Aug 3, 2012
Executives
Elizabeth A. Werner – Investor Relations Robert Benmosche – President, Chief Executive Officer, Director David Herzog – Chief Financial Officer, Executive Vice President Peter Hancock – Executive Vice President - General Insurance Jay Wintrob – Executive Vice President-Domestic Life and Retirement Services Brian Schreiber – Executive Vice President, Treasurer William Dooley – Executive Vice President-Investments and Financial Services
Analysts
Josh Stirling – Sanford C. Bernstein & Co., LLC Jay A.
Cohen – BofA Merrill Lynch Adam Klauber – William Blair & Company, L.L.C. Joshua D.
Shanke – Deutsche Bank Securities, Inc. Michael Nannizzi – Goldman Sachs & Co.
Mark Finkelstein – Evercore Partners Thomas Gallagher – Credit Suisse
Operator
Good day and welcome to the American International Group Second Quarter Financial Results Conference Call. Today’s conference is being recorded.
At this time I’d like to turn the call over to Ms. Liz Werner, Head of Investor Relations.
Please go ahead.
Elizabeth A. Werner
Good morning and thank you for joining us on our second quarter 2012 earnings call. Speaking today will be Bob Benmosche, President and CEO, David Herzog, Chief Financial Officer; Peter Hancock, CEO of Chartis; and Jay Wintrob, CEO of SunAmerica Financial Group.
Other members of senior management are also in the room and available for the Q&A period. Before we get started this morning, I’d like to remind you that today’s presentation may contain forward-looking statements which are based on management’s current expectations and are subject to uncertainty and changes in circumstances.
Any forward-looking statements are not guarantees of future performance or events. Actual performance and events may differ possibly materially from such forward-looking statements.
Factors that could cause this include those described in our second quarter 2012 10-Q, on our 2011 10-K and our Form 8-K filed on May 4, 2012, under the management’s discussion and analysis and risk factors. AIG is not under any obligation to expressly disclaim any obligation to update any of our forward-looking statements, whether as a result of new information, future events, or otherwise.
Today’s presentation may contain non-GAAP financial measures. The reconciliation of such measures, to the most comparable GAAP figures is included in our financial supplement, which is available on AIG’s website, www.aig.com With that let me turn the call over to Bob Benmosche.
Robert Benmosche
Thanks Liz and good morning everybody, if we go back to the first quarter of 2011, seems like a long time ago, but that was when we restructured. We talked about we’re going to focus on as the management team fixing the foundation of AIG, our basic businesses and how we run those businesses.
In May of 2011, when we did our first re-IPO of the company, of selling our shares. We talked about aspirational goals that we are going to achieve, as we rebuild that foundation.
And you’ve seen us perform very well for quarters since then. And if you look at this quarter, its no exception.
We had an outstanding quarter across the board with all of our businesses contributing to profits in this quarter. We also saw ML III, basically almost finished, in terms of sell-off of the assets in ML III, so we have significantly derisk the company, this year with ML II and ML III and by the way, we did buy almost $7 billion of ML III assets, which we feel are very good, for this company on the yield basis going forward especially in this low interest-rate environment.
And so when we think about capital management for our company, we think we are actually slightly ahead of our aspirational goals for 2015, with some of the stuff that's already happened. Today we’ve given almost $37 billion back to America, for the aid and support they’ve given to AIG, so we are well on our way to living up to our commitments, to pay back all of the money given to us by the US government, and you’ve seen numbers now there is going to be a very healthy profit as well.
So all of our businesses, as I said have done well. Then David will talk, as well as Peter and Jay, so let them do that.
But on the non-core assets, let me talk a little bit about ILFC and AIA, we will continue to work to take ILFC public, however, the markets have not been very receptive, at this point in time, but we're continuing to match that business very effectively. On an AIA, we have very good performing company out there, and Mark Tucker has done an outstanding job for that business and so we're looking for the right time and the right price to monetize our ownership of AIA.
We have often asked about regulation, we really don't know and when we would be regulated, but we do believe we will be regulated by the Federal Reserve probably, that I think is the most likely candidate and we are putting enormous amount of effort and cost to make sure that we're Fed-ready as the project is called for that oversight. Before I turn it over to David just a comment about capital management, we're looking and making sure that we use that capital for the best performance of our shares for our shareholders.
So, buyback is one of the things we can do with that capital and another is to buy businesses, and you can see in a small way, we did an acquisition of Woodbury Financial Advisors, it enhances our advisor group we have today and build a stronger and bigger platform for us, able to continuing to invest, in businesses that give us growth, but that also allows us to use money for share buyback, but it’s not just for share buyback and doing what’s right for the shareholder. Let me turn it back over to David and he'll pick it up from here.
David Herzog
Thank you, Bob, and good morning everyone. I'm going to start with the discussion of our financial results.
As evidenced from our results for the quarter, it’s been another very busy quarter for AIG, as we continue to execute on the capital management and operating funds. Year-to-date we've repurchased $5 billion in shares and as Bob as mentioned, we remained committed to $25 billion to $30 billion of capital management through 2015.
I’ll discuss liquidity in a bit more detail in a minute. Turning to our financials on slide four, you can see that after-tax operating earnings per share were up 56% to $1.06, which is driven in part by 26% pre-tax insurance operating earnings growth and overall strong non-core asset performance.
