Goldman Sachs US Financial Services Conference 2011

Dec 7, 2011

I am very happy to have with us today, Peter Hancock from AIG. He is the CEO of Chartis, AIG's flagship P&C company. Peter joined AIG in 2010 as Executive Vice President of Finance, Risk and Investments, and was appointed CEO of Chartis earlier this year in March. Prior to joining AIG, Peter held senior roles at JP Morgan, including Chief Risk Officer and Chief Financial Officer, which positions him well for his current role. With that, it is my pleasure to introduce Peter Hancock. Thank you, Michael. Good morning, everybody. Pretty dreary day. I feel I got whipsawed when I moved from London to escape this kind of weather. I hear that the mood in this conference in the last two days has been pretty dour. All I can reassure you is that the sun is shining in at least one of the 90 countries in which AIG operates. I always like to think of that when I am feeling down in Lower Manhattan. First of all, I wanted to really ask the audience, which is, I am sure, helpful for those of you who have come in tired and looking forward to a long day, who really cares? Is anybody in the audience willing to admit to being long AIG at this point? Show of hands. I am glad to see a few. How about shorts? Any shorts in the room? We have a few. Who is a taxpayer? Okay, the shorts are outnumbered. My objective today is to make the longs feel a little bit more comfortable, including the taxpayers, and the shorts a little bit more uncomfortable. I hope I can do that in an objective way. I really wanted to start by the usual disclosure. I have no slides. I do not have the usual Reg FD. I refer you to our website where we talk about forward-looking statements and why you should not take them too seriously. Seriously enough to make good investment decisions. Let me leave it at that rather than using up my time to go through legalese. I feel very grateful to have this opportunity to speak to you. My boss, the CEO of AIG, Bob Benmosche, took a big bet in hiring me 18 months ago. I feel really, really privileged to have had this extraordinary experience to be a part of this company at a critical stage of its history. I feel that what I can best do for you is to share my observations as a relative newcomer to this company. To give you a sense of its history, where it is today, and where I think it is heading in the future. To convey to you some of the excitement that is generated in me about this company. Simply put, this company is too valuable to ignore. It is too valuable to ignore. Even where we stay today with a market cap north of $40 billion, with a book capital of $80 billion plus, which by the time we've removed the reserve on the DTA, by the time we've taken the DAC write-off on EITF 09-G, we'll be, roughly speaking, $100 billion of book capital in the not-too-distant future. Even if you don't like the stock, you're going to be measured against it. You can't really ignore it. I really welcome this opportunity to give you an opportunity to ask questions about this company and for me to give you my impressions of it as a relative insider after only 18 months at the firm and about nine months in my current job. I'll start first with a sort of sense of what has been accomplished over the last couple of years, especially at the AIG level. It's really quite a remarkable journey, and one that defied a lot of predictions of people who felt this company would not survive the crisis and come out the other end as a strong company with over 70 million customers, retaining the vast majority of its best people, and with its franchise very much intact. Well, we did simplify the company. We sold off about 30 companies. In doing so, really focused this company on two core businesses. One, Chartis, which I manage, the property and casualty business. The other, SunAmerica Financial Group, which is a domestic life and retirement business. In that period of time, we also massively de-risked the holding company. What really got us in trouble was a leveraged holding company straying away from our core competence in insurance. The de-leveraging of that holding company was a very major accomplishment over the last three years. It culminated in January of this year of repaying the Federal Reserve. Today, this company doesn't owe the government anything. This company does not owe the government anything. We share in a bunch of non-recourse partnerships with the Federal Reserve, where we have residual upside on a number of assets that are non-core and in runoff, but there is no recourse debt to the government left because part of the restructuring was to change the top assistance into common equity. Today, the U.S. Treasury owns 77% of the company. I think that's a very, very important backdrop. The government has a totally aligned interest with shareholders to maximize value of this company over time, and management is highly incented to do the same. I think we've accomplished in record time, two years ahead of prediction, the repayment of the Fed. Have come out with a franchise which I think is well-positioned for the future. Let's talk a little bit about that franchise. I'm going to start very briefly at the AIG level and then drill down to Chartis, because obviously that's what I'm most familiar with. Let's just take a quick look at the AIG level. We talk about Chartis, which represents roughly 50% of the pre-tax income of AIG, roughly 40% of the total assets of AIG, and roughly two-thirds of the workforce of AIG. To give you a sense of that, the AIG workforce is about 65,000 people. Chartis is about 43,000 operating in 90 countries. The company is