From a valuation point of view, separation looks like the right move for this particular market. Despite the pandemic and looming recession, P&C businesses such as Travelers Cos. and Chubb are trading right around their five-year average forward price/earnings multiples. Investors are betting that a so-called hard market will see insurance rates rise more than enough to cover any increased losses from Covid-19, wildfires and other risks.
Meanwhile, life-insurance multiples are depressed. Life insurers are hit hard by superlow interest rates, which reduce the long-term returns they can earn on cash collected by the policies. The mortality risk of Covid-19 doesn’t help. AIG is valued at about 8 times the next 12 months’ earnings, a discount of around 25% to its five-year average multiple, putting it more in line with where S&P 500 life-insurance companies are trading, according to FactSet figures.
In theory then, an AIG P&C business could receive a significant rerating. However, it isn’t at all clear whether AIG’s P&C business is poised to earn the same multiple as its peers right now. AIG for years has been aiming to improve that business by reworking policies and exposures with its customers, taking out reinsurance on certain legacy risks and bringing down expenses.
It still generally trails peers on some key measures, though it is trending in the right direction. Its combined ratio, which measures losses and expenses as a percentage of premiums earned, has been above those of Travelers and Chubb for some time. But that gap has narrowed in recent quarters, especially when excluding catastrophe losses and past-reserve adjustments.
One area in which AIG trails is more within its control—its expenses, according to figures compiled by Erik Bass at Autonomous Research. AIG’s ratio of expenses to premiums in P&C was 34% in the first half of the year, versus 28% and 30% for similar measures at Chubb and Travelers, respectively. The company’s AIG 200 initiative is aimed at improving its efficiency.
The stock’s trading performance after the announcement suggests investors are taking a wait-and-see approach. Wells Fargo analysts, for example, figure that P&C would make up about 60% of the firm’s estimated 2021 after-tax core operating earnings per share. The fact that AIG shares rose only around 3% Tuesday morning suggests investors aren’t yet ready to grant the P&C unit a full rerating.
Investors also will likely wait to hear more about how exactly the life-insurance unit will be sold and whether some additional value can be wrung out of it. Some investors may be wary of a spinoff: MetLife’s separated life unit, Brighthouse Financial, is trading at just over half of its 2017 initial price, hit in part by collapsing interest rates. However, there may be more upside potential now, with rates already at historic lows. Other life-insurance spinoffs, such as Equitable Holdings in 2018, also have performed better.
As for a sale, AIG’s life-and-retirement business may be worth about $14 billion by Wells Fargo’s estimates. A single transaction would be far bigger than another recent big deal in the space, the $6 billion sale of a Cigna unit to New York Life. Perhaps AIG could do it piecemeal. Already, it sold a large part of the Fortitude business. But that approach might also take more time and test investors’ patience.
AIG may finally be doing what activist critics have long urged it to do, and the company’s path to normalcy in investor’s eyes may have taken a major step forward. But the shares are unlikely to reap the full benefits right away.