Is Now the Time to Buy AIG?

On Tuesday I went to hear Josh Stirling, who covers Property/Casualty (P&C) insurance stocks for Bernstein Research.

I have only seen Josh a couple of times, but I have been impressed with his knowledge of the industry and of the companies he follows.

P&C insurance stocks have done well in the last couple of years. While earnings growth has been reasonable for most of the stocks, investors who want exposure to the financial sector but have been wary of the bank and brokerage stocks have found a refuge in the P&C insurance group.

Their relative outperformance has driven valuations on many of the P&C insurance stocks to the upper end of their historic ranges.  According to Josh, many of the stocks may continue to perform well, but it is less likely that we will see the strong relative performance that has characterized the group - an assessment that I largely agree with.

That said, there is one stock that Josh has a "table pounding" buy on:

American International Group (AIG).

AIG, of course, was in such tough shape during the financial crisis that the government had to inject billions of dollars to keep the company afloat.  If it hadn't, AIG surely would have failed, and its vast size and huge credit exposures would have been catastrophic.

In 2012, however, the Treasury sold its stock in AIG (at a profit) and the company is once again totally owned by public shareholders.

Current management of AIG is determined to restore its reputation, and has already started the long process to getting the company back to business.

However, its troubled past, and the fact that AIG remains a very difficult company to analyze, has left its stock trading at just 0.5x tangible book value. Most of the other stocks in the PC insurance space, by contrast, are trading at a modest premium to book value.

If AIG can get its operations together, it is not out of the realm of possibility for the stock to trade in-line with its peer group, which would mean big profits for shareholders (in its heyday AIG traded at 4x book, but this would seem unlikely to occur again).

That said, the AIG story still carries significant risks. Although Treasury no longer owns a part of the company, AIG's business operations are still being monitored by the Federal Reserve, making it less likely that it will be able to earn the mid-teen's ROE that many other large PC companies are achieving.

In addition, AIG remains a "show me" story in terms of its operations.  On paper it would seem likely to be able to improve returns, but it is not yet clear that it has the team in place to do this. The current low valuation of its stock reflects the market's skepticism.

Josh, however, feels that for the intrepid investor AIG could be a double or triple in the coming years.  I want to do more work on the stock, but I am definitely interested.

Josh is not the only one who thinks that AIG could continue to work in here.  I came across this piece on the blog Seeking Alpha - here's an excerpt:

The discount from book value for shares in AIG will shrink as the company continues to improve its coverage ratio, which in turn would improve AIG's rating. AIG also has a goal of being investment-grade in 2015. Such a goal will support the view that AIG shares will keep rising. Resuming a share buyback and initiating a dividend would signal management confidence in AIG's interest coverage ratio. This in turn would attract more buyers for AIG shares.

http://seekingalpha.com/article/1232231-4-catalysts-that-will-drive-aig-shares-higher

Interesting Idea on Health Care Reform

From Tom Kuntz in today's New York Times:

February 25, 2010, 6:38 am

A 19th Century Idea for Health Reform

Today’s idea: To get healthy young Americans into the insurance pool, pay them bonuses if it turns out they’re correct in their belief that they won’t get sick, say two academics.

Health | Floundering health-care reform plans in need of new ideas? Writing in Regulation magazine, Tom Baker and Peter Siegelman offer an old and nearly forgotten one.

They suggest copying the wildly popular “tontine” life-insurance policies of the mid-1800’s, which paid a bonus if the insured happened to outlive the policy’s term. The writers think that applying the same concept to health coverage would, consistent with behavioral economics, entice the all-important, uninsured “young invincibles” into the insurance pool and reduce costs for everyone:

Young, “invincible” — and here to save the day?

The simplest arrangement would award the bonus to those who did not consume more than a threshold value of medical care during a three-year period, potentially excluding preventive care. … Ordinary health insurance provides a tangible benefit only when you need health care. Tontine insurance pays a cash benefit when you don’t use it, as well as covering your medical expenses when you do. As such, tontine insurance is structured to be maximally attractive to those who have an overly optimistic assessment of risk.

True, the authors note, tontines (named after an Italian banker) were outlawed in life insurance in 1905, after a political scandal stemming from all the cash they generated. Thus tontines were victims of their own success, the authors say, but there was nothing intrinsically wrong with them as insurance products. [Regulation]

Disability Insurance

Most of us, I think, are worried about disability, especially long-term disability. Yet, as this article in today's New York Times indicates, perhaps the odds of the need for extended care might not be as high as the insurance industry would have us believe:

Here's an excerpt; full link follows:

February 6, 2010

Your Money

The Odds of a Disability Are Themselves Odd

...You’ll need an education about all the ways in which the companies may limit your ability to make a claim. One of the biggest restrictions comes when insurers try to force you back to work in any job you can perform, even if you can no longer do the work you did before you were disabled. If you can afford it, you want what’s known as “own occupation” coverage instead, which should pay claims if you can’t do your old job.

There are at least a few dozen other questions you’ll need to ask your employer, your insurance agent or yourself when considering the coverage you need. I’ve posted them on our Bucks blog and linked to it from this sentence in the Web version of the column. Please post comments on any issues you think I’ve neglected, and I’ll update the list accordingly.

All of this may sound as if I’m trying to scare you away from disability insurance, in the same way that many people in the industry seem to want to scare you into buying a policy. But that’s not my intent. If you can afford a policy but lack the savings to stave off ruin during an extended disability, paying a few hundred dollars a month for coverage may be a fine idea.

But the disability insurance industry can do better here. Exaggerating for effect doesn’t really help the cause when its product is confusing to begin with.

http://www.nytimes.com/2010/02/06/your-money/life-and-disability-insurance/06money.html?em