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American International Group (AIG) Q4 2018 Earnings Conference Call Transcript

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American International Group (NYSE: AIG)
Q4 2018 Earnings Conference Call
Feb. 14, 2019 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator 

Good day, and welcome to AIG's fourth-quarter 2018 results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Liz Werner, head of the -- investor relations.

Please go ahead, ma'am.

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Liz Werner -- Head of Investor Relations

Thank you, and good morning, everyone. Before we get started, 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 the factors described in our first, second and third-quarter 2018 Form 10-Q and our 2017 Form 10-K under Management's Discussion and Analysis of Financial Condition and the Results -- and Results of Operations and under Risk Factors. AIG is not under any obligation and expressly disclaims any obligation to update any 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 the slides for today's presentation and in our financial supplement, which are both available on our website.

This morning, you'll have the opportunity to hear from members of senior management, including CEO Brian Duperreault, CFO Mark Lyons, the CEO of General Insurance Peter Zaffino, and the CEO of Life and Retirement Kevin Hogan. Joining us in the room are others in senior management, including our Chief Investment Officer Doug Dachille. [Operator instructions] Thank you. And with that, I'd like to turn over it to Brian.

Brian Duperreault -- Chief Executive Officer

Good morning, and thank you for joining us today. In addition to reviewing our 2018 fourth-quarter and full-year financial results, I plan to spend a part of my remarks reflecting on my first full year as CEO of AIG. Throughout 2018, we uncovered many issues and challenges and took actions on a number of fronts to lay the foundation for long-term, sustainable and profitable growth. We reorganized and repositioned our businesses, significantly reducing risk and volatility; recruited industry-leading talent; and fostered a culture of underwriting excellence and accountability.

The problems at AIG were deeper and more pervasive than I originally anticipated, but we have put the right people and the right strategies in place that will allow us to accelerate our progress in 2019. As Mark will discuss in more detail, our fourth-quarter results were significantly impacted by a decrease in net investment income due to volatility in both equity and credit markets, particularly in the latter part of December, which impacted the operating results across our businesses. Our results were also impacted by CATs. However, these losses came within our previously disclosed range.

In addition, we reported $365 million of unfavorable prior-year loss reserve development, driven mostly by underwriting decisions from 2016 and prior years. We are pleased that the fourth quarter also showed positive improvements in general insurance, reflecting actions we took in 2018 that demonstrate that we are on the right path to restoring this business to profitability. For example, the accident year combined ratio ex-CATs for the fourth quarter was 98.8%, a 140 basis point improvement over the fourth quarter of 2017, largely driven by an improved loss ratio of 63.9%. The expense ratio of 34.9% was 90 basis points better than the third quarter of 2018, and we continue to work on reducing our overall expense base.

The foundational work we did over the course of 2018, particularly in general insurance, has positioned us well for the future, and we are reaffirming the guidance we gave in mid-December, including achieving a double-digit ROE, excluding AOCI and DTA, in the next three years; as well as the combined ratio, including AALs in general insurance, below 100 in 2019. To be clear, a combined ratio of below 100 is an inflection point. It is by no means where we expect to be longer term, but crossing over into profitability for the first time in over a decade is an important milestone we will achieve in repositioning AIG for the future. Now I want to step back to when I joined AIG in mid-2017.

One of the first things I did was suspend guidance. I know that made it difficult for all of you to recalibrate your models and predict our earnings, but I had to do it because I knew I needed time to get a handle on the issues at the company before I could speak confidently about its future performance. So let me give you some insight into what I learned, and more importantly, what we've been doing about it -- about what we discovered. I knew coming into the job that the organizational structure of the company and the split between commercial and Consumer was different from our peers.

In September 2017, I announced the reorganization of our business units to create general insurance and life and retirement and made investments a separate business unit. I also restored greater accountability within the leadership team for business performance. It was also clear to me that AIG experienced a major talent drain dating back to the financial crises, but more acutely in recent years. I knew I needed to bring in the best people in the industry to help me fully understand the extent of the company's issues and fix them.

Shortly after my arrival, I added several new members to my leadership team, including my first hire, Peter Zaffino, who joined as AIG's global chief operating officer, and later in 2017, also took on the additional role of CEO of the newly constituted general insurance business unit. The caliber of people who joined AIG over the last 18 months has been a significant highlight and exceeded my expectations. The combination of AIG's iconic status, coupled with the professional and intellectual challenge this turnaround provides is a compelling proposition. And I am incredibly pleased that so many wanted to be part of it.

And great talent attracts more great talent. We continue to fill key positions with a combination of elevating internal talent and recruiting new hires, all of whom have proven track records of success and are committed to our mission and are energized by what the future holds for AIG. I also needed to make sure our people were focused on the right issues. By the fall of 2017, we shifted the company's focus from principally capital management back to insurance fundamentals.

This shift in focus allowed us to concentrate on uncovering the underlying issues in our core insurance operations that have contributed to the unpredictably and volatility in AIG's financial results. Our main priority in 2018 was to return general insurance to profitability as soon as possible and restore its position as an industry leader. We knew that any remediation efforts would need to be concentrated on critical foundational elements of insurance. When Tom Bolt arrived on January 2018, Tom and Peter moved quickly to overhaul our risk appetite and redesign our underwriting philosophy.

Not only have we made significant progress in that regard, but the discipline now being applied through revised underwriting guidelines for every underwriter in the world, along with new assessment tools, allows us to better measure our underwriting performance. In addition, our limit management, coupled with improved underwriting discipline, has helped us overhaul our reinsurance program, which had been deemphasized. The support we are receiving from broker and reinsurance partners and feedback regarding the changes we are making to our underwriting standards provides independent validation and endorsement of the actions we are taking and the strategy that we have laid out for the future. As additional industry veterans stepped into key positions and focused on fixing the fundamentals, we discovered issues and unintended consequences of prior strategies, particularly as a result of what was referred to as the go-large strategy.

This approach to the market created outsized risk and volatility for AIG. By expanding its risk appetite to encompass very large limits on a gross and net basis, AIG added significant risk to its earnings pattern and balance sheet. Additionally, certain of these issues were exacerbated by risks being written on a multi-year basis and record CAT losses and $30 billion of stock buybacks which reduced AIG's capital, making the outsized limits more risky. Another example of an unexpected trouble area that started to emerge in early 2018 but really manifested itself in the second half of the year is personal Insurance, particularly our Private Client Group, PCG.

Problem areas that were discovered included geographic zones with disproportionately large and dense accumulations of total insured values in CAT-prone areas and inadequate pricing of the book. As these and other issues in PCG emerged, we quickly began to reposition the portfolio as well as reduce risk and volatility. In 2019, we will continue to work to reduce aggregate exposures and right-size risks in this business, but it'll take some time to fully execute on our ongoing remediation plan. We also brought focus and clarity of mission to various businesses, such as Agram and Lexington, again adding world-class talent and leadership positions.

I could go on at length with other examples because, with very few exceptions, almost every business suffered from underperformance. And while I had some understanding of the go-large strategy before I arrived at AIG, I had not appreciated the extent of the issues it created or that had been deployed throughout the company. The prior strategies, coupled with the loss of underwriting discipline, helps to explain the magnitude of the PYD recorded over the last few years. I do want to emphasize that our team has been digging into every aspect of general insurance, and it has made significant progress on transforming the business.

Peter is going to give you more detail on what we accomplished in general insurance in year one. What you will see is both impressive, and more importantly, sustainable. While I spent most of the past few quarters speaking about general insurance, I have also been focused on our life and retirement business. life and retirement has been stable, considering almost five years of a low rate environment, combined with uncertainty related to rule-making on best interest and suitability standards.

It has delivered consistent low to middle double-digit ROE, including in 2018. However, like the rest of AIG, this business suffered from inadequate investment in developing technologies, which is critical for a business expected to deliver a high standard of care. Kevin will go into more detail about the actions we are taking in this business. We've also made progress in Legacy by moving most of our runoff portfolios into a new entity, Fortitude Re, freeing up management to concentrate on our in-force business.

We continue to receive a significant amount of investor interest in this business since we announced the sale of a minority interest at Carlyle and are focused on fully deconsolidating this business while ensuring we meet our commitments to our policyholders and regulators. In 2018, we also completed acquisitions, including Validus and Glatfelter, which deepened our talent bench, and will help to accelerate improvements in our core underwriting fundamentals. In addition, we repurchased $1.8 billion of shares and warrants over the course of the year, including $750 million in the fourth quarter. We also announced last night that AIG's board of directors has approved an increase in our share repurchase authorization to $2 billion, including the $512 million that was remaining under the previous authorization.

