American International Group Inc

NYSE:AIG

Earnings Call Transcript 2019-Q3

[Operator]

Good day everyone, and welcome to AIG's Third Quarter 2019 Financial Results Conference Call. Today's conference is being recorded.

And at this time, I would like to turn the conference over to Ms. Sabra Purtill, Head of Investor Relations. Please go ahead, ma'am.

[Sabra Purtill, Head of IR]

Good morning, and thank you all for joining us. Today's call will cover AIG's third quarter 2019 financial results announced earlier this morning. The news release financial results presentation and financial supplement were posted on our website at www.aig.com at 7.00 A.M this morning and the 10-Q for the quarter will be filed later today after the call.

Our speakers today include Brian Duperreault; President and CEO; Peter Zaffino, CEO of General Insurance and Global Chief Operating Officer; Kevin Hogan, CEO, Life and Retirement; and Mark Lyons, Chief Financial Officer. Following their prepared remarks we will have time for Q&A.

Before Brian begins please note that our commentary and discussion may contain forward looking statements relating to company performance, market conditions, business mix and opportunities and strategic priorities. These statements are not guarantees of future performance or events and are based on management's current expectations. Actual performance and events may differ materially. Factors that could cause results to differ include the factors described in our first and second quarter 2019 reports on Form 10-Q or 2018 annual report on Form 10-K, and other recent filings made with the SEC. AIG is not under any obligation and expressly disclaims any obligation to update any forward looking statement, whether as a result of new information, future events or otherwise.

Additionally, some remarks may refer to non-GAAP financial measures. The reconciliation of such measures to the most comparable GAAP figures are included in our earnings release, financial supplement and presentation.

I’ll now turn the call over to Brian.

[Brian Duperreault, President and CEO]

Good morning and thank you for joining us this morning.

As I've said over the past few quarters, our leadership team has taken significant action on a number of fronts to lay the foundation for long term sustainable and profitable growth at AIG. The execution of our strategy is reflected in our results this quarter, which were in line with our expectations.

Our efforts in General Insurance have been focused on fostering a culture of underwriting excellence, outlining a consistent risk framework and reducing risk and volatility in our portfolio. Peter and the team in GI are executing with focused urgency that is impressive and the marketplace has taken notice. You're beginning to see the significant efforts pay off in our results with the third quarter performance in GI yielding remarkable improvement over prior years. I am particularly pleased that the GI reinsurance strategy played out as designed dramatically reducing volatility in CAT season and preserving capital.

We've been leading the market with our professional approach to judiciously deploying capacity, appropriately addressing laws cost inflation, and continued underwriting discipline on our pricing models. These actions are playing out against an industry backdrop of prolonged pressures on accident year loss ratios, laws costs inflation, significant catastrophes over multiple years pressuring the property loss, a lower interest rate environment, a complex retro market and a fatigue alternative capital market.

This market dynamic is different from the past because we now see the industry as a whole is acting more rationally and this combination of change behavior and external forces reaffirms my belief that this market cycle is sustainable for the foreseeable future.

One example where AIG has taken a leadership position in the industry is the way we tackle the increasing industry wide issue in cyber insurance. Companies are more focused on the severity of losses, increased systemic risk of more stringent regulatory environment, and ransom demands that are dramatically escalating. In September, we formally announced our affirmative cyber initiative, and it provided clarity for the market on how cyber coverage should be addressed and mitigated ambiguity that existed.

Turning to our third quarter financial results as you saw on our press release this morning, adjusted return on common equity for the third quarter was 4.1% and 8.6% year to date. Adjusted after tax income was $505 million or $0.56 per share for the third quarter compared to an adjusted after tax loss of $301 million or $0.34 per share in the prior year quarter.

Year-to-date 2019 adjusted after tax income was $3.57 per share, reflecting a $1.80 per share improvement over the first nine months of 2018. General Insurance delivered a third consecutive quarter of adjusted accident quarter underwriting profit. The adjusted accident in quarter combined ratio excluding cash was 95.9% and we remain on track to deliver an adjusted underwriting profit for the full year.

In addition, last week, GI announced the new syndicate at Lloyd's, serving the 50 billion specialists U.S. high net worth market. Lloyd's has undertaken a comprehensive plan to regain its preeminent position on the marketplace. We've been actively seeking opportunities to be part of that effort, first with our acquisition of VALIDUS, which included Talbot, a respected Lloyd's platform and now with this further partnership. Peter will give you more detail of the great progress we are making in General Insurance, as we position that business for the future.

Turning to Life and Retirement we continue to produce solid results in the third quarter with adjusted pretax income of $646 million and adjusted return on equity of 10.1% including the impact of the annual assumptions review. The adjusted return on equity was 12.5% if you exclude the impact from the actual review process. Despite continued headwinds from sustain low interest rates, we remain optimistic about our ability to deliver return on common equity in the low to mid teens for the year given the strength of our diversified product portfolio, and broad distribution network. Kevin will provide additional information on the work he and his team are undertaking in Life and Retirement.

Net investment income was $3.4 billion for the quarter and $11 billion for the first nine months, which is ahead of our original expectations. Our year-to-date performance is due largely to strong alternative returns. Mark will provide more detail on this and our overall financials.

Finally, I wanted to touch on AIG 200 our multi-year enterprise wide program to improve our core processes and infrastructure. We have four core objectives for AIG 200, which are achieving underwriting excellence, modernizing our operating infrastructure, enhancing user and customer experiences, and becoming a more unified company.

This work is absolutely critical if AIG is to become a top performing company, and we are carefully prioritizing areas for investment and transformation. We will provide estimated levels on investment charges and savings for 2020 on our fourth quarter earnings call. Peter as the executive leading this important initiative will elaborate further on the progress we've made through the third quarter.

Our ability to tackle transformational projects are supported by our strong balance sheet. We are focused on maintaining financial flexibility while reducing our leverage and reinvesting in our businesses. Looking to the remainder of the year and into 2020, we were confident in our ability to achieve our goals for 2019 and continue to believe that the momentum we have generated will enable us to deliver a double digit ROCE by the end of 2021. We still have a lot of work ahead of us and I'm very pleased with the progress we're making across the organization. Remain confident that AIG is well on its way to being a leading, global insurance company.