really, in the case of Chartis, very global. More than half of our business is outside of the U.S. SunAmerica, entirely domestic. That's important to remember. We have two other operating companies. ILFC, the aircraft leasing business, which is the biggest in this industry, which we did the S-1 registration in September for a potential IPO, has a book value of about $7.5 billion. It has a balance sheet that's largely matched off in terms of maturities, much better than it was before. It has a balance sheet that owns almost a billion airliners and is the largest, as I say, in its industry in terms of aircraft leasing, and I think represents an attractive and monetizable asset in the not-too-distant future if market conditions stabilize. We have a few other run-off assets which create a fair amount of P&L noise. The most notable of which is the one-third stake in AIA, the Asian life insurance company that we floated a year ago. That is a $12 billion asset that has fluctuated north of $1.5 billion in the last two quarters, both positive in the second, negative in the third. I think you can normalize that out of your assessment of our value by just looking up the stock ticker. It's not too difficult. Some of the other mortgage assets are a little bit more challenging to forecast in terms of valuation. ML3, which is one of the partnerships with the Fed that, in our view, represent modest downside and significant upside, but some P&L noise as that portfolio runs off. Let me talk about Chartis now and what it represents. Chartis is a property and casualty business really focused on a number of distinct business lines. Unlike many of our global peers, we're not dominated by a domestic auto business. We've got a leadership position in the commercial space in the U.S., the largest commercial insurer. It's the largest U.S.-based property and casualty insurer in Europe. It's the largest foreign insurer in a number of other countries, including Japan and South Africa and Singapore, Indonesia, and I could go on with a list of 12. It really is an extraordinary franchise. Today, it's 60% commercial, 40% consumer lines. That commercial focus is mainly in North America and Western Europe. The consumer lines is really a mixture of Japan and the rest of the world. In Japan, it's a very important part of the company. We have almost 12,000 people in Japan, and we are bigger than all foreign general insurers put together. It's a very important part of understanding who we are to understand our Japanese franchise and what that does for us in terms of skills and technology and concepts which we've been able to leverage in other countries. Most notably, the direct marketing business. We operate there in a number of different legal entities, different brands. The direct marketing is one of the most distinctive aspects of our Japanese business. We've taken those ideas over the last 15 years, applied it in Korea, in Israel, and now in over 40 countries. Very much a part of our growth story is how direct marketing of personal lines can work in a number of growth economies. We've got a long standing position in what we call growth economies, or a lot of people call emerging markets. The nine out of the 90 countries we operate in that we've really prioritized for growth. Three in Asia. That's Vietnam, Indonesia, and China. China's a very interesting special case. We have our 100% owned license and operation in five provinces, but we also have a 9.9% stake in PICC, the largest domestic player and a joint venture with them in accident and health. The three priority countries in what we call the central region is India, United Arab Emirates, and Turkey, then in Latin America, Mexico, Brazil, and Colombia. Between those nine, all of which we've been involved in for decades and decades. We've been global long before it was cool to be global. I think that's important. When I go to visit these countries, I'm astonished at how many long service awards, 20, 30-year service awards I hand out to employees. I think that gives us a really rich and deep sense of the opportunities. Bringing state-of-the-art technology to these countries, leveraging the scale that we have represents a tremendous opportunity. Today The premium that we write in growth economies represents about 9% of the $33 billion that we wrote in 2010. We'd expect by 2015 for that proportion to be about 15%. It's an important part of our growth story. Importantly, we're not staking our growth on any two countries. I saw some pretty disappointing growth news from Brazil yesterday. We're not banking on any one country working for us, but we've really got a tremendously diverse portfolio of businesses and geographies in which we can exploit our comparative advantage. Our people have really a deep understanding of this business. I think our underwriters and the skill that they have is a huge source of distinctive advantage that is constantly cited by our customers when I ask them, "Why on earth did you stay with us given all the things that were happening over the last three years?" It usually boils down to the people and the unique nature of the business that we do with them. With that depth of workforce talent, I think we have a wonderful ability to marry that with state-of-the-art technology. One of the things which I find really exciting about this industry is that even though by some measures it's quite mature, it's quite immature in the use of technology and data. The opportunity to improve our performance through better use of data for risk analytics, risk segmentation, as well as from a sheer efficiency point of view, I think represents significant