American International Group ( AIG -4.28% ) will always be associated with the fear and uncertainty most Americans felt during the 2008 financial crisis. but the AIG that was involved in myriad complicated financial products is history. Many investors are still wary of the insurance giant, but there are several reasons to believe that this company has turned the corner and can thrive for a long time.
1. Its management executed an historic turnaround and is following through on its promises.
Imagine your dream retirement. Does it include owning and living at a vineyard in southern Europe? That's the retirement that current AIG CEO Bob Benmosche was enjoying until 2009, when AIG and the U.S. Treasury Department asked him to lead the biggest and most scrutinized turnaround in corporate history. It's hard to argue with the choice. Benmosche, who until his retirement in 2006, had been CEO at Metlife, went to work with a clear strategy in mind: divest the businesses and divisions that don't fit in the new AIG.
To that end, AIG has been wildly successful. The company has divested tens of billions of assets culminating in the aircraft-leasing business late last year. AIG also wound down the financial products operations that contributed $4.28 billion of operating income in 2005, but ultimately contributed significantly to the company's downfall.
Benmosche's and management's second mandate was to refocus on AIG's strengths in insurance. AIG succeeded in that goal as well because...
2. I can illustrate the business with a crayon.
Well... almost. One of investing legend Peter Lynch's most famous quotes was to "Never invest in anything you can't illustrate with a crayon." The pre-crisis AIG's complicated financial products would have made this exercise impossible. The new AIG has simplified operations dramatically. In the 2012 annual report, AIG provided a small graphic that did a fantastic job of simplifying AIG to its core.
AIG has two main components, a property and casualty insurance operation and a life insurance and retirement services operation, that account for nearly all of its revenue. Obviously, this doesn't make AIG immune from trouble; it still has to price risk correctly and serve customers well. But the company has stripped away the extra risks that aren't part of the core operations.
3. AIG is improving
AIG is no longer on the verge of collapse, but it still has a long way to go to be a world class insurance operator. Even though I have praised Benmosche and management for what they have been able to accomplish, what they haven't yet accomplished is even more important for long term success in the insurance business.
AIG hasn't achieved an underwriting profit since the new management took over, but its combined ratio, a metric that measures underwriting profitability, has been improving. Any number under 100 is an underwriting profit, the lower the better.
AIG's previous poor performance has resulted in a much lower valuation than the two peers I compared it to earlier. Both Allstate and Travelers trade right around 1.2 times book value. If AIG can continue to improve underwriting and bring its combined ratio to a level more in line with Allstate and Travelers, AIG investors could benefit doubly from the improved profitability and the price to book multiple expansion. AIG currently trades at 0.7 times book value, but if AIG were to trade at 1.2 times book today, the stock would be trading for over $82 per share.
The most important thing
Baseball legend Babe Ruth once said, "Yesterday's home runs don't win today's games." To turn his phrase, yesterday's strikeouts don't lose today's games either. AIG should be evaluated on what is happening now. The AIG of today is an improved underwriter with the team in place to turn it into a great one. And as an investment opportunity for us, AIG could be great for that too.