Updated to include closing share price, clarification of headline, spokesperson comment.
NEW YORK (
American International Group
shares extended losses late in Monday's session after an already bearish Bernstein Research issued a report saying the insurer's loss reserves are "significantly deficient" and slashed its price target on the stock by 40%.
The stock closed down 14.7% at $28.40. Volume of 40.7 million exceeded the issue's three-month daily average of 36.8 million. At the session's low of $28.04, the shares were down more than 50% from their late August 52-week high of $55.90. The decline put the stock convincingly below both its 50-day ($38.06) and 200-day ($32.13) moving averages.
Bernstein Research, which lowered its price target to $12 from $20 but maintained an underperform rating on the stock, said it now estimates AIG's loss reserves are short roughly $11 billion on a pre-tax basis, and called the conclusion of its analysis "a very unexpected result that could have major ramifications in the coming year." The firm said the deficiency in the reserves came "much sooner than we would have forecast two years ago." The $11 billion figure -- with a standard deviation of $4 billion either way -- is equal to about $10 per fully diluted share after-tax, or 24 points of the company's total 2008 earned premium, the firm said. An insurer's loss reserves represent monies set aside by the company to cover claim payouts.
An AIG spokesperson declined comment for this article.
Roughly $10 billion of the estimated deficiency was in three of the company's "long-tailed" casualty lines, according to Bernstein Research, with workers compensation associated with $1.8 billion; general liability, $5.6 billion; and professional liability, $2.6 billion.
The firm reached its conclusion about AIG's loss reserves while doing an analysis of the industry as a whole. The study sought to pinpoint possible competitive issues that could come up in the next few years, but found that, in general, the subgroups of the insurance sector all showed "strong and relatively comparable loss reserve adequacy to the other segments" with the average industry reserve adequacy running at about 8 points of 2008 earned premium.
As for what its findings may mean for AIG, Bernstein Research said that, if its analysis is "even directionally correct," the implication is that AIG and major stakeholder, the U.S. government, "face considerably more uncertaintythan they may have anticipated: recall that AIG's insurance units were not generally considered to be part of its problems." Indeed, the company's Financial Products unit, over-burdened by credit default swaps and other toxic assets, is what it's working so hard to wind down.
Bernstein Research believes possible fallout from the loss reserves deficiency could be having to record a related charge prior to being able to sell or conduct an IPO of its Chartis unit, and increased government scrutiny and/or penalties. It also feels the company could end up at a competitive disadvantage that rivals such as
may be able to capitalize upon. The firm has in the past resisted this thesis, believing clients would "stay put and wait for the uncertainty to pass" before making such a major decision.
"But now, with this loss reserve result, we have a more analytical case to make that AIG may face client flight in the future, driven by fear over its potentially weakened claims-paying ability," the note stated.
Despite its bearishness about AIG, Bernstein Research was still fairly incredulous when confronted with the number, calling the results of the study "a big surprise" and saying it was prompted to conduct further "independent reasonableness" checks of the analysis.
"In each case, looking at paid/incurred ratios, implied real price adequacy,and empirical loss development factors, it appears at a minimum that AIG's results are worse than its other large peers, and directionally worse than its booked reserves," the firm said.
The firm's theory as to how the deficiency in loss reserves ballooned to such an extent is lesser usage of reinsurance by AIG since the late 1990s. It noted that AIG's rate of cessions -- essentially passing along risk through reinsurance agreements -- fell to 22% in 2008 from 43% in 1999.
"This fact supports both the idea that AIG's underwriters never adjusted to the greater need for more "net line" underwriting, as well as the possibility that AIG's reserves will have a "thicker" tail without so much reinsurance usage," Bernstein Research said.
Written by Michael Baron in New York.