upside. How does that translate into specific goals? We've laid out a goal at the AIG level to bring our normalized return on equity up from about 6% in 2010 to north of 10% by 2015. As a part of that, we really sort of four planks to that. One is capital management. This is a company which for years with AAA capital, seemed like it was free. We really think hard about whether our capital is earning its keep. Over the next 5 years, we estimate $25 billion to $30 billion of free capital at the holding company level. We've really changed the way we think about capital and capital adequacy by implementing a doctrine of what we call Strength from Above. Today at the holding company, we have roughly $15 billion of liquidity in the form of $13.5 billion of core liquidity plus contingent liquidity. The philosophy is to have any surplus capital upstream to the holding company as soon as we can. We've put in place over 30 capital maintenance agreements with the operating companies to satisfy rating agencies and regulators that we have not only good standalone capital adequacy, but we also have a mechanism to regularize dividends up and then capital injections done down should they be needed. In doing so, we anticipate roughly $5 billion of dividends from the operating subs up to the holding company per year over the next five years. In addition to that, about $1 billion of what we call tax sharing payments. These are tax payments from the operating companies to the holding company. Because we have a large tax loss carry forward, there's no tax payable to the government, that accumulates as cash to holding company. You can see where that cash is going to accumulate over the next five years, the capital that gives us lots of flexibility to deploy that. You may have noticed in our third quarter, we announced a $1 billion stock buyback program and the ratings affirmation after that that came with it. We're very committed to getting capital managed very effectively. That's one lever. The other is what we call global opportunities. That's really increasing performance at Chartis from its current level to where we're targeting. We're targeting ROE improvement at Chartis from about 6% to 10%-12% by 2015. That corresponds to bringing our normalized combined ratio from what it was last year of about 103.6 to the low 90s by 2015. We're well on that track. There are a couple of other drivers at the AIG level of the improvement. One was investing all of the cash that we had sitting uninvested in the operating companies. Over $40 billion in January. That's largely accomplished, that starts to kick in through the investment income. In terms of what are the drivers of the performance improvement at Chartis? I'd say that the most important one is business mix shift. I talked about the shift from commercial to consumer. Importantly, we have a clear vision for the company to be the most valuable insurance company, not the biggest. We happen to be very big. We don't need to prove anything about our size. It's about value. An important part of our business mix shift is to identify which business lines, which customers, which distribution channels, which geographies add value, which ones destroy value. I'm glad to say there's sufficient dispersion when I look at that to give me confidence that with the levers that we have at our disposal to redeploy capital where it's getting the best return and pull it back where it's not. We have a way to close that gap quite comfortably over that five-year time period. What does that mean in practice? It means we're pushing for rate in the domestic commercial market, and we have led the market up in terms of rate over the last four quarters. We still don't believe we're getting adequately compensated in a number of lines domestically, but we're still growing aggressively in countries and in lines where we're getting properly compensated. I think that business mix shift is a very important part. I talked earlier about direct marketing. It's a business that's going to be very important for us. What do we mean by business? It's auto, it's homeowners, it's accident and health, and it's in countries where we've really seen a big growth in the middle class, and it's unattractive from a short-term GAAP earnings perspective, especially under EITF 09-G. I want to signal that, but it's very attractive from an economic point of view. We've seen that, and we are very confident in terms of persistency, upsell, cross-sell ratios. We feel very confident about that as a growth strategy. The brand is something that is undergoing some study. We use Chartis in most of the countries we operate in, but we also use AIG in a couple. One is India, where we have a joint venture with Tata AIG, and in Israel, where we use the AIG brand. Israel, AIG is the top brand. Even better than Nike. 78% of the adult Israeli population can quote our telephone number. Extraordinary. Absolutely extraordinary. Direct marketing. It's been an immense success there, and we can replicate that in other countries in which we operate. I think that direct marketing represents a pretty exciting opportunity for us where we can leverage our scale, leverage what we've learned, and apply state-of-the-art data analytics in terms of optimizing risk segmentation and marketing. I'm looking at the clock here. I want to make sure that I leave plenty of time for questions. I just want to leave you with a strong sense that I believe this is a franchise that has a real extraordinary uniqueness to it. I give tribute to the people over the last 90 years who've built it. I think that it's a culture that's very execution focused, so if