American International Group Inc (AIG) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the American International Group's second-quarter financial results conference call.

As a reminder, today's call is being recorded.

At this time I would like to turn the conference over to today's host, Ms. Liz Werner, head of Investor Relations.

Please go ahead, ma'am.

Thank you and good morning, everyone.

Welcome to AIG's discussion of our second-quarter 2013 results.

Speaking this morning will be Bob Benmosche, President and CEO; David Herzog, Chief Financial Officer; Peter Hancock, CEO of AIG Property Casualty; and Jay Wintrob, CEO of AIG Life and Retirement.

Other members of senior management are also in the room and will be available for a question-and-answer period.

Before we get started this morning, I would like to remind you that today's presentation may contain forward-looking statements which are based on management's current expectations and are subject to uncertainty and changes in circumstances.

Any forward-looking statements are not guarantees of future performance or events.

Actual performance and events may differ, possibly materially, from such forward-looking statements.

Factors that could cause this include the factors described in our first-quarter 2013 Form 10-Q and our 2012 Form 10-K under Management's Discussion and Analysis, under Risk Factors.

AIG is not under any obligation and expressly disclaims any obligation to update any forward-looking statements whether as a result of new information, future events, or otherwise.

Today's presentation may contain non-GAAP financial measures.

The reconciliation of such measures to the most comparable GAAP figures is included in our financial supplement which is available on AIG's website, www.AIG.com.

Now I would like to turn the call over to Bob.

Bob?

Good morning, Liz, and everyone; and thank you, Liz.

I am on slide 3.

Clearly, as you can see, another -- and let me underline the word, another -- strong quarter for AIG.

We continue to show consistency and we show very strong across-the-board earnings and fundamentals for all of our businesses.

Two things that I know that you are focusing on that are not in the strong numbers, and that is -- what is going on with ILFC?

So let me deal with that right up front.

We are continuing to negotiate with the consortium.

And keep in mind, we don't have a buyer but we have a group that is buying ILFC.

So this is a very complicated transaction, first on the nature of the transaction and who are the people that we are negotiating with and expecting to sell to.

So we are continuing that dialogue.

We are continuing those discussions.

We did not receive the money on time, and now both sides are working on whether we and how we continue to do this.

But we are focused on an IPO at this stage of the game.

So that if they can come together and the money comes in, then we will proceed.

If not, we are preparing ourselves for later this year for an IPO, where we hope to be able to do a deconsolidating trade with ILFC.

We also were named a SIFI during the quarter, which allows us to now deal with the AIG Bank.

We had retained the Bank, not because we wanted to keep the Bank as a business.

It is less than $1 billion, so we felt it was time to close it.

But we kept it such that we would be able to continue having the Federal Reserve in and getting started early with the Federal Reserve so that we are well prepared for when the SIFI designation comes in.

It has come in, but we are not under CCAR until late next year possibly, or even the first quarter of 2015.

So we are still being regulated as a savings and loan holding company, and that is how it is proceeding, although the auditing and the efforts working with the Federal Reserve is about getting ready for our SIFI period of time, when we are regulated by those rules and regulations.

We were also named a G-SIFI, again by being regulated by the Federal Reserve we are assuming that will be the lead in this effort as we think about global regulation.

And we're going to continue to operate that way, looking at the Fed as the lead regulator working with the others.

And hopefully that will simplify this very complex regulatory world that we are now facing as a Company.

As a result of the strong results of this quarter and, quite frankly, all the preceding quarters, we had recommended to the Board of Directors and after a review with the rating agencies, who were required to give us their green flag, if you will, on capital management, the Board has approved a $0.10 dividend per share, as you saw, and also allowing us to begin to buy back shares with an authorization of $1 billion.

In addition to that, we said that those are priorities, but capital management on debt is also important.

So we reduced our debt, and in fact we have reduced our expense, interest expense by about half the dividend that we are going to be paying out.

So we have got about a $300 million savings in interest.

And we are talking about, if the dividend continues at the rate we are talking about, you are talking about $600 million basically for the year.

And we continue to see strong dividends from our subsidiaries, with $1.3 billion of dividends and loan repayments (inaudible) Insurance Company.

Our Parent liquidity, absent the Bank lines which is on top of this, we have almost $11 billion in cash, so we are really very strong both from a cash and capital point of view as well as operating results.

Peter is going to talk about in just a minute the Property Casualty business.

It is continuing its strong turnaround.

You can see that in the accident year losses, the ability to get rate where it makes sense, we're still growing the top line in a very strong way.

And you can see that our reserve is continuing to be maintained at roughly the levels we think is necessary.

The only exception -- and Peter will talk about this -- is the add to the reserve for the Storm Sandy, which as you know is a very, very serious storm and a very complicated storm to deal with.

On the Mortgage Guaranty front, we have talked about reengineering that business.

We have said that we are now on our way with our new approach to risk selection.

We think we have got a very good, well thought out, state-of-the-art process; and in fact that is in the numbers that you see now as it is emerging, because about half of our earned premiums are coming from our performance premium risk selection capability.

You will also see new business coming in.

So while we have a strong risk selection model we are continuing to show strong growth.

And of course in the legacy book, we are still seeing modest decline in our delinquency rates.

AIG Life and Retirement, again a very strong performer over time and for the quarter.

Variable annuity sales continue to be strong as others struggle with what to do with that business.

Our mutual funds also are very positive.

