Michael Wong: We recently changed our Morningstar Moat Trend Rating for American International Group (AIG) to positive from stable. At Morningstar, we generally view economic moats for insurers as being based on them attaining superior underwriting profits. We don't view sustainable competitive advantages being built on the investment-portfolio side. This is because higher investment returns are usually correlated with increased investment risk-taking.
In order for an insurer to generate superior underwriting profits, they have to build a cost advantage. Cost advantages in the insurance industry are generally based on insurers being able to either price or select insurable risk more accurately than peers.
Effective underwriting shows up in a low combined ratio, which is the sum of insurance losses and underwriting expenses divided by premiums. Over the past decade, AIG's average P&C segment combined ratio was 103%. This means that for every $1 that AIG earned in premiums, they paid out and incurred $1.03 worth of insurance losses and underwriting expense.
Following the financial crisis, AIG changed its strategy to focus on risk-adjusted profits. We believe that AIG's investments in its data analytics and claims-handling ability mean that, going forward, its loss ratio and combined ratio will be sustainably lower. Therefore, we forecast that AIG's combined ratio in its P&C segment will improve to the high 90s, that its returns on equity will climb, that it's currently on a positive trend in terms of its competitive positioning, and that shares are modestly undervalued at current prices.