Best Takes a Number of Rating Actions on AIG and Subsidiaries

A.M. Best Co. has affirmed the financial strength rating (FSR) of ‘A++’ (Superior) and issuer credit ratings (ICR) of “aa+” of the domestic life and retirement services subsidiaries of American International Group, Inc. (AIG). Best also removed these ratings from under review with negative implications and assigned a negative outlook.

The rating agency also affirmed the FSRs of ‘A+’ (Superior) and ICRs of “aa-“of most of AIG’s domestic P/C subsidiaries. These ratings too have been removed from under review with negative implications and assigned a negative outlook.

Best also affirmed the FSRs of ‘A+’ (Superior) and ICRs of “aa-” of the subsidiaries of AIG’s 60 percent majority owned company, New York-based Transatlantic Holdings, Inc., removed them from under review with negative implications and assigned a stable outlook.

However, Best said it has downgraded AIG’s ICR to “aa-” from “aa”, removed the rating from under revue, and assigned a negative outlook.

Best also affirmed the ICR of “a-” and all the debt ratings Transatlantic Holdings, Inc., removed them from under review with negative implications and assigned a stable outlook.

For another AIG subsidiary, Best said it has “affirmed the FSR of ‘A++’ (Superior) and ICRs of “aa+” of the Connecticut-based Hartford Steam Boiler Group, “as the group has met the criteria for A.M. Best’s highest rating category on a stand-alone basis.” The outlook for these ratings is stable.

“The FSRs of ‘A+’ (Superior) and ICRs of “aa-” of the Personal Lines Pool and operating subsidiaries of 21 Century Insurance Group as well as the ICR of “a-” and debt ratings of 21st Century Insurance Group remain under review with negative implications.” Best added that, due to a change in leadership, it would “hold discussions with management to evaluate future strategies and business plans,” which it expects to finalize during the third quarter of 2008.

Best explained that the companies were placed under review on February 14, 2008 following AIG’s February 11, 2008 SEC Form 8-K. That status was maintained for AIG’s major insurance subsidiaries through the release of the company’s first quarter 2008 financial results, pending continued management discussions and completion of the annual review.

“The first quarter results included a $7.8 billion net loss that was substantially due to continued significant pre-tax unrealized market valuation losses of $9.1 billion on the credit default swap (CDS) portfolio,” Best continued. “The net loss also included $6.1 billion of pre-tax realized capital losses, including other than temporary impairments (OTTI) of $5.6 billion. The net results coupled with substantial unrealized losses contributed to the $16.1 billion decline in shareholders’ equity.”

Best then explained that its current rating actions on AIG’s domestic life and retirement services and P/C operations “was based on the enviable franchise value and sustainable competitive advantages of these operating segments, the ability to generate significant earnings, product proliferation, overall diversification and considerable intellectual capital. The positive reputation and earnings contributions prior to inclusion of realized losses should not be overshadowed or undervalued. AIG’s ability and willingness to provide implicit and explicit support remains and, coupled with the quality of these franchises, was the basis of the affirmation.”

Best added that the holding company downgrade reflects its “viewpoint of the detrimental implications of AIG’s risk management and aggressive risk appetite relating to investment concentrations within the securities lending portfolio and matched investment programs tied to mortgage related securities.”

The article added that AIG’s “risk appetite” had been larger than Best’s expectations, “regardless of AIG’s market surveillance resources within the mortgage industry.” Best also noted that its concerns “included potential liquidity issues within the securities lending program, lack of proactive management or containment of exposure to the mortgage and real estate industry on both the liability and asset sides of AIG’s balance sheet, and over reliance on the amount of support provided by the company’s strong balance sheet.

“Noteworthy is the significant concentration of mortgage and asset-backed securities in the sizable securities lending portfolio which resulted in the majority of the consolidated OTTI losses. The negative performance of this portfolio permeated the earnings of AIG’s major business segments, although they mainly were concentrated in Life and Retirement Services, clouding its otherwise positive performance, and to a lesser extent in Asset Management.”

The ratings report was surprisingly frank in some of its criticisms. “The company’s actions have led to earnings volatility, management distraction, and a decline in equity which prior to the capital raise temporarily increased financial leverage,” said Best. “Asset writedowns have reduced subsidiary capital accumulation leading to additional capital support from
the parent company.”

However, Best said it “believes there is no tangible evidence that these concerns will result in franchise deterioration,” and that AIG’s rated subsidiaries “are adequately capitalized for their rating level. To their considerable credit, AIG easily raised approximately $20 billion of capital through offerings of straight equity, mandatory
convertible and hybrid securities.

“AIG’s ICR continues to reflect its considerable ability to attract investors, and its liquidity was positively tested over the last few quarters in that counterparties apparently maintained their confidence in AIG. However, AIG’s financial flexibility has been somewhat compromised, in part due to a material decline in share value.”

As far as the “negative outlook” is concerned, Best said it should be “considered long term. The outlook anticipates continued earnings variability in the next few quarters albeit to a lesser extent. A change in outlook is less dependent upon a reversal of the market valuation adjustments and more heavily weighted toward unexpected franchise detriment and greater comfort in AIG’s level of risk appetite.”

For a complete listing of American International Group’s FSRs, ICRs
and debt ratings, go to: www.ambest.com/press/052807aig.pdf.

Source: A.M. Best – www.ambest.com