Assets under management continue to grow, which is a key measure as you think about this business, because you earn fees on assets under management, and so it is really a very simple method to say that if those are going down dramatically eventually your fees will start to go down.

Here we are seeing good growth and good net flows from our businesses.

A lot of questions about low interest rate.

Isn't that a problem?

Isn't that a problem?

It must be a problem.

I am sure it is a problem.

We have said to you quarter after quarter after quarter -- I guess that sounds like I am repeating myself and I apologize, but I do that once in a while.

Clearly the way that Jay's organizations is dealing with this and the way the Investment department is dealing with it, we felt that it was within the realm of being able to manage it without severe problems.

And you can see again this quarter, looking at our crediting rate, Jay and his team has done outstanding job of keeping our spreads pretty much what we need them to be.

So in addition to that, of course, we have low interest rates putting some pressure on us.

You also get the opportunity with a well-designed book; you have the earnings benefiting from investment income during this quarter to offset some of that drag.

So, bottom line is we are having another great quarter.

We are continuing to see strong fundamentals and we are optimistic about our future.

So what I am going to do now is turn it over to David, who will take you through the details of the quarter.

David?

Thank you, Bob, and good morning, everyone.

As Bob mentioned, we die deliver another strong operating quarter, and we importantly continued to execute on our capital management objectives.

With respect to ILFC, I would add that we continue to think of ILFC as a non-core asset.

It remains as a held-for-sale asset given our intent and our plan to monetize it through either a sale or an IPO, as Bob referenced.

On the operating front, we saw solid premium growth and positive pricing in our Property Casualty business along with continued improvement in the accident year loss ratio.

Peter will talk about that in a moment.

Life and Retirement continued to actively manage spread, and it also benefited from strong investment returns.

On the capital management front we continue to optimize our capital structure, and through the first half of the year we have retired a little over $5.5 billion in debt, including $2.9 billion in face amount of debt and hybrids that we have either tendered for, called, or repurchased.

Of the total debt that we have retired [to date] approximately $1.2 billion of that is associated with the Direct Investment book.

Going forward, we will opportunistically execute on our share repurchases as well as debt capital management.

As Bob mentioned, we have reinstituted a dividend and have a further share buyback authorization, both of which point to our positive view of future profitability and capital generation.

Turning to slide 4, second-quarter operating earnings per share were $1.12, up 17% from a year ago.

Operating ROE, which excludes AOCI from equity, was about 7.4% for the quarter.

On a basis consistent with our long-term aspirational goals, which also excludes the deferred tax asset from equity, as we tax-effect our operating earnings, operating ROE was about 150 basis points higher.

Net income for the quarter was $2.7 billion and includes net realized capital gains and the related DAC and loss recognition effects on those gains; certain legacy legal settlement gains of roughly $260 million, net of tax; and a deferred income tax valuation allowance release of approximately $700 million associated with our capital loss carryforwards.

Inception to date we have been able to recognize a little over 50% of the deferred tax asset on our capital loss carryforwards.

Book value per share excluding AOCI was $61.25, up almost 11% from a year ago.

Reported book value per share declined during the quarter to just over $66, reflecting the impact from the recent rise in interest rates.

Operating results begin on slide 5. Each of our Insurance operating businesses reported operating earnings improvements over a year ago, driven by favorable fundamentals.

Again, Peter and Jay will go into further detail.

The Direct Investment book and Global Capital Markets benefited from positive marks in the quarter.

The Direct Investment book earnings were driven by positive nonagency RMBS marks reflecting housing price appreciation, prepayments on the underlying collateral, and spread tightening.

Global Capital Markets also benefited from amortizations and market appreciation on the underlying covered securities in the legacy multisector CDS portfolio.

This appreciation reduces the liability we carry on the related CDS.

Interest expense from the prior year declined, reflecting the interest savings from our liability management actions we have completed thus far.

The corporate expenses, including the impact incurred during the quarter for continued infrastructure buildout, were modestly higher than our expected run rate of about $225 million a quarter.

There is roughly $20 million or so of corporate expenses related to our data center consolidation that winds down going into 2014.

Operating results for the quarter included higher compensation expense related to share-based legacy programs that are tied to changes in AIG's stock price.

AIG's stock price improved about $6 a share, which translates into about $100 million of total compensation expense for the Company.

The effective operating tax rate was almost 32%, slightly higher than our expected run rate, reflecting certain discrete items in the quarter.

We continue to expect that the operating tax rate will be roughly in the 31% range for the second half of 2013.

As you may recall, we will not be paying any US income taxes for some time, given our NOLs, which we expect could provide annual liquidity to the Parent of approximately $1 billion in 2014 and beyond.

Our capital position remains solid, and on slide 6 you can see the current debt levels reflect the nearly $950 million in liability management actions completed in the quarter.

During the quarter, we called $750 million of our 6.45% hybrids.

We called them at par and we purchased nearly $200 million of debt in the open market.

Annualized interest savings from the debt we retired this quarter is a little over $60 million.

And as Bob referenced, the total savings for the annual activities that we will have completed either through scheduled maturities, the active debt capital management completed for the full year will be about $300 million.

We received dividends from our insurance subsidiaries of $1.3 billion in the quarter or $2.7 billion year-to-date, as shown on slide 7. We continue to expect $4 billion to $5 billion in annual dividends and distributions from our insurance subsidiaries.