Book value per share was $60.58 or $56.07, excluding AOCI was up 4% sequentially. Share buyback contributing $1.30 to this quarter’s book value per share growth.
GAAP earnings per diluted share were $1.33 for the quarter which reflects certain items that are excluded from operating EPS, the primary drivers for that difference in the quarter were $1.3 billion of tax valuation allowance releases or capital loss carry forwards partially offset by an increase in tax reserves of approximately $300 million for legacy tax issues related to foreign tax credits associated with cross border financing transactions, and an increase in legal reserves of approximately $470 million net of tax associated with various legal contingencies. We also have some discrete items in the quarter that lowered our operating tax rate by 3 to 4 points or just under $100 million in taxes.
Slide 5 provides a breakdown of segment operating earnings which reflect strong growth in insurance, operations and Peter will speak to that in just a minute. I know the gains in the direct investment for this quarter were driven primarily by positive fair value adjustments on DIB assets, CVA, and unwind gains.
At the end of the second quarter, the DIB had assets of a little over $37 billion and liabilities of just over $29 billion. I will note that much of the DIBs assets and liabilities were swap, eliminating interest rate and FX, risks in those books and the bulk of the $3.5 billion of net assets in our global capital markets, as reported in our queue can be ascribed to those assets and liabilities associated with DIB.
Slides 6 and 7 highlight our capital structure and liquidity. We remained well capitalized with a debt to total capital ratio of approximately 19%.
During the quarter, the holding company issued a $1.5 billion of senior unsecured notes and ILFC raised a little over $750 million in secured debt. Liquidity remained strong as we have realized close to our target of $4 billion to $5 billion in annual dividends from our operating subsidiaries.
In the second quarter the holding company received a $1.3 billion in dividends from the insurance companies bringing the six month dividends and payments to roughly $4 billion. Slide 8, summarizes Maiden Lane III at the end of the second quarter.
At June 30, ML III liquidation value was $8.2 billion or 11% sequential increase reflecting the Fed successful auction process. There have been 12 Maiden Lane III auctions representing little over $39 billion in par value and there is a little over $6 billion in par value remaining to be liquidated.
Maiden Lane III cash flow since inception paid down another $16 billion in par value. Going forward we would expect continued strong cash flows on our Maiden Lane III related investments.
We participated in the vast majority of the auctions but were selective in our bidding and we are successful in roughly a third of the deals. There was strong demand for these assets as Bob referenced.
We will receive cash as the proceeds of the completed auctions are paid. Through the end July, we received proceeds of $6.1 billion and based on the auctions that have occurred since the end of the quarter, we would expect another almost $2 billion in cash in mid-August.
The ML III assets were part of the DIB at the end of the second quarter. We believe that DIB now has more than $5 billion of liquidity in excess of its needs to meet all of its maturing liabilities even in stress scenarios without having to liquidate DIB assets or rely on additional liquidity from the parent.
Looking ahead to next quarter, given the ML III purchases, a portion of those acquired assets will remain at parent or within the DIB and a portion of those will be in our insurance subsidiaries. The assets acquired from ML III will continue to be accounted for at fair value to earnings.
Slide 9 provides a summary of all the cash received on ML II and ML III along with our purchase activity. Our purchase decisions consider opportunities to improve operating earnings in returns and our capital management.
The ML III purchases were good fit for insurance subsidiaries and the ML III related assets held in the insurance companies will be highly rated as NAIC 1 or 2. So at this time, I’d like to turn it over to Peter, to discuss our progress on Chartis.
Peter?
Peter Hancock
Thanks, David. Good morning, everybody.
I’m going to provide a brief update on Chartis’ second quarter results, which was summarized in the earnings presentation and comment on our progress growing the value of this franchise. AIG’s second quarter property, casualty result highlight our commitment to improve the quality of our portfolio.
We are seeing positive trends as a result of successful execution of our initiatives including an improved accident year loss ratio, growth in products that produce high-risk adjusted returns and advancement of infrastructure improvements that ultimately make us more efficient and provide better customer service. Turning to Slide 10 of the presentation, Chartis reported operating income of $936 million in the second quarter, a 20% increase over the prior year driven by underwriting improvements and lower catastrophe losses, partially offset by an increase in expenses.
Catastrophe losses were $328 million in the quarter largely from storm activity in the United States, Japan, and floods in the UK. While catastrophe losses were higher than expected, we’re comfortable with the result given the general level of cat activity and the extend of our geographic mix of business.
Our combined ratio includes net prior year adverse development of $117 million, which was partially offset by a favorable change in net reserve discount of $94 million. Favorable development from prior year catastrophe losses partially offset this adverse development.
Our reserves are subject to robust internal and external review. In the second quarter, several third party studies using diverse methods confirmed that our reserves are reasonable.
In addition, we continued our ongoing review of the bulk of complex environmental claims supplementing traditional actuarial techniques with case by case forward-looking engineering and litigation analysis, leading to reserve strengthening on a small number of individual claims. The accident year combined ratio excluding catastrophes was 98.3 driven by improvement in the underlying loss ratio of 2.9 points compared to the prior year.
The effective use of data and analytics has improved underwriting decision making and allows us to shift our portfolio towards more profitable products and regions. For example, we’re growing consumer insurance, which represents 40% of total net premiums year-to-date.
