The insurance industry has been on a roller coaster ride over the last few weeks. Riviera Insurance Services received numerous questions from clients and friends as the events were unfolding. Concerns from policyholders with AIG companies topped the list. We believe an overview of AIG and some comments about the future are appropriate.

Most people associate AIG with the insurance industry.  However, AIG is much more than an insurance company.  The best description of AIG’s business model is that they are an international financial conglomerate. AIG’s product line falls into two categories; insurance and financial services.  These products are available to businesses, individuals and families.  AIG operates in more than 130 countries and its stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo

A business unit, separate from AIG’s insurance business, has been heavily invested in a financial instrument called a credit default swap (CDS) issued by AIG Financial Services.  The CDS product provides protection against a default tied to corporate debt and mortgage securities.  The CDS product requires AIG to post cash collateral if the value of the corporate debt or mortgage securities deteriorate.  It is well known that the housing market has deteriorated; much of AIG’s CDS exposure is tied to sub prime mortgages.  Mid-September AIG was required to post $14.5 billion in cash to meet the collateral obligation.  They were unable to do this, in part, because the insurance company regulators would not allow AIG to shift cash from AIG’s insurance companies to shore-up AIG Financial Services.

Faced with the inability to meet the collateral cash obligations, AIG was facing Chapter 11(reorganization) bankruptcy.  The Federal Reserve decided that this could hurt the U.S. economy, which was already reeling from sub prime mortgage losses.  The federal government announced it would provide AIG with an $85 billion loan.  In return for the loan, the federal government receives 80% control of AIG stock.

AIG’s insurance operations are very healthy.  AIG’s U.S. commercial insurance operations have $26.7 billion in policyholder surplus with additional surplus from U.S. personal insurance operations and international subsidiaries.  As cited earlier, AIG could not shift this surplus to meet the collateral cash obligations of the CDS portfolio.  This protection is a savior for policyholders relying on AIG’s insurance policies to respond to current and future claims  

The future for AIG is starting to take shape.  The new CEO will lead the effort to sell parts of the conglomerate to pay off the $85 billion loan and bring AIG back to a financially sound entity.  Given the profitability of the insurance operations, it appears some of these entities will be sold.  In the U.S., AIG has 71 insurance company subsidiaries.  Already, several other major insurance companies have expressed interest in acquiring portions of AIG’s insurance operations.

Setting aside the financial service operations of AIG and focusing on the insurance operation, it appears the regulatory practices and oversight has successfully protected policyholders.  Key provisions have sheltered the insurance operations so that AIG could not strip-away policyholder surplus to correct the mistake they made in the financial service business.

The damage we see to AIG’s insurance sector is the negative perception of AIG’s image.  The insurance companies left in the AIG conglomerate will have an uphill battle to turn their image around.  Potential challenges include:

• Current policyholders may decide to leave mid-term.  At the very least, policyholders may seek alternatives at renewal.
• The new CEO has the task of stabilizing the conglomerate.  Accomplishing this may include selling some or all of these insurance companies. 
• Insurance brokers may steer policyholders away from AIG.
• AIG employees may seek employment elsewhere.

One final editorial question for thought: What can be done to persuade corporate executives to improve performance and stay within risk tolerance that keeps the corporation out of harms way?  I bet we will hear more on this topic!