An Analysis of the Aig Case - Understanding Systemic Risk and its Relation to Insurance

Abstract

This study describes the AIG model of operations prior to the conglomerate failure up to the point when the liquidity crisis triggered the massive bailout by the US government. It is a study designed to provide understanding of the key factors in the demise of AIG in relationship to systemic risks in insurance. The main contribution of this report is the delineation of the key internal factors from the external macro market and regulatory factors that contributed to the failure. We regard the latter as macro factors underpinning the foundation that propelled the activities of AIG Financial Products Unit (AIGFP). The study shows that if it were not for the “non-insurance” activities of the AIGFP under the AIG Holding Company, the averted collapse (with the bailout), in all likelihood, would have been avoided. The main key takeaways are: AIGFP was not an insurance company; AIGFP was not regulated by insurance regulations; AIGFP’s credit default swaps were the key factor to the AIG collapse. As global regulators look into indicators for Systemically Important Financial Institutions (SIFIs), the macro factors should be integrated into any newly created regulatory framework: 1. Use credit ratings with care and avoid exploitation of high ratings, 2. Be aware of banks’ capital being replaced by new opaque financial products, 3. Remove gaps in regulations and require transparency, 4. Forbid companies to select their own regulatory bodies, 5. Understand insurance vs. non-insurance or quasi-banking activities and products, and 6. Create clarity to delineate between the banking and insurance models. In brief, the key lesson is that when non-insurance or quasi-banking operations enter the insurance arena, expert insurance supervision is needed to close gaps in regulation.