AIG Lags Peers in Underwriting Improvement (Update 1)

Updated from 8:02 a.m ET with early market action, a downgrade of AIG from Drexel Hamilton analyst Gloria Vogel and comments from other analsyts revealing mixed opinions of AIG.

NEW YORK ( TheStreet) -- The early reaction to American International Group's ( AIG) third-quarter earnings report shows investors are disappointed with the company's continued underwriting losses in its Property Casualty unit.

AIG following Thursday's market close reported third-quarter after-tax operating earnings of $1.421 billion, or 96 cents a share, declining from $1.621 billion, or 99 cents a share, during the third quarter of 2012. The company's third-quarter EPS matched the consensus estimate among analysts polled by Thomson Reuters.

Despite a 12% year-over-year decline in after-tax operating earnings, AIG's earnings-per-share only dipped by 3% because of the company's continued share repurchases, which reduced the count of common shares to a weighted average of 1.475 billion in the third quarter from 1.643 billion during the year-earlier quarter.

AIG's pre-tax operating income declined by 32% year-over-year to $1.709 billion in the third quarter, mainly reflecting extraordinary gains in the third quarter of 2012 of $527 million on the partial sale of AIA Group, and $330 million in gains on Maiden Lane III.

Maiden Lane III was set up in 2008 by the U.S. Treasury and the Federal Reserve to purchase heavily discounted AIG credit default swaps as part of AIG's bailout by the federal government. The Fed sold the last of Maiden Lane III's portfolio in August 2012. AIG's bailout came to an end in December 2012, when the Treasury sold its last holdings of AIG shares and said "the overall positive return on the Federal Reserve and Treasury's combined $182 billion commitment to stabilize AIG during the financial crisis is now $22.7 billion."

AIG reported a 38% year-over-year increase in pre-tax operating income within its Life and Retirement business to $1.144 billion, with significant increases in premiums and policy fees partially offset by a small decline in investment income. "Other income" within the Life and Retirement unit was up 39% year-over-year to $443 million. The Life and Retirement unit's improvement also reflected "positive adjustments netting to $118 million related to a review of estimated gross profit assumptions," according to the company.

The company reported improved results in its Property Casualty (P&C) insurance unit, with an underwriting loss of $135 million during the third quarter, compared to an underwriting loss of $441 million during the third quarter of 2012. The P&C combined ratio improved to 101.6% during the third quarter from 105.0% a year earlier.

The combined ratio is an insurer's claims and expenses divided by its earned premiums. A ratio below 100% indicates an underwriting profit.

For the first three quarters of 2013, AIG's P&C unit showed an underwriting loss of $129 million, improving considerably from an underwriting loss of $838 million a year earlier. The P&C combined ratio for the first three quarters was 100.5%, improving from 103.2% a year earlier.

In contrast, many of AIG's P&C competitors have been showing P&C underwriting profits, as the company has adopted more rational premium pricing over the past few years and has benefitted from a decline in overall catastrophe losses this year.

Allstate ( ALL), for example, on Thursday reported underwriting income in its Property-Liability unit of $1.424 billion for the first three quarters of 2013, increasing from $1.316 billion during the first three quarters of 2012. The unit's combined ratio was 93.1% for the first three quarters, improving from 93.4% a year earlier.

Allstate reported third-quarter net income available to common shareholders of $310 million, or 66 cents a share, declining from $723 million, or $1.48 a share, a year earlier, with the decline "driven primarily by an estimated $475 million after-tax loss on disposition of Lincoln Benefit Life Company (LBL) partially offset by the favorable impact from changes in employee benefit plans," according to the company. On an operating basis, Allstate earned $713 million, or $1.53 a share in the third quarter, compared to $717 million, or $1.46 a share, a year earlier.

Getting back to AIG, investors showed disappointment with the company's results, sending the company's shares down 5.5% inearly trading Friday, to $49.79.

"The P&C results (including continuing adverse reserve development) that broadly matched our forecasts and the reliance on favorable tax settlements to match the Street consensus estimate will probably disappoint investors," wrote KBW analyst Meyer Shields in a client note late Thursday. "We're neither too impressed with the accounting-driven Life & Retirement outperformance, nor too depressed by weak, but inherently volatile, Other Operations results," he added.

Shields rates AIG "market perform," with a $46 price target.

Drexel Hamilton analyst Gloria Vogel early Friday downgraded AIG to a "hold" rating from a "buy" rating, while lowering her EPS estimates for the company slightly to $4.54 for 2013 and $4.41 for 2014. Vogal's rating cut reflected "slow revenue growth, delays in the ILFC sale, lack of share buybacks or a dividend hike in the 3Q, after tax operating ROEs that have declined sequentially by quarter, and a stock price that is up about 49% year-to-date."

AIG announced last December an agreement to sell an 80.1% stakte in its International Lease Finance Corp. (ILFC) subsidiary for $4.2 billion in cash to an investor group led by Weng Xianding, the chairman of New China Trust Co. Ltd. The investor group has an option to purchase up to 90% of ILFC. The date after which either party could walk away from the deal was extended to July 31.

In its third-quarter 10-Q filing on Friday, AIG said, "no assurance can be given that the Share Purchase Agreement will not be terminated."

Bernstein analyst Josh Sterling on Friday struck a more positive tone, writing in a client note that "with the firm making progress on its combined ratio, in our view, the quarter is evidence that AIG's turnaround story remains intact." He rates AIG "outperform," with a $60 price target.

On the other hand, Sterling wrote "the quarter may be seen by some, as low-quality -- since AIG enjoyed a benefit from unlocking DAC in Life, the firm's income was taxed at only half the usual rate, and yet, in spite of these benefits, AIG's EPS only met the consensus estimate."

Deutsche Bank analyst Joshua Shanker rates AIG a "buy," with a $56 price target, and wrote in a client note late Thursday that the company "seems ahead of plan on improving results in Life Insurance. However, that will not be enough to convince investors that 3Q13 wasn't a miss." Shanker wrote that AIG's stock was likely to suffer "a day of weakness," but added that the insurer's quartrly results were unlikely to lead to significant downward revisions in consensus earnings estimates.

AIG's shares have returned 47% this year through Thursday's close at $51.65. The shares trade for 12 times the consensus 2014 EPS estimate of $4.32.

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-- Written by Philip van Doorn in Jupiter, Fla.

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Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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