Moody’s Downgrades AIG’s P/C Subsidiaries

Moody's placed on review for downgrade the Baa1 IFS rating of United Guaranty Residential Insurance Company (UGRIC) based on AIG's plan to conduct an initial public stock offering of up to 19.9% of UGRIC's parent, United Guaranty Corporation, as a first step toward full separation. The rating agency also placed on review for downgrade the A2 IFS rating of AIG's P&C subsidiary in China given that this rating reflects implicit and explicit support from AIG P&C affiliates.

RATINGS RATIONALE

"The downgrade of AIG's main P&C units reflects persistent adverse loss development and weak underwriting results plus the ongoing challenge of setting reserves for long-tail casualty lines," said Bruce Ballentine, Moody's lead analyst for AIG.

AIG took a $3.6 billion charge to strengthen its P&C loss reserves, effective in Q4 2015, continuing a history of reserve problems that included charges totaling about $7 billion in 2009-10. The company has announced underwriting and expense initiatives to boost its P&C profits, but these efforts will be constrained by increasingly difficult market conditions, said Moody's. Offsetting the reserve charge, AIG contributed about $3 billion of capital to its P&C subsidiaries, drawing on the large liquidity pool the parent holds to support its operating subsidiaries as needed.

In affirming the AIG L&R ratings, Moody's cited the group's strong market presence and good capitalization. "AIG L&R is a large, diversified US life insurer, although streamlining initiatives under the new strategic plan could weaken the credit profile," said Laura Bazer, Moody's lead analyst for AIG L&R.

With the AIG L&R and P&C ratings aligned at A2, AIG now has a two-notch differential between its main IFS ratings and the parent senior debt rating, rather than the standard three-notch spread. "Our affirmation of the parent ratings, with narrower notching, reflects the diversification benefit from owning sizable P&C and life insurance businesses along with the company's good geographic spread," said Mr. Ballentine.

AIG PARENT

AIG's Baa1 senior debt rating is based on its leading market positions in global P&C insurance and US life insurance, its diversification across products and geographic regions, its successful divestment/unwinding of noncore holdings, and the healthy liquidity of the parent company. These strengths are tempered by the company's record of weak profits and volatile reserves in P&C insurance, its above-average exposure to structured and alternative investments (although the company plans to reduce its hedge fund allocation), and the complexity of risk management across its many business lines and countries/regions.

AIG aims to return at least $25 billion of capital to shareholders over the next two years, funded through a combination of ordinary dividends and tax-sharing payments from operating companies, capital released from operating companies through reinsurance transactions and reduced hedge fund investments, proceeds from divestitures, and increased financial leverage at the parent company. Moody's expects that AIG will manage these initiatives so as to balance the interests of creditors and shareholders, maintaining ample resources to support the operating subsidiaries as needed.

Moody's cited the following factors that could lead to a rating upgrade for AIG: (i) improvement in the stand-alone credit profiles of the US P&C operations and AIG L&R, (ii) consolidated return on capital in the high single digits, and (iii) improvement in financial flexibility (e.g., total leverage below 25%, pretax interest coverage in the high single digits).

The following factors could lead to a rating downgrade: (i) deterioration in the stand-alone credit profiles of major operating units, (ii) insufficient liquidity within operating units or at the parent relative to the company's or Moody's stress tests, or (iii) a decline in financial flexibility (e.g., total leverage of 35% or higher, pretax interest coverage below four times). To the extent AIG sheds major businesses and reduces its diversification, Moody's could widen the notching between the IFS ratings of the operating companies and the senior debt rating of the parent.

PROPERTY CASUALTY

AIG has one of the world's largest P&C networks, writing a broad range of commercial and consumer coverages. The A2 IFS ratings of the US and Canadian subsidiaries are based on their market leadership in commercial and specialty lines, diversified product offerings, and expertise in writing large and complex risks. These units also benefit from AIG's global footprint, which helps the group serve multinational accounts and deploy resources to markets and business lines that offer favorable returns.

Challenges for the P&C group include a record of adverse loss development and weak profitability, along with exposure to natural and man-made catastrophes. A majority of the reserves are in long-tail casualty lines, heightening the risk and uncertainty regarding ultimate losses. AIG aims to improve its profitability through better client segmentation and risk selection, exiting subpar business units, greater use of reinsurance, and reducing its expenses. However, this effort may be hampered by a downward trend in commercial P&C pricing, continued low yields on fixed-income investments, and modest global economic growth.

