AIG Financial Products (AIGFP), the business that wrote the credit default swaps that were a significant source of AIG’s liquidity issues in 2008, held a notional amount within its derivative portfolio of some $940.7bn at December 31, 2009.

After the initial $85bn bailout that gave AIG the breathing space to survive, the group worked out a longer-term rehabilitation package with the US Treasury, and Federal Reserve in November of 2008 that was designed to establish a durable capital structure for AIG. Facilities designed to resolve the liquidity issues that AIG experienced in its credit default swap portfolio and its US securities lending programme were also created.

At the time, Edward M Liddy, Mr Sullivan’s successor as AIG chairman and CEO, said these agreements were a ‘dramatic step forward’ for AIG and all of its stakeholders. “Today’s actions send a strong signal to our policyholders, business partners and counterparties that AIG is on the road to recovery. Our comprehensive plan addresses the liquidity issues that threatened AIG, and gives us the financial flexibility to complete our restructuring process successfully for the benefit of all of our constituencies,” said Mr Liddy continued.

Over the last three years AIG has therefore embarked upon a complex strategy of sales of what were deemed non-core businesses, de-risking of the remaining business and restructuring and simplification of the ongoing business not least through the creation of Chartis, the business that holds the group’s commercial business lines.

The basic goal was to convince policyholders and staff that it had a business worth saving so that cashflow could be maintained to support the remaining infrastructure and give the group time and space to unravel its financial commitments in an orderly fashion, pay back the government and ultimately prepare itself for a sale back to the private sector.

The plan got off to a good start as it became clear in the key renewals in late 2008 and during 2009 that the group would not suffer an exodus of core commercial customers and staff to rivals.

These rivals said that Chartis only maintained its business through suicidal rate cutting and that its strategy was unfairly underpinned by the government support.

Chartis said that the reaction of customers and staff rather proved the quality and durability of the underlying business that overrode the negative messages sent by its ill-judged foray into the credit derivative markets.

Whatever the causes of the loyalty, the business survived and over time started to move on to the front foot under the new Chartis brand as customer and broker doubts over the security of the Chartis paper receded.

As the management of Chartis focused on looking forward under the new brand the AIG management concentrated on sorting out the financial situation.

And on 14 January this year AIG took a major step forward as it executed the first part of its recapitalisation plan to repay all its obligations to US taxpayers, including repayment of the Federal Reserve Bank of New York (FRBNY) Credit Facility and conversion of the US Treasury Department’s holdings into AIG common stock.

The insurer repaid the roughly $21bn, including $6.4bn of accrued interest, owed under the FRBNY Credit Facility, which was then therefore terminated. It also retired about $6.1bn and purchased the remainder (approximately $20.3bn) of the FRBNY’s preferred interests in two special purpose vehicles that held two of the group’s main subsidiaries—AIA and ALICO—and transferred the purchased portion of those interests to the Treasury Department.

On 29 October, 2010, AIG sold, in an initial public offering, 8.08 billion shares (or 67%) of AIA for approximately $20.51bn and on 1 November, 2010, it sold ALICO to MetLife for roughly $16.2bn ($7.2 bn in cash and the remainder in securities of MetLife).

In the recapitalisation, the preferred shares previously held by the Treasury Department and the AIG Credit Facility Trust were exchanged for 1.655 bn shares of AIG common stock. This meant that roughly 92% of the total outstanding common stock of AIG immediately after the recapitalisation was held by the Treasury Department. This has since been cut back to 72%.

In short AIG used about $27bn of cash proceeds from the sale of those AIA and ALICO [that collectively generated $36.71bn in cash and shares for the group]—to repay the US government. The government also exchanged three classes of illiquid preferred stock for regular, liquid, tradable AIG common stock.

“Overall, AIG lessened its debt burden and gave the government a liquid, tradable instrument that can be sold off, so we view the transaction as a win-win. It also greatly simplified AIG’s capital structure,” explained the group.

And it added that the Treasury Department is expected to sell its AIG common stock ‘over time’ through which process AIG will return to normal.

As noted above, the decision by the bulk of Chartis’s key customers and staff to remain with the group through the crisis period provided it with the basis to reach this point.

But the next big step towards a return to private ownership will only be achieved if already nervous investors can be convinced that AIG offers a decent investment, its risk has been reduced to market comparable levels, it has a credible long-term strategy that makes maximum use of its still unrivalled global spread despite the divestments and, perhaps above all, can be understood—simplified.

To help achieve this goal, AIG stated that it has ‘modified’ its operations and structure to strengthen its financial condition and ‘enhance’ the enterprise value of its ‘nucleus of businesses’.

To meet these objectives, the group explains that it has focused on four main priorities. These are:

To build AIG’s enterprise value by strengthening its international property and casualty and domestic life insurance businesses. The creation of the Chartis brand for the P&C business and further simplification of the business as explained in the interview with Mr Hancock is a core part of that element

Repayment of the loans from the US government by divestment and ‘monetisation’ of assets no longer deemed to be core. The latest big move in that programme was the sale of Nan Shan Life Insurance Company that enabled it to cut the Treasury’s stake by another $2bn in August

Reduction of its operating costs through a comprehensive review of AIG’s cost structure; and,

Reduction of ‘excessive’ risk by the winding down of AIG’s exposure to financial products and derivatives trading activities. For example, AIGFP reduced the notional amount of its derivative portfolio by 46% from $940.7bn at 31 December, 2009, to $505.8bn at 30 September, 2010.

This four plank strategy is working, proven by the successful reordering of the business, ongoing divestments and a big repayment in January, says AIG.

“Since September 2008, AIG has made substantial progress protecting and enhancing the value of its key businesses, restoring AIG’s financial strength, bolstering corporate governance, instilling a performance management culture, reducing risk and repaying US taxpayers,” claims the group.

Given the uncertain state of the global financial markets, particularly in light of the Eurozone crisis, it is anyone’s guess, however, when and how the final repayment to the government and return of AIG to the private market will occur.

Please sign up here to our full-time mailing list to ensure that you receive our weekly newsletter.

• More Insurance News