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Inside in Full: Zaffino at AIG: Five more years!

AIG chairman and CEO Peter Zaffino signed a new five-year deal this month...

With the company until recently almost permanently in crisis since the mid-2000s, it has been difficult to look forward over that kind of time horizon.

But with AIG emerging from perma-crisis and this five-year deal in place, it makes sense now to look forward and ask what success would look like for Zaffino by year-end 2027, and what AIG might need to do to get there.

There will be some absolute measures of success. Investors will want to see AIG deliver the 10%+ ROE that has been promised to them many times over the years, supported by low volatility profitable underwriting.

They will also want to see a meaningful re-rating of the stock, which currently trades at 1.18x book, but only 0.83x adjusted for the impact of mark-to-market losses that will unwind. Success will require it to hit a more typical trading multiple, probably somewhere in the 1.3x-1.6x range.

  

 

But success will also be judged relatively. The most common comparator for AIG is Chubb.

Success for Zaffino will depend upon narrowing the underwriting performance gap, seeking to outgrow Chubb and eroding its significant trading multiple advantage.

Given the enduring success of Chubb, this is a tough head-to-head for AIG, but given their shared global specialty and large account focus, their private client groups, and the Greenberg connection, it is the unavoidable comparison – and one which, sources suspect, Zaffino actually relishes.

  

 

Expectations for what Zaffino can achieve with AIG are also effectively set by his compensation. Total compensation for the period of ~$150mn – roughly ~$30mn per annum if you evenly spread the $50mn restricted stock option – sets a high bar for delivery.

Sector-leading compensation is not paid for keeping the lights on. Having been instrumental in fixing the unfixable P&C business in Act 1, the board now expects a great Act 2 in which Zaffino really makes something of it.

To make that happen, I think there will be five key areas of focus.

1. Deliver consistent underwriting profitability and an end to unpleasant surprises.

AIG has already made huge strides on improving its P&C underwriting performance, but from here it needs to be unerring in delivering an ex-cat combined ratio below 90%, favorable reserve development and an underwriting profit in all except the most extreme cat quarters.

  

 

The wholesale re-underwriting and the overhauled reinsurance purchasing look to have brought cat losses largely under control. Typical quarters are now below 5%, and even Hurricanes Ian and Ida resulting in less than a 10% impact on the combined ratio that allowed an underwriting profit to be delivered.

Prior year reserves have also become much more stable, but the company did absorb a $660mn reserve charge in its financial lines unit in Q3, primarily driven by excess D&O written out of the US and Bermuda.

The losses emerged from poor years for D&O and reflected the scrapped large-limits strategy, but the reserve addition has come late, and investors will want this to be the last negative news to emerge from the bad old days.

Premium multiples rely heavily on investor conviction that reserves are conservatively set and will run off favorably. AIG needs to establish confidence its reserves are an asset and an earnings stream, not an accident waiting to happen.

2. Finish reshaping the portfolio through the life separation and other challenging areas, simplifying the story for investors.

Having gritted his teeth through the listing of Corebridge into a volatile equity market, Zaffino must now see through the divestiture of the remainder of the stake.

An 18-24 month timetable for the divestiture of the remaining 78% of the business is a sensible baseline, with selling starting when the lock-up expires in Q2 next year. AIG will hope the stock re-rates from its current 8x price-to-earnings ratio during the sell-down, which seems possible given high-yield environments support life insurer multiples.

Selling out of Corebridge entirely will establish AIG as a pure-play P&C franchise, which should allow it to escape some of the composite discount it was suffering from.

But it also offers the business a windfall infusion of cash over the next two years. At its current market cap, AIG’s stake in Corebridge is worth $11bn, although it will hope for additional upside.

A significant chunk of the proceeds are likely to go to share buybacks to squeeze the share count. A double-digit reduction in the share count would give the company a clearer line of sight on delivering a 10%+ ROE.

As previously argued, AIG should over the five-year period also look to divest Validus Re and AlphaCat. Reinsurance is an odd fit for the kind of low-volatility business that Zaffino wants to create.

In addition, one of the central original theses around the use of third-party capital to finance primary insurance risk looks utterly dead in the water.

The lack of potential buyers after Covea bought PartnerRe has essentially provided AIG with no opening to sell Validus, but that may change if sentiment bounces off the bottom based on a hard reinsurance market.

