AIG: Rise, Fall, and Rebirth

Sector

Insurance

Background

Austin Hawley is a Portfolio Manager at Diamond Hill. We cover the history of AIG before and after the financial crisis, why it chose to spin out its life and retirement business, and the market dynamics affecting how insurance policies are priced.

Cover

Date

October 10, 2024

Episode Number

187

Background / Overview

History and Context: Founded in 1919 in China, AIG grew to become the world’s most powerful insurance company by the late 20th century. Under Hank Greenberg’s leadership (1970s–2000s), AIG was known for its entrepreneurial drive and ability to underwrite complex, high-risk policies that competitors avoided. Its global distribution network, particularly in international markets, and its appetite for specialty risks fueled rapid growth. However, diversification into non-core areas like aircraft leasing, bond insurance (insuring mortgage-backed securities), and complex investments led to its near collapse during the 2008 financial crisis, requiring a $180 billion U.S. government bailout, which was fully repaid with interest by 2012.

Turnaround Story: Post-crisis (2009–2017), AIG struggled with underwriting losses exceeding $30 billion, driven by mispriced policies and a damaged reputation. The turnaround began in 2017 under Brian Duperreault and Peter Zaffino, who refocused AIG on its core P&C business, divested non-core units (e.g., life and retirement, reinsurance, crop insurance), and re-underwrote its book of business. Today, AIG is a near pure-play specialty P&C insurer, targeting top-quartile industry returns.

Category and Scale: AIG operates in the P&C insurance sector, with a focus on specialty lines (e.g., marine, aviation, excess and surplus). It writes $35 billion in gross premiums annually, with ~$24 billion in net premiums after reinsurance. Its tangible book value is ~$31 billion, and its market cap is ~$50 billion, reflecting its Corebridge stake ($9 billion) and deferred tax assets (~$4 billion).

Ownership / Fundraising / Recent Valuation

• Ownership: AIG is publicly traded, with no major private equity or sponsor ownership. Its market cap of ~$50 billion includes the P&C business, a ~49% stake in Corebridge (life and retirement, to be fully divested by 2026), and ~$4 billion in deferred tax assets (DTAs) expected to be utilized within 3–4 years.
• Valuation Context: AIG trades at a premium to its ~$31 billion tangible book value due to its Corebridge stake and DTAs. Adjusting for these, the P&C business is valued at a relatively low multiple compared to peers like Chubb, suggesting potential for re-rating as AIG achieves top-quartile returns.
• Recent Transactions:
• Corebridge Demerger: AIG spun off its life and retirement business (Corebridge) in 2022, retaining a ~49% stake. It plans to sell a 20% stake to Nippon Life in 2025 at a premium, with the remainder to be divested by 2026.
• Validus Sale: AIG sold its reinsurance business (Validus) to RenaissanceRe at a high multiple, capitalizing on a hard reinsurance market.
• Other Divestitures: Sold crop insurance, a small personal lines travel business, and placed its high-net-worth homeowners business into a joint venture (JV) to transition it off the balance sheet.

Key Products / Services / Value Proposition

AIG’s core business is P&C insurance, with a focus on specialty lines (75% of net premiums) and niche personal lines (25%). Its value proposition lies in its ability to underwrite complex, non-standard risks that require deep expertise and global capacity.

Value Proposition:

• Specialty Expertise: AIG excels in underwriting complex risks (e.g., marine, aviation, E&S) that are rejected by standard markets, requiring tailored structuring and historical data.
• Global Footprint: One of few insurers with a true global presence, enabling it to serve multinational clients.
• Capacity: AIG’s large balance sheet allows it to offer significant coverage limits, critical for high-risk policies.
• Discipline: Post-turnaround, AIG’s methodical re-underwriting and capacity reduction (by >$1 trillion in limits) signal a focus on profitability over volume.

Segments and Revenue Model

Segments:

1. Commercial P&C (75%, ~$18 billion net premiums): Specialty lines (marine, aviation, E&S, cyber, D&O) for businesses, split 50/50 between U.S. and international markets.
2. Personal Lines (25%, ~$6 billion net premiums): High-net-worth homeowners (transitioning to a fee-based JV) and international accident & health (supplemental health products).

Revenue Model:

• AIG earns premiums by insuring risks, with $35 billion in gross premiums, of which ~$24 billion is retained after reinsurance ($10 billion ceded). Premiums are priced based on risk assessment, historical loss data, and market conditions.
• Specialty Lines: High-margin, non-standard policies with limited competition due to underwriting complexity. Pricing is driven by expertise, capacity, and market cycles (hard vs. soft markets).
• Personal Lines: More standardized, lower-margin products. The high-net-worth business is shifting to a fee-based model, reducing balance sheet risk.
• Investment Income: AIG invests its float (premiums held before claims) in a low-risk, outsourced portfolio (primarily high-grade bonds managed by BlackRock), contributing to revenue but less significant than underwriting profits.

