If the venerable adage about an ill wind is true, then we think the ill wind embodied by the monumental financial troubles of American International Group (AIG) is destined to blow some good to competitors in the insurance business.

AIG, the world’s biggest insurance company, accounts for about 7% of all insurance premiums written in the U.S., according to A. M. Best Company. AIG has been a leader in most of its insurance lines; domestically the company holds double-digit market shares in aircraft, directors and officers liability, accident and health, fire, marine, and product liability insurance. But those market shares are in jeopardy due to AIG’s badly eroded financial condition, in our view.

In the past six months, AIG has required four rescues by the federal government, which now owns about 80% of the company. Altogether, the federal government has injected about $170 billion in AIG in an effort to buy time for the company to streamline itself, sell many of its insurance businesses, and concentrate on reorganizing its core property and casualty insurance lines.

As we see it, AIG’s weakened balance sheet, bled by disastrous investments and contracts in derivatives, nullifies a competitive advantage that has been instrumental to the company’s rule of the insurance roost. In the process, AIG’s total debt-to-equity ratio has soared to 3.7, compared with 0.8 for all of the companies in the S&P 500 Index. The company’s book value per share has plummeted to 40 cents, down from $37.90 in December 2007, in the estimation of Credit Suisse Equity Research.

What’s more, AIG is losing underwriters and key managers by the score, partly because the AIG shares that represented a significant part of their compensation have sunk from a 12-month high of about $49 a share to less than $1. And the federal government’s populist efforts this month to block AIG’s planned payments of $165 million in bonuses may serve as yet another incentive for key employees to leave. Recently, for instance, a team of dissatisfied AIG underwriters involved in professional liability insurance defected to a more financially stable competitor, W. R. Berkley. At AIG that team oversaw more than $600 million in business annually, according to Bank of America/Merrill Lynch Research. To the Wall Street Journal, such employee departures are yet another "sign of the difficulties AIG will encounter in trying to maintain the value of its franchises."

Also, the financial crisis is deflating the value of the units that AIG is seeking to sell. For example, late last year Munich Re, the world’s biggest reinsurer, bought AIG’s Hartford Steam Boiler unit for $742 million -- a price that was about 33% less than what AIG paid in 2001. We think other businesses that AIG will divest are likely to be similar bargains, since the company is in no position to hold out for top dollar; AIG needs the money now to pay off loans from the federal government. For would-be buyers, the chance to purchase these assets at sharply discounted prices is, of course, another advantageous byproduct of AIG’s tenuous financial condition.

In light of all of this, we think AIG may lose some risk-averse customers who are worried about the company’s finances. And we think other customers may continue to do business with AIG but do less of it going forward, relying more on other insurers instead. As Keefe, Bruyette & Woods, an investment bank, noted in a research report, clients are "diversifying away from their heavy use of AIG." Mike Foley, an executive at Zurich Financial Services Group, told Dow Jones Newswire that uncertainties about AIG’s future have inspired a customer "flight to quality" to AIG’s competitors. He and others in the industry anticipate the flight to quality would accelerate if AIG’s credit rating is downgraded. For its part, AIG reported that net premiums fell 22% in its U.S. commercial-insurance business in the fourth quarter from a year earlier. In a Securities and Exchange Commission filing in early March, the company conceded that some customers have "reduced the number of lines or limits of coverage due in part to concerns over AIG’s financial strength."

We think those concerns present a distinct opportunity for competitors to seize market share in all the lines of insurance in which AIG is a leader. In our judgment, AIG’s franchises in so-called "excess and surplus" insurance (insurance that generates above-average profit margins because it covers unusual risks that many traditional insurers don’t want to assume), directors and officers liability insurance, and aviation insurance are particularly vulnerable.

Our analysis indicates that there’s ample capital and capacity in the global insurance industry, so competitors can easily absorb much of AIG’s business if worse comes to worst for the company. Beyond  that, competitors’ forays into AIG’s turf are occurring at an opportune time, as prices in many types of insurance are starting to firm up after a recent stretch of softness.  For instance, in a conference call with analysts, senior managers at Navigators Group confirmed that pricing for their marine, energy, and directors and operators insurance is improving.

Who will benefit?

In our estimation, the insurance companies that have the best chance of benefiting from the ill wind pounding AIG are those with financial characteristics that we happen to prize.  Specifically, the beneficiaries are likely to be those with strong balance sheets and conservative investment portfolios, and with little or no exposure to subprime-mortgage debt or collateralized debt obligations that have been the bane of AIG.  One reason their balance sheets are strong is that they, unlike some less-prudent peers, had the discipline to resist relaxing their underwriting standards in this decade; instead they generally turned away new business when they believed the insurance premiums received would likely prove inadequate for the risk assumed.

We think three relatively small insurance companies, among others, possess those characteristics in abundance and thus are well-positioned to gain market share at AIG’s expense: W. R. Berkley (market capitalization: about $3 billion), HCC Insurance Holdings (about $2 billion), and Navigators Group (about $800 million).

W. R. Berkley is often compared to Berkshire Hathaway, the insurance conglomerate headed by Warren Buffett.  Like Berkshire Hathaway, W. R. Berkley is decentralized, grants considerable autonomy to the heads of its businesses, and is led by a highly respected chief executive officer, William R. Berkley, the founder.  W. R. Berkley has “amassed one of the industry’s best records since it went public in 1973” by insuring “the likes of NFL teams, New York cooperative apartment buildings, tanning salons, and scuba-diving operations that many rivals ignore or won’t touch,” says Barron’s.  The company has assets of $17 billion.

HCC: avid acquirer

HCC Insurance Holdings competes with AIG in several lines: directors and officers liability, aviation, marine, and energy insurance.  The firm has assets of $8.3 billion and is continually on the prowl for niche acquisitions to broaden its business.  Over the past 15 months, HCC has acquired six companies, including Arrowhead Public Risk, a risk-management insurer serving the public sector, and Surety Company of the Pacific, an underwriter of license and permit bonds for California contractors.  We think HCC has shown exceptional underwriting discipline, which has consistently enhanced its cash flow from operations.

Navigators Group, with assets of $3.3 billion, is a holding company with a number of subsidiaries, including a major marine-insurance unit and operations at Lloyd’s of London, the legendary 321-year-old British market for specialty insurance. The company has capitalized on its Lloyd’s overseas licenses, which enable its U.S. underwriters to offer insurance all over the world. Navigators has beaten Wall Street analysts’ earnings expectations over the past 12 months. We think Navigators has the potential to capture market share in directors and officers liability insurance (which accounts for about 10% of the company’s revenue) not only from AIG but from another troubled firm, XL Capital, in the near term.

The views expressed represent the opinions of Turner Investment Partners as of the date indicated and may change.  They are not intended as a forecast, a guarantee of future results, investment recommendations, or an offer to buy or sell any securities.  Opinions about individual securities mentioned may change, and there can be no guarantee that Turner will select and hold any particular security for its client portfolios.  Earnings growth may not result in an increase in share price.  Past performance is no guarantee of future results.

Turner Investment Partners, founded in 1990 and based in Berwyn, Pennsylvania, is an investment firm that manages more than $15 billion in stocks in separately managed accounts and mutual funds for institutions and individuals, as of December 31, 2008.

As of February 28, 2009, Turner held in client accounts 197,286 shares of W. R. Berkley, 233,538 shares of HCC Insurance Holdings, and 251,150 shares of Navigators Group.  Turner held no shares of American International Group, Munich Re, and XL Capital.