What could the Fed's $85 billion loan to the insurance giant mean to your business, and what can you do about it?
A tumultuous 10 days on Wall Street recently culminated in an $85 billion federal
loan to insurance giant AIG, part of an agreement that gives the U.S. government a 79.9 percent equity interest in the company and the right to veto the payment of dividends to common and preferred shareholders. In addition, the company's CEO,
Robert Willumstad, has been replaced by former Allstate chief executive Edward Liddy.
AIG's near failure is considered an anomaly among insurance companies, a position it found itself in as a result of its involvement in credit default swaps -- complex arrangements that boil down to insurance against loan defaults. Say a major bank needs to mitigate its risk against billions of dollars in loans it's made to corporations. To protect itself against the risk of those loans going into default, a third party assumes the risk in exchange for payments by the major bank, similar to insurance premiums.
Since defaults had been so rare over the past few years, these credit default swaps were a way for the issuing companies to make easy money. One major financial columnist compared it with selling car insurance in a world where there are no car accidents.
Eventually, however, the center could no longer hold, and when AIG defaulted on $14 billion worth of credit default swaps it had made to investment banks, insurance companies, and other entities, it had to turn to American taxpayers to bail it out.
The federal bridge loan came as a surprise to some after the government on Sept. 14 refused to bail out Lehman Brothers Holdings Inc., which filed for bankruptcy-court protection and was being sold off in pieces. Most importantly, it has brought the insurance industry into the midst of a financial crisis that has politicians and policymakers calling for sweeping regulatory reform.
"Up until recently, for the most part, the anxiety among consumers has been [focused on] the banks, driven by the subprime issue, and the brokerage houses," said American College President and CEO Larry Barton. "Now, for the first time, we have a major insurer with what at first we thought was heartburn but which has very much been blossoming into cancer. This will create the potential for a number of companies with no association with AIG whatsoever to be receiving questions from the public."
Those questions, said Barton, can include concerns about the safety and solvency of products, the stability of premiums and rates of return, and the source of financial reserves. Clients are also likely to wonder what would happen if their insurers, most of which are likely to be smaller than AIG and not tagged for federal assistance, faced a similar financial crisis.
According to Insurance Information Institute President Robert P. Hartwig, state guaranty funds help protect the investments of both life and annuity policyholders in cases such as these. Before these come into play, however, an insurer experiencing financial difficulty would enter rehabilitation, typically under the auspices of a state insurance department, which would attempt to reform the company so it could meet its obligations using its existing assets. Should those assets fall short of expectations, the company would be liquidated and guaranty funds would be leveraged.
Hartwig did point out that AIG's main issues were not created by its insurance unit, but rather by its parent company. In fact, the carrier issued a statement on Sept. 16 addressing policyholder concerns and assuring them that its life insurance, general insurance, and retirement services businesses will continue to operate normally. Agents within its insurance unit are being urged to conduct business as usual, Hartwig added.
"The insurance policies written by AIG companies are direct obligations of its regulated subsidiary insurance companies around the world," the statement read. "These companies are well capitalized and meet or exceed local regulatory capital requirements. The companies continue to operate in the normal course to meet obligations to policyholders."
Barton, however, said that consumers are unlikely to distinguish between AIG's insurance division and its other financial units. What matters to them, he said, is that the entire company appeared to be on the verge of collapse.
"It makes total sense that AIG was running a sound insurance division," Barton said. "We know that for a fact; we know their insurance products were sound. But if I'm a client sitting there in El Paso or Spokane or Portland, Maine, AIG is one company. It doesn't matter what the product is. It's kind of like Wal-Mart. It doesn't matter if the shampoo is bad or the cash register doesn't work -- it's one company."
What's next?
In an Oct. 3 conference call, Liddy announced that AIG would retain its U.S. property and casualty business, as well as its general insurance businesses outside the country. It will also continue ownership in its foreign life insurance businesses, most of which reside in Asia. That leaves everything else, including its U.S. life insurance companies, up for sale.
On that same call, Liddy said the company had already drawn down $61 billion of the $85 billion it had received from the federal government.
According to John Davis, president of the brokerage Insurance Designers of Dallas, AIG policyholders with divisions purchased by other insurance companies will retain all the original terms of their contracts. But for now, it's business as usual -- AIG has outfitted its home page, www.aig.com, with an AIG Answer Center, which features a letter from Liddy assuring policyholders, agents, and brokers that "our insurance companies remain strong and well-capitalized... your policies are safe."
When dealing with other carriers, Hartwig said, clients, prospects, and agents should continue to look at the financial strength ratings of potential insurers. Several credit rating agencies downgraded AIG in late September. Standard & Poor's dropped the company's rating to A-, Moody's to A2, and Fitch to A.
He added that the AIG crisis and resulting bailout provide an opportunity for agents to keep their longtime customers informed about the current financial climate and provide both existing and new clients with options based on their goals and risk tolerance.
Ultimately, Hartwig said, time is of the essence: Don't wait for your clients to contact you. Reach out to them now with the latest news, regardless of whether they hold AIG policies or not. And let them know what's next to the best of your ability.
Barton added that while other companies may remain financially secure, the resulting shock waves will be felt throughout the insurance and financial services industries.
"When you have an icon brand collapse, it makes it harder for everyone," he said. "I don't care who they work for -- nobody celebrates this. It's a loss to the entire industry and a loss for all agents. They'll need to work doubly hard to regain the trust of their clients."
No matter what, said Davis, it's an agent's job in these tough times to make sure their clients are protected -- and insurance can offer them the protection no other vehicle can.
"I think this is a time when people see that their investment and savings have eroded, and insurance plays a vital role in replacing that," he said. "That can be done instantly. We can insure the risk -- it's part of what insurance is about."
Christi Daughenbaugh of the brokerage Borden Hamman agreed.
"America is strong, and it'll come back," she said. "People still need insurance more than ever before. We help manage risk; that's what we do, and people feel very afraid of the risk right now."
Christina Pellett is managing editor of the Agent's Sales Journal. She can be reached at ASJeditor@AgentMediaCorp.com or 800-933-9449 ext. 226.