I have done turnaround work throughout my career and remain committed to completing this one. As I said earlier, I am more confident today than I was a year ago that AIG is on the right path. We continue to focus on making sustainable changes that will yield long-term profitable results, which means we are not taking shortcuts or settling on easy fixes. Instead, we are doing this the right way.

We have the best talent in the insurance industry at AIG, we have the right strategies in place, and we will restore AIG as a leading insurance company in the world. I'll now turn the call over to Mark, who will then be followed by Peter and Kevin.

Mark Lyons -- Chief Financial Officer

Thank you, Brian, and good morning, all. This morning, I plan to go over the key financial impacts for the quarter as well as an actuarial discussion around prior-year loss reserve development. I'll begin with some of the largest, or in some cases, most notable financial impacts incurred, namely investment in Legacy, then turn to general insurance and life and retirement. Despite volatile financial markets and their impact on investment returns, and by consequence, business segment results, there are clear green shoots that bode well for the future, and I will highlight them as well.

Turning to Slide 4. On December 5, AIG provided some guidance at the Goldman Sachs conference in New York, and I'll now provide some color on the actual variances from that guidance. Consensus fourth-quarter adjusted after-tax earnings per share was $0.42 post the Goldman conference, whereas AIG reported a $0.63 per share adjusted after-tax loss, representing $1.05 variance. All per share variances commences -- comments that I will make will be utilizing the consensus tax rate of 25.4%.

This permits each variance discussed to be a pure impact without any tax interactions. Instead, I will isolate the pure tax impact from consensus separately later in these comments. So the major items comprising the $1.05 per share variance are as follows. First, a $0.38 per share difference associated with capital markets volatility.

And by this, we mean net investment income differences for general insurance and Legacy, and differences above credited interest for life and retirement, along with policyholder and advisor fee reduction, net of associated offsets like that in advisory fee expenses. Included within this is an $86 million pre-tax impact or a $0.07 per share after-tax impact associated with hedge fund and Japanese equity marks usually recorded on a one-month lag that were recognized in the fourth quarter due to materiality. Secondly, since the loss reserve reviews at the time of the Goldman conference were still under way, it was December 5, we gave no explicit guidance other than to indicate that we preliminarily saw no major issues at that time. Having said that, the consensus estimate of prior-year reserve development seemed to only reflect the amortization associated with the adverse volatile cover.

As we will explore in more depth later in my comments, AIG reported $365 million of pre-tax net unfavorable development, so the variance from post-guidance consensus was $26 per share. Thirdly, and fourthly, Legacy represents a $0.17 per share variance, and general insurance's accident year underwriting income represented an $0.08 per share variance, both of which we will delve into during these remarks. Now the pure tax difference between consensus and actual represents $0.05 per share. Therefore, the remaining $0.11 per share is a combination of corporate operations and miscellaneous items.

Now shifting gears to Slide 5 into investment results. As you are all aware and Brian mentioned, the fourth quarter saw significant volatility of both equity and credit markets. Consequently, net investment income for the quarter across all segments on an adjusted pre-tax income basis was $2.8 billion, compared to $3.4 billion in the fourth quarter of last year and $3.4 billion sequentially in the third quarter of 2018. This net investment income pre-tax reduction of $600 million was driven by an approximate $300 million decline in the quarter from hedge funds and roughly $120 million recorded decline in equities, acknowledging that some of the hedge fund declines stems from targeted reductions.

These reductions were partially offset by positive recurrence, primarily in private equity, and were aided by, in a ballast sense, a relatively flat level of interest income from non-FA or fixed income securities. With respect to hedge funds, this has been a profitable asset class historically, and this quarter was the first loss since the first quarter of 2016. The biggest financial recognition from the widening credit spreads, however, was reflected in equity as approximately $1.1 billion of unrealized pre-tax OCI losses, relative to a fixed income carrying value of about $230 billion. As for the impacts on segment reporting, due to differing asset composition, the impact was not felt proportionally across the various segments, with general insurance and Legacy taking the brunt of the market downturn impact.

general insurance net investment income, for example, declined for $510 million relative to the fourth quarter of 2017. Moving on to Legacy on Slide 6. The fourth-quarter adjusted pre-tax income loss of $150 million was driven by $105 million pre-tax charge or $0.13 a share after tax resulting from loss recognition testing on certain A&H cancer and disability blocks within the legacy life and retirement subset or runoff line, with an $83 million sequential decline of net investment income primarily due to hedge fund declines relative to sequentially last quarter. Our general insurance component on the Legacy runoff was also negatively affected by an increase to unearned premium reserves related to the earnings pattern of certain environmental and cost-containment policies amounting to roughly $50 million pre-tax, which will earn through in future periods.

Turning to general insurance on Slide 7. The accident quarter combined ratio ex-CATs for the fourth quarter of 2018 was 98.8%, which represents 140 basis point improvement over the corresponding quarter of 2017, virtually all driven by an improved loss ratio of 63.9% that Brian also mentioned. The expense ratio of 34.9% is 10 basis points lower than the fourth quarter of 2017 and 90 points better sequentially. Expense ratio reduction was a key objective that management previously identified, and the material progress made on this objective is worth commenting on further.

Moving to Slide 8. There has been a 260 basis point improvement in the GOE component of the expense ratio, moving from 15.1% in the fourth quarter of 2017 down to 12.5% in the fourth quarter of 2018. On an apples-to-apples basis, excluding Validus and Glatfelter, who were acquired during the year, the dollar reduction is nearly 16% or $152 million. Although net earned premiums increased approximately 4%, the GOE ratio would have reduced 240 basis points even if the premiums were flat relative to the fourth quarter of 2017.

Before moving on to the acquisition ratio component of the expense ratio, it's important to note that the GOE ratio improvement emanates from all areas of the general insurance operation, including North America and International, commercial and personal line. And furthermore, it declined even with the broad amount of talent brought into the organization throughout 2018. Now the acquisition ratio had a nearly offsetting quarter-over-quarter increase of 250 basis points, driven primarily by a few high acquisition ratio transactions within our personal line travel unit, mostly domestically. The travel transactions come with a lower loss ratio expectation, which has contributed to the 130 basis point reduced accident quarter loss ratio referred to earlier.

The loss ratio also improved due to a materially better international commercial loss ratio quarter-over-quarter of about 1,500 basis points. Now this segment represents about 25% of the worldwide general insurance net earned premiums, so its influence is material. The fourth quarter of last year reflected severe loss activity, but even adjusting for this, the international commercial accident quarter loss ratio, excluding CATs, still improved materially quarter-over-quarter. Lastly, there has been a lot of focus on 2018's catastrophe losses this year, largely within our various personal lines operations that masks the improvement made within the North American commercial segment, which historically has been a recurrent pain point.

The North America commercial accident quarter combined ratios ex-CATs for the last two quarters have been 99% and 102.2%, respectively. On an absolute basis, they need to improve, but the underwriting action and reinsurance protection implemented during 2018 are expected to reduce them further going forward. Most importantly, these commercial -- these North American commercial accident quarter ex-CAT loss ratios are materially lower when compared to those in the first half of 2018, largely due to the decreasing influence of the prior management's go-large underwriting approach, which produced significant quarterly volatility. That influence has been decreasing but is not quite yet fully implemented due to multi-year policies that were bound in 2017 and prior in conjunction with those large loads.

Now turning to catastrophe losses for the quarter. The company recorded $798 million, including Legacy, for the quarter, which is in line with the guidance previously provided. general insurance recorded $826 million of 2018 event catastrophic losses split as follows: $520 million into North America, $116 million internationally and $190 million from Validus. Hurricane Michael remains within the guidance range previously provided.

And together with the California Woolsey wildfire event, constitutes the vast majority of the quarter's CAT losses. Severe losses for the quarter at 1.3% of net earned premium represents the lowest severe ratio quarter of 2018, and further evidences the continuing favorable impact of underwriting and reinsurance actions that have taken place to reduce limits employed within our various worldwide property and energy areas. Now moving on to Slide 9. The fourth-quarter reserve review focused primarily on the remaining 25% of reserves not yet examined through the third quarter.

These areas were U.S. financial lines, workers' compensation buffer excess policies, International casualty and financial lines other than the U.K. and Europe and personal lines exposures. Net prior-year development, ignoring associated premium adjustments, was unfavorable by $365 million for the quarter, which improved Legacy in this discussion for $0.31 per share after tax.

Unpacking that for you and referencing Slide 10. The PYD was unfavorable by $445 million on a pre-ADC basis, $422 million on a post-ADC basis and $365 million recorded earlier, which is net of $57 million of ADC amortization. On a pre-ADC basis, U.S. Financial Lines accounted for $362 million of net unfavorable development emanating from our primarily D&O facilities; employment practice liability insurance, mostly in the private not-for-profit segment; and excess D&O.

