American International Group’s record net income loss may be only the tip of the iceberg for an insurance industry that could still suffer significant net income losses through investment write-downs in the coming year, according to one consultant.
Chris Karow, a partner at the New York office of the consulting firm Ernst & Young, said the losses AIG and other insurers are experiencing is a result of an accounting system that is forcing companies to take impairment charges when securities fall below a percentage of value for a given length of time. The depressed market, resulting from the sub-prime mortgage market crisis, is having a devastating effect on company balance sheets, and a change in direction does not appear to be in the offing soon.
“Unless the markets recover dramatically over the next couple of months, much of that ‘other than temporary impairment’ will likely go through the income statement in the next quarter,” observed Mr. Karow. He explained that “other than temporary impairment” is the accounting term used for security losses.
He noted that AIG is not the only insurer suffering from these accounting charges, but the large loss number, coupled with the New York-based insurer’s diverse portfolio of financial investments, brings a higher profile to its financial statements.
On May 9, AIG reported a first quarter net income loss of $7.8 billion or per share loss of $3.09. This compares to net income of $4.13 billion and earning per share of $1.58 for the first quarter of 2007.
The primary driver for the loss was a $15.3 billion write down caused by the credit crisis. During an analyst’s conference call, Steven J. Bensinger, vice chairman–financial services for AIG said the financial environment that caused the crisis is “expected to continue for some time” and the economic stress “is not over.”
Martin J. Sullivan, AIG’s president and chief executive officer said the company felt the investments it made were “prudent,” but it is making adjustments in its investment portfolio.
In view of the losses and the deterioration in underwriting revenue, he said the company would seek to increase rates and tighten underwriting going forward.
Despite the losses, Mr. Sullivan called the underlying business solid, noting that the losses occurred primarily in its lending and investment segment.
The earnings announcement was not the only news the company made that day, with a decision by AIG to raise its quarterly cash dividend by 10%, or 2-cents a share, to 22-cents a share. At the same time the company said it would raise $12.5 billion in capital in response to the two quarters of losses, posting a $5.29 billion net income loss in the fourth quarter of 2007.
“We think it is absolutely the right thing to do though dilutive in the short term,” said Mr. Bensinger in defense of the decision.
“The dividend increase is a reflection of both the board’s and management’s long term view of the strength of the company’s business, earnings and capital generating power,” said Mr. Sullivan.
Reacting to the news, Standard & Poor’s Corp., New York, and Fitch Ratings, Chicago, both lowered the credit rating of AIG’s subsidiaries connected to the sub-prime crisis by one notch and placed the ratings on credit watch.
In the ensuing week, AIG faced rumors that one of its subsidiaries, International Lease Finance Corp., a major airline leasing business, was considering going its separate way. The reason, cited by reports originating in The Wall Street Journal, was that ILFC’s chief executive was unhappy with the prospect of rating downgrades that would make borrowing more expensive, increasing the cost of leasing and making his company less competitive.
AIG also faced criticism from its former chief executive Maurice R. “Hank” Greenberg. He wrote a letter to the board of directors requesting the company postpone its May 14 shareholders meeting. The postponement, he said, was necessary to allow shareholders time to digest AIG’s plan to increase its dividend and raise capital in the face of two losing quarters.
In the letter, filed with the Securities and Exchange Commission, Washington, Mr. Greenberg, who remains a significant shareholder of AIG stock, said the company “is in crisis” and that shareholders need time to “give careful thought to how best to move AIG forward.”