we can point people in the right direction, and it's value over volume is what we're really emphasizing. I believe that we can meet these expectations and exceed them. I think we are so diverse that despite the very severe macroeconomic challenges that we faced in the immediate term, I think we are as resilient as any large financial institution to not only survive but prosper through a time of a lot of change. We've done more to de-lever our balance sheet and become Fed ready because we expect to be regulated by the Fed than I think almost any other large insurance company and certainly are ready from a controls point of view and a risk profile to manage unexpected events. With that, I'd like to open to questions. Yes. Can you tell me, excluding cat losses, why has the combined ratio been so horrible over the last few years, and what are the things that you can do at a very granular level to improve that? Last year, we had a combined ratio of 103.6, including cats, but the cat load last year was pretty normal. I don't know whether you're referring to accident year or calendar year, but I like to separate the two. If you look at the difference between the two, there's an enormous difference. If you look at restating the last 15 years' accident year combined ratio versus calendar year, you see the accident years 1998-2003 were very challenging. We had a major reserve addition at the end of last year and the year before that, largely related to those early years. We've got $68 billion of total reserves. I think we've got fresh eyes looking at that. I think that today I feel as good as I can feel about challenging long tail lines that we've got our reserves absolutely down the middle. In terms of new business in the current accident year, I'd say that I'd point to the big mix shift that's already been underway. Some of the businesses that caused the challenges in terms of reserve additions that we talked about represented about 22% of our business four years ago, represented about 5% of our business in 2010. There's been a big mix shift to get around what you're talking about. Peter, if I could ask one question. Sure. We've heard from other P&C companies so far during this conference and during the third quarter. Pricing trends in some areas of commercial lines are seeing some improvement. You've talked about AIG migrating its strategy towards consumer lines to leverage some of the company's strength there. How should we think about that? Are you able to take advantage of A, are you seeing some of these positive pricing trends in domestic commercial lines? B, are you able to take advantage of those trends given your kind of pre-description? Very much. Very much so. I think the first thing I'd say is that our U.S. domestic commercial lines trends in aggregate had about a year-on-year 4.6 year-on-year improvement in rate. That's overall. In the property space, commercial property up about 8.8 year-on-year. If you track our year-on-year improvements, it started in the first quarter while the industry really only started in the second. I think we started to assert our leadership position, which we traditionally had in terms of price setting. You can almost date it from the moment we repaid the Fed. I think our underwriters had a lot more confidence to ask for rate after that point, when it was very clear to our customers we're here to stay. We held on to 92% of our customers, but I think that our underwriters are that much confident to ask for rate. Secondly, I want to touch on metrics. You've got explicit metrics and implicit metrics. As an industry outsider, I was really interested to see how the traditional metrics that have evolved in the insurance industry apply to a company like Chartis. I don't think they apply very well because of the diversity of our business. I think that our long-term ROE goal can only be accomplished by giving clear signals to people as to what we're trying to optimize and grow. I've introduced a concept which is a risk-adjusted profitability or RAP. Simply put, it's return on equity minus cost of equity times the amount of equity employed. We want to grow that over time. You say, "Well, why do you have to introduce something new?" Well, we could have just used ROE. Why do we want to use ROE? Because a combined ratio of 100 with a 7% interest rate environment is very different than a combined ratio of 100 in a 3% interest rate environment. Why don't we just use ROE? That would at least factor in investment income. An ROE of 10 is very different in Japan, where it's pretty attractive versus an ROE of 10 in Brazil. We operate in 90 countries. You need to factor in different cost of equity by geography, likewise, financial lines versus property cat. RAP provides a better metric that's more adaptive to different environments, interest rate environments, geographic, and lines of business, and helps us to unify people around some common goals. Once you give people that clear goal and relieve the pressure to just hit top-line goals, I think that you have people making a better trade-off between asking for rate if you're really not covering a technical pricing level for the risk that you're taking, and it gives people a much better framework. A huge change in the management philosophy that Robert Benmosche has brought to this company is empowerment. We have today hundreds of managers at the top level who are now fully informed as to all of the moving parts of the balance sheet and what makes the place more valuable. That's not the way the place was run before. We believe in giving people the tools to make good management decisions close to the customer, there's