Good afternoon, everyone, and thank you for joining us. I'm Liz Werner, and for anyone I haven't had the chance to meet yet, I'm the Head of Investor Relations at AIG. Today you'll have the opportunity to learn more about our global consumer strategy and our valuable presence in Japan. There'll be two sessions for Q&A today. While we may not answer all your questions, we recognize that future financial presentations will allow for additional follow-up. Your patience as we consider ongoing potential financial disclosures is appreciated. I must remind you that today's presentation may contain certain forward-looking statements, which are based on management's current expectations and are subject to uncertainty and changes in circumstances. Any forward-looking statements are not guarantees of future performance or events. Actual performance and events may differ, possibly materially, from such forward-looking statements.
Factors that could cause this include those described in our first and second quarter Form 10-Qs and our 2013 10-K. AIG is not under any obligation, 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 also contain non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures are included in this presentation and may also be found in our financial supplement that is on our website at www.aig.com. In addition, similar to other U.S. companies, our Japanese statutory filings do not reconcile to U.S. GAAP financials. At this time, I'd like to introduce Jose Hernandez. Some of you have had the opportunity to meet Jose. He is the CEO of our Asia Pacific region.
He has been with AIG for 20 years, including experience as Global Head of Accident & Health and 10 years of experience in Japan. He's currently based in Tokyo, and he'll begin our welcoming remarks today.
Thanks, Liz. Good afternoon, ladies and gentlemen, and welcome to AIG's Investor Day. I'm Jose Hernandez, and I am the President and CEO of the Asia Pacific region, and today I will serve as your moderator. This is the first time that AIG has participated in this event. Before we start, we wanted to take the opportunity to thank all of you for your participation. The Asia Pacific region is a strong contributor to the overall results of AIG. In 2013, net premiums written of $9.7 billion represented 28% of the AIG P&C overall contributions to AIG. The region is comprised of 14 countries, of which Japan is by far the largest, especially considering that Japan is the second largest operation for AIG outside of the United States.
AIG is uniquely positioned in the region, particularly here in Japan, to better balance growth, profit, and risk as we strive to become the most valuable insurer in the eyes of our customers and shareholders. To facilitate the interactions today, we thought best to break down the presentations into two sections. First, we will present our global consumer businesses. After a very short break, we will introduce the Japan team to present our overall operations in Japan and strategy. That will be followed by a Q&A session. Sorry, because I skipped over this. After the global consumer business presentation, we will also have a Q&A session to focus on that part. The presentations today will be done in English, as we start the Q&A session, we have translators here in the room.
For those of you who prefer to ask and have your questions answered in Japanese, we can certainly do that. Let's get started. Our first presenter was appointed Chief Executive Officer, AIG Global Consumer Insurance in October of 2013. Mr. Hogan, who previously had a 24-year career with AIG, was most recently Chief Executive Officer of Global Life at the Zurich Insurance Group. It's a privilege to have Kevin in Japan to firsthand present AIG's global consumer business. Please welcome Kevin Hogan.
Thank you, Jose, good afternoon, ladies and gentlemen here in Tokyo, also good afternoon, good morning, good evening to those on the webcast. As Jose said, the first part of our sessions today is an introduction to the Global Consumer Insurance business, a business that was formed late last year by AIG. Global Consumer Insurance brings together AIG's life, health, and disability businesses alongside our property casualty consumer businesses of personal accident, supplemental health, automobile insurance, extended warranty, and our travel services business. Global consumer and Japan are very closely linked because Japan is one of the largest, it's the second largest of the global consumer businesses. Here in Japan, by far the majority of the business is in fact the global consumer portfolio.
I hope that this introduction that I'll provide in the next roughly 30, 35 minutes of presentation, followed by a brief Q&A, will act as context for the deep dive that we'll provide you on our Japanese businesses in the subsequent presentations. Global consumer builds off of the One AIG philosophy as we leverage the learnings of both our brothers and sisters in the property casualty commercial business, as well as the experiences of the life and retirement services businesses from the last few years. The global consumer business, as you will see, is large and diverse. In order to stay focused, I would ask you to pay attention to three important messages from the information I'm going to provide. The first is that we believe we have a unique franchise that will be difficult to duplicate in today's world.
We are driven by a data-oriented strategy, data-oriented decision making, including our data-driven pricing, which we'll provide more information about today. The third is that we have a focused growth strategy. It's a big world out there. There's a universe of opportunities, and it's important that we have a way of prioritizing our investments. I will address each of these three topics in succession and provide some examples. First, I'd like to just take a step back and provide a little bit of context around One AIG. Per our first and second quarter releases, we had two solid quarters as we focus in 2014 on our core operations, balancing between growth, profitability and risk.
We're driven by economic value, seeking economic returns in excess of our cost of capital as we drive towards our mission of being the world's most valued insurer, as defined by our various stakeholders, by our customers, our shareholders, our distributor partners, and our people. We intend on being the most valued insurer by using our risk expertise to help our customers understand and reduce ultimately their costs and risks. Using the global capabilities of AIG to provide value-added products and services that leverage our unique global position, our unique access to data, and our unique capabilities to deliver the insights needed to serve our customers. In 2014, our priorities have been an intense focus on our customers, strong growth and profitability in our operating businesses, enhancing our operational efficiency, and continuing to invest in our people.
The global consumer business brings together all of AIG's insurance products and services for consumers, whether individual or group-based contracts. The strategy is built on three foundation pillars, each of which I'll provide more detail about today. First, we have a unique franchise, not only in terms of the territories in which we operate, not only in terms of the products, where we're bringing together the life, health, and disability, along with the former P&C consumer products, but also in the long operating experience that we have and the expertise we have developed over time, and now most importantly, the relationships that we've built, many relationships going back decades. Second, we use a data-driven strategy, including data-driven pricing. This is an area AIG has invested and will continue to invest in significantly.
We emphasize the use of data in all of our decisions, whether in terms of product development, in marketing, in pricing, in customer selection, in behavior analysis, in overall optimization of our portfolios. We're beginning to see results, which I will share today. Third, we target focused growth. The universe for our business is huge, and so we have to be disciplined in our strategy deployments. We're balancing, remember, between growth, profitability and risk. This is one of our cornerstones as which we build our business to maximize the risk-adjusted returns for our shareholders. To put the opportunity in context, in the markets in which we already have either a property casualty or a life insurance license, predominantly property casualty licenses, the total universe between the life and property casualty products we participate in is over $3 trillion.
At $19 billion, which is not an insubstantial portfolio, we still represent less than 1% market share in the territories in which we operate. Clearly, we have room to grow. We have the franchise we believe to build on this opportunity. A franchise can be defined in several different ways. The first way I'll describe the franchise to a certain extent is the scale. On the left side of the page here, you see some comments on the property casualty part of consumer. Because we are a go-to-market business, we go to market as both the life and the property casualty product range, but we continue to report within the PC and the Life & Retirement segments. On the property casualty side, consumer is really the heart of the international business.
At 6 months of this year, 75% of the PC business outside of the U.S. is actually consumer business. We have very strong positions in key markets, including the world's biggest markets of the U.S., Japan, and the U.K. We have a multi-product, multi-channel strategy that generates great diversity, which benefits our portfolios in many ways. On the right side, we have the life, health, and disability businesses, a sound building block for the future. Right now, our biggest life operation is the U.S., where we have great underwriting and marketing expertise and a multi-channel strategy, which is core to our business model. As you'll see later today, a business model that we're now developing here with AIG Fuji Life in Japan. The life portfolios also represent stable earnings and further diversified risk across the portfolio.
The size and scale of a franchise is one thing, but what about the capabilities and the quality and the experience? I'd like to provide some background information on the components of this global consumer franchise. First, our travel insurance business. We have a leading global travel, medical assistance, and security assistance provider we market under the name of AIG Travel Guard. We've been focusing on the travel business since the 1960s. In fact, we've been a participant here in Japan in the travel business since the 1960s. For a long time, we have focused on what are the customer needs in the travel space, and what are the distribution techniques that can be successful.
One of our hallmarks is that for our business in Japan, we have established a global network of Japanese language doctors as well as Japanese culturally familiar services, so that as our customers from Japan travel around the world, we can provide them the services that they need. This is something that we began doing in the 1970s and the 1980s, not just recently, and represents the deep history of our travel franchise. We're building off of that experience as we expand our travel franchise, for example, into China now, which is the world's largest outbound travel market, or anticipated to be the world's largest outbound travel market in the next 10 years, and one of the fastest-growing. We also have a unique capability to launch multi-country programs to serve big providers in the travel businesses.
Just this week, we simultaneously launched a program for one of the airlines best known for customer service in the world in 22 different countries, a full-blown mobile and digital offer that within minutes of its launch had already contracted its first policies. We've taken our experience from travel services and expanded that into our extended warranty services franchise, which started as a country-by-country operation but has evolved into a business that's now focused on mobile communications, electronic devices, and multi-country programs. In the last 12 months, we launched programs in 17 different countries where the services that we provide have become an important part of their value proposition. In addition, a lot of companies talk about accidents and health. Personal accidents and supplemental health has been a focus of AIG since the 1960s. We have many long-term distribution partnerships and alliances that go back over 40 years.
For example, here in Japan, we have been working with the Hojinkai, the Small Business Taxpayers Association, as well as with the Daido Life Insurance Company since the early 1970s. For a long time, we've had a partnership with the Japan Travel Bureau, one of the biggest travel agents in the world, in such a great relationship that we decided to form a partnership together in a permanent foundation of our relationship. This type of relationship development doesn't exist only in Japan. It exists all over our franchise. For example, in the United States, some educational institutions, some volunteer associations, including firemen and policemen, and some other relationships go back over 50 years with the foundation of our A&H portfolio. In addition, in terms of distribution and distribution developments, we have long been a pioneer in direct marketing.
Our first direct marketing license here in Japan was issued in 1982 under the American Home Assurance Company. Not only here in Japan, but in other countries, we have been a pioneer, first in dropouts from newspapers and radio, in television, in telemarketing, and now in digital and mobile spaces. This is a substantial part of our portfolio we've talked about over the last couple of years and continues to be a rapidly evolving space. We have a very highly regarded network provider in the United States under the name of the Private Client Group. We insure around 40% of the country's billionaires. We insure some of the most important collectors in the country. We have very strong risk management practices, unique capabilities such as our wildfire protection unit, which physically tracks where fires occur in the Western United States.
If we identify a home that we insure and they're in the path of the fire, we can take actions to protect that home by spraying the foundation or the roof with chemicals and preventing damage, where we're using our risk expertise to help our customers reduce our cost of risk. Finally, one of our greatest assets is the data that we have access to. We're beginning to unlock the tremendous value in all of the sources of customer and distributor and behavioral data that we have. So when I say we have a unique franchise, a franchise difficult to duplicate, this is the value of our franchise. In terms of financials, I'll first talk about the property casualty business because it's maybe the most well-known portion of Consumer. I'd like to draw your attention to the bottom right part of the page.
The last couple of years, we have focused on getting the foundation right so that we have a solid foundation on which to grow. As you can see, we have enjoyed an improving loss ratio, and we'll talk about that in a while related to our data-driven pricing. In addition, from the numbers at the top half of the page, you can see that consistent with the rest of AIG's strategy, our emphasis is on value and not on volume. We focus on risk-adjusted, accretive business that returns excess of our cost of capital, and the results can be seen in the improving underwriting trends as well as in other aspects that I will demonstrate to you today. In talking of portfolio diversity, the next page is actually a combination of the portfolio with the go-to-market approach, including life as well as property casualty.
