The key to an insurance company's survival is (of course) its primary revenue generator -- premiums. But in the aftermath of the financial crisis, American International Group (NYSE:AIG) found it had a much larger issue to focus on: rebuilding its balance sheet.
The insurance giant's very close call with bankruptcy in 2008 provided a wake-up call that management has been acting on ever since, and with its recent tender offer to purchase up to $1.25 billion of debt securities, AIG has given investors one more glimpse at how the company continues to fortify its balance sheet. Let's take a look at what AIG was dealing with, how it's improved, and how the company will benefit from its continued hard work.
A look back
We all remember the fiasco that ended up with the government having to bail out AIG. But what most of us didn't know was that the investments being made by AIG were some of the riskiest you could find. At the time, AIG was invested approximately $1.8 trillion in derivatives -- complex, confusing, and risky investment vehicles. Because of the complex nature of the derivatives, it was often difficult for firms like AIG to truly evaluate their risk exposure. Since the government bailout, AIG has been de-leveraging its balance sheet, including huge reductions in its derivative portfolio.
Back to now
The current levels of the insurer's derivatives portfolio show a concerted effort to reduce risk exposure, with up to 93% in holdings reductions based on value. The measured risk of the company's exposure has been reduced by 99% according to AIG's most recent financial release.
On top of the measures it's taken to reduce its pre-crisis portfolio of risky assets, AIG management is still very keen on monitoring its capital management levels, reducing its debt coverage ratios, and minimizing interest expenses through debt reductions. That brings us to the insurer's most recent tender offer, set to eliminate up to $1.25 billion in outstanding debt securities.
Some analysts have questioned why AIG chose the securities it's listed. The company has callable bonds available that only pay coupon value; the securities in the offer provide higher returns. Targeting these hybrid and legacy SunAmerica securities allows AIG to get rid of some balance sheet items that management views as having low capital content. Since AIG will continue to participate in intense regulation and oversight by the Fed, there will be capital requirements that it has to maintain on an ongoing basis. By removing these "low content" securities, AIG management doesn't believe that it will be hurting its ability to meet any (currently undisclosed) requirements -- leaving the callable bonds available for future liabilities-management opportunities during the year.
AIG's executives have painted a clear picture of their priorities for the next few years: $25 billion-$30 billion in capital management, a 10% return on equity, and a 1-2 turn improvement on the company's debt coverage ratio. The first two objectives are targeted for achievement by 2015, while the company will be working hard to realize the last during the next year, through capital management improvements and earnings growth.
With reduced exposure to risky investments and a reduction in debt, AIG has given itself more room to expand and integrate business lines and products. Not only will this help with efficiencies and cost reductions, but also with growing premium generation -- its key revenue source and lifeblood. The steps taken since 2008 will allow AIG to return its focus to an insurance company's primary concern and away from the debilitating aftermath of the financial crisis.
The insurance behemoth has already made great progress over the past four years, and it's finally getting the recognition it deserves from Wall Street. Though the company still has its ups and downs, management's goals (and drive to accomplish them) will only help the company reach its full potential. And for investors that can stomach any uncertainty they still feel and invest at AIG's current discount, the upside may repay them four-fold for any initial discomfort.
Fool contributor Jessica Alling has no position in any stocks mentioned, but you can contact her here. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.