trade-off between growth, profitability, and risk. If you get the balance between those right, you can grow value in a sustainable way. I think that that's the spirit in which we're asking for rate, where we deserve that rate for the risks that we're taking, for the services we're providing. We've got 9,000 claims professionals around the world. No other company can boast that. With some of our multinational clients, we're doing a business in a dozen different business lines in 40 countries, tying it all together in a seamless service offering. They shouldn't be haggling over rate. That's not the main reason why they do business with us. Yes. Can you talk about the U.S. business a little more? Because I'm confused by number one personal lines in Israel and number one personal lines in Japan. You should have huge ROEs in those countries. Just given terrorism, given natural disasters, et cetera. What's the U.S. business like? Are you suggesting we don't have terrorism in Lower Manhattan? We're pretty close to ground zero. Yeah, I'm very aware of that. Come on. In Israel, you live with that on a daily basis, right? Yeah. I understand. Back to the question. The U.S. business, can you size it for us in terms of premiums, in terms of capital premiums to surplus? What lines are you growing? I know that you had the issues reserving in the longer tail stuff like workers' comp. What are these new businesses that are 22% today versus four or five years ago? The U.S. is, as I said earlier, 50% of the $33 billion net premium. For the most part, we are shrinking the U.S. relative to the rest of the world. We will do so until we get an attractive return on the risk that we're taking. For the most part, we've used too much reinsurance for our foreign operations and underutilized reinsurance for our property cat exposure here. We're pulling back our capacity in the property cat market here in the U.S. because we don't think we're getting enough rate, even with an 8.8% increase year-over-year. We're using it selectively. As I said, a lot of our U.S. clients are companies that operate across multiple lines. We don't think we're getting enough rate in workers' comp, we're pulling back on that, especially the monoline business, what we call specialty workers' comp, which at its peak was a $3 billion a year business four years ago. Today, it represents less than $700 million. I'd say until the pricing environment improves in the U.S., it's going to be a shrinking part of our business with obviously some notable exceptions. I don't want to generalize too much. That'd be the quick answer to your question. Maybe I should have a follow-up question from somebody else, and we can meet outside in a one-on-one. No, just to clarify, the ROE goals that you laid out and the combined ratio. For AIG or for Chartis? Well, that's what I was going to clarify. Is that for Chartis or AIG? Chartis, we're saying 10%-12%. AIG, north of 10%. Thank you. We have time for one more question. Yes. A number of your competitors complained vigorously over the last couple of years that while the company was in trouble, you were mispricing risk. My question is, it sounds like you've changed that definitively. What assurance can you give investors that you've adequately gone back and reserved properly for the risk that was not priced appropriately during the crisis? Well, I think that the first thing is that our competitors would say that, wouldn't they? It sparked a lot of inquiry, as you can imagine. There was an independent inquiry on that very fact, led by the Pennsylvania Insurance Department, where they got outside actuaries to examine those charges, and they found no evidence of that whatsoever. I would say that we have appointed a new chief actuary at the beginning of this year at Chartis level, came from Allianz, so fresh set of eyes. We have created a new function at the AIG level of a chief actuary to look over both SunAmerica and Chartis to verify those. We added 28 pages of disclosures to Schedule P so that you can reach your own conclusions. We are committed to adding even further disclosure in terms of loss triangles to make it easier for people to reach their own conclusions. We accelerated the pace of third-party scrutiny by outside actuaries so that it's not as slow a cycle. Finally, we just cut back aggressively on businesses that were providing the greatest challenges in terms of reserving. The numbers I mentioned in terms of reduced business mix. There's just less at stake from that. Where I would grant some grounds to the charge is that during the midst of the crisis, the industry lost their favorite leader on pricing. I've got a lot of feedback that when starting in January, started to ask for rate, there was, I think, a lot of relief from the industry that finally we're back driving the bus in terms of getting a proper return on risk. I think the inadequate pricing for risk is not an AIG specific issue. I think it's an industry issue. I think that if you look at the numbers of many of our competitors, their calendar year results have been flattered a lot by reserve releases, not through current pricing. I think that as an industry, we need to be better as a whole at understanding the risks that we're taking and getting properly compensated for them, and stressing value over volume, which is really at the heart of our philosophy. I think that we've done everything we can possibly do, but we don't expect to get fully credited for that until development demonstrates that we're right on that. Good question. Thank you for that. I think we're done. Yeah, we're done. Okay. Great. Thank you very much, Peter.