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Dear OtterPater:
Over the time that we've been investing, we've had some really great discussions on both the theories and the practice of how great companies are formed, how they operate, and how they maintain dominance. One company that has been a fairly constant example of excellence in these conversations is insurance holding company American International Group (NYSE: AIG). AIG fits many of the key elements we look for in a company:
AIG is not cheap, but excellence rarely is. You and I have been quite willing to pay for quality, and this company firmly falls within that camp. AIG sports a $182 billion market cap with a current P/E of 35. But, its positioning and financial strength, plus some recent political events and AIG purchases, lead me to believe that this company is perfectly situated for significant future growth.
As you know, the way insurance underwriting tends to work is that policy-writing is usually break-even to unprofitable. Insurance companies count on making their money by investing those premiums and deriving profits from this float prior to having to pay it out in claims.
However, AIG's longtime CEO, Hank Greenberg, has always demanded that the company's underwriting efforts be profitable, and has held each branch of the AIG network accountable to reach this goal. This means AIG will refuse to write policies when insurance premiums fail to cover costs, a discipline shared by the insurance underwriting subsidiaries of Berkshire Hathaway (NYSE: BRK.A).
The underwriting profit for AIG last year was $669 million, and it had a profitability of some 3.4% on these operations, compared to an industry-average loss of 7%. Also, AIG either canceled or did not renew more than $450 million in unprofitable insurance policies in the last year. This clearly shows that the company is more focused on the long term, as it risked a drop in short-term revenues to retain fiscal superiority.
There is a specific reason that I'm writing about AIG now. It is the only foreign insurance company with a large presence in Japan, a dramatically closed and controlled market. It has been one of the few sources of real innovation in the Japanese insurance market since its entry there in 1946. Its international focus provides a significant differentiation of service. AIG has 100,000 insurance agents in Southeast Asia alone, and manages to profitably underwrite insurance in markets that other companies won't dare cover, such as Vietnam, Kazakhstan, and Russia. Large companies with operations in those regions almost have to use AIG by default. And, that AIG demands these policies be profitable is a good thing.
AIG also has a significant and long-standing position in China, since 1980. In 1993, AIG received the first foreign insurance license for China, and it now has operations in five Chinese cities. But, to date, its insurance market position has been limited to covering Chinese portions of international projects. AIG has focused on investment banking in China. In 1994, the AIG Asian Infrastructure Fund LP was launched and raised $1.1 billion for infrastructure projects in China and the rest of Asia. Similarly, the AIG Asian Fund II LP received capital commitments of $1.7 billion at its first closing in late 1997.
Now that Permanent Normal Trade Relations between the U.S. and China seem a certainty, paving the way for China's admission to the World Trade Organization, AIG and other international insurance corporations should have increased access to the Chinese market. I am not the most positive person on the ability of foreign companies to operate profitably in China, but in this industry I make a huge exception. AIG has the largest presence of any foreign insurance company in China, and it has significant experience at profitably insuring in unstable market environments. What's more, AIG has willingly lent its expertise to the Chinese government to help the country update its own insurance industry, a strategy I expect to pay off handsomely.
Add to this AIG's recent agreement with the largest conglomerate in India, the Tata Group, its position as the largest and most respected insurer in Southeast Asia, its strengthening of U.S. operations through its 1999 purchase of SunAmerica, and its financial position, and you have the making of a gorilla. AIG ranks 17th among all US companies in revenues, has the highest credit rating from Standard & Poor's and Moody's, and even in a poor overall insurance year the company recorded an 18.1% growth in NOPAT (net operating profit after taxes).
'Course, if you'd rather I give you another necktie, that can be arranged.
Happy Father's Day!
Otter
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