American International Group, Inc.
Q4 2007 Earnings Call Transcript

Published: 4 Mar 2008

Operator:

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. [Operator Instructions]. Today's call is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the meeting over to Ms. Charlene Hamrah. Ma'am, you may begin.
Charlene M. Hamrah:

Thank you very much. Good morning and thank you for joining us today. Before we begin, I would like to remind you that the remarks made today may contain projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management operations, products and services and assumptions underlying these projections and statements. It is possible that AIG's actual results and financial condition may differ, possibly materially, from the anticipated results and financial conditions indicated in these projections and statement. Factors that could cause AIG's actual results to differ possibly materially from those in the specific projections and statements are discussed in item 1A Risk Factors of AIG's Annual Report on Form 10-K for the year ended December 31, 2007. AIG is not under any obligation and expressly disclaims any such obligations to update or alter its projections and other statements, whether as a result of new information, future events or otherwise. The information provided today may also contain certain non-GAAP financial measures. The reconciliation of such measures to the comparable GAAP figures are included in the fourth quarter 2007 financial supplement, which is available in the information... Investor Information section of AIG's corporate website. And now, I would like turn the call over to Martin Sullivan.
Martin J. Sullivan:

Thank you very much Charlene, and good morning ladies and gentlemen. As usual, I am joined this morning by a number of my senior management colleagues. AIG's results in 2007 were clearly unsatisfactory. This was a very challenging quarter and year. Rapid deterioration in the U.S. residential, real estate and credit markets significantly affected several of our operations and investments. This offset the strong results generated through the first half of the year. As expected, a number of our businesses were adversely affected by their exposure to the domestic residential real estate market and we expect these businesses will continue to be challenged in the foreseeable future. As you have seen, AIG reported a net loss of $5.3 billion in the fourth quarter of 2007 and an adjusted net loss of $3.2 billion. Two large items have adversely affected the quarter's result. First, adjusted net income for the fourth quarter was reduced by the net unrealized market valuation loss of $11.12 billion pretax or $7.23 billion after-tax, related to AIG financial products' Super Senior credit Default Swap Portfolio. These losses occurred in the context of a significant widening of spreads of asset-backed securities, principally those related to U.S. residential mortgages, the severe liquidity crisis affecting the structured finance markets and the affects of rating agency downgrades on the underlying collateral. Second, net income was affected by $1.7 billion in after-tax net realized capital losses, as well as $418 million in after-tax other than temporary impairment charges related to AIGFP's 'Available for Sale' investment securities. Two of our other operations exposed to the U.S. residential real estate market, were also affected in the fourth quarter. United Guaranty reported an operating loss of $348 million and American General Finance reported $9 million in fourth quarter operating income, principally due to an increase in the provision for finance receivable losses and a decline in mortgage banking revenues. We expect operating results in both these businesses to continue to be challenged. In UGC, our best estimate is that future premiums on the existing in-force broking, of both domestic first and secondly lien risks will exceed future losses incurred. However, losses will likely emerge in advance of premiums earned and we expect that negative operating results will persist throughout 2008 as a result of continued weakness of the U.S. housing market. While not immune to the downward cycle of the housing market, AGF's adherence to disciplined underwriting standards will continue to help maintain credit quality. We also believe opportunity is to acquire high-quality portfolios, similar to the pending acquisition of Equity One's branch loan portfolio will continue. We are obviously witnessing and living through extraordinary market conditions. And we are trying as all many others to value very complex instruments. These valuations are not mechanical. They involve difficult estimates and judgments. I can tell you that we have at all times brought our best judgment to bear in making these valuations. I want to take a few minutes now to further comment on the valuation of AIGFP's credit default swap portfolio, and the circumstances that lead to the filing of our recent 8-K. In response to strong investor interest in November, we decided to devote a previously scheduled investor conference on December 5th that is subject AIG's exposure to the residential mortgage market. During that webcast conference, the AIGFP team discussed the model and the methodologies that they use to value the Super Senior credit default swaps. They also discussed that their estimated numbers accounted for the differences between most described as
Steven J. Bensinger:

Thank you very much Martin and good morning. Overt the next few minutes, Win Neuger, Bob Lewis and I will update you on various developments in certain of our businesses during 2007. First, I will discuss the Super Senior credit derivative business at AIGFP, including comments concerning the unrealized market valuation loss we have taken. Second, Win will comment on selected components of AIG's insurance investment portfolios, concentrating on the U.S. residential mortgage-related investments, commercial mortgage-backed securities, our exposures to monoline insurers and our exposures to CDOs and CLOs. Finally, Bob will conclude with brief remarks on United Guaranty, our mortgage insurance business and American General Finance, our domestic consumer finance business. We've posted two presentations to the Investor Relations section of our website. During our discussion this morning, we will be referring to the one entitled Conference Call Credit Presentation. The other one is entitled Conference Call Credit Presentation Supplemental Materials. This presentation contains more detailed information regarding our businesses and portfolios for your information and review. Now if you would turn to slide four, in the Conference Call Credit Presentation. One of the businesses in which AIGFP is engaged is the business of writing credit derivatives to cover the risk of incurring realized credit losses on the most senior tranche in the capital structure of the securitization, referred to as the Super Senior Risk Layer. The terms Super Senior is used by market participants to denote very remote credit risk, but there is no single definition of the term. Each transaction is spoke [ph] highly customized and designed to withstand extreme stress, and yet incur no expected loss. Great care has been exercised in structuring the deals starting with due-diligence of the counterparty's motivation for entering into the transaction, positive selection of the assets, experience of the manager and definition of portfolio maintenance characteristics to name just a few. Each underling security is assigned an internal credit rating by AIGFP where possible, based on the fundamental credit analysis and judgment of AIGFP's credit officers and on the ratings assigned to the collateral from the three rating agencies where available, along with the review of its current market spread. AIGFP augments the Super Senior structuring process with its own actuarial models, using assumptions more conservative than those used by the rating agencies. The minimum attachment point for the Super Senior portion of the portfolio is modeled as a minimum threshold above which there is no expected loss to AIGFP. The final attachment point is negotiated to exceed the model detachment point and we will discuss typical transaction structures in a moment. AIGFP started writing this business in 1998 and to-date has not incurred or realized loss in any of its Super Senior transactions. Now if you turn to slide five, AIGFP has entered into Super Senior credit derivative transactions in three broad categories
Win Jay Neuger:

Thanks Steve. I will provide you with an update on AIG insurance investment exposure to residential mortgages, commercial mortgage-backed securities, monoline insurers and collateralized debt obligations. We posted a more detailed presentation on the website, as Steve mentioned. Here also we incurred the significant negative realized and unrealized accounting losses during the fourth quarter. The overall, market dislocation had an impact on investment valuations, which resulted in realized capital losses in 2007 of $3.6 billion. We also have reported an unrealized depreciation on investments of $8 billion, reducing accumulated other comprehensive income to a still positive $4.4 billion net of tax. On slide 19, the components of the 2007 losses and declines are detailed. Above all risk assets were impacted the RMBS securities were most affected, as shown in the far right column. I also want to point out that these combined realized and unrealized losses are approximately 2% of the total insurance investment portfolio and not all of the losses on the left hand column are even related to these portfolios, and non-RMBS losses amount to 1% of non-RMBS insurance investment portfolios. Beginning with realized losses, more than 100% of the net number is accounted for by the $4.1 billion, other than temporary impairment. Of that OTTI loss approximately $3.1 billion is expected to recover in value. The 3.1 billion amount that we expect to recover is associated with either our inability to reasonably assert that certain severe declines in valuations are temporary, our lack of intent to hold to recovery or an adverse change in the timing, but not the amount of cash flows in structured securities. Another $500 million is associated with other than temporary changes in currency valuations and that leaves the remaining approximately $500 million which is associated with credit and structured securities impairments, with all the expectation of full recovery of principle. Please note that actual transactions during the year generated net gains of $1.2 billion and only $30 million of losses were taken on sale of RMBS. Moving to the $8 billion of unrealized depreciation for the year, $5.1 billion or 63% is associated with RMBS mostly rated AAA and AA. In addition we have also seen declines in valuation of monoline insurers, commercial mortgage-backed securities and CDOs. We continue to believe that these market value declines are driven predominantly by market conditions, not by significant changes to the risk of principal repayments. I will now move to talk in more detail about the key segments of the RMBS portfolio and explain our current position and why we believe that will be mostly repaid. I am going to skip from slide 20 to 21 and talk about the breakdown of the $89.9 billion of RMBS exposure. Our sub-prime RMBS holdings totaled $24.1 billion down from $28.6 billion at the end of June and $29.9 billion at the end of September. Alt-A RMBS holdings totaled $25.3 billion also down from earlier periods. Slide 22 displays further details of the RMBS portfolio by rating for each type of mortgage-backed security. The slide underscores the point that we overall RMBS portfolio is high quality with 91% rated AAA by agencies and 7% rated AA. On slides 23 and 24 are details of the sub-prime and Alt-A portfolios, by vintage year, rating and weighted average expected life. Slide 23 shows the details of AIG's investments $24.1 billion of sub-prime holdings. 87% of sub-prime is rated AAA and another 12% is rated AA. Slide 24 provides details of our Alt-A holdings totaling $25.3 billion, of which 95% are rated AAA, and 4% are rated AA. An important component in understanding the risk in our RMBS holding is the degree of credit enhancement. On slide 25 we presented our original and current average credit enhancement for this sub-prime 2006 vintage, the largest vintage year among our portfolio sub prime holdings. Although the market's loss expectation has increased, our portfolio has delevered significantly, with an average credit enhancement of 29.6% for our AAA holding, and 21.5% for all holding below AAA. While sub-prime 2006 vintage loss estimates have risen into the high-teens or even low 20s, the combination of excess spread and current credit enhancement is providing the intended cushion. Slide 26 shows comparable information for the Alt-A portfolio. As shown on slide 27, the major rating agencies have been downgrading and placing many securities on negative watch during the past six months. About $443 million of AIG's RMBS securities were downgraded in the fourth quarter of 2007 and an additional $3.6 billion were downgraded through February, 25th. $9.7 billion of the portfolio is on negative watch as of that date. Of these downgraded securities, $2.7 billion were sub-prime exposures and represented 11% of the total sub-prime holdings. Taking into account all rating actions through yesterday, 93% of our sub-prime RMBS exposure is still rated AAA and AA. It's important to note also that rating agency downgrades do not affect the structural priority of payments, so the securities originally rated AAA retain their payment priorities including trigger or treble rates irrespective of their current ratings. Turning to Commercial Mortgage-Backed Securities or CMBS, on slide 28, our holdings are $23.9 billion with close to 89% rated AAA or AA and only 0.2% below investment grade. Moreover $21 billion are traditional CMBS securities. Of the 9% of the CMBS exposure that come from resecuritizations of CMBS and Commercial Real Estate or CRE CDOs two-thirds of the loan underlying these securities are seasoned 25 months or more. Side 29 presents the CMBS portfolio's current delinquency profile compared to market experience, showing positive comparison with only 23 basis points of delinquencies on the portfolio. Next, slide 30 shows our CDO portfolio, shows that our CDO portfolio amounts to $4.6 billion, most of which are CDOs of corporate bank loans. In general, the pricing of this portfolio has been adversely affected by current marketing conditions. However, after fourth quarter write-downs, the portfolio has only $58 million of remaining ABS CDOs with sub-prime exposure and only 1.6% of the holdings in the total portfolio were downgraded in 2007. Based on our current analysis, the ultimate loss of principle in the CDO holdings is expected to be minimal. Turning to AIG's exposure to the monoline insurers on slide 31, the investment portfolios have $42.2 billion of exposure, of which more than 99% are financial guarantees from the monoline companies. $31.4 billion of the monoline exposure supports the municipal bond portfolio, which has a high underlying credit quality of AA. Slide 32, which shows or slide 32 rather, shows that the 84 % the monoline exposure has an underlying rating of A or better, in other words the bonds that are being insured are rated A or better without the guarantee. Financial guarantees are viewed by AIG purely as a secondary source of payment for all wrapped investments. On slide 33, is the breakdown of our exposure to each monoline insurer. You'll see that 96% of the monoline exposure is to MBIA, FSA, Ambac, and FGIC. Slide 34 summarizes the characteristics of our RMBS, CMBS and ABS wraps that are wrapped by the monolines. The RMBS, CMBS positions with internal ratings below investment grade represent primarily Second Lien and HELOG, Home Equity Loan Goals that have worst experienced... that have experienced worst than anticipated performance. Currently, there are 10 RMBS Second Lien and Home Equity transactions totaling at $380 million, or less than 1% of AIG's total insured portfolio that are known to be receiving contractual payments through their financial guarantees. Concluding with slide 35, since August 2007, the broader capital markets have emphasized liquidity and aversion to risk. The U.S. residential mortgage market has continued to deteriorate, with limited financing opportunities from mortgage borrowers and substantial increases in lifetime loss expectation on 2006 and 2007 U.S. mortgages. This deterioration has increased our mark-to-market and downgrade risk. However, our preference for RMBS exposure is high in the capital structure, continues to guide a current expectation that the risk of an ultimate loss to investment principle in these securities remains low. We've also focused on monoline, CMBS and CDOs in this presentation, all to varying degrees have been focal points of market volatility in the past six months. So our CMBS holdings have suffered from volatile market pricing, underlying fundamentals remained strong with very low delinquencies. Furthermore our CDO holdings have suffered minimal downgrades in 2007 and have little exposure to the current struggling sub-prime CDO market Because AIG focuses on fundamental credit analyses, our holdings did not rely on financial guarantees for monoline insurers... from monoline insurers as a primary source of repayments at the time of acquisition. In this environment, in our insurance portfolio as we have been opportunistically increasing liquidity, further downgrading migrations are... seem fairly likely but its important to note that ratings changes do not affect the structural protection and unless we expect substantially full recovery of principle interest from most of our investment holdings. Furthermore, we are looking for opportunities to take advantage here as the markets create what are truly compelling opportunities in the market. And I will turn it to Bob.
Robert E. Lewis:

Moving on briefly to AIG's mortgage insurance subsidiary, United Guaranty in slide 37, UGC has been providing lenders mortgage insurance on first and second lien mortgage since 1963. As the broad market participates in the cyclical business, UGC's performance is highly correlated to the fortunes of the housing market. The current housing downturn has affected performance in asset quality, but UGC continues to outperform the industry on average. Several underwriting and eligibility adjustments being implemented by UGC and their lender customers are improving the quality of new business production. The composition of UGC's portfolio has not changed significantly as shown on slide 38. Loans to borrowers with FICO scores less than 620 constituted about 8.4% of UGC's domestic mortgage risk enforced and 70% of their net risk-in-force has FICO scores greater than 660. Furthermore, high risk products such as interest only and option ARMS remain less than 10% of the risk-in-force. The 2007 vintage exposure was driven by higher utilization of mortgage insurance in the overall mortgage market. However UGC's market share of its traditional first lien flow business did decline by 1.2 percentage points quarter-over-quarter and 2.3 percentage points year-over-year. Turning to slide 39, the deterioration of the U.S. housing market has affected all segments of the mortgage business, but the high LTV second-lien product is particularly sensitive and accounts for 51% of UGCs 2007 domestic mortgage net losses incurred. Due to the accelerated claim cycle of second-lien mortgages, these net losses incurred should work through the portfolio much faster and peaked in 2007. First lien net losses incurred however are starting to have a significant affect on operating results and some further deterioration is expected in 2008. Nevertheless, as of December 31, 2007, expected losses are significantly below the net risk-in-force. Moreover future premiums are projected to exceed future losses on the existing domestic mortgage portfolio, despite an inherent mismatch in the timing of premium earnings and incurred losses. UGC's decision to be only a minor participant in the higher risk bulk channel which is predominantly sub-prime, Alt-A, and option ARM business is the primary driver behind UGC's better delinquency performance on first-lien mortgages than the rest of the mortgage insurance industry, as depicted by the graph on slide 40. The graph is narrower than historical levels due to a rapid deterioration in the overall markets. However in January the gap widened to 73 basis points from the 64 basis points in December. The slides 42 and 41 describe UGC continues to implement key risk initiatives to improve the quality of new business production in both the first and second lien businesses, including tightening eligibility guidelines and increasing rates in select high-risk business segments. There are a number of risk-mitigating factors described on 43. In light of this the cyclical nature of the mortgage insurance business, UGC employs risk-sharing arrangements or captive reinsurance with most of its major lender customers. It also purchases quarter share reinsurance on quotients of its sub-prime first lien business and segments of its second lien product. UGC maintains an important exclusion for fraud on both its first and second lien business and it has a geographically diverse book and continues to focus on ensuring single-family owner occupied residency. In summary on slide 44, UGC has engaged in the highly cyclical business and downturns in the housing industry have negatively affected short-term results. UGC continues to implement key risk initiatives to improve the quality of new business production. However, UGC expects the downward market cycle will continue to adversely affect its operating results for the foreseeable future and is likely to result in another significant operating loss in 2008. Turning to slide 46, American General Finance is AIG's domestic consumer finance business. AGF is a portfolio-based lender whose product includes real estate, non-real estate and retail sales finance loans. It originates real estate loans through a 1600 branches. AGF also originates and acquires loans through its centralized real estate operations. Slide 47, depicts the slowdown in AGF real estate production beginning in the third quarter of 2005. As we have mentioned in previous calls, AGF did not relax underwriting standards in the market overheated in late '05 and '06. Rather they anticipated many of the real estate market issues and scarified growth for long-term credit quality and earnings stability. The results of AGF's underwriting discipline has resulted in a mortgage portfolio with credit quality far superior to that of the sub-prime asset-backed security real estate market as shown on slide 48. On slide 49, AGS Real Estate 60 plus delinquency rate was 2.64% and its real estate net charge-off ratio was 0.47% at year end '07. The current housing downturn has resulted in delinquencies and losses that have risen form recent all-time lows and credit quality remains subject to future of macroeconomic conditions. Nevertheless, AGF's credit quality remains below its target ranges which were set by AIG and AGF management years ago, to the sound credit quality parameters. Slide 50 highlights key risk mitigants in the mortgage portfolio. AGF has required full income verification on almost its entire real estate book. In addition 88% of the portfolios are fixed-rate mortgages which have much lower delinquencies and losses than adjustable risk products. The limited ARM customer base is qualified on a fully indexed and fully amortizing basis at origination and only 9% of the overall real estate loan portfolio is due to reset interest rates by year end 2008. Furthermore, AGF did not delegate underwriting on purchase loans and has not made option ARMs. Essentially all other real estate loans are first mortgages and owner-occupied. AGF recently announced the pending acquisition of $1.5 billion and outstanding balances of branch-based consumer loans of Equity One Inc. representing approximately 130,000 accounts. As described on slide 51, this transaction is expected to close during the first quarter of '08. AGF believes this is an excellent opportunity to augment organic growth with a large portfolio of first and second fixed rate mortgages, consumer loans and retail receivables that is similar to AGF's customer profile and credit quality performance. In summary, on slide 52, at the end of the fourth quarter, the real estate portfolio remained at $19.5 billion, flat to the end of the third quarter. AGF believes that the housing market will likely continue to deteriorate for the remainder for '08, but the company's business model and underwriting approach are sound and will allow the company to continue to pursue opportunities, as they arise. Back to you Martin?
Martin J. Sullivan:

Thank you Bob. I want to conclude by reinforcing that AIG remains a great company. With unmet competitive advantages, strong brand recognition and a unique global franchise, we believe AIG is extremely well positioned for the upcoming market opportunities. We know that this has been a very long presentation that there has been much to cover and I hope that that our disclosure has been helpful for you to understand these issues in more detail and in more depth. We appreciate your patience and now we will be more than happy to take your questions. Question And Answer
Operator:

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. And our first question comes from Jimmy Bhullar with J.P. Morgan.
Jamminder Bhullar:

Hi thank you.
Martin J. Sullivan:

Good morning Jimmy.
Jamminder Bhullar:

Hi good morning. I just have a few questions. The first one is for Edmund, if he is there. You mentioned that there is a chance that you had to contribute additional capital to your dial-on [ph] business, because of higher capital requirement. If you could quantify that on what that could be and secondly, on your $14.5 billion to $19.5 billion estimate for excess capital, what's the potential that this number could decline when you revise your excess capital estimate, once you use the updated 1231 inputs. I think it's made your publishing utilized number. And the final question is on your economic loss language for the capital market business. If you can discuss the rationale behind the change in language, how much of it's driven by the deterioration in the market and how much of it is just conservatism on your part and then just generally talk about the factors that could affect your realized loss estimate of $900 million, that would be revised higher or lower over time?
Martin J. Sullivan:

Okay Jimmy.
Edmund S.W. Tse:

Hi Jimmy, Edmund here. I am here with the group. I'd just answer your first question relating to the capital requirement in Taiwan, namely Nan Shan. In fact we have a very strong underlying performance in our life company in Taiwan. Nan Shan is making a operating income of like $900 million for the year, but there is some new capital requirement as regulated by the insurance commissioner and they had some capital charge to certain type of investments and as a result that our RBC, Risk Based Capital maybe in case of investment performance below the requirement of 200%. Right now, we don't have a problem, we that impairment ahead. In case, we are below that, then we may have a problem to increase our offshore investments as only if our RBC is above 200%, they will approve further increase in offshore investment from the 35% to 40%. But based on a current situation, we do not need an injection of capital to support our local operation there. It's very profitable and the financial is very strong. We are thinking of different ways to see if we could further improve our RBC including possible reinsurance and/or realized some capital gains from sudden investment asset and so forth. But the last resort to probably thinking of issue preferred shares to enhance our further capital base in Taiwan. But that's really for precaution.
Steven J. Bensinger:

Let me, it's Steve, with regard to your second question on excess capital. The $14.5 billion to $19.5 billion range that we just published is based upon the roll forward of our current modeling as I have talked about earlier. To what extent that might change when we do the full review on the December 31, 2007 numbers. I mean it's very difficult for me right now to project that. If we look at the past circumstances the updates have been pretty consistent with the roll forward. But it's really impossible for me to give you any real level of confidence on that, although I would say, we feel pretty good about how we've derived these numbers at this point of time. With regard to your third question on economic capital, loss estimates or I am sorry the cost estimates on the stress studies, I'll turn it over to Bob Lewis.
Robert E. Lewis:

Yes, Jimmy, you asked given our conservative estimate of excess capital at the end of '07 of between $14.5 billion and $19.5 billion. But when we actually run the numbers and validate whether you think that there will be a substantial change in that number. No, we do not but the initial assessment, our estimate is based upon our roll forward of certain assets and liabilities, which we of course need some time to fully to fully model. So there is no expectation that there would be a major adjustment. That range does already take to account the results, the financial results that we have reported. Regarding your third question on the stresses, regarding on that, as far as effect of further rating changes, I think you can see from the stress description on page eight, that we have taken into account one, the current ratings that exists through January in our current estimates and then also we have stress those ratings substantially from here. And so that I think that stress that we provide there in detail shows a significant change of potential quality in the portfolios that is really driven from the current analysis of expected delinquencies and loss development as well as recovery rates or housing price depreciation. So by assessing are own views and also those of third party, third party analyst particularly the rating agencies, who have used that in determining the stress test that we have shown there. Regarding how that estimate could move and what could move it? Obviously no one knows exactly how deep and how long live this downturn will be. However, given the assumptions of delinquencies and losses and housing price appreciations that effect, we are quite comfortable with that stress really is a severe stress to our business and then that number is right now our current best estimate of a real severe stress loss.
Jamminder Bhullar:

Okay and are the $6.2 billion credit that you are taking or the benefit in your excess capital assessment is that something that the rating agencies are okay with or there is some, are the rating agencies are okay with that treatment.
Martin J. Sullivan:

Well Jimmy I think we have been pretty clear as we discussed this over the last year that the rating agency is right now, are not as far along as we are in terms of our own economic capital modeling. So the rating agencies are using their own testing. Now, I think you have seen from some of the publications over the past few weeks that a number of the rating agencies are doing their own modeling of our underlying Super Senior portfolios, some of them gave some initial views a couple of weeks ago, when they changed our outlook or put the company on rating watch or review. So they are not on... they are not using the same methodology as we are, but we expect that as we continue to converse with them over the next few weeks in the immediate future that will be showing them the rationale for our own modeling and comparing that with them to their own and providing them with the information they need to come to their own conclusions.
Jamminder Bhullar:

Okay, thank you.
Martin J. Sullivan:

Thanks Jimmy.
Operator:

Our next question comes from Ron Bobman with Capital Returns [ph].
Unidentified Analyst:

Hi. Good morning. It would seem to me given the circumstances that the greatest area in your control to create value and make money is in getting better rates in the property and casualty area. And I wanted to know what you are doing on that end? Thank you.
Martin J. Sullivan:

Thanks Ron. Well obviously, during the fourth quarter and year end, we continue to see rating pressures in the P&C environment and domestically in the United States overall I think rates were down around 9% and I think internationally in our commercial business rates were down about 11%. The good news is that so far again generally speaking terms and conditions high policy wordings and deductibles holding reasonably well. They're always of course examples where that is challenged. But both Kris Moor and Nick Walsh are here to give a little more color maybe by line, where we are seeing continued rate pressures. One area I am particularly concerned about is the aviation sector, which continues to see significant rating pressures over many years, but I'll let Chris and Nick add a few words.
Kristian P. Moor:

Yes Ron, this is Kris. Overall monetary that was 9%, but on the... excluding the property and workers comp for the fourth quarter they were down 10% and for a whole year about down 8%. The property rates declined in the fourth quarter about 13%. We're seeing similar in the first quarter so far overall rates are down about 10% and property rates are down about 12%, but with that said, we still feel that in almost all our lines the business set for a few that rates are plenty, adequate and there is a lot of opportunity out there for us. The areas that we are watching very closely or looking at closely is the aviation area and also in some of the states for workers comp, but besides that we still see a lot of opportunity out there.
Nicholas C. Walsh:

Ron from a Foreign Gen standpoint, the comments on pricing are pretty much the same. But we have some terrific opportunities across the world. We have excellent growth in Latin America where there are some pricing opportunities because of reducing local capacity. We are doing extremely well in Continental Europe, where we are primarily under scale, so there is lots of upside as well there. I am very excited about Middle East and some of the emerging markets. So it may be tough in some of the more conventional markets, but there are still lots of opportunities for Foreign Gen.
Unidentified Analyst:

I appreciate the commentary and the discussion of opportunity. I am surprised I don't hear any talk about rating action that you are taking as a leader in large swaps of lines of business and in P&C, basically taking a leadership position to hold rates or take rates up.
Kristian P. Moor:

Ron this is Kris again. It's a good comment. In areas... there are always areas that have exposures that you feel that you are coming close or you are at the point where the rates have to change and obviously in today's environment, financial institutions is an area that rates we are pushing and leading the market and there are one or two others that are with us on that and increasing the rates in that area. And in some other product lines and if you go don very specifically, you will see spots where we are increasing rates. Then in other areas we see opportunities, where the rates don't need to be increased. But we look at that and we do lead the market in that area.
Unidentified Analyst:

Thank you.
Martin J. Sullivan:

Thank you Ron.
Operator:

And our next question comes from Andrew Kligerman with UBS.
Andrew Kligerman:

Hey good morning. Couple of question more conceptually; what was it that led to the conclusion by Price Waterhouse Coopers that you have a material weakness. Where did that... when did that thinking coming into play? And with that and correct me if I am wrong, I don't want to focus on the monoline insurers, but don't they use a fair amount of manual marks in their accounting. So that would be question one. Part two is I know you've just touched a bit on your economic capital on the $14.5 billion to $19 billion I think it is and it's not clear what the rating agencies are thinking. Is there a risk that they're going to ask you for more capital may be you can... I assume in your comments early you indicated no, but could you give us a sense of what you're thinking on that front? And mainly in terms of the Japanese market, it looked like there were a few pressure points, you had let's see your Japan sales were down in the fixed annuity area about 10%. You saw some weakness in the group premiums about 9% and the personal accident area actually showed an 8% increase, also weakness in variable annuity sales so. So may be if you could I don't mean to this a long one, but may just a quick color around each of these products, real quick in Japan and what the environment is like?
Martin J. Sullivan:

Thank you Andrew. Well I'll take question number one. I'm sure Steve will tackle question two and Bob Clyde is on the line from Japan, so what I'll defer number three to him. He can give lot more color. Just on the first part of your first question, obviously given the extreme dislocation in the markets, affecting obviously AIGFP's Super Senior Credit Default Swaps, we were working during the fourth quarter of implement system and controls to accurately report financial results. While obviously we didn't succeed, obviously because we have the material weakness that evolved during the close process in implementing an oversea and a sufficient valuation process before the end of the fiscal year, we obviously have addressed those issues in preparing our year-end numbers by obviously inserting compensating controls. The good news and of course in the bottom line is that we have a clean ordered opinion and that the accountants signed off on the numbers and as Steve mentioned earlier, we are obviously working very hard to remediate as soon as possible, the material weakness. Obviously on the second part of your question, I obviously can't comment, on the other companies, particularly the monolines as you suggest and haven't formulated their numbers.
Andrew Kligerman:

Then Mart then may be just, you seem so confident at that December Investor Day and it just makes me wonder where what was, Price Waterhouse Coopers thinking, at the time to where go into that Investor Day, and be so confident. May be this stuff could have been corrected in time before the material weakness and actually on that note, when do you think it's possible that could get lifted?
Martin J. Sullivan:

Yes, well on the first part of your question there Andrew, obviously those numbers that were presented at December 5th were unaudited. And secondly, as I have indicated we are going to work very diligently to remediate the material weakness as quickly as we possibly can and we will be working very hard to do that through the balance of 2008. And as soon as we have fully remediated obviously we will advice you as soon as possible.
Andrew Kligerman:

Okay, alright...
Steven J. Bensinger:

Andrew on the question of the rating agencies, obviously I can't speak for them. However, I think if you read the publications that all four of the major rating agencies made a couple of weeks ago after we filed the 8-K, I don't think that you will see any indication that they feel that we have capital issues discussed and that has not been the subject of any discussion with them so far. Now again, I can't speak for them or what their conclusions might be, once they digest our year-end numbers. But so far that has not been discussion topic.
Andrew Kligerman:

Steve spread had widened a fair amount in January and February. If you had to remarks today, would you be looking at something similar again for the first quarter and then will the agencies get concerned?
Steven J. Bensinger:

Andrew I think a lot of what we have discussed with the rating agencies and what they have written has not only been focusing on the fair value marks for GAAP but they are also looking at the economic stress test analysis and the underlying strength of the portfolios. If you go back to the presentation that we discussed a few minutes ago, these Super Senior structures were designed to withstand very severe economic stress, that's how they were underwritten. And so far from an economic standpoint they certainly seem to be performing as they were designed. So I think the substance of that is also going to be a significant factor in the actions that the rating agencies take, based upon the conversations we've had with them and also what they have actually already written. So I think we just have to see how it evolves and again, I really can't speak for them other then to point you to what they have been saying publicly.
Andrew Kligerman:

Steve, do you think the mark will be similar in the first quarter to what we have just seen in the fourth quarter?
Steven J. Bensinger:

