The importance of loss reserving in one chart

 

Reversal of fortune

AIG is such a big company, and its reserves have deteriorated so much in recent years that with yesterday’s release of its 10-K, I decided to look here and here. Yipes!

I took a couple of shortcuts, but they don’t affect things much. I haven’t adjusted for the discount in loss reserves, which is worth a billion or so. And I haven’t adjusted for assets sold over the years, but as far as I can tell that would actually make things a bit worse by a billion or so.

Update: An earlier version of this chart simply lowered capital by the amount of the reserve deficiency. But of course there should be an offset for income taxes owed. There’s also additional premiums that would be booked on retrospectively rated policies. I allowed 35% of reserves, which doesn’t seem unreasonable, since the company had a tax rate of about 29% in 2001. That leaves a bit under $2 billion for the retros and anything else. So my capital estimate could be off here by a couple billion – more than my lunch money, certainly, but not enough to change the message.

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