Moody's cited the following factors that could lead to a rating upgrade for AIG's US pool members: (i) improvement in underwriting results and profitability (e.g., combined ratio consistently below 100%, return on capital above 8%), (ii) consistent favorable development of loss reserves, and (iii) improvement in AIG's financial flexibility (e.g., total leverage below 25%, pretax interest coverage in the high single digits).

The following factors could lead to a rating downgrade: (i) deterioration in underwriting results (e.g., combined ratio above 103%, return on capital below 5%), (ii) significant further adverse loss development, or (iii) a decline in statutory surplus by more than 10% in a given year.

AIG's Canadian subsidiary could see a rating upgrade in the event of: (i) a shift in business mix to more granular, less volatile product lines, (ii) lower gross catastrophe risk, (iii) strong profitability with a return on capital above 10%, and (iv) rating upgrades of other AIG P&C companies.

The Canadian subsidiary's rating could be downgraded in the event of: (i) outsized growth in more volatile product lines, (ii) a return on capital below 8% on a sustained basis, (iii) a meaningful decline in regulatory capital (e.g., decline of more than 10% in a given year or a Canadian MCT regulatory solvency ratio below 230%), or (iv) rating downgrades of other AIG P&C companies.

AIG's Chinese subsidiary is a leading foreign insurer in that market, with good brand recognition and a global network to serve multinational clients. However, the foreign ownership leads to regulatory constraints, limiting the company's growth rate and elevating its expense ratio. In reviewing this company's A2 IFS rating for downgrade, Moody's will consider the implicit and explicit support it receives from AIG, as well as the strategic importance of the Chinese presence to AIG. Deep integration and support could lead to a rating confirmation, whereas low growth potential and limited parental support could lead to a downgrade.

AIG LIFE AND RETIREMENT

The A2 IFS ratings of AIG L&R are based on the group's continuing significant (top 10 in several cases) positions in a number of individual annuity, life insurance and retirement product markets along with good capitalization, said Moody's. Reducing hedge fund exposure, as the company has proposed, should improve the quality of AIG L&R's investments, although it will incrementally lower long-term net investment income and profitability.

Offsetting these strengths are AIG L&R's significant exposure to interest rate risk and spread compression from its dominant fixed annuity businesses, and a growing exposure to equity market and hedging risks, largely through its growing individual variable annuity business.

AIG L&R's streamlining of distribution channels, including the planned sale of AIG Advisor Group, and its greater use of life reinsurance, will result in a smaller, more narrowly focused life insurance operation with lower capital levels over the next two years. Moody's still expects the group to maintain a consolidated NAIC risk-based capital (RBC) ratio of at least 425% and statutory return on capital (ROC) in the 4%-8% range, consistent with its ratings.

Moody's said the following factors could lead to a rating upgrade for AIG L&R: (i) continued leading market presence and business diversification, (ii) consolidated statutory ROC consistently exceeding 8%, (iii) NAIC RBC ratio of at least 425% company action level, with no decline in consolidated statutory surplus exceeding 10% in a given year, and (iv) improvement in AIG's financial flexibility (e.g., total leverage below 25%, pretax interest coverage in the high single digits).

The following factors could lead to a rating downgrade: (i) consolidated statutory ROC below 4% and/or continued earnings volatility, (ii) a decline in consolidated statutory surplus by more than 10% in a given year, (iii) NAIC RBC ratio below 350% company action level, or (iv) pretax gross asset losses of 35 basis points or more in a given year.

UNITED GUARANTY

Moody's said the review for downgrade of UGRIC's Baa1 IFS rating is based on AIG's planned initial public offering of up to 19.9% of UGRIC's parent, UGC, as a first step towards full separation, pending regulatory and other approvals. The rating agency will consider what implicit and explicit support AIG will provide to UGRIC following the spinoff, including the potential termination of a capital maintenance agreement. UGRIC's IFS rating currently reflects a Baa2 stand-alone assessment plus one notch of rating uplift based on AIG support.

Moody's cited aspects of the proposed spinoff that would be credit negative for UGC and UGRIC, including fewer funding sources, a higher cost of capital, and higher reporting and compliance expenses as a public company. Nevertheless, the rating agency expects that UGRIC will remain a leading mortgage insurer, with AIG providing reinsurance protection for a transition period, or arranging for substitutes, to ensure that UGRIC complies with capital standards of Fannie Mae and Freddie Mae.

A multi-year extension of AIG's capital maintenance agreement and reinsurance support could lead to a rating confirmation for UGRIC. Absent such support, Moody's would likely downgrade UGRIC's IFS rating to its stand-alone credit profile of Baa2.