AIG Alchemy Produces ... Tin

NEW YORK (TheStreet) -- American International Group's (AIG) alchemy team is a world leader, fully deserving of gold. Investors -- and ordinary Americans, for that matter -- are so numbed, a $9 billion quarterly loss described as "great progress" appears to be almost acceptable.

The truth is that AIG's insurance business is badly underperforming.

Great spin from Friday's fourth-quarter earnings release was AIG's description of the record-setting $178 billion bailout, which resulted in an 80% ownership stake by the U.S. Treasury, as a "pre-paid commitment fee."

AIG referred to a $2.3 billion failure to appropriately set aside reserves for losses at its Chartis property and casualty insurance companies as an important strengthening of loss reserves. AIG had no choice. The company underestimated anticipated losses and had to make the adjustment.

AIG's insurance companies, as a whole, had disappointing results. Premiums were down in all areas, both on a quarterly and annual basis. They fell 14% from a year earlier at Chartis; declined 30% at SunAmerica Financial, the rebranded U.S. life and annuity business; and dropped 8% in its foreign life and annuity arm.

Chartis recorded underwriting losses because of the shortfall in reserves. Excluding that, the subsidiary barely broke even. Income before capital gains plunged 64%. Its loss ratio, payouts on claims versus premiums, was 79%.

Other insurers have said AIG is under-pricing its services to maintain business. Profit margins as thin as those reported in the fourth quarter will only support those accusations.

The life and annuity business continued to suffer from reduced premiums, down 23.6% in the fourth quarter. The spin? There was an improvement in fixed-annuity sales.

"The lingering effects of negative AIG media coverage" may, indeed, have some effect, and rightly so, but re-branding and spin can't hide executives' poor judgment, which singlehandedly put the insurer in its current situation.

Foreign life and annuity businesses include the AIA unit now to be sold to U.K.-based Prudential PLC, and ALICO, which is in negotiations with MetLife ( MET). AIA and ALICO, which owe $25 billion to the Federal Reserve Bank of New York through preferred shares held in exchange for reducing the bailout loan, recorded a 14% reduction in income before capital gains in the fourth quarter.

The stock-market rally, as expected, lifted investment income. Chartis' net investment income increased 26%, resulting in a small ($169 million) operating profit for the year versus a $2.4 billion loss in 2008.

SunAmerica Financial's investment income jumped 79% in the fourth quarter, though it was up only 4.6% for the year. SunAmerica posted $670 million in operating income in the fourth quarter and a $1.2 billion loss for the year.

The foreign life and annuity business, including AIA and ALICO, recorded massive investment income of $11.5 billion in 2009.

AIG must continue to service substantial debt while trying to attract new business with sustainable profit margins. The company has a long way to go.

-- Reported by Gavin Magor in Jupiter, Fla.

Gavin Magor is the senior analyst responsible for assigning financial-strength ratings to insurance companies. He conducts industry analysis and supports consumer products. Magor has more than 22 years of international experience in operations and credit-risk management, commercial lending and analysis. His experience includes international assignments in Sweden, Mexico, Brazil and the U.S. He holds a master's degree in business administration from The Open University in the U.K.

More from Investing

Immigration, Instagram and Oil - Here's What You Can't Miss Wednesday

Immigration, Instagram and Oil - Here's What You Can't Miss Wednesday

REPLAY: Jim Cramer on Fed Rate Hikes, Oil Prices and Starbucks Worries

REPLAY: Jim Cramer on Fed Rate Hikes, Oil Prices and Starbucks Worries

What Will GM Do With Cruise -- and Is Its Stock Worth $55?

What Will GM Do With Cruise -- and Is Its Stock Worth $55?

3 Must Reads on the Market From TheStreet's Top Columnists

3 Must Reads on the Market From TheStreet's Top Columnists

This Should Be Your Retirement Savings Plan When the Stock Market Crashes

This Should Be Your Retirement Savings Plan When the Stock Market Crashes