AIG Enters Into Reinsurance Deal to Restore Profitability

American International Group, Inc.AIG has entered into a reinsurance agreement with National Indemnity Co. (NICO), a subsidiary of Berkshire Hathaway Inc. BRK.B . This is yet another effort taken by the company to de-risk itself from long-term claims tied to its commercial insurance policies.

Although the company has been taking several strategic steps in recent times to return to profitability, its shares returned 8.1%, underperforming the Zacks categorized Insurance Multi-Line industry's return of 13.6% in 2016. The weakness implies that investors are closely watching the several turnaround actions taken by the company and their outcome. We expect the stock to gain going forward as and when the growth initiatives start bearing fruit, resulting in clear visibility in the company's profitability.

Coming back, the reinsurance coverage from NICO will cost AIG an estimated $10.2 billion. In exchange, the company will get coverage to long-tailed liabilities arising from excess casualty, workers compensation to the tune of $20 billion or 80% of net losses in excess of the first $25 billion.

The charge of this reinsurance transaction will be accounted for in the first quarter of 2017. It will also dent the company's 2017 investment income, in terms of premium forgone which could have been otherwise been used to make investments.

Despite this costly solution, investors seem to be okay with this move by the company. They viewed this deal as the best way to manage complex claims arising out of commercial insurance policies written prior to 2015 that have been an eye sore. The deal will significantly reduce earnings volatility and provide clarity to the company's earnings.

Along with minimizing the company's liabilities, the reinsurance deal will solidify the group's risk-adjusted capitalization. AIG has been making contributions to its reserve additions in order to clear claims arising from these policies. Consistent reserve addition has taken a toll on the company's capital and earnings. It will now no longer have to fortify its reserves by the addition of funds, to pay for claims arising from it. These funds can now be used for making investments, undertaking shareholder initiatives and growing its core business operations.

This move marks one of the many strategic initiatives taken by the company last year to return to profitability. The Chief Executive Officer of AIG, Peter Hancock, has long been under pressure to take aggressive profitability steps from activist Carl Icahn and John Paulson. He has therefore been taking all the necessary measures like shedding unprofitable and non-core businesses, entering into risk-transfer deals, boosting share buybacks, increasing dividend, taking cost-reduction measures, reducing exposure to hedge fund investment, and forming a new executive leadership team.

AIG carries a Zacks Rank #3 (Hold). Some other stocks worth considering include Radian Group Inc. RDN and Everest Re Group Ltd. RE . Both stocks sport a Zacks Rank #1 (Strong Buy). You can see the complete list of today's Zacks #1 Rank stocks here .

Radian delivered positive surprises in two of the last four quarters, with an average beat of 5.9%.

Everest Re delivered positive surprises in three of the last four quarters, with an average beat of 25.6%.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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