commercial premium, given all the moving pieces, 2020, up, flat, down. Any sense of that?
I sat Mark in the middle.
Oh, nice. North American commercial Let me answer a different question. Let me attempt to answer a different question, which is, there's revenue growth, then there's underwriting gain growth, right? We can focus on top or bottom. If I'm a shareholder, I want earnings per share. Earnings per share is underwriting gain. As we transition from evolving the book and post-cauterization of some parts of the book, as Brian said on the call today, you get a book you're really happy with, then you're focusing on growth. There's so much change with distribution changing as well, that tends to not be focused on as much because you don't see that in an earnings model. The whole risk selection, the breadth of distribution that we have now and funneling down clearer risk appetites.
I think I've said this before, because of the broader spectrum of risk quality, you keep binding the same proportions, your average rate accuracy goes up because you got better quality risk that you didn't have before. That's hard to measure, but we know it's happening.
You mentioned distribution, you're right, it is hard to model. Anything more you can add to that, what's changing and how it could help the numbers?
In terms of like with distribution?
Yeah.
We have spent a lot of time, you can imagine, with going through that dramatic change, being able to articulate a strategy in terms of our risk appetite to brokers and do that across the globe just took a little bit of time. I believe that we are much more aligned with distribution in the back half of 2019 as we enter 2020 with a refined risk appetite. We're executing on where we want to grow, where we want to shrink, opportunities in geographies, in international as well as within the U.S. of real growth opportunities. I think that I believe we'll grow on a like for like basis. As Mark said, we had to turn the book over a lot, excess and surplus lines, I mean, our submission activity's up almost 100% year-over-year.
We've seen a lot of growth opportunities and believe that that market is the market that we're in for a while, and believe that there'll be some other discrete opportunities for us to grow in areas where we're probably a little bit more accelerated on some of the stuff that we've done on the turnaround. The brokers have been tremendous in supporting us, and they've been tremendous in terms of aligning on risk appetite and have a lot of very good data analytics that they use to mine their portfolio and allow us just to be more aligned. I think that there's a lot of momentum there.
Let's talk about pricing outlook. I'm sure it came up on the call, but I'd love to get your view of what you think will happen to commercial pricing in 2020 and 2021.
It's always hard to predict, wish we had the crystal ball, but what I would say is the underlying fundamentals that exist in the market today, I have to talk myself out of it versus talk myself into it in terms of its sustainability, because I don't believe it's being driven by any one factor, and so there's multiple factors. If I look at where it's happening, it's multiple lines of business, and it's in multiple geographies. That, it's been accelerating in the back half of 2019. Do I think that acceleration will continue in 2020? Hard to tell, but I certainly believe that the rate environment in terms of getting paid better pricing on a risk-adjusted basis will continue in 2020.
The other side of the margin, claims. A lot of talk about social inflation, rising claims. What are the trends you're seeing there?
I can start that. A little different story in different areas and different lines of business, of course. We're pretty diversified. One good thing is there's a big international component, which doesn't have U.S. has 70% of the world's lawyers. That's what happens. The other 30 are scattered all over. That's a more stabilizing influence. Limits aren't as big and so forth. In U.S. related, I said this before, we have pretty high loss assumptions in what we've had, and some of that is probably due to the AIG experience brought forward, which probably had increasing levels of adverse selection. You really have adverse selection masquerading as severity trends, but that's never the case, nevertheless the case, which makes it more art than science with such a radically changing book of business since Peter's driven the change.
You got to look at it, but the importance of the past is now partial because book's no longer homogenous. It's radically different. Securities class action suits are up, but that's just the highlight, the top line. You got to look underneath it. A lot of that state court or merger objection cases, the dismissal rates are huge on those. It's almost like medmal business. You have a lot of claims, no pay. You have suits dismissals that only give you a little defense cost. That has to work its way out.
I think it's good to see, David McElroy, since he's really gotten there, is putting this in place, that looking currently and backward of the proportion of times that AIG is hit with securities class action suits, and is it full coverage, is it just Side A coverage and so forth, and managing that, and that's been a very favorable trend for us. You got all these things out there that are specters, and social inflation, very hard to measure. Litigation with being represented by lawyers and outside funders. There's a lot of dynamics changing it, which makes the trend more uncertain. One thing we're pretty happy about, though, is the kind of rate changes that Peter's been quoting. Pick your loss trend, we're in excess of it.