With that, I'll turn it over to Pete.

[Peter Zaffino, CEO, General Insurance and Global COO]

Thank you, Brian. Good morning, everyone.

Today, I will provide an update on the General Insurance, third quarter financial performance, the turnaround that we are executing in key business units, along with our observations on the current rate environment. I will discuss the recently announced new Lloyd's syndicate serving the U.S. high network market. And finally, I will close with comments on AIG 200.

The General Insurance, third quarter results reflects steady progress towards our goal of achieving sustained underwriting profitability. We continue to execute on the bold strategic moves we identified as critical to reposition our global portfolio, which include disciplined underwriting and reinsurance strategies, a clear focus on operational excellence and investing in talent for the future.

We continue to significantly reduce volatility through improved risk selection, aggressive limit management, and align our businesses with our redefined underwriting strategy. We're achieving better rate adequacy; and in many cases, are leading the market.

As we expected, it will take time for these actions to fully earn through our reported results. But I'm very pleased with our improving financial performance.

Turning to our results, the third quarter adjusted accident quarter combined ratio was 95.9%, a 350 basis point improvement year-over-year, including a 210 basis point improvement in the adjusted accident quarter loss ratio, and 140 basis point improvement in the expense ratio.

In North America, the adjusted accident quarter loss ratio was 69.5%, a 30-basis point improvement year-over-year. Our financial performance in the third quarter reflected the favorable impact of changes to our business mix, which was achieved through reductions in higher loss ratio businesses, strong results from glad Glatfelter, improved rate adequacy across a number of lines, lower frequency of property attritional losses across retail, wholesale and western world, and the benefit of treaty and facultative reinsurance.

These positive drivers were largely offset by our Crop and Specialty businesses. Crop, negatively impacted North America's adjusted accident quarter loss ratio by approximately 100 basis points. Significant spring flooding in the Midwest, affected many of our insured farmers, which drove a higher volume of prevented-planting claims.

As a result, we increased our 2019 loss ratios despite remaining uncertainty regarding the ultimate profitability of this crop season.

We experienced higher losses in the Marine, Aviation and Energy, which negatively impacted North America's adjusted accident quarter loss ratio by approximately 250 basis points. We continue to take actions to improve performance in U.S. Specialty lines through enhanced risk selection, rate improvement strategies and reinsurance.

Despite these headwinds in North America, on a global basis, our Specialty business performed very well, with international seeing lower expected loss. North America, Personal Insurance performed as expected with 110 basis point improvement in the adjusted accident quarter loss ratio, and 100 basis point improvement in the adjusted accident quarter combined ratio.

Overall, I'm very pleased with North America's core performance, and believe the trends we're seeing demonstrate a higher quality, better price and more balanced portfolio that is improving each quarter.

Moving to International. The adjusted accident quarter loss ratio was 53.9%. A 430-basis point improvement year-over-year. In the International Commercial, we had fewer severe and attritional losses that were below trend, particularly in Specialty and Talbot, a Lloyd's syndicate.

Additionally, re-underwriting efforts in property within the U.K. and Europe are beginning to earn into our reported financials. The International Personal Insurance adjusted accident quarter loss ratio improved 290 basis points, as we continue to see a favorable trend in Japan Personal Auto.

The third quarter expense ratio for General Insurance of 34.4%, was in line with our expectations, and reflects our sustained diligence around expense control. The third quarter of 2019 was an active CAT quarter. Total net CAT losses were $497 million compared to $1.6 billion in the third quarter of 2018, and $3 billion in the third quarter of 2017.

There were nine events in the quarter, six of which occurred in North America and three occurred in Japan. Our net CAT ratio in the third quarter with 7.5%, with 2.9% attributable to events in North America, 3.5% attributable to Japan, and 1.1% attributable to Validus Re.

Net CAT losses from events in North America were $203 million. Hurricane Dorian was a single largest driver of net losses at $135 million, of which $10 million was attributable to Validus Re. The five remaining smaller events in North America, range from $10 million to $14 million and net losses per event.

Net CAT losses from the Japan events were $294 million, of which $65 million was attributable to Validus Re. Typhoon Faxai, the strongest typhoon to hit the Kantō region since 2004, was the main driver of these losses.

I want to provide an overview of our business in Japan, given our significant market presence and the actions we have taken to address our CAT exposure. Japan is AIG's largest market outside the United States. It represents approximately $5.1 billion in gross premiums written, with 82% in personal lines and 18% in commercial lines. AIG is the largest foreign owned General Insurance Company in Japan, with an average market share of 6% and the region is most impacted by recent CAT events.

As I said in the past, as part of our strategy to contain volatility and manage CAT within our risk appetite site, we enhance our reinsurance coverage in Japan to reduce net retention and protect against tail events.

When we restructured our worldwide CAT program for 2019, this included moving to a single occurrence tower for Japan, with a model expected to cash in point of the 1 in 7-year event.

This dedicated occurrence protection exhausts at the model 1 in 69-year event. We have additional protection from our global CAT cover, that provides protection in excess of the 1 in 500-year event.

Additionally, we also purchased international annual aggregate protection, which attaches at 1 in 10 year event for losses outside of North America, with approximately 80% of the model expected loss is coming from Japan.

Overall, Japan has been a profitable business with an average historical adjusted accident year loss ratio of approximately 50%, and its prospects for improved profitability are very strong. With respect to the recent CAT events in Japan, it is still early days from typhoon Faxai. And as a result, industry loss estimates from the modeling firm stand at broad range of between $3 billion and $9 billion.

Typhoon Hagibis, a fourth quarter event, is also expected to be sizable with AIR's early industry loss estimate currently at $8 billion to $16 billion. To the put the recent CAT activity in Japan perspective, there have been 12 designated catastrophic tropical storms since 1984. Four of which occurred in the last two years. 2018 and 2019 will be the two largest years for insured losses from tropical storm events in the last 40-years.

However, irrespective of the eventual size of these industry losses, AIG's expected maximum retained net loss is limited due to the benefit of both the occurrence reinsurance and the International CAT annual aggregate protection.