Another area it will need to find a way to address is its high-net-worth (HNW) business. Like reinsurance, HNW inevitably brings volatility. AIG will need to solve for that either by shrinking it, or by finding other pools of capital to support it like a reciprocal or additional reinsurance (which would be much easier said than done).

3. Make a successful major acquisition, or establish a strategy based around a series of smaller acquisitions.

M&A is definitely part of the plan over the next five years, according to multiple deal bankers that work in the sector that are already on notice.

A crucial prerequisite for this is a re-rating of the stock to ~1.3x. If AIG trades below that level, there will be shareholder pressure to return any excess capital through buybacks.

The Corebridge funds provide a one-time opportunity for AIG to put more cash on the table for a deal. In really round numbers, AIG has $6.5bn of parent company liquidity which it could partly utilize, cashflow of ~$5bn per year (netted down for the ~$1bn dividend) and could maybe bring another $6bn-$8bn from Corebridge proceeds if it gets a valuation lift.

It’s impossible to work to an exact number based on public information, but AIG becomes one of the insurers with the highest potential cash contribution to any deal.

And with a slim majority cash deal, you could see scope for the firm to stretch towards a $30bn total consideration – although its own shareholders would likely face book value dilution in the process, and it would have to make moves that hurt returns like pausing buybacks and holding the excess capital on its balance sheet.

The obvious deal in this bracket would be The Hartford (market cap: $23bn), the firm where Zaffino started his career. As it stands, AIG in retail is essentially a large account business. The Hartford would give it a small US commercial franchise, something which is very hard to build organically.

Diversification into a part of the market with stickier pricing, broader distribution and lower volatility would be strategically attractive and clearly additive. But even if this deal wasn’t a stretch on size, and didn’t throw up social issues, other companies in the sector also perceive the value in the same play. Crossing swords with Chubb and Zurich would increase execution risk substantially for AIG.

Less ambitious versions of the same playbook would see AIG move on The Hanover (market cap: $4.9bn) or Selective (market cap: $5.5bn), although they lack The Hartford’s scale and nationwide reach, and would be perceived as more conservative moves.

AIG is a majority international business, and some bankers believe this is actually the more obvious M&A frontier than the US. Once you rule out life and reinsurance, though, it is harder here to generate a list of targets that hit the right size threshold - with RSA sold last year and QBE having a sizeable US business AIG would not want to buy. Generali would be a potential option, sources said, or Aviva’s GI business if it was ever willing to part with it.

That may point to the need for an international middle market M&A strategy that went country-by-country, including taking the firm back into Latin America. Although this may well be perceived as less appealing than a Big Bang.

4. Demonstrate that AIG can generate robust organic growth without undermining its underwriting turnaround.

I’ve argued at length before that AIG needs to find a way to land the pivot to growth, having imposed tight central controls and a culture of saying “no” to brokers to land its remediation.

One more quarter down and AIG has yet to prove it is passing this test with below-peer 6% FX-adjusted growth, despite bright spots like Lexington.

And, as much as the re-underwriting of recent years was an unavoidable necessity, AIG cannot move indefinitely lower in the market share rankings.

  

 

Success for Zaffino has to include establishing AIG as a company that can go on the offensive, and sure-footedly deliver organic growth.

To do that it is likely to have to go after increased client counts rather than dialing up line sizes. There would be no surer cycle killer than AIG dusting off its larger-limits strategy.

AIG will also need to find a way to build a growth machine that can operate successfully in a much less congenial environment as well.

This will reflect (a) the fact the Long Firming cannot go on forever; (b) the recessions that are likely in all of its major markets; and (c) inflation coming down from its 2021/22 peak.

5. Ensure that succession in key leadership roles is in place and that the transitions are landed.

One of the things that undergirded the turnaround of P&C underwriting was successful hiring, with almost all of the top 50 staff turning over.

Zaffino built an imperial guard of highly talented people around him who were fiercely loyal to the project, and helped overhaul the organization.

  

 

That team has held together well, but looking out to a five-year time horizon there are certain to be a number of notable retirements.

The default last time round was for talent to be parachuted in from the outside. This time AIG will likely look to promote from within when vacancies emerge via those retirements. When it does so, it needs smooth transitions.

 

Inside P&C provides unparalleled market intelligence on the entire US P&C market – from small commercial and personal lines right through to reinsurance and Bermuda. Redeem your complimentary 14-day trial for more premium content from Inside P&C.

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