AIG Is the Right Post-Sandy Play

TheStreet.com

NEW YORK (TheStreet) -- When I was just starting out as a business reporter, in the late 1970s, my best friend was in the insurance business.

He was hugely entertained by it, and entertained me in turn. His job was to put together "excess and overage" packages for Houston's riskiest businesses -- construction companies, pipeline constructors and oil refiners.

His sense of humor was macabre -- workers falling out of trucks, getting blown up due to their own negligence -- but at the end of the day what was really crazy were the prices he was able to get from the market for his risks.

A policy worth $100 million might be sliced and diced several ways, with different players taking different levels of coverage. So when my friend reached the top slices, from $50 million on up, the customers were getting odds of better than 100 to 1. It made sense since the odds of something going really, drastically wrong was low, and if there was no claim the money stayed with the insurer.

It's a gamble, and insurers are bookies. They're betting you won't die, your car won't crash or your refinery won't blow up during a specific period of time. If you win, they pay, but if they win they keep your money. While the bet is on they hold the money, and can do with it what they wish.


What I learned from this is that disaster is great for insurers. And so it has been in the case of Sandy. Your best play since the storm struck last October has been American International Group .

Since the super-storm hit of October 2013 AIG stock is up 25%. It fell in the weeks right after the storm, and from those mid-November lows it's up nearly 50%.

How can this be?

Two things happen in the wake of a catastrophic event. Everyone rushes to buy insurance, and insurers raise rates. Higher rates are necessary because capital is scared away by big payouts. They see the risk, they lost their money. People are also frightened about what might happen "next time," and rush to increase their coverage if they can.

That's why, in the wake of every disaster, you'll always see commercials with agents staying up to all hours finding customers and handing out checks. This is when the agents find their jobs fulfilling, it's when customers see the value in coverage and it's when price hikes are pretty easy to get.

Insurance is all about the odds, as my friend explained to me 35 years ago. What got AIG into trouble had nothing to do with the insurance markets, but what AIG chose to do with its money, which was to guarantee things such as Credit Default Obligations, CDOs, that were, in fact, guaranteed to blow up. The company lost its collective head and paid the price.


AIG shareholders paid the most fearsome price. Most were wiped out by the crash. The company's current price of about $45/share is misleading. It reflects the 1-20 reverse stock split of July 2009. An equivalent shareholding of AIG from mid-2007 was worth almost $1,500. At its current price AIG is, as they say, "cheap as chips."

Sandy represents a more normal turn of business. Loss ratios across AIG's property businesses are getting better, according to its most recent quarterly earnings statement.

You can measure risk, you can balance this against rates, and when nothing bad happens you get to keep the money. Even if you don't get to keep the money, you get to invest it while you have it. The odds are always with the house.

Insurance is a great business, and I'm reminded of that again every time disaster strikes.

At the time of publication, the author was long AIG.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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