Andrew I really... we really don't know that at this point in time. I mean there has been more deterioration in the underlying market as a whole. There has been as you stated further spread widening. What that precisely implies through our overall portfolio, we just know at this point in time. The processes that we now employ that I went through with you are highly complex. They involve a great deal of market information that takes time to obtain. We will have our best estimate mark, when we publish our first quarter financials. But right now, I think it would be just too difficult to really give any kind of an answer to that precisely.
Martin J. Sullivan:

Okay, thanks Andrew. Bob if I can ask you to respond to the third part of Andrews' question.
Unidentified Company Representative:

Yes, hi, Andrew. Let me start with your questions about annuities. The sales of fixed annuities were 11% below the fourth quarter of the prior year but it improved by 6% versus the third quarter, which marks the third straight quarter of increasing sales, due largely to strengthening yen and steepening of the yield curved in the recent equity market volatility, and also fixed annuity sales for face-to-face channel has shown some nice gains to with the new not got wider option that we offer. Now we'd initially introduced that in the face-to-face channel. We also introduced in the bank insurance channel in fourth quarter and thus far. Three banks have taken up and that we are in the process for launching a number of others. With respect to variable annuities, we were 5% of our fourth quarter but we were declining... we declined 22% versus the third quarter due to the turbulent equity markets. And of course, the risk characterization applied to these products which the... because the new financial instruments and exchange law that has created some of... bit of current going the other direction, but the new lifetime guarantee minimum withdrawal benefit VA for life product saw really significant growth in the fourth quarter. The sales grew to 65%, versus the third quarter and 53%, versus against the fourth quarter and that's helped. That was helped in large part by a third quarter launch by SMBC one of the mega banks and a mid fourth quarter launch by BTMU another mega bank. And as a result at the end of December, we had launched that product in 35 banks and we are the only VA... similar VA products sold off for mega banks incidentally. And the sales of that GMWB for life VA had continued to increase every month. Let me just move over to the A&H sales which in fourth quarter declined by 15.6% over prior year, mainly due to deliberate measures that we had to reduce our advertising spend in ALICO's direct marketing channel to improve profitability. And to offset that decline, we had increased A&H sales through face-to-face channels. As we look forward, we're anticipating a stronger outlook for A&H sales as concerns raised by the claims payment issue are starting to fade. We are into the final phase of the bank deregulation which has opened up new opportunities as well. In fact on 22nd December, as you know that was the final phase of deregulation and ALICO started to sell four A&H products including a new innovative single premium whole life FIH in 20 major banks including four mega-banks and we're, again we're the only provider of products in all four mega-banks. And the mandates in the banks are running ahead of our plans that we have 24 tie ups by the end of February. And we expect 30 banks by the end of April, until we have several other product initiatives as well. We got a new cancer product that we'll be launching in June, we are excited about, it will be competitively priced, it will be particularly important to the female and younger market segments. We expect a new FIH product to be developed in December. Just briefly, I would like to... you didn't ask about life, but let me just mention one thing that about why life insurance is down 12.3% for fourth quarter. Major driver of that negative term was the suspension of the lapse-supported increasing term product back in April 2007. And following that suspension, our sales totally dried out. If you exclude that increasing term products, sales were up 14% in the fourth quarter and 8.6% for the year and we had other products to overcome that impact with the suspension of LSIT and for example we posted record sales of dollar products which have profit margins but are significantly higher, than our yen based products, so that was a really positive outcome. If we look forward in life, the outlook I think is very favorable. Single premium dollar and whole life products remain very strong in both face-to-face and bank channels. ALICO launched a very innovative product called ESDN [ph] or yen so to dollar [ph] which is a product that's yen on the outside and dollar on the inside. And that product has surpassed our expectations in the first couple of months and we have a suite of about six products now through the banks.
Unidentified Company Representative:

Bob, if can and I'm going to have to try and end your response there. Because we've got a lot of people on the call. Andrew, if you like any more information, obviously we can get back to you on that.
Andrew Kligerman:

That was great.
Unidentified Company Representative:

Okay thank you very much, indeed. And ladies and gentlemen I think we've got enough number of callers obviously and if may ask that you kindly limit may be to one or two questions. And then so we can take as many calls we possibly can. Thank you very much indeed.
Operator:

And our next question comes from Nigel Daly with Morgan Stanley.
Nigel Daly:

Great, thank you Good morning.
Unidentified Company Representative:

Good morning Nigel.
Nigel Daly:

You... coming into that consumer financed delinquencies and charge-offs remained below your target ranges; you're barely breaking even in these operations. So perhaps you can provide some additional color on what's driving the significant pressure on the earnings, if it's not the performance of your loan portfolio. Second, just numbers question, if you can break down the mark-to-market losses between the high grade and the mezzanine model CDOs and subprime?
Martin J. Sullivan:

Great, Nigel we have Rick Geissinger with us, obviously he runs our domestic consumer finance business. So I'll ask him to respond.
Frederick W. Geissinger:

What was driving the fourth quarter is basically three or four major factors. We continue to have problems in our mortgage company. We have taken a number of actions to correct that and we'll continue to do so. We also added about $70 million to our allowance for loan losses, the reason for that is that we came off historical lows for the company in summer of '06. And delinquency and charge-offs are up somewhat. We are not immune to what's happening in credit markets. But we are still below the target ranges that the we published in the 1997 in all of our products. So this is a little bit of margin spread... margin squeeze I should say and that's fundamentally what's driving the earnings in the fourth quarter.
Martin J. Sullivan:

Nigel, on the second part of your question. We're looking for that information and we'll try and get back to you during the period of this call.
Nigel Daly:

Okay that will be great. Thanks.
Steven J. Bensinger:

Appreciate it. Nigel just a clarification you are talking about the investment losses correct?
Nigel Daly:

The TDS mark-to-market loss which you took in the quarter, is breaking it down between the high grades and the mezzanine?
Steven J. Bensinger:

Are you talking about the super senior block?
Nigel Daly:

In the super senior, yes that's right.
Steven J. Bensinger:

Alright. I am not sure would we be able to have that information in this call but we can try to provide that.
Nigel Daly:

Great, thank you.
Martin J. Sullivan:

Thank you Nigel.
Operator:

And our next question comes from Josh Shanker with Citi. Your line is open.
Joshua Shanker:

Thank you. Two questions the first I want to discuss the $900 million stress test scenario number. How that relates to the less than $600 million discussion, and what seems like a worst case scenario described at the December 5th conference call. And then I want to also ask about the $900 million during the commentary and the Q&A you said that that number was as of January 31st. I just want to confirm that that's actually as of December 31st. And finally I wonder if you could get any commentary on the D&O subprime exposure. I noticed you added some new disclosure there I am curious to know if you can talk about number of potential policies affected or what's kind of rate online per million of coverage, we are talking about in that book of business?
Martin J. Sullivan:

Sorry Josh, Bob will respond to the first part of your question there and we have John Doyle with us who is responsible for executive liability business and he'll give you some color on the last part and I think Nick will chime in there with some information on the international side as well. But first Bob.
Robert E. Lewis:

Good morning Josh, Bob Lewis. As far as the comparison of your, of the $900 million and the $600 million, the $600 million I assume you are referring to one of the frequently asked questions in the December 5th presentation which described in it what the actual stress, if you will what's defined as being. And the $900 million, the stress there is identified for you on slide eight of the presentation, we just referred to. So the actual components of the stress are slightly different. I don't have the actual $600 million in front of me here. But the $900 million that we have just discussed is really as we articulated there what we feel from current situation and rating situations that are in the marketplace. What we feel is a severe stress from here and that is rolled up on the portfolio too. This $900 million potential unexpected loss.
Joshua Shanker:

To be fair, the 600 million was writing off all 2005 subprime RMBS BBB and below in all '07 and '06 regardless of Vintage as well as ABS CDOs from those here, I think because of the Vintage and... it seems like an extreme structure do you think the $900 million isn't even more extreme stressing then that?
Robert E. Lewis:

I think it said what principally say is that there is a different stress we have done a number of stresses and the one that we have articulated in the presentation today is that one that we feel given where the current stress is being shown in the marketplace which is in the subprime and all day areas. This is a stress that we feel is the most appropriate for our own internal purposes to use as a severe stress.
Joshua Shanker:

And that's as of December not January.
Robert E. Lewis:

Yes, as of December incorporating however rating actions that through January 3rd. So there were significant rating actions taken in January 3rd and our stress is a stress from that.
Joshua Shanker:

Okay very good. And on the D&O front?
John Q. Doyle:

As Good morning Josh as Martin mentioned we continue to monitor the issue very, very closely and claim activity remains manageable on at this time. We have as of a week ago and dating back to the beginning of 2007, were unnoticed of claims or potential claims on 261 policies its 334 potential moves.
Joshua Shanker:

And is there any way to, get any more granular about how that $347 million in premium is divided among various clients about now?
John Q. Doyle:

Sure. That number of claims by the way, is a global number its our worldwide operations, $301 million of the $347 million in written premium is from our domestic operations. I am not sure what other information we can pull there.
Joshua Shanker:

Can you talk of rate online for D&O at times or anyway that we can translate that in to $347 million coverage, how many clients or anything of that nature?
Unidentified Company Representative:

How many clients we have...
Joshua Shanker:

How many possible clients, you talked, you totaled the total sub prime potential exposure, how many clients does that actually cover?
John Q. Doyle:

I don't have any number in front of me but we did an extensive ground up review in a domestic insurance operation to come up with the, the profile of the accounts that are potentially exposed in the footnote, it notes all the various class of that business that, that we took a look at, as Chrisman mentioned we are pushing price in the financial institutional area, and prices very widely from private, private to public risk. From inner risk, the other part of portfolio, So prices are very, very different from one segment to another.
Joshua Shanker:

Okay. Well you guys are going to get further disclosure on that, I am sure I would appreciate. Thank you very much.
Martin J. Sullivan:

Thank you.
Operator:

Next question comes from Larry Greenberg with Langen McAlenney. Your line is open.
Larry Greenberg:

Thank you and Good morning.
Unidentified Company Representative:

Good morning, Larry.
Larry Greenberg:

On the FP side, I know that AIG guarantees the debt capital there. Is there any possibility that the rating agencies will reflect some more capital into FP?
Martin J. Sullivan:

Larry that again, that has not been a subject matter of discussion, because of the guarantee that AIG provides to AIG financial products. They are relying on AIG's overall financial strength and support to operation. So that has not been a subject of discussion, now.
Larry Greenberg:

Okay great. Have any other key management of FP left or are planning to leave beyond June?
Martin J. Sullivan:

Yes, Larry and they are getting back to work straight after this call.
Larry Greenberg:

Great and just a couple of small pieces, what was the FX impact in the foreign life earnings?
Martin J. Sullivan:

Kristian.
Kristian P. Moor:

For the quarter it was 3%, 2% year-to-date. And it was less. It was a benefit on revenue, on operating income bottom-line. We disclosed the impact on revenues and GAAP premiums in our step supplement, but bottom-line was of 3% for the quarter, 2% year-to-date.
Larry Greenberg:

Great. And you made reference to some unusual expenses in the foreign gen expense ratio, I mean it looks there was about 4 points above normal which is about $130 million. Is that reasonable for me to assume?
Unidentified Company Representative:

Nick's, Nick Walsh has got some color on that Larry in great detail.
Nicholas C. Walsh:

For those of you don't have supplements in front of you, the fourth quarter '07 expense ratio is 42.25 against the prior 38.48, which is a difference of 3.77 and the year is at 34.95. First comment is that the fourth quarter expense ratio is always the highest of the year for seasonalization issues. But the reasons for the difference is primarily through the realignment of certain legal entities and integration costs and major part of that is the, we call it part transfer of organization in the U.K. from a U.S. branch to a local subsidiary that started on time and it will finish on time, it is finished. Give you some numbers involved, 200 people for the majority of the year. We send out information pact to 2.2 million customers and that was 10.5 million pieces of paper and we received 47,000 in cards [ph] with which we dealt with. The other part of integration is between our acquisition in Taiwan Central and AIG operations. Asides from that Ascot had a... Lloyd [ph] business had a spectacular year and the increase profit commission shares up as an impact on fourth quarter expense ratio. Aside from that we have a continuing emphasis on the consumer business and part of our strategic imperative is to change the format of some our commercial business we're targeting are expecting about this in previous events. We're targeting smaller businesses, because we think we have an opportunity there and the commission cost and of course the operating expenses around that are higher, but that's all according to our plans.
Martin J. Sullivan:

Thanks Larry.
Larry Greenberg:

Thank you
Operator:

Our next question from Jay Cohen with Merrill Lynch.
Jay A. Cohen:

Yes. Thank you. Two questions, first on UGC, clearly you're suggesting the '08 year is going to be another pretty bad one. I am wondering if you can put any parameters around this. Should be we expecting losses in '08 to essentially mimic what we saw in the fourth quarter of '07, that's the first question. And secondly, in lot of your analysis you make a reasonable distinction between '06 to '07 vintages and the five vintages which I think up until this point has been pretty reasonable, but with real estate prices continuing to come down. Do you see a risk or why don't you see a risk at the '05 year will you look may be as bad as '06 given that the real estate prices continue to fall?
Martin J. Sullivan:

Jay, Bill is Nutt is with us, so I'll ask Billy to respond to the first part of your question.
William V. Nutt, Jr.:

Sure good morning Jay. First question is we all seen the housing indicator as we're trending negative, trending negative at it and an accelerating pace particularly in fourth quarter and likely to continue to do so. We've pushed our economic forecast to suggest that the housing market is going continue to experience a lot of stress through '08 and probably will not bottom out until the first half of '09, if then. So the combination of deterioration in the housing market combined with obviously a slowing economy is going put quite a bit of stress on our domestic portfolio and as Bob Lewis said it is likely to result in another significant operating loss in 2008. Without giving any specifics we would anticipate that, that operating loss would be somewhere in the range of where we were in '07 to some what higher then that. As regards the decline in home price appreciation and the impact on the '05 book, the '05 book was underwritten with more conservative underwriting criteria then the '06 book in the first half of '07 book. So it should perform better although, it will experience some additional stress as property values continue to decline and we are estimating a decline or forecasting, a decline in property values of another 7% or 8% for 2008. On the line with me is Lynn Swiny [ph], our Chief Risk Officer. Lynn would you like to add any color to the '05 in the prior books?
Unidentified Company Representative:

No Billy, I think you said it well. The '05 book we have about $5 billion risk in force again it is stating to see the same level of stress, it's as the more recent books, but it did enjoy some early appreciation, so again under stress, but probably not to the level of the '06 and '07 books.
Jay A. Cohen:

Actually with that distinction I was thinking more on the credit derivative business, where in the stress test, obviously you are stressing the '06, '07 year as more intensely and I am wondering in really that business why don't you do a similar stress on the '05 year?
William V. Nutt, Jr.:

Jay I've got Kevin McGinn with us, our Chief Credit Officer. So I am going to ask Kevin just to respond on that.
Kevin B. McGinn:

Yes hi Jay. The rating agency is definitely and all the delinquency default data suggest that the '06 and '07 loses are going to continue to the decline and you're now seeing the estimates size in the high teens, low 20s. The '05 is definitely showing some deterioration, but the numbers are not nearly as bad and that's probably a large part, because of lot of the resets have already happened in the '05 vintages. The highest loss assumptions we are seeing in the '05 were really around 7.5. The ratings stress test that we ran essentially took that into... specifically took that into account, because we're expecting some more downgrades in the '05 vintages. We think we are in top of that and we've essentially stressed it appropriately.
Jay A. Cohen:

That's helpful, I hope if you can point about the reset too. Thank you.
William V. Nutt, Jr.:

Thank you, Jay.
Operator:

And our next question comes from line Alain Karaoglan with Banc of America Securities.
Alain Karaoglan:

Good morning, a couple of questions of on capital and on the property casualty business. From an enterprise risk management point of view are you considering weather you should be in the AIG financial products business at all, given the heartache that it's given to the stock and mark-to-markets on the portfolio and the volatility to the book value and from an excess capital point of view you mentioned $14.5 billion to $19 billion, but that seems to be little inconsistent with the fact that we are stopping the share repurchases. Could you... would it be possible to us the excess capital, versus what the capital requirements from the rating agency at the ratings that you would like would be, if there would be any excess capital at that level?
Martin J. Sullivan:

But Alian on the first part of your question I said in my earlier remarks, AIGFP has been very important and continues to be a very important part of AIG. Its produced very good returns over many, many years and a very good return on capital. Obviously, like all of that, businesses everybody stays under constant review. But the business has performed exceptionally well that they were in what I have described as unchartered waters and like everybody else they'll continue to be reviewed, but at the present movement I think they add significantly to the diversification. On the second part Steve...
Alain Karaoglan:

If I could follow up a just on that, but on that capital Martin isn't that a notional amount of capital that you are allocating that AIGFP wouldn't be able to operate on a standalone basis and so the return on capital are high, but they are not similar or comparable to the rest of the business?
Martin J. Sullivan:

It's notional, but it's a... they are... it's also drawing on the implied guarantee of AIG. So that would when AIGFP's capital position is being reviewed by the agencies or by its clients I think they are looking at the entire financial strength of AIG. Joe.
Joseph J. Cassano:

Yes hi, Alain its Joe Cassano, how are you?
Alain Karaoglan:

Good thank you.
Joseph J. Cassano:

One of the things that we've done historically, when we go through our own capital management within FP and measure the usage of capital with FP that we then, is it's basically a charge against the AIG for capital booked and when we've done that up until this period of time where we have these unrealized loses right now. We have always been a very high performer in terms of return on capital if you can think back or if you can find the files where we gave a presentation in May where we posted some of the historical return on capital; it's actually been relatively good. It is the case that right now with the unrealized losses it's a completely different story, but I wouldn't one of the things we do look at and one of the things we've been presenting over the last six months is the fundamental positive attribute of the portfolio we've written. And looking at that we really and if you look at that at that basis we think the return on capital is still very robust and when we get through this period. The company and the team will continue and will return back to the very-very positive types of returns that we've had in the past, hope that helps.
Alain Karaoglan:

Thanks Joe.
Unidentified Company Representative:

Alain with the respect to your second question on excess capital, again the $14.5 billion to $19.5 billion range is our estimate based on our own internal economic capital modeling. It does not reflect the rating agencies views of our excess capital. They all have their own different perspective on what level of any of excess capital that we have and again I really can't speak for them. I think as we go through the process in the near term, hopefully settling our ratings which are now, as I said some on negative outlook and two on rating watch and review that we will have more of a dialog on that to see where they are relative to us. So for the time being given the fact that our ratings right now are negative outlook and in some cases on review we think it's prudent to suspend any new share repurchase activity until we have a better view on capital with all four of the major rating agencies.
Alain Karaoglan:

And on the property casualty business could you comment on the adverse reserve development on the 2000 to 2002 year, is that still bothering you and not the allowing the benefit of the recent year reserve releases to flow to the bottom line completely. And on the personnel line segment, if I did the math correctly, even excluding cash and adverse reserve development. I get a combined ratio of 112. Wouldn't anything additional happen in the quarter in personal lines to lead to such a high combined ratio?
Martin J. Sullivan:

Alain, Frank Douglas is here. So I'm going to ask him to respond to the first part and then Bob will respond, Bob Sandler will respond to the second part.
Frank H. Douglas:

We've seen continued development, as we've described really all years, it's not new this quarter from acting years 2002 and prior, in general the development has been less adverse and than it was in prior years. I think if you'll look in the 10-K, you'll see that 2002 and prior has about $1 billion less adverse development, but $800 million actually less than it did last year. So it is trending down, not as fast as we'd like. It's coming largely from excess casualty to some degree form Transatlantic and to some degree from workers compensation those three areas, this we've talked about I think throughout the year. We are seeing a lot of latent claims still emerge from our excess casualty books that are function of the soft market years. And we've improved our terms and conditions and underwriting guidelines to the point where we just don't think we're going see that kind of latent development from the more recent accident years. And as those all, the year continue to wind down, we should less of those surprises. But they did happen this year. They probably won't go away tomorrow, but we are certainly expecting minimal adverse development, certainly as we go forward, we expect those numbers to diminish.
Operator:

And our next question comes form Eric Berg with...
Frank H. Douglas:

No we have a response to the second part of that question.
Operator:

Pardon me.
Unidentified Company Representative:

Okay.
Robert M. Sandler:

This is Bob Sandler. Let me take you through some of the pieces. You've mentioned some of them, but not all of the pieces that distort the quarter and there is a lot of noise in the quarter. There was $75 million roughly of wildfire losses that are included in those numbers from the private claims. You've got about $33 million of integration merger integration cost coming out of the merger of AIG and 21st Century. We've got about $36 million of adverse development in the quarter. We increased our lowest pick in the quarter for the year for current accident year loss pick and that had about $50 million impact on the first three quarters of 2007. Though if you look at those pieces in total and subtract then you actually find the quarter is probably running more on the 104-105 range, if you do the math, which is not a brilliant quarter. I would just remind you that it's the... fourth quarter is typically seasonality generally affects that quarter last year for example we ran about 102 in the quarter, so we are running may be 2 to 2.5 points higher than that. And some of that is being caused by the newer business that we've been writing in 2007 to the higher proportion of our in force than in previous periods that's particularly true of the 21st Century business outside California. So that business first year business does carry higher loss ratios typically and so while the... 104-105 is not a number we aspire to. I think the underlying book is pretty strong. We still anticipate that the direct business is going to produce a pretty good underwriting profit in the year '08, and the fourth quarter we probably read in the 97-98 range on that direct book, anyway when you count for some of this.
Alain Karaoglan:

Thank you, very much.
Unidentified Company Representative:

Thanks Alain.
Martin J. Sullivan:

Next question please.
Operator:

And the next question comes from Eric Berg. Your line is open.
Eric N. Berg:

Thanks, very much I have two questions, both for Steve Bensinger. Steve with respect to this line on page 8 that culminates with the discussion of the realizable loss of $900 million, can you just...
Steven J. Bensinger:

You are breaking up there.
Eric N. Berg:

Can you here me now?
Steven J. Bensinger:

Yes.
Eric N. Berg:

Steve, with respect to the slide on page 8, that culminates with a realized loss under the severe stress scenario of $900 million, can you just clarify what is being expressed in the right hand side of the table, what the various percentages mean?
Steven J. Bensinger:

Okay yes, so I think I will let Bob and Kevin give you more color on that one, they are the architects of that stress tests.
Robert E. Lewis:

Well if I understand. This is Bob Lewis here. I want to understand what this means. You're talking about the severe stress criteria..
Eric N. Berg:

Yes.
Robert E. Lewis:

Okay, I got it. I think, that it will be useful for Kevin McGinn, our Chief Credit Officer, who has been the managing the stress scenario work that we do to describe input that stress in overall context which I think is your question.
Eric N. Berg:

Yes.
Robert E. Lewis:

That we essentially stress three categories of asset, sub-prime RMBS, Alt-As and CDOs and going from the top, you will the... we essentially took all the to 2007 vintage, and anything below AAA and loaded off a 100% with no recoveries. We took... we did the same thing for the second half of '06 and for the first half of '06, we essentially took a 100% of anything A+ and below and 50% of the AA and we thought that was the appropriate stress given all the rating activity that's happened around the '06 and '07 vintages. In the '05 area, we essentially wrote-off 50% of all the second half of '05, the BBB and below. Now this is of again a lot of rating activity took place for all the way through the fourth quarter. So we think we basically captured that pretty well. We took also 100% of anything BB+ and below from the first half of 2005. We then wrote-off a 100% of all the... what we call the inner CDOs, so this would be any CDO buckets within the CDOs themselves, A+ or below regardless of vintage and regardless of type whether you are high-grade and mezzanine. And finally we took a 100% of the... we wrote-off everything A+ and below of Alt-A for '06 and '07 that basically takes you though the various categories there.
Kevin B. McGinn:

And again just to reemphasis Eric that those stresses were performed as static stresses, that's what that footnote says. I'll assume to result an immediate losses which they wouldn't, they would occur over time and also there is no benefit in this scenario for cash flow diversion features and other litigants that AIGFP has structured into these portfolios. So that's why we call it severe.
Eric N. Berg:

My second question Steve relates to your discussion or in connection with the negative spread or the negative basis. And I think you said, I hope I have it right when I say that you said that one can think of this negative basis as the difference between the value of a CDO, if it were uniquely a credit instrument verses the or the spread no the CDO, if it were only a credit instrument, verses the actual spread that is observed given the multiple risks on the CDO liquidity of aversion to risk and so forth. Is that what you were saying?
Steven J. Bensinger:

What I was saying, I think that's yes. I think you have got it. Let me restate it in.
Eric N. Berg:

Yes please.
Steven J. Bensinger:

Different way. A bond has a total spread attached to it, a cash bond. That spread has various components that I outlined credit, liquidity in this market perhaps market aversion risk and others. And the difference between the total spread on the bond and just the credit spread on the bond would be the negative basis.
Eric N. Berg:

Okay so here is then is my... I think I have it right and I understand and thanks for that follow up explanation. Here is my second and final question. If you were, if the dealers were able to identify this spread differential on December 5th and you felt like it was perfectly fine to use it then, what exactly happened between December 5th and when you issued your 8-K that no longer made application of the spread differential appropriate under U.S. GAAP?
Steven J. Bensinger:

Yes, it was a matter of absorbability. As of the December 5th call, our colleagues at AIG Financial Products had indications, as I stated from market participants on different levels of negative spreads and they made a judgment regarding how those spreads that they were... that they gathered from the market were related to their book of business. At year end, I've found an exhausted review what we learnt is that in today's market which had deteriorated much more significantly that those spreads were no longer identifiable and therefore, we could not take credit for those in coming up with the fair value determination at year end.
Eric N. Berg:

Thank you.
Martin J. Sullivan:

Thank you very much. Ladies and gentlemen, I think we probably got time for one or two more questions.
Operator:

Okay, our next question comes from Ian Gutterman with Adage Capital.
Ian Gutterman:

Hi. Thanks for keeping call going, so long. I just also want to clarify but on the negative basis, really from the material weakness side and just... can you clarify is there is material weakness... do you have to resolve the material weakness to take credit for the negative basis. Or is the material weakness is much about procedures and that you might be able do if the market gets more robust and you can identify the negative basis in a way that Pw agrees, can you start taking that earlier in a material weaknesses result?
Steven J. Bensinger:

Yes. I don't really see them connected on a perspective basis, or it's like the credit for negative basis will come about based upon market changes that will illuminate the spreads more clearly. It's not connected to the material weakness. The material weakness is surrounding resources, the additional controls and procedures we're putting in place and what I talked about earlier in terms of sustainability of those controls. So I wouldn't connect them on a perspective basis.
Ian Gutterman:

Okay. And is there anything you're doing procedurally to try to use limited information to get more clarity, or is it really just have to be patient and wait for the market structure any better?
Robert E. Lewis:

Well we did a lot of work around year end to see if we could, if there was market clarity and I don't think there, the opacity of the market has clarified any further since then. In fact, I think it's probably even less liquid and more opaque than it has been. So right now certainly I wouldn't say that we see that in the immediate future.
Ian Gutterman:

Okay and then you can clarify the ratings agency issues to the extent that is your sense of the concern is an overall perception of consistency of results or is it some thing very like that or they've been more specific, we're worried about the CDS losses or investments portfolio losses and I guess where I am going with this is to the extent that market seems to be most worried about the CDS, if that's really the issue. Is the possible that the rating agency concerns were more around FP and may at the corporate debt rating and less around the P&C and life and subsidiaries, maybe do you just see where I am trying to go. Why they were talking about corporate excess capital and why they were talking about possible rating, versus the P&C or life companies actually would affect your business more?
Robert E. Lewis:

I think different rating agencies have different views. So I can't... it'll take too long for me to recount each of them, but some of the ratings agencies are looking more at the AIG, debt rating, some are looking more at the underlying subsidiary financial strength rating. And so I would say everything right now is under review or under outlook and we are taking all that very seriously in terms of providing all of them with as much information as we can descriptions of what we've done to try to clarify it and ensure that we can try to stabilize as soon as reasonably possible.
Ian Gutterman:

Okay, just one quick numbers question, you had at the tip of you fingers, you said there was remaining repurchase that was already committed, so it is the dollar amount of what that would be coming through?
Robert E. Lewis:

Yes, it's a little over $1 billion.
Ian Gutterman:

Okay,
Robert E. Lewis:

After that we would have about $9 billion remaining in the current authorization that the board provided but as I... as we stated we don't intent to utilize that in the immediate future.
Ian Gutterman:

Right.I just wanted to clarify that thing. Okay thank you so much.
Unidentified Company Representative:

Thanks Ian.
Operator:

And our last question comes from Gary Ransom with Fox-Pitt Kelton.
Gary Ransom:

Thank you. I sneaked in here. I just wanted to ask about the business of the CDO wrapping and how all this mark-to-market that has occurred is at all changing your strategy and whether there are certain parts of that business you never want to do again or want to get in to again, when times improve and just how has it changed your thought process abut the business itself?
Martin J. Sullivan:

We have Andrew Foster with us Gary, so he will respond to that.
Unidentified Company Representative:

Yes I think, really since we pulled out I thing the subprime sectors back at the end of '05, beginning of '06. Our focus has predominately been in the regulatory capital space and where we've continue to do business, we did an additional $39 billion of business in the fourth quarter and that's really been the focus, that's been still been a very strong sector for us. And again that's probably declining, as well with the onset of volatility [ph] that was mentioned before. So in general, it is a space that is going down in our priorities.
Gary Ransom:

And in the multi-sector and the arbitrage type deal, especially is that since that's the area where we've had these big marks, can you see a possibility in the future that you would get back in to it, would there be or would this size of a mark more or less or the potential for the size of the mark we've seen more or less permanently take you out of that marketplace?
Unidentified Company Representative:

I think that marketplace in general is very much reduced anyway. I mean the new issues space there with that sort of clutch [ph] release is pretty much dead and has been for sometime and it's likely to comeback at anytime. But going forward, I think we expect a lot of... most of the losses to be reversed and we will always look at to the different opportunities that are available to us and assess them on an ongoing basis.
Gary Ransom:

All right thank you. And that speaking [ph] one little probably casualty question on loss ratio picks for current accident year. You already address that for personal lines, were there any other changes of note or significance in any of the other classes for the current year accident pick in the fourth quarter?
Frank H. Douglas:

This is Frank Douglas. Nothing significant in the fourth quarter, what we've seen throughout the year is downward pressure from the favorable development as you know in accident years 2006, 2005 and 2004 tended to offset the rate decreases that have earned into 2007 year-end rate decrease were probably only about 5% though. So obviously, you don't have to watch that going forward, when the rate decreases may be a little bit larger. But for now the answer was very little change was needed in loss picks, virtually none.
Gary Ransom:

Alright thank you very much.
Martin J. Sullivan:

Thank you, Gary. Ladies and gentlemen let me apologize to those who didn't have to opportunity of asking their question. If you like to call Charlene, we will try and respond as quickly as we can. Thank you very much indeed for your patience. It's much appreciated. Thank you.
Operator:

And that concludes today's call. Please disconnect your line at this time.

American International Group, Inc. Q4 2007 Earnings Call Transcript

Other American International Group, Inc. earnings call transcripts:

American International Group, Inc.
Q4 2007 Earnings Call Transcript