By Sonja Ryst, Research Analyst
In a Wall Street Journal article published more than a decade ago and titled “AIG: A Complex Industry, A Very Complex Company,” Lanny Thorndike, manager of the Century Shares Trust mutual fund, expressed his discomfort that he didn’t know everything about the New York-based insurer. He kept a 3-foot-wide color-coded map showing 250 of American Insurance Group Inc.’s subsidiaries and where they fit into the parent company. “What investors understand, however, is that AIG delivers double-digit earnings growth year in and year out, which is why AIG stock is richly valued, particularly compared with other insurers,” the article said.
After an accounting scandal in 2005 that got Maurice R. “Hank” Greenberg ousted from his role as AIG’s CEO and the recently celebrated (ahem, also due) repayment of its $182 billion government bailout, AIG is at last filing earnings statements that are easier for investors to parse. Instead of pure gibberish, AIG’s financial results are now merely incomprehensible. The U.S. government’s accomplishment of this confusing turnaround highlights the uncertainty that continues to threaten the global economy, particularly after AIG said in October that the U.S. Treasury’s new Financial Stability Oversight Council is considering whether to determine it a “systemically important financial institution” under the Dodd-Frank Wall Street Reform and Consumer Protection Act, in a move that some desperately hope will subject such companies to tougher standards.
The average investor still won’t be able to understand AIG’s earnings, said Paul Newsome, a senior insurance analyst in the research department at Sandler O’Neill + Partners, L.P. “They’re much less complicated than they were before, but they’re still complicated.”
Mr. Benmosche has shown some optimism when discussing his team’s financial statements with investors. For example, AIG reported a deferred tax asset of $15.6 billion as of September 2012, or nearly 27% of its total operating expense versus the industry median of only 4%. Mr. Benmosche said in a February 2012 statement that the accounting benefit reflects a “high degree of confidence” in AIG’s future earnings prospects. Should this confidence about AIG’s ability to produce substantial, taxable profits down the line prove unfounded, AIG might not be able to use that $15.6 billion and will end up having overstated its assets as a result, but apparently Mr. Benmosche is comfortable taking that risk.
There are other red flags. AIG remained burdened with $73.7 billion of debt as of September 30, or nearly 73% of its total equity versus the industry median of only 20%. And AIG paid Mr. Benmosche $13.9 million in 2011, but CFO David L. Herzog only $6.5 million, even when the company was following executive compensation requirements overseen by the U.S. Department of the Treasury. Large inequities in named executive officer pay may negatively affect things such as corporate profitability and the stock market response to acquisitions, according to a 2010 study by Harvard professors Lucian Bebchuk, Martijn Cremers, and Urs Peyer.
Despite years of government control, analysts say it remains a challenge to discuss financial results stemming from AIG’s complex business model, which it in 2009 had called “a sprawl of $1 trillion of insurance and financial services businesses, whose AAA credit was used to backstop a $2 trillion dollar financial products trading business.” While Mr. Benmosche and others have succeeded in cutting arms from that octopus such as AIG’s former Asian life insurance unit AIA Group Ltd., others remain; for example, AIG continues to differ from most U.S.-based insurers in doing both life and property/casualty insurance rather than focusing on one line of business.
“AIG’s earnings aren’t easy to understand because they’re so heavily involved in financials,” said Jim Ryan, a senior analyst at the Chicago investment research firm Morningstar. Insurance by itself is already complicated, and when you have a company the size of AIG involved in so many different areas it becomes even harder, he explained. “It’s gotten easier (to understand AIG’s earnings statements,) but it’s still not easy.”
If AIG remains incomprehensible despite its distinction as the financial crisis’ poster-child, what about all the other companies in the world whose earnings numbers are duly reported as fact every quarter without much understanding of why? AIG’s earnings statements might be confusing, but they also reflect a conservative AGR ® score of 80 as of December, indicating that the insurer had higher accounting and governance risk than only 20% of comparable companies. This is a marked departure from every quarter since at least 2005 until the second quarter of 2012, when AIG’s AGR score had indicated that its risk was above most peers.
Mr. Thorndike says that after The Wall Street Journal quoted him expressing his discomfort with AIG in 2002, then-CEO Greenberg disparaged him on a conference call about his need for a color-coded chart and some of his colleagues gave him flak about it. But he’s moved on from AIG long since. These days Mr. Thorndike manages the Century Shares Trust and the Century Small Cap Select Fund, so he spends most of his time keeping tabs on small companies such as Signature Bank (SBNY.) The New York bank’s financial results are “infinitely simpler” than AIG’s, he says. They describe only a few lines of business with a little commentary, while Signature Bank earnings calls typically last a mere 20 minutes or so and require few follow-up questions. Visiting a local office would be almost impossible at a large company, but at Signature Bank Mr. Thorndike can get all the information that he needs from management very quickly. “Intellectually it’s been more rewarding” to invest in the smaller firms, Mr. Thorndike said. “It also means they can fail – in truth there’s a double-edged sword – but I find that an interesting place in which to hunt.”