You can see here that our emphasis is on diversification. Around 59% of the portfolio is the life and accident and health portfolios, very stable sources of income. On the right side of the page, you can see the regional distribution, the Americas and Asia Pacific, each representing just shy of 45% of our portfolios, driven by the large markets of the U.S. and Japan. In terms of diversification within the product lines, the short tail nature of our property casualty consumer business is very attractive and contributes tremendously to our business diversification as well as our capital diversification opportunities. There's almost an even split between personal lines and accident and health businesses. As you can see on the right side of the page, Japan is a tremendous contributor to the property casualty consumer businesses, the largest contributor to the consumer businesses.
The overall portfolio of $6.7 billion grew just shy of 4% in the first six months. In terms of the life portfolio, this is primarily our U.S. life and A&H business as reported. There's also a story of diversification. You can see the product diversification on the left side as well as the channel diversification on the right side. It's long been our strategy to manage channel diversification. You can see we span from career agents, independent general agents, broker-dealers and banks, independent broker general agents, and also consumer direct and digital marketing across the U.S. portfolio. When my colleagues talk about Japan this afternoon, you'll see that we're beginning our channel diversification in our life insurance portfolios here, and our property casualty portfolios have long benefited from significant distribution diversification. Our U.S. life strategy is a story of stability. We've intended on developing modest growth.
We have a conservative portfolio, and we're generating steady earnings, as can be seen from the numbers and the results on this page, as reported previously. Another look at our franchise is by region. Here we have the Americas, predominantly commercial insurance business. The consumer portfolio is very important. I mentioned Private Client Group, and you can see some of the statistics there. We have the travel insurance business, a very large and successful warranty business. Of course, our foundation portfolio of accident and health, which includes business travel accidents, education markets, healthcare markets, and specialty groups. The next region, Asia Pacific, some of the world's fastest-growing markets, we have a solid track record of success.
Some of our success is relevant to our emphasis on customer service, we've received excellent external recognition for our performance there, including for six years in a row, the J.D. Power Customer Satisfaction Award for automobile insurance claims experience here in Japan. In addition, other awards to our franchises across the region. Second thing I'd like to draw your attention to is our distribution development and innovation, including our unique relationship with The People's Insurance Company of China, now in its 10th year, where we have a strong partnership in the accident and supplemental health businesses and more recently announced a life insurance joint venture to develop distribution in that fast-growing marketplace. Finally, we have targeted scale.
We don't try to achieve scale in all markets, in markets where the opportunity exists, we do develop a full product range, scale-oriented operation, such as in Singapore, where we are the largest general insurance provider. In EMEA, we have lots of opportunities in this very large and wealthy market, Europe, Middle East, and Africa. As you can see, AIG's portfolio is still primarily commercial. However, we've recently made tremendous strides there, including the previously announced partnership with HSBC in Turkey, one of the world's fastest-growing markets, as well as our pending acquisition of Ageas Protect, an innovative, nimble platform in the U.K., the third largest life and savings market in the world. We have a diverse, unique, and difficult-to-duplicate franchise, we've been focusing on improving our underwriting results. Now turning to the next page, some of our activities in underwriting area.
Some of these tools will likely be familiar to you because they're similar to tools that have been successfully used in AIG's commercial portfolios for the last couple of years. In some of the earnings calls, I've commented on the fact that we in consumer are learning the lessons and deploying and applying similar tools, although we're at slightly earlier stages of development. The reality is our portfolios are shorter term. We're able, in some cases, to see the impact of our underwriting results visibly. Whether it's enhanced rate level reviews, enhanced rating structures, standardized global raters, advanced catastrophe pricing, or price optimization strategies, we're learning from and developing the tools necessary to optimize this portfolio. We don't try to do everything everywhere.
We recognize that we have to balance our initiatives, we've prioritized using a risk-based approach, focusing on the biggest opportunities in the biggest markets. These results are leading to stability in our loss ratio, albeit with some natural event-driven variance. There's a few key points on this accident year excluding cats and PYD page results as reported. The first is that over the last three years, although the loss ratio has moved around a little, it's within a very narrow band. On the high end, 60.7%, on the low end, 55.7%. Again, accident year excluding cats and PYD. There are a few events, largely stable to improving trends.
You can see the comment on the weather-related claims in early 2012, our as-earlier-reported warranty situation in the U.S. where a particular product changed in its experience, and we moved very quickly both negotiating with our customers and taking underwriting actions to respond to that change, which is now starting to earn through the portfolio. We had a spate of unusual weather late in 2013. Of course, in the second quarter of 2014, where we've started to see the benefit earning in from the hard work that has been done here in Japan in the last couple of years, which my colleague Tim will provide more information about, as well as our underwriting actions in the large market of the U.S.
We've reached sustainable competitive loss ratios in most of our major products, and we continue active portfolio management, data investment, and enhancing our tools as we continue to optimize the portfolio. That's the close of our second message. We're confident that our data-driven pricing is a sustainable strategy. The third message, actually, we have a broad and a diverse business, and we have plenty of opportunities. So one of the things that we've worked on is developing an appropriate framework by which we determine how to prioritize our actions, how to prioritize our investments. We call this tool the market maturity model. Now, I apologize that this slide is a little bit noisy. I'd like to describe it.
Essentially, what we've determined is that markets develop in a certain way, whether it's the products that are available, the channels that exist or are viable, and the customer segments which are appropriate for certain insurance products and channels evolve over time. Now, we're not naive. We know every market doesn't evolve in a linear fashion, and we can't necessarily plug a country into a specific place in this model at any time. However, it is instructive in terms of taking a large and diverse portfolio such as AIG has and identifying what are the various characteristics that determine which products and channels that we should be mobilizing in a particular market. So we have mapped our enterprise to reflect where we believe we are on the continuum and then optimize by market accordingly.
Now I'd like to provide sort of a few examples of how this works in practice. First, on the left side of the page, there's many markets that are in early stages. Sometimes these are fast-growing markets. The populations are at a stage where they may not be able to afford the more sophisticated products, or the overall opportunity size may not warrant the investment in the infrastructure for some of our more sophisticated products. So in those places, we focus on areas like accident, personal accident, and travel insurance, warranty insurance, programs which are relatively low cost to administer, many of which are multi-country distributor partner in nature, and where we can access mass distribution, sponsored distribution, or travel industry distribution service program providers.
There are few examples of markets such as this that are now in the process of potentially transitioning to the next stage, including many of our what we used to call strategic business expansion units, the SBEs, such as Turkey and Colombia and Mexico. The next phase as a market develops is a very important one because as a market matures, the opportunity becomes viable to invest in some of the more sophisticated business. In most cases, that starts with automobile insurance. We have to be careful about making decisions where and how to invest in automobile. It's a challenging line of business. It also requires investments in the appropriate systems, actuarial skills and capabilities, claims management practices, et cetera. We don't underestimate those. Also, distribution becomes more as the models evolve.
We have several examples of portfolios that are at this stage, where we have almost the full suite of the property casualty consumer products available and where we're growing our market position. Greece, Israel, and Ireland are three examples. We're not just boot stamping out the same model everywhere. We remain market sensitive. Although these are three countries which we consider at similar stages in the market maturity continuum, our business model is different in each. In Greece, we primarily work with agents. In Israel, because of the way that market has developed, we primarily focus on direct marketing. In Ireland, we have a combination of direct marketing agency and independent distribution. All three equally attractive, equally successful operations.
Where great opportunity lies for us is on the right side of the page, the world's mature or the world's fast-growing markets that have reached the stage of maturity in the insurance marketplace of distribution and product. This is where we have the opportunity to enter the life, health, and disability product lines. We have to make careful investment decisions because once we decide to enter the life business and we accept policy number 1, we realize we have to be committed to that market for 20 or 30 years to serve those customers. There will be fewer countries that qualify for our investments in these areas. Distribution is much more sophisticated, including, in some cases, the very capital-intensive development of career distribution, as well as working with independent advisors in institutional sales.
These represent some of the world's largest markets, the U.S., the U.K., and importantly, Japan. Japan today is our deep dive, and it is a great example of the consumer insurance strategy at full bloom. It's in early stages because of the early stages of our acquisition of Fuji Fire and Marine, including AIG Fuji Life, but it is representative of the opportunity of this strategy. In conclusion, I'll reaffirm, we believe we'll be successful because we have a unique franchise, one that will be very difficult to duplicate, especially our relationships and our experience, that we are successfully deploying a data-driven strategy, and we're starting to see the results. Third, we have a model by which to target our growth so that we can remain balanced between growth, profitability, and risk and maximize the risk-adjusted returns for our shareholders.
Thank you very much, and I'm happy now to take your questions. I think we have a couple of microphones down here in front.
Thank you. Jay Gelb from Barclays. On slide 10, we've got an accident year, first half combined ratio around 99. What do you think that should be? It seems high. On page 20, you've shown the accident year loss ratio improved the past two quarters. What do you need that to be?
As I said, we've done a lot of work on the loss ratio. I believe our loss ratios are at competitive and sustainable positions in most of our major products and major markets. The 99, I will remind you, in the first half of this year, we had a spate of severe losses in the U.S. personal property portfolio that were quite unusual. It was the first quarter, I think, in 27 quarters in which we've had more than a single severe loss, and in fact, we had three, which drives up the aggregate loss ratio for the first half of the year.
Okay. Kevin, where does this business need to be on the combined ratio level for you to hit a target far away? I think that's what we're trying to get at.
Well, similar to what has been disclosed and what AIG describes as our position, we base our focus on an economic model. We are working towards contributing to AIG's movement towards achieving a risk-adjusted return excess of our cost of capital rather than stating a specific combined ratio target. Actually, we do continue to work on all aspects of our business and optimizing the economic returns. We use a risk-adjusted profitability measure to determine our pricing models and our underwriting strategy.
Hi, Kevin. Josh Steiner from Deutsche Bank. On the second quarter conference call, Peter Hancock mentioned, I'm looking at slide 20 here, that investors should expect an elevated consumer insurance accident year ratio for 3Q14 because of seasonally high losses in the Japanese auto market. If I look at historically, third quarter seems to be the best quarter for Japanese auto results, not the worst. I'm wondering to the extent, what did he mean by that third quarter being seasonally high for losses? Two, when we look at the improvements in the first half of 2014, how much of that is process-oriented and getting down results? How much of that will be seen then in 3Q mitigating that seasonally high loss trend that you see in third quarters?
Okay. I think that what Peter's comments were really driving at and the reality is it's the second quarter, which is, in many cases, I think seasonally improves. The weather is something that has to do with that. The miles driven is something that is also relevant to that. The gas price in Japan has had an impact on the miles driven. Second quarter was a low-frequency quarter. I believe that if we return to historic norms, the second quarter level is unlikely to necessarily be sustained throughout the year.
Third quarter won't be particularly a spike compared to 3Q '13. I mean, I have to make a forecast, we shouldn't necessarily prepare for elevated results in 3Q.
We certainly can't predict the future, but the second quarter was unusually low as a result of a variety of factors, including the miles driven and also the historical fact that the second quarter is generally a better weather quarter.
I know it's difficult to say, but looking at 2Q13 being at 60.2% and 2Q14 being at 55.7%, how much of that was process-oriented improvement, and how much of that was a very good 2Q for weather and miles driven?
If you're looking across this portfolio, the Japan auto is an important contributor, but also the U.S. warranty business is relevant. We did have a spike in warranty losses in the second and third quarter of last year, which we have disclosed. The underwriting improvements that have taken place in warranty also contribute.
Thank you.