This was partially offset by $60 million of favorable development emanating from various professional E&O exposures. International financial lines also experienced some unfavorable development of $87 million, but this emanated from independent large claims from various countries around the globe. Therefore, as you can see, worldwide Financial Lines accounted for $389 million of unfavorable development, which really means that all -- the balance of the other lines had a combined unfavorable development of only $55 million, most of which stem from an overall ULAE reserve strengthening adjustment. Now I want to address the key difference as I see it between this prior-year development and the current accident year.

The reserve strengthening in U.S. Financial Lines centered primarily in the 2016 and 2017 accident years, which are not subject to the ADC, as can be evidenced by the small $23 million ADC recovery this quarter. More importantly, the issues in these years stem from an influx of security-class action claims, mostly impacting our primary D&O operations in those same two accident years. The frequency of these claims reduced in our books from 2016 to 2017 and more dramatically so from 2017 to 2018, reflecting a concerted underwriting effort to reduce writing primary IPOs and primary life science and healthcare risks along with an approximate one-third reduction in total gross limits across various primary D&O units.

Additionally, in the private D&O sector, bankruptcies also fell off dramatically from 2016 through 2018. As a result of these actions and observations, I view the issues as being largely limited to the 2016 and 2017 accident years and having no material roll-forward impact on accident year 2018. I have now reviewed all the worldwide general insurance loss reserves and feel that AIG is within a reasonable range, which dovetails with the opinion of our outside actuarial consultants for the group of segments that they have independently reviewed. The ADC as of December 31, 2018, has approximately $7.6 billion of limit remaining at the 100% level, and given the 80% cession, has nearly $6.1 billion of remaining limits still available to AIG.

During 2019, we will be working to have a more expansive view of reserves each quarter rather than focusing -- mostly focusing on predetermined schedule lines of business. This should help reduce volatility and provide interim views of any trends that may be arising throughout the year. Given the earlier discussion on investment performance, let's now turn to the life and retirement segment. The L&R segment recorded $623 million of adjusted pre-tax income, which represents a $90 million reduction sequentially from last quarter, and there are many drivers of this sequential difference, and Kevin Hogan will discuss both the quarter and the year in detail during his comments.

Although the L&R segment fixed income was largely stable, the results reflect the impacts of the December equity market decline and widening credit spreads on certain assets affecting net spreads, fee income and amortization, which Kevin will also go into. Sequentially, however, included in the impact to the annual subsidy review -- actuarial subsidy review, Independent retirement was down $66 million of adjusted pre-tax income, group retirement was down $83 million, Institutional Markets by $12 million, while life Insurance was up $71 million sequentially. As respects tax, we finished the year at a 24.9% effective tax rate, including discrete items, or ETR, on adjusted pre-tax income. As you know, the ETR is updated each quarter using actual results then supplemented by reforecast of the remaining quarters.

The fourth-quarter incremental tax rate, inclusive of discrete items, was 18.5%. Moving on to capital management. We repurchased $745 million of our stock during the quarter at $41.22 per share, along with another $5 million in warrants. The shares outstanding as of December 31, 2018, for book value per share purposes, is approximately 867 million, whereas the average diluted shares outstanding used for EPS purposes is approximately 888 million shares.

As Brian already commented, we secured a board share repurchase authorization that now puts the available amount at $2 billion. Book value per share and adjusted book value per share, excluding OCI and DTA, were $65.04 and $54.95, respectively, which represent reductions of 1.8% and 1.1% relative sequentially to September 30, 2018. Our total capital at December 31, 2018 stands at $81 billion, comprises 71% equity, inclusive of OCI and DTA, 2% hybrids and 27% debt, which is up from last year end, primarily as a result of the Validus acquisition. After the first quarter, we expect to begin discussing a more industry-consistent view toward PML that centers around measures that is against our established risk tolerance and the stated return levels rather than discussing AAL, which is merely an expected value.

More importantly, we consider catastrophic risk to be primarily a balance sheet issue rather than the income statement view that AAL provides. Given the way underwriting and reinsurance actions burn into calendar quarter results, we expect net improvements in CAT exposure and overall results as we cascade throughout the year. Finally, with now two months under my belt as CFO, I'm very appreciative of the support I received from my -- all my colleagues and am extremely excited to see and have committed to reap the fruits of our hard labor in 2019. And with that, I'll turn the call over to Peter.

Peter Zaffino -- Chief Executive Officer of General Insurance

Thank you, and good morning. Since Mark provided detailed financial information for general insurance, I will expand on Brian's prepared remarks and highlight some of our more significant accomplishments in 2018. This will include insight on the progress we have made to overhaul our core underwriting capabilities and reinsurance program. I will then give a brief overview of market conditions and summarize our view entering 2019.

As Brian noted, a significant amount of foundational work was completed in 2018 as we repositioned general insurance and worked toward creating a culture of underwriting excellence. Our principal focus was to outline a new underwriting risk appetite, improve underwriting capabilities and create business units that could positively distinguish themselves in the market. Key components of this work included a rigorous review of the entire portfolio, an aggressive limit reduction effort and embedding an enhanced governance and control framework. Detailed portfolio reviews uncovered significant complexity and exposures resulting from the prior large limit deployment strategy that made AIG an outlier in the industry.

I'd like to provide you with more detail on our key areas of focus. First, with respect to the general insurance organizational structure, we established or reestablished numerous business units focused on the strategic positioning for each business within the portfolio and empowered our leaders with end-to-end accountabilities to drive results. We also filled critical positions, including chief underwriting officer, chief actuary, head of international, head of claims and the CEO of Lexington. Our new leadership team is working to weave the company closer together, and we are building a strong bench to execute on improving our underwriting performance.

The new organizational structure was designed to better position us to serve our brokers and clients and allowed us to outline a more coherent risk appetite and underwriting strategy. Throughout 2018, we prioritized a reduction of gross and net limits to reduce risk and volatility in our portfolio. Let me provide a few examples. In Property, gross limits deployed in the field were reduced from $2.5 billion to $750 million.

Net limits were reduced from $611 million at the end of 2017 to a range of $5 million to $50 million as we entered 2019, depending on the nature of the business. In Casualty, gross limits were reduced from $250 million to $100 million, and net limits were reduced significantly. I will provide more detail when I discuss 2019 reinsurance. Primary D&O gross limits at January 1, 2018, were reduced by over $8 billion in the aggregate throughout the year.

In our Caribbean business, we moved away from PML and instead shifted to managing our exposures using TIV, and on this basis, reduced gross limit over 50% and reduced net exposure by over 75%, again, through aggressive limit management and thoughtful execution on reinsurance. With respect to Lexington, our new leadership team, led by Dave McElroy, shifted his focus to the E&S market to reduced maximum property limit deployment from $2.5 billion to approximately $100 million. In 2019, we will continue to shift the Property and Casualty lines to have greater balance and risk selection, account size, attachment points and geographic spread. Our program business had combined ratio of well north of 100%, and we've eliminated 20 programs that no longer fit our risk appetite or did not meet profitability thresholds.

We are committed to maintaining a program business, and in the second half of 2018, acquired Glatfelter, a company with talented leadership and a deep bench, a long track record of profitability and best-in-class underwriting, technology and systems capabilities. Our progress and achievements from a risk management and underwriting perspective have already improved our portfolio and have been critical to our ability to execute on our reinsurance strategy. Taking a step back, our work related to reinsurance started in late 2017, when we quickly evaluated the Legacy reinsurance strategy and discovered it had a large -- it had largely been based on an assessment of capital benefits. We found that the reinsurance programs had substantial shortcomings when it came to relevance in supporting the prior go-large underwriting strategy and managing volatility across return periods.

Those programs did not adequately protect against tail risk events. Our approach to reinsurance has dramatically shifted in line with our belief that there is strategic value in utilizing reinsurance to strengthen and enhance our portfolio, ensure a balanced book of business with appropriate management of net volatility and protect against extreme risk events. Heading into January 2018, we made initial decisions to reduce the significant net risk in the portfolio. This was most notable in the North American catastrophe treaty, which provided us with meaningful recoveries in the second half of the year.

Throughout 2018, we undertook a much deeper review of all treaties and identified additional notable gaps. The new general insurance reinsurance team worked with our reinsurance partners and outlined a revised and more sophisticated approach to underwriting while designing a global reinsurance program for the January 2019 renewal season. This past renewal season was challenging and complicated by the following: The increased frequency of catastrophes over the last couple of years, reduced supply in the retro market and market contraction in the ILS market and the ceded losses to our reinsurance partners in late 2018. Having said that, we were extremely pleased with the outcome and with the strong support we received from the reinsurance market.