Based on our current estimation of year-to-date CAT losses in International, and excluding Validus Re, our net loss before reinstatement premium arising from this event is estimated at no more than approximately $75 million.

We have significant additional covers in place to protect against further fourth quarter CAT activity in our international business, including Japan. And taking Hagibis into account, our maximum retention on any one loss is now $20 million before any additional reinstatement premiums for the remainder of the year.

With respect to Validus Re, we have an aggregate retro in place. Given the wide range of model loss estimates, it's too early to provide a net CAT loss estimate from typhoon Hagibis. However, we expect the retro aggregate to attach with another 155 million in CAT losses.

As I've done in past calls, I'd like to highlight a few businesses that exemplify the work we're doing to reduce risk, reposition our portfolio and establish AIG as a market leader. I recognize that I've mentioned Lexington often, but the magnitude of the turnaround in this business over the past year is powerful and worthy of another update.

In Casualty, submission volume increased 62% in the third quarter, and we were successful in further diversifying in the middle market while reducing total limit by 58% and improving rates by 31%.

In Property, submission volume increased 47%, while we reduced total limits by 74% and increase our overall proportion of excess policies from 11% at the end of 2018 to 25% on a 2019 year-to-date basis.

In addition, we increased deductibles by 18%, continued to improve terms and conditions and achieve third quarter renewal rate increases of 15%, which we expect will continue to increase particularly due to the recent global CAT activity.

Turning to North America retail property, we continue to reduce aggregates and exposure to certain classes, increase deductibles and achieve meaningful rate increases. We reduce total gross limits by over $20 billion or 37% of the third quarter and over $80 billion or 49% year-to-date.

Average deductibles increased by 27% in the quarter and 30% year-to-date. These significant underwriting actions are reducing volatility, improving attritional loss exposure and significantly reducing cat exposure.

Multi-year agreements represented approximately 30% of the retail property portfolio at the end of the third quarter. These agreements will be approximately 20% of the portfolio by the end of 2019. And we'll trend lower during 2020 as we will drive additional momentum in our reunderwriting efforts.

In the third quarter, we saw North America retail property rate increases accelerate as there was broader pullback in market capacity, and discipline underwriting was more prevalent. The portfolio yielded high teen rate increases and achieved mid 20s rate increases when you exclude the impact of long-term agreements. We expect to continue to see rate increases through the remainder of the year and then to 2020.

In North America, financial lines we accelerated remediation of challenge segments, and in the quarter we achieve rate increases exceeding 30% across commercial D&O led by increases exceeding 35% in public D&O. At the same time, we reduce primary commercial D&O aggregate limits by over 40% compared to a 30% reduction the second quarter, and we reduced primary commercial D&O policies with limits greater than 10 million in lead layers high over 40%.

While we've done significant work to reunderwrite our global portfolio we're also focused on investing and attractive growth opportunities such as accident and health. A&H represents more than 3 billion in gross premiums creams written and is one of our best performing businesses. We believe A&H will be a strong engine of future profitable growth because global demographic trends and demand for A&H products match up well with our product offerings and global footprint.

Now I'd like to comment briefly on the overall rate environment and some broader market observations. We continue to see meaningful rate increases across the board in the third quarter a trend that is accelerated throughout the year. In some lines rate improvement has been at the highest level in over a decade. The overall third quarter rate improvement for general insurance excluding Validus and Glatfelter was in the high single to low double-digits.

North America commercial rates increasing in the low double-digits compared to a high single-digit rate increase in the second quarter. International commercial rates increased in the low to mid single-digits on average across all geographies, consistent with the second quarter.

Outside the specific businesses I highlighted earlier in North America were seeing meaningful rate increases in the mid 20% range in admitted excess casualty and energy and international rate increases continue to accelerate in the UK, driven by approximately 20 points of improvement in D&O over 30 points improvement in marine and low double-digit improvements in energy.

These increases are being driven by proactively addressing loss cost trend inflation, as well as our unique position as a primary lead market across the commercial insurance landscape. As we've noted on prior calls, loss trends due toward environment and social inflation continue to be key areas of focus for us. We recognize this growing trend a while ago and we continue to monitor the changing landscape and respond to risks as they evolve.

Given recent news reports about settlement activity, I want to touch on developments concerning litigation related to opioids, which has been filed primarily by state and local governments against manufacturers, distributors, and retailers. While it's too early to predict or quantify the outcome of all the litigation, or the insurance that may apply, we've been very closely tracking these developments so that we can address these complicated risks appropriately as they continue to evolve.

As Brian noted, we recently announced the plan to launch an innovative syndicate Lloyd’s focused on the U.S. high network portfolio. We expect this syndicate will support new and renewing business starting in the first quarter of 2020. The specialist syndicate, syndicate 2019 is expected to be Lloyd's largest ever single new engine premium of up to $1 billion. Lloyd’s unique capital structure provides us with increased flexibility and efficiency, and enables us to attract new and diverse long-term capital partners to support profitable growth where opportunities exist.

Before turning the call over to Kevin, I'd like to make a few comments on AIG 200. As Brian noted, AIG 200 is our global multi-year effort to reposition AIG as a top performing company. We're focusing on programs that involve transformational change to our infrastructure and underwriting operations, as well as developing a new data architecture, all of which will be designed to achieve best-in-class operations that deliver value to scale and simplification.

While AIG 200 primary purpose is not cost cutting, we do expect to achieve a reduced expense base over time, and more importantly, a much better experience for our distribution partners, clients, policyholders and colleagues. AIG 200 reflects our commitment to continuous improvement as we pursue operational excellence and fortify our competitive position. We're very pleased with the high level of engagement from colleagues across the company who are committed to shaping the future of AIG.

Now, I'll turn the call over to Kevin.

[Kevin Hogan, CEO, Life and Retirement]

Thank you, Peter and good morning everyone.

Life and Retirement recorded adjusted pretax income of 646 million for the quarter and adjusted return on attributed common equity of 10.1%. Excluding the annual actuarial assumption update, the adjusted pretax income was 789 million and adjusted return on attributed common equity was 12.5% within our expectations. Adjusted pretax income decreased by 67 million from the prior year quarter.