Thank you. Ryan Tunis, Credit Suisse. On non-Japan Asia, it's 11% of your global consumer portfolio. I'd argue it's the highest growth potential out of all the markets you're in. You've got a very fragmented early stage market in many countries. You've got regulators trying to consolidate the market. You've got de-tariffication of motor in China and Malaysia as examples, which would be, I think, catalysts for companies like yourself with the skill set you have to create opportunities for you. Given you didn't mention the Asian countries in the developing and emerging part of the slide you've got up there, can you talk a bit about non-Japan Asia and your focus growth strategy and which markets appeal to you, where you would like potentially to grow, from where you see the opportunities for you?
Sure. Getting back to the maturity model, depending upon the state of the evolution of the market, we have different opportunities. In all markets, we have the opportunity of travel insurance and warranty services, which are two global franchises that we have. We have begun to roll out some of these multinational programs in various territories across Asia. In our markets where we are investing in the development of the multi-line offer, we have a substantial presence in Singapore and in Malaysia to build off of. These are very important opportunities for us. In China, we have two unique opportunities. We are among the first companies to have a telemarketing license for automobile insurance in China. Whilst it's at early stages, we are in the process of piloting telemarketing in two different provinces in China.
Also we have the relationship with the PICC, which has the accident and health aspect of it, which is a relationship that's ongoing for 10 years. More recently, we had the opportunity to develop a life insurance distribution company. Our primary focus is on building off of the capabilities that we have in those places where we have them, as well as expanding the global franchises in the more emerging markets. I think there's a question down here.
Hi, thank you. Josh Sterling from Sanford Bernstein. I'll follow up a little bit with the conversation around the sort of targets and profitability and where we're going. I really liked your slide 19, which was a bunch of different details on how you guys are driving presumably for future profitability. I was wondering if you could walk us through just a little bit more color, how to interpret this. In particular, if you could give us any sort of anecdotes or have a sense of how much impact each of these individual levers might have. In particular, I'd ask around the enhanced rate level review, I imagine that's the one that is most important for driving margins. It looks like it's already implemented in most of your big drive lines.
I was kind of curious, linking back to some of the comments we've already had, are you guys satisfied with your current, one, can you walk us through this, two, does this imply that you're already satisfied with the level of profitability that you're at currently? Thank you.
Great. Thanks. First of all, are we satisfied? I think that we have to look at the portfolio of the loss ratio and other components. We've been working on improving the loss ratio. Whilst we're never satisfied, we do believe that with the disciplines that we've implemented in the last couple of years, we've reached competitive levels that are sustainable, we will continue to work on further refinements and improvements, and we have opportunities to do that. Of the various tools and techniques, actually, enhanced rate level review is important, and ensuring that we maintain rate adequacy in advance of the cost of inflation on claims is a critical part of the strategy. I wouldn't underestimate the importance of the rating structure because the rating structure can also lead to segmentation changes which we can operationalize into the business.
It's not purely a matter of the actual rate structures themselves, what that facilitates in a marketing offer in selecting the customers that we believe will have the best risk-adjusted profitability. Clearly the automobile line of business is one which is most sensitive or among the most sensitive to price, and that's one of the areas that we've worked on a lot there. Representative of some of the actions that we've taken, and I think Tim Schultis this afternoon will describe the results in our automobile and A&H business here in Japan. We've adopted a process of regular reviews, even where previously they may not have been determined as necessary. For a portfolio that historically may have been profitable, it may have been well in excess of our profit expectations, doesn't necessarily mean that there aren't opportunities to further optimize.
We've gone beyond the level of the obvious. We are now working on optimization of portfolios that may already otherwise be profitable. We have been able to continue to work on those areas. In some cases, we have products out there where we may not have filed for a rate review in several years, in some cases longer than several years. Yet the opportunity is there in restructuring the rate filings to then be able to improve our optimization of the portfolios. I think that the rate level reviews and the disciplines around rates have yielded the results of just regular improvements in rates to keep up with loss cost inflations, plus further optimization on portfolios that are attractive portfolios for us.
The rating structure is something that has improved our ability to attract customers in the segments that we prefer that have the better margins. The standardized global raters are important for the global businesses. To a certain extent, this is one of the opportunities that we have in the global business, is to pool the experience and build off of that pooled experience. Some of our strategies are specific market to market. Other of the strategies are built off of the pooled global experience. I hope that provides some insight.
Thank you, Kevin. If I could ask just one follow-up. I think people have asked you already for your targets, you guys can't give them, I understand. If I were to ask you sort of a different way, which is when you think about strategic planning for your business, you look across your portfolio of businesses. Some of these are clearly specialty businesses, things like warranty and travel and Accident & Health. For a lot of competitor, high 80s, low 90s kind of combines. Auto and Japan, more challenging. When you think about all of your challenges, whether it's need to get to scale or invest in the business, what do you think is possible? What should we be thinking about as long-term sort of the opportunity here in this business? Thank you.
The long-term opportunity of this business is for us to carefully build off of the franchise that we have. We're already leveraging the global franchise in travel and in warranty by multiplying the number of partners that we work with. Warranty is a good example. We innovated the opportunity to simultaneously provide services in 17 different countries on a standard basis for one particular retailer, or one particular manufacturer, I should say. We've now extended that capability to other similar manufacturers and also to retailers. We're leveraging the infrastructure that we built for multiple transactions. It takes quite a lot of work in terms of legal, contractual work, systems investments, et cetera, to enable a program like that. The efficiency gains on the second, third, and fourth programs are substantial. Same thing with respect to the airline programs.
The airline program that I mentioned we just launched this week is not the first multi-country airline deal. It is probably the largest that we have done to date, it's using the same infrastructure that we put in place for regional programs and global programs in the past. I believe that we have an opportunity to optimize in terms of efficiencies by using the capabilities that we have for greater scale and creating economies of scale. That also is an opportunity as we add lines of business. We're not representing all of the lines of business in all of the markets. For example, in the United Kingdom, where we have a very substantial Property & Casualty operation, we recently made the decision to acquire an acquisition that's pending with the Ageas Protect.
This will allow us to leverage off of the customer bases, the distribution channels, the capabilities that we have, bringing their unique skills and capabilities straight through processing, et cetera, such that we can gain efficiencies of scale out of the platform that we already have in place. In terms of our overall acquisition costs, our expenses, we can certainly improve our efficiency by increasing our scale. Other questions in the back here?
Hi, Jimmy at J.P. Morgan. I had a couple of questions. First on your, I think you mentioned you expect the loss ratio to stay stable. I was a little surprised since over time it seems like Accident & Health is a product that you're trying to grow and should have better just given the business mix shift, your loss ratio should get better over time, just naturally. The second question on page 10, you show a slide with just operating income for the global consumer business. Maybe if you could talk about how the operating earnings compare to cash flow that the businesses are generating, especially outside of the U.S., and what's your ability and intent to bring that capital to the U.S. versus just leaving it in international markets?
Okay. The first question on the loss ratio, what I said is that we believe that we have sustainable and competitive loss ratios by our major product lines and major businesses. In terms of improving loss ratio based on mix, we certainly have that opportunity. I didn't mean to suggest that we don't have the opportunity to manage the product mix. Certainly, we will and we do. In terms of the cash flows, as you know, we have a global capital management strategy, and we determine where the best risk-adjusted returns are, and we use our global liquidity and capital management strategy accordingly. The specific results of the consumer business are not necessarily relevant to the overall question of cash flows and capital management.
No, my question is more about if you think about the earnings that you're generating outside of the U.S. in the consumer business, how close are they to real cash that the business is generating and what you're doing with the cash? Do you intend to take it back to the U.S.? Would you leave it here to invest for growth or acquisitions or whatever else?
Well, again, that gets back to the capital management strategy. I think that in terms of the earnings versus the cash flows, many of these portfolios, except for the supplemental health portfolio, some of the accident and supplemental health portfolios are relatively short term in duration. So I think the fact that the liabilities are relatively short term in duration largely speaks for itself.
Just one more on, what's your desire for acquisitions in the international consumer market? If you have a desire for acquisitions, what are the markets or regions that are the most attractive?
Well, obviously, I don't think we historically comment on that. What I will say is that acquisitions are an important potential part of the strategy, where they are consistent with the strategy, where there is an opportunity to expand on capabilities that we have or to complement the capabilities that we have, obviously, most attractively, where we have the right price. In addition, in the consumer business, acquisitions that bring along substantial distribution opportunities can also be consistent with the strategy. Okay. One more.
Thank you. Jay Gelb from Barclays. If Scotland becomes an independent country, what is the impact on AIG?
I'm not going to predict what the outcome is going to be, I think that there are broad discussions around the contractual measures. It would depend on what the nature of the determination is, depending upon the outcome as to how the process will unfold. I don't think AIG is alone in being aware that we need to be prepared for multiple outcomes. Okay. Oh, one more back here. I think we're going to wrap it up after this.
Hi, Thomas Gallagher, Credit Suisse. Just from flipping through the slides, it looks like the majority of your A&H business is actually accident. Most of the other companies who have presented this week are more health. We've been hearing how terms and conditions are softening, I'd be curious what that environment looks like for you on the accident side.
Okay. Well, it is true, we have a strong component of the portfolio in personal accident. That has been something that we have very carefully focused on for many, many years. The faster-growing part of our portfolio is, in fact, the supplemental health portfolio, both here in Japan and elsewhere. I think my colleague Tim this afternoon will provide more information and insight with respect to our third sector strategies here in Japan. It continues to be a very important part of the strategy. With the demographics, the aging around the world, we have been working in a variety of markets on products that are appropriate to the senior space, and we have some track record of success there. Health and supplemental health is a significant opportunity for us because it is not a substantial part of our portfolio right now.
We don't have a great deal of in-force to protect, and we can adopt more disruptive strategies.
Just a follow-up. Is the accident market a hard market right now? What are pricing trends like right now? I think there was a slide I flipped through a little further on that looks like the loss ratio has shown steady improvement. Just curious what it looks like right now.
Historically, the personal accident market has not been all that price sensitive of a market. It's a market that's much more driven by marketing and positioning. I think that the margins have been consistent in the personal accident business, and that's a common trend, not just here in Japan, but in many places. It's a slightly different line of business than many.
Thanks.
Okay. All right. Today, I will let you introduce the break, I guess.
All right. Thank you, Kevin. If there were any questions that you were keen to ask, hold them up. We'll do it at the closing Q&A session after the Japan presentations. I think after our colleagues from Japan make their presentation, I think that'll give additional context to some of the things that Kevin shared with us. We can pick that up there. Why don't we take a short break? If we can get back here in 10 minutes, that would be great. Thank you. How's everything we're doing in Japan? See my friend? Folks, if we could take our seats. Gosh, it's making me run off schedule. That's a nice light right there. Thank you. We're running a little bit behind schedule, I just wanted to start again fairly quickly.
As I mentioned before, the second part of the presentation will provide all of us with an overview of our operations and strategy in Japan. The presentation is going to be shared by three of my colleagues. What I'm going to do is I'm going to introduce the three of them now and then allow them to deliver their presentations and pass the presentation along to each other. Leading off the Japan overview and strategy will be Robert Noddin. He's the President and CEO of AIG Japan. Bob began his career at AIG back in 1985 and has held a number of roles of increased responsibility in New York and throughout Asia. His experience in Japan dates back to 2002, when he first served in an operations and systems leadership position. Following Bob will be Tim Schultis, Japan's Head of Consumer Insurance.
Tim has over 30 years experience in the insurance industry, mainly in the life and retirement space. Since 2000, Tim has focused his efforts here in Japan, and he's currently based in Tokyo. Closing out the Japan operations and strategy session will be Naomi Matsuoka. Naomi is AIG Japan's Chief Transformation Officer. Naomi recently joined AIG and brings an extensive experience in investment banking, especially as a trusted advisor to companies in Japan looking to improve their capabilities and to transform. To get us started on the Japan overview, Bob Noddin.