We believe the strong support provides independent validation of the progress we are making to enhance our core underwriting capabilities and is evidence on the confidence the industry has in this leadership team and its ability to execute on the turnaround taking place at AIG. A lot has been said and written about our reinsurance programs, so I'd like to give you more detail on what we've achieved. AIG's Legacy property per risk coverage was developed to support gross limits in property coverage of up to $2.5 billion. In light of our underwriting actions in 2018 to reduce gross limits, we were able to redesign this aspect of our reinsurance program to be purchased at lower attach points.

This new property per risk reinsurance dovetails with the continued reunderwriting of our overall portfolio and reduces volatility across our worldwide property business with the per risk attachment points now having a net retention of between $5 million and $50 million, depending on the class and location of the risk. With respect to property catastrophe, we now have a worldwide occurrence and aggregate coverage reducing risk for both our North American and international businesses. Overall, we have reduced the modeled standard deviation of our Property portfolio by 40% and have put in place programs that provide capital and earnings volatility protection. For example, we reduced the modeled volatility on the worldwide all perils occurrence exceedance probability by approximately 75% in the 1 in 100 return period.

Since 2017, the 1 in 100 U.S. hurricane occurrence exceedance probability has reduced by 45% on a net basis, excluding Validus. And in 2019, our modeled expected worldwide, all peril, 1 in 100 occurrence exceedance probability decreased in excess of 15%, and that includes Validus. Recent enhancements to the worldwide catastrophe program resulted in significantly reduced Japanese net exposures, which contributed toward the purchase of one combined commercial and personal lines Japanese tower.

In addition, we have much lower attachment points on our global catastrophe treaties, particularly in international and personal Insurance. Attachment points for international catastrophe outside of Japan range from $50 million to $75 million. In addition, we recently completed the purchase of a $275 million CAT cover designed specifically for our personal Lines business in the U.S., which provide additional coverage with variable attachment points in peak zones ranging from $40 million to $170 million. We also made substantial enhancements to our casualty programs.

This included expanding the international $75 million excess to $25 million excess of loss program to North America, which is now a global program and adding a new 50% quota share for the first $25 million for our U.S. Primary and Excess Casualty lines. Together, these treaties reduce our net limits in U.S. casualty on a risk-attaching basis and contribute to a rebalancing of our overall net portfolio.

Before concluding, I also want to provide an update on market conditions in the fourth quarter of 2018. On a global basis, general insurance achieved a weighted average 4% rate increase, both in North America and international. Rate increases were higher in certain lines of business, such as North America primary public D&O, which achieved low double-digit rate increases; commercial Auto, which also experienced rate increases in the low double digits; U.S. Excess Casualty, which achieved double-digit rate increases in most units; and commercial Property, which saw mid single-digit increases.

In international, Asia Pacific achieved approximately 3% rate increases, led by Property and Financial Lines, which achieved mid single-digit increases. U.K. and Europe also achieved roughly 3% rate increases, led by motor business, which achieved upper single-digit increases; and D&O, which achieved mid single-digit increases. While rate is an important area of focus for us, the work we are doing to improve risk selection and our core underwriting capabilities as well as the overall repositioning of our portfolio will be the primary drivers of our future performance and profitability.

As Brian noted, 2018 was a year of heavy lifting. While a tremendous amount of foundational work was done, we still have more work to do. The general insurance leadership team is fully committed and aligned with our strategic direction. We continue to be laser-focused on repositioning our portfolio, instilling underwriting discipline across general insurance, improving profitability and continuing to evolve our reinsurance program.

In addition, examining our expense base to identify additional efficiencies and cost-savings opportunity remains a priority. We continue to expect that these actions, together with benefits from the acquisitions of Validus and Glatfelter, will allow us to achieve an underwriting profit, in general insurance in 2019. We have momentum, a clear vision for the future, an improved risk profile and a culture that is evolving in general insurance into a business that strives for underwriting excellence. I'm proud of what our colleagues around the world accomplished in 2018, and I am confident we are well positioned to continue our journey.

With that, I'll turn the call over to Kevin.

Kevin Hogan -- Chief Executive Officer of Life and Retirement

Thank you, Peter, and good morning, everyone. As you can see on Slide 12, life and retirement recorded full-year adjusted ROE of 12.6%, consistent with our long-term expectations. The year-over-year change from the annual actuarial assumption update unfavorability impacted ROE by 156 basis points, which was more than offset by the favorable impact of tax reform and reductions in the attributed equity consistent with our ongoing de-risking. Adjusted pre-tax income of $3.19 billion represents a $641 million reduction from the prior year.

The primary drivers of the year-over-year difference were: The annual actuarial assumption update, which accounted for $382 million of the decrease, lower returns on fair value option securities of $114 million, higher deferred acquisition cost amortization of $31 million, higher new business expenses of $33 million, $17 million from modernization investments and $39 million from miscellaneous other items that lowered 2017 expenses. Looking ahead to earnings in 2019, having largely completed our portfolio repositioning, we expect adjusted pre-tax income to be essentially flat with full-year 2018 with a consistent adjusted ROE. These expectations assume a modest improvement in equity markets from year end. In addition, absent significant changes in the overall rate environment, our current expectation is that base net spreads will decline by approximately zero to 2 basis points per quarter at least through 2019.

We also expect lower yield enhancements as interest rates rise. Our 2018 results reflect strong growth from our ongoing strategy to leverage our broad product portfolio and diversified distribution network to satisfy customer needs. As pricing conditions improved in the second half of the year, we significantly increased sales of indexed and fixed annuities. With growth in Individual retirement, Group retirement and life Insurance, we increased total premiums and deposits for the year.

We've maintained our disciplined, opportunistic approach in Institutional Markets and closed a number of pension risk transfer deals in the fourth quarter. We are well positioned in 2019 to continue to serve a growing market, enabling us to continue to deploy capital at or above our targeted economic returns while recognizing we will incur some additional new business expenses associated with such growth. The investments we have made over the last few years and continue to make to modernize our operating platforms and enhance digital capabilities are already demonstrating benefits in each of our businesses. In Group retirement, where we have invested in enhancing the participant web experience, DALBAR recognized our efforts by awarding us the ranking of No.

1 behavior-centric plan participant website. We followed this in 2018 by launching a web-based platform to also modernize the plan sponsor experience. In Individual retirement, we continue to enhance our award-winning platform that is consistently recognized by DALBAR for excellence across multiple customer touch points, ranking No. 1 for variable annuity statements 17 years in a row, receiving an annuity service award for 12 consecutive years and being the only recipient of the Communications Seal of Excellence for 2018.

Further enhancements for 2018 included a redesigned mobile-friendly website and the implementation of a new administration system for our fast-growing index annuity new business. We continue to enhance our digital capabilities for our life business while planning the necessary infrastructure changes to completely separate our operating model from Fortitude Re. Finally, to our Institutional Markets business, we converted the administrative system for pension risk transfers to a new platform to enhance our competitiveness in this growing market. Our modernization effort to fix the core is broad, mostly bringing immediate benefits in the form of automation, use of robotics and digitization, all of which improve our efficiency, quality and customer experience.

Turning to the fourth quarter. Against the backdrop of a quarter marked by attractive new business margins and growth in total premiums and deposits, our results reflected the impact of sharply declining equity markets and widening credit spreads over the last month of the year. For the quarter, we reported adjusted pre-tax income of $623 million, which represents a $159 million reduction from the prior-year quarter. The primary drivers of the quarter-over-quarter difference were market-driven, including lower returns on fair value option securities of $94 million; lower net policy fee and advisory fee income of $44 million; and lower-based investment spreads of $33 million, due in large part to reduced accretion income.

Finally, despite the significant equity market and credit spread volatility during the quarter, I am pleased to report that our hedging program for living benefit guarantees once again performed as expected, resulting in a modest hedging gain. Turning to Individual retirement on Slide 13. Premiums and deposits grew by over 35%, with particularly strong growth in Fixed and Indexed Annuities. With these strong sales levels, we achieved positive net flows for the quarter, excluding Retail Mutual Funds.

Retail Mutual Funds, which is a comparatively small part of our earnings, is a defensibly positioned portfolio that is countercyclical to our individual annuities and may continue to face headwinds in the current rate environment. Assets under management declined along with the markets, impacting fee income, with net spreads also pressured by the market impact on yield enhancements as well as lower accretion income for Fixed Annuities. Turning to Group retirement on Slide 14. Premiums and deposits grew by approximately 14% for the quarter with continued growth in individual product sales, resulting in record-high premiums and deposits for the full year.

