In These New Times

A new paradigm for a post-imperial world

AIG Spells Out What a Run On Insurers Would Mean

Posted by seumasach on March 13, 2009

David Goldmann

Asia Times Blog

12th March, 2009

What happens if insurance policyholders lose confidence in their provider and cash in their policies? It’s a run on the insurance industry, same as a run on the banks — except the regulators have no obvious mechanism to stop it. This could blindside the system in a big way. The academic tinkerers (Roubini, Krugman) who propose nationalizing the banks and haircutting their debt didn’t think about this one. But AIG did. An AIG presentation to Congress on the consquences of its failure was posted today on the Financial Times “Alphaville” blog. It is one of the more entertaiing things to circulate in the course of the crisis.

Some highlights:

1) $30 billion of AIG Financial Products debt would go bad

2) $38 billion worth of wraps (insurance) on stable value funds would disappear, leading them to break the buck and provoking a run on money market funds;

3) $63 billion of guarantees on Collateralized Debt Obligations and Collateralized Loan Obligations would vanish, blowing up the hedges of most correlation (synthetic CDO) trading desks on Wall Street

But the best part is AIG’s depiction of what a run on the insurers might look like:
AIG has written more than 81 million life insurance policies to individuals worldwide

If AIG fails, policyholders are likely to seek to “cash in” policies, placing enormous strain on the insurance system, as well as bond and equity markets as assets are liquidated to pay policyholders as capital, along with state guarantee funds, might be insufficient to pay all policyholder claims

– Third-party sellers of AIG products would face an unmanageable spike in customer redemption demands, damaging consumer confidence

– Forced sales of assets would be required to cover withdrawals
AIG Retirement Services

6.7 million policies/accounts – including many retired Americans

• Total account value: $147.5 billion

• Many beneficiaries are middle-class Americans earning around $50,000-60,000 a year

• Income from AIG’s 403(b) plans is often the beneficiary’s only source of retirement income

– Products include defined contribution retirement accounts, such as 401(k) (VALIC), deferred fixed

annuities (AIG Annuity), variable annuities and brokerage accounts

– AIG Annuity: #1 ranked seller of fixed annuities through financial institutions

– VALIC: #1 or #3 ranked across non-profit sectors (#1 in K-12 teachers, #1 in higher education and #3 in healthcare)

§ Consequences of Failure

– A VALIC/AIG Annuity failure would be one of the largest failures in the history of life insurance, putting applicable retirement savings significantly at risk and causing a loss of confidence in the private pension  system in the U.S.

– Seizure by state regulators would have an adverse impact on state guarantee funds, which are unfunded, resulting in assessments against other insurance companies

– Such assessments in an already weak market could lead affected industry players to sell assets, resulting in downward pressure on fixed income markets

– Under current market conditions and because of the capital intensive nature of the fixed annuity business, capacity may not be picked up by peers

– Given the foregoing, there is a risk of undermining the confidence in the private pension system in the United States

– Failure would produce an immediate “run on the bank,” which would likely lead to state seizures of local operations, causing a lock-up in customers’ retirement accounts and payment of monthly/quarterly annuity checks

As I have been trying to explain for the past two months, that is precisely why the US government will not nationalize the banks. The insurers would be next. They may be next in any event, as the Wall Street Journal warned this morning.

There are no academics in the trenches. All of the hobgoblins of the finance profession will be exorcised when the Treasury finds itself up against a wall, starting with the mark-to-mark delusion.

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