Parent Company cash and unencumbered securities of approximately $11 billion at the end of the quarter reflect these distributions and liability management that I referenced earlier.

This parental liquidity includes about $5.4 billion related to the Direct Investment book and Global Capital Markets, which is currently allocated towards future maturities and liabilities and also contingent liquidity stress needs.

Nearly 80% of the Direct Investment book's debt matures by the end of 2018.

At this time I would like to turn the call over to Peter to comment further on our Property Casualty business.

Peter?

Thank you, David.

Morning, everybody.

AIG Property Casualty results in the second quarter reflect continued progress towards achieving our goals.

Our second-quarter results were driven by continued underwriting improvements and better than expected alternative investment returns.

Turning to slide 8, net premiums written grew 4%, excluding the effect of movement in the yen and the accounting changes for the excess of loss reinsurance premiums.

Price increases and organic growth initiatives both contributed to this growth.

We continue to expect modest net premium growth for the remainder of 2013 as we continue to write profitable new business.

Our accident year loss ratio, as adjusted, of 61.9% for the quarter improved by 2.9 points from the second quarter of 2012, and was slightly better than trend.

The improvement is due to business mix shift, continued enhanced risk selection, loss mitigation initiatives, and positive pricing.

Importantly, we see no signs that the trend is changing.

Operating income was nearly $1.1 billion, and included catastrophe losses of $316 million from flooding in Europe and the Americas, as well as US tornados and hailstorms.

Net unfavorable prior-year reserve development for the quarter totaled $154 million net of premium adjustments, largely from additional losses on Storm Sandy of $142 million.

These losses resulted from higher severities on a small number of existing large and complex commercial claim notifications.

The increased severity was driven by a number of factors including the extensive damage caused to properties in the downtown Manhattan metropolitan area.

On a year-to-date basis, net prior-year development was favorable by $40 million if you exclude development related to Storm Sandy, and was unfavorable by $102 million including it.

Turning to slide 9, Commercial's net premium written on a reported basis grew by 5.5% from a year ago, or 3.6% excluding foreign exchange and the accounting change for excess of loss reinsurance.

We saw growth in property, financial lines, and specialty which all benefited from improved retentions, new business, and pricing.

In the US, we saw rate increases of 7.3% for the quarter, led by US casualty with 9.4%.

Property and financial lines in the US reported positive rate of 5.7% and 6.8%, respectively.

The market remains modestly more competitive outside of the US, but we continue to be encouraged by casualty pricing in the US, where rate is most needed.

Our efforts to optimize mix, enhance risk selection, claims handling improvements, and increased pricing have lowered the accident year loss ratio for Commercial to 62.2%, down over 5 points from the year-ago quarter.

Turning to slide 10, Consumer net premiums written grew about 5%, excluding foreign exchange and the excess of loss reinsurance accounting change.

Accident and health experienced growth outside the US, particularly in individual A&H in Asia-Pacific as well as in direct marketing.

Net premiums written for our direct marketing business grew 5% for the second quarter of 2012 and accounted for 16% of total Consumer net premiums written.

Consumer acquisition ratios increased a little over 2 points from last year and reflected our investment in the profitable direct marketing channel and other channels.

The bulk of these costs are nondeferrable under US GAAP accounting rules.

Personal lines benefited from improved margins related to our Japanese auto business and should continue to improve through the remainder of the year.

Slide 11 illustrates our investment portfolio mix.

Second-quarter net investment increased 14%, reflecting strong performance of equity partnership investments and fair value increases associated with PICC Property Casualty shares that were purchased during the second quarter and for which we elected the fair value option.

As a result of our strong alternative investment return and the PICC gain, net investment income was about $150 million above our expected return.

We made $792 million in dividend payments to AIG Parent in the second quarter and look forward to contributing our planned dividends to the Holding Company during the remainder of the year.

The second quarter marked continued progress towards increasing the intrinsic value of AIG Property Casualty.

Our shift to high-value business combined with underwriting and claims practice improvements exemplified how our focus on balancing gross profitability and risk is helping to produce better margins.

We maintain our commitment to capital efficiency and optimizing our risk profile.

As part of our continuing legal entity and capital restructuring efforts, we recently announced the planned merger of AIU and Fuji Fire and Marine Companies in Japan.

We expect synergies from merging these large companies and will result in improved customer service, greater management efficiency, as well as to provide us with greater capital flexibility and expense savings.

In closing, I am satisfied with our positive momentum and I am confident that the progress we made this quarter will continue.

Turning to slide 12, our Mortgage Guaranty business reported operating income of $73 million, which represented another quarter of improved profitability and growth in new business.

Delinquency counts continue to fall; and in the second quarter, half of earned premiums related to high-quality business written after 2008.

Mortgage Guaranty results for the quarter also benefited from $49 million of income associated with commutations, settlements, and reserve releases.

We believe UGC is well positioned to take advantage of the mortgage insurance market.

The quality of the business written since 2008, improvements in home pricing, and increasing home sales should drive future profitability and allow UGC to capitalize on its unique underwriting approach, risk-based pricing, and strong capital position.

Now I would like to turn it over to Jay.

Thank you, Peter, and good morning, everyone.

I am going to begin on slide 13, where you can see that AIG Life and Retirement delivered solid results this quarter with operating income of $1.2 billion, up 23% from a year ago.

This increase reflects growth in variable annuity fee income, effective spread management, and higher investment returns.