Thank you, José. Welcome back. Had Kevin handed off to me, I wouldn't have had to fix the mic, but José's significantly taller, so bear with me. Thank you, José, for stealing my notes. Tim, Naomi, and I have the privilege to introduce you to AIG Japan today. We want to focus on what makes us different to other AIG businesses around the world and what makes us different in the market here in Japan. I'm going to touch on, through this process, a quick overview of our history and some of the key major milestones in that process. We'll talk about our different businesses here in Japan. We'll talk about the context of the Japanese property casualty marketplace and how we sit against that. Then we'll talk about some unique aspects of the AIG Japan business.
This timeline has been skinny down from an awful lot of things that happened on it. Basically, the intent of this is to give you a context of our long history here in Japan, and also to highlight our ability to integrate locally and how we've approached segmentation. Obviously, the first date on the slide here is 1946. That was where AIG was the first foreign non-life insurance company here in Japan. We started serving a unique post-war need supporting the occupation forces. Obviously, the Fuji Fire and Marine organization was founded earlier than that as a local organization and has only recently become a full addition to the AIG suite. In 1971, Kevin mentioned this before, and this is kind of a key part of local history for us here in Japan.
We partnered with Daido Life Insurance for product development and distribution to address the needs in the Hojinkai marketplace. Kevin touched on that briefly. They do have a sister organization, or maybe better to say, a brother organization in the Kansai part of Japan called the Nozokyokai. Effectively, that small taxpayers' association in Japan is quite unique to Japan. In 1989, he also mentioned the partnership with the Japan Travel Bureau, obviously one of the world's largest travel companies, and we focused aggressively on how to provide and offer unique offerings in the travel marketplace. These hopefully should give you a sense for the clear evidence of our experience locally on a long-running basis here in Japan with an appreciation for what it takes to become a local partner in the business place here.
It's also a clear evidence of our ability to understand the proper opportunities and how to find segments where we felt we could bring something unique and different in both product and distribution. In 2002, our initial investment was made in the Fuji Fire and Marine business. 2011, that acquisition was completed, quite an extensive period of working together, working with that organization, and growing to a greater understanding of what Fuji brings to the marketplace. In 2013 and 2014, we completed the localization of the AIU branch and the American Home branch. We completed the creation of a local insurance holding company here in Japan. Big milestones for us that we'll factor into this conversation as we go further on. The stars across the bottom are just trying to highlight several of the more significant innovations and demonstrations of recognized market leadership in Japan in that process.
In 1964, we introduced the first third-party automobile claims capabilities. We also introduced a feeder system of developing a pipeline of professional producers in Japan we refer to as the independent solicitors or the IS. This is where we've recruited and trained and developed our own sales force, which then graduates and becomes independent producers, and I'll talk more about that in a few minutes. In 1976, we introduced, as Kevin mentioned, as a part of our unique travel franchise, the ability to real-time link the issuance of a travel ticket reservation with the travel insurance capability, a key part of a lot of the strategies we've worked on in the travel business here with our partners. In 1997, the first license in Japan for differentiated automobile product through the American Home operation. In 2006, the first electronic digital policy issuance in Japan in the industry.
The thing I think Kevin mentioned, and I'll highlight here, which I think is the best indication of how our customers in Japan value our service capability and the role we play for them, is six consecutive years for the AIU operation of recognized as number one in customer satisfaction for automobile claim handling by J.D. Power. These are obviously some of the more significant examples of how we look to bring innovation to the marketplace, a position we have both the global footprint and the local scale to continue to do it. Next slide. A quick sense for our go-to-market positioning in Japan. Our footprint here reflects what we believe is quite a unique difference from most other markets we operate in, other than perhaps the U.S. It plays to clearly customer segmentation and a diversified distribution capability.
As we've previously announced and are actively pursuing the merger of the two largest businesses in Japan, AIU and Fuji Fire and Marine . These two companies are roughly similar in premium size, but quite different in their strengths. Naomi will discuss this in more detail shortly. The American Home and AIG Fuji Life consumer businesses were touched on briefly by Kevin. As mentioned previously, American Home is and has been since its inception, a market leader in the direct marketing space. AIG Fuji Life, while a relatively younger business for AIG, provides the foundation for further opportunities for us here in Japan. Tim will take you through that AIG Fuji Life piece shortly.
Our One AIG effort in Japan is positioned around how we become a more seamless offering to our targeted customers, how we best leverage our transformation investments in Japan, and how we maximize the distribution opportunities of our 39,000+ agencies. That number reflects both individual producers and multi-sales force agents in the business. The actual number of salespeople on the street is significantly larger to that, I'll give you a little bit of sense of that in a few minutes. The overall property casualty market here in Japan. I was going to say I appreciate that most of you have tremendous life insight and experience, clearly based on some of the questions to Kevin, you also have considerable property casualty market experience. This is the world's second-largest property casualty marketplace after the U.S. It is a mature market.
However, it is quite under-penetrated here, we have selected growth opportunities, which I'll talk on in a few minutes. That under-penetration has a lot to do with the traditional nature of large Japanese corporate relationships, which I'm sure you will know are referred to as keiretsu, and their cross-shareholdings. If we look at the pie chart in the middle, you'll see that the largest component of the P&C market here in Japan is automobile, both voluntary and compulsory. I'll talk to how AIG is positioned against that mix in a minute, and Tim will talk to you about our efforts to improve in that area shortly. If you look at the right-hand side of the page, you will see how the market consolidation of the past 10 or so years has impacted presence.
This also should show you that AIG represents the only true scale alternative to the largest three local players. I'll take you through here at a very high level, the legal entity view on the left-hand side. This reflects the four licensed insurance companies here in Japan. These operating companies sit underneath the recently created AIG Japan Holdings local holding company, and they are supported by a number of other support organizations locally. On the right-hand side of the page, you'll see that accident and health number, which Kevin mentioned before. This is the third sector A&H cover. Fuji Life has both first and third sector, so life and accident and medical in that number as well. The fire business here is both consumer and commercial because the local market does not distinguish between the two.
In the case of AIG, the internal strategies and capabilities to manage them are quite different. The others category here is casualty and other specialty lines such as trade credit, political risk, financial lines, aviation, and environmental products. How does that stack up against the local competitors? While the Fuji Fire acquisition several years ago did expand the size of our automobile share in our overall mix, we are still significantly smaller in auto than the local players. Also, that third sector accidents and health portion has brought a real differentiator to our mix that impacts both the loss and expense ratio components of our business here in Japan. It carries with it a slightly higher expense ratio acquisition component, but it operates at more attractive loss ratios.
To be clear, the biggest points of note for AIG versus the market are that our automobile portfolio, the sum of both the voluntary and the compulsory, runs anywhere from 8%-19% smaller than our largest local competitors. Our accident and health portfolio runs roughly 13% more in our overall mix. We do think we have that mix right at the moment, but as we'll see the demographics presenting new opportunities in the life, medical, and commercial space for targeted growth as we go forward. Positioning and unique aspects of AIG. What makes AIG Japan different, and how can we succeed in the market so heavily controlled by three local players? As Kevin said earlier, data-driven analytics and segmentation to focus on the right growth opportunities are quite pivotal to our history, our present, and our future plans.
That gets us to the right risks with the right balance of growth and profitability. I'll take you through one key example. As Kevin mentioned, we are one of the largest pieces of the overall AIG consumer pie, but please bear in mind that we are also one of AIG's largest commercial operations across the world. We look materially different in that book from both our product and distribution components to how the rest of our AIG businesses look globally, but that's also quite true for our comparison against domestic competitors. In order to crack into that commercial market, where so much of the large corporate business was controlled through those keiretsu connections, we needed to find the places to play, the products that were needed, and the distribution to get those to those places.
That's where the SME, that small medium enterprise marketplace business, has come into play for us here in Japan. SMEs make up the vast majority of commercially licensed businesses in Japan, and they generally don't have those keiretsu controlling links. That's where the partnership with Daido Life, dating back to 1971, in the form of distribution and product, and the Hojinkai for segmentation and their endorsement to their members have played a key role in helping us find the spots to play in and win. It was also in this space that we focused the development of professional consultative sales capabilities by recruiting and building a professional needs-based sales organization of both independent and internal career producers. That's quite different from other AIG country operations around the world, and that's not a new strategy for us here in Japan. That's something we've been doing for the last 43 years.
If we look at distribution, in basic order of their contribution to us, let me walk you through that. The independent agents are just that. These are professional, full-time insurance agents. A large portion of those producers have been AIG recruited and developed and trained a la that independent solicitor component I mentioned to you previously. Many of them are co-registered with other property casualty companies here in Japan, so they have a choice. Many of them are also registered as life providers. The partner channel consists of a variety of non-insurance professional agents whose primary business is not insurance. Examples would be automobile dealers and repair garages, realtors, home builders, mortgage brokers, travel agents, and so forth. We've partnered with them to produce a seamless insurance sale component to their primary businesses, quite successfully.
Direct marketing is also a large part of our franchise here in Japan, and that will continue to expand. The American Home operation has pioneered in this space for AIG and is currently working with AIG Fuji Life in exploring new opportunities to leverage that infrastructure. Case agents, something quite unique to Japan, are those large internal entities of major Japanese corporations that serve to handle placements for all of their related subsidiary risk needs. Life alliance is business sourced through the barred and proxied business relationships we have with different life companies' distribution channels here in Japan. Global brokers is just what it says, but you'll note that again, this reflects the traditional Japanese keiretsu cross-shareholding and the case agent behaviors of the past.
We see that changing, while the speed will accelerate with increased foreign investment into Japan, the influence that we'll have in driving true risk management, it will take some time for that to be a large market maker in the future. I come back very quickly to this small, medium enterprise business component because it talks very aggressively to our growth strategies as well as our uniqueness around distribution and segmentation. SMEs are a clear growth component of the market in Japan, both in terms of size and penetration opportunities. Our outside-in efforts in this area, teamed with science-based analytics and considerable history, have allowed us to target both industry and geographic segments for profitable growth. We have those targeted businesses tell us what they need and why, how they prefer to buy and from whom, and what matters most, price or convenience.
We reconfigured our product offering to reflect the coverages they expressed the most interest in and the need for combining those coverages into things such as group PA, property liability, and so on. We made that product flexible and industry-tailored. We punch above our weight in this segment, and we do so because of these factors and the recognition of the partnering needed to bring something unique to the marketplace. This SME space during the economic boom period was centered around key man coverages. As the demographics and global economy have changed, the needs have changed with it. We've adapted to offer those tailored capabilities into those preferred segments that cut across consumer and commercial products, it's through consultative risk advising and distribution that we've built and we've equipped ourselves.
To give you a similar sense for our consumer business in Japan, I will ask Tim Schultis to come up and walk you through his business in more detail. Thank you.
Thanks, Bob. As was mentioned, the Japan consumer business is the second largest consumer business in AIG. It is well-diversified between the property casualty and the life and A&H businesses. Today, I will focus on our two largest consumer portfolios in Japan, auto and A&H. I will also briefly introduce a key growth engine for our Japan consumer portfolio, AIG Fuji Life. Across all our Japan consumer businesses, we utilize data-driven analysis to focus on portfolio management, actuarial rate adequacy, producer management, and targeted growth opportunities that balance profitability growth and risk. While auto loss ratios vary somewhat each quarter due to seasonality, the rolling 12-month loss ratios shown in this chart are more smooth, with the overall trend indicating an improvement in the range of around four points post the acquisition of Fuji Fire and Marine.