Revenue Drivers:

• Pricing: Determined by market cycles, loss cost inflation, and AIG’s disciplined underwriting. AIG reduced capacity by >$1 trillion, driving industry-wide price increases (2019–2022 hard market).
• Volume: AIG shrank premiums by 10–12% (2018–2020) to eliminate mispriced business, prioritizing profitability over growth.
• Mix: Shift to specialty lines (75% of premiums) increases margins due to lower competition and higher pricing power.

Splits and Mix

• Channel Mix: AIG distributes through brokers and agents, leveraging its global network. Specialty lines rely on specialized brokers, while personal lines use broader channels.
• Geo Mix: ~50% U.S., ~50% international (commercial P&C), reflecting AIG’s global footprint.
• Customer Mix: Large corporations (specialty commercial), high-net-worth individuals, and international retail (accident & health).
• Product Mix: 75% commercial specialty, 25% personal lines. Shift toward specialty increases margin potential.
• End-Market Mix: Diverse, spanning marine, aviation, cyber, D&O, homeowners, and health.
• EBITDA Mix: Specialty lines contribute disproportionately to EBITDA due to higher margins, while personal lines have lower contribution margins.

Historical Mix Shifts:

• 2018–2020: Reduced premiums by 10–12%, exiting mispriced business.
• 2020–2025: Divested non-core units (life, reinsurance, crop) and shifted to specialty P&C, increasing specialty’s share to 75%.
• Future: Full Corebridge divestiture by 2026 will make AIG a pure-play P&C insurer, enhancing focus and margins.

KPIs

• Underwriting Margin: Improved from $30 billion in losses (2009–2019) to consistent profitability, with reserve releases every quarter for the past three years.
• Return on Tangible Equity (ROTE): ~10% currently, targeting mid-teens (top quartile) by 2027.
• Premium Growth: Stabilized post-2020, with selective growth in high-margin specialty lines.
• Capacity Reduction: Reduced limits by >$1 trillion, driving industry pricing power.
• Reserve Releases: Consistent releases indicate conservative reserving, rebuilding trust.

Acceleration/Deceleration: AIG is accelerating toward top-quartile performance, driven by underwriting discipline, divestitures, and cost management. However, growth is selective, prioritizing margins over volume.

Headline Financials

Long-Term Financial Trends:

• Revenue: Declined 10–12% (2018–2020) due to re-underwriting, now stabilizing with selective growth in specialty lines.
• EBITDA: Shifted from significant losses ($30 billion, 2009–2019) to profitability, with consistent reserve releases signaling conservative reserving.
• Margins: Expanding due to specialty focus, capacity reduction, and operating leverage from fixed cost optimization.

Value Chain Position

Primary Activities:

• Underwriting: Core value-add, leveraging expertise in specialty risks (marine, aviation, E&S).
• Risk Assessment: Uses historical data and proprietary models to price complex risks.
• Distribution: Global broker network for commercial lines; agents for personal lines.
• Claims Management: Efficient claims processing to maintain trust and control losses.
• Investment Management: Outsourced to BlackRock, focusing on low-risk, high-grade bonds.

Value Chain Position: AIG operates midstream in the insurance value chain, between policyholders (customers) and reinsurers (risk-sharing partners). It adds value through underwriting expertise and capacity, distinguishing itself from standard insurers (upstream) and reinsurers (downstream).

GTM Strategy:

• Commercial: Targets large corporations via specialized brokers, emphasizing tailored solutions and global capacity.
• Personal: Shifts high-net-worth homeowners to a fee-based JV, reducing balance sheet risk, while international accident & health uses retail channels.

Competitive Advantage:

• Underwriting Expertise: Deep knowledge in specialty lines, supported by historical data and managerial talent.
• Global Scale: Enables AIG to serve multinational clients with significant coverage limits.
• Discipline: Capacity reduction and selective underwriting enhance pricing power and margins.

Customers and Suppliers

• Customers:
• Commercial: Large corporations in marine, aviation, cyber, and E&S markets, requiring high-capacity, tailored policies.
• Personal: High-net-worth individuals (homeowners) and international retail clients (accident & health).
• Suppliers:
• Reinsurers: AIG cedes ~$10 billion in premiums to reinsurers (e.g., Berkshire Hathaway) to manage risk.
• Brokers/Agents: Key distribution partners, especially for specialty lines.
• Investment Managers: BlackRock manages AIG’s float, minimizing costs.

