Last night, the Federal Reserve Board and the Treasury Department announced that the Federal Reserve Bank of New York would lend up to $85 billion to American International Group (AIG). According to the Fed, “The purpose of this liquidity facility is to assist AIG in meeting its obligations as they come due. This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy.” In return for the loan, the U.S. government will receive an 80 percent equity stake in the company. In addition, the loan is collateralized by all of the assets of AIG and its “primary non-regulated subsidiaries,” as well as the stock of “substantially all of” AIG’s regulated subsidiaries—that is, the operating insurance companies. A statement from AIG this morning indicates that the offer by New York Governor Paterson to bend New York's insurance regulations to allow AIG to access $20 billion in liquid assets from certain of AIG’s insurance company subsidiaries is no longer “necessary.”
Does this loan get AIG out of the woods? Presumably AIG’s credit rating is secure for the moment, but for how long is unclear. Many questions remain to be answered:
- How will the agencies that rate the financial strength of the operating insurance subsidiaries, such as A.M. Best and Standard & Poor’s, react?
- If the operating insurance subsidiaries are sold, will the buyers be viewed as strong as AIG was prior to this crisis? This can impact the ratings of the subsidiaries, even if they are sold with their surplus intact.
- What will the terms of any such sales be? Will buyers be permitted to tap into policyholder surplus?
- If the property and casualty subsidiaries are not sold, will the AIG that emerges from this crisis be strong enough to meet market expectations and overcome the reputational damage that this crisis has wrought?
Insurance companies are regulated by the states, with minimal interference by the federal government. AIG’s insurance subsidiaries are domiciled in various states, and it is unclear to what extent those states and regulators comprehend the full impact of the Fed’s action. Those regulators will be involved in approving any sales of these companies. Insurance companies are not governed by federal bankruptcy law, but are instead regulated by state insurance insolvency statutes and solvency regulations.
In all of this, an important piece of the puzzle will be the financial-strength ratings of the insurance subsidiaries. The ratings are likely to remain under review as the situation unfolds. Many large insurance brokers and insurance consumers have minimum security requirements or require a minimum financialstrength rating in order to purchase insurance or maintain a relationship with a particular insurance company. If those ratings fall too low, insurance buyers may cancel existing policies and refuse to buy new ones. The ultimate result could be a solvent run-off or, in a worst case scenario, a reorganization or a liquidation.
As of this morning, the largest brokers are being cautiously optimistic, counseling clients that the subsidiaries remain within their security guidelines. The rating agencies have yet to be heard from. In recent insolvencies, however, rating agency downgrades were overtaken by events.
Many AIG policyholders will remain concerned about AIG’s short-term and long-term ability to pay claims as they come due. Furthermore, AIG holds very significant amounts of collateral from policyholders, including bonds, letters of credit, and cash, in order to secure policyholder obligations relating to premiums, deductibles, and retentions. At a minimum, policyholders should be monitoring the situation closely to ensure their insurance assets are protected. Reed Smith will be closely monitoring developments and analyzing issues, including:
- The impact of the loan on subsidiary financial strength
- Considerations for policyholder purchase/renewal decisions
- Potential impact on pending claims/litigation with AIG companies
- Potential interaction and conflict between the bankruptcy laws governing the parent, and state insurance insolvency laws governing the subsidiaries