This trend is very strong, let me spend a minute explaining how we got here and what it implies for future actions. The acquisition of Fuji Fire and Marine gave us a much larger auto portfolio, as well as an opportunity to instill the AIG culture of strong analytics and corresponding underwriting and pricing actions. After the acquisition, our portfolio management analytics indicated a need to tighten underwriting on certain less profitable segments of the market. Our actuarial analysis showed areas where we needed to take rate, and we implemented these several times in the past few years to drive down the loss ratio. In addition, we introduced new pricing segments and varied the underwriting authority by agent, depending on the quality of the business that they wrote.
At the same time, the entire Japan auto industry has benefited from various external factors that are driving down the frequency of auto accidents and claims, as well as increased prices for the compulsory automobile liability insurance. The combination of our internal actions and these external drivers contributed in total to the loss ratio improvement in the portfolio. Given these results, we do not see a need for additional underwriting or rate actions outside of our normal portfolio management process as we continue to balance profit, risk, and growth. Speaking of growth, now that the auto portfolio loss ratio is in line with our pricing assumptions, we are in a position to grow our business in targeted consumer segments. Accordingly, there are several catalysts driving recent growth in terms of number of new vehicles being insured.
As a result of some of the prior actions we talked about on the prior slide, AIG's auto block did not require the same level of price increase as the industry at the end of last year. When competitors raised rates, our agents were able to take advantage of the relative competitiveness. We've been training and recruiting more of our agents to take a customer segment approach and offer AIG products that are needed, including auto. We've expanded auto sales in the insurance shop distribution channel and finding early success there. We've added a position in the organization specifically to drive new business growth in auto, providing clear and consistent messages to the agents about how to grow auto sales, including additional training and incentives around the segments that we believe are most profitable.
The increase in the number of new vehicle sales is a leading indicator of new business growth. Combined with improving retention, we're now getting to the point where our auto portfolio could be growing for the first time in many years. Similar to our auto portfolio, we've seen improvement in our A&H loss ratios by utilizing analytics and taking appropriate underwriting and rating actions. As with the auto portfolio, our A&H loss ratio is now in a sustainable range that will enable us to grow in focus segments going forward. Let me highlight a few of the areas we've focused on to improve the A&H loss ratio. We've created more granular segments within our group personal accident block by occupation and have automated most pricing actions to deliver appropriate rates for each type of occupation.
In addition, we've instituted some manual processes in the field to ensure that these actions are effectively instituted by capping discounts in some segments and training underwriters to place surcharges on others. In the personal accident, travel accident blocks, we further segmented our customers by age to better reflect the actual loss ratios associated with each segment. Again, as our agents are doing more needs analysis with our customers, we're able to sell multiple products packaged with what used to be just a group personal accident sale to improve the overall profitability. While personal accident is the vast majority of our current A&H book, medical and life are becoming a much bigger portion in line with the overall market shift. Much of our growth in these product lines comes from AIG Fuji Life, and I'll spend a few minutes talking about that now.
AIG Fuji Life has been a growth engine for Japan Consumer since shortly after it was acquired as part of the Fuji Fire and Marine transaction. Let me briefly describe the profitability, risk, and growth actions AIG undertook to position this success. After the AIG acquisition, the product portfolio was repriced to meet AIG profitability and risk guidelines, with certain products being discontinued, such as a Japan Yen-based fixed annuity that was briefly sold in 2010. During the same period, other products were made more competitive, still in line with our profit and risk requirements, to enable an expansion into independent distribution channels. AIG Fuji Life currently sells mostly life and medical products that meet the needs of our customers and distributors who are looking for straightforward products at a fair price.
Our operating model continues to be built around the needs of these distributors as they service our end policyholders. We see additional opportunity in the future for life, medical, and savings products designed to meet the needs of the growing senior segment in Japan. This graph describes the shift in distribution channels at AIG Fuji Life since AIG took over the portfolio. At the time of acquisition, most of AIG Fuji Life's sales were through Fuji Fire and Marine agents. After revising the product portfolio and refocusing some distributor services, we've been able to penetrate more third-party distribution, including insurance shops and life pro agencies. The overall growth and expansion of AIG Fuji Life's product portfolio and distribution channels shows the benefit of data-driven decisions around price and risk, as well as the focus on targeted growth, a consistent theme across all our consumer products in Japan.
As you've seen in this presentation, the Japan Consumer business has taken the difficult and disciplined steps necessary to position us for future growth. Now I would like to introduce Naomi Matsuoka, who will tell you more about how AIG Japan is planning to transform its operations to further enable that growth.
Thank you, Tim. Okay. You have heard from Bob on AIG Japan and Tim on AIG Japan Consumer. Let me talk about how this all fits together, and how we expect our overall efforts in Japan to create value for our customers and for AIG. I will first discuss how we have reached to where we are leading into the merger, which is one of the key triggers to realizing our vision for transformation and our strategy to enable that. It is important to highlight upfront that our journey starts with a focus on the customer with the following three objectives in mind. First, simplify. We are looking to simplify ourselves in order to make it easy and effective as possible for our targeted customers and business partners to do business with us.
In the past, our four operating companies in Japan have focused on their unique strengths and have grown in their targeted areas, leveraging AIG global capabilities and synergies rather opportunistically. Our legal entity simplification and our merger efforts, as discussed, will enable real leveraging and collaboration within AIG Japan. Second, focus on the customer. The customer is there. We are focused on understanding the evolving needs of our target customer segments and are delivering products and services to meet those needs. We will achieve this based on our focus on increased market awareness, customer simplicity, and working as One AIG, bringing effectiveness, efficiency, and speed to market. Third, differentiate. We are driving real change in the organization across products, culture, technology, and services to deliver on current and future anticipated customer and partner expectations.
We will constantly be innovative and efficient in delivering effective products and services to targeted customer segments in the competitive and mature market in Japan. Although we have made great progress to date, our transformation agenda will deliver on a series of capabilities that will help us focus on the customer. The merger of AIU Fuji is a great opportunity to drive change. The event in itself enables us to get our organization focused and motivated to succeed. The merger enables us to establish scale and strengthen our position in the market while introducing sustainable expense efficiency gains over time. It thus will enable us to deliver value to our targeted customers in a very aligned and effective way. Let's review the history.
We established first a strategic relationship with Fuji Fire and Marine Insurance. Later took full control of the company, which was a great opportunity for us and at an attractive valuation, but with the recognition that subsequent investments would be necessary. Subsequent to that, we have been in the process of the preparation work for the merger for Fuji Fire and Marine Insurance and AIU Insurance Company. As the first step, streamlined our group legal entity structure, enabling us to effectively conduct reorganizations leading into transformation. We've also been engaged in integration work for the merger, which is a highly complex process involving various initiatives and multiple steps. Integration for Japanese companies, or Japanese insurance companies more specifically, are required to be conducted fully prior to the merger by laws and regulations.
This includes product integration approval, system integration into development, organizational reforms, training and education, and extensive testing and rehearsals all happening prior to the merger. The merger will bring together the respective strengths in our people, our clientele, distribution, products, claims, operations, and technology of the two operating companies. Simplification and consolidation efforts will be the trigger to transform into a value-based, customer-focused organization. The merger will also drive efficiency in the end-to-end operations and will enhance our competitiveness in the market. It is very easy for an organization which is going through a merger to become too internally focused and tend to neglect its business partners and market-focused activities during that time. Recognizing that, we are, to the contrary, actually currently focusing on delivering new market-facing tools and services for our business partners and customers.
A good example of this is our new agency platform, which will be gradually rolled out to our thousands of agents across Japan starting from the end of this year, leading into the merger. These new capabilities will not only help facilitate the transfer of business to the new merged entity, but will also provide agents with new capabilities to grow their businesses. On transformation. Our vision for AIG Japan is to lead the market in delivering value to our customers by helping customers understand and manage their risks through products and services tailored to their needs with intuitive, simple, and effective customer experience. We look to leveraging our created value in Japan across the border in the AIG group as well. Our strategy for our vision is threefold, as you can see. The first is segmentation and customer centricity.
We will look at our business first and foremost through a customer segmentive lens, individuals, SMEs, and large businesses, and target specific sub-segments within these groups where we believe we have competitive advantage and which are attractive to us. We will rely on advanced analytics and science to identify and target these segments, superior marketing skills to develop the right propositions for their needs, and diversified points of access for ease of purchase. Second, unlocking distribution. We will serve our customers through a broad range of owned and independent channels to best deliver on how they want to do business with us and to maximize our available market in this country. This includes non-traditional insurance distributors for whom we can enhance the value of their offerings by integrating insurance into the holistic purchase decisions around key life events and needs.
We will deepen relationships with existing distributors by providing more products and cross-sell support, identifying and supporting the penetration of new markets, providing further customer insights relative to future needs, and offering greater ease of doing business with us. This will enable us to earn higher distributor and customer shares of their wallets, lower cost of customer acquisition, and improve customer lifetime value. Third, agility, speed, and efficiency. We will continue to innovate around products and services backed by our increased customer segment focus. We will build faster customer feedback loops, substantially upgrade our system capabilities, and drive cost and complexity out of our business at all levels for our customers and distributors. It will be based on a new target operating model oriented around customers and designed to streamline and accelerate our decision-making. What makes us transform?
Transformation is realizing our vision for Japan and implementing strategies to achieve our goals. We will maximize growth opportunities by transforming ourselves, leveraging our capabilities, and driving efficiencies and strengthening our competitive edge. We talked about the merger being a catalyst. We are the only company in Japan where the merger is initiated by the parent, and not the conventional subsidiaries creating the parent, which implies that we can lead ourselves to change with real drive and substance. We believe changing our people and culture is actually the heart of our differentiation. We are building a performance-based organizational structure and discipline that aligns our people to the vision. We are streamlining positions and roles, and as well as evaluation criteria, and making sure that our leadership exemplifies how our people should think, talk, and walk in our organization.
We will enhance our segmentation strategy and focus through further targeting and leveraging of our distribution. We will rationalize and standardize products for the merger, enhance products and services for our targeted customers, our targeted segments in terms of industry, location, et cetera, first to SMEs, and then age group, family, et cetera, for individual customers. We will be aligning our distribution channels towards higher market penetration and focus segments while we enhance cross-selling as well. In addition, we will be focusing our efforts on investing for penetrating our brand, not only in line with the name change of the merger, but towards an enhanced recognition and brand proposition of AIG Japan in this market as a whole. With the merger, we will achieve the goals of simplification and consolidation in AIU and Fuji Fire.
We will further explore opportunities of deriving scale and efficiencies across the other operating companies through implementation of centers of excellence, optimize utilization of shared services, and streamlining of our operations. In parallel, the corporate governance and risk management frameworks here are being strengthened across our organization. We will employ our analytics and science capabilities to help manage our customers' risks and become the most valued insurer in our eyes of the customers. Japan transformation aims to enhance growth, balancing profitability and risk. At the same time, we believe that it is essential that we carefully manage and balance our focus on business as usual, the merger, and transformation. Before Q&A, let me ask Kevin Hogan again to put together Japan and AIG Consumer as a whole.
Well, thanks, Naomi, and thanks, Bob and Tim, for those presentations, which, ladies and gentlemen, I hope provide a context in terms of where the consumer strategy and where AIG Japan kind of become hand in glove. This afternoon, we've demonstrated how AIG Japan is really representative of the three pillars of the strategy. We do have a unique franchise here in Japan. We have a long operating history. We've demonstrated success. We have a history of real innovation in products and distribution channels. We have a diversified product and distribution mix with an emphasis on personal accident in the A&H/third sector and niche segments. The acquisition of Fuji Fire and Marine is a catalyst to transformation for us. It also provides for access to a life insurance license at an important time of demographic change.