Pricing

• Contract Structure: Annual renewals for most policies, with pricing based on risk assessment, market conditions, and loss cost inflation.
• Pricing Drivers:
• Industry Fundamentals: Hard market (2019–2022) increased pricing due to capacity constraints; AIG’s $1 trillion limit reduction amplified this.
• Expertise: Specialty lines command premium pricing due to limited competition and complexity.
• Mission-Criticality: High-risk policies (e.g., aviation, cyber) are less price-sensitive, enhancing pricing power.
• Discipline: AIG’s willingness to non-renew mispriced business ensures profitability.
• Visibility: Annual renewals provide moderate visibility, with pricing tied to market cycles.

Bottoms-Up Drivers

Revenue Model & Drivers

How AIG Makes $1 of Revenue:

• Premiums (~95%): $0.95 from net premiums ($24 billion / ~$25–26 billion revenue), earned by insuring risks in specialty (75%) and personal lines (25%).
• Investment Income (~5%): $0.05 from investing float in high-grade bonds, outsourced to BlackRock for low-cost, low-risk returns.

Revenue Models:

• Specialty Lines: High-margin, non-standard policies with pricing power due to expertise and limited competition.
• Personal Lines: Lower-margin, with high-net-worth shifting to a fee-based model.
• No Aftermarket Revenue: Unlike industrial businesses, insurance lacks recurring aftermarket revenue (e.g., spare parts).

Pricing Drivers:

• Market Cycles: Hard market (2019–2022) increased prices; current pricing remains above loss cost inflation.
• Capacity Reduction: AIG’s >$1 trillion limit reduction forced industry-wide price increases.
• Expertise: Specialty lines command premiums due to complexity and AIG’s reputation.
• Mix Effect: Shift to specialty (75%) boosts blended pricing.

Volume Drivers:

• Selective Growth: AIG shrank premiums by 10–12% (2018–2020) to eliminate mispriced business, now growing selectively in high-margin specialty lines.
• Market Dynamics: End-market growth in cyber, marine, and aviation drives volume.
• Switching Costs: High for specialty clients due to AIG’s capacity and expertise, reducing churn.
• Contract Type: Annual renewals with disciplined non-renewals ensure profitability.

Absolute Revenue and Mix:

• Absolute: ~$25–26 billion, with ~$24 billion from net premiums and ~$1–2 billion from investment income.
• Product Mix: 75% specialty (high-margin), 25% personal (lower-margin).
• Geo Mix: 50% U.S., 50% international, balancing risk and growth.
• Customer Mix: Large corporations (specialty), high-net-worth and retail (personal).
• Organic Growth: Stabilizing post-2020, driven by specialty lines; no significant M&A.

Cost Structure & Drivers

Cost Structure:

• Variable Costs (~70–80%):
• Claims (Losses): Largest variable cost, tied to claims payouts. Improved underwriting reduced loss ratios.
• Reinsurance Premiums: $10 billion ceded to reinsurers to manage risk.
• Commissions: Paid to brokers/agents, proportional to premiums.
• Fixed Costs (~20–30%):
• Overhead: Admin, IT, facilities, and employee costs.
• Underwriting Expenses: Risk assessment and policy structuring, partially fixed.
• Stranded Costs: From Corebridge demerger, being reduced methodically.

Cost Drivers:

• Variable:
• Claims: Driven by loss experience; improved underwriting and reserve releases indicate better risk selection.
• Reinsurance: Costs rise with market pricing but stabilize with AIG’s disciplined risk-sharing.
• Inflation: Impacts claims and commissions but mitigated by pricing power.
• Fixed:
• Operating Leverage: Fixed costs (overhead, IT) spread over growing premiums, enhancing margins.
• Cost Reduction: Methodical cuts (e.g., stranded costs) improve efficiency.
• Economies of Scale: Global footprint and specialty expertise reduce per-policy costs.

Contribution Margin: Specialty lines have higher contribution margins (price – variable costs) due to premium pricing and lower competition. Personal lines have lower margins but are less capital-intensive.

Gross Profit Margin: Improving as specialty lines grow and claims losses decline, though exact figures are unspecified.

EBITDA Margin:

• Drivers: Revenue growth (specialty focus), variable cost control (better underwriting), and fixed cost leverage (cost cuts).
• Trends: Expanding due to underwriting profitability and operating leverage.

