AIG bailout

The United States government proposed an $85 billion bailout package for the American International Group. Within a few months, the bailout’s worth had risen to $ 180 billion. During the slump, AIG was the world’s wealthiest firm, with assets worth over $1 trillion and about 77 million customers from 130 countries (Ferris 2). Asset management, life insurance, general insurance companies, and other financial service providers were among the divisions of the group. However, insurance firms accounted for more than 90% of overall sales, while financial services, asset management, and others accounted for just 10%. (Ferris 4). Various studies have tried to explain how problems of affiliate or parent companies can negatively affect an insurance company. Indeed several insurance companies have become bankrupt due to financial problems at affiliate companies. The purpose of this paper is to explain affiliate risk, following the experience of the many insurance companies that made up the American International Group in the 2007/2008 global recession.

Business at AIG was profitable until the onset of the global financial crisis where the cooperation began to accumulate losses without realizing. The losses only began to reveal when the counterparties started demanding billions as well as collateral for risk exposures. Although the parent company guaranteed the Financial Product liabilities, it did not have money for margin calls; gradually leading it into crises. By the time the government declared the bailout in September 2008, the company was just about to be declared bankrupt (Ferris 6). The announcement of the first bailout evoked discussions on the liquidity of the parent company and its financial product groups. However, the state regulators maintained that the subsidiaries were solvent and ‘walled off” from the problems of AIG.

On 22nd September, the Superintendent of Insurance for New York maintained that the problems AIG was facing did not affect insurance companies; hence the companies still had more than enough to pay all the claims without any problem (Katz 1571). However, the reports from the Government’s review suggest that the companies were not as “walled off” as claimed by the Superintendent. In fact, those reports suggest that life insurance companies also suffered major losses through the AIG’s Security Lending Program, as well as the tragic intra-group investments, and needed billions of dollars to retain their solvency. The parent company could only support the subsidiary companies from the support that had been given by the government (Katz 1574). The review also revealed that by the end of 2008, a total of $81 billion had already been used, where $25 billion provided either indirect or direct support to the subsidiaries.

The announcement of the government bailout led to adverse publicity that caused liquidity problems not only for the subsidiary insurance companies but also from the Security Lending Program. There was a great need for the capital infusion and liquidity support. Following the need, the New York Federal Reserve Bank established the Security Borrowing Facility in October 2008 as a special program to provide $20 billion to the corporation’s life insurance companies (Katz 1581). The government had considered using assets of the subsidiary company to support the AIG but thought that such move would increase risks for the subsidiary companies. The emergency eased after the bail. However, the reputation of most subsidiary companies had been damaged. Hence the AIG sold a good number of its subsidiaries; consequently raising funds to pay some of its bailout funds.

Possible Consequences in case AIG was not Bailed Out

Shauna Ferris presents an assessment of various stakeholders to determine the potential outcomes in case the government couldn’t have bailed out AIG corporations. Based on her findings, government regulators would have detained to company’s subsidiaries. Every insurance commissioner had the responsibility of protecting their constituents; hence a commissioner could seize the assets of an insurer if they felt that seizing would protect policyholders. Boyd, 2008 asserted that whereas AIG was staggering on the edge of insolvency, the department of insurance at Texas had already directed the legal counsel to prepare the legal documents for the size of four subsidiaries (280).

Solvency of the subsidiaries

Although the insurance superintendent maintained that the crises at the American International Groups did not affect the subsidiary insurance companies, evidence point out the contrary. Supposing the government did not bail out the AIG Corporation most of the subsidiaries would have simply collapsed. At the beginning of 2008, the parent company has over $20 billion as the regulatory capital. The value is above the $2.9 billion authorized control level. By September the same year, subsidiary companies had suffered massive capital losses above $ 24 billion. Harington, 2009 emphasizes that the losses could have been higher if not for the change in the accounting standards that were changed on 1st October 2008 (786). By the end of 2008, the regulatory capital had decreased from $20 billion as it was in January, to $15.653 billion, and that was the value after AIG had received $23.116 billion from the government (789). There is no doubt that some of the company’s subsidiaries must have required the capital infusion to qualify the solvency standards at the end of the year.

According to GAO 2010, subsidiaries of the AIG cooperation could only manage to maintain their income through the support from the government (37). Similarly, the AIG’S financial reports hinted that the emergency fund was used to stabilize the company’s subsidiaries. The Congressional Oversight Panel report of 2010 confirmed that American International Group provided its subsidiaries with funds in 2008 as well as 2009. The parent company offered a total of $27.2 billion in 2008 and $5.7 billion in 2009. Out of the 27.2 billion that was given out in 2008, $22.7 billion was awarded to the local insurance subsidiaries whereas $4.4 billion awarded to the foreign subsidiaries (51). It is evident that some of the insurance subsidiaries had suffered massive losses by investing in security lending, and those losses were so big that they could clear the capital of the subsidiaries.

Impact on the Subsidiaries’ Credit Ratings

The AIG executives kept assuring the public that the subsidiaries were insulated since the capital of the insurance subsidiaries are insulated by the government insurance regulations. However, in case the government had refused to bail out the corporation: First, due to the financial pressure, AIG would not offer capital assistance to the subsidiary companies in instances where the insurance companies do not have capital to cover up for their losses or whenever they may need to be recapitalized. The second negative impact on the subsidiary would result from the bad reputation of its parent company (Ferris 85). The subsidiary companies would have struggled with maintaining and attracting customers because of the uncertainty concerning the mother company.

Reactions of the Policyholders

Policyholder would have run on the company’s subsidiaries. After the corporation had experienced adverse publicity, its competitors approached the company’s policyholders to convince them to surrender their policies and replace them with other policy of a different insurer. However, the government insurance regulations released several statements that urged policyholders to think critically before replacing their policies (Ferris 86). Although the press released reduced the rates of turnovers, still surrenders were as high as $800 million each week from September 2008 (Ferris 87). So if the government had not bailed out the company, all policyholders would have left the company leaving behind a collapsed multi-billion dollar corporation.

Following the above discussions, it is evident that the American International Group Corporation was at the edge of insolvency. Being the world’s biggest company of that time, AIG was too big to be allowed to fail. The corporation housed numerous institutional investors, including hedge funds, pension funds as well as mutual funds, which not only invested in the corporation but were also insured by it. Several banks insured by the corporation risked parting with billions. Although policyholders were not at great risk, the financial products of the company were under crises. With billions of dollars at stake, the company needed an intervention. The company was too important to the global economy, and hence the government would not have allowed it to fail. Hence, the deal struck by the Federal Reserve and the IAG’s executives saved the cooperation and the economy as well. The goodness in the government’s move is that if AIG turns out as successful, the taxpayers will benefit the most since the government holds 79.9 percent of the AIG shares.

Works Cited

Boyd, Roddy. Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide. John Wiley & Sons, 2011.

Ferris, Shauna Diane. “Repercussions: The Impact of the AIG Crisis on Its Insurance Subsidiaries.” (2015).

GAO (United States Government Accountability Office). Troubled Asset Relief Program: Update of Government Assistance Provided to AIG, Report to Congressional Committees (2010). Available from http://www.gao.gov/products/GAO-10-475

Harrington, Scott E. “The Financial Crisis, Systemic Risk, and the Future of Insurance Regulation.” Journal of Risk and Insurance 76.4 (2009): 785-819.

Katz, Jonathan G. “Who Benefited from the Bailout.” Minn. L. Rev. 95 (2010): 1568.