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.