We also increased our investment in consumers’ direct marketing business, which is currently operational in 50 countries. We remain focused on international growth in the quarter with 48% of total premiums generated outside of the U.S and Canada, and growth economy nations or emerging markets represent 10% of total premiums.
In commercial insurance, we’re using predictive modeling and analytics to optimize our mix of business and to identify profitable growth opportunities within this customer base. In addition, we are taking corrective underwriting action when returns are projected to be less than our cost of capital over a reasonable time frame.
We continue to see general improvement in pricing, terms and conditions most notably commercial rates in the U.S improved 8%. In Europe, rate improvement was approximately 1% on average, reflecting the macro challenges affecting that region.
While we didn’t characterize the environment of the hard market, it’s certainly improving. Overall, customer retention and new business remains strong and in line with expectations given our business mix and improved risk selection initiatives.
We balanced growth, profitability and risk by understanding customer preferences including the value they attach to our distinctive product offerings. Expense increases offset some of the positive trends in the quarter, which were primarily driven by higher acquisition costs attributable to our business mix shift and higher general operating expenses tied to strategic investments in people and processes.
You should expect to see further loss ratio improvement and a gradual decline in the expense ratio through the end of 2013. Operating income including $1.2 billion in net investment income, a slight improvement compared to the prior year.
This is primarily due to redeployment of excess cash and short-term investments away from our concentration of nontaxable municipal bonds into high yielding corporate and structured securities. This was partially offset by decreases in hedge fund returns.
Slide 11, summarizes the top line. Chartis’ net premiums were down slightly compared to the prior year’s quarter after adjusting for foreign exchange.
The continued restructuring of our loss sensitive business in the U.S. casualty reduced overall premiums by approximately 1%, but it improves capital efficiency.
The remainder of the decrease reflected enhanced risk selection and rate discipline strategies particularly in casualty lines. This was partially offset by increases in higher value lines and growth across the consumer portfolio.
Capital management remained a critical focus for us. As David mentioned, we met our dividend payment commitment to AIG during the second quarter.
Our capital adequacy levels are solid and we maintained strong financial strength ratings that carry a stable outlook with the four major rating agencies. Let me conclude by saying that second quarter results were encouraging as they reaffirm progress against our strategic initiatives.
We will continue to direct capital and resources to optimize risk adjusted profitability were we see opportunities. We remained confident that these strategies will help us achieve our aspirational goals as well as make us the most valued insurance company in the world.
Now, let’s turn over to Jay.
Jay Wintrob
Thanks, Peter, and good morning everybody. Turning over to Slide 12, SunAmerica delivered another solid quarter with $933 million in pre-tax operating income, strong sales across most product lines, positive net flows, and improved base net investment spreads.
As a result of our strong statutory earnings and capital position, SunAmerica distributed over $800 million to AIG this quarter, and for the year, we’ve distributed $2.4 billion to AIG. Our sales trends were perhaps one of the best indicators of the value of our diversified business model.
While we remain disciplined in the fixed annuity market in this low interest rate environment, our increased sales of individual variable annuities and mutual funds drove overall positive net flows. During the second quarter, individual variable annuity sales were $1.3 billion, up 51% year-over-year.
Importantly, sales growth was driven by our new product launched earlier this year, which includes a volatility controlled fund and rider fees linked to changes in the VIX index. Both of which reduce our risk related to market volatility while offering customers an attractive benefit.
Although, we’re seeing robust growth in variable annuities, you should expect us to continue managing risk through product design and redesign and maintaining an effective hedging program. Individual variable annuities with living-benefit guarantees represent 6% of total SunAmerica Financial Group assets under management.
Thus we have the capacity, the distribution reach, the risk controls and financial discipline to capitalize on the growing demand in this market, while certain competitors are pulling back. As expected, fixed annuity sales declined this quarter given the low interest environment, and I’ll discuss the overall impact of low rates in the next couple of slides.
Sales in group retirement products were up 2% year-over-year as rollover deposits have become too slow with the low rate environment. Retail life sales continue to outpace overall life industry sales growth, increasing 3% year-over-year and 14% sequentially, due to our continued focus on expanding distribution.
Mutual fund sales were up significantly contributing to positive net flows for the sixth consecutive quarter at SunAmerica, which again highlights the advantages of our diversified product portfolio. As announced earlier this week, we’re further strengthening our extensive distribution capabilities with the acquisition of Woodbury Financial Services from The Hartford.
This transaction represents the first acquisition for SunAmerica Financial Group in recent years and we expect the transaction to close by the end of 2012. Once the transaction is finalized, Woodbury Financial will become part of our Advisor Group, one of the nation’s largest networks of independent broker-dealers.
Woodbury Financial has approximately 1,400 advisors complement very well Advisor Groups network, which includes more than 4,800 independent financial advisors at SagePoint Financial, Royal Alliance Associates, and FSC Securities Corporation. We are confident that the expansion of our broker-dealer network will provide growth opportunities for SunAmerica, for Advisor Group, and for Woodbury Financial.
On Slide 13, you can see base yields for our major spread business continue to benefit from the cash redeployment in the second half of last year. On a sequential basis, we saw another slight uptick in base yields due to recent investments in structured security.
We’ve been opportunistic with our investments in these securities in order to increase net investment income and offset the impact at the lower interest rate environment. During the quarter, SunAmerica Financial Group invested $1.5 billion in structured securities consisting principally of purchases from Maiden Lane III.