Premiums and deposits grew 24% from a year ago, largely due to individual variable annuity sales, which exceeded $2 billion in the quarter.

Net investment income increased 5% from the year-ago period, driven primarily by higher returns in our alternative investment portfolio.

Now, this was partially offset by an $84 million fair value loss we reported on our investment in PICC Group shares this quarter, which we now hold at slightly above cost.

We continued our strategy of actively managing spreads in our interest-sensitive businesses.

Our strong results this quarter enabled us to provide additional liquidity to AIG Parent; and as David mentioned, Life and Retirement paid $545 million in distributions to AIG in the quarter and $1.9 billion during the first half of the year.

We are on track to meet our expected dividend payments for the full year.

Assets under management grew 10% from a year ago, driven by increases across our business lines, with strong account value growth in individual variable annuities and Group Retirement, as well as additional institutional assets accumulated through our Stable Value Wrap business.

Net flows increased substantially from the prior quarter and the year-ago period, reflecting robust sales of variable annuities and Retail Mutual Funds.

With the recent rise in interest rates, we saw the unrealized gain position in our general account partially erode, dampening the increase in AUM in the quarter.

Rising interest rates, however, have a positive impact on sales and earnings in our interest-sensitive businesses in particular, which I will elaborate on later in my comments.

To provide additional insight into the diversity of our businesses, this quarter on page 13 we added disclosure on our assets under management by product line.

Our scale and highly diverse business mix provide a strong platform for growth and enable us to perform well in various market environments.

Slide 14 further illustrates the diversity of our businesses based on earnings contribution.

The solid performance this quarter reflects favorable trends across both the Retail and Institutional segments.

The growth of our Retirement Income Solutions business is a good example of our ability to be opportunistic while maintaining our pricing and risk management discipline.

After a significant de-risking of living benefit features beginning back in 2010, we continue to benefit from strong demand for our variable annuity product and remain comfortable with the current trajectory of our sales run rate.

At quarter end, our variable annuity account value, including both fixed and separate accounts, was $32 billion in our Retail or individual variable annuity business and $52 billion in our Group variable annuity business.

Because of our large presence in qualified plans in the Group business, 69% of our total variable annuity AUM provide only a Guaranteed Minimum Death Benefit, with no guaranteed lifetime benefits.

In addition, 77% of our GMDB by account value is in the lower-risk return of premium, or rollups that revert to return of premium, at age 70.

Of our $22 billion of variable annuities with Guaranteed Minimum Withdrawal Benefits, 59% are in benefits with strong de-risking features such as VIX indexing of fees, volatility control fund requirements, and required minimum allocations to fixed accounts.

So the combination of a relatively small legacy block and enhanced risk control in our current features has allowed us to capitalize on opportunities when competitors have chosen or been forced to pull back from the market.

Now in addition, this quarter we introduced a new suite of fixed-index annuities with living benefits to further diversify and enhance our guaranteed income offerings.

In our interest-sensitive businesses in both the Retail and Institutional segments we continued our strategy of active spread management to enhance profitability.

With the recent rise in interest rates we are seeing an acceleration in sales of our Fixed Annuities, which we reprice weekly.

We are encouraged by these initial indications, as it remains our view that a moderately rising rate environment will be positive for our operating fundamentals.

Slides 15 and 16 depict our investment portfolio composition, returns, and yields.

Overall base yields improved slightly in the quarter, benefiting from mortgage loan prepayments and increased accretion income, principally from structured securities.

These were partially offset by the impact of investment purchases made at yields lower than the weighted average yield of the existing portfolio.

Our total or reported yield reflects strong alternative investment returns, partially offset by the fair value loss in PICC Group shares which I mentioned earlier.

Net spreads benefited from our active spread management actions, principally the lowering of renewal crediting rates and maintaining disciplined new business pricing.

At the end of the second quarter, approximately 74% of our fixed annuity and universal life account values were at minimum guaranteed crediting rates, and we remain focused on managing spreads actively.

To sum up, we are pleased with our solid earnings and distributions to Parent through the first half of the year.

We will remain focused on executing our growth strategies by leveraging our strong relationships with distribution partners to increase profitable sales of our broad product portfolio across all channels, while continuing to look for opportunities to grow our businesses where we can achieve the most attractive risk-adjusted returns.

Now I will turn it back to Liz to open up the Q&A.

Thank you, Jay.

Operator, could we please open the line for questions now?

(Operator Instructions) Josh Shanker, Deutsche Bank.

Good morning, everyone.

As the capital return story unfolds and you get dividends from your subs, maybe ILFC closes, I am wondering; in the conversations you have had with the rating agencies, what kind of mix of debt retirement versus share repurchase are you thinking to keep in good stead with them?

We have not had that level of conversation.

We go to the rating agencies when we have something specific to say we want to do.

But as an overarching we continue to focus on taking care of the dividend.

Doesn't mean we might want to increase that, but our focus is on debt and share buybacks.

But, David, do you want to comment?

Yes, thanks, Bob.

Good morning, Josh.

As we think about our capital management, we have discussed in the past a targeted capital structure, and we are nearing that optimal mix of debt and capital.

We still do have some expensive hybrids out that are of interest to us, but that will occur over time.

We have taken an approach with the agencies, with other various stakeholders, with respect to our capital management that we first raise the deployable capital, get it to the Holding Company; we then run through a rigorous set of internal stress tests and analytics; and then we consider the best way to deploy the capital.

