All right. Good morning, everyone. I'm Jay Gelb from Barclays. Thanks, everyone, for joining us over the next several days for the 14th Annual Barclays Global Financial Services Conference. I'm the senior analyst covering the U.S. property casualty and life insurance industries. I'm very pleased with us to have today Rob Schimek from AIG. AIG is among the largest property casualty insurers and also has a substantial U.S. life insurance and retirement savings business. Rob is AIG's Executive Vice President and CEO of the Commercial Insurance unit. Prior to his current role, Rob has served as AIG's CEO of the Americas, CEO of EMEA, and CFO of AIG's Global Property Casualty business. Before joining AIG, Rob was a partner with Deloitte & Touche. Rob, thanks again for joining us today.
My pleasure, Jay.
You were recently promoted to be head of AIG's Commercial Insurance business. What's been your strategy to improve results? How would you characterize performance so far?
We outlined a strategy on January 26th. A copy of that strategy deck, by the way, is on the AIG webpage for everyone to see. As it relates to the Commercial Insurance business, we articulated a strategy to move our adjusted accident year loss ratio down by six points between the beginning of 2016 and the end of 2017. Over a two-year period. One important point is that we wanted to make sure people understood how confident we were in our ability to do that. It's not a back-end-loaded plan. As a matter of fact, our plan delivers four points of the six-point reduction in the adjusted accident year loss ratio here in 2016 with the remaining two points in 2017. The strategy really focuses around fundamentally three things. There's five components. I can summarize it for you in three pieces.
The first is the use of reinsurance and other risk mitigation tools like reinsurance to improve the loss ratio. The second is narrowing our focus. Narrowing our focus means narrowing our focus with respect to which clients we focus on. Our vision at AIG is to be our clients' most valued insurer, but clients where we only have a one-product or a two-product relationship is not really necessarily consistent with our view of becoming a holistic trading partner with those clients. We want to either expand that relationship or if it's not profitable just end the relationship. That would be narrowing our focus with respect to monoline or dual-line clients is what we refer to it. The second element of narrowing our focus is narrowing our focus with respect to which products we offer.
There are some products that we have exited, and in particular here in the U.S. and Canada, we actually did two lines of business, one in the environmental area known as Pollution Legal Liability, solely in the U.S. and Canada. The other is a line of business we refer to as Buffer Trucking, and that's a casualty layer of protection for long-haul truckers. Fundamentally, those two lines of business represent about 2.5% of AIG's portfolio, but represented a very outsized portion of the amount of losses that we incur. We decided to narrow our focus with respect to the products. Lastly, we're really focusing on narrowing our focus with respect to geography.
We serve clients in total in over 200 countries and jurisdictions, but we have AIG operations in over 90 countries, and we simply can't be all things to all clients in all geographies. Narrowing our focus. The first element was reinsurance, the second element was narrowing our focus, the third piece of the strategy is really focused around segmentation. Just Micro Segmentation. Get really down to the very detailed level to make decisions about which clients you want to be in and in which places you want to serve those clients. Refer to that as Micro Segmentation that uses both internal and external data to do a better job with respect to risk selection. Those things in total, I'd say, were the plan we outlined on January 26th.
I think our performance year-to-date demonstrates that we've been doing a very good job with respect to executing.
I'd agree with that, Rob. There's been a clear trend of improvement in the underlying loss ratio over the past two quarters. Oftentimes the question I get is, well, is this a bit more front-loaded than you would have thought? Do you still think we can see improvement come through over the course of this year and next year?
Yeah. I will reiterate that we are absolutely confident that we'll deliver the six points of improvement over the two-year period as we outlined in our strategy. To the extent that it has felt more front-end loaded, I would say that there's a very interesting dynamic that I think plays out here, and that is people who doubted our ability to execute the strategy generally said, "Well, look, market conditions will be wind in your face. It will make it more difficult to execute the strategy." I would actually just observe that in some ways, the soft market conditions have actually been a help to us in implementing our strategy. I'm not so sure that I would say that we'll deliver any more than the six points of improvement.