We clearly have a data-driven strategy, whether it's underwriting, pricing, agent management, our direct marketing businesses, our digital interfaces, and the use of our immense customer and behavioral data as represented in the new agency system, which Naomi just described. Third, although Japan is a mature market, our emphasis is on participating in its faster-growing segments, the segments of the third sector and of small and medium-sized enterprises, all in a mission to maximize the risk-adjusted returns for our shareholders. This is how Japan and consumer fit together. This is why we believe we will be successful here with our new strategies in Japan. Now I'd be very happy, thank you for your attention, to hand over to Jose, who will administer the Q&A for you. Thank you.
We're going to bring some chairs up here so I can ask the presenters if they can. In the meantime, in addition to our presenters, we have a number of the key Japan leaders here with us, and I'm going to ask them to stand up and face the group. I'm going to introduce them real quick. For the Q&A session, not only will I take on some questions or defer them to our presenters, but we will also be able to reach out to the rest of the leadership team that's here with us. Taka Yokohama, who's the Representative Director and President and CEO of Fuji Fire and Marine. We have Makoto Ozeki, who's the Representative Director. He's the President and CEO of AIU Insurance Company of Japan. Kitamura-san, who's the Representative Director and President and CEO of American Home Assurance Company in Japan.
Norio Tomono, who's the president and CEO of AIG Fuji Life Insurance Company. In addition, we have Larik Hall, who is the chief distribution officer for Japan. Wayne Lewis, who is the chief financial officer of Asia Pacific, and in addition, we have Ken Reilly, he's executive corporate officer, and he's the head of our Commercial Division here in AIG Japan. With that, we'll be very happy to take your questions.
Hi, my name is Jeffrey Cho from . We heard from several competitors that competition in the medical space was heating up, and they actually called out AIG as being one of the most aggressive. Kevin, you mentioned that you can adopt more disruptive strategies because you don't have a back book. Can you just help me understand the type of margins you are targeting for this book, the type of returns, and maybe address comments from your peers about AIG being the most aggressive?
I think, Ken, you're probably in a better position.
Okay
to address that.
In the competitive space, the people you spoke to, like in the insurance shops or in the life pros, mentioned that we had gone in for some straightforward products at a fair price. We've really done some unique things there in terms of simplifying the product features that we provide relative to the competitors, in terms of the products that we're selling quite a bit of. Especially in our very popular cancer product, for example, we're the first to really focus on a diagnosis-only style benefit that was very simple and straightforward and that people could understand, distributors could understand, and that they have been selling quite a bit. As Kevin said, we do price these at full margins on economic value, as well as looking at other types of accounting bases.
The products that we do sell do meet all of the margins that we are shooting for.
Is there any way you can give a sense of X in your combined ratio is X Fuji Life? I'm assuming this is a higher margin product. This is a follow-up, I'm sorry. Follow-up.
On this particular product, no. We don't necessarily measure and disclose any of the loss ratios in Japan at this point in time.
It's fair to say Fuji Life is a higher margin product than the overall consumer book?
To the extent that we're doing returns on excess capital, the more capital that you put into a business, you're going to have higher margins, all else being equal. We are looking at risk-adjusted returns on investors' capital, to the extent there's more capital, there's going to be more margins. A lot of the Fuji Life products are longer and do consume more capital per policy than the shorter duration accident policies or auto policies and other portfolios.
Thank you. Randy Benner from FBR Capital Markets. It's on slide 45, where you kind of transition from the preparation arrow to the merge arrow. I appreciated the commentary around that, but was hoping to kind of get a better sense of how you can describe the upfront cost that comes with that merger, and then what the ultimate expense benefit is. I think for those of us who look at the international segment at AIG, the expense ratio would be a key way that the combined ratio would be improved. I appreciate you can't give us a forward look there, but I feel like there needs to be a little bit more quantification or specifics around how that comes across.
Let me take that. As you said, we don't necessarily focus on providing individual project cost or benefit information. What I could do is I could draw your attention back to our fourth quarter releases, where our management team clearly talked about the investment. They talked about $250 million that we're going to spend over the next two years associated with the various integration and transformation activities in Japan. Those are continuing to be and are on schedule.
Just to follow up, there's no quantified benefit, I guess is the first part. Secondly, I guess you're saying that's on track, but what is that timeframe where that $250 upfront merges into a potential benefit?
Look, the whole merger, when you heard Naomi talk a little bit about the complexity around the merger in terms of the different steps and activities that you have to go through this merger in Japan, it's very difficult for us at this time to disclose and talk about those benefits. I think what I can do, again, is if we talk about the $250 million that we talked about, those are the upfront costs that we feel confident that are going to be necessary to complete the integration of the projects.
Maybe we take a step back for a moment because Jose mentioned the fourth quarter release, and there's a couple of things at play here across the property casualty portfolio that maybe it's helpful to put in context. The first is the acquisition of Fuji Fire and Marine goes back a couple of years.
Right. This merger and integration process is a part of the continuum of what that has allowed us to do here in Japan, as was described with my colleagues. But it's not the only thing that's happening across the world at PC. In the fourth quarter, we announced a $265 million severance charge that's related to activities taking place across the PC organization. At the second quarter release this year, we clarified that the benefits from that $265 million severance are anticipated to begin to emerge in the second half of 2015. With respect to the Japan integration, in the fourth quarter, we announced a $250 million relative to that. In the second quarter, we clarified we anticipate a little bit less than half of that being expended this year with a little bit more than half of that being expended in 2015.
I think it's important to recognize the 265 and the benefits from that versus the Japan integration are really two different sets of projects. You look at the benefit of the investments being made in the merger and integration, you have to go back to the original acquisition of Fuji Fire and Marine, because a number of steps had to take place, including the change in the structure of the subsidiaries, creation of the holding company, et cetera. It's one continuum, and that continuum is a very attractive investment result overall for AIG.
Thanks.
Good.
Ajit Brendan again, because they missed the mark. There you go. Please.
Ajit Brendan, Credit Suisse. I have a question in three parts on your P&C business. The first being your three biggest competitors are at least three and a half times your size. I just want to get a feel for the extent to which competitive scale and is a competitive advantage to them, and in particular, what the gap is around expense ratios and post integration, how much that closes. The second one is around to the extent you have any sort of pricing advantages, segmentation advantages, to the extent that there's impediments in the Japanese market that you're likely not to fully take advantage of that. Thirdly, again, when we look around the world and you see these kind of concentrated P&C markets, you tend to get very nice pricing environments, which is not the case yet in Japan.
We have seen the three put prices up since 2009 on a very gradual, slow basis. To what extent do you think, and when we talk to them, the returns are still not great on particularly the auto portfolio. Maybe do you have a view in terms of whether you think that current scenario is likely to continue?
Why don't we try to break that into a few parts? I think the first part, I'll kick this off, and then I'm going to pass it on to Bob to talk a little bit more about the integration, the expense, and then maybe Tim can help on the pricing. What I would say in terms of three times the size, I think Kevin mentioned that in his original remarks. For us, it's about value over volume. We're not here to compete for market share. As we've said, it's a large, mature market here in Japan, we believe the success is around our focused growth initiative. It's not only around the world, but around here in Japan. We believe that there are a number of very attractive niches for us, and I think some of those were touched upon earlier today.
I think on the expense and integration, I'll pass it on to Bob to kind of address a little bit more the specifics.
I would say that to Jose's point and Kevin's point earlier, let's put this a little bit into context. If you look at the players in the marketplace, clearly, the three local guys control the vast majority of that marketplace. When you look at the outside perspective or the regulatory perspective on that, with the Fuji Fire acquisition, with the creation of the local holding companies, et cetera, the regulator here now views that there are four major players in this marketplace, and we're one of those four. When they look at market change, when they look at innovation, and they look at the future, they have an expectation that somebody needs to bring best practices, global capabilities, and innovation to this marketplace, which is not necessarily in the best interests of our large domestic competitors. That's not to say that they wouldn't be driving that themselves.
We believe that while we're not trying to be the biggest, we do believe that as a part of this transformation process, becoming more nimble, and as Naomi talked about, the agility aspect of being able to bring variety and innovation faster to market is a key part of this process. If you look at their strategies, they're going through merger processes themselves. None of them are terribly painless. The Tokio guys have basically come out the other side of that, and they've seen the benefit of those investments from an expense ratio standpoint. We certainly have expectations and desires to see something akin to that. Again, we're not trying to be the biggest, our message very clearly is we're trying to be the clear alternative.
We're trying to be focused on better positioning our offering to be more tailored to what the customers are looking for, offering it through a more professional risk consultative needs-based selling process, which is a message we have heard loud and clear in Japan, is that people are generally getting a little bit tired of being sold to and want to start talking to people and understanding that the people they're talking to are listening and are bringing a vast array of options to them. We think we're very well positioned to do that. From our standpoint, it's not about size. It's about our flexibility, our nimbleness, and our willingness, and frankly, our ability to bring innovation to this marketplace and to drive that change.
Tim, would you like to comment a little bit on rates?
As I mentioned, on our auto portfolio, when we acquired the Fuji Fire and Marine block, it tended to be somewhat typical of the big three's portfolio in terms of the various underwriting practices and rates. It was a very painful process over the last 3 years for a lot of people in our distribution to actually live through the amount of underwriting changes and rating actions that we had taken. As I mentioned, I think that we are now in a very favorable position relative to where we were before with the 4-point decrease in our loss ratio. I do think that relative to some of our competitors, everybody has gained from some of the changes in the industry. I think, on a relative basis, we may be in a position for our own personal pricing to be able to start growth.
As you saw on the growth slide then, for the 3 years that we were taking all those actions, our new business kept going down and down. Our renewals suffered as well. Now that's all turned around, and we're actually starting to see some growth. That's one of the areas that we are targeting for growth because we are in a range now of sustainable loss ratios.
Jose, could you go back to slide 31, please?
If I look at AIG Japan's product mix, I think it would be helpful for all of us if you could give us a contextual view of what you view of those businesses, the slices of the pie, life, fire, accident, health, auto, and the others. What are currently your most attractive businesses, and which are in the most need of improvement from a return standpoint?
Well, I think that's in a way, a very tough question. I think when Kevin was addressing his remarks and the team was talking, we were talking about business mix. It's not only about looking at the individual lines of business for us here in Japan as we start talking about auto and A&H, but it's talking about the right business mix. I think the other part that's really important is the actual segments within. In general terms, I would find that to be a very tough question to answer in terms of what are the ones that we see more opportunity for.
In terms of profitability or the need for improvement, I think also Tim and Kevin also talked about that we felt very comfortable where we were in terms of the underwriting actions that we had taken in our portfolios, we felt that we had a very competitive position in the product, this is in the target segments that we were targeting in.
In order to get the return profile up, is there any part of that pie that you feel needs more attention than others currently?
I'm going to see if my colleagues have particular comments. What I would say is that that's a very active very closely with our distribution partners is understanding macroeconomic conditions. Behaviors, I think when we talk about data-driven analytics and having deep customer insights is really understanding that maturity curve, understanding where our customers are going to go. That business mix has to be able to change fairly quickly. I think the ability for us, which talks to the underwriting capabilities, and Kevin was explaining about the raters and about the pricing models, it's our ability to change pricing quickly and our speed to market. It's very difficult to pinpoint and say, it's that particular. The portfolio is very large, and to a certain extent, it's more about the nimbleness and how we move forward. Sorry.
