Why AIG is important!

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

Great explanation of the insurance industry, Rick. It is also important to note that AIG, like all insurers, is not just a single company issuing insurance policies – it is a group of many different companies. AIG’s insurance subsidiaries are all solvent, have enough cash and investments to pay their claims and, most importantly, are heavily regulated by state insurance commissioners. The problem with AIG is that there are other subsidiaries that have made risky investments or have written risky insurance instruments. The broad scope of AIG’s influence in all kinds of financial products is what makes it too big to fail. It, and a few other entities – insurance and financial – are so intertwined in all aspects of global risk management and finance that letting one fail could cause the global economy to suffer even greater loses than those to date. This will be a messy, expensive clean-up, but it needs to be done. Hopefully, the financial and regulatory worlds will realize that the system that permitted this all to happen needs to be cleaned up.

Johnathan:

You are exactly right in your additional explanation. Thanks for the additional information.

Rick

Thanks so much for your detailed explanation. I hate the massive bailouts that have been going on, but I realize that some of them are necessary or else basically the deck of cards will fall flat. Living w/ diabetes and in a hurricane area, I fo’ sho’ don’t want reinsurers failing. Now I’ve got some good ammo to go at my father with.

Most of us (me included) really hate the “bail out” however the consequences of not intervening are so severe in this case that there really is no choice. Imagine, if the reinsurance market collapsed, and we went (all of us with health insurance) went to the pharmacy to get a desperately needed scrip. First, the pharmacy would likely not be open, because they are not insured, second if they are open they likely would require a cash payment for the drugsa, because our insurance would be suspect, and ultimately, we likely could not drive over to get it.

Like i said i am no fan of AIG, this issues is repugnant to me, but I am also realistic, and I can see why the federal government is doing the cash infusion. Frankly, the very foundation of the economy would crumble if they did not. We need to keep that in mind when many of friends start to complain about the AIG matter. They really are to big to let fail, because if it fails, all of us those with and without insurance will see a dramatically different America.

Rick

There comes a time when we need to make a choice between “bad” and “worse”. The bailout is “bad”. Not doing anything is “worse”.

Rick, you obviously are in the insurance industry – your knowledge is beyond impressive. I’m in the financial/legal side, and we rely on healthy insurance companies to make loans that help pay for economic growth. These insurance companies are often the life insurance companies, since they write policies that are expected to last a long time. Those policies are also reinsured. If the reinsurers are not around, the insurers will need to increase their reserves, which means less lending, which means less money available in the credit markets.

None of this bailout is good, but it is necessary. We saw what happened in the last quarter of 2008 when there was no credit available. Without serious financial market remedies (the bailout, and likely more to come), the credit crisis will continue and we are all going to be looking for paddles as we float up the creek. You think health insurers are increasing premiums now and decreasing coverage? Just wait.

I know it’s needed, but to me it seems like we have a bunch of folks addicted to money so we’re gonna give 'em alot more! I know there is a psychological therapy about giving an addict too much of what they are addicted to, but come on! lol, it is such a damned if we do, damned if we don’t situation.

Also, if we’re going to be giving this kind of money to these types of institutions, I really want to see people go to jail. Not just the big fraudsters we’re seeing in the headlines, but the actual corporate types who were making these types of decisions with no regard for anything more than a few months out. If it wasn’t actual malfeasance, it certainly rises to the level of gross incompetence. But then, I’m just old and cranky.

Scott’s dead on, and if he is old and cranky, I wonder what that makes me. There need to be consequences, and it should start with getting those obscene bonuses back and continue with civil liability against those who caused all these loses. Jail would be nice, but the government, in the past, has proven so lame at making these charges stick that it is not worth the effort.
More importantly, though, as we give these gluttons more money, we need to know it is stopping the problem, not funding more bonuses, corporate planes and executive junkets.

Actually I am not int eh insurance industry, I have however been in a position to purchase group health, Liability and other insurance for schools and city government for several years. As a consumer of individual and corporate insurance for over 30 years, it does give one some knowledge.

Now please do not misunderstand, I really dislike giving this money to AIG or anyone else. I cannot think of a good excuse for funding excess at any level of government or industry. Unfortunately in this case being and doing nothing will have catastrophic consequences for those of us who rely on health insurance. Just so we all understand, even if we do not have health insurance we rely on it because without health insurance no doctors or hospitals would exist.

Hopefully I can give folks an understanding of the choices faced. It is not a black and white issue.

Rick

Knowledge as a consumer is just as important.

See the NY Times Dealbook today on why AIG needs to be saved:

http://www.nytimes.com/2009/03/03/business/economy/03sorkin.html?dlbk

The article focuses on life insurance, primarily, but it is applicable to the entire insurance industry. AIG does not deserve and has not earned the bailout. The consequences are just too great to not do it. And those who have contributed to this set of circumstances need to be punished, whether it is in the criminal justice system or forfeiture of bonuses received or whatever else is appropriate. Perhaps bringing back the public stocks in the town square would be a good punishment – it would certainly drive up the demand for tomatoes (particularly rotten ones).

One thing that seems to have been barely mentioned by the media in all this is that the US gov’t encouraged this behavior with laws designed to increase home ownership, esp among those with low incomes. Therefore, the banks had a legal basis for approving loans they normally wouldn’t have. And they needed insurance for those loans. This started under the Clinton administration and the Bush administration seemed to just let it go on.

Oh, and lets not forget that the insurance industry is the single largest loaner of money to the Fed.

Sometimes, I think it is just time to get a six pack, sit on the front porch and wait for the coup… /sigh

Can I bring the scotch – it has no carbs!!

hell yea, we’ll even cook out!

If AIG, is to big to fail is it big to exist?

I would have to agree that they likely are. We need to remember that bell operated as a regulated monopoly and was broken apart in favor of competition, should AIG be broken apart? I have to think yes it shoudl, as soon as the assets can be sold. Right now no one, I mean no one is buying. When they are buying we should take the Teddy Roosevelt approach, trust busting may be best.

Rick

I think a lot of these entities are too big to exist. I’d like to see AIG, Citi and BofA all broken up – not just having their various divisions or subsidiaries sold to others, but broken in to separate, stand alone entities. I do not subscribe to the concepts of bigger being better or “synergistic economies of scale” (if that’s not consultant-speak, I’m not sure what is).

If something is too big to be allowed to fail, then it should be rescued, fixed, and then broken into smaller pieces that can compete and stand on their own, or fail on their own.

I love the logo. Where did you get it?

it was on a tshirt-of-the-day site last week… cracked me up

That is funny, I want the T-Shirt.

Rick