So we do not get out in front of ourselves with respect to spending it before we get it.

Understandable.

Peter, can you talk a little bit about where you are on Sandy in terms of approaching the full limit of, I guess, your deductible for the reinsurance?

We haven't disclosed the attachment point on the reinsurance, but suffice it to say that we don't expect to pierce it.

But on the other hand, we're not too far from it, when you actually look at what we expect the ultimate to be.

But in terms of where we are, in terms of the remaining tail, we are about 50% settled and about a third paid, cash out the door, on the Sandy claims.

But there is still a number of repairs underway as we speak, so it will be probably another quarter before we really get to a final number.

Okay.

Thank you and congratulations on the good announcements.

Paul Newsome, Sandler O'Neill.

Good morning, everyone.

Thank you for the call.

I was wondering if you could go just in a little bit more detail into the steps that allowed you to announce the dividend and the repurchase.

I guess I am surprised that you were able to do this before the ILFC transaction.

So maybe if you could just talk a little bit more about how that process worked in terms of discussions with the regulators as well as your own thinking.

And what is left that is contingent, if anything, on capital management, given the ILFC transaction?

I am not sure understand the last question.

You want to know how much more I am going to do?

I am not sure I would give you a specific answer, so let me give you a general answer.

The way we did it -- I know you're going to think I am being trite, but I am not.

The fact is you first get your fundamentals right, make sure the Company is operating well, make sure all of the buckets of risks have been accounted for.

And we have a very -- while we need to improve our stress testing, we have to improve the systems, improve the process, improve the automation to be much more industrial-strength in terms of what we do, we have a process that we know works well.

So you really need to satisfy your selves as a management team that we can afford to do capital management.

That is number one.

Number two, we then sit down with the rating agencies and walk them through what we want to do.

And they give us their opinion based upon the information we have provided them and the track record we are showing them.

And then we spend considerable time with our Board of Directors, who want to make sure that we are not being premature in some of the things we want to do as a management team.

And we spend a great deal of time with the Board in detail, taking them through our whole capital planning process, taking them through our stress testing.

For example, our stress testing is basically modeled using a lot of the information from the Federal Reserve.

But as I have said before, when you think about -- and I think it is a shame that America doesn't understand the amount of stress testing that is done at financial institutions to make sure -- forget about being too big to fail.

They can't fail because of what they are required to maintain on their books.

So for AIG, we go through a process that says, over the planning period of 2013 and '14, what would happen if we underperformed our profit budget by $23 billion?

What happens during that same time if the S&P is down close to 700?

What happens if the credit aspect of credit spreads, not interest rate-sensitive, but what happens if we have a period of WorldCom, Enron -- and you pick any other period you want -- and so credit spreads widen dramatically about 400 basis points?

And at the same time, what happens if unemployment doesn't go in the 10%s but goes to 12.5%?

And, by the way, if that is not enough, what would happen to AIG if in fact housing prices were to drop 20% from here, knowing the amount of mortgages we have on our books plus the mortgage insurance business as well?

And by the way, since you are an insurance company, why don't you throw a Storm Sandy in there and make sure that you've got enough money to cover that storm at the same time?

That is in English what a stress test is.

And I have given it to you at 10,000 feet.

We showed the Board that after all of that we could maintain our CMA levels, maintain the risk-based capital in this Company at those levels which are required for our ratings.

I would think if that kind of scenario occurred the states would be really pleased that we could at least meet our minimum regulatory requirements and work our way back up.

We're not talking about minimums.

We're talking about the CMA levels.

So based upon that, the Board said -- we think it's sound for you at this time to proceed with your dividend and proceed with a $1 billion share buyback.

If ILFC closes or when ILFC closes, the Board will look at what we prepare.

We will then update our stress test, update the information.

We will share it with the Board; we will share with the rating agencies.

And based upon all of that, the Board will make a decision.

So that is how the process works.

I know people are asking -- well, did the Fed approve it?

The Fed does not approve these things.

The Fed oversees what we are doing, and if the Fed felt at any point in time that we are doing something as a savings and loan holding company they would go and say -- look, I think you are being imprudent.

But they don't approve things.

Once we get under the CCAR test, however, then they will in fact look at our CCAR, look at the amount of capital we have, and look at the process we have in place to calculate that information.

And based upon the quality of our systems, we have a runway to get there and we are working hard along that runway.

And that is why we wanted to -- actually, people said -- are you nuts?

Why would you want to start early?

It is because you want to get prepared so that you have an acceptable process and it is a repeatable process such that the Fed is very comfortable that not only do you have numbers that say you are okay, but you have a process that says your numbers are okay.

And that is all what we are working towards.

And that is something at the end of '14 into early '15.

(technical difficulty) now is making sure we live with the first half of what I said, and that is we run the Company the right way and we are being prudent.

Long-winded answer; I apologize.

But I know a lot of you are trying to figure out what happened here, and it is what we said all along.

When we are ready, we will.

No, that was a terrific answer.

Thank you very much.

That's very helpful.

Jay Cohen, Bank of America Merrill Lynch.

Thank you, a couple questions.

I guess just to follow up on that last one, so while the Fed didn't explicitly approve this, you obviously had discussions with them prior to making this announcement.

We inform the Fed of everything we are doing of any consequence so that they are aware of any issues we have so they don't read about it in the paper.

So yes, they're our regulator; they are aware of all of our -- they are in many of our meetings; they are in many of my leadership meetings, attending them.

