WASHINGTON – The insurance giant American International Group’s announcement Tuesday that it plans to split off its mortgage insurance business is not a sign that the company intends to break itself up—yet.
Peter Hancock, AIG's chief executive, said during a conference call that there is no financial incentive to a breakup at this point, noting that the firm’s deferred tax assessment credit associated with keeping its property and casualty and life insurance businesses together provides ample economic rewards not to break up.
But Hancock signaled that the situation could change in the future.
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American International Group announced $3.6 billion in new costs to fill a reserve shortfall and said it will hold an initial public offering for its mortgage insurer and sell an adviser network as Chief Executive Peter Hancock seeks to boost returns and protect his job after criticism from activist investor Carl Icahn.
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“There are no sacred cows, but there are also important tax and diversification reasons that would preclude major divestitures in the short term,” Hancock said. “To give you a sense of the scale, each year we have about $1.3 billion of benefits from keeping life and [property and casualty] together, and that will persist for the next three years. That’s roughly 10 times our annual cost of being a SIFI" —systemically important financial institution — "and there’s no guarantee that if you split the two, we wouldn’t be a SIFI.”
In a statement accompanying the announcement, AIG nonexecutive Chairman Douglas Steenland said that the company’s SIFI status “is not currently a binding constraint on return of capital.”
The company instead said it would spin off its mortgage insurance unit, United Guaranty Corp., and split and sell its broker-dealer unit, AIG Advisory Group, to the private-equity firm Lightyear Capital LLC and the Canadian pension fund management firm PSP Investments. AIG also said that it would reduce operating expenses by roughly $1.6 billion within two years and return “at least” $25 billion in capital to investors through stock buybacks and dividends, among other organizational changes.
The moves come amid increasing speculation about an impending breakup at the firm.
AIG is unique among the three insurance firms designated by the Financial Stability Oversight Council as SIFIs in that it is the only one that has both substantial property/casualty and life businesses. The other two, Prudential and MetLife, are more centered on life insurance and related fields.
The mood among nonbank SIFIs has also been steadily shifting toward downsizing for strategic and regulatory reasons. GE Capital – the sole capital firm named a SIFI by the FSOC — said last April that it would sell off its financial arm in order to refocus its business and to shed its SIFI status so as to avoid the heightened Federal Reserve oversight that it would entail.
MetLife earlier this month announced that it would split off a sizable chuck of its businesses – covering roughly $240 billion in assets – into a separate company, either by way of public offering, private spin-off or sale. MetLife maintained that the split was not made specifically to shed its SIFI status, but the move heightened speculation that other nonbank SIFIs – and even SIFI banks – could be next.
Company investor Carl Icahn issued an open letter last fall calling on AIG to break into three separate companies specifically in order to position itself to shed its SIFI status, arguing that such a breakup would enhance shareholder value and return on equity. Icahn had no immediate response to the announcement on Tuesday, but said in another open letter, on Jan. 19, that unless the company embraces the kind of radical breakup he envisions, AIG will lose the confidence of its shareholders.
“I suspect, after two months of waiting, management will release a ‘strategic update’ on January 26 that fails to present a drastic strategic shift and instead is limited to only incremental changes such as small-scale asset sales and incremental cost cutting,” Icahn said. “If this occurs then the little credibility management now has will be lost.”
Aaron Klein, director of the Bipartisan Policy Center's Financial Regulatory Reform Initiative, said that AIG’s decision to restructure rather than break up is probably more idiosyncratic than it is a broad reflection on the FSOC or SIFI designation.
AIG was among the largest recipients of federal bailouts during the 2008 financial crisis, receiving over $180 billion, and in many ways was emblematic of the need for a mechanism for designating nonbanks as systemically important, Klein said. That status is one that is designed to have costs, but ultimately it is up to management to decide whether those costs are excessive, he said.
“AIG is slightly unique because it is the poster child for what a SIFI is,” Klein said. “While the business of AIG today is significantly different than the business that AIG was involved in in 2008, the brand has stuck.”
Other observers said the announcement may have been more of a reflection of poor timing for a breakup than a declaration that the firm intends to stay together forever.
Tom Dawson, a partner leading insurance regulatory matters at Drinker Biddle, said large insurance firms' movement toward paring themselves down is more of a fashion than a trend, and one that may not last. By quelling some of the calls from investors to improve their return, they buy some additional time to assess whether maintaining the current business model is a smart play in the longer term, he said.
“The timing may be not right to do it now from management’s perspective,” Dawson said. “As a purely personal observation, I don’t see the motivation to do it at this point, given the conditions in the industry, both in the capital markets and investment markets, as well as the insurance markets.”
But Alan Morley, head of regulatory compliance and surveillance for the consulting firm GFT, said the announcement amounted to a “slow-motion breakup,” since management will likely have to spin off or eliminate additional divisions over time to produce the $25 billion in capital it promised to return to its investors.
“By not announcing a full split-up, the current management team has to deliver on what it’s talking about,” Morley said. “By the end of this year, they will have announced, or they may have already executed on, more divisions of the firm being [spun] off. That’s where my money is.”
Insurance companies’ relationship to capital is very different from the relationship that banks have to capital, Morley said. For banks, having a certain reserve of capital serves not only a prudential function – offsetting losses – but a practical one, since a bank undertakes untold numbers of transactions on a daily basis and needs capital to complete those transactions. The insurance business is fundamentally different in that it seldom, if ever, is subject to floods of claims for which it would need large volumes of capital on hand.
Because of that difference, Morley said, any requirement by regulators that entails keeping large volumes of capital on the sidelines will severely disadvantage those firms in a way that benefits rivals that are not subject to those rules. To the extent that those pressures come into play, AIG and other insurance SIFIs will have to take breakups seriously as an option.
“The new regulations are really targeting banks, not insurance companies,” Morley said. “It’s an inefficient model for them.”