The primary driver’s of the difference was the annual actuarial assumption update, which accounted for 45 million of the decrease and elevated mortality. These unfavorable impacts were partially offset by the lower interest rate environment driving increased call and tender income and higher returns on fair value options securities, as well as other net investment income adjustments.

There was nothing in our assumption review or mortality experience has suggested a change in the inherent profitability of our products, nor a need to change our pricing strategy. Also it's worth noting that from a pretax income perspective, the overall impact from the assumption update was positive 20 million.

Year-to-date, our adjusted pretax income was 2.6 billion and adjusted return on attributed common equity was 14%. We are pleased with our results to date, but recognize the challenges and headwinds below interest rate environment presents, along with the potential for increased volatility in equity markets, given global trade and geopolitical concerns. Declining equity markets would among other things, negatively impact fees as well as deferred acquisition costs amortization.

Declining interest rates would typically result in higher returns on fair value options securities although the impact on net investment income could be uneven, and would depend on the timing and degree of interest rate movement. At interest rate levels as of the end of the third quarter, our current expectation is for base net spreads to decline by approximately one to three basis points per quarter through the end of next year.

Finally, from a statutory perspective, we expect to continue to generate solid earnings before our year end 2019 risk based capital levels to be higher than our strong year end 2018 levels. Our topline results continue to reflect our ongoing strategy to leverage our broad product portfolio and diversified distribution network to satisfy customer needs.

During the quarter, we grew indexed annuity sales and individual retirement and executed opportunistic transactions in institutional markets. We expect lower levels of sales for certain product lines in the fourth quarter, due to lower interest rates and the uncertain environment. We will remain disciplined with respect to product pricing and features and continue to deploy capital to available attractive new business opportunities.

For individual retirement, premiums and deposits increased slightly due to growth and indexed annuity sales. Although fixed annuity sales were basically flat from the prior year quarter, they have declined significantly from first quarter levels. We expect lower sales of fixed annuities in the prevailing interest rate environment. We achieved positive net flows excluding retail mutual funds, which is a comparatively small part of our earnings.

Total assets under administration increased driven by strong equity market performance and growth of annuity deposits during the first half of the year. For Group retirement premiums deposits were lower than the prior year quarter driven by a decrease in individual product sales related to lower crediting rates. Net flows improved from the prior year quarter due to lower group surrender activity but still remain negative.

Although the timing of group acquisitions and individual contributions will result in quarter-over-quarter variances in deposits, we expect surrenders and other withdrawals to continue to drive negative net flows.

It is also important to note that the financial impact of outflows will vary based on product characteristics. Despite facing negative net flows for a period of time, we've continued to produce solid earnings for this business, as assets under administration have continued to grow.

For our Life Insurance business, total premiums and deposits increased to the international sales. Our U.S. life sales declined as we deemphasize guaranteed universal life sales in the current interest rate, environment and index universal life sales remain under pressure while mortality was elevated during the quarter, it should be viewed in the context of generally favorable mortality trends we have seen over the last two years.

For institutional markets, premiums and deposits increased due to a large GIC issuance and select transactions in our pension risk transfer business. We have continued to opportunistically grow our asset base, and our institutional markets business continues to be well positioned to capitalize on available growth while remaining focused on achieving targeted returns.

Across our businesses, we are continuing to invest as needed to prepare for the evolving regulatory and accounting landscape, including the SECs regulation best interest, New York State's Regulation 187, NAICs variable annuity framework and FASB LDTI among others. We will take the opportunity to leverage these ongoing investments to further improve our efficiency and competitive position.

The close, we remain committed to our ongoing strategy to leverage our broad product expertise and distribution footprint to deploy capital to the most attractive opportunities, which we believe positions us well to help meet growing needs for protection, retirement savings, and lifetime income solutions.

Now I will turn it over to Mark.

[Mark Lyons, CFO]

Thank you, Kevin and good morning all.

AIG's adjusted after tax earnings per share $0.56 for the quarter, compared to a negative $0.34 per share in the corresponding quarter of 2018 representing a $0.90 per share improvement. Adjusted book value per share, which excludes AOCI and the DTA increased 1.2% sequentially from second quarter and increased 4.8% relative to year-end 2018.

As Brian mentioned, adjusted return on equity was an annualized 4.1% for the quarter and 8.6% on a nine-month year-to-date annualized basis. Keeping that theme, the individual segments achieved the following annualize nine-months year-to-date returns on attributed equity. General Insurance 9.5%, Life and Retirement 14%, and Legacy of 4.6%.

Net investment income or NII in the third quarter was nearly $3.5 billion on the adjusted pretax income basis at $3.4 billion on a GAAP basis. This was nearly identical to the third quarter of 2018 on both an adjusted and GAAP basis, and sequentially was $260 million lower on an adjusted pretax income basis, and $337 million lower on a GAAP basis.

This quarter investment income from all fixed income securities was virtually identical to that of the third quarter of 2018, whereas returns from the hedge fund and private equity composites is down materially to an annualized 4.6% versus the previous six months year-to-date return of approximately 17.6%.

Turning to General Insurance, Brian and Peter commented on the accident quarter results, so contrastingly the calendar quarter combined ratio of 103.7% reflects 7.5 points of CAT losses as Peter pointed out with Japan representing approximately 60% of the global CAT losses.

The combination of gross line re-underwriting together with our improved reinsurance program has resulted in a material reduction in General Insurance net CAT ratios from 45.5% of premium in the third quarter of 2017 to 22% even in the third quarter of 2018 to the 7.5% this quarter, an 84% reduction over a two year period.

Additionally, the prior period development ratio was negligible for the quarter net of ADC recoveries and ADC amortization. Broadly speaking, calendar quarter underwriting gain was nearly $1.5 billion higher than the third quarter of 2018 with North America contributing $802 million of underwriting gain improvement and the international operations providing $675 million of underwriting gain improvement.