The ability to get there faster is helped by the fact that while we're practicing very careful restraint in the market, there's a lot of other competitors who have not been. When we want to exit a single product in a multi-line product relationship, we can constructively work through with the broker and with the client how to make that change. We found that competitors have been very happy to take that piece of business from AIG, a piece of business that we've had for a long time, that we know really well, and that we know on its own is not a profitable piece of business. I think the soft market conditions have actually, in some ways, been wind at our back and not wind at our face.
That's an interesting dynamic. I would've thought with the soft Commercial Insurance market persisting for the past several years, that that would be a headwind on margin improvement. What you're saying is because that business can be shifted to competitors, given their hunger for growth, that becomes less of an issue?
Yeah. I might describe the situation as saying, if you want to change your mix of business when market conditions are soft, it's a good time to change your mix of business. The reason is, if I were trying to shed a particular product, I can do that without horribly disrupting my client relationship or my broker relationship. That helps me to optimize my mix of business. Obviously, soft rates impact all of our lines of business. In that area, I would say it is wind in our face. Generally speaking, it's probably been more wind at our back where we've been able to improve the mix of business than it's been wind in our face.
That kind of leads to one of the concerns that was probably raised initially when AIG was exiting lines of business or certain geographies. Is there a risk of AIG losing profitable customers as it exits these areas? Where they might buy one of those unprofitable lines, but overall, is a profitable relationship at risk?
Yeah. We're very pleased with our retention of client relationships. Year to date, we've retained 94% of our major account relationships, and that's in an environment where we've had a much larger than a 6% decline in overall premium. What you can see is that we've been able to reduce the premium writings in those more challenged lines without disrupting the broader client relationship. With that said, I think it's just so important to remember that we're here for the purpose of serving those clients. The reason that our client relationships have been able to be retained is because we focus on what are the other differentiating characteristics of AIG that we can bring to the table, are there capabilities that enable us to say, "This is why AIG is different than our competitors.
Therefore, while we want to maybe change our mix of business in an area, you should be very happy to continue to maintain your long-term relationship with AIG." To date, I think it's been very successful.
AIG's Commercial Insurance property casualty top line has declined significantly. I believe it was down 18% in the first half of 2016 on a year-over-year basis. What's driving this trend, which seems to be a larger decline than the broader market? When could premium volume perhaps stabilize?
Let me take the second quarter, the results that we posted most recently as a case in point. We declined. We managed to see our premium volume there decline by about 20% in the second quarter of 2016 versus the second quarter of 2015. I would say that this was a part of our active management strategy. That's what's so important. About half of the reduction in premium was attributable to a combination of our reinsurance activities, which fundamentally mean we're still writing the business, we're just not retaining it net on AIG's books. As well as the exits where we've decided that that's just a line of business that it doesn't make sense for AIG to continue to focus on, as I described narrowing our focus earlier, and rate declines. I would say about half of it, 10 points, relates to those three factors.
It was the use of reinsurance is about six points. The reduction associated with the exits you could consider to be about two points, and the global rate decline for us about a point. That leaves about 10 points of our reduction in premium volume in Q2 to be attributable to really the microsegmentation and risk selection activities that we've undertaken. I think that that's been the driver. My view is that for the full year, premium volumes will be down about $3 billion on our starting point of $20 billion, so down about 15% for the year. Attributable, generally speaking, to the factors that I just outlined. I think for 2017 and 2018 and beyond, really the market conditions will dictate for us where we have the opportunities to grow.
What I can absolutely reinforce is that there are parts of this business that we really want to grow and where we're having success in growing. We find growth in the mergers and acquisitions space, in the cyber space. We're seeing growth in our middle market property, which is an engineered property portfolio. Of course, in a very important part of the AIG business, which is our multinational portfolio. We see great opportunities to grow in some places, but the market conditions will dictate for us whether we see additional opportunities to grow or whether we see additional opportunities to reshape the portfolio, with our primary focus being on value creation.