Our surrenders and other withdrawals also increased for both the year and quarter periods, driven by the loss of some large groups due to competitive factors, which I have talked about in previous calls and higher individual surrenders and other withdrawals. We expect higher surrenders and other withdrawals to continue to negatively impact net flows in 2019. However, we continue to believe that our differentiated model, which focuses on the value of the advisor, positions us well as a leader in attractive segments with the growing not-for-profit client contribution market. In addition to decreased assets under administration and fee income due to declining equity markets, net spreads were pressured primarily by the market impact on yield enhancements and lower accretion income.

Adjusting for lower accretion income and specific nonrecurring items, base net investment spread was in line with the prior-year quarter. Across the retirement portfolio, new money rates are still below portfolio yields, resulting in reduced but still attractive spreads in many products. Also, in a rising rate environment, it may be appropriate for us to reflect this in crediting rates for certain of our in-force business. Let's now move to life Insurance on Slide 15.

Total premiums and deposits increased for the quarter, and we continued to produce healthy sales in the U.S. and strong new business growth in the U.K. Our adjusted pre-tax income reflects the material impact of non-deferrable acquisition costs associated with new business, masking an underlying contribution consistent with our long-term low to mid-double digit return targets. Lastly, our overall mortality experience for the quarter and full year were favorable to pricing assumptions and the prior-year periods.

Turning to Institutional Markets on Slide 16. We executed several opportunistic pension risk transfer transactions in the fourth quarter at attractive economic, statutory and accounting returns. The market pipeline for pension risk transfer transactions over the next 12 to 18 months continues to be robust. Overall, our Institutional Markets business continues to be well positioned to capitalize on available growth across its product lines while remaining focused on achieving targeted returns.

To close, as we enter 2019 with a sustainable business model, well positioned to continue to leverage our broad product expertise and distribution footprint to deploy capital to the most attractive opportunities as we reposition the portfolio and prepare to return to overall growth. Now I would like to turn it back to Brian to open up to Q&A. 

Questions and Answers:

Brian Duperreault -- Chief Executive Officer

Thanks, Kevin. We gave you a lot of content, which used up a lot of the first hour. So we will press this and we'll go a little longer on the Q&A. So operator, let's go to Q&A.

Operator

[Operator instructions] Our first question comes from Kai Pan with Morgan Stanley.

Kai Pan -- Morgan Stanley -- Analyst

Thank you and good morning. You guys have reaffirmed the guidance for 2019. I just want to make sure, like, including the underwriting probability in the first-quarter 2019, from the 98.8% underlying combined ratio, you need more than a 3-point improvement, assuming a 4.5% of sort of AAL, to get to that level in the first quarter. I just wonder how do we bridge the gap, the 3-point improvement in one quarter, is that mostly from expense savings or from the underlying loss ratio?

Brian Duperreault -- Chief Executive Officer

Well, I think it's going to come from a variety of sources. We thought you might ask this question, so Mark's going to answer and Peter's probably going to supplement.

Mark Lyons -- Chief Financial Officer

Yes, we can tag-team that, Kai. So let me address that in kind of two ways: A conceptual approach so you kind of -- you get it, and a partial numerical approach. First off, if you look at how the book has changed and you look at some of the issues, all areas of the book have gotten a lot of focus. Now North American commercial is a book that, as I said before, a lot of recurrent pain points, probably got a little more focus on it, but good kind of improvements.

So when you look at fourth quarter of last year to fourth quarter of this year, North American commercial was 31% of the earned premium, now it's 36% of the earned premium, where all the focus has been. And with Validus and Glatfelter coming into play, that's going to be pushing a little bit more, and they got very good -- Glatfelter in particular, very good program results. And the program unit terminated about 20 programs, so you can see loss ratio improvement because of what left and new business coming in with Glatfelter that's going to help that skew. Secondly, we talked about rate changes that we've gotten on the book that overall averaged, like, 4%.

4% really belies next year's by-unit. And when you get into North American commercial, first, rate changes are on a gross basis, and what's going to happen in 2019 is going to be a little different skew to where the rate increase is a little bit higher. And therefore, there's more distance between loss trend and achieved rate change. So keep that in mind.

Next is think about that with all the reinsurance that Peter described, you're going to have a changing mix, more so on a net basis, that we believe is to our favor. So that's important, I think, to recognize. So on top of that, when you think about portfolio construction, it's just as important. I mean, we focus on rate change, but rate change is just a piece of the pie.

It's just as important to understand the impacts on the book by what left. So what got nonrenewed and what was the economics associated with that versus what stayed on the books and what got onto the books. And that's a pretty material incremental improvement. And as Peter highlighted, when you change your underwriting risk appetite to make them clear to the outside and you start to get more lasered and focused to the kinds of risks that you want, and therefore, the quality of the average flow into the business is superior, by doing nothing else, you've increased the rate adequacy.

By doing nothing else. So you've got all that. So on the portfolio construction, all that aspect is a little more conceptual, so let's get back into some of the numbers. So we just had a 98.8%, and you can throw whatever CAT load you choose for that.

So that was a 63.9% and a 34.9%. So -- because you asked a sequential question. So we have 22 points roughly of acts let's assume that doesn't change, even though there will be a lot of actions taking place to improve that, let's assume that doesn't change. You got the fixed expenses, which we've demonstrably showed massive improvement on.

So rate changes are going to help that because you're going -- everything else being equal, you're going to get a bigger premium base, it's going to help the loss ratio. So just on the margin expansion, without giving any credit to the portfolio change, you're going to be, in my view, in the middle 96s on that regard, without CAT or AAL. So even if everything else I talked about, from the rate changes growth, how it's better on a net basis; the fact that there's effective rate changes on the book by what left, not just what we report -- let's just say that's worth one point, and there's no way it's only one point, but let's say it's one point, you're at 95.5%. So pick your CAT load, you want to pick four, you want to pick three, you want to pick 4.5, we're there.

So that's how I view it.

Brian Duperreault -- Chief Executive Officer

Peter, do you want to say anything about the expenses?

Peter Zaffino -- Chief Executive Officer of General Insurance

Yes, I think as Mark said, I mean, when we looked at it in terms of looking at how we're going to be below 100, it was the mix of business, it was going to be how we were reducing the volatility in the portfolio, and we ended up having a forecasted better accident year loss ratio. The reinsurance then reduced volatility but also shifted that balance, as Mark said, on the overall loss ratios. So we'll see Casualty business in the U.S. having a bigger cession, so therefore, better balanced.

And then I don't want to lose sight again of what Validus and what Glatfelter will contribute. And as Brian said on the expense side, we saw a lot of ramping up of the acquisition expenses this year, that was from a portfolio shift. In addition, when you looked at the comparisons in '17, there were some one-time anomalies, it looked like it is growing a little bit more. And we've been addressing the general operating expenses in the back half of the year.

So while you didn't see perhaps a lot of material impact in the first half of '18, you saw it in the back half of '18. And we believe that that will continue to not only sustain, but we're going to be focused on it throughout the year. So I think when you look at all those different components, you get to below 100.

Brian Duperreault -- Chief Executive Officer

And I'm just -- let me just add two things. One, Mark said pick an AAL. The AALs, we haven't given you one, but one can assume they're not going up, they're going down either -- but through a combination of that, it's reducing our gross and net per risk; reducing concentrations; and of course, reinsurance structures that we put into place which are all reducing the AAL. That's how I'd say that.

So the only other thing I'd say, a little caveat, so give me a break here, is -- and we talk about volatility. So volatility in this book is diminishing. But it's not -- we haven't gotten it at all out of the system yet. We've got risk-attaching covers and things like that.

So there's still a few of the old-tier policies left and the unearned bleeding in as we still have some stuff with larger per risk limits. So the volatility in the first quarter should be greater than the volatility by the end of the year. So you can't -- I mean, you got to just recognize that volatility thing is there. But I think Mark and Peter outlined why we have -- we've set entering 2019 -- about ending 2019.

Kai Pan -- Morgan Stanley -- Analyst

That's very helpful. My follow-up is on net invest income, the $13 billion annual run rate you guided to. What's the base assumption for market return in that $13 billion? I'm wondering what's the sensitivity around that. For example, this quarter, market up 10%, how much you saw better than the run rate you're going to realize in net invest income?

Mark Lyons -- Chief Financial Officer

So I mean, we're making the assumptions consistent with what we made in the financial supplement last year. I mean, to give you a sense of the volatility from a perspective of return on assets, I mean, we're managing $313 billion of assets. The volatility of net investment income, which is a function of both the economic risk and the accounting mechanisms by which we account for these things, is roughly 25 basis points of return volatility on assets.

Brian Duperreault -- Chief Executive Officer

That said, that was done to shield our investments. OK, next question. Next questioner.