Also both commercial and personal lines improved their accident quarter underwriting margins third quarter over third quarter. It's also informative to comment on the General Insurance performance on a year-to-date nine months basis versus the first nine months of 2018. And on that basis, the year-to-date current accident year combined ratio excluding CATs improved 390 basis points with the loss ratio contribution being a 240 basis point improvement, another 200 basis point improvement from the GOE ratio with a partial offset of a marginal 50 basis point increase through the acquisition ratio.

As respect to volume, year-to-date reported net or premiums are nearly flat with last year on a U.S. dollar basis but the continued success with the improved gross underwriting strategy together with the increasing seeded earned premium from reinsurance previous place, are expected to reduce the fourth quarter net earned premium by approximately 5% sequentially bringing the additional reinsurance purchases.

Now, I want to take the opportunity to reinforce the magnitude of the portfolio reshaping that Peter outlined in his prepared remarks. This level of change is unprecedented in my 42 years in this business, but there are nuances however, that should not go unnoticed.

For example, reducing Lexington causality total limits by an impressive 58% in the quarter, while simultaneously increasing or achieving an average rate increase in excess of 30% is only part of the story. The 62% increase in submission volume signals the igniting of the wholesale distribution channel along with its emphasis on smaller accounts that have more localized exposures and lower capacity needs. The result in spectrum of risk quality has also broadened thereby improving overall rate adequacy as well.

Peter also commented on General Insurance's achieved rate increases for the quarter and helping to put the trajectory of those rate increases in context two lines will be highlighted. First U.S. Directors and Officers liability or D&O combining primary and excess coverages accelerated between the fourth quarter of 2018 and the third quarter of 2019 inclusive as follows; 9% increase in the fourth quarter of 2018, 11% in the first quarter 2019, 17% in the second quarter of 2019, and then 28% this quarter.

Secondly, Lexington's casualty business rate increases were similarly increasing as follows; 6% in the fourth quarter of 2018 increasing to 8% in the first quarter of 2019, 20% in 20 - in the next quarter and then 31% this quarter.

Furthermore, we were extremely pleased that our leadership position is driving rate extended even further beyond the United States with Canada achieving a 9% weighted overall increase, the U.K. with a 10% increase and continental Europe achieving 6% in the quarter.

Turning to prior year development, although actual versus expected loss emergence was reviewed and incorporated globally, the major areas receiving deeper reserve dives this quarter, were in decreasing order of reserve size, U.S. primary workers compensation, U.K. and Europe casualty lines, U.K. and Europe financial lines, U.S. commercial property, and U.S. financial lines errors and omission for E&O disclosures.

The negligible prior periods development referenced earlier benefited from $58 million of favorable impact from the ADC amortization of the deferred gain and therefore adjusting through this the development was unfavorable by $55 million.

Unpacking this further, the pre-ADC prior period development before any ADC recoveries was favorable by $74 million. This potentially counter-intuitive results stands from the sliding by accident year, $226 million of net favorable development emanated from accident years 2015 and prior at approximately $152 million of net unfavorable development coming from accident year's 2016 through 2018.

The accident year 2015 and prior net favorable development emanated primarily from U.S. worker's compensation, whereas accident year 2016 through 2018 net unfavorable developments stand primarily from U.S. financial E&O lines, the U.K. European casualties in financial lines with a partial offset of a favorable development from European property in specialty and European and Japan personal lines.

Digging further, approximately one-third of this aggregate $152 million of net uncharitable development for accident year 2016 to 2018 stems from an isolated impact of one large long-term agreement affecting all three accident years. Approximately another third was centered in the U.S. architects and engineers book on both the primary and excess basis and we reacted to this due to an increased frequency of moderate severity claims so as to reflect negative trends more quickly than positive trends.

The remaining one-third were collected various U.K. and European impact in casualty and financial lines driven by a smattering of loss claims such as in French and Italian motor business and Irish's employers liability.

Overall though, the pre and post ADC prior period development represents approximately one-tenth of 1% of carried reserves. As for accident year 2019 implications of the net on favorable development, we don't see any carry forward issues with the one long-term agreement, whereas the U.S. architects and engineers was deemed to have a minor roll forward impact, as well as some of the European indication.

As a result, these deep dives, which year-to-date, represents 65% of total loss reserves, saw 0.5 point loss ratio increase to action year 2019, which reflected about 0.2 points for the current action quarter with another 0.3 points of catch up, for the first two quarters of 2019. This was virtually offset by the earned impact of stronger rating versus being achieved on the subject lines of business and anticipated within the original 2019 budgeted loss ratio.

Turning to the Life and Retirement segment, the annualized nine month return on attributed common equity of 14% would be unchanged after adjusting for both the actuarial assumption impact and the removal of a large beneficial IPO gain discussed last quarter, so they virtually negated each other.

It's also informative to note that on a nine-month year-to-date basis, the adjusted after-tax income is nearly identical at $2 billion even compared to 2018. Net spreads on the variable and indexed annuity composite were up marginally from last quarter, and so fixed annuities were virtually flat with the sequential quarter.

Surrender rates on a year-to-date basis were flat for the variable and indexed annuity composites, and slightly better for fixed annuities within Individual Retirement, and 70 basis points better for Group Retirement.

Life Insurance experienced moderately increased mortality relative to the first half of the year, with overall lapse rates fairly consistent with a year ago. And institutional markets had roughly $350 million of pensioners risk transfer deals and also have roughly $375 million in debt issuance as Kevin noted. Lastly, assets under administration increased 1.1% sequentially, and grew 10.4% since year end 2018.

Turning to Legacy. Adjusted pre-tax income was down slightly to $93 million on a sequential basis, but up from $84 million in the third quarter of 2018. Like Life and Retirement, Legacy's results reflected an adverse impact to the annual actuarial assumption update of $30 million. Legacy net investment income on a year-to-date basis was flat with 2018 at $1.8 billion. And the annualized return for the quarter was 4.4%.

As respect tax, the estimated effective tax rate was 22.6% for the year, applicable to adjusted pre-tax income, and was 25.3% for the quarter, inclusive of discrete items. As you know, the effective tax rate is updated each quarter using actual year-to-date results, and then supplemented by the forecast of the remaining quarter.

As always, the tax rate is heavily influenced each quarter by the geographic distribution of income by tax jurisdiction. We did not repurchase any shares in the third quarter, so our Board authorization remains at $2 billion.

And moving to leverage, as compared to year end 2018, our total debt and preferred's to total capital ratio has now improved to 26.1% this quarter, which represents a 320 basis point improvement relative to year end.

We also had a bond trunk redemption of $1 billion in mid-July, that had been prefunded by our March 2019 debt raises. This debt overlapped at the end of the second quarter, plus growth in earnings flow and leverage ratio improvement to 26.1%.

Adjusted book value per share, increased 4.8% from year end 2018 and GAAP book value per share increased 15.1% since year end 2018, benefiting from approximately $7 billion of year-to-date AOCI gains.

And with that, I'll turn it back over to Brian.

[Brian Duperreault, President and CEO]

Thank you, Mark. So let's go to the questions-and-answers. Operator, please go ahead.

[Operator]

[Operator Instructions] We'll take our first question from Paul Newsome with Sandler O'Neill. Please go ahead.

[Paul Newsome, Sandler O'Neill]

I guess I'd like to focus in on the underlying combined ratios improvement. And is there any sense of how we can think about the magnitude as we look respectively into - not necessarily next quarter, but prospectively, obviously there was sort of a big bang this year with - from certainly pretty serious changes in reinsurance. But how does that rule forward look into 2020?

[Mark Lyons, CFO]

Well, clearly, you have a lot of things going on at the same time, which I understand makes it somewhat difficult to try to penetrate. You have all the gross changes that Peter has itemized, which are fairly massive.

You have an increasing accelerated rate change on a written basis that will earn in to 2020. And you have some level of loss trend that the industry's discussing, that could perhaps go a little bit the other way.

So without getting into chapter or verse, I think it's fair to say there'll be some level of improvement into 2020. But the magnitude is, let alone the reinsurance purchases, which affect your mix of business, really all need to come to bear. So at this point, I'd say that is good. You should think about improvement, but I'm not prepared to get into magnitude.

[Brian Duperreault, President and CEO]

Peter?

[Peter Zaffino, CEO, General Insurance and Global COO]

Brian, there's one thing I would just add to agree with everything Mark just outlined. But the other piece of that, we've been designing reinsurance structures that reflects the portfolio that we have. And so with all the massive changes that we've seen in the property book, I mean, that's what we're assessing over the next, call it, 45-days in terms of putting together some of the reinsurance structures that reflect the risk of the portfolio today. So that that will evolve as we enter into 1-1

[Brian Duperreault, President and CEO]

Yes, you know, the other thing I'd say, Paul is, I've given you a data point, which is our expectation for return on equity; which by the end of 2021, we want to get over 10%. So, in order for that to happen, clearly the GI, big portion of it has to continue to improve.

And I think that gives some indication of what we think is going to happen. A lot of the work that gets done is in rate, underwriting, et cetera. But it also is the expense levels that GI has, and those expense levels are high. We have to get to those as well.

So, yes, we'd love to be a little clear on that. But all I would say to you is we're committed to continuous improvement in the combined ratios to get it to what should be world class levels. That's going to take some time, but we're committed to doing it over multiple years.

[Paul Newsome, Sandler O'Neill]

I was just going to ask on the Life side, any thoughts or comments on the SEC investigation that's obviously very topical to investors?

[Brian Duperreault, President and CEO]

I think you can appreciate that we just were not able to go into any detail about ongoing regulatory inquiries beyond what you would read in our 10-Q disclosure. That document is going to be on file soon. So I just want to point you to that for the additional information.

Okay, next question, please?

[Operator]

We'll take our next question from Tom Gallagher with Evercore ISI. Please go ahead.

[Tom Gallagher, Evercore ISI]

I'll just ask two quick ones. Given the increase in specialty losses in North American commercial this quarter occurred while you've been growing top line pretty well; are you comfortable, you've been growing that line profitably? That's my first question.

And then Peter, your comments on the Hagibis losses for 4Q, I just want to make sure I have the numbers right. I was getting AIG's net retention being a maximum of around $75 million, and Validus max of $155 million. Is that a good way to think about 4Q, based on what you know today?

[Brian Duperreault, President and CEO]

Yes, let's do it backwards. Let's do the Hagibis first.

[Peter Zaffino, CEO, General Insurance and Global COO]

Yes, correct. I mean, the maximum – the first part, I just want to clarify the Validus Re. The first part is that because of the per occurrence and the way the international aggregate and our global aggregate works, that the maximum we would have on Hagibis is $75 million, assuming the forecast we've had for Faxai and others, end up having the gross loss that we anticipate.

So I think that $75 million is a very good number. What I said in terms of the Validus is that their retro would attach with another $155 million, or thereabouts, of retro loss. So you should think about, as it goes above $155 million, we have significant retro protection in place.

[Brian Duperreault, President and CEO]

Yes, on the specialty, let me start. But I think Peter needs to give you the most clarity on it. The first thing we said was, North American specialty was higher. The International was lower. Net-net was actually pretty good. But it just happens to be the geographies here. And frankly, we managed that business on a global basis. We think of it as a truly global line. You're writing aviation across the world.

I'm not sure it's fair to classify it as something we've been growing dramatically. And maybe Peter, you could give a little bit more color on it.

[Peter Zaffino, CEO, General Insurance and Global COO]

No, I think you really outlined it well, Brian. I think the only other thing is we've been getting rate in the specialty classes. When we look at global performance in the quarter, we were very pleased. Then when we look at the global performance what we seen here year-to-date, it's been a very strong performer and expected to continue to have, good performance in the future. So like what I said in the prepared remarks is that we're looking at, limit management, our driving rate and how we’re underwriting it. But overall, it's a very good book.

[Brian Duperreault, President and CEO]

You wanted to add.

[Kevin Hogan, CEO, Life and Retirement]

Just one thing if I could on Peters, I think good explanation to your question about the maximum. Just keep in mind that the 75 million as he outlined it, in a likelihood sense is more likely than Validus additive number as a collection of seating companies its different attachment points and that’s remains to be seen. I wouldn't take those two as additive necessarily.

[Operator]

Our next question will come from Josh Shanker with Deutsche Bank. Please go ahead.

[Joshua Shanker, Deutsche Bank]

Yes thank you for taking my questions. I'll be quick, there is sort of similar on life one P&C. On the P&C, the improvement in commercial is outstanding when you take the medium and large loss in the crop numbers out of it. I'm just wondering with the new orientation of the book, is there seasonality in the accident year loss ratio in North American commercial that 3Q would be better than other quarters?

[Brian Duperreault, President and CEO]

Well look at accident quarters are so little small that the volatility of a single accident quarter, I think would, exceed any kind of seasonality. I suppose you could come up with some in property where with wind activities and things like you could have a seasonal movement. But I just think you can't look at this an accident quarter as something that's very, very predictable. There's a lot of volatility in a particular quarter that's why we report it because we have to I really point to the nine months as a better indication of movement.

[Joshua Shanker, Deutsche Bank]

And then I'm life, Kevin said that the mortality in the life business should be viewed in the context that you've had very good mortality for the last couple of years. Does that mean that that life has been over earning just that one sub segment and we should consider that in our forward model?

[Brian Duperreault, President and CEO]

Well, Kevin?

[Kevin Hogan, CEO, Life and Retirement]

Yeah thanks, Josh. No, I think that the underlying message is, is that the third quarter was an anomaly. We have seen, our mortality well within pricing, in fact that for eight of the last 10 quarters within pricing. And so the message is, is that we don't see this quarter as a suggestion that our ongoing trend for mortality is likely to change.

[Operator]

Going next to Brian Meredith with UBS. Please go ahead.

[Brian Meredith, UBS]

One quick clarification number and then another one. Peter, I think you said that the events going forward now we're going to have $20 million retention. So either the California fire is going on right now, if they get big or small whatever, it shouldn't be that big of an issue?

[Peter Zaffino, CEO, General Insurance and Global COO]

What I was referring to was 20 is after Hagibis, that's our maximum retention in our international business.

[Brian Meredith, UBS]

International got you.

[Peter Zaffino, CEO, General Insurance and Global COO]

Yes, I mean Brian, in terms of North America, we still have significant cover. I mean, we have, you know, some buy downs at are California specific that attach at 50 million. We have a lot of occurrence cover, and we have a lot of aggregate. So I mean, it's really hard to predict in terms of North America with the wildfires, but we have ample protection. And, we'll see how it all evolves.

[Brian Meredith, UBS]

And then my next question is there's been a lot of discussion this quarter about the total inflation environment, particularly with respect to general liability lines. I'm just curious - give your perspective on it as well as what are the severity assumptions that you're assuming in your loss picks and your kind of preserving actions today?

[Brian Duperreault, President and CEO]

I think Mark that probably more yours.

[Mark Lyons, CFO]

Yes, happy to thanks hello Brian thanks for the questions.

[Brian Meredith, UBS]

Hi.

[Mark Lyons, CFO]

I think as we mentioned last quarter, we have I think, some pretty steep loss trend to our premium assumptions - a lot the lines of business subject to what you’re concerned about. Some of them in the mid to upper single-digit trends already. So that's already been kind of baked in and how we look at things translates into pricing models, so forth and so on. I think on even a broader basis, I mean, our view of those last trends is based upon a lot of our own information.

And how that's moved over time between actually years, and when you kind of think about the overlay of the macroeconomic environment with everything Peter described, about moving up, and attachment points, chopping the limits dramatically. I tend to look upon a portfolio basis of all that reshaping becoming a natural inflation hedge irrespective of whether it’s economic or social. So I think the book characteristics are very protective in that respect.

[Brian Duperreault, President and CEO]

Yes, I can emphasize enough thanks Mark, about the - whether it's a deductible or it's an attachment point or it's layering done in some of the excess whether it's D&O or other excesses, all of those things are more powerful than the rate in terms of adjusting for inflation. Next question.

[Operator]

Our next question will come from Jimmy Bhullar with JPMorgan. Please go ahead.

[Jimmy Bhullar, JPMorgan]

I had a question first just on the lack of buybacks so far this year. So given that you've got the AIG 200 initiative coming up, and I'm assuming you're still interested in acquisition. Should we assume that buybacks are probably going to be fairly light until maybe the leverage ratios improved further. And then I had a question also on just your flows on the Life and Retirement aside, specifically at VALIC they seem pretty weak. And if you could just comment on what's going on there and your outlook?

[Brian Duperreault, President and CEO]

Okay, Kevin can take the flows. Let me address the buyback so yes we didn't buyback this quarter in my prepared remarks, I emphasized that I want to invest. Well, first of all, we want to do leverage so that's an important thing to keep in mind. And I want to reinvest in the business. Some of that is the AIG 200 still being quantified.

And, the other thing to keep in mind is, when you're in a catastrophe quarter you wouldn't normally buyback anyway. And whether it's the third quarter, the fourth quarter we see in the fourth quarter also produce some catastrophes. I just think it would be prudent not to buyback in any case, but the emphasis is on the other aspects of capital management that I refer to. Kevin wants to talk about the flows.

[Kevin Hogan, CEO, Life and Retirement]

Yes, sure so thanks, Jimmy. So, the situation at VALIC we have been in a negative flow environment over the last couple of years. I think it's a reflection of the fact that, the new case acquisition for a period of time had tailed off. We've seen an improvement in that recently, but this is a natural effect of the ageing of the portfolio.

The VALIC has been a leading participant in this business for a long time and as either in plan participants rollout of the plan or as people start to utilize the underlying benefits that they have, that certainly is part of what leads to the outflows.

In addition to that, particularly in the healthcare industry, over the last couple of years, there has been a lot of M&A activity. And in cases where plan consolidations occur, in some cases, we're on the winning end of those, in some cases, we're on the losing end of those, and we've reported those sort of large outflows as and when they occur. So, we're continuing to be successful in new plan acquisition.

We continue to see strong periodic deposits and non periodic deposits. And we're likely to continue to see some negative flows in this business because of that natural ageing effect in the portfolio. But I think it's also important to recognize that the dollar value of the flows is uneven if they're higher guaranteed minimum interest rate flows that is less of an impact on future earnings then more recent products.

