AIG's Wrong Solution to Cash Crunch


A move by New York state to allow beleaguered insurance company AIG (STOCK QUOTE: AIG) to raise money secured against the assets of its insurance subsidiaries is not a viable solution.

It is simply a bandage over a bleeding wound and risks infecting the financially secure life and health and property and casualty insurance businesses if AIG is unable to diagnose and cure the cause of the hemorrhage.

AIG was given permission by the New York state insurance commissioner to leverage the assets of subsidiaries to raise up to $20 billion, New York Gov. David Paterson announced Monday.

Trading at 95% below its stock price of a year ago, AIG reportedly sought $40 billion from the Federal Reserve over the weekend but was denied. Following the demise of Lehman Brothers (STOCK QUOTE: LEH), the Fed is not in the mood to bail out businesses unless they could affect the economy, as Freddie Mac (STOCK QUOTE: FRE) and Fannie Mae (STOCK QUOTE: FNM) would have. After all, AIG would spread the impact of failure across the many countries where it operates.

AIG's life and health and property and casualty insurance companies are financially secure. The insurer's 71 companies in the U.S. -- which offer policies in all states and Puerto Rico -- were last rated using the 2007 financial data. The 28 entities with at least $1 billion in assets are shown below in table A.

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If AIG borrows against its assets, fails to get out of the financial mire it is sinking into and files for bankruptcy, it will be the policyholders who are exposed. Policyholders currently are in a reasonable state of security, as AIG has the liquidity to meet claims.

The National Association of Insurance Commissioners did not immediately return calls seeking comment. The commissioner for the domicile state of the holding company is responsible for taking the lead in protecting AIG policyholders, spokeswoman Vanessa Sink said.

In this case, it appears New York is taking the lead. The state may believe it is better to give AIG a way to raise cash rather than allowing it to fail.

In table B below, the assets most likely to be used represent 46% of the insurer's total. Clearly, $55 billion in mortgage-backed securities, as they were at year-end, will not be considered acceptable by any lender. The most likely assets to be used will be the approximately $218 billion in class one bonds. These consist of a mixture of government-backed securities, AAA-, AA- and A-rated corporate bonds. Any lender will almost certainly require a multiple of coverage for the debt in collateral. A $20 billion loan would represent approximately 10% of the available security.


If the insurance commissioners think policyholders are at risk, they can take regulatory control of the company. With $20 billion being insufficient for AIG's needs and the ability to raise additional capital questionable, the temptation to return to regulators will be high. Regulators must be aware that further exposing AIG's insurers to the ills of the group by allowing the company to return for more collateral will threaten their viability.

The structure of the $20 billion collateral leaves open questions: Which insurance subsidiaries would be used as collateral? Is New York, suggesting the subsidiaries move money "upstream" to the parent? Regulators in each subsidiary's domicile state must explicitly approve the transfer of money upstream, so the state's suggestion that AIG, the parent, could use subsidiaries' assets as collateral makes no sense.

It remains to be seen if AIG can find a lender prepared to offer even $20 billion.

Assets of 71 AIG Insurance Subsidiaries as of 12/31/07
Total Assets 470,649,710,000
Total Class 1 Bonds 218,228,697,000
Total MBS 55,190,096,000
Assets of NY AIG Insurance Subsidiaries as of 12/31/07
Total Assets 73,929,679,000
Total Class 1 Bonds 41,145,047,000
Total MBS 4,773,194,000 Ratings issues financial strength ratings on each of the nation's 8,600 banks and savings and loans which are available at no charge on the Banks & Thrifts Screener. In addition, the Financial Strength Ratings for 4,000 life, health, annuity, and property/casualty insurers are available on the Insurers & HMOs Screener.

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