Yeah. It was interesting when other companies began taking some reserve charges or having some issues over the last couple of years, I would get the question: Well, what about AIG? They have exposure to all of these lines of business. My view was you have sort of dealt with that. In other words, when you came in as Chief Actuary and now CFO, you had a fresh look at reserves. My assumption is, and I want you to comment, you would have been addressing some of the issues that other companies now seem to be addressing with their reserves.
Well, interestingly, before we got there, on some of the things you're talking about that could spread back to past accident years, let's say, kind of under the covers, I think I alluded to this on a prior earnings call, there had been an accumulation of mass tort reserves, kind of a rainy day, but they were designated as mass tort, kind of bulk, kind of like Donald Rumsfeld, the unknown unknowns. There's a lot more than you think, firstly. Secondly is on a net basis. Secondly, because the Adverse Development Cover, there is $8 billion still untapped, and we have 80% of that. There's $6.4 billion, plus what we have in mass tort. Even if hell went away in the handbasket, I like where we're sitting.
Yeah. I did look at the numbers this morning before the conference started, and you did have some adverse development in financial lines in the quarter, U.S. commercial. What was driving that?
Well, I kind of got into it on the call a little bit. When you really focus in on it's private, not-for-profit business, which is overwhelmingly primary. It was the D&O side more than the EPLI side, which is much more manageable in a frequency base, in a corrective sense. I think we're in good shape there. We write a fair amount on mergers and acquisitions, the old Representations and Warranties businesses. We put up some provisionals there. There was some severity being seen. Those two that I just mentioned are 80% of what drove it. There was a little spot here and there, a little spot on the cyber, a little spot on miscellaneous, fidelity, stuff like that. That was the real driver. It wasn't really the publics.
Got it. Okay. I want to make sure we get some questions from the audience. It's a big group, if you do have questions, just raise your hand and we'll just wait for the mic. I guess I'm the only one that missed the call this morning. Wanted to just quick question on the quarter.
Thanks.
Sorry, go ahead, Ron.
Your dramatic underwriting actions have really reverberated across the whole industry, and I expect it's sort of a reasonable expectation that there will be a point at some renewal of, whether it's a segment or at the account level, but there'll be a point at the renewal where the market will present the opportunity for you to continue to get rate in excess of the acceptable margin and return that you'd like to get on any particular account or book of business, and you'll be sort of presented the opportunity to sort of seek premium at the expense of excess margin. What will the posture be to the underwriting teams at that point in time when, if this reverberation and sort of amplitude that's resulted from your past and current actions play out?
The guidance to the underwriters will not be to drive revenue at the expense of getting the appropriate profit. They're focusing on bottom line, focusing on repositioning the portfolio and finding opportunities if there are growth that are consistent with making sure that we continue on the path of improving underwriting. One of the things that's interesting to note, and again, this is an anecdote, but in some of the limit reduction that we've done, and again, it gives you the scope and size of the insurance industry.
It's taken sometimes 20 to 25 markets to fill in the limits that we shed. It's not as though a couple of insurance companies are coming up and just taking the aggregate, and this is not an industry issue. Quite frankly, it's not just property, it's on casualty. Then also, there's been a pullback in terms of just limits deployed by the market in general. I think that you see placements being done on excess or limits that are more stretched. It just takes more companies to do that. There may be opportunities for us to find ways to ventilate better.
Where we might have been focused on lead layers, and that's where our capacity was, we pulled that back and said, "Well, wait a second. We're driving the program. Maybe there's opportunities in the mid-excess or high excess to do if we think the appropriate risk-adjusted returns are there. Those are some of the things underwriters are looking at, just getting better balance in the portfolio, but we won't be sacrificing margin to focus on top line.
