Why AIG is important.
Today the federal government will likely intervene in favor of AIG once again. No doubt many of us (including me) are angry and a little upset about these massive interventions. What many us do not know is why7 the AIG intervention is so important. Here is an explanation.
First we have to start with the nature of Insurance. When we buy insurance either at our employer or from the guy on the corner we prefer to think the name on the policy is our insurance provider. That is only partially true. In reality we are purchasing a house of insurance. It is termed spreading the risk. Lets take health insurance for instance.
Say we buy insurance form XYZ company, they will administer the claims process and pay some portion of each claim based on the premiums received. However XYZ company also uses a portion of our premium to purchaser what is called reinsurance. It specifies that after a certain level of claims, $100,000 is typical, the reinsurance carrier will pay all claims.
This reinsurance, makes all insurance possibile. In fact all insurance is backstopped by a system of reinsurance. All reinsurance carriers are in fact reinsured by other carriers. In fact the there only a few carriers in the world who hold the majority of risk. In the health insurance market there are perhaps ten to twenty reinsurance carriers. All of which are reinsured for some level of risk. Almost no company takes both the first dollar and the last dollar of risk for any policy.
Now this is where AIG comes in. AIG is one the largest reinsruser in the world. Along with Loyds of London , AIG is the backstop for millions of health, life and commercial transactions int eh world. In fact oif AIG went bankrupt tomorrow, almost all business int he world would come to screeching halt. AIG reinsures, property, liability, health, auto and transactional activities. In fact the insurance house of cards would collapse in a matter of hours if AIG were to fail.
Consider this, you might have an auto policy that is reinsured by AIG and not even know it. In fact you may have several policies that are reinsured by AIG, in most cases it is unlikely you know about this arrangement. Now suppose AIG fails. Almost immediately there will be a crisis in the reinsruance market. Insurance companies will be searching for new reinsurers and the price will escalate dramatically. Making current policies unprofitable. At the very least the price of insurance will escalate significantly.
Of more immediate importance is that many of the current policies will immediately no longer be “insured”. With the reinsurance carrier no longer in business, the basis of the individual policies would not be valid thus rendering them little more than paper promises without good back up for catastrophic claims. In short without insurance business stops.
One area of insurance is for decisions made by boards of directors, so that they can make decision about the company. Without this insurance, no sane person would serve on a board of directors for any company because every decision from the simple, should we shovel the walks to the complicated business decisions have potential for ligation. Without insurance, this litigation is personnel, Directors are personally liable for these decsions and as such no one would serve, it is simply to risky. AIG in its various forms and acting as a backstop for other companies can and does reinsure a great potion of the business climate.
Now lest say you drive a car, have life insurance, health insurance, property causality, liability, or homeowners insurance. It is a safe bet that at least some of these products are reinsured by AIG. In short if AIG fails, a vast portion of the US and World economy simply becomes uninsured. And if it is not insured, it will not operate. WOudl you drive a car without insurance? Well for one it is illegal, and second the risk would be astronomical.
In short, AIG is way to big to fail,.
Rick
