AIG Feeling Subprime Fallout Losses

American International Group's net income dropped 27 percent in the third quarter as fallout from the subprime mortgage meltdown took a toll on the company's earnings.

The New York-based insurer saw hits taken to its mortgage lending facilities and insurance business in this line of business. The results, reported today, included a $325 million charge in its Financial Product Corp's super senior credit default swap portfolio.

During an analyst's conference call today, AIG President and Chief Executive Officer Martin J. Sullivan said the company is operating in a “very uncertain and volatile market environment.” While the company “has ample resources to weather continued uncertainty to take advantage of market opportunities as they emerge,” he said he was not satisfied with the performance of a number of the company's businesses.

Among these are the company's mortgage businesses, life insurance and “headwinds” being faced in the property-casualty business.

AIG reported net income of $3.1 billion in the third quarter, down 27 percent, or $1.14 billion, from the same period last year. Net premium written rose 5 percent, or $599 million, to $11.8 billion. However, operating income from insurance services dropped 7 percent, or $186 million, to $2.44 billion. Net income per share dropped from $1.61 to $1.19 for the quarter.

For the nine months, net income is up 8 percent, or $883 million, to $11.5 billion. Net premium written rose 6 percent, or $1.96 billion, to $36.07 billion. Operating income from insurance services rose 9 percent, or $692 million, to $8.5 billion. Net income per share is up 36 cents to $4.40 per share.

The combined ratio for the third quarter rose 1.07 to 90.17 compared with the same period last year. For the nine months the combined ratio is up slightly by .07 to 88.26.

Despite the write down, Mr. Sullivan said the company will not experience a loss in the super senior credit portfolio (related to its lending mortgage lending interests). He noted that the write down was the result of a change in the value of the portfolio, resulting from the spread of credit from the underlying collateral. The company estimates it will take an additional valuation loss of $550 million through October of this year.

On the insurance side, AIG expects to take a $220 million loss from the California wildfires, which will come to $140 million after tax, to be reflected in the fourth quarter.

Looking at property-casualty insurance performance, there was a $215 million loss in the Mortgage Guaranty business tied to the subprime meltdown. Mr. Sullivan said pressures on the business from the subprime crisis would continue through 2008.

Operating income for personal lines went from $133 million in the third quarter of 2006 to $28 million this quarter. The result was due to unfavorable loss reserve development from discontinued business and the costs in acquisition of 21st Century Insurance Group.

Losses from flooding in the United Kingdom, lower favorable loss development in prior accident years and an increase in severe but noncatastrophic losses in its foreign general business in the third quarter resulted in a 12 percent income decline to $631 million.

Robert E. Lewis, AIG's senior vice president and chief risk officer, discussing the company's exposure to the U.S. residential housing market, said the company dropped its interest in lending in the subprime market in 2005 and its exposure should be minimal. The mortgage securities and investments the company holds “should experience a hold to par absent a severe recession or depression type deterioration in the collateral securities,” he said.