Let me just add a little something there, Ron. There's the individual underwriter. Peter continues to be improving the quality of the underwriters, all the ranks, all the way through. There's also steerage. We can get up there, any company can get up here and talk about a rate change. Hypothetically, let's say they got 20%. Oh, it happens to be an exposure set invoking New York Labor Law. They need 150%. 20% means nothing unless the relative measure needs an absolute measure with it, right? It's a dog, 20%. It's just a dog that barks less often, but it's still a dog, right? You need that steerage from the top as to where we think the margins are thick, marginal, or negative.
What other questions do you guys have?
Yeah, I was hoping you could talk a little bit about AIG 200. I'm not sure how much detail you got into on the call, but it might be a good opportunity to reiterate what you've been talking about.
We did get into a fair amount of detail on the call of a strategic repositioning of AIG. We spent a lot of time over the past 6 months of looking at the entire global operations and finding opportunities with really a lot of input from employees. I think we got over 1,000 ideas that we digested and worked through of putting into specific work streams that we felt were aligned with what we wanted to do strategically with the company. It's just taken a lot of time to make sure that we put that into key categories, and I'll give them to you in a second.
Also making sure that we documented everything in high level of specificity because we have quite a few going on at once and how those intersect and the sequencing of all of AIG 200 is going to be very important. We started with three really in underwriting. One is putting in a more standardized commercial underwriting platform in North America, continental Europe, and the U.K. That's really just creating better data architecture, end-to-end process, digital enablement through a policy admin system. It's not standardizing one global model, but it is recognizing that workflow and data architecture matter, just going to allow us to do a much better job of underwriting, better insight in terms of our data capture, and turning that into better insights with actuaries claims. It just connects the entire organization.
The other one is Japan, which we have a terrific business. It's fairly sizable, we're the largest non-domestic insurance company in Japan, north of $5 billion of premium. Digitizing that workflow and the SME, just focusing on not only digital enablement through workflow, but digital enablement in terms of our connectivity to agents and to our clients. That'll really create efficiency, and focus on Again, we have an expense ratio issue there that just needs to be addressed through investment. Our high net worth business was the next one, very similar to Japan, which is a more digitized workflow, but also more self-service with our agents, brokers, and clients of just getting just better insight on what high net worth individuals buy, instead of it just being a more antiquated and stale model of going in, getting quotes.
Unfortunately, you have a lot of aggregation issues because it's Southeast, Northeast, West Coast. Making sure that we put in a digitized platform that will allow us to do all the things we want to do to reposition the business. It's a good business. We have a great foundation to build on. The other ones, we have two in Mark's world in finance transformation, two in IT. We have a lot of applications that need to be consolidated, a more robust cloud strategy in IT. A big one is going to be shared services, which we are converting to AIG operations. It was an inefficient way of structuring shared services because we had a lot of horizontal reporting, it was not connecting the entire and unifying the organization to have better end-to-end process.
The other two are just more tactical, at least in procurement. We had a lot of places where you can negotiate with vendors, we just consolidated that and made one global location believe that there's real opportunities to get synergies there. All of this will trail with real estate, to make sure the real estate strategy matches the footprint of what we do on the transformation in terms of our global footprint. That's really what we outlined. We said it was going to be a $1.3 billion of cost to achieve a $1 billion run rate benefit at the end of 2022. Mark went into more specifics around how that would look in terms of year-over-year.
From a timing standpoint, over what period of time is this happening?
Well, it's already started. We've launched one of them, we said we would be doing it in the first quarter of 2020. We are, again, finalizing all of the 10 different charters, we'll be starting to commence many of the work streams in the first quarter. We'll give a lot more specificity, Jay, in the first quarter call.
In terms of part of the end game, like we said on the call, the $1 billion of annualized run rate Peter's talking about, that's exiting 2022.
Yes.
it'll work its way up.
That $1 billion, this is a cost item, or is it cost plus added revenue item?
No, we're looking at that. That's a cost item. You can get lost in the sauce and justify revenue or say this is going to help the loss ratio and which are kind of alchemy. We're focusing on things that are trackable.
Do you see revenue opportunities or benefits from the program?