Operator

And we'll take our next question from Josh Shanker with Deutsche Bank.

Josh Shanker -- Deutsche Bank -- Analyst

Good morning, everyone. I fear all these questions are going to be about how to get to 100%, but I'm going to also try and dovetail on Kai. In the quarter, we saw a big increase in acquisition expense ratio offsetting the improvements you guys have made on the GOE expenses. Going forward, where should we see the acquisitions? Since you're buying more reinsurance and whatnot, that's taking it up.

Is that going to offset the improvements you're making on the operations in terms of people and proper allocation of expenses?

Brian Duperreault -- Chief Executive Officer

Well, I think -- let me start by saying, no, that increase in the acquisition expense was really related to personal Insurance in particular, right? That book of business runs at a high combined ratio, about 1 under 100, so it actually is additive to the portfolio, particularly when you think about the volatility of it. What was missed was the PCG business deteriorating, so you didn't see the loss ratio improvement. So the acquisition will stabilize. We don't see that growing.

I think there's reason to believe we would get that down. And we will be working on the fact that the offset didn't happen because of the PCG loss ratio deterioration. So Peter, is there anything you want to add to that?

Peter Zaffino -- Chief Executive Officer of General Insurance

Nothing. It's just fair, and we don't see acquisition expenses increasing in 2019. We just had, like you said, the ramp-up of shift in portfolio. And then again, having some tough comparables year over year.

And believe that we'll continue to focus on the GOE and don't expect to see expenses go up in acquisition.

Josh Shanker -- Deutsche Bank -- Analyst

OK. And one related question, I guess, maybe unrelated. You are not responsible for the decisions made by the previous management team. But trying to understand what this go-big strategy meant.

There was also a strategy called rapport, where they were trying to minimize, I guess, the capital consumption of various underwriting decisions. Were the two things in conflict with each other? Did one of them not exist? Was the company trying to minimize its underwriting appetite in order to return capital? How do those two things dovetail with each other? And were there conflicting messages, I guess, given to underwriters? What's -- I guess, explain sort of what was going on before a little better so we can understand how it can improve.

Brian Duperreault -- Chief Executive Officer

Sometimes, you can't explain things. I'm not sure I can, but let me try and answer this thing. So look, I think there was a belief in the balance sheet. It starts with a belief in the balance sheet.

And that's OK. We need a balance sheet. We need a balance sheet to take risk. And it's got to -- your risk has got to be matching that balance sheet.

But if you tell underwriters it's OK to write $2.5 billion, and by the way, who else is going to do it? So you think you'd corner the market, right? So if you don't get paid for it, you got a problem. So you put out an extra $1 billion of limits with almost no payment because it's impossible to get value for that kind of additional limit. So when you add that to, let's say, underwriting where the underwriters were not selecting properly or they were adversely selecting against -- being selected against, and you go large, you go large on risk you shouldn't be writing. It just exacerbates everything.

And then you try -- then as a actuary, you try to reserve this stuff, where the volatility is impossible. How much risk can you put into your reserve levels to try to recognize the extreme volatility that might occur. So look, I don't -- all I know is I wouldn't have done it and I know we're not doing it. That's about all I can say.

Hope that helps.

Josh Shanker -- Deutsche Bank -- Analyst

OK. Thank you and good luck.

Brian Duperreault -- Chief Executive Officer

Next question.

Operator

We'll take our next question from Elyse Greenspan with Wells Fargo.

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Hi, good morning. My first question. So in response to Kai's question, Brian, I think you said that sometimes, there's some volatility, given some multi-year policies potentially in the first quarter. I just want to reaffirm that, based on how you see your book running, that you do expect to come in below 100 in general insurance in the first quarter.

And then a couple of Q4 numbers that might help us think through that. Were there any kind of current accident year adjustment that would have impacted the fourth quarter, chewing up earlier quarters? And can you let us know what Validus, if it was additive to margins in the fourth quarter?

Brian Duperreault -- Chief Executive Officer

OK, well. Those are three different questions. You're good, Elyse. But anyway, let me see if I can remember them all.

Yes. I did -- I just put a little caveat that there's volatility. But yes, I'm reaffirming that we're entering 2019 expecting to make an underwriting profit, including AAL. So that's answer number one.

Then there was a question about whether or not there were things that occurred in the fourth quarter. Mark, do you want to talk -- take that?

Mark Lyons -- Chief Financial Officer

Yes. I also applaud you, Elyse. That's like an SAT question, parts A through H. I was pretty good at it.

So yes, to the question about accident year '18 were there any movements? There were some ups and downs, but the net was 30 basis points on basically $7 million for the whole year. So it's $20 million. So it's nothing to get excited about.

Brian Duperreault -- Chief Executive Officer

Yes. And there was one other one, right? Validus.

Mark Lyons -- Chief Financial Officer

Validus.

Peter Zaffino -- Chief Executive Officer of General Insurance

Elyse, this is Peter. It was -- is it with or without CAT? Because of it's with CAT, it was not accretive because the one -- when you look at '17, they're very good at how they buy reinsurance. But '17, if you look at comparables, was more active in the third quarter than the fourth quarter. So if you look at both quarters together, it was roughly the same in terms of what contributed to net CAT.

If you take out CAT, it was in the range of where we were in general insurance, so it wasn't terribly far off.

Brian Duperreault -- Chief Executive Officer

Right. OK. Do you have follow-up series of questions, Elyse?

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Yes. I mean, the one other thing that I think just stood out to me, and Mark, maybe you can give a little bit more color, or Peter, the international margins. I know you made the year-over-year comparative, they got better relative to the fourth quarter, they didn't get better relative to the third quarter. Did guys see any one-off kind -- did you realize any large property losses or something that might have impacted the numbers? Or was it seasonality that you're not necessarily comparing international Q4 to Q3?

Brian Duperreault -- Chief Executive Officer

Mark?

Mark Lyons -- Chief Financial Officer

Yes. It's a good question. If you look at the history, you're going to see it's bounced all over the place. It's a lot of different lines of business, it's 80 countries reflecting kind of like what I -- my prepared comments on FL, in international, you get a pop here out of India, then you get one out of APAC and then that's great the next quarter.

But if you look back to the full accident year of '18 and the full accident year of '17, they're basically mirror images of each other. One was 65.2%, one was 65% even. So yes, you're going to get pops. So sequentially, I don't think gives you any information context.

OK.

Brian Duperreault -- Chief Executive Officer

Next.

Operator

We'll take our next question from Yaron Kinar with Goldman Sachs.

Yaron Kinar -- Goldman Sachs -- Analyst

Good morning, everybody. Mark, I thought your walk to a mid-90s accident year combined ratio was very helpful. And I think I understand the math around the impact of the rate improvement. But ultimately, there must be some assumption around loss trends there as well, right? So I just want to make sure that the way I'm thinking it, the way you guys are thinking about it are roughly the same, namely that to get to this mid-90s, you're assuming that the rate improvements are in excess of loss trends, even in lines that -- where you're getting the rates.

Clearly, those are long term, so they would see some steeper loss trends.

Brian Duperreault -- Chief Executive Officer

Yes, I think -- yes. The answer is yes. But let me -- I just I want to emphasize something here, and that is rate alone would not have improved this portfolio, OK, even if it was above the loss trend. Because if the portfolio is a collection of risk you shouldn't be writing, you can't get enough money for that stuff.

So there's -- the untold story is the improvement of the portfolio, which really affects the loss ratios and combined ratios, and that's an important thing to keep in mind. You have anything else you want to ask, Yaron?

Yaron Kinar -- Goldman Sachs -- Analyst

Yes, I do. Maybe shifting gears to the investment portfolio. So you guys have clearly spent a lot of time and effort to de-risk the liability portfolio, especially in general insurance. What are your thoughts around the investment portfolio today broadly and in general insurance specifically?

Brian Duperreault -- Chief Executive Officer

Doug?

Doug Dachille -- Chief Investment Officer

Well. Actually, we've had three years to do the de-risking of the investment portfolio. So if you look out over the past three years, we've dramatically reduced all the fair value option equities. We eliminated a whole host of Legacy investments that I -- we took over in 2015, things like life settlements, which were both illiquid and had modest returns for the risks that we were getting.

We reduced our hedge fund exposures by over $7 billion. We reduced our private equity exposures. We changed where the investments -- those risk investments were held. We reduced the amount of those exposures in the life and retirement business because there's so much more capital markets exposures to the underlying core business that it didn't make sense to include those types of asset classes in those books of business.