In that comment on 2017 and beyond, having top-line growth being driven more by market opportunity, does that mean that AIG has completed its view of major transitions in the reinsurance buying patterns?
I think the vast majority of our reinsurance transactions that we wanted to implement over the course of the two-year strategy period that we outlined on January 26th, we've largely been able to implement. We'll continue to be opportunistic. You will see where we've tested the reinsurance market, and maybe the market's not interested in something we want to do. I look at that as healthy. We're testing the market. We think we're offering things to the market that should be a good deal between us and the reinsurance market. With that said, we recognize the fact that it's a two-way street. This has to be something that works for us as well as for the reinsurer. Even though it may look good in my eyes, it may not look as good in the reinsurer's eyes.
Generally speaking, I think we've executed the transactions we need to and intended to execute, we'll continue to opportunistically look for places to even more further optimize the reinsurance buying decisions.
Right. Even though there might be some stabilization on a gross written premium basis in 2017 and beyond, taking into account perhaps buying more reinsurance, we should expect maybe some still downward trend in volume over the next couple of years, at a slower pace.
That's right.
That's helpful. Thanks, Rob. Let's touch base on expense savings. Can you give us an overview of your expense savings targets in Commercial Insurance, and how they'll be achieved?
I think it's important to begin on expenses by saying that this is bigger than a Commercial Insurance activity. It's actually an AIG-wide effort. I think that that's really important because the AIG organization is very interconnected, and it's important to me that other parts of the organization are working as hard as we are in Commercial Insurance to make sure that we're making operational improvements and improving the efficiency. We've outlined, again in our strategy presentation for January 26th, that we intend this year to improve our expenses by about $700 million. I think for the first six months of the year, we surely have demonstrated that we're at least on track for that $700 million improvement in expenses. The Commercial Insurance expense reductions are just a piece of that overall $700 million improvement in expenses.
Again, we benefit in Commercial from everyone's improvements in expenses because some of those expenses are allocated to us from other parts of the AIG operation. What I think is really important is in order to reshape the portfolio and in order to have the conviction and the courage to shrink, if we need to shrink to really get this portfolio to its optimal mix of business and its optimal profitability sort of targets, we have to be confident that we don't shrink the portfolio, improve the loss ratio, but see our expense ratio balloon back up, so that we have an improving loss ratio, but a deteriorating expense ratio. That's not really achieving the objective. What I'm really proud of is that we've demonstrated that we're heading in the same direction on both.
We continue to believe that the improvement in our loss ratio will not be given up in a deterioration of the expense ratio. That's because of the holistic efforts of AIG across the Commercial Insurance business, across the rest of the organization.
That seems to signal that any of the announced or achieved expense savings are going to nearly all drop to the bottom line.
I think that the expense savings will also be used to make sure that we can fund investments for future success of the organization. You'll see AIG continuing to invest in innovation, continuing to invest in technology, continuing to invest in what we refer to as the science part of the organization. I think our expense reductions fuel the future of AIG through those investments in technology, in science, in data, as well as enable us to have the conviction to shrink the portfolio and see the loss ratio not be offset by increases in the expense ratio, which does mean that much of that loss ratio or those expense reductions will flow through to the bottom line.
Okay, that's great. A question I often get about AIG's Commercial Insurance business is the reserve business. AIG took a substantial $3.6 billion reserve charge at the end of 2015. How can investors or other external observers have confidence that another reserve charge won't be needed?
I think it's very important to refer you back to the comments that our CFO, Sid Sankaran, made both in the January 26th strategy presentation as well as in our year-end earnings release. If you get the opportunity, I'd go back and read those because I think they're extremely helpful. One key point that I wanted to make is that we've continued to address focusing our resources not only around what is the central point estimate for our reserves, but spending a lot of time trying to figure out what the level of volatility we can expect around that central point estimate. We've put more and more resources around having greater conviction around the volatility around our best estimate assumption. I think it's really important to emphasize that we write many long-tail lines of business.