Absolutely. We do. As Mark said, none of that is baked into the assumptions. It's about improving the organization workflow, digital capabilities, and enabling us to do things that we want to do better, which is on the underwriting side. You think about just use like a high volume like Excess Casualty, where just building in with the data architecture and workflow, just getting rid of business that we are not going to underwrite and just spend more time on matching our risk appetite with distribution our clients. Today, it's much more of a manual process, and so we've got to vet a lot of that, and there's just too much downtime and believe that we'll have better opportunities, more consistency and risk appetite, and more alignment with distribution.
It's amazing that you go back five, six years, and the company was taking what we thought was pretty significant action to change the company, and it just feels like there's still so much to be done. You guys are on top of this now, but it's remarkable the starting point was where it was.
You could write a book on that one.
It'll be my next career. At the end of this, we're going to say either it was successful or it wasn't. If we're saying it's successful, what are we seeing from this company as far as ROE, for example, longer term?
Mark went into a lot of detail on ROE today.
If it's really longer term, there's a lot of dimensions, I think, to that. One thing Peter pushes through the company is back to being maybe not the, but a highly respected market leader driving it and a thought leader and have consistent and strong financial performance, and pick your metric right on that. Strong distribution, broad, I don't know. We don't necessarily want to be all things to all people. I think we'll evolve, some companies are in every market and every strata of customer size and every geography and so forth, that'll evolve probably. Best I can say.
Separate topic. I'm not sure if it came up on the call or not. It's come up a little bit in this conference. Coronavirus. What do you see as your exposure to it? Are there any business interruption type contracts that might be exposed to this?
We're obviously watching it very carefully. Probably the 3 segments that we watch the closest would be in our travel business. Trip cancellation, there was significant amount of, we have a decent-sized portfolio. Again, there's no indication in terms of claims activity or there's anything that would amount to anything emerging that we're just watching it. Trip cancellation and travel, Accident and Health, but that's more of if it spreads beyond China. We don't have a big Accident and Health portfolio in mainland China, but that's another segment. Looking at the business interruption is another one on property and what is the language, what would be covered, and then is it sub-limited, and then do we have clients that actually have China exposure. Those are the 3 that we've been watching very carefully. It's early days, and there's nothing that's emerging that's concerning.
Did it come up on the call?
It did not.
All right. Got a new question, thankfully. You do have this other business, small little business called Life and Retirement, which we've ignored so far, but just a couple of things on that. I know it hasn't been a big focus of investors, but as you look at 2020, outlook for, let's say, annuity sales as an example.
Let me start with that. The really good thing about AIG when it comes to the annuities, they're evenly distributed between fixed annuities, variable annuities, and index annuities. If interest rates are lousy, the kind we've been living with for a while, fixed annuities aren't as attractive. People might look at equity markets. Equity market's been gangbusters. The net flows for index annuities were $4.7 billion positive in 2019, right? It's a growth product.
Right.
To the extent that they both go out of sync at the same time, interest rates are low and equity markets go the other way, okay, that's a problem. As long as you give more choices and people can flip to one or the other on group first, and a little different on group than it is on individual. I think that balance provides a competitive advantage. When we look sideways, we see Pacific Life having a similar balance, but they're half our size. Everybody else, it's more concentrated in one or the other.
Yeah.
I think that bodes well. If you tell me the economic situation, I can tell you which one will respond.
No matter what the environment, you've got a product that you'll be able to sell and probably grow in some parts.
Yes. They do a pretty good marketing job, too. Give them credit.
Yeah. Any other questions from the audience before we wrap up? We got one down here.
Okay, a question on the accident year guidance. If you normalize for crop, it was like 95.5 for the year, which implies a point to point and a half of improvement in 2020. You've had written pricing well ahead of loss cost trend for a couple of quarters, why isn't it more? Part of that improvement is AIG 200, right? Why aren't we seeing more improvement in 2020?
A couple of things quickly come to mind. One is you generally measure rate changes on a growth. First, it's written, not earned. Then it's on a gross basis, not net. With reinsurance changing pretty radically from year to year or product to product, it kind of changes that. Secondly, for some of the reasons we outlined, severity trends are really not clear. Rather be safe than sorry in this organization. With the underlying changes, as Peter outlined, so radical, you hope the P&C changes are doing it, but time will tell. We just think that's a more prudent approach.
Any other questions? Going once.