If you look at the exposures that we have to equity markets, let's understand, when you look at our overall investment portfolio, it's still an ALM-based book of business designed to match our liabilities. So we -- all the alternatives are really allocated to the surplus of the general insurance books, and it's very modest. And what we try to do is manage liquidity, economic and accounting volatility and also try to get excess risk-adjusted return. So when -- in looking at that portfolio, we're very comfortable with what we currently have in our alternatives, which is a mix of private equity and hedge funds.

But we're always tweaking it. But the absolute holdings that we have and scale, we're very comfortable with. We'll continue to make ongoing rebalancings of how we allocate that risk bucket, but I think the size of it will continue on going forward.

Yaron Kinar -- Goldman Sachs -- Analyst

Thank you.

Brian Duperreault -- Chief Executive Officer

Next question.

Operator 

We'll take our next question from Erik Bass with Autonomous Research.

Erik Bass -- Autonomous Research -- Analyst

Hi, thank you. Two questions on life and retirement. First, can you talk about how much impact the market's had on DAC amortization in the fourth quarter? And then secondly, you've talked about expecting a couple basis points of core spread compression per quarter. I think the decline was much greater this quarter due to higher crediting rates, and you mentioned some unusual items, but how should we think about the rate base level of this for 2019?

Mark Lyons -- Chief Financial Officer

Yes, thanks, Erik. First of all, in terms of the fourth-quarter impact, the impact on DAC from the market was -- versus the prior year, just over $80 million. And of course, it's a combination of where the equity market's levels are, impact from the credit spread widening, et cetera. And so as you look at the overall fourth quarter, the sharp decline in the AUM in the last four weeks impacted not just the DAC, but also fee income, which is a reflection generally of where the equity markets are; and also the impact of the spread widening on mostly the fair value options.

And the impact of the markets on yield enhancements and accretion income is also something to keep in mind. So as we look at the whole question of the cost of funds and base spreads, I think what's important is there were some anomalous items mostly in Group retirement in the fourth quarter. But year over year, cost of funds was 2.73%, which is just 3 basis points from the 2.76% in the prior year. So it's not actually above the prior year.

Fixed Annuity year over year was flat at 2.65%, and variable and index almost flat at 1.24% versus 1.26%. So really, the cost of funds is not something other than that one-off item in the fourth quarter, significant concerns. And as we look at the base spreads, obviously, in particular, some of the market effects were primarily what you saw in the effect in the fourth quarter. And assuming where the markets were at the end of the year and where we believe interest rates are going to be -- or interest rates were, we are still confident that that maximum negative spread compression of 2 basis points in 2019.

Erik Bass -- Autonomous Research -- Analyst

And then just wanted to clarify, for your guidance, you talked about life and retirement earnings being flat in 2019. Just to be sure, that's off of the adjusted 2018 number you show in the supplement? And then what are you the assuming for the equity market return?

Brian Duperreault -- Chief Executive Officer

Kevin?

Kevin Hogan -- Chief Executive Officer of Life and Retirement

Yes, that is correct. We are assuming that's comparable also on the ROE, '19 versus '18. In terms of equity markets, we're assuming a modest improvement in the equity markets from where they were as of the end of the year.

Erik Bass -- Autonomous Research -- Analyst

Thank you.

Operator

We'll take our next question from Andrew Kligerman with Credit Suisse.

Andrew Kligerman -- Credit Suisse -- Analyst

Hey, thank you for taking my question. First question goes to Mark. Last quarter, on the call, late November, you talked about how you had reviewed much of the book and saw no material red flags upon that material review. So Mark, I'm wondering, I think you mentioned a little earlier something about amortization.

I'd like a little clarity on what you saw subsequent to that November call. And what your confidence is with regard to the prior-year developments going into 2019.

Mark Lyons -- Chief Financial Officer

OK. So with respect to November, so when we looked at -- in -- for the fourth quarter, effectively backwards, there's really no adjustments of note on anything prior reviewed. So as far as I'm concerned, those numbers are stable. Might be some reallocations between a couple of lines, in the aggregate, nothing moved.

So if you're -- by end of November, you're really talking about Goldman's December 5 conference, which I'll assume you're referring to. December 5 already...

Andrew Kligerman -- Credit Suisse -- Analyst

No, they didn't invite me.

Mark Lyons -- Chief Financial Officer

OK. Well, I'm sure you...

Brian Duperreault -- Chief Executive Officer

Might have read about it.

Mark Lyons -- Chief Financial Officer

Yes, I'm sure you read everything.

Brian Duperreault -- Chief Executive Officer

Get some invitations.

Mark Lyons -- Chief Financial Officer

I mean -- but what's our responsibility as an insurer, it's setting reserves for all occurrences that have happened 12/31 and prior. This was December 5, so there still had three weeks of losses to emerge. But -- so at the time, everything was still in flight, but I'm not making any excuses. The point is that when you get into the depth, you didn't hear us talk about personal Lines problems, you really didn't hear us talk about rest-of-world Casualty in any material way, and you didn't really hear us talk about the buffer or comp excess on it.

So it was Financial Lines, that was the center issue, it had mostly U.S. issue, some scattered pops. So one factor, the reasonable range, we're comfortable with that. To your question about -- well, I think that really was the net of your question, is how do we feel about things now that we've been through a whole cycle? I feel pretty good about it.

Andrew Kligerman -- Credit Suisse -- Analyst

On prior-year developments, yes. That's what I meant...

Mark Lyons -- Chief Financial Officer

Reserve adequacy. Yes.

Brian Duperreault -- Chief Executive Officer

Yes.

Andrew Kligerman -- Credit Suisse -- Analyst

Yes.

Brian Duperreault -- Chief Executive Officer

Yes. I mean, look, the confidence in the reserve -- and let me just say something. I mean, the confidence in our reserves starts with the confidence in the underwriting that's producing those reserves. So the more and more comfort we have about what we're doing as a company and the work around taking the volatility out to make the results more predictable just adds to our confidence, OK? You wanted to add something else, Andrew?

Andrew Kligerman -- Credit Suisse -- Analyst

Yes, So I understand the business mix and the pricing increases, but where I'm not getting the math is if I make an estimate of Validus and Glatfelter premium, I still see 2019 over '18 getting a premium increase. And even with the rate increases, which you say are about 4%, if I subtract that out, maybe premium are about flat. And so I guess, how are you going to get this loss ratio improvement? How -- what business are you departing that would get this improvement? If premium is so flat, it's just hard to see what the moving parts are that are going to get you this loss ratio improvement. So maybe you could give me a little math on what's going away and what's coming in and still being able to maintain flat premium.

Brian Duperreault -- Chief Executive Officer

Peter.

Peter Zaffino -- Chief Executive Officer of General Insurance

Well, thank you for the question. And it's a complicated answer because the portfolio has been shifting across the world, as we outlined, in terms of going from a large limit strategy to using limits a little bit more discreetly. But also Brian keeps emphasizing, it's also the risk selection and rebalancing the portfolio. So within every business, within every geography, we have been looking very hard at getting the appropriate returns.

Once we make good risk selections, we have the right coverage, and that has happened in a dramatic way. So the one I will highlight because it's happening across many of the portfolios would be the Lexington. The Lexington was doing admitted and non-admitted. It was doing business from wholesale and retail.

It was doing large limits on Property and Casualty as well as having a very large program business. And so it has been recalibrating its risk appetite to substantially play in a role where it has very strong expertise. We have brought in industry leaders, focusing on the E&S space, focusing it through wholesale, making sure we're using tighter limits when we do the risk selection, going into having a better balance with, not only large accounts, but in the middle market. And so the portfolio has been starting to move in a direction where we're recalibrating and reconstituting what the portfolio looks like.

At the same time, there are some businesses that are further along, some that are not. And with that, you're going to have the general insurance, excluding Validus and Glatfelter, will decrease year over year on a premium basis, then the complexity of the reinsurance. So I know it's hard to do the math, but we believe that we are repositioning the portfolio with a better risk selection, and that will be reflected in the accident year loss ratios as we earn into 2019. Mark, do you want to add anything to that?

Mark Lyons -- Chief Financial Officer

Yes, it's just the fact that I think what we said on our last quarter's call, that we don't need a hard market to improve this book. It comes back to the composition and what we're letting go if we can't get rate and structure that we want, and what's coming in. And everybody focuses on price, I get it, because it's measurable and it's something you can compare, but the whole flow of business, the whole understanding of the CAT exposures, the whole structure, price is last. And that's what we measure.

Brian Duperreault -- Chief Executive Officer

Andrew, can I just give you an example? Andrew, let me just -- so you have a risk that comes in the door, right? And we've been writing it for some time. We've been attaching too low -- so it's either a deductible or it's an excess placement. We've been attaching too low and we've been getting way too much limit at the top, OK? So you get rid of the limit at the top you weren't getting paid for, you just improved your portfolio immediately. You raised up from where you were to a higher limit where the risks diminish, right? Now that all causes you to get less premium.