We write business in many geographies around the world, and we're subject to regulatory changes, random court decisions, to the tort temperature in those countries. All of those things will create, by definition, a level of uncertainty. We've put a lot of effort into getting our best estimate out there, and we use a lot of third parties to help us to validate the best estimate as well as our view of the variability around that best estimate.
Okay. Broadly, how would you characterize the conservatism baked into your reserves at this point?
I think I have to keep it simple and say that as the SEC rules require, we've put forth our best estimate. Our best estimate is informed by all the things that I just described. I hate to say that we can guarantee any particular result, and I hate to say that anything other than the estimate that we've put forth is our absolute best estimate.
Okay. Let's turn to another timely and favorable topic. The company recently announced the sale of its mortgage insurance business to Arch Capital for $3.4 billion. I know this is separate from Commercial Insurance, but it still falls within the, I believe, your area of oversight. Can you discuss the decision to sell this business rather than pursue an IPO of the mortgage insurance business?
Let me highlight a couple of very important points here. First of all, you noted the headline price of $3.4 billion. I just also want to emphasize that there is a very important element of reinsurance associated with the transaction. For the underwriting years 2014 through 2016, AIG has assumed from UGC the reserve risk. I think that we consider that to be a very favorable element also of the transaction that's not part of the headline purchase price.
Favorable from AIG's side?
Favorable from AIG's perspective. The truth of the matter is, obviously, it's a transaction with all of those factors put in place, the headline price as well as the reinsurance agreement that makes sense for both Arch and for AIG. You can imagine that this was an interconnected element of the negotiation. I think many people skip past that reinsurance element way too fast. Therefore, it is very important to me in Commercial because the insurer of that mortgage guarantee business is the Commercial Insurance business that I'm responsible for.
Okay.
The second thing I would say is we always take a very thorough, very holistic view of the options and the opportunities that are out there in the marketplace. We considered a partial IPO, we considered a full IPO, we considered multiple sale opportunities, and ultimately, we concluded that the best economic answer for AIG was this sale to Arch, which we announced just last quarter. I will say that that transaction is slated to close late this year or early next year, so it's very difficult for us to say much more about it, including I know many folks want to know what will we do with the proceeds, since maybe this is an accelerated timeframe versus what people might have expected for the sale of UGC.
Accelerated proceed amount.
That's right. Accelerated proceed amount and accelerated timeframe. I guess what I'd say is we'll disclose more when we get to the actual closing. In the meantime, you've seen this from us. We're very thoughtful about how we manage capital. Capital means whether we're doing buybacks, or whether we're paying dividends, or whether we're managing our debt capital. We're trying to really optimize the way we handle all elements of capital, not simply what's the quickest way to buy back. We are not marching to a metronome that just really moves at a very specific pace. We're very opportunistic, and we're trying to be very thoughtful about the way to optimize the result so that we can get the best return for our stakeholders.
That makes a lot of sense. At the same time, would it be fair to say, even at the outset where AIG said its goal was to return at least $25 billion of capital to shareholders by the end of 2017, that there might be even some additional confidence around that?
I surely would say that I can strongly reiterate our confidence in all of the metrics that we outlined in our strategic plan. Whether it was the Commercial adjusted accident year loss ratio, or our expenses, or our buybacks, or our return on equity, the truth of the matter is they're all interrelated, and this absolutely gives us confidence. The truth of the matter is we always have had confidence, and this just gives us further confidence.
Great. Okay. Last question before we go to the audience response systems. It's on mergers, acquisitions, and divestitures. I think it ties nicely into Arch, with the Arch transaction. There's been clearly a substantial increase in property casualty, merger, and acquisition activity over the past several years, most notably ACE's $30 billion acquisition of Chubb that closed earlier this year. What's AIG's appetite for acquisitions, both large scale and bolt-on?