So this is important, that you keep your regulator understanding what you are doing and you are very transparent with that regulator.

So they are aware of not only this but everything else we are doing.

That's great.

And by the way, Jay, the key is the rating agencies.

And right now that is where we go, and if the rating agency said -- we are having some concern with what you are doing, I can assure you we would not have done it.

Exactly.

Second question, I know the details of any prior-year development will come out in the Q. But, Peter, I am wondering if you can talk, excluding Sandy, the Sandy development, what you saw.

Were there any particular lines where there was material adverse development?

No, it was very benign.

Everything was immaterial in the context of our reserves.

I don't know whether, John, you want to make a comment.

Yes, I certainly agree with the way Peter described it.

We had some movement up and down I guess within Casualty, some loss-sensitive adjustments that were offset by premium accruals.

But outside of that we had a bit of adverse development in a construction defect-related claims out of a program that has been in runoff for a number of years, largely around legal expenses.

But inconsequential, immaterial relative to the total.

That's great.

Thank you.

And we had a slight favorable in Japan Consumer.

Good.

Thanks, guys.

Jay Gelb, Barclays.

Thank you.

Can you give us a sense of how long you think it would take to complete the $1 billion buyback authorization?

I would appreciate giving you all advance notice, but we will continue to do what is prudent and we will continue to evaluate different options and different techniques.

So for now we will let you know when we are done, and we will keep you posted as we buy them back and what the average price per share is.

In terms of future buybacks on top of this authorization, is there anything?

Does the sale or IPO of ILFC need to be complete before we can expect additional buybacks to this authorization?

What I said on the -- when I was asked the other question, we look at our capital, we look at our results, we look at how we are faring, we do our stress testing.

We update our stress testing throughout the year.

And we would continue to do what we think is prudent for AIG.

So if ILFC were to close, and depending upon what kind of transaction we do, we would factor that into our thinking.

Okay.

Then for Peter, based on the first-half results, it still appears that there is 5 to 10 points of combined ratio improvement that is needed to get to that 90% to 95% calendar-year goal by 2015.

What is your confidence level in achieving that?

Well, I think that I listed out the various initiatives that have led to the trend in accident year loss ratio improvement that we have had now for 10 quarters.

And I think that there is no sign that any of those initiatives are experiencing diminishing returns.

So eventually, obviously, we will experience diminishing returns, but we are making good progress on all of them.

The actuaries take time to recognize initiatives that are emerging in the loss triangles but may not be confirmed with enough statistical significance yet; so we have some line of sight into the future momentum.

Obviously pricing is outside of our control.

But again as I mentioned, where we felt there was the greatest pricing inadequacy in the US Casualty lines, we continue to have seen quite good pricing trends.

And in Europe, where the pricing has been a bit softer, we already had pretty decent adequacy.

So I see no change in my level of confidence that we will accomplish that target.

Great.

Then in the meantime, does that also mean you have confidence in the adequacy of AIG's overall Property Casualty reserve position?

Yes.

All right, thank you.

Jimmy Bhullar, JPMorgan.

Hi, good morning.

The first question is on the P&C business.

Your expense ratio picked up a little bit sequentially, and I think you have talked in the past about expenses being elevated in the near-term as you are investing in the business but then starting to improve sometime in 2014 and beyond.

Are you still comfortable with that?

And then on the ILFC transaction, I don't think there is a breakup fee.

And when you talk about deconsolidating trade, I am assuming you are implying over a 50% sale.

But I just wanted to make sure that that is correct.

And the last question is on the fixed annuity business.

We have seen industry sales improve as rates have gone up.

Your sales sequentially were actually down and your surrenders were up.

Not sure if that is because the block is aging or what is going on there.

Well, as I have said before on the expenses, yes, we are spending on infrastructure and a number of analytical resources, data improvements that are integral to our improved risk selection and claims handling.

So we are seeing benefits in the loss ratio offset by increases in the GOE ratio, and we continue to invest in acquisition costs.

So the overall expense ratio remains elevated.

I would expect the GOE ratio to come down, as you point out, in the mid 2014 period.

So a lot of the heavy lifting in terms of investments will start to tail off in that period.

The one area, though, I would point out where there may be slightly more delayed expense benefits is what I announced in the comments earlier, which is the merger savings between AIU and Fuji Farm Marine, which is a very substantial merger integration effort that will take some time to execute because of the sheer scale of it.

It is between the two companies almost 6,000 people, so it is very substantial.

Jay, why don't you cover the fixed annuity comment and then turn it over to David, who will finish up with the question on ILFC?

Great.

Thanks.

Jimmy, I think your presumption is correct.

Being the largest in the Fixed Annuities, we probably have the biggest book and the block is aging.

That is, as expected, leading to higher surrenders which, because the vast majority of those surrenders are from contracts with high guaranteed minimum interest rates -- 3% and above in some cases -- that is actually a very good thing from a profitability standpoint.

We did see some interesting competitors come in early in the quarter and increase their sales.

We stuck with our pricing discipline, as we always do.

And having said that, late in the quarter and through the month of July, as I mentioned earlier, we have begun to see an acceleration in sales of Fixed Annuities now that rates have spiked up.

So the block is behaving as expected; and again the vast majority of what is surrendering is at high guaranteed minimum interest rates.

Okay.

I would just follow up -- and we have said this I believe on a previous call.

