LevonP
10-07-2008, 12:19 AM
Very interesting article about insurance industry called Very Complex Industry:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/fivecopractices.htm
Lanny Thorndike, manager of the Century Shares Trust mutual fund, knows as much about insurance company American International Group Inc. as almost any other investor. He keeps a 3-foot-wide color-coded map showing 250 of AIG's subsidiaries and where they fit into the parent company. It's the only such map the fund manager has. "It's the only one we've needed it for," says Mr. Thorndike, who says AIG is one of his fund's largest holdings.
But Mr. Thorndike admits he doesn't know everything about AIG. "It's the only company we feel we have not developed the type of subsidiary knowledge we want," says Mr. Thorndike, whose firm specializes in financial-service stocks. Mr. Thorndike says his research on AIG includes talking to rivals and insurance brokers who sell AIG products. "You have to talk to that many more people just to get a sense of understanding" even a small piece of it.
New York-based AIG falls into the realm of black-box companies both because of its sheer size and because it is in the insurance industry, which itself is rife with black-box issues. "To some extent, every insurance company is suspect," says David Schiff says, editor of Schiff's Insurance Observer, a newsletter, noting that insurers have leeway in the way they reserve for claims.
Many Accounting Practices Are Hard to Penetrate
Insurance companies take in premiums and set aside some of that money as reserves for future losses. Insurers have discretion about how much to set aside, which means they can build bigger reserves during the good times and put aside slimmer ones when times get rough. A big reason for the discretion is that setting up reserves involves a large number of assumptions about claims that in some cases, as with workers' compensation and medical-malpractice insurance, won't be paid for years.
Mr. Thorndike believes that AIG could be in the camp that maintains better-than-adequate reserves in the good times, a tactic that helps smooth out earnings in what is normally a cyclical business. Aside from the quarter including claims from the Sept. 11 terrorist attacks, AIG hasn't had an earnings disappointment of any real note for at least 15 years. "It's part of the mystery of AIG, they just make their number," says David Bugajski, a senior analyst at Fred Alger Management, a big AIG shareholder.
For its part, an AIG spokesman says, "Our reserve development is fully disclosed in our regulatory filings," declining to elaborate. He adds: "AIG's strong performance year after year speaks for itself."
Insurance companies' financial statements are complicated enough -- then add AIG's hundreds of subsidiaries to the mix. "Who the hell knows what each one does? In trying to analyze their numbers, it's not obfuscation, it's sheer complexity," Mr. Schiff says. "So many businesses -- and businesses that involve estimates that can be proven wrong even if they're made with the best of intentions. It's hard to understand these things."
What investors understand, however, is that AIG delivers double-digit earnings growth year in and year out, which is why AIG stock is richly valued, particularly compared with other insurers. The company, with its $207 billion in market capitalization, boasts a price-to-earnings trading multiple of 22.7 based on estimates of its earnings for this year, highest of any property-casualty insurance carrier and well above the industry average of 13.4.
Insurance reserves are watched by state insurance regulators and ratings agencies, but as a sign of how malleable they can be, consider the experience of Reliance Group Holdings Inc., the insurance holding company long controlled by financier Saul Steinberg. Hit in 2000 by ratings-agency downgrades and deteriorating underwriting results, Reliance boosted its reserves by more than $1 billion in roughly 12 months, adding to the $3 billion it already had set aside. Even that, however, wasn't enough, and regulators announced in October that it would liquidate Reliance's insurance operations.
Of course, no one is comparing Reliance with AIG, whose chairman, Maurice R. "Hank" Greenberg, has been at the helm since 1967 and is famous for his strong oversight of the company and knowledge of insurance. "Their reserves are always top level, even using our stringent requirements," says Peter Dickey, a managing senior financial analyst who follows AIG's property-casualty operations for ratings agency A.M. Best Co.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/fivecopractices.htm
Lanny Thorndike, manager of the Century Shares Trust mutual fund, knows as much about insurance company American International Group Inc. as almost any other investor. He keeps a 3-foot-wide color-coded map showing 250 of AIG's subsidiaries and where they fit into the parent company. It's the only such map the fund manager has. "It's the only one we've needed it for," says Mr. Thorndike, who says AIG is one of his fund's largest holdings.
But Mr. Thorndike admits he doesn't know everything about AIG. "It's the only company we feel we have not developed the type of subsidiary knowledge we want," says Mr. Thorndike, whose firm specializes in financial-service stocks. Mr. Thorndike says his research on AIG includes talking to rivals and insurance brokers who sell AIG products. "You have to talk to that many more people just to get a sense of understanding" even a small piece of it.
New York-based AIG falls into the realm of black-box companies both because of its sheer size and because it is in the insurance industry, which itself is rife with black-box issues. "To some extent, every insurance company is suspect," says David Schiff says, editor of Schiff's Insurance Observer, a newsletter, noting that insurers have leeway in the way they reserve for claims.
Many Accounting Practices Are Hard to Penetrate
Insurance companies take in premiums and set aside some of that money as reserves for future losses. Insurers have discretion about how much to set aside, which means they can build bigger reserves during the good times and put aside slimmer ones when times get rough. A big reason for the discretion is that setting up reserves involves a large number of assumptions about claims that in some cases, as with workers' compensation and medical-malpractice insurance, won't be paid for years.
Mr. Thorndike believes that AIG could be in the camp that maintains better-than-adequate reserves in the good times, a tactic that helps smooth out earnings in what is normally a cyclical business. Aside from the quarter including claims from the Sept. 11 terrorist attacks, AIG hasn't had an earnings disappointment of any real note for at least 15 years. "It's part of the mystery of AIG, they just make their number," says David Bugajski, a senior analyst at Fred Alger Management, a big AIG shareholder.
For its part, an AIG spokesman says, "Our reserve development is fully disclosed in our regulatory filings," declining to elaborate. He adds: "AIG's strong performance year after year speaks for itself."
Insurance companies' financial statements are complicated enough -- then add AIG's hundreds of subsidiaries to the mix. "Who the hell knows what each one does? In trying to analyze their numbers, it's not obfuscation, it's sheer complexity," Mr. Schiff says. "So many businesses -- and businesses that involve estimates that can be proven wrong even if they're made with the best of intentions. It's hard to understand these things."
What investors understand, however, is that AIG delivers double-digit earnings growth year in and year out, which is why AIG stock is richly valued, particularly compared with other insurers. The company, with its $207 billion in market capitalization, boasts a price-to-earnings trading multiple of 22.7 based on estimates of its earnings for this year, highest of any property-casualty insurance carrier and well above the industry average of 13.4.
Insurance reserves are watched by state insurance regulators and ratings agencies, but as a sign of how malleable they can be, consider the experience of Reliance Group Holdings Inc., the insurance holding company long controlled by financier Saul Steinberg. Hit in 2000 by ratings-agency downgrades and deteriorating underwriting results, Reliance boosted its reserves by more than $1 billion in roughly 12 months, adding to the $3 billion it already had set aside. Even that, however, wasn't enough, and regulators announced in October that it would liquidate Reliance's insurance operations.
Of course, no one is comparing Reliance with AIG, whose chairman, Maurice R. "Hank" Greenberg, has been at the helm since 1967 and is famous for his strong oversight of the company and knowledge of insurance. "Their reserves are always top level, even using our stringent requirements," says Peter Dickey, a managing senior financial analyst who follows AIG's property-casualty operations for ratings agency A.M. Best Co.