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NEW YORK–American International Group Inc.'s $4.6 billion reserve boost to its Chartis Inc. property/casualty subsidiaries makes AIG an outlier among its peer insurers, many of which have been releasing reserve redundancies for the past two years.
Still, observers note that last week's reserve hike, which follows a $2.3 billion boost in 2009, is for is for pre-2006 long-tail business that AIG is de-emphasizing.
AIG said the latest reserve increase is net of $446 million in discount and loss-sensitive business premium adjustments and will result in a $4.1 billion reserve charge when it posts its fourth-quarter results next week.
AIG said 80% of the reserve strengthening is for four classes of business: asbestos, $1.3 billion before the discount; excess casualty, $1 billion; excess workers compensation, $825 million before the discount; and primary (specialty) workers compensation, $420 million before the discount.
In a statement, AIG said it also has strengthened reserves in its construction/commercial risk and national accounts classes of business by about $820 million before the discount. It said various other classes comprise the remaining $250 million of reserve strengthening.
AIG said the reserve strengthening resulted from a comprehensive review of net loss reserves that Chartis conducts at the end of every year, representing accumulated estimates of reported losses and provisions for incurred-but-not-reported losses, both of which are reduced by applicable reinsurance recoverables and the discount for future investment income, where permitted.
The reserve strengthening amounts to about 6% of the $63.7 billion of its total general insurance net liability for unpaid claims and claims adjustment expenses, which was reported as of Sept. 30, 2010, according to the insurer.
AIG also said it has entered into a letter of agreement with the U.S. Treasury Department that permits AIG to retain $2 billion of net cash proceeds from the recently closed sale of AIG Star Life Insurance Co. Ltd. and AIG Edison Life Insurance Co. The proceeds will support Chartis insurance subsidiaries' capital in connection with the loss-reserve strengthening. As a result, AIG said it expects the Chartis insurance companies' statutory surplus to remain largely unaffected.
In response to the announcement, Fitch Ratings downgraded the property/casualty subsidiaries' ratings, including the Chartis units, to “A” from “A+.” However, Oldwick, N.J.-based A.M. Best Co. Inc., New York-based Standard & Poor's Corp. and New York-based Moody's Investors Services affirmed their ratings.
Fitch analyst Mark Rouck said the reserve charge “in some respects points out the difficulty of trying to establish reserves” for long-duration, excess casualty lines, for which the company had held large market shares.
There are a lot of “challenges with trying to accurately establish reserves for those businesses,” he said.
“We view the development that AIG's taken in the last couple of years as an outlier relative to some of its peer companies, as well as the overall property/casualty industry,” Mr. Rouck said (see related story).
New York-based Moody's Vp Bruce Ballentine said, “The reserve charge underscores the challenges that AIG has in this area, with a history of relatively volatile reserves and a history of adverse development.”
He added, “We believe that they are changing their business mix to tone down some of those challenging business lines, but it takes time to have that play out, so this is a credit weakness for AIG relative to other highly rated insurers.”
In its report affirming the ratings, Moody's noted that Chartis is placing greater emphasis on consumer segments, multinational business, specialty markets, and accident and health lines, while significantly reducing excess casualty and workers compensation. It has excluded asbestos coverage from its policies since 1985.
While some observers said the boost had been expected, others were unpleasantly surprised.
“I think a number of people who were watching the loss trends felt that there was still a deficiency in the older reserves,” and this had already impacted AIG's stock price, said John Wicher, principal at John Wicher & Associates Inc. in San Francisco. But news of the charge is “rattling for the insurance marketplace, particularly,” Mr. Wicher said.
AIG's stock closed at $41.63 Friday, up $1.63 for the week.
Cathy Seifert, an equity analyst with S&P, said the reserve boost is a continuation of a “two steps forward, one step back” trend at AIG. “The successful sale of more assets is offset by the need to bolster reserves, and I think this is continuing the trend that, quite frankly, I've seen for a while,” she said.
S&P analyst Steven Ader said the charge “raises concerns regarding overall risk controls when you consider enterprise risk management, but we felt these concerns at this point were not sufficient enough to change our view of prospective operating performance.”
Mr. Ballentine said a significant drop in excess casualty and workers comp premiums, restructuring activities and more emphasis on risk management, with some new individuals overseeing the reserving process, “should eventually improve their reserving pattern,” although “that's going to be a gradual process.”
But the charge also “creates, in some ways, more concern,” said Cliff Gallant, an analyst with Keefe, Bruyette & Woods Inc. in New York.
“They've taken several swipes at these old accident years, and they clearly have trouble getting the number right” in setting reserve levels, although “their competitors seem to be able to do it, so why can't AIG? It's a worry,” he said, pointing to 2009's $2.3 billion boost in reserves.
The fact that AIG “can't get the old years right” raises “the question of their ability to get the recent years right,” during a period when insurance products are being aggressively priced, Mr. Gallant said.