AIG $836m Q3 reserve charge puzzles analysts

American International Group (AIG) has taken an $836m pre-tax reserve charge in commercial lines in the third quarter of 2017 that also resulted in the company increasing the full-year loss estimates, surprising analysts who thought the casualty issues at the company had been addressed.

AIG’s US casualty business had performed significantly worse than expected by the firm in recent years, resulting in a $3 billion loss in the fourth quarter of 2016 as the company reacted by striking a reinsurance deal and significantly increasing claims loss reserves.

The 2016 fourth quarter results included a $5.6 billion prior year adverse reserve development, driven by the US casualty operations.

AIG entered into an adverse development reinsurance agreement with National Indemnity Company (NICO), a Berkshire Hathaway subsidiary, in the first quarter of 2017. The agreement retroactively covers the majority of US long tail lines reserves for accident years 2015 and prior.

But in the 2017 third quarter results, Brian Duperreault's first full quarter as CEO of AIG, the company announced a $705 million reserve charge related to accident year 2016 in "reaction to early unfavourable loss emergence, primarily in Commercial long-tail lines."

"The prior year loss development was largely in reaction to early unfavourable loss emergence in US Casualty and Financial Lines in accident year 2016, and an increased number of large claims in European Casualty and Financial Lines primarily in accident year 2016," according to the company.

The charge didn't impact 2015 and prior accident years, which for US (but not international) casualty lines, losses would be reduced by AIG's reinsurance agreement inked earlier with NICO, according to a Nov. 3 Credit Suisse analyst note. Nevertheless, it was enough for AIG to increase year to date 2017 commercial P&C loss ratio picks by about $187 million ($250 million annualized).

The move has surprised the market: “Although we think that some level of ‘reset’ was expected by the market given AIG’s valuation, we were cautiously optimistic that 2016 AIG loss picks set by previous management (and in turn 2017 loss picks) would hold and serve as a base for improvement,” Credit Suisse analysts wrote.

The analysts had derived this confidence from an early, “perhaps too early, comments from Duperreault suggesting that AIG’s reserves ‘appeared reasonable,’ and, the fact that the company accelerated the review of 50 percent of its problematic casualty lines to the second quarter where there was just a small gross charge.”

“At face value, we read this quarter's reserve actions as a partial rebuttal to our thesis that previous management left AIG P&C in somewhat better condition than perceived by the market, though the rebuttal is not complete,” the analysts wrote.

The 2016 charge brings the 2016 commercial accident year loss ratio from 67 percent to 71 percent, right inline but not worse than where the old AIG management team reset the 2015 loss ratio back in February, the analysts explained.

More importantly even this year’s increased commercial loss ratio implies 2pts of improvement year to date versus last year. “Considering that Mr. Duperreault is accountable for underwriting results going forward and not 2016 or year to date results largely tied to 2016, we see little incentive for him to set a tone around underwriting improvement that has already taken place unless he has very good reason to believe it is being achieved and isn't directly threatened by what he sees in the internal or external environment,” the analysts wrote.

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