Reed Smith Podcast on the Federal Bailout of AIG - Now Available on the Insurance Law Center

Reed Smith Podcast on the Federal Bailout of AIG - Now Available on the Insurance Law Center

In a podcast currently on the Insurance Law Center, James M. Davis and Paul R. Walker-Bright of Reed Smith discuss the implications of the federal bailout of AIG. They first noted that AIG comprises one of the largest insurance conglomerates in the world. It is the largest insurance company in the world if measured by amount of premiums. AIG provides credit default swaps which constitute a type of insurance mechanism for securitized packages of mortgages and this was in large part what undermined its value. AIG had to pay out on this “insurance” as the underlying mortgages defaulted. The ensuing losses eroded AIG’s overall financial strength which resulted in a degrading of AIG’s credit rating. This made it virtually impossible for AIG to raise the money it needed to meet its obligations.

Readers may access the Davis/Walker-Bright podcast by clicking here.

If AIG collapsed many other companies dependent upon AIG would collapse as well. So the federal government intervened to rescue AIG. The government loaned AIG $85 billion in exchange for gaining 80% equity in the company. Moreover the government’s loan carries a high interest rate and is for a limited period of time (24 months). So AIG probably must sell off a lot of its assets quickly (under government approval) to gain liquidity in order to meet its obligations and regain a good credit rating. Such sales are already starting to happen. In general, AIG’s shareholders have been “pushed aside;” shareholders will not have a say in sales of AIG’s assets.

What about AIG’s policyholders? So far, brokers in the main are telling policyholders to not abandon AIG and there has not been a massive abandonment. If there should be such a run, AIG may fail. It is important to note that while credit default swaps work like insurance, they were managed by the financial wing of AIG, not its insurance wing. The insurance wing of AIG is relatively strong with over $26 billion in assets. It was the financial wing that was near collapse.

Nevertheless, other insurance companies are taking steps to increase their capacity to accommodate policyholders wishing to abandon AIG. So one expected effect of the AIG bailout is increased competition in the insurance industry. If some of AIG’s insurance divisions are sold off and have to survive on their own, this will only add to the competition.

The international insurance market is also potentially significantly affected as it depends on giant AIG for insurance. AIG has been relied upon to meet large insurance needs. If AIG recedes will there be enough insurance available to meet the world’s needs? So far foreign insurers haven’t significantly indicated that they are in danger.

In terms of predicting the future, the speakers thought the financial wing of AIG may want to utilize the relatively cash rich insurance wing, so some insurance assets of AIG may be sold off. In a larger sense, the stability of the national and international financial structure may be in some doubt if giant and heavily capitalized organizations such as AIG, Merrill Lynch, Washington Mutual, etc. can come to the brink of collapse. That is, the pillars of our system may be no safer than small enterprises. Are we facing a string of falling dominoes?

An interesting observation in terms of insurance regulation is that the failing financial wing of AIG was regulated by the federal government while the solvent insurance wing of AIG was regulated by the states. The speakers asked, “Does this argue for the continued regulation of the insurance industry by the states rather than by the federal government?” Concomitantly, does this argue for augmented federal regulation to meet state standards as a precondition for the federal regulation of insurance?