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Most thought it was a good idea but nobody said it would be easy.
When American International Group (AIG) announced it was going to separate and rebrand its U.S. and foreign insurance operations as an independent entity using the name AIU Holdings, Inc., the Federal Reserve Bank of New York called the move “an important next step in the company’s efforts to place key business units in the best position to optimize their operations and maximize their value.”
Ratings analysts at A.M. Best called it a “positive first step” and Standard & Poor’s said “the transactions have positive benefits.”
Principals from AIG’s insurance operations expressed optimism and relief that a plan was underway.
There were, however, underlying doubts about the strategy.
One of the doubters was Stewart Johnson, portfolio manager and analyst with the Stamford-based investment banking and insurance consulting firm Philo Smith.
“I personally don’t think it is going to help. It’s like a good bank, bad bank except you also have the reputation issue to deal with… How do you run away, how do you get as far away from that AIG reputation?” he told Insurance Journal shortly after the spin-off plan was announced.
Whether AIU can run fast and far enough away from AIG and its financial products reputation remains to be seen but analyst John Nigh of consultant Towers Perrin thinks AIG is right to at least try.
“[T]his action that they’re taking makes a lot of sense from a shareholder perspective, in the sense that by getting the confidence back, by retaining key personnel, and being able to wait out for a period of time to maximize the probability of getting maximum value for the operations is, I think, a prudent move,” said Nigh, a managing principal who leads the mergers, acquisitions and restructuring practice at Towers Perrin.
Johnson and Nigh acknowledge that AIG leaders had to do something, especially with the government breathing down their necks.
“The government wants its money back. If you let that thing sit like it is, it’ll just atrophy. The clients will continue to leave, the employees will continue to leave, you under price the business and the existing business is worth less and less and fast forward two years,” Johnson said.
He said that it’s “almost a foregone conclusion” that any money received from the spin-off is going to go to pay back the government.
Nigh agrees that AIG executives are under unusual pressure in this case given that the federal government is so involved.
“[T]he big influencing factor here is the fact the government owns so much of AIG already, and is, in effect, looking for repayment. I think even if the government wasn’t involved, this is the equivalent to a ‘public spin-off,’ if you will. Instead of it being the public, it’s the government owning the economic value of the trust that’s being established,” Nigh said.
The Plan
On April 21, AIG began transferring its business units to a special purpose vehicle in preparation for the potential sale of a minority stake in the new AIU business, which if markets cooperate ultimately may include a public offering of shares. The plan is for AIU Holdings to be the holding company for AIG’s Commercial Insurance, Foreign General Insurance and Private Client Group units. Eventually, AIU Holdings will have its own board of directors, management team and brand that executives hope will appear distinct from AIG.
Last week, AIG CEO Edward Liddy said the company is moving as quickly as it can and hopes to have an initial public offering for the new entity ready in early 2010.
The AIG signs outside the Manhattan headquarters on Pine Street have been removed. However, in a sign that even the best plans are subject to change in this environment, Liddy indicated that the new brand name might not be AIU after all. That name has been used by the company outside of the U.S.— now the thinking is that a cleaner and more complete break might be needed. The names of all of the subsidiaries are also under review.
Three R’s
Johnson of Philo Smith and Nigh of Towers Perrin think the challenges AIG faces in trying to save its insurance franchise are considerable — challenges Johnson neatly summarizes as the three R’s of “run, retention and ratings.”
“You’ve got to get away from the problems at AIG. That’s the run part. What they are focused on is the business and really the brand. You’ve got to come up with a new brand. The whole AIG name has really been tainted,” said Johnson.
While the reality may be that AIG’s insurance units are healthy, AIG must deal with perception, however unfounded, that the insurance units are tainted as well, or it risks another sort of run, according to Nigh.
“[A]s far as franchise erosion… that is perception followed by reality in the sense that if somebody perceives that there is an issue at the company, you could have a so-called run on the bank,” said Nigh.
Rough Spot: Retention
In a sense, running away from the AIG parent’s reputation is the easy part, according to Johnson. The complicated part is retention.
“There are really two things you’ve got to retain in this instance– one is your existing clients and the other is your employees. Well, the employees have already started leaving. Competitors have already hired a number of key people. I use the word ‘key’ purposely… in fact, I’ve adjusted our portfolio starting last September buying up companies that I thought would benefit from AIG’s problems. That includes being able to hire some employees and being able to hire away some of the business,” said Johnson.
Nigh added that it’s not only the number of executives and accounts leaving but also the quality. “The good people will seek security elsewhere. That in turn contributes to the perception of what the franchise is really worth or what it really stands for,” he said.
One factor that might work in AIU’s favor is that a run on an insurance company is not like a run on a bank.
An insurance company’s main source of funds is premiums, which are usually signed up for on an annual or even multi-year basis. “So they are locked in. Customers don’t really have the option of going any place as easily…. They have an option but it is not something that you read about something in the paper and you go down that afternoon and pull your money out. It’s going to take a longer period of time. In that period brokers are able to talk to their clients and kind of calm them down,” Johnson said.
Ratings Challenge
What happens to the third R—ratings— turns on what agencies like A.M. Best and Standard & Poor’s think about the financial strength of the insurance operations going forward, and whether buyers are paying attention.
“Most consumers don’t seem to know that the insurance subsidiaries are in perfectly fine, good financial positions,” noted Johnson.
The ratings agencies appear to share the concerns voiced by Johnson, Nigh and others about the coming stages.
Standard & Poor’s said it harbors intermediate-term concerns about AIG’s ability to “retain key staff and underwrite profitable insurance business, specifically within its commercial and life insurance segments, in the face of a recession, volatile capital markets, and soft pricing for commercial insurance expected over the next 12 months.”
A.M. Best has also identified other “near-term challenges” that may be encountered by the subsidiary companies including “market acceptance of the rebranding initiative, maintenance of their franchise value and intellectual capital, account retention and the ability to sustain their distinguishing competitive advantages with innovative programs and significant market capacity.”
As for credit ratings, all AIG companies are currently rated as a group. Under the spin-off, the new group would be able to get its own credit rating independent from the parent AIG’s and would be able to directly access capital markets.
“If you are able to carve out the liabilities of the financial business now, you’re in a better position from a ratings standpoint. You don’t have the drag of the financials,” Johnson said.
Fourth R
There is another obvious addition the three R’s: recession.
In this economy, business growth is hard to come by even for those insurers not running from trouble. AIG has acknowledged that its insurance business is down. AIG is scheduled to release its first quarter results this week. Preliminary reports indicate the company will show another loss, but not a bad enough loss to require another infusion of government bailout monies.
In addition, today’s economy and financial markets can work against a company trying to sell or spin-off assets.
“The problem with this is when this occurs in this economic environment, you have no negotiating strength,” said Nigh. “So the pricing you get from those companies that do have the wherewithal, either through ability to raise capital or cash on hand or the ability to raise debt, they know it, they know they have an upper hand so the price that you get in the marketplace is not at all attractive.”
Also, the current high-pressure and high-profile crisis atmosphere is not exactly conducive to strategic planning.
“[T]hese decisions are very weighty decisions that are being made with a lot of anxiety behind them, and a lot of urgency. Things are cascading much more rapidly than expected. The plan that was envisioned back in October, when they announced they were going to sell those various life insurance units throughout the globe, the subsequent developments changed the landscape completely,” Nigh said.