FCF Drivers

• Net Income: Driven by underwriting profits (improving) and investment income (stable but low-risk).
• Capex: Low, as insurance is not capital-intensive. Primarily IT and facilities, <5% of revenue.
• NWC: Moderate, with premiums collected upfront (float) offset by claims payables. Cash conversion cycle is short due to float.
• FCF: Likely positive and growing, supported by underwriting profits, low capex, and efficient NWC management.

Capital Deployment

• Divestitures: Corebridge (by 2026), Validus, crop insurance, and travel business, unlocking capital for reinvestment or shareholder returns.
• Share Buybacks: Not emphasized but possible as Corebridge proceeds are realized.
• M&A: Minimal post-Validus; focus on organic growth in specialty lines.
• Organic Investment: IT and underwriting talent to enhance specialty capabilities.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Market Size: Global P&C insurance market is ~$2 trillion in gross premiums, with specialty lines (marine, aviation, E&S) at ~$200–300 billion.
• Growth:
• Volume: Driven by economic growth, increasing insurable assets (e.g., cyber, marine).
• Price: Cyclical, with hard markets (2019–2022) boosting pricing; current pricing above loss cost inflation.
• Absolute: 3–5% CAGR, with specialty lines growing faster (5–7%) due to complexity and demand.
• Industry Growth Stack:
• Population/GDP: Drives insurable asset growth.
• Inflation: Impacts loss costs, requiring price increases.
• Regulation: Influences capacity and pricing.

Market Structure

• Competitors: Fragmented, with large players (Chubb, W.R. Berkley, Arch Capital) and niche specialty insurers. AIG is a top-tier player in specialty lines.
• MES (Minimum Efficient Scale): High in specialty lines due to expertise, data, and capacity requirements, limiting competitors.
• Cycle Stage: Post-hard market (2019–2022), with pricing stabilizing but still favorable.
• Traits: Cyclical, competitive, with low barriers to entry in standard lines but high barriers in specialty lines.

Competitive Positioning

• Matrix: AIG competes on expertise and capacity in specialty lines, targeting high-margin, complex risks. It avoids commoditized standard lines (e.g., auto, homeowners).
• Disintermediation Risk: Low, as specialty lines require deep expertise and scale, deterring new entrants.
• MES Advantage: AIG’s global scale and $31 billion tangible book value enable it to offer large limits, a barrier for smaller players.

Market Share & Relative Growth

• Market Share: AIG holds 1–2% of global P&C premiums, with higher share in specialty lines (5–10%).
• Relative Growth: AIG’s selective growth (post-2020) lags market volume growth (~3–5%) but outperforms in profitability due to specialty focus.

Competitive Forces (Hamilton’s 7 Powers)

1. Economies of Scale: Moderate. AIG’s global footprint and $31 billion book value reduce per-policy costs, but specialty lines rely more on expertise than scale.
2. Network Effects: None. Insurance lacks network effects, as policies are independent.
3. Branding: Moderate. AIG’s reputation is recovering, but peers like Chubb have stronger brands, commanding premium pricing.
4. Counter-Positioning: Strong. AIG’s focus on specialty lines (marine, aviation, E&S) positions it in less competitive, high-margin niches, where standard insurers cannot easily compete.
5. Cornered Resource: Strong. AIG’s underwriting expertise, historical data, and managerial talent (led by Zaffino) are difficult to replicate.
6. Process Power: Strong. AIG’s methodical re-underwriting, capacity reduction, and cost management reflect superior processes, enhancing margins.
7. Switching Costs: Moderate. High for specialty clients due to AIG’s capacity and expertise, but lower in personal lines.

Porter’s Five Forces:

• New Entrants: Low threat in specialty lines due to high barriers (expertise, data, scale). Higher in personal lines.
• Substitutes: Low. Specialty insurance is mission-critical, with few alternatives.
• Supplier Power: Moderate. Reinsurers (e.g., Berkshire) have leverage, but AIG’s scale mitigates this.
• Buyer Power: Moderate. Large corporate clients negotiate, but AIG’s capacity and expertise limit price sensitivity.
• Rivalry: High in standard lines, moderate in specialty lines due to fewer competitors.

Strategic Logic

• Capex Bets: Minimal, focusing on IT and talent to enhance underwriting.
• MES: AIG operates at MES in specialty lines, leveraging scale and expertise without diseconomies (e.g., bureaucracy).
• Vertical Integration: None; AIG outsources investment management to BlackRock, focusing on core underwriting.
• Horizontal Expansion: Selective growth in specialty lines (e.g., cyber, marine) rather than new markets.
• M&A: Divestiture-focused (Corebridge, Validus), with proceeds funding organic growth or returns.