And the finally that the assets under management of this portfolio, which is the source of earnings in the business have continued to grow along with the equity market. So we're outpacing the negative flows with growth and assets under management.

[Operator]

We'll go next to Elyse Greenspan with Wells Fargo. Please go ahead.

[Elyse Greenspan, Wells Fargo]

My first question, you guys provided a lot of good information on the pricing environment, high single to low double-digit increases, getting a lot of rate in your commercial book. I guess I'm trying to think through the rate versus trend if you could help us think where kind of loss trend is on a composite basis. And then how we could think about I think you guys said half a point of rate versus trend this quarter. How we could think about that building up as when it comes into earn over the course of the next year?

[Brian Duperreault, President and CEO]

Mark?

[Mark Lyons, CFO]

Well, it's a great question. See if I can give you a great answer you bet. So - first is very generic comment when you get a 12%, that's a North American number a 12% weighted average written rate increase. What is your loss trends assumption is four, six or eight? Yeah you're getting expansion, and I'm picking those out just illustratively. So, we don't really get into what our weighted average is across the board it really does vary by quarter with the massive changes Peter described.

But we're viewing that as a beneficial 2020 benefit. And because the way things go in, it's going to be more second half, associated with the rate of increases of the rate changes. So, it's expansion, on a gross basis, but you're looking at our results on a net basis, and that interaction between it, is very difficult to measure and probably from new law and the outside looking in even more so. But I'll just keep it at least that you should expect expansion.

[Brian Duperreault, President and CEO]

Okay.

[Elyse Greenspan, Wells Fargo]

And then my second question on kind of ties back to the comment you made about gross versus net. You guys have been buying a lot of, you know, changing your re-insurance strategies in addition to re-underwriting the whole book. As we think about 2020 - there is still big reinsurance projects or something that you have in mind or should we think about kind of a stable-ish retention year-over-year meaning, we could start seeing on some expansion on the net premiums line?

[Brian Duperreault, President and CEO]

Peter?

[Peter Zaffino, CEO, General Insurance and Global COO]

Thanks, Elyse. So a couple things, one is we will be consistent with making sure that we're looking across the portfolio for reduction of volatility and outsize line size. So there could be segments such as financial lines that we'll look at of doing something perhaps as we enter 2020. And then the most important part is looking at the CAT because we've made so much dramatic change in terms of the gross limit and CAT exposed and the strategic projects that we're doing with Lloyd’s.

So again, there's a lot of moving pieces and the reinsurance, and what we decide to put together for 2020 will reflect the portfolio that we have in force. And so there will be some changes. I can't describe those today because we're in the middle of it and, but we'll be very transparent as we hit the sort of fourth quarter call.

[Brian Duperreault, President and CEO]

Okay, good. So we've just crossed the hour, but I think we should take only one more question and we will close. So operator, take one more - one last question.

[Operator]

Our final question will come from Erik Bass with Autonomous. Please go ahead.

[Erik Bass, Autonomous]

Hi, thank you for fitting me in. Can you provide more details on the drivers of your annual assumption review updates and particularly any changes you made to your long-term interest rate assumption. And if there's any impact on go forward earnings from that?

[Brian Duperreault, President and CEO]

Well, Mark. No, I mean, Kevin is better at this. Go ahead.

[Kevin Hogan, CEO, Life and Retirement]

Sure, thanks Erik. First let's talk about what we didn't change. We did not change our long-term interest rate, assumption, our assumption - each product has its own parameters - to derive - the final assumptions. But generally we assume a reversion so they mean over 10 years to 3.5% for the 10 year treasury. Now to the rest of the review as we have a strong diversified portfolio between fixed index and variable annuity as well as a life insurance.

And each of those lines response to economic changes differently and experience emerges separately. So the overriding situation rates are lower this year, which inevitably results in reduced lapse expectations for the fixed annuities where we write up the DAC and that increases sort of APTI. And then in index one of our newer products, we're just seeing some experience emerged and where we updated, lapse rates.

And then in the guaranteed living benefits, as we account for those as an embedded derivative below the line. There were two different effects on that this year. The first was updating, our lapsed model and the second was updating our mortality. And both the fee income as well as the benefit usage goes below the line, which is why you see that economic movement below the line. And then finally, in the life insurance business, there is the effect of interest rates on policyholder behavior, not to similar to fixed annuities.

And we've updated some of our premium projection capability and reinsurance calculations. So, net-net I think that these are largely changes associated with what we've seen happen in the market. No dramatic changes relative to the sizes of our reserves. And as I stated in my prepared remarks, we do not see anything that changes our understanding of the inherent profitability of the business nor we need to change our pricing strategy.

[Brian Duperreault, President and CEO]

Okay Erik.

[Ryan Tunis]

Thanks, so this is Ryan Tunis. I just had one follow-up on the P&C side for Peter. In your opening statements you touched a little bit about the opioids and how it's still too early. Just hoping you could maybe expand a little bit on what you guys are looking for there and what we should be thinking about in terms of timing of any potential reserve action or anything along those lines.

[Brian Duperreault, President and CEO]

Well first of all, I think look at reserve action I'd like Mark to talk about them first.

[Mark Lyons, CFO]

Sure well, interestingly AIG over time has been building up mass tort reserves. Not that we really talk about it, but it's a meaningful number, associated with in our aggregate reserve levels across all accident years. When you get into some of these complex coverage issues that you're talking about, it's really difficult to even talk about it because we don't know the theory of liability that’s going to come down.

You don't know how it's going to be triggered. Therefore you don't know exactly how it may also be play out, but we have a good amount of net mass tort reserves and we still have roughly $6.5 billion in the ADC. So that is still available for this. So we feel - from a reserve standpoint and given what we know today in pretty good shape.

[Brian Duperreault, President and CEO]

Yes look, I think that's probably is a good conclusion to the opioid question. So let me just thanks Erik let me close by just - and telling everyone how pleased I am with our progress to achieve long-term, sustainable and profitable growth rate AIG. And I want to thank our clients, colleagues, shareholders, industry partners, and other stakeholders for their continued support. Thank you and have a great day.

[Operator]

This does conclude today's call. Thank you for your participation.