Base net investment spreads for Western National, our leading fixed annuity writer and VALIC, our group retirement business also benefited from active benefited from active crediting rate management. Base net investment spreads were up 45 basis points from a year ago at Western, and at VALIC, they were up 47 basis points.
Crediting rates for Western were down 21 basis points from a year ago, and at VALIC, they were down 31 basis points. We will continue to actively manage spreads for both annuities and universal life products.
Approximately 56% of SunAmerica’s annuity and new VALIC account values are now at minimum guarantees, up from 51% last quarter, and 38% at the end of the second quarter of 2011. Nearly 70% of total annuity in universal life account values have minimum guaranteed credit ratings of 3% or lower.
On Slide 14, we’ve provided additional disclosure on the impact of sustained current low interest rates. There is no change to our outlook for the remainder of this year or next year.
Looking further out to 2014 and 2015, you can see that there is additional pressure on earnings assuming no changes in rates, with no meaningful impact to DAC or statutory capital as expected. Our projections are for a steady decline in base portfolio yields in this scenario and new money yields are between 4% and 5%.
And to give some context, our new money yield in the second quarter with 5.03% in the aggregate. So we continue to manage through the current interest rate environment and expect that we’ll have opportunities to grow profitability through continued focus on product innovation, strong in-force product management and strengthening and growing our distribution footprint.
And with that, I’m going to turn it back over to David to wrap this up?
David Herzog
Thank you, Jay. And before I turn it over to Liz, just a comment or two on Slide 15 for a few highlights of our mortgage guarantee business United Guaranty.
We continue to make good progress in terms of operating earnings, which this quarter were driven by favorable development and continued decline new delinquencies. We also continue to grow our new insurance in-force or new insurance written and I think most importantly, we’ve assisted over 24,000 Americans stay in their homes through modifications and refinancings.
And so that continues to be a focus for the United Guaranty team. So with that, Liz, I’ll turn it back to you for Q&A.
Elizabeth A. Werner
Thank you. Operator, at this time, we’d like to open up the lines for questions.
Operator
(Operator Instructions) And we’ll take our first question from Josh Stirling with Sanford Bernstein.
Josh Stirling – Sanford C. Bernstein & Co., LLC
Hi, good morning. Thank you for taking the call.
So a question for Peter, could you help us better understand some of the actual operating leverage that you guys are pulling on the initiative to improve underwriting discipline and then separately the critical initiatives that you are pursuing in claims? We’ve talked a lot about the mix lever, which I think it makes a lot of sense given the range of profitability in those businesses, but I think what’s less clear for investors is exactly what you are doing, I mean, and how you are reflecting the lives of desk underwriting and client adjusters as you guys mange through process changes and under – a change in your underwriting policy?
Peter Hancock
Well, I think starting on the underwriting side, it’s the process of really exploiting best practices around the world through integration of the best thinking that has grown up in the historically world of separate cultures of the Domestic Broker Group and the Lexington in the U.S. versus AIU internationally.
And so the global management structure that we have for underwriting in commercial was announced when I took the role, but was really rolled out at the level of the underwriting management structure over the course of last summer. So, we're starting to reap the benefits of those consistent global standards, which allocate risk appetite where we are getting best rewarded for the risks that we're taking.
So, that's had a sort of how underwriting authorities are delegated, how technical pricing models are used, where underwriting judgement is allowed to alter the results of technical underwriting models. So, these are work in progress, but I think we made a lot of progress in the last 12 months, which is starting to feed through in the lower loss ratio.
The business mix shift is both a macro point recognizing that long tail causality lines are less attractive in a low interest rate environment then they were in the past. However, as we applied greater and greater understanding using analytical techniques predictive modelling and other methods.
We're finding attractive areas of business mix at a more micro-level that are also coming to fruition. On the claims side, it’s a long investment, which started in ’08 in our global claims initiatives that is starting to be rolled out around the world and giving us some very encouraging improvements in reduced leakage and so in one very tangible example of that in commercial order fleets in the UK we’ve seen loss ratios drop by 10% by exporting best practices.
So we're quite encouraged that the return on investments for using systematic claims management techniques all over the world is going to continue to reap benefits and again this is an area, which lends itself to analytics and predictive modeling especially in the area of fraud control where we have pockets of excellence, but a lot of the world has not fully embraced, state of the art modern fraud control. So, I think that we see some interesting opportunity to further improve that.
Josh Stirling – Sanford C. Bernstein & Co., LLC
Great, thank you. And David, I very much appreciate the expanded disclosures on global capital markets and the direct investment book.
I’m wondering if you could just spend a little more time talking about how the capital balances or at least the excess assets in these businesses, we should think about tying those back to the holding company assets you’ve indicated that you have and I guess the question that ultimately most investors are trying to figure out is if you sort of add up the holding company liquidity risks, liquidity that maybe available on other buckets. If we look forward to 90 days maybe imagine a AIA transaction, markets depending on that.
What are reasonable level of liquidity that will be available when truly accessed to the company would be? Thank you so much.
Unidentified Company Representative
Sure, I’ll comment and if my colleague Brian Schreiber wants to add, he’ll do so. I think we were pretty clear about our view of the excess liquidity in cash and financial resources that were now available that were coming out of the direct investment book, which is why we made the disclosure that we did and we’re trying to give people a better sense of the size and magnitude and the financial resources that stand behind the direct investment book.