Unique Dynamics of AIG’s Business Model

1. Specialty Lines Focus:
• Why Unique: AIG’s emphasis on complex, non-standard risks (marine, aviation, E&S) differentiates it from standard insurers. These lines require deep expertise, historical data, and significant capacity, creating high barriers to entry.
• Impact: Higher margins and lower competition, with pricing power driven by market cycles and AIG’s capacity reduction.
• Interviewee Insight: Austin Hawley emphasizes specialty lines as “difficult to standardize,” requiring “individual structuring” and “real underwriting expertise,” positioning AIG for top-quartile returns.
2. Methodical Turnaround:
• Why Unique: AIG’s turnaround (2017–present) involved painful but disciplined steps: re-underwriting its book (shrinking premiums 10–12%), divesting non-core units, and reducing capacity by >$1 trillion. This contrasts with typical insurers chasing volume.
• Impact: Restored profitability, rebuilt trust, and drove industry-wide pricing power, with consistent reserve releases signaling conservative reserving.
• Interviewee Insight: Hawley describes the turnaround as “methodical,” with the 2017 adverse development cover from Berkshire Hathaway as a “huge step” to eliminate tail risk, enabling AIG to attract talent and clients.
3. Capacity Reduction as a Pricing Lever:
• Why Unique: AIG’s reduction of coverage limits by >$1 trillion is unprecedented in scale, forcing competitors to raise prices in a capacity-constrained market.
• Impact: Amplified the 2019–2022 hard market, boosting AIG’s margins and industry profitability.
• Interviewee Insight: Hawley notes this “massive” reduction as a “less well understood” driver of AIG’s success, highlighting its leadership in pulling capacity out of the market.
4. Global Footprint:
• Why Unique: AIG is one of few insurers with a true global presence (50% U.S., 50% international), enabling it to serve multinational clients with large, tailored policies.
• Impact: Enhances pricing power and diversification, reducing exposure to regional risks.
• Interviewee Insight: Hawley underscores AIG’s “true global footprint” as a differentiator, critical for specialty clients.
5. Outsourced Investment Strategy:
• Why Unique: Unlike peers like Berkshire Hathaway, AIG outsources its float to BlackRock for a low-risk, low-cost bond portfolio, de-emphasizing investment returns.
• Impact: Focuses value creation on underwriting, reducing volatility and aligning with AIG’s core competency.
• Interviewee Insight: Hawley highlights the “plain vanilla” portfolio as a deliberate choice to prioritize underwriting margins over asset-side risks.
6. Managerial Talent:
• Why Unique: AIG’s turnaround is driven by a top-tier management team (Zaffino, Duperreault), with deep industry expertise and a track record of successful turnarounds (e.g., Marsh & McLennan).
• Impact: Enables disciplined underwriting, strategic divestitures, and cultural transformation, positioning AIG for top-quartile returns.
• Interviewee Insight: Hawley calls Zaffino’s team “one of, if not the best” in the industry, critical to AIG’s path to top-quartile performance.

Valuation and Market Overview

• Valuation:
• Market Cap: ~$50 billion, including ~$31 billion P&C book value, ~$9 billion Corebridge stake, and ~$4 billion DTAs.
• P/B Multiple: Adjusting for Corebridge and DTAs, AIG’s P&C business trades at 1.2x tangible book value, below peers like Chubb (1.5–2x), reflecting its turnaround status.
• Upside Potential: Achieving mid-teen ROTE could justify a higher multiple (~1.5–1.8x), implying a $45–55 billion P&C valuation, plus Corebridge proceeds.
• Market Overview:
• Size: ~$2 trillion global P&C market, with specialty lines at ~$200–300 billion.
• Growth: ~3–5% CAGR, with specialty lines at ~5–7%.
• Competitors: Chubb, W.R. Berkley, Arch Capital. AIG’s global scale and specialty focus position it as a leader in high-margin niches.
• Cycle: Post-hard market (2019–2022), with pricing stabilizing but favorable, supporting margins.

Conclusion

AIG’s transformation into a focused specialty P&C insurer is a masterclass in disciplined turnaround. Its unique business model—centered on complex, high-margin specialty lines, global scale, and methodical execution—positions it for top-quartile returns (mid-teen ROTE by 2027). Key dynamics include its $1 trillion capacity reduction, which drove industry pricing power, and its outsourcing of investments to focus on underwriting. The management team’s expertise and strategic divestitures (e.g., Corebridge) further enhance its trajectory. Despite a competitive and cyclical industry, AIG’s counter-positioning, cornered resources (expertise, data), and process power create durable advantages. Investors should monitor its progress toward top-quartile margins and potential re-rating as a pure-play P&C leader.

Transcript