(By Mani) Shares of insurer American International Group (NYSE: AIG) doesn't have any near-term catalysts after the recent stock sale by the U.S. Treasury. However, it is a stock to own in the long-term despite the U.S. government continues to own 16 percent of AIG's shares, which creates an overhang for the stock.
Longer term, AIG's shares look more interesting as the company improves underwriting results at Chartis and uses excess capital freed up through additional asset sales, dividends from operating subs, and utilization of its tax loss carryforwards to repurchase stock at a steep discount to book value.
Strategic initiatives related to lower return businesses is the key to improving the companywide operating return on equity (ROE), which is expected to be 6.5 percent by 2015, up from an expected 5.2 percent in 2013.
"Additionally, AIG could show better than expected progress in achieving its 90%-95% combined ratio target for Chartis in 2015, which would increase our 2015 operating ROE forecast by 60 to 200 basis points and likely result in a significantly higher share price," UBS analyst Brian Meredith wrote in a note to clients.
Chartis, AIG's property and casualty arm, should substantially improve its underwriting margin and ROE through price increases, business mix shift, tighter underwriting, and expense discipline.
"For Chartis, we forecast an unleveraged operating ROE of 8.5% by 2015, which would be at the low end of our estimates of the leveraged operating ROEs of peer companies. Assuming that commercial-lines insurance pricing remains in the mid to upper single digits for the next 24 months, we forecast improvement in Chartis's combined ratio to 97.3% in 2015 from 102.7% in 2012," Meredith noted.
If Chartis improves its systems, strengthens data analysis and implements expense reductions, the expected combined ratio could be conservative.. AIG targets a combined ratio that is between 90 percent and 95 percent by 2015. If the company can achieve a 95 percent combined ratio, it would improve the companywide operating ROE by 70 basis points.
In addition, life insurance unit SunAmerica can generate modest topline growth as it picks up market share in variable annuities and leverages its large multi-channel distribution network. Growth will also be supplemented by acquisitions.
SunAmerica is currently taking advantage of other life insurers' curtailment of growth in variable annuities by increasing its market share in this area.
"We forecast 10% growth in variable annuity deposits and 6% growth in group retirement deposits in 2013. For SunAmerica, we estimate pre-tax operating ROE of 14.5% in 2013, compared to 13.8% in 2010 and 11% in 2011," the analyst said.
While low interest rates are headwinds for SunAmerica, AIG's active management of net investment spreads should contribute to the maintenance of relatively stable profitability of the life insurance operations.
"Through a combination of improved underwriting profitability at Chartis, growth at SunAmerica and capital management, we forecast AIG will compound growth in BVPS plus dividends at 10.7% annually from mid 2012 through year-end 2015 (8.8% CAGR from YE2012 through 2015)," Meredith wrote.
On the capital management front, even after repurchasing $13 billion of its common stock from the U.S. Treasury this year, AIG continues to have meaningful sources of holding company liquidity, which it can use to continue to repurchase its shares. Holding company liquidity is expected to come from dividends from its insurance operations, tax loss carryforwards, the sale of the company's remaining interest in Asian insurer AIA, and proceeds from sales of other noncore assets.
Another potential source of liquidity could come from the Direct Investment Book (DIB) operations, if the assets included in the portfolio appreciate over time to what AIG views as their true intrinsic value.
"We estimate AIG will refrain from repurchasing its shares until the outcome of non-bank SIFI capital requirements becomes clearer. For modeling purposes, we forecast that AIG will resume share repurchases in the second half of 2013," the analyst added.
AIG could sell its remaining interest in AIA and use the proceeds to repurchase shares from the government. Besides share buybacks, AIG could use the excess liquidity for dividends, debt pay- downs acquisitions or for support of growth of its existing operations.
"With AIG shares currently trading at a significant discount to book value, share repurchases are very accretive to book value per share," Meredith added.