Our confidence in those future cash flows in the stress testing that we do in conjunction with our enterprise risk management people to assess how much is truly excess at this time and I think that our disclosure around that is pretty clear. So I think again, we are evaluating from time to time based on market conditions and where we are and we’ve not made any decisions as Bob said, with respect to either ILFC or AIA at this time.
So I think it would be premature to comment on that and speculate about what we may or may not do. Brian anything else on the direct investment book?
Brian Schreiber
Yeah, I think generally a simple way of thinking about is, as David mentioned earlier, we are still standing by our aspirational goals for capital management. And when we did the re-IPO we explained that the sources of available capital will come from non-core assets dispositions, but also from excess capital being generated in the operating company, as well as maintaining leverage at the holding company.
That said, the DIB will run-off overtime, it’s got substantial NAV and a meaningful amount of [pull through] intrinsic and its underlying assets.
Josh Stirling – Sanford C. Bernstein & Co., LLC
That’s great. And just a minor clarification, so the direct investment, the excess estimate are in addition to the $7.3 billion of holding company cash and investments, that you guys have disclosed?
Unidentified Company Representative
We consolidate, again the DIB liquidity is part of sort of overall parent liquidity. So in that number you have the DIB but keep in mind, the number in the queue is as of 630 and since then we’ve received the proceeds from ML III, so if you’re doing sort of a pro forma, you’d need to add that to the parental liquidity balance?
Unidentified Company Representative
Yes, Josh, just to be clear though that the NAV is different from cash. So I just want to make sure you’re clear on that, okay?
Josh Stirling – Sanford C. Bernstein & Co., LLC
Okay, that actually makes a prefect sense. Thank you.
Operator
And now we’ve move to our next question, and that will come Jay Cohen with BofA Merrill Lynch.
Jay A. Cohen – BofA Merrill Lynch
Yes, thank you. I guess a couple of questions.
The first is in the Q you talk about some pressure in the Japanese consumer business. I am wondering can you talk about what’s happening there, and what you’re doing to address that.
Robert Benmosche
Yeah, I am going ask to Jeff Hayman to answer that.
Jeff Hayman
Hi, Jay. So I think the Q commented on both auto and accident and health.
So let’s address them in that order. The auto severity issue that was highlighted really only, it’s in relation to the Fuji Fire and Marine portfolio.
Our legacy if you will, auto portfolio has performed quite well in the quarter. The Fuji Fire and Marine portfolio is reported to us on a quarter lag, so this is actually first quarter months reported in the second quarter.
It has a much wider geographic spread than our historical businesses and there was a lot of bad weather in Japan in the first quarter, the heavy winter weather. And that affected our physical damage and property damage liability severity.
So we look at that as episodic not chronic. On the A&H front, we sell basically two chunks of business.
We have an individual supplement medical type of business and we have a group benefits, combination of that work and 24 hour largely accidental death and dismemberment business. The AD&D business is basically a large loss business.
So a number of the industries were we have good penetration from a group benefits perspective have increased activity as a result of the reconstruction after the Tohoku Catastrophe. So we’ve had to play catch up in terms of rates, we just implemented an 11% rate increase in that portfolio on June 1, renewals are already going out, we’ve already done some rebalancing, remixing of benefits and some other product changes.
There is also a small amount of individual AD&D that we really don’t sell much in the way of new business, but it’s a historical portfolio that the rates are governed by the rating organization in Japan and they’ve just promulgated a 15% rate increase that the industry will have to adopt at some point within the next 12 months. So, we are confident that we can get a handle on those portfolios as well.
Jay A. Cohen – BofA Merrill Lynch
That’s really helpful. Thanks.
And the second question, on the commutation of the insurance, reinsurance treaty, which resulted in a change in the reserve discount are there other internal reinsurance treaties that also can be commuted, is this another source potentially of more reserve discounts to come?
James Bracken
This is James Bracken. We do have internal reinsurance contracts within the organization to enable us to deploy capital effectively.
The contracts that we commuted in the current quarter was one of the few that actually seeded U.S. workers comp business offshore.
And so you shouldn’t expect us to be – to see this type of benefit arising from internal commutations on a go forward basis. This was part of our overall restructuring of internal reinsurance for the organization.
So, we’ve been working through this for a fair long time.
Jay A. Cohen – BofA Merrill Lynch
That’s great. Thanks a lot.
Unidentified Company Representative
Just to put that in a broader context of the simplification of our legal entity structures around the world and the conversion of branches to subsidiaries, especially in Asia, while in Europe, we are converting to a series of branches in Europe, of one central European hub in the UK, and a revision of internal reinsurance and capital maintenance agreement that optimize our capital fundability around the world.
Unidentified Company Representative
Let me be more candid, we did a lot of auditing to make sure that the reserve development and this action were absolutely independent of each other. It would long in the works.
Jay A. Cohen – BofA Merrill Lynch
Got it, thanks for that.
Operator
And now I’ll move to the next question that will come from Adam Klauber with William Blair.
Adam Klauber – William Blair & Company, L.L.C.
Thanks good morning. At the end of July, how much cash and short-term securities do you have at the parent company?
And could you give us some range and how much of that may be used for near-term buybacks?