I would say that we are very active in looking at any way to achieve growth, whether it's organic or inorganic growth. Quite frankly, we're also looking at divestitures if there's opportunities for us to optimize our portfolio. I would note, by the way, that we have made a number of smaller bolt-on acquisitions over the past couple of years. We've also made some smaller dispositions, including most recently the sale from the Commercial business of NSM, which is a managing general agent that we had acquired just over a year ago. The idea here is we're seeking to optimize the portfolio. In general, the way I say it to people is we already have size and scale and depth and breadth of capability.
I don't need to get bigger as my primary objective. I want to create more value. I want to be able to do things for our clients that no other insurance company in the world can do. If I can find opportunities to add a valuable specialty capability that we currently don't have, or that would be very difficult for us to build out, that's attractive to us. In general, we're not trying to simply collect companies or simply trying to get to be bigger. We're really trying to optimize the overall value equation.
Excellent. Why don't we go to the audience response systems since this is the first round of this during this conference? The way this works is I'll put up a question on the presentation slides, and I believe you have around 10 seconds to key in. You should all have a remote near you, and just press what you feel is the best answer. The first question is, if you currently don't own shares of AIG or are underweight, what would cause you to change your mind? We can start the countdown. The results here should come up in just a second. Around 40% saying they'd want to see a higher return on equity. The next largest answer being improved property casualty insurance underwriting results. We didn't talk too much about ROE, Rob, but the property casualty underwriting results was probably tied together pretty well.
Yeah.
On an all-in calendar year result, do you think there's the ability to drive improvement there, both on the loss ratio and expense ratio?
Yeah, absolutely. I think all of these things are interconnected. The improved P&C insurance underwriting results, the improved expenses that I described earlier, the $25 billion worth of buybacks that we've announced for over the course of the next two years, they really all tie nicely into our end objective, which is value creation that would be reflected in a higher return on equity. We have given a return on equity target for this year of 8.5%-8.9%, and we do absolutely expect to achieve that. We hear you loud and clear when people say that a higher return on equity would be a big motivator for buying stock.
That ROE, that's on a normalized basis, right? That would also normalize for things like catastrophes, some lower alternative equity, alternative investor returns in the first half, too?
That's right.
Next question, please. My confidence in AIG's ability to achieve its target Commercial Insurance property casualty accident year loss ratio of 60% by the end of 2017 is? Keep in mind that the accident year loss ratio was 63.4% in the first half. The result here. 45% saying high or very high. Good job, Rob on the-
Thank you
On convincing folks and also showing that you're well on your way in the first half.
It's clear we have a lot of work to do for those of you who show it as very low, low, and even neutral. For the record, you have my attention, and I am absolutely committed to making sure that we do that in a smart, thoughtful way.
All right. Next question, please. Should AIG remain a multiline insurer, or would it create more value for shareholders by separating its life insurance business from its property casualty business? We can start the timer. I put this question up sort of more related to the activist stance from a year ago, and that clearly that's had some updates since then. I feel it's just helpful for investors to express their view here.
Yeah.
All right. The response is 31% saying AIG should stay in its current form, 50% saying AIG should separate its life business from P&C, and 19% no opinion. It must be too early in the day. Any thoughts on this, Rob?
Yeah. Look, I want to use for you an opportunity here just to communicate about reinsurance because I think it's a great way to illustrate this point. We announced in the first quarter a reinsurance transaction with a major European counterparty. In that case, we announced the transaction with Swiss Re. As you know, Swiss Re does reinsurance for property casualty as well as for life business. You might ask yourself, how can AIG enter into a transaction that improves its loss ratio, therefore it must be good for AIG, also send it to a very capable, very informed reinsurance partner who is one of the best reinsurance counterparties in the world and have them feel good about it too?
