AIG Earnings: Losses Hide Real Growth

The analysts got it right. Predicting that insurer AIG (NYSE: AIG  ) would report a loss for the fourth quarter 2012 was correct, though it only covers one aspect of the company's operations. When we dig a little deeper, it becomes clear that AIG has been improving its business in various ways that will allow it to continue growing and post profits down the line.

Devil's in the details
If we focus on the two main components that contributed to AIG's fourth-quarter loss, it's apparent that these one-time items do not reflect problems in the fundamentals of the insurer's operations. A $4.4 billion loss from the sale of its aircraft leasing business and a $1.3 billion after-tax loss from paid claims related to Hurricane Sandy were the main factors leading to AIG's $4 billion loss for the quarter.

Hurricane Sandy took a toll on most insurers, so AIG has plenty of company:

Insurer Reduction in Profits
AIG 348%
Allstate (NYSE: ALL  ) 45%
Progressive (NYSE: PGR  ) 3%
Travelers (NYSE: TRV  ) 52%

Sources: Company earnings releases and earnings reports.

While the effect of Sandy on AIG may seem extreme compared to the other insurers, keep in mind that AIG is the No. 5 property and casualty insurer in the country, only below Allstate, which is ranked No. 4 based on premiums written. In the past five years, Allstate had taken steps to reduce its exposure to states along the east coast, reducing Sandy's impact on its financial results.

What's actually going on
Despite Sandy, AIG's accident year loss ratio continues to decline, down to 63.3% from 69.3% in 2011. This ratio shows the company's yearly exposure to claims losses based on its earned premiums during that same time frame. And though AIG's P&C net premiums written were essentially flat year over year, increased rates have helped it mitigate its losses. Commercial rates are up 6% since 2011, with the U.S. up 8.6%. Property rates alone have increased 14.6% since 2011. AIG's consumer insurance segment has also grown, now accounting for 41% of the company's P&C net premiums written -- showing an increased focus on improving development across business segments.

Though its P&C business produced losses in the fourth quarter, its life and retirement service boosted operations. Increases across all types of assets under management lead to a 13% increase in total AUMs since 2011. The L&R segment has also enjoyed a 50% increase in variable annuity sales during the year.

AIG's mortgage guaranty business is also picking up speed, though increased foreclosure timelines and changes to the ultimate cure rate caused a loss during the quarter. The delinquency rate for guaranteed mortgages covered by AIG has steadily been declining, and was down 5.1% compared to 2011. New insurance written in the mortgage guaranty segment was helped by increased mortgage origination during the quarter, jumping 63% year over year.

Since the financial crisis, AIG has been diligently reducing its exposure to risky investments. It has already decreased its derivative exposure by 93% since 2008. And while there is still room to reduce its multi-sector credit default swap exposure, the company believes it currently provides "significant future upside," but it will consider further reductions if the economics are right. Investment income also grew 21% and 14% during the fourth quarter in its P&C and L&R segments, respectively.

The insurer's book value per share has continued to appreciate, rising 24% since 2011 to $66.38 from $53.53. A $5.5 billion increase in AIG's cash reserves and short-term investments since September doesn't hurt either. With the sale of its remaining AIA shares and its investment in PICC, the company realized $297 million in gains from those transactions. The company has been focused on growth, and it will most likely continue to make investments and acquisitions that help it achieve that growth.

In the end
Don't be scared off by AIG's reported fourth-quarter loss, as it doesn't provide the correct picture for you. Investors should consider the steps AIG has taken to improve its position after the financial crisis. And as the top hedge fund darling, investors may begin to see an AIG investment in a different light going forward. 

Now, we at the Fool realize most investors are still wary about owning a stake in AIG today. But after seeing continued improvement in AIG's operations, you may want to think about if that concern is still justified. In a special report, our top financial sector analysts will fill you in on both reasons to buy and reasons to sell AIG, and what areas AIG investors need to watch going forward. Just click here now for instant access.

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