You got a much better risk on your hands. And that doesn't even count getting rid of the bums that we shouldn't write in the first -- let's just say risk selection was our key. So you got to trust us on us. And I'm telling you, the premium could be flat and we don't need a hard market to make this thing better, as Mark said.

Anything else you want to ask?

Andrew Kligerman -- Credit Suisse -- Analyst

Yes. I mean -- yes, just very bluntly, then, I mean -- because while your strategy makes impeccable sense, bluntly, it would sound to me, with these reinsurance issues and lower limits, that at least 25% of your portfolio was turning over. The good stuff in, the bad stuff out. Is that a good assessment?

Mark Lyons -- Chief Financial Officer

Getting back -- some stuff is going, clearly. But we're not, like, getting wholesale out of line of businesses. But what Brian said is key. You can stay -- we could stay at 100 risk, we could still stay on the 100 risk, but on a different place on the structure, where the risk/reward trade-off is better, 100% renewal retention on the account and the volume is down 33%, but it's a better loss ratio expectation.

That's what you've got to internalize.

Brian Duperreault -- Chief Executive Officer

Yes. Exactly.

Andrew Kligerman -- Credit Suisse -- Analyst

OK. Thank you.

Brian Duperreault -- Chief Executive Officer

OK. Next question.

Operator

Our next question comes from Tom Gallagher with Evercore.

Tom Gallagher -- Evercore ISI -- Analyst

Good morning. Brian, so your description of the go-large strategy in large limits and de-risking this. Can you talk about where we are on this de-risking process? Would you say it's largely done, or is 2019 going to continue to be a risk reduction year? And point of my question is, usually, when you materially reduce risk, normalized earnings go down, absolute ROE goes down. I understand risk-adjusted earnings should be getting better and cost of capital should be lower, but I guess, broadly speaking, where are we on that risk-reduction journey? What does that really mean for ROE? About 2019, I know you've really given out, like, three-year forward ROE.

Does it mean near-term ROE is going to be more depressed, you're going to get more of a back-end loaded improvement? Anyways, pretty broad question there, but what are your thoughts?

Brian Duperreault -- Chief Executive Officer

Yes. So is the process done? Well, as we described, Peter and I, the -- Tom Bolt's work with all our underwriters has been distributed. So we've set the tone of what we want to do, OK? So the strategy, yes, I think the strategy is done. The implementation is being done.

And risk-by-risk, as they come up for renewal, you make adjustments and things bleed off. So that's what I was saying. The quarter's going to be riskier in terms of volatility than the fourth quarter, just as the portfolio earns in at the strategy that we've been deploying. So strategy is done, implementation is weaving its way through the book this year.

This ROE -- de-risking ROE thing, well, that just presupposes that you were getting paid for the risk. But if you aren't getting paid for the risk and you stop taking it, your ROE goes up, right, if you -- and that is not even risk-adjusted. So when I said eight travels to double-digit, a lot of that has to do with a continuing effort on our expenses, which is a significant task for us over the next several years. And that's why that journey is a little longer.

Hope that helps.

Tom Gallagher -- Evercore ISI -- Analyst

No, that does. And when I think about, to your point, to me, the clearest expression of what risk reduction is going to mean, it is AAL. But can -- I know, previously, it was 4.5 points, and I guess you're not giving specific guidance on that. Why not give specific guidance on that? Because that's the one tangible thing we could point to, to describe the actual earnings benefits from the risk-reduction program.

Brian Duperreault -- Chief Executive Officer

Well, first of all, the AAL is one measure, right? But it's not the only measure of risk, right? So you've got a lot of risk kinds of measurements that you should deploy. What I would say is this AAL number is a moving -- it's moving, right? Obviously, it's moving for a lot of reasons. We're reducing concentrations, as I said earlier. We're changing risk profile in terms of per risk size, the per risk limits that are being deployed out there.

And the reinsurance is being put into effect. So you have to understand that the AAL is a moving number right now, getting better. So when we feel we've got a good number, I wouldn't have any problem telling you what it is since I'm not hung up about it. But I can tell you it's moving south.

And it's not the only measure, though. It's got to say something, though. Mark wants to say something.

Mark Lyons -- Chief Financial Officer

Tom. Tom, just one thing on your preface on that that AAL. AAL is explosive, or the underlying risk associated with AAL, right? So it's just that that's in your face. CAT occurs, earthquake occurs, front page of the Journal, right? Everybody focuses on it.

That's why with CAT 5s, everyone thinks they understand the model risk and all that. Now look at the history of AIG, look at the history of any large company. It's -- there's deferred risk, not immediate risk, associated with Casualty business. So Primary Casualty excess comp, I mean, look at the past of the industry, that risk is simply deferred, but it's as vague and real and more capital-exposed as Property, but everybody gives it short shrift.

But that's what you have to focus on, and that's what Peter and his team has done.

Tom Gallagher -- Evercore ISI -- Analyst

OK. Thanks.

Brian Duperreault -- Chief Executive Officer

OK. Thanks for the question. We're just about of time. Let's take one more.

Let's take Meyer. Meyer?

Operator

We'll take our next question from Meyer Shields from KBW.

Meyer Shields -- KBW -- Analyst

Great. OK. I'm on so -- Great. So looking forward to 2020, if I can.

Is it fair to assume that the impact of multi-year P&C contracts and the expenses associated with 2019 life and retirement growth, that both of those will be sources of improvement in 2020?

Brian Duperreault -- Chief Executive Officer

Well, I'd say certainly, the multi-years should have bled off by then. No question about that. And I'll let Kevin talk about the...

Kevin Hogan -- Chief Executive Officer of Life and Retirement

Yes. So Meyer, on the expenses, I think -- I mean, if you look year over year, right, '18 versus '17, we had a reported increase in GOE of about $110 million. $40 million of which were one-time items in '17 that helped '17 and don't repeat. So the expense increase base is about $70 million.

Around half of that is actually directly associated with new business growth. Obviously, our premiums and deposits are way up. Serving those policies, et cetera, has its additional burden. So relative to the projects, we're recently getting an immediate benefit from those, and we'll continue to invest what we need to in order to keep up with increasing regulatory demands and customer expectations.

But a part of that increase in GOE is related to new business. And so to the extent that our new business continues to grow, then we're going to continue to see new business expenses associated with that growth.

Brian Duperreault -- Chief Executive Officer

Meyer, we're going to give you a follow-up if you have one, and then I'm going to cut this off. So do you have anything else?

Meyer Shields -- KBW -- Analyst

Yes, I do. Just looking within Casualty, is the mix of business between the four lines of business you report: property, special risk, liabilities, Financial Lines, is that going to shift dramatically when we take into account all of the things that have been done on gross and net writings?

Brian Duperreault -- Chief Executive Officer

Yes, Peter, do you want to do that?

Peter Zaffino -- Chief Executive Officer of General Insurance

Yes, thanks, Meyer. Yes, the portfolio will continue to shrink on a net premium earned basis because we just placed the 50% quota share of the first $25 million. And like Property, we have been reducing the gross limits substantially, so that portfolio will continue to be recalibrated. And again, you'll have the impact of the reinsurance in 2019 and 2020.

Meyer Shields -- KBW -- Analyst

OK. Thanks.

Brian Duperreault -- Chief Executive Officer

OK. So let me just close here -- thanks, Meyer. Let me just close here. And first of all, I want to thank you for participating on our extended call today and bearing with us.

We had a lot that we wanted to talk about. I hope we gave you a good sense of the hard work we've been doing and continue to do here at AIG. Maybe it's a cliché, but it's absolutely true, our greatest strength is our colleagues, and I want to thank them all for all they're doing, not just for the company, but for our clients and our stakeholders. Thanks, guys.

And have a good day.

Operator

[Operator signoff]

Duration: 93 minutes

Call Participants:

Liz Werner -- Head of Investor Relations

Brian Duperreault -- Chief Executive Officer

Mark Lyons -- Chief Financial Officer

Peter Zaffino -- Chief Executive Officer of General Insurance

Kevin Hogan -- Chief Executive Officer of Life and Retirement

Kai Pan -- Morgan Stanley -- Analyst

Josh Shanker -- Deutsche Bank -- Analyst

Elyse Greenspan -- Wells Fargo Securities -- Analyst

Yaron Kinar -- Goldman Sachs -- Analyst

Doug Dachille -- Chief Investment Officer

Erik Bass -- Autonomous Research -- Analyst

Andrew Kligerman -- Credit Suisse -- Analyst

Tom Gallagher -- Evercore ISI -- Analyst

Meyer Shields -- KBW -- Analyst

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