I would tell you that the diversification that Swiss Re achieves through owning property casualty risks that we've sent to them from the U.S. alongside of, for example, international life insurance risks creates a very interesting element of diversification and a very interesting element of capital efficiency. Don't underestimate the importance and the value of the capital efficiency and the diversification benefit. I think that many people continue to view the only path forward for exiting the "SIFI" designation is the separation of life from P&C business. I don't agree with that.
It's also fair to say that the life and retirement savings business has historically generated the majority of the free cash flow available for buybacks, dividends, and debt service compared to P&C. If you split those up, that could cause a lot of challenges in terms of return of capital.
I love that point, Jay. I would also say just by the very nature of the business that we write the results of a P&C company will be more volatile than the results of a life and retirement company because we're subjected, for example, to natural catastrophes in the P&C business. These two businesses together create a very important element of stabilization. I think we can optimize that in a better, smarter way, and I think we're working hard to do that. I do absolutely believe that the life business and the P&C business have a very valuable place together inside of the AIG organization.
Okay. Next question, please. Should AIG allocate excess capital more to share buybacks and dividends or bolt-on acquisitions? I'm going to start the clock. Okay, winding down here. Almost 80% saying more share buybacks and dividends. Only 13% saying bolt-on acquisitions, 8% saying both.
Yeah
what I would've thought.
What I would say is it's very consistent with the strategy that we've been implementing. $25 billion worth of repurchases in buybacks in the 2016, 2017 strategic plan that we've outlined is very consistent with what's showing up here. I'll say we'll continue to be opportunistic. I think as this market is a soft market in the P&C space, it can present for us interesting bolt-on acquisition opportunities, and you should expect that we'll be very thoughtfully evaluating whether or not there's opportunities to do something that will create even greater value. I think generally speaking, that's very consistent with our strategy.
In AIG's view, how big is a bolt-on dollar amount?
Look, I think that for us to buy a company that has a purchase price in the hundreds of millions of dollars space is very natural and very easy for us to do. At some point in time, I think we have to just make sure that we're continuing to just stay focused on the main objective and not get distracted by too many small bolt-on acquisitions. I would say low billions or hundreds of millions is probably a range that I would consider would be bolt-on.
Okay. I don't know if we have any more ARS questions. All right. We have a couple minutes left. We can turn over to the audience for any questions they may have. First question. Right up here up front, please.
Thank you, Rob. This is Esra Kurum from Barclays. You mentioned about investment in innovation technology, Internet of Things, artificial intelligence, big data, big challengers for the future of insurance, for sure, as well as banking. How are you prepared for that change? Do you see it as an opportunity or a challenge, threat? How do you think your new strategy will be facilitated by this change, or perhaps potentially challenged by that change?
Yeah. We think that innovation is the only option. I think I would think of this sometimes when I do a presentation, I'll show a picture of a dinosaur, and it basically just says innovation or extinction. It's not a complicated message. Just remember, when you think about the Internet of Things, there's something like 10-20 billion objects connected by the Internet of Things today. By the end of this decade, that number will be 50-60 billion objects. You think of the pace of change in the world around us as continuing to increase. It's really important for us to continue to invest in this space.
That's why when Jay asked me about our expense reductions and that would all fall through to the bottom line, I paused there and said, "We'll continue to make investments in technology, in data, in innovation." The reason we will is because that's the path to being our clients' most valued insurer. That's the path to creating differentiation for AIG from the rest of the pack. We have a really wonderful advantage at AIG versus many of the rest of our peers, and that is the size and scale at which we can do things. The ability of us to capture data. For example, we pay $130 million worth of claims every business day around the world. $130 million worth of claims every business day around the world. That is a treasure trove of data.
When combined with data that's available in the outside world, we can have insights that we think are much more valuable than most others in this space. That's the kind of thing that you'll see us invest in. We see this as a huge opportunity and a huge differentiator for AIG.
That's great. Well, I'm afraid we're out of time, please join me. Thank you, Rob Schimek from AIG.
Thank you.
Well done. Thank you.