Unidentified Company Representative
Okay. In the queue parental liquidity is 7.3 billion, that includes the (inaudible) numbers as well, but it also includes some restricted cash at some of our subsidiary.
So parental liquidity, excluding some of the restricted cash of $6.5 billion, then we’ve received roughly $6.1 billion so far and Maiden Lane three proceeds. We expect to get another roughly $1.9 billion by mid-August and spend another roughly $0.5 billion at some point in the future.
So, we do have ample liquidity in the organization and ample capital. We did also buy reasonable amount of the Maiden Lane through securities, which could use some of that liquidity.
So as David mentioned, there was – it seemed to be $5 billion of excess liquidity that could be allocated to other uses of the parent and other than that I don't think we're going to comment anymore on capital management.
Unidentified Analyst
Robert Benmosche
I feel we did pretty well so far. I am going to turn it over to Peter.
Peter Hancock
I think that of this 26 years in New York City, I’m slowly getting, yeah understanding of the metaphor. But yeah, I think that the improvement in underwriting methods, I see is a perpetual striving for improvement but with some low hanging fruits that's more front loaded and I think that some of that’s visible to you and some of it’s going to be much more difficult to see.
The most visible evidence of that is the reduction in topline over the last four quarters as we changed the way we looked at the loss sensitive business which is over $1 billion in premium that produced negative risk-adjusted profitability, the way it was configured. The customers weren’t different to us providing the same service for a fee, so that's just a very visible evidence of a change in mindset, where we're focused on value for our customers, not so much, the appearance of volume in the topline net premium written number.
We do see growth in that value as our focus is around growing profitable lines. And that starts out at macro business mix shifts, which we talked about that increasing micro ones and the more micros, the more complex and the longer it will take.
But I think that’s just natural competition. So, I think that we’ve turned the corner in the most visible evidence of change in approach to underwriting.
We have a full year underwriting cycle under our belt and so, I think trends as they emerge from here on out will be more representative of our progress.
Unidentified Company Representative
Let me give you a simple example. We’ve been talking about using information and we talked about, we repaid in the last 10.5 years, 27 million worker comp claims.
We never did analytics on it. Peter, his team, the actuarial team are now working with Johns Hopkins University to study 27 million claims record.
What’s an example of things we’re now learning that if you injure your shoulder at the workplace and go to the emergency room, and they – because it’s painful, they put your arm in a sling, it will generally cause us an additional 50,000 because generally that will cause your shoulder to lock up. And so we’re now thinking about how do we use that information to go out and tell hospitals how AIG feels, you need to deal with this kind of injury to prevent it from getting worse.
That’s a huge insight. It allows us to market the company to the medical community that we’re doing things, that will help them heal their patients better.
It also helps us deal with our claws, so that’s just one example of many, many, many years. We go through this database and begin to use information we’ve never used before, so as you ask what inning it is, I don’t know, but all I could say is we are going to have a good inning in the first, in the second, in the third, in the fourth because this data will continually rollout and give us an enormous competitive advantage over the next four, five years.
Adam Klauber – William Blair & Company, L.L.C.
Great. Thank you very much.
Operator
And the next question will come from Josh Shanker with Deutsche Bank.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Yes, good morning. Some items that were below the line, if wondering if you can kind of walk through why we don’t have to fear more litigation expenses in the future and talk a little bit of legacy FIN 48 issues?
David Herzog
Sure, Josh. Good morning.
Thanks. It’s David.
So let’s take them one at a time. So the three big items with the valuation allowance release, we put some disclosure in our Q around I’ll say, why now and why that number.
So we’ve been very active in developing prudent and feasible tax planning strategies and transactions and we now believe we have met the standard to now project forward the benefits of those, so that’s that. So we’ve made our estimate of what that is and so you can put that – that’s what, that’s the number and we feel good about the trajectory in the path to that.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
On the DTA, you’re saying?
David Herzog
Yeah, on the DTA.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Okay, okay.
David Herzog
That’s the valuation allowance on the capital loss carryforward. That was $1.3 billion benefit.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Yeah, yeah, more of the FIN 48 doesn’t offset I guess or something…?
David Herzog
Yeah, so the next item was the FIN 48 related to the foreign tax credits associated with some cross-border financing transactions. And what I would tell you is that a couple of things, one, we absorbed a piece of litigation not related to AIG, but it was a market event and we’ve researched that, understood that and then evaluated our entire portfolio of related transactions and made our best estimate of what the potential exposure is on those and we made our adjustment accordingly.
I would never tell you that that there never will be another, but we made our best estimate based on looking at the entire portfolio, based on facts and circumstances as we know. So again, we looked at the whole portfolio.
And then I think you had a question on…
Joshua D. Shanke – Deutsche Bank Securities, Inc.
$719 million of litigation expense.
David Herzog
Yeah, and on the litigation, the only thing I would say, our disclosure speaks for itself and we made our best estimate on what the exposure is and I wouldn’t comment any further than that. Again, I’d point you to our disclosure and I wouldn’t go any further than that.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
There is no color in the disclosure. So is it a general – is it one specific piece of litigation?
David Herzog
I’m not going to comment any further than what our disclosure says, Josh, I’d appreciate that.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Okay. And then for Jay, how confident are you that you can fully hedge-out the equity risk on the variable annuity sales that you are doing.
