Tuesday, September 16, 2008

Why AIG Matters

American International Group is the world's largest insurer and has been Wall Street's biggest worry for a while now. The insurer is struggling to raise cash while in the midst of a government bailout. Despite the company's importance, the average American is probably not sure how, or why, its problems will affect them.

AIG's current woes and what they mean to you
At least in the short term, you probably don't need to be worried at all. The problems are with the AIG holding company, not the individual insurance company subsidiaries that you do business with, according to a source with New York State's insurance regulator. Even if AIG's holding company is forced to file for bankruptcy court protection, there's a good chance that the subsidiaries will continue to operate normally with no disruption in claims payments. That has happened in the case of other insurance holding companies bankruptcies in the past, such as Conseco.

Typically, if an insurance company falls into financial distress and is at risk of having claims that exceed the assets it holds to make those payments, the insurance regulator in its home state will take control of the firm and make payments. The state regulator will not only use the firm's own assets to make those payments but if necessary can also make payments out of a state fund into which all insurers in the state are required to pay. This guarantee applies not just to traditional insurance policies but also to retirement products that have a promised payout, such as annuities. But there are limits to the payments that will be made to customers that vary depending on which state a particular AIG subsidiary is based, according to Joseph Belth, professor emeritus of insurance at Indiana University and editor of The Insurance Forum, a newsletter often critical of the industry.

Changing from AIG to another insurer
While credit rating agencies downgraded debt held by AIG on Monday, AIG's ratings are still considered investment grade and the company's insurance subsidiaries are considered to be secure, at least for now. Belth said changing insurers is not a simple decision. "A lot depends on what kind of insurance you talk about," he said. "If you're talking about life insurance, you have to think about whether you can qualify with a new insurer, if your health has changed. But it's something you have to consider if the ratings decline into the vulnerable range."

Why you should care about problems at AIG if you're not a customer
AIG is by far the world's largest insurer and its stock is found in many mutual funds, including any S&P 500 index fund. It is also a component of the Dow Jones industrial average. All by itself, it's been responsible for dragging the Dow down more than 400 points so far this year. AIG is also active in the business of credit default swaps, complicated financial instruments used by investors to protect themselves from bond defaults. Lehman Brothers was another major player in that field. If both go away, it would create a tighter credit market for consumers and businesses trying to get loans. For this reason, there has been a debate about whether the Federal Reserve would agree to lend the company the tens of billions of dollars it needs to cover its short-term funding needs or if the Fed will try and get private firms to assist AIG instead.

AIG is an insurer, not a lender
All insurers take money they collect in premiums and invest them in different forms of assets. The idea is to make money on those investments so that the insurer can keep their premiums low and attract more clients. But AIG made a bigger investment into securities that were backed by subprime mortgages than most other insurers. As defaults and foreclosures of those loans rose, the value of those securities fell, creating big problems for the firm. In the past nine months, AIG has reported net losses of more than $18 billion, largely due to its exposure to bad mortgages.


Sources: WSJ, AP

No comments: