AIG: Picking at the Pieces

For the moment, giant American International Group (AIG) lives on government life support, for which it’s paying 850 basis points (8.5 percent) over LIBOR, effectively 11.4 percent, on an $85 billion loan.

“My intention is not to liquidate the company,” Edward Liddy reportedly said at an employee meeting right after he was named CEO to oversee the selling off of assets so AIG can pay back the loan as quickly as possible.

Will AIG survive? Probably, but it will emerge from the crisis as a very different company than the one founded by C.V. Starr, and brought to the pinnacle of the insurance world by Maurice “Hank” Greenberg.

Although no company has as yet made a firm offer for any of AIG’s approximately 240 different units, bids are expected. The rumors and speculations are flying.

There are, however, some basic questions that have to be answered before anyone will make a firm offer for anything.

First, Liddy, and his advisers have to decide what they might sell. They were scheduled to come up with a list by the beginning of this month.

Second, they have to determine a price, and everything from a “fire sale” valuation to “full value” is possible. Obtaining that will not be easy in the present financial climate, where “asset deflation” has reduced the value of company holdings to well below what would have once been considered “fair market value.” Assets of companies like AIG, which must sell, are especially affected.

Third, at least regarding the insurance subsidiaries, putative buyers have to satisfy regulators of their competence and financial means. This requirement should not be taken lightly. New York State Insurance Superintendent Eric Dinallo, who heads a national panel of state regulators overseeing possible sales of AIG’s assets, has asked Centerview Partners, an investment advisory firm, to help in assessing the terms of any potential sales of regulated entities.

A fourth consideration is finding sufficient available funds to make an offer. This might be more difficult than usual, given the current financial meltdown, which caused AIG’s problems to begin with. A notable exception is Berkshire Hathaway, which has been sitting on a pile of cash for years (around $35 billion less the $5 billion it paid for a stake in Goldman Sachs).

There are close ties between the two groups. AIG’s surplus lines insurer, Lexington Insurance Co., recently arranged a contingent property reinsurance cover from Berkshire Hathaway’s National Indemnity Co. for its real estate portfolio. Perhaps, more significantly, Warren Buffett, Berkshire’s legendary CEO, has gone on record, as being “interested in one or two AIG units.”

Some European and Japanese companies might also have the necessary funds, as well as Australia’s QBE. So, what are they going to be interested in?

David Bradford, executive vice president and editor-in-chief of the New York-based advisory firm Advisen, prepared a comprehensive analysis shortly after the bailout was announced. He foresees a first-in, first out “FIFO” approach to the sales, in which AIG’s more recent acquisitions would be the first ones offered for sale.

“The most likely U.S. candidates are those companies that are comparatively autonomous and which serve well-defined sectors,” Bradford wrote. He cites Hartford Steam Boiler Inspection & Insurance Co., 21st Century Insurance Co., and Audubon Insurance Co.

In Bradford’s opinion other AIG insurance units “are deeply entwined through interlocking business models and inter-company pooling arrangements that would have to be disentangled before selling the companies as discreet entities.” The National Union Inter-Co. Pool, for example, has nine companies including flagship commercial lines carriers National Union and American Home. “These companies are the core units of AIG’s P/C operations, and are unlikely to be sold except under extremely dire circumstances,” Bradford added.

Other analysts, as reported by Reuters and other news agencies, have singled out International Lease Finance Corp., AIG’s highly profitable airline leasing operation, and its U.S. life insurance and annuity arm American General, which it bought in 2001, as well as AIG’s 59 percent stake in reinsurer Transatlantic Holdings. Institutional investors hold another 37 percent.

The analysts have also compiled lists of possible buyers.

Canada’s Manulife Financial seems to top their list on the life and pension side. In addition Manulife is very interested in entering the Japanese and Chinese wealth-management markets, where AIG has a long standing and substantial presence.

Australia’s QBE features prominently in many reports as a possible buyer of AIG’s U.S. commercial and specialty lines businesses. After having been unsuccessful in its attempt to acquire Insurance Australia Group, the company has a substantial war chest, and one of its main priorities is further expansion in the U.S.

There’s also been speculation that Liddy might do a deal with Allstate, which he formerly headed, for AIG’s personal auto lines.

If Transatlantic goes on the block, it’s a safe bet that the buyer will be either a Berkshire unit, probably General Re, or a European, most likely Swiss Re or Munich Re. Transatlantic’s market capitalization is a hefty $3.55 billion, which would probably put it out of reach of any smaller players, including most Bermuda companies. It could, however, be attractive to a large Japanese company, such as Tokio Marine.

If the insurance industry loses AIG, or sees it reduced to a shadow of its former self, the effect will be profound. Bradford concluded: “The most significant impact of the AIG crisis would result from a sale of AIG insurance entities to companies with different business models and risk appetites.”