Jay Wintrob
I think we are very confident in the way we structured our VA hedge program, if you are referring to the equity risk exclusively…
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Yes.
Jay Wintrob
Yeah, I think that we are very confident, I think that the market is deep with the contracts we use to hedge that out and we’ve said in the disclosure that we basically are market neutral in terms of the equity markets, and then we’ve commented separately on our approach to interest rate hedging try and do a balance both the economic interest, the statutory capital interest and the GAAP reporting interest.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Is there a certain amount of growth that could occur or you would find it difficult to continue to hedge of the equity risk?
Jay Wintrob
I think the answer is no, at this point, I think the market there is quite deep on that, some would continue to accept that reevaluated, but I think from where we are now essentially the answer is no.
Joshua D. Shanke – Deutsche Bank Securities, Inc.
Well thank you very much.
Operator
And now we’ll move to our next question that will come from Michael Nannizzi with Goldman Sachs.
Michael Nannizzi – Goldman Sachs & Co.
Thanks. Just going back to the kind of the cash and cash offer segment, how much of the $7.1 billion in ML III purchases came from the $6 billion that you got in July, sounds like a $1.5 billion within SunAmerica, just trying to understand, is the rest from that or did they come earlier in the year and then just one follow-up.
Thanks.
Robert Benmosche
Well through June, there were roughly $500 million I think purchases so most came subsequent to that again I don’t think…
Unidentified Company Representative
I did in fact mentioned that we did about $400 million of first tranche of the (inaudible). $600 million.
David Herzog
Yeah and again some of the purchases were done at parent some of purchases were done directly into the insurance companies and we haven’t disclosed any additional details on that so I that’s where we’ll leave it.
Michael Nannizzi – Goldman Sachs & Co.
And then just how understand like how do you think about the decision to deploy into these assets versus to hold further uses and just trying to understand kind of, what are the kind of trade-offs in that you think about – that you thought about in terms of choosing to buying those assets?
William Dooley
Yeah, hi, this is Bill Dooley. This is just part of our normal evaluation on our strategic asset allocation and where do we want to put both the free cash flow of the insurance companies and the reinvestment of the maturities within the insurance companies.
And you look at the overall interest rate environment, which everyone seems to be concerned about. And these assets fits our risk profile very well, it fits our duration on the book very well and we allocate these type of assets between the life businesses and the property casualty business and with the blend of our – what I would say core investment with the additional yields that we make on these asset classes, it gives us, I think a very acceptable return on our overall investment policies.
Michael Nannizzi – Goldman Sachs & Co.
So $1.5 billion was in SunAmerica, a chunk happened, and do we know how much happened in Chartis?
William Dooley
No, we don’t know. I don’t have that number in front of me right now.
Michael Nannizzi – Goldman Sachs & Co.
Okay, great. Thank you.
Operator
Next question will come from Mark Finkelstein with Evercore Partners.
Mark Finkelstein – Evercore Partners
Good morning. I guess a point of clarification on the disclosure around the derive assets and liabilities, just a confirmation, of the $39 billion of assets that you disclosed, roughly $8 billion of that relates to Maiden Lane III is that correct?
Unidentified Company Representative
That’s correct.
Mark Finkelstein – Evercore Partners
Okay. And I guess just how much capital do you think needs to manage that book or to support that book?
Unidentified Company Representative
We don’t look at a single measure of capital, we look at NAV in an absolute basis, we look at economic capital, which is again available capital versus required capital under various stress scenarios and we also look at cash flow sufficiency of our assets to cover our maturing liabilities. And we look at that under stress as well.
So, it’s not just one approach or methodology that we use. And I think as David said, based on that analysis we have made a decision to reallocate some of the capital within (inaudible).
So that gives you a sense that we believe there was excess capital and excess liquidity. In addition, the portfolio isn’t wind down.
The assets and liabilities are matched up quite well and then again over time, we would expect to realize the freeing up of the NAV, as well as the additional capital created from the pull through intrinsic of the assets.
Mark Finkelstein – Evercore Partners
Okay. On SunAmerica, you sold about $9 billion of assets to harvest gains, you released $1.3 billion or so to capital loss carry forwards.
Can you just expand upon the strategy of harvesting gains going forward, you did talk a little bit about that in the queue. And I guess what I’m interested in is how much more should we be expecting and how do you expect these assets to be redeployed?
David Herzog
This is David. I’ll touch on the expectation of the strategy and then Bill can talk about redeployment.
We evaluated the totality of again the prudent and feasible strategies and transactions, including a capital gain harvesting. So that was incorporated into our overall assessment for the quarter.
We have again, various transactions that have as a consequence tax outcomes and then we’ve identified certain portfolios where capital gain harvesting is an appropriate step to take, again, balancing the need for maintaining our capital sufficiency, statutory reserves, cash flow testing, maintaining margin and operating earnings. So we’re not again, not looking at any one individual measure, but trying to balance the need for operating earnings with the need to realize the benefits of the capital loss carryforward.
I would say that the amount of expected realization is in line with what I had commented earlier even going far – in fact as far as when we run the initial offering back in May 2011. So it’s consistent with that, we’re executing in line with that – with those expectations.
So Bill, do you want to talk about the redeployment?
William Dooley
Sure. I guess my first comment is that in just the normal course of business on managing these portfolios, we take gains from time to time and we continue to take gains from time to time, as we take different views on different credits within the overall portfolio.
