The difference eight years makes.
During an interview in October 2008, less than a month after the financial crisis came into full bloom with the announcement of the bankruptcy of Lehman Brothers, Rob Schimek was telling CFO that “liquidity is absolutely a number one priority, and [must] never be called into question” at AIG Commercial Insurance.
The economy was in free fall and the commercial insurance unit’s parent company, American International Group, was already in the process of being taken over by the federal government. Hanging on to cash was thus more of a priority than seeking higher yields for the bonds in AIG’s investment portfolio, Schimek, then the CFO of the group’s commercial insurance unit, said. But in buttressing liquidity, AIG was trading off investment gains.
At the time, that was a no-brainer. “The tradeoff of market perception versus the additional yield — today that’s a pretty easy decision to make,” he said then.
Throughout the crisis, Schimek’s property-casualty unit proved a bulwark against losses stemming from credit-default swaps and other risky securities sold by the company’s financial products group. Today, just as there were in 2008, there are calls to break up the company — most notably coming from the activist investor Carl Icahn. And just as it was then, the commercial insurance unit is viewed as one of the strongest parts of the group.
Much else, however, has changed for both AIG and the property-casualty insurance insurance industry. With investment income much tougher to come by, profitability has again become a key focus. In December 2015, following a number of executive jobs succeeding his CFO role, Schimek was named, as part of a management shakeup, chief executive of AIG’s worldwide commercial insurance operations.
The company quickly followed that up by announcing a strategy of divesting weaker performing units and tightening its management structure. The strategy includes layoffs across the group. Further, the company set up strict insurance underwriting goals for Schimek’s division, calling on it to improve the commercial property-casualty accident-year loss ratio by six points. “I know that’s going to be difficult, but also within reach,” he says.
The investment picture has also changed a great deal. The current prolonged period of low interest rates has the entire insurance industry scrambling for yields, and AIG is no exception. Like other property-casualty insurers, the group is heavily invested in fixed-income securities. But unique to AIG is a whopping tax asset sitting on its balance sheet, causing it to shun now-redundant, tax-advantaged munis.
The insurance industry is also carrying huge policyholder surpluses, and large amounts of capital are flowing into it from alternative sources like hedge funds, sovereign wealth funds, pensions, and mutual funds. By increasing the supply of capital, those two factors are boosting competition among insurers. The result? A P/C insurance market that may offer lower prices and more coverage availability for commercial insurance buyers.
The increasing insurance market competition, in turn, is prompting AIG commercial to distinguish itself from carriers that are mere “capital providers,” as Schimek puts it. Instead, the division wants to focus on its ability to help assess and manage the risks of its corporate clients — in part by putting large numbers of engineers to work in gauging customers’ safety risks.
Although liquidity is still on his radar, Schimek is talking more these days about future growth, and especially sees that coming in the internet of things. The IoT, he says, could help the company gain heaps of added data to help it manage client risk, offer new forms of coverage, and provide it with new safety services to sell.
CFO spoke with Schimek about how AIG and the commercial P/C insurance industry are managing their financial and business risks nearly a decade past the Great Recession. An edited and excerpted version of his remarks follows.
How do you rate the goal of liquidity versus that of profitability today?
We continue to maintain an appropriate level of liquidity inside of all of our legal entities. We disclosed, for example, that AIG’s parent company liquidity stood at $9.2 billion at December 31, 2015. The industry overall appears to be in good shape. Policyholder surplus for the industry is at record highs in 2015, in the vicinity of $670 billion. Most companies, including AIG, maintain an appropriate level of that surplus in liquidity. It’s always on our radar screen.
With respect to profitability, AIG disclosed its strategy on January 26. Profitability is playing a prominent role in the strategy. We have the goal of a return of capital of about $25 billion to our investors over the course of the next two years. We also said we will do a series of strategic divestitures including, initially, the 19.9% IPO of U.G.C. [United Guaranty Corp., a mortgage insurer], which were the first steps towards full separation [of the entities from the parent company], and the sale of our entity called AIG Advisor Group [a broker-dealer].
We also said we would even consider separation of larger modular business units, as the commercial and the consumer segments over time might possibly be separated. We also said we would make some operating improvements, including reducing our firm wide general operating expenses by $1.6 billion over the course of the next two years.
When we talked during the crisis, AIG had $70 billion in its investment portfolio, 75% of which was in municipal bonds. How has that changed?
Surely AIG’s tax position has changed since 2008. Today we have a significant deferred tax asset on AIG’s balance sheet, and because of that, AIG has certainly modified its investment strategy. Holding municipal bonds, which are tax exempt, would not be a primary focus of the organization today, given its current tax position. And so we continue to invest heavily in fixed-income securities, but not in tax-exempt munis. That would not be a move that would be consistent with our current net operating loss carry forward position for the company.
Why does that particular investment strategy work well with the deferred tax asset on your balance sheet?
To use the net operating loss carry forward, we have to generate taxable income. And so we have a portfolio of investments that we now generally invest in securities designed to try to make the best use of that tax attribute. Holding a municipal bond on our balance would not be consistent with trying to generate taxable income and use a piece of the NOL.
How widespread do you think that strategy is across the rest of the P/C industry?
Holding fixed income securities is a strategy that’s generally consistent across the property-casualty industry. However, our strategy with respect to municipal bonds versus the strategy of other companies would certainly be different because our tax positions are different. We want an investment portfolio that matches AIG’s needs. What we’re trying to do with our clients drives what kinds of liabilities we take. The liabilities drive what kinds of investments we hold.
So, for example, our focus is to be our clients’ most valued insurer. We take risks that are designed to help make our clients feel as though they can operate their businesses with a greater degree of confidence. We try to reduce their fear of risk. We try to reduce the likelihood that they get a risk on their balance sheet that they’re not prepared to be able to handle.
How do you match your investment philosophy with your operating goals?
We establish our investment philosophy and investment portfolio after first studying our liability portfolio. So we take risks; those risks create our liabilities. We study our liabilities, and we seek an investment portfolio that is properly matched to those liabilities. We’ve got a very strong chief investment officer, Doug Dachille. I spend time with Doug trying to make sure that the investments team is as familiar with the liabilities as the underwriting team is so that they can make the smartest decisions about how to invest our dollars.
Late last year, the Fed hiked interest rates a bit, indicating to some a reversal of policy. How does that affect you?
Despite the Fed’s December 2015 rate hike, yields remain low on the portfolio. Insurance industry investment income is therefore depressed. And while the Fed began to raise rates, yields are still unlikely to return to their pre-crisis yields anytime soon. Roughly 80% of property-casualty bond or cash investments are in ten-year or shorter durations. Most property-casualty insurer portfolios have low-yielding bonds for years to come.
We evaluate our performance on the basis of what we refer to as a risk-adjusted profitability, which is our underwriting results plus our investment income minus our cost of capital. And so we are always adjusting our portfolio mix and our pricing in response to changes in the marketplace with respect to either the rates we can achieve from an underwriting perspective or the effect of investment income on the portfolio. But overall our portfolio liability is not significantly different in 2016 than it was in 2015, except that we will likely continue to shorten our duration.
In 2008, you were worried about the possibility of no longer being part of one of the world’s biggest and strongest financial services companies. How has that changed?
I’m extremely proud of the progress that AIG has made, and I’m extremely proud to be able to say that our commercial insurance operation is a part of the AIG family of companies. We still get tremendous benefit from the strength of AIG’s liquidity. That’s a tremendous benefit to the property-casualty subsidiaries, and all of our subsidiaries, in the event that we ever needed liquidity.