How AIG Makes its Money

Investing News

Capitalism, at least in its pure theoretical form, is supposed to reward success and punish failure. Build a better mousetrap, sell enough units at a sufficiently high markup, and you’ll prosper. Burn through billions of dollars of investors’ money without showing a profit, and you should cease operations and find yourself another line of work.

American International Group (AIG) didn’t merely fail, it failed at a level that no business before or since has. AIG lost tens of billions of dollars in the late aughts and what’s worse, most of that money wasn’t even the company’s to begin with. The company’s managers went broke, petitioned the U.S. Treasury to make up a $40 billion shortfall and — somehow — got it. The generous representatives of the Treasury weren’t spending their own money, and thus had no skin in the game, but the result is that AIG survived to seek alms another day.

That’s not an auspicious start to a tale about a mammoth company with a history of growth and success, so bear with us.

Covering the World

AIG is, innocently enough, an insurer. Insurance sounds like the second-blandest enterprise this side of accounting, and it is. An insurer makes calculations in advance, determines how many policies it’ll end up having to pay out on, then charges high enough premia to turn a profit. The behind-the-scenes work may be complicated, but the finished product is easily understood, and it ought to be easy for an observer to navigate the road from revenue to profits.

AIG shook things up for the better in 2014, at least as far as reporting activities goes. That’s a promising move for a company that could use an image makeover after the debacle of 2007-08. (The firm’s previous CEO infamously drew a parallel between outrage over executive bonuses and lynch mobs. His predecessor authorized an executive retreat at a luxury hotel on the Pacific Coast, less than a week after receiving bailout money.) In 2017, AIG restructured its operations into three major segments: general insurance business, a life and retirement unit, and a stand-alone technology unit.

Commercial insurance is nominally defined as things such as general liability and workers’ compensation for your clothing store, airplane parts factory or car dealership. AIG separates those commercial operations into three subsets — property casualty, mortgage guaranty and institutional markets.

Property casualty insurance can cover contingencies you never thought of, probably because you’re not an insurance adjuster. Cybersecurity risk? It’s there. Marine insurance and natural disasters? Ditto. When a giant container ship meets a cyclone and has to jettison some of its cargo, it’s companies such as AIG that provide the coverage. Even such arcane types of insurance like kidnap and ransom coverage fall here. Among the three types of commercial insurance under the AIG umbrella, property and casualty is easily the largest, responsible for 88% of said revenues.

As for the antiseptic phrase “institutional markets,” that’s the category for such items as stable value wraps: funds that hold low-risk securities (highly rated bonds, mortgage-backed securities, etc.) This is also where AIG keeps its arsenal of guaranteed investment contracts, which are sold to large institutions as a means to pay out on, say, a highly rated bond series. The institutions in question are typically 401(k) providers and other large entities with millions of customers. By the way, guaranteed investment contracts is where AIG spent almost $10 billion of the original round of taxpayer money it received back in 2008. GICs are supposed to be conservative investments, but then again, GIC issuers are supposed to report billion-dollar losses accurately and honestly.

Consumer Offerings and “Other”

Consumer insurance is subdivided into retirement, life and personal. Through its subsidiaries, AIG offers retirement planning on a colossal scale, providing plans for school districts, healthcare organizations and governments, among others. As for life insurance, that’s fairly self-explanatory. AIG allows you to effectively bet on your own demise via several of its companies, including American General Life, United States Life and AIG Fuji Life.

Personal insurance refers to coverage of everyday, non-vital things. Cars, health, travel, home, etc. Among the varied types of corporate insurance AIG offers, personal insurance makes up a plurality: about 44% of the personal insurance total. Retirement planning income accounts for most of the remainder.

That leaves corporate insurance and “other.” Corporate insurance consists mostly of the derivatives and hedging instruments that made AIG notorious, and they’re still a large and lucrative part of the firm’s portfolio. “Other” includes AIG’s business consulting arm and the firm’s real estate investments: aircraft leasing operations, etc.

To peruse the AIG organizational chart is to see an impenetrable ganglion of subsidiaries, parent companies and overseas departments. AIG’s property casualty business includes smaller companies, some purchased, some organic, and many of those with no obvious connection to AIG, like National Union Fire, Fuji Fire & Marine and Lexington.

For a company that was allegedly too big to fail, AIG has recently gotten gradually smaller. Revenue has dwindled consistently over the past three years with profits down a marked 19% year-over-year. About 58% of last year’s revenue derived from policy premia, and as AIG’s fortunes fall, such payments account for a larger and larger proportion of the whole.

AIG’s operations aren’t restricted to the U.S. Slightly less than half its net premia are written outside the Americas, and in its home hemisphere AIG conducts operations everywhere from Guyana to Uruguay.

The Latest Chapter

In June 2015, the U.S. Federal Court of Claims ruled that the Fed’s bailout of AIG was not authorized by the Federal Reserve Act and therefore illegal. A lawsuit filed by AIG shareholders and led by former AIG CEO Hank Greenberg and Starr International Co. (the largest AIG shareholder at the time at 12%) sought $25 billion in damages. They argued that federal officials acted illegally in the initial $85 billion loan package to AIG, imposing a 14% interest rate and securing an 80% stake in the company. It turned out to be a pyrrhic victory, though; the judge ruled that equity losses from a bankrupt AIG would have been total, so no damages were due (which AIG would have had to pay).

The Bottom Line

It can take years, if not decades, to wash off the residue of propping up private companies with public funds. It should be noted that when the $182.3 billion the Treasury loaned AIG through the Federal Reserve Bank of New York was paid back it generated a $22.7 billion profit for the government via its sale of AIG shares (AIG also sold off several businesses to repay the loan). That said, even a relatively happy ending to government intervention is overshadowed by a simple public relations gaffe; when AIG paid back its initial round of bailout money, company pride called for a series of YouTube videos about AIG’s honesty and forthrightness. When the reaction turned overwhelmingly negative, AIG decided to disable comments. With taxpayer-generated cash flow in the past and operations in the black, AIG hopes to maintain its position as a global insurance giant for the rest of the decade and beyond.