So that was number one. Number two, if you look over the portfolio over the last 18 months or so, with the redeployment of the cash that builds up over that period of time, the portfolio has undergone a lot of changes to its asset classes and things like that.
And at the same time, it allowed us to take some of these gains that maybe in the past, we would have it during this period of time. The other aspect of the thing two is that we took this opportunity to rebalance the duration of the portfolio’s.
So, right now particularly in SunAmerica portfolios we feel that the assets are reflective of the proper duration against the liabilities and I think that’s also very important given the interest rate environment that we’ve find ourselves in and we could be looking at in the near term as well.
Unidentified Company Representative
And I just want remain everybody, we did talk about [cycle ending] and we’ve gone through a whole approach to our liquidity management here and what are the most effective ways to do that and as part of that liquidity management we determine that we could do some securities lending and that as a consequence of that at securities lending it would create capital gains and so that’s another form of harvesting capital gains, which is part of that liquidity program that we probably wouldn’t take that approach if we couldn’t cover some of the costs of those capital gains, but that’s covered now. So, it made sense to take that approach to how we handle our liquidity.
So that’s another thing that’s allowing us to get there without actually selling securities and losing the yield.
Mark Finkelstein – Evercore Partners
Okay, Alright thank you.
Operator
And now we’ll take a question from Thomas Gallagher, Credit Suisse.
Thomas Gallagher – Credit Suisse
Unidentified Company Representative
I don’t think there is any concern we have about the businesses we have and so on. We are discussing internally the effects the Volcker Rule could have on us and so there is little concern there.
We’re thinking about that if we – and we are giving thoughts to whether we should now close the bank we have, thus we’re concerned about that aspect of it, and then insurance company invest very differently than a bank would. But aside from that issue, this is really about making sure we have really good process, and good controls especially in the risk management arena, very good controls around how we determine we can handle a bump in the night that happened in ’08 for example.
And so that’s the SECORP process that we go through. And we’re doing it in the same discipline, then look a lot of us were frustrated with the SOX or so on.
It was lot of formal receptions, but the process itself made sure companies really thought through the controls they need to have to make sure that they issue numbers that are correct. And so we see this as an enhancement to that process.
And so it’s really about process policies and making sure we have really good controls over some of the assumptions around our liquidity and so on. So that’s really the major changes, it is just how we do things.
Thomas Gallagher – Credit Suisse
Got it. And you wouldn’t see necessarily an asset allocation change within the portfolio and in particular, now you read some of the NPRs that have been put out by the Fed.
And again a lot of this for – as it relates to you guys is probably still someone uncertain, but when I look at like RWA charges just for things like alternatives, it seems very high. So just curious from a height level whether there would be a change for you?
Unidentified Company Representative
We have the NAIC, they do a very effective job in the US, you have the FSAs around the world and so on. All of them have their capital charges at the insurance companies prior to maintain RBCs and so on.
So the insurance companies in my opinion are already there and I think that we don’t know, because we don’t know, what we don’t know, from my sense is that that’s not going be an issue. The real question becomes the amount of money that we hold at the holding company above all of the regulated entities and to the extent that we own these regulated entities what requirements the Fed may have.
And for example at AIG, we have as you know the capital maintenance agreements, which says that we can contribute back into the insurance companies if RBCs fall. We got to make sure that money is actually there and it’s available if in fact there is a crisis at insurance company.
And so having the Fed regulate that money and making sure that when we have a liquidity plan, we have one, that’s reassuring for the insurance regulators that are looking at AIG’s ability to live up to its commitments. So in a way we see that is a big positive.
Thomas Gallagher – Credit Suisse
Okay. That’s helpful.
And then just last question. Just a question, in the Q it references on the DIB that excluding the mark-to-market adjustments, there was a negative spread.
I think that’s just because ML III has its own entity on a segment reporting basis, and right now technically it’s in the DIB, but as we think about selling off or using potential proceeds from ML III for something else, how should we think about the earnings power of the DIB assuming there is a drawdown of assets – from use of assets from Maiden Lane III?
Jay Wintrob
Yeah, I think, it’s a good question. I think you are right.
The spread number does not include Maiden Lane III, but what it also does and include is a – the most significant source of earnings going forward in DIB is the pull to intrinsic of the underlying assets. So to the extent there are assets going out of the DIB, the remaining assets will, as we said, we will be sufficient to meet maturities and you’ll see the pull to intrinsic coming through over time.
And excess liquidity, to the extent it exists within the DIB, could be used to make further attractive investments or to retire debt. So as the DIB winds down, you’ll see more and more of that kind of activity.
Thomas Gallagher – Credit Suisse
So, in other words, there is a lot of assets within the DIB that have an element of below par that you would expect to get to par over time?
Brian Schreiber
It maybe not par but to intrinsic but they are trading at deep discounts to what we believe intrinsic value.
Thomas Gallagher – Credit Suisse
Understood, thanks.
Elizabeth A. Werner
Thank you everyone. Operator, at this time, I think we are going to have to take off the remaining questions off-line.
So please don't hesitate to give us a call if you are in queue. And thank you again for joining us for our second quarter earnings call.
Operator
And ladies and gentlemen, with that, that will conclude your conference for today. We do thank you for your participation.
Have a wonderful day.