And that is that Jay and his team are holding to a very strong discipline, because when you think about rising interest rates, and I don't need to -- if you look at book values this quarter you all understand it clearly, of what can happen.

With rising interest rates you don't want to have a very tightly priced fixed annuity book sitting at these rates right now.

And if you do see a couple hundred basis points rise that will be very helpful for AIG and for Jay's business.

But if you have a large block of low interest rate annuities, Fixed Annuities, in that kind of environment, you could see some extensive disintermediation.

So part of our hedging strategy is to make sure we don't have an oversized book at these levels that we have to worry about rates going up and what happens to that block.

So I think right now we see rising interest rates, at least for the first couple hundred basis points, as a big positive for the Company.

Jimmy, it's David.

With respect to your ILFC question, as I said in my remarks ILFC is a non-core asset and we will pursue our plan to dispose of it, either through a sale or through an IPO.

And with respect to the sale, again -- and you had asked about a breakup fee.

The deposit is not a breakup fee, but you could -- we will protect our rights to that deposit.

So that is all I would say with respect to that.

Then with respect to the 51%, yes, that is the level at which we deconsolidate it.

And we, of course, would evaluate market conditions and valuations etc.

at the time of an IPO to optimize the value of that monetization for the benefit of AIG and our stakeholders.

So we haven't set any predetermined notion, but we will optimize the value.

And then protecting -- I don't understand what protecting the rights on the deposit means.

Maybe you could just --

Well, it would just -- I'm not going to say any more than that, just we will protect them.

It is not a breakup fee, which was your question; and we'll move to -- we'll pursue our rights under the terms of the contract.

That is what I thought.

Maybe if I just ask one more, I think Peter mentioned that the actuaries were being somewhat conservative in their loss picks.

So I am assuming that that is implying that there is some level of cushion in your reserving.

Is that the right read?

And if that is the case, then how do you reconcile that with the fact that if you look at the last six quarters you have had, I think, four of those quarters where you've had actually adverse reserve development.

What he said was -- let me be really clear -- that until you see the emergence of a pattern that the actuaries are comfortable with is not a short-term blip, but in fact that is what we call vectors in math, but you've been to look at it over an extended period of time so you have a clear pattern, until that emerges they are not going to make some early judgments.

The judgments they make are what they believe is the best estimate and the most accurate estimate based on the data that they are seeing.

So they want to see more of an observable period before they make any judgment.

So that is what he said, and so don't misinterpret it.

All right.

Thank you.

I would also add that the reserve adjustments that you have witnessed in the last two and a half years have been largely related to older accident years.

I have been talking about accident year loss ratios and the impact of new underwriting guidelines and risk selection techniques.

So they will take longer to emerge, and so I think they are really separate issues.

Okay, thanks.

Josh Stirling, Sanford Bernstein.

Good morning.

Thanks for having us on the call and congratulations.

A good quarter and exciting news.

So, a question on capital returns.

When you began this journey you guided to $25 billion to $30 billion of capital management.

So rough math I think you are somewhere around $9 billion to $14 billion remaining by 2015.

As you are now finally being allowed to act like a normal company, should investors expect measured, regular, and recurring buybacks like we see at your peers?

Or is this something where we should expect this to be very opportunistic and episodic as we have seen over the past couple of years?

I'm going to turn it over to David.

But I would say that our first and really -- we said dividends, capital management.

But our first priority is to find businesses that may be strategic and make sense for AIG, and are not closed blocks but growing blocks.

So we like to continue to invest our money in those businesses.

We're going to continue to look at the best way to deploy our capital.

With the stock price as you saw last night where it's got, and you have our book value and you see what is going on, obviously as you get closer and closer to book you want to think more carefully about what you are doing.

If you get over book you think a lot about what you want to do.

So I think all of that is an overarching concept which is not new to any of you.

David, want to talk about the particulars on our aspirational goals?

Yes, sure.

Thanks, Josh.

Just again to recap, we have done a total to date of about a little over $18 billion -- with the $13 billion of equity we did last year, equity buyback; a little over $3 billion of debt capital management, going after some of the callable very expensive hybrids; the recent share buyback we just announced on the authorization; and then a couple of years' worth of the dividend.

They sort of add up to $18 billion.

And you are right.

So we have got $7 billion to $12 billion to go.

I think the fundamental foundation, as we have said, is we raise the deployable capital to the Holding Company, and a very important part of that is the dividend flows that both Jay and Peter referred to, is raise the deployable capital.

In addition to that we have the ILFC proceeds that will -- that are unencumbered up at the Holding Company.

And I also referenced in my comments about the tax-sharing payments that in '14 should be in the $1 billion range, and they grow from there and they're annual after this.

So you can see a path and we can see a path to raising the deployable capital.

And then that is input to the framework that Bob laid out in terms of how we and how the Board and the various stakeholders think about how we go about deploying it.

It could be lumpy.

Yes, it is likely -- again, it is going to be opportunistic as we have done in the past.

It is going -- we will be prudent, and I think Bob laid out a very clear framework for how we think about it and how you should think about it.

That's helpful.

Thank you.

If I might switch to Peter, you guys made a really relatively dramatic progress in the accident year loss ratios and combined ratios in P&C Commercial, and it is great to see that playing out.

The question I would ask is as you continue the journey to get to a low 90s combined ratio, the Consumer lines don't think to be going the same direction, and it looks like maybe there is some noise in the quarter.

