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COMMENT: Why AIG can’t have it both ways

24 May 2010

AIG is finding it hard to convince people that everything is fine at its insurance units while making slow progress on reducing its obligations to the government.

Read more: american international group aig

You made a $1.5bn profit? Big deal.

That is the attitude many are taking towards American International Group (AIG)following its first-quarter results. The slowly-recovering, government-backed insurer reported net income of $1.5bn for the first quarter of 2010, a reverse from a net loss of $4.4bn in the first quarter of 2009. Despite the improvement, analysts remain sceptical about AIG's recovery.

For example, Cliff Gallant, analyst at Keefe, Bruyette and Woods, is unimpressed by the results, saying that the reported income is meaningless unless the benefits trickle down to the shareholders.

"They are not paying their series dividend and over the quarter they increased the amount of debt they owe to the federal government," he told Reactions. "From my point from view the net income that they are reporting is not accruing to the common shareholder so to me it is a somewhat irrelevant figure."

Gallant caused AIG's share price to drop 6% on April 27 after he released a report saying there is little long-term value in AIG's shares under its ownership structure and that the shares are grossly overvalued.

Other analysts Reactions has spoken to point out that AIG remains extremely thinly capitalised. This means the market is very skittish and skeptical about AIG's long-term prospects.

Others are more bullish, however. In May, Fairholme Capital Management increased its holding of AIG shares to 25.5m shares from 15m shares as of the end of March 31.

But I am not so sure anybody truly understands the endgame here. This is an extraordinarily bizarre situation that the insurance market has not seen before.

Following fellow US insurer The Hartford ridding itself of its debt to the government earlier this year, AIG is now the only insurance firm still being propped up with government funds. AIG is in an incredibly awkward position.

According to Gallant: "On the one hand you have a company that wants to say they are making money and financially stabilising but at the same time they are saying: 'We can't pay the interest we owe you.' That's not the degree of income, strength and stability that most people want to see from AIG."

Therein lies the problem.

AIG wants to have its government-bought cake and eat it too. It has to adopt a bullish, hard-nosed business attitude of fighting to keep its business and saying everything is fine while also remaining propped up by the taxpayer. Its recent sales of AIA and Alico will help a lot, but it may still take another two or three years for the government to get out of the insurance game and it is far from clear it can do this without the taxpayer making a great loss.

The situation clearly irks its competitors, and understandably so. Mike McGavick, CEO of XL, went public with his grievances in March at the World Insurance Forum. He said the problem of everybody else competing with a government-owned entity is very real.

"I am quite astonished, and I suppose at some crass level, very jealous of [AIG] being able to call the Treasury to refuel reserves. I think this is fascinating idea and should be offensive to all of us that compete," was one of his comments.

McGavick was merely saying what a lot of AIG's rivals must be thinking. He added that he found it offensive AIG could pick and choose which assets to sell, especially given the common accusation that AIG is slashing rates in a desperate bid to hold onto business. McGavick predicted that consumers would ultimately lose out because pricing will have to go up when the situation corrects itself.

AIG's largest competitors have another reason to hate the firm. Insurers are being caught up on the focus on financial institutions that are deemed too big to fail and may end up lumbered with onerous new regulations.

I cannot help feeling that it would have been fairer to carve AIG up quickly and separate its insurance units from the parent company that, as a result of absurdly stupid risk taking, found itself with higher obligations than it could ever hope to pay by itself.

Its former CEO Hank Greenberg now believes AIG should have been allowed to go bankrupt. I am not sure I agree with that. The actions taken by the government were tough decisions made under incredible pressure. But it seems in trying to stabilise AIG, the government may end up destabilizing the rest of the insurance market.

It is a bit rich that AIG's insurance units get to fight another day and remain in the fold of the parent company. They would argue that the problems were not related to insurance. That is fine, but what use is having a free market if firms do not get punished for making stupid decisions that bring a firm to its knees? By rights, all of AIG's insurance units should have been split from the parent as soon as possible, whether by sale or IPO. This was the plan, hence the rebranding of Chartis in preparation of a clean break. That the plan got changed should be a source of outrage for its competitors.

Michael Loney is editor of Reactions


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