IMPORTANT TERMS
AIG CASE STUDIES

1. How the Insurance Industry is Segmented * Property and Casualty * Life Insurance * Reinsurance

2. Profitability Measures of Insurance Companies * Expense Ratio * Loss Ratio * Combined Ratio

3. Credit Default Swaps * A financial swap agreement that the seller of the CDS will compensate the buyer in the event of a loan default or other credit event (pay-off third party debt if this party defaults on loan) * The buyer of the CDS makes a series of payments (the CDS ‘fee’ or ‘spread’) to the seller and, in exchange, receives a payoff if the loan defaults * CDS protects against a default on assets tied to a corporate debt & mortgage securities * Buyer receives credit protection; seller guarantees the credit worthiness of the product * Is CDS an insurance? i. Function similar to insurance; provide protection against non-payment of loans

4. Sub-prime mortgages * Home loans given to people who are high-risks and can’t afford them reasonably

5. Collateralised Debt Obligations (CDOs) * Asset-backed commercial paper * A group of bad mortgages sold as a single investment for other banks or financial institution to buy

6. Liquidity Risks

7. Systemic Risk * The risk imposed by interdependencies is a system or market, which could have the potential to bring down the entire market or system in one player is eliminated * Compare systemic risk with catastrophic risks

ISSUES 1. Who is American International Group? * Was one of the world’s largest international insurance and financial services companies with operations in more than 130 countries * Multinational insurance corporations; HQ in new York, British Office in London, Europe office in Paris, Asian office on Hong Kong * Offers 3 main lines of insurance products i. Property & casualty ii. Life and health insurance & retirement products iii. Asset management and financial services

2. Who is AIG Financial Products? * The subsidiary of AIG that wrote the CDS * AIGFP insured CDOs against default through a financial product known as CDS

3. What happen to AIG when the housing bubble burst? * In 2008, AIG suffered liquidity crisis following the downgrade of its credit rating from AAA to below AA. * Due to the downgrade of its credit rating, AIG was required to post additional collateral for the CDS that was written. * The case is worst because AIGFP wrote unsecured debt – no collateral. When the meltdown of the subprime mortgage market – AIG was required to post collateral in cash as the value of the assets underlying the CDS deteriorates.

4. In your opinion, why the US government decided to bail-out AIG? * If not, it will cause systemic risk * AIG has 116,000 employees and 74 million customers worldwide * If AIG fails, policyholders may cancel their policy and request their cash value – forced sales of assets – enormous strain to the insurance system * Large number of counterparties will be affected include banks, sovereign wealth funds, money managers and hedge funds. More than 1500 major corporation, government and institution investors would be affected. iv. State & local government had lent more than 10 billion to AIG v. Some 401(k) plans had purchased US40 billion of insurance from AIG * Q – why can’t the policy/insurance contract be transferred to another insurance co? Or why can’t other insurance co purchase the existing AIG policyholders’ policy? vi. Some of the contract will result in higher premium vii. Some of the contracts may not be renewable because of higher risks, eq health insurance

5. In your analysis, what are the main reasons for AIG failures? * Poor Risk Management viii. CDS is highly risk products ix. No questions when AIGFP recorded extraordinary increase in revenues. Even twice-a-month assessment meeting was eliminated * Poor Regulatory Oversight x. AIGFP was not monitored. It offers hedge fund that was attached to a large and stable insurance co.