But just generally I am wondering if you can give us some more color on the relative magnitude of some of the key levers and how you think about the status of the initiatives on that side of the house.

Sure.

The big noise in the quarter is the yen exchange rate.

There is a very, very big portion of our Consumer business in Japan, and so you need to strip that out before you even think about it.

There is, I think, some significant opportunities in Japan to improve profitability as we talked about, in terms of both the expenses but also as we reinvigorate the brand in Japan.

Outside of Japan there is another one-off item that came through the loss ratio but not net income, which is in one very large extended warranty program where there is an offsetting profit-sharing agreement that is not -- it is an issue of geography on the income statement.

So that is a one-off adjustment you need to make when you look at the loss ratio in the second quarter.

Beyond that, I think that the emerging markets story is very positive in terms of long-term profitability and growth.

But the startup costs of that are quite substantial so that adds to the expense ratio.

And we have talked many times about the direct marketing business, which we feel has excellent lifetime profitability over customer relationships, but has pretty unfavorable GAAP accounting.

So we want to take a measured approach to how much of that we do, but we like it from a marginal ROE point of view over the lifetime of the customer relations, based on the persistency that we have been seeing in that book.

So we will be doing that in a number of additional countries.

So I think in general we see continued growth in Consumer.

I think we have opportunities to focus more than we do today.

We operate in 90 countries, and so I think that that will bring some efficiency gains.

And the convergence to common technology platforms will make it also more efficient.

Great.

Thank you.

Keep up the good work.

Operator, I think since we are getting close to 9 we will only be able to take one more question.

But please reach out after the call with your additional questions and we will certainly do our best to follow up as soon as possible.

Mark Finkelstein, Evercore.

Good morning, everybody.

Maybe I will start with Peter on international Commercial.

The numbers were just a little bit lighter than I had expected.

Maybe user error.

But I guess the way I would frame up the question is -- and I get the point about less need for rate than you have in North America.

But are you satisfied with these margins?

And do you feel like you need to improve them on a core basis in terms of achieving your overall targets?

I think that, again, there's a little bit of a foreign exchange element in terms of the top line there.

And there is continued opportunities for streamlining technology and reaping the full benefits of legal entity consolidation.

As you may know at the end of last year we consolidated all 25 European countries into one legal entity, and that is starting to give us efficiencies.

But on the capital efficiency that has not fully come through.

But in general, the international business has a better ROE because it is shorter tail, less dependent on investment income.

And I would say that the success of our property business, Commercial property business internationally has been very pleasing.

We are seeing a good takeup rate of our large limit highly engineered property activities, further diversifying our book away from overconcentration in US commercial property.

So I don't know whether, John, you would want to elaborate on your level of satisfaction with the international operations.

Yes, I see an opportunity for us to continue to grow that business.

Peter mentioned the FX pressure from Japan; that obviously had an impact on the top line in the quarter.

But we saw outside of Japan, the rest of Asia 18% growth in the quarter; Middle East and Africa, 19% growth; 27% growth in Latin America.

Obviously, those are smaller parts of our overall Commercial insurance franchise.

In terms of pricing or rate adequacy, on a major line basis -- so if you think of it from a property casualty, financial lines, and specialty point of view -- all of our major regions outside of the United States in those major lines cover their cost of capital currently.

There are some opportunities for margin improvement and obviously there are some smaller lines that in any given jurisdiction you have some profitability challenges that we'll always be dealing with.

There were some cats in the quarter, right, as well.

In Argentina; a modest amount in Australia; and then the flooding in Europe as well.

So all those events had an impact on the bottom line in the quarter.

But we think we are very well positioned outside of the United States and inside the United States.

But we see good opportunities for profitable growth all throughout the rest of the world.

Okay.

Maybe a question on the DIB.

I think every quarter I look at my model and what you guys produced; and at least for the last four or five I feel like the DIB has beat my expectations, pretty widely in a lot of cases.

I guess you've got 80% of the maturities coming within 2018, I think you said.

Maybe the way to ask the question is -- how far do you think we are from that so-called intrinsic value?

Is there any framework for how to think about DIB earnings going forward?

Brian, you want to cover that for us as we close down the call?

Sure, be happy to.

Again, the performance of the DIB is not going to be linear.

We have had market conditions that have allowed us to recognize the gains you have seen over the last few quarters.

As we talked about, we gave some rough ideas of what we think the pull to intrinsic is.

At the end of last quarter we said it was around $5 billion, a little under $5 billion.

We had approximately $750 million or so of gains, and we have also sold some assets in the DIB to the Operating Companies.

So those, the gains and the sale of those assets, reduced that future upside.

So if you think about it now at around $4.1 billion, $4.2 billion, that is probably where we are.

But another way to think about it is if you look at the DIB capital, the NAV of the DIB; and you look at the composition of the assets, you could think about it as having roughly a 10% return on that capital over time.

Again that is probably the simplest way to think about it, if you are trying to model.

And this will come in, again, over time.

We could have down quarters.

Again, a lot of it depends on the markets.

But I think from the 2018 period forward, you are probably looking at six to eight years before you see a bulk of that capital start freeing up and coming through.

Okay.

That's very helpful.

Thank you.

Thank you, once again, for joining us this morning.

And certainly if you have any follow-up questions, please reach out.

And we look forward to speaking with you next quarter.

That does conclude today's conference.

Ladies and gentlemen, we would like to thank you for your participation.

You may now disconnect.