Let me try to context a few elements of this. First of all, in an overall marketplace, as is clear, automobile is huge in Japan. As Tim and Kevin both mentioned, it's gone through a lot of change in terms of it was traditionally, or at least for the last four or five years, very unprofitable. A number of factors have come in to change that equation. I think what lies ahead is more destabilization in some respects. The demographics, the number of licensed drivers, the increased sales in mini vehicles, which are average premiums are significantly lower. The government is focusing on road safety initiatives, et cetera. There's a whole host of things that are poised to reshape the automobile market in Japan.
We think that the decisions that we've taken, as Tim mentioned, it was not easy for the Fuji Fire producers, for AIG to bring its underwriting discipline and mentality to that portfolio, but we've come out the other side. The growth that you see there has come through several different initiatives, both in AIU and the Fuji Fire piece. We like where auto's going. We like the fact that it's destabilized because we think that positions us to be quite unique in how we can bring variety to that. The third sector piece, and that's shifting. I think one of the questions we heard earlier. You've got a lot of increasing concern and reservation around the social capabilities of Japan to be able to provide the medical insurance going forward that this aging population calls for. We see that as continuing to evolve and continuing to shape opportunities.
That large demographic position around senior citizens and people of older age is, we believe, an opportunity there.
Both in our life businesses and in our property casualty businesses, we believe that we're well-positioned to take advantage of that and to help shape that future. On the commercial side of things, we've been very specific in how we target this business. We're going to be very difficult for us to play in the high end, so we needed to target what we do in the lower-end segment of that and focus on how to get to it and how to provide variation to that. While I do believe, and we've seen considerable change in the major corporate side of the Japan marketplace, it will continue to move forward at a slower pace than some of the other changes in that marketplace. Our view is that there's an awful lot that's attractive about this process.
Some of it is not about massive growth, but it's about improving overall profitability, in that respect. When the demographics are playing to windows of opportunity, we think we're well-poised to take advantage of that.
I just want to add two things in terms of pure margin. First, as we talked about, we're pre-merger stage. We have two sets of a lot of different things, and post-merger, we'll gain efficiencies. There's no question about that. The second thing is that several years ago, the GAAP accounting rules for direct marketing amortization changed. We haven't slowed down our direct marketing because we focus on the economic results and not necessarily the accounting results. There's certainly an impact on our acquisition cost because the duration of the direct marketing and the profit streams is longer than just one or two years. We continue to make the decision based on the economics of the business as opposed to the accounting outcome.
Thanks. Brian Meredith of UBS. Kevin, I am just curious, with respect to technology and analytics, where do you think you are right now relative to your competition in the consumer businesses? You can focus kind of globally and also Japan. Where do you want to be? Where are we with respect to that investment spend with respect to analytics? Are we a year, two years, three years away from where you want to be? I assume the merger is having some implications as far as your ability to actually build out that plan.
Right. It is a multi sort of oriented question. In terms of data and analytics for pure underwriting purposes and the basics there, we are pretty close to where I think we need to be. I think we are at the leading edge of where the market in the international property casualty space I think largely is. That is just the sort of the beginning of the journey. If you look at the tremendous capabilities that we have built across PC and science and some of the ability that we have had to leverage that into other of our lines of business, we are at the early stages of turning our attention to leveraging the capabilities of science into the consumer space. We have already made good strides in terms of some of our life underwriting practices and some of our marketing optimization.
I think that we are in the early stages, I would say, of the deployment of the science initiatives. In terms of IT, it is kind of a mixed bag. The IT necessary to support the analytics we are making a lot of investments in terms of the data records, data warehouses, access to data. We are at far improved stages than where we were. Whereas in terms of the operational systems themselves in IT, that is the reason why we need to make some of the big investments preparing for the merger and transformation, et cetera. As to where we are versus peers is a big thing. We compete with a lot of different companies in a lot of different markets. There are a handful of companies that are much more attentive to the sort of the front-end use of technology and interfacing with customers.
We are making some investments in those areas on the front end. In terms of interfacing with distributors, I think we are actually at a quite good point, in particular in our U.S. life and retirement businesses. That is one of our real skills that we can build off of and expand that around the world. It is such a big portfolio. That is one of the reasons why the maturity model and our focus is important, is that we cannot afford to make these investments everywhere. We are targeting where we make them in terms of what makes sense in a specific portfolio or in a specific opportunity. We may be early in the journey in some places, whereas we are late in the journey in other places. We are anticipating that the places where we are making the biggest investments are where the biggest returns will be.
I would just add to that I think Naomi hit on something that I think we can't lose sight of, and that is that the challenge really from our standpoint, and I think competitively as well in the local marketplace here, is that it's one thing to make the IT investment. If you haven't simplified the offering and you haven't made it more componentized, then it's an expensive endeavor, and changing it is an expensive endeavor. An awful lot of the focus that we have around the merger, around the activities that lead us to that, and the expected outcomes coming out of it are around how do we drive a value add from what we offer to the customers, but make it easier, make it simpler.
The regulator here years ago, 2009, implemented for the first time in over 100 years, sweeping changes from a product standpoint. Everybody had to refile their products. The entire focus was on simplifying what you did, making it easier for the customers to understand and trust in the transaction that they were engaged in. People didn't do it, including us at the time, right? As we look at how we look to go forward, that's a key component to this. Concentrating the IT investment is in fact the second step. The first step is simplifying and componentizing what it is you want to offer, because that will create the agility that we're looking for in this process, and that will create the competitive opportunity to get there faster and differently than the competitors.
Thank you. Josh Sterling, Bernstein. Listen, page 46 and 47, really enjoyed the sort of the color around what you guys are trying to do in your transformation. I'm wondering, though, I mean, in some ways it was kind of missing the grand simplification of here's ultimately what we're trying to achieve, because there's a lot of different pieces moving here. I'm wondering, when you guys meet with the board, you meet with your sort of higher-ups in the organization, what is the primary driver here? Is this about scale? Is this about getting to an expense ratio of, like you mentioned, Tokio Marine? Help us understand, I guess, not the 2015, 2016 guidance elements of this, but what are you really going to achieve in the long run? Or at least what is the goal?
If you can't give us a financial target, at least maybe can you give us like a sense of magnitude with respect to either maybe potential headcount reductions or numbers of systems you'd eliminate or something else to try to make this a little bit more tangible. Thank you.
Scott, do you want to do this?
Sure. I'll be circumspect in how I answer this, but you hit on a couple of key buttons from our standpoint. Clearly, we would like to achieve the scale in our ability to deliver service through our distribution. The traditional approach in Japan from a marketplace standpoint is quite regulated. The context around firewalls and what information can be shared and how products can be distributed, et cetera, has an awful lot of boundaries around it. The simpler the organization, the simpler the offering, the more agile and flexibility that we bring to our value proposition. Clearly, we'd like to see scale in the way we make investments and the way we deliver on those investments.
The IT investments Kevin mentioned and Naomi mentioned, if we're looking at that across four separate standalone entities as opposed to a more seamless AIG, we get shared service capabilities out of that, we get capital leverage capabilities, the investment capabilities. We do have a desire and an expectation that we will produce a more agile organization on a lower cost base. We do believe that the future of Japan is tightly coupled with the future of AIG relative to brand and how it looks to establishing its preeminent view of the most valued insurer in the world, in the views of our customers and in the views of our shareholders. I have plenty of focus from the bosses up above in terms of how we bring that through the merger, but the merger's only part of it.
As Naomi mentioned, as Jose mentioned, the transformation agenda here isn't specific to a Fuji Fire and AIU organization. It is more broadly around how we use our resources more effectively, how we access those customers in a more diversified fashion, how we give them the options around how to choose what to buy, how to buy it, and when to buy from us, and how we make that an easier, more painless process. Brand is a component of our thought process. Efficiency is a component of our thought process. Again, the nimbleness to be able to bring offerings to the table without having to come through vertical components on a constant basis. Go to market in the past, and it was product by product, and there was a lot of expertise and a lot of capabilities.
We don't see that as what the customers are asking for, and we don't see that's how we will maximize distribution as we go forward.
I think ultimately, if we can become more efficient in acquiring and administering our customers, that will improve our margins, that will improve the returns and contribute to our efforts to achieve a return in excess of our cost of capital and also to maximize the risk-adjusted returns. All of this is based on financials. All of the projects, the internal rates of return are well in excess of our hurdles. It is achieving a market outcome that will allow us to deliver the financial result.
Thank you. If I can ask just one other question. You guys price the sort of economic returns, you use your risk-adjusted capital models. These conceptually make a lot of sense, but aren't particularly transparent to all of us. Japan is a big deflationary market, and it's a big part of consumer. Are you guys permanently going to be a drag on the overall P&C businesses as part of ROE because of Japan? Is this something you can overcome through niche strategies, the realignment, and everything else? Thank you.
I'm not going to be around very long if I'm a drag.
Ultimately, when you're looking at the targeted returns, it's a reflection of risk and return. In some aspects, some markets are lower risk, it's not purely a matter of what the return is, but what's the balance between the risk and the return. We believe very fundamentally in the triangle between growth, risk, and profit, and I think Peter has been very clear with respect to his focus on that balance, and at the same time, on the objective of contributing to the long-term objectives that we've set.
Thank you. Josh Shanker from Deutsche Bank. I want to just say hats off looking at slides 37 and 39. You've obviously made a lot of improvement here. 400, 500 basis points of improvement over the last three and a half years. That's not all weighted towards 2010, 2011. Really about 50% of that improvement has come since the end of 2012. We know anecdotally that the company's made huge improvements in terms of re-underwriting the U.S. warranty book. That's also a benefit to consumer. If I go back to slide 20, it looks as if the loss ratio for the business was about 58 on a trailing 12-month basis ended 3Q12, and it's about 58 on a trailing 12-month basis ended at 2Q14.
You've made massive improvements in three very significant lines of business that comprise the consumer segment of AIG, yet overall, the loss ratio for the company hasn't really improved over a two, three-year period. For every step forward you've taken a line that you've improved. Are there other lines of business where the loss ratio is deteriorating and that's complicating your improvements? Why does it look that way?
No, there are no other lines of business that have had obvious deteriorations in loss ratio. There's a few spikes here and there. Nothing unusual. It's mostly a factor of product mix in terms of some of our products having a slightly higher natural loss ratio, lower expense components, versus others which have maybe a lower loss ratio, a higher expense component.
Okay.
Thanks. Tom Gallagher, Credit Suisse. On slide 40, AIG Fuji Life, it shows, from 2011 to 2013, a CAGR of something around 20%-30%. That's at a time when the industry growth rates have started to stall. I guess that's also in contrast for what happened to the property casualty side after the Fuji merger, meaning you took rate, the loss. You had sales momentum that went the other way. Can you give some color for what was driving the substantial growth here? Also, has that continued into 2014?
Tomono-san, probably going to put you on the spot. Did you get that question?
Yes.
Goes on.
I'd like to talk in Japanese, if it's okay. There are actually two reasons. One is that our product competitiveness has enhanced, and this was accepted by our customers, as Bob and Tim mentioned. That is one big reason. Another reason is that we have seen a big change in the Japanese customers' behavior in terms of purchase of insurance products. I think in the past, what happened most of the time was that customers purchased certain company's products from the exclusive agent to that company. However, over the past two to three years, we have seen a change in customers' behavior when they purchase insurance products. That now they're comparing different products from two to three different companies, and then they compare before they purchase.
With that, we were able to achieve a big success in terms of partnership with insurance shops and life pro channels over the past few years. These are the big reasons behind this big growth. Did I answer your question?
Yes. As Tomono-san mentioned, as you saw on the slide 41, most of the growth has come from distribution diversification. Just even getting a very small portion of the sales in those particular channels on a relative basis, relative to just selling through the Fuji Fire agents mostly, has driven most of that particular growth. In terms of the future, if you think about those are additional types of things that we could do is additional products, innovations like we've been doing or even potentially additional distribution channels could fuel growth. That's been the pattern and the reason for the last three years.
