By the time the markets opened Friday morning, investors were shedding shares of American International Group (NYSE:AIG) en masse. The insurance behemoth lost 6.5% on Friday following the release of its third-quarter earnings and subsequent conference call. But for long-term investors, this stock drop should be a welcome event. Here are three solid reasons why there was no need for such an overreaction, as well as the top reason why you could benefit from the drop in share price.
1. Core businesses are strong performers
When you look at AIG's results for the third quarter, it's clear that the company's central insurance operations are going strong. Though at first blush the property and casualty segment appeared to report a decline in new premiums written, a closer look shows that the decline was really caused by negative impacts from foreign currency exchange -- the division had a 3% increase in NPW when that factor is excluded. The division's combined ratio also continued to see improvements, with a 3.4-point drop for the calendar year.
AIG's life and retirement division was going gangbusters again during the quarter, with higher interest rates spurring higher sales of fixed annuity products. Assets under management increased another 10% compared to the prior year's quarter, which helped generate higher fee income for the segment.
Mortgage guaranty business continued to come through the door, with new insurance written totaling $14.4 billion for the quarter. Delinquencies continue to decline, with AIG reporting a delinquency ratio of 6.4% versus 9.6% from 2012. With more than half of the division's premiums earned coming from business written after 2008, it's likely that the company will continue to see declines in its delinquency rate going forward.
2. Market-wide issues
The one area of real concern for investors should be the declines in investment income for the quarter. AIG reported a 4% decline for its property and casualty portfolio and a 5% decline for its life and retirement investments. Since interest rate sensitivity is one of the company's weaknesses, management has turned to alternative investment to offset some of the low yields from its traditional choices. But with interest rates strengthening during the third quarter, the alternative investments proved a hindrance and were the main reason for the drops in investment income.
Investors should keep in mind that AIG's struggles are not unique. MetLife (NYSE:MET) reported that overall investment income was flat for the quarter versus 2012, but its variable investment income (which is more sensitive to interest rates) dropped by more than 9%. Genworth Financial (NYSE:GNW) reported a much more modest decline of 2.4% for the quarter, while Allstate (NYSE:ALL) reported that it has largely escaped the impact of changing interest rates due to investment cash flows being used to pay outgoing liabilities.
3. Shareholder value
One of the keys to Friday's precipitous drop for AIG may have come from its earnings conference call, during which CEO Robert Benmosche said the company would no longer provide guidance for the "aspirational" goals set in the prior few years. This includes a return on equity goal of 10% by the end of 2015. Though the company will still aim for that result. Benmosche was frank in stating that it might not happen in the set time frame. As of the current quarter, AIG reported an after-tax ROE of 6.2% versus 7% from the previous year's quarter.
As my fellow Fool Matt Koppenheffer noted on Friday's Where The Money Is, investors shouldn't be backing away from AIG just because the return on equity isn't up to snuff already. If you bought shares of AIG at Friday's close, you were only paying 70% of the company's book value per share (excluding AOCI), so a 6% ROE from AIG results is an actualized ROE of about 8% for you based on buying the company at a discount.
AIG is also providing plenty of value in other ways, with the continuation of its $0.10 per-share quarterly dividend, as well as share buybacks. So far this year, the company has spent upward of $18 billion in capital on equity buybacks, dividends, and debt management.
If you follow the famous Warren Buffett tenet of being greedy when others are fearful and fearful when others are greedy, now may be the perfect time to apply it to AIG's stock. Friday's drop was a sure sign of fear in the market when AIG "missed" expectations, but a closer look shows that the core businesses are growing, challenges are not just reserved for AIG, and the company is still focused on returning value to its shareholders.