The AIG Liquidity Crisis and It’s Impact on the Insurance Market

Advisen has just published a QuickNote (find it here) which explains how AIG is set up, how one of the smallest of its 4 divisions (less than 10% of overall revenue) got involved in derivatives based on mortgage back securities, including subprime securities.

These securities don't trade on exchanges like stocks and they don't have daily pricing from many sources and as the subprime market collapsed, AIG was forced to show lower value for these securities and the derivatives. This led to the market asking AIG to put up cash collateral (over $40b) and AIG the parent didn't have the cash.

AIG has 2 divisions with many subsidiaries writing insurance policies, 1 division for commercial lines and 1 division for personal lines. Together they are 88% of the parent's total revenue and nearly all of the positive value of the balance sheet. AIG can't take cash from these subsidiaries because state regulators require cash on hand to cover claims. Therefore AIG was forced to announce a plan to sell assets (non-core businesses).

AIG wasn't able to do this quickly enough to provide cash collateral so the government provided an emergency loan, fired the CEO for not averting this crisis and brought in a new CEO to get the assets sold to pay back the government.

Meanwhile the insurance subsidiaries are profitable and have lots of cash to pay claims.

AIG staff have seen their stock wealth disappear, risk managers are getting questions from their officers and directors, the ratings downgrades didn't help. and generally this may lead to a reduction of market share by AIG.

These are the issues in the marketplace and this paper gives buyers and brokers the facts they need to separate the problems in the one division that nearly bankrupted the parent from the sound health of the insurance subsidiaries.

Below is the executive summary of the briefing by Advisen on AIG. The full report is available here.

Liabilities incurred under sophisticated financial instruments ravaged American International Group. As AIG teetered on the verge of bankruptcy Monday and Tuesday, brokers were flooded with calls from nervous AIG policyholders. However, the financial strength of AIG’s insurance subsidiaries was not threatened: insurance regulations insulated the insurance entities from the losses. Tuesday evening the U.S. government announced an $85 billion loan to the company, averting a collapse. Assuming AIG’s customers don’t abandon the company in large numbers, the long-term impact of the crisis on the insurance pricing cycle should be minimal.

This Briefing was written by David Bradford, Executive Vice President and Editor-in-Chief, dbradford@advisen.com, 212.897.4776.

Penny for your thoughts

With the size of these market cap drops, how steamed up are Mssrs. Lerach and Weiss in their cells today?

Advisen M&A ?

I was asked recently by Mergermarket about whether Advisen would be interested in M&A activity. Here's the relevant excerpt from the published article (which is for their subscribers only so I don't provide a link):

New York-based insurance data group Advisen ... although US-based, ... operates in Europe, through its London office. Advisen's managing director for Europe Mason Power ... said the group could engage in M&A activity if there was a "two plus two equals six type of concept". "We are always looking for third parties we can work with. If it made more sense to our clients to do M&A, then we would look at it," he added. Advisen has some 100 employees, and provides information into underwriting, marketing and purchasing commercial insurance. The group is privately-funded and independently-owned.

Advisen has partnered with dozens of firms (clients and third parties) to aggregate the leading database and set of analytics in the commercial lines insurance industry. Where we can work with any third party to deliver value to our customers, we are very interested. Contact me to discuss.

Notes from the John Street Club Luncheon - New York, Sept 5th

Talking about the soft market:

John Keogh, head of ACE Overseas pointed out that beyond continued overcapacity, rates won’t change while carriers are cash flow positive in a soft market. But that when cash dries up they will have a panic and topping up balance sheets now will not be as easy as in 2005. John thought we’re probably 2 years away from the bottom.

Greg Flood, head of IronPro, echoed those thoughts and noted that the soft market will be strengthened after the end of the releasing of reserves but also pointed out that subprime is percolating and is major, even beyond the D&O market for financial institutions.

Talking about industry M&A activity:

Bill Malloy of Private Equity firm Aquiline Capital talking about actively looking for new investments but finding the challenge in valuations, focused on “distribution space” saying that 1-2% growth doesn’t sustain their desired valuations of 8-10x EBITDA.