A massive new retroactive reinsurance agreement with Berkshire Hathaway Inc.'s National Indemnity Co. may help put to rest persistent investor concerns about reserve volatility at American International Group Inc., but not before the company takes another fourth-quarter charge in response to adverse development.
According to a news release announcing the agreement, through which National Indemnity will assume 80% of the net losses and net allocated loss adjustment expenses for substantially all of AIG's pre-2016 U.S. commercial long-tail exposures in excess of the first $25 billion up to a limit of $20 billion, AIG expects a "material prior-year adverse development charge" in its forthcoming fourth-quarter 2016 earnings report.
AIG did not provide additional information as to the magnitude or nature of the reserve charge as its review is still being finalized.
President and CEO Peter Hancock said the National Indemnity agreement, which comes five years after the effective date of a previous deal between AIG's Eaglestone Reinsurance Co. and the Berkshire Hathaway unit involving U.S. asbestos liabilities, represented a "decisive step" that allows the company to focus on the future.
The agreement should materially reduce headline risk for a company that conceded during a November 2016 investor day that it was aware of the investment community's skepticism surrounding its reserving. And, perhaps, it will mark an end to the questions about reserve adequacy and the potential for additional charges that consistently arose during management's interactions with Wall Street.
AIG reported total prior-year unfavorable development of incurred losses and loss adjustment expenses of $4.12 billion in 2015, according to disclosures in its most recent annual report on Form 10-K. The majority of that amount was incorporated in a fourth-quarter 2015 reserve strengthening that AIG revealed Jan. 26, 2016. AIG previously took multibillion-dollar fourth-quarter reserve charges on a pretax basis in 2009 and 2010.
Through the first three quarters of 2016, AIG recorded total unfavorable development of incurred losses and loss adjustment expenses of $214 million, inclusive of unfavorable development of $7 million in the second quarter and $273 million in the third quarter. The former figure included adverse prior-year development of approximately $100 million in response to judicial rulings impacting Florida workers' compensation business, and the latter was primarily driven by higher-than-expected loss emergence from a portion of the company's U.S. program business.
On a statutory basis, AIG's U.S. P&C units generated $3.37 billion of adverse development of incurred net losses and defense-and-cost-containment expenses in calendar year 2015, according to a review of data reported on Schedule P, Part 2 of their most recent combined annual statement. It had been since 2008 that an AIG combined annual statement showed favorable prior-year development of incurred net losses and DCCE across business lines. In four of the seven subsequent calendar years, the aggregate amount of unfavorable development across lines exceeded $1 billion.
With that history as a backdrop, AIG executives spent time during the recent investor day highlighting the various steps they have taken to reduce reserve-related risks. Among them were the management of the amount of capital allocated to longer-tail businesses that had historically been the source of adverse experience, the entry of the National Indemnity asbestos transaction, a reduction in limits, portfolio exits, lower U.S. casualty premium writings, improvements in reserving and pricing techniques, and the employment of enhanced reserve governance and controls.
"We are confident that our reserve risk has declined, that the management of our reserve position is strong, and that we'll continue to execute on our financial targets," CFO Siddhartha Sankaran said during the investor day.
Those assurances notwithstanding, one analyst asked during the event why the company had not established a "cookie jar" for the issues that emerged in the U.S. programs business in the previous quarter.
"We look at the history of reserving in this industry and in this company, and we'll do everything we possibly can to make sure that the process has integrity ... whatever the outcome, however inconvenient that outcome may be to a nice, smooth narrative," Hancock said in response. "Certainly, my life would be a lot easier if there was a cookie jar."
The Jan. 20 announcement might give AIG the next best thing as it attempts to tell its story.