Has that momentum carried into 2014 as well?
Gotcha. First half of 2014?
I think that, yeah.
The answer is yes.
Clearly.
Yes.
Just one last one. Can you remind us the expected timing of the closing of the merger?
Look, I think I have to refer back to the slide and Naomi's comment. I think right now we're still working on the process in terms of all the pre-merger activities that she detailed that have to go through. At this point, that's just still something that we're not going to be in a position to share at this time. It's very complex, a lot of moving parts, as Naomi was explaining, we're working hard just to make sure we get all those moving parts right.
I would just add to that all of that is obviously subject to regulatory approval. One of the aspects of this is rather intimate engagement on a constant basis with them. If we were to tell you what the plan was right now, I probably couldn't execute it because they wouldn't be real happy with me with sharing that with you. Subject to their approval, and when that happens, which is an ongoing process, we will be very clear about that.
Ricky?
Scotia Capital. Just as a follow-up to Tom's question, maybe if you can't give us a timing on the closing of the merger, perhaps you could give us, and I'm sure that you're probably going to be restricted on this as well, but I'm going to ask anyway, timing of the realization of some of the benefits associated with the $250 million of spend. We know that when you're going to spend that, you've outlined that for us, but we don't know when we can start to see the benefits. I'm not asking for you to quantify what those benefits are going to be at this time, but when should we expect to start to see them?
I think it's a fair question, but I'm going to be restricted in the way that I'm going to answer that question. I think it's fair to say that we've outlined the $250 and where that spend will be. I would say that those benefits will come over time. I wouldn't have huge expectations for those benefits to come early in the process. I think that's the way we've communicated around what the spend is over the next couple of years and what the benefit expectations are. I'll refer back to that.
I would just add one amendment to that, and that is, part of this process is about how we can make that as much of a non-event as possible. An awful lot of the work that we're doing through distribution and the product alignment issues are around how do we get more comfortable around how we can begin to make some of those things happen before a legal merger takes place. Co-registration of producers is clearly something that exists in the marketplace and is an opportunity for us. As Naomi mentioned, introducing a new sales tool that makes that a more straightforward, seamless process is clearly in our best interest. Our goal is to try to ensure that wherever possible and wherever permitted, we're making those steps before the legal aspect of this happens. There's nothing inhibiting us from doing that.
That's actually a big part of what we're trying to achieve.
I'll try to bring that together and just remind everyone, I think it's a little bit obvious in the presentation, but when you're looking at our journey here in Japan and what my colleagues presented today, you're talking about three major components. You're talking about business as usual operations in Japan, and Naomi talked about the fact that we need to keep our eye on the ball, continue to be competitive, continue to grow and drive the results in Japan. The second is the merger and the integration, and we talked about the highly regulated and complex environment, and we have to navigate through that process as we continue to do business as usual in Japan.
I would then think about overall transformation, but don't think about transformation as something that will start and it will be a big project that will start as soon as we merge the entity. I think from what the message from my colleagues was, that we're looking for transformational related activities and actions that happen as business as usual. I think Bob talked about simplification and consolidation before we moved into an IT environment, and then looking at the merger as an ability to, when we have to pick and choose products, when we have to get product filings, when we have to do all that pre-work that Naomi talked about, there's a lot of opportunity for us to be innovative and to transform in terms of anticipating what the needs of the market. There will be transformation activities that will continue post that merger that will complement.
I just wanted to make sure that was clear that when we're looking at the journey here in Japan, you got to think about those three key components of that because they will have an impact on obviously the results here in Japan and obviously the results of the consumer business around the world in AIG. Hopefully that helps a little. I think, can we bring the mic up here? There's friends in the front. Where is it? Who's got the mic? Okay. There's one behind you. We'll pass it forward when that question comes. Great. Thank you.
Howard Schleicher from Aristotle Capital. We've not talked about the management of your capital at all. I know it's most relevant maybe for your first and third sector products, but is that something that's handled by this group or somewhere else? If it is, can you talk about your strategies and changes in strategies? Is that an important part of what you do, particularly for the first and third segment products? Thank you.
Obviously we carefully manage the economics of the various products, and we do balance between the profit growth and risk equation. What we choose to commit in terms of capital and the returns on that capital, we manage carefully product by product, portfolio by portfolio. What the aggregate impact of that sort of capital is across the organization is something that's addressed through the global capital management process, which is really a separate process where the risk-adjusted return opportunities are high. The company considers capital fungible, and we'll invest in those particular areas. Obviously, we try to the extent possible to be capital liquidity and tax efficient
With respect to those strategies. Part of that profitability growth and risk equation that we balance is that. We manage carefully the capital committed and the returns on the capital at the product distribution level, but where the actual actions take place is more at the global capital and liquidity management level.
Yeah, remember that in creating the simplified legal entity structure here in Japan that started last year, all of that sits under a holding company here in Japan. Instead of having a vertical view down individual operating companies in the past into Japan, there's now the ability for us to sit at a holding company level here and manage that across the group in Japan. It's intended for that very reason, to create a little bit more greater flexibility here on the ground in terms of understanding what's happening, but then liaising with and communicating with the head office. As Kevin mentioned, yeah, we're very actively involved in that.
As we look at that decisioning process around what to do with it and where to handle that, we work closely with York, and we look at across the whole spectrum of the businesses here in Japan.
Would you mind passing the mic right across? Thank you.
Afternoon, Scott Russell, Macquarie Securities. I'm interested in drilling into the local pricing environment, so P&C market here. There's a clear observation that the concentration of the market should lend itself to favorable pricing environment. Perhaps it's not that simple, and one constraint that occurs to me is the local ratings bureau. I'd just be interested to understand, what are the main constraints to lifting prices? If it's commoditization of product then understand. Specifically, I was kind of thinking about by line of product, how much flexibility do you have to actually lift price in the eyes of the local ratings bureau?
Okay. We do follow the ratings bureau, as you mentioned. There is a band around the filed rate that you actually do have some flexibility in terms of being able to set your pricing. We use that in terms of when we do come up with our segmentation strategy to be able to vary the rates around those that are filed in order to be able to price when we see that we need to take rate in a certain area or in a certain product type relative to the industry, we can actually do that. To the extent that we can be more competitive in certain areas, we can do that as well. There is some flexibility around the filed rates that each company is allowed to have.
Yeah. Markets largely tariff, right? Those ranges are structured and set. The variation that you introduce to that is around how you combine coverages in that process. That's where Tim's factoring in the deviation components to that. You have some discounting and surcharging capability within that range, but the actual coverages themselves have tariff structures around them. It's more in how you combine them to deliver to the market. That's also where some of that complexity has come in, right? People traditionally, when the market deregulated here years ago, there was this massive rush to throw riders and add on coverages in that process, which added complexity to the process, added complexity to the training components of how you educated distribution force, added complexity to how the consumer viewed, well, what am I buying type of thing, right?
That was one of the underpinnings of the regulatory changes that took place here five years ago. It comes back to what I mentioned before, that there's flexibility, and it's in around how you componentize what you do and how you really, truly identify where you want to play. If you look at it across a broad marketplace, then yeah, you're going to get stuck into a very tariff-driven, heavily commoditized conversation. If you focus on how you want to be very specific and who you want to play with and how you want to play with them, through which distribution channels, et cetera, that's where the diversification of the distribution, that's where the ability analytically to do that segmentation, and that's where the componentization of what you bring to the market really adds an awful lot of value and flexibility for the consumer.
Yeah, thanks for the clarity there. I guess my follow-up would be just, would it be fair to say that across most lines of business, you price near the ceiling?
No.
What about the major peers? Would they be similar to you? Where would you categorize your pricing relative to the three majors?
If you look at auto as an example, we had several go-to-market strategies. Automobile business in Japan is not one product for us. American Home sells individual automobile in single vehicle policies. AIU tends to be heavier in what we call corporate auto or small corporate fleets. Fuji is very much in the commoditized individual space, right? Even in that context, it's probably incorrect to review it as one product, one competitive scheme of things. When we moved forward before we had fully purchased the Fuji Fire organization, we took underwriting action and pricing action in our AIU portfolio that was painful five years ago because it looked at what did we need to do to drive what we thought was going to be a more competitive product suite.
That's the same type of exercise that Fuji Fire had to go through three years ago when we brought them into the fold, brought the analytics that had been so successful in shaping that agenda for us in AIU, having to work with, educate, and incent producers to begin behaving differently. It wasn't a top-line driven discussion. It wasn't a let's get the most premium for this. It was around where is the most profitable segments for us to play, whether that's business size, whether that's in age of the driver, whether that's in a geography, and how do we then incent that kind of behavior through our distribution channels?
Of course, sharing too many of our secrets. I think I want to bring that whole conversation back about our focus growth initiatives and about our data-driven analytic work. The market might be structured, it might be tariff, but we believe that there are opportunities in understanding customer behaviors and where the opportunities are. I think we're very well-positioned to maximize those opportunities.
Hi. Vaibhav Vashishth with the Dollar Investment Group. What I was taking away from your slides on Japan Auto and Japan A&H was that there's been a lot of improvement in the margins so far. Do you feel comfortable kind of turning on the growth engine at these margin levels and that maybe we're at risk-adjusted returns that we want to be at now? There wasn't necessarily a lot more underwriting improvement or underwriting actions to be implemented going forward. When I look at slide 19 and I look at the auto side, you have two out of five underwriting actions still upcoming to be implemented. On the personal accident side, you have three out of four that are still upcoming to be implemented.
Is it fair to take away from that then that a lot of the benefit of those actions are going to be in other regions of the world outside of Japan? If that is fair, then secondly, why wouldn't it be fair to think that there would be some benefit from common systems and things like that would be sort of global that you'd be implementing?
Okay. I'll field that one. These are not necessarily systems, maybe more processes. First of all, it's not like there's a big hulking system out there associated with these initiatives. It's about the process and discipline that we put behind the various areas. Some of them are much more relevant to advanced new research that we're doing in terms of the capacity pricing. In the rating areas and the global raters, those are use of data, not necessarily a system that's associated with those. We didn't say that there weren't more underwriting actions to take here in Japan. What we said is that we're comfortable at the levels that we're at, that we can balance between the opportunity to grow the business and what we continue to do in actively managing portfolio. There isn't a portfolio anywhere in the world that we're not actively managing.
As I mentioned before, that's not just portfolios that are running hot or warm, but rather the whole portfolio. There's always an opportunity to optimize. We've paid more attention to the larger portfolios. As I said, we took a risk-adjusted approach. We're further down the track, perhaps in the deployment of some of these advanced techniques in the biggest portfolios in Japan and in the U.S. than other markets. We are deploying those in those markets. With respect to some of these global tools that we're developing that haven't yet been rolled out, Japan will benefit from those as will other areas.
Just on the returns, now that you're more comfortable with where those returns are on those two respective businesses, can you give us some color on kind of what type of returns you're targeting on those?
I think what we said is we believe that the loss ratios are competitive and sustainable. We know that at the pre-merger stages, our expenses are higher than ultimately where they will be. What the returns will be versus what they are is one of those balance issues that we're dealing with in the triangle between growth, profitability, and risk. I think that we have to factor that in. Also, I mentioned the issue around acquisition costs. For our direct marketing business, which is a relevant part of our business, the economic margins right now are better than what the accounting margins look like. It's going to be a continued period of time before we see the normalization after the fact that we are no longer deferring the acquisition costs.
Okay. I don't see any active hands. Why don't I take this opportunity on behalf of Liz and the presenters and the management team to say thank you very much for today. Have a good evening.