Insuring AIG: State commish says policy holders safe despite possible sale of AIG Hawai’i

The American International Building in lower Manhattan.

AIG Hawai'i is not likely to go out of business, nor are its thousands of Hawai'i insurance customers likely to lose their policies, as a result of the well-publicized financial problems of its parent holding company, American International Group. But AIG Hawai'i and other local companies held by AIG may be sold off to repay the billions in loans that the parent company is getting from the federal government.

According to the AIG Hawai'i Web site, "It was announced at the conference call to investors on October 3, that the AIG Personal Auto Group is on the list of assets for sale. This does not necessarily mean that the company will be sold, or a buyer has been identified."

The state, meanwhile, says policy holders are safe.

"Edward Liddy, the fellow who took over AIG with the Fed's blessing, has said that he doesn't want to sell off the companies individually," says Hawai'i Insurance Commissioner Jeffrey P. Schmidt. However, Schmidt believes AIG's local assets may be sold off as part of a larger package.

AIG Hawai'i's Web site also states that the "AIG Family of Companies" is Hawai'i's largest property and casualty insurer, with 11 percent of the market. AIG Hawai'i is the state's third-largest supplier of auto insurance, according to Schmidt. It also sells workers' compensation and disability insurance. AIG's in-state holdings also include American Pacific Insurance, Hawai'i Insurance Consultants, Human Resources Solutions, 50th State Risk Management Services and a software consultant company called Veyond.

Paying for the parent company's debt

"AIG Hawai'i is in good financial shape, as are most of the insurance subsidiaries of AIG," Schmidt says. "It is the financial services subsidiaries that have the problem. However, because they are affiliated, we are monitoring the insurance companies closely."

Last October, the federal government granted the AIG holding company an $85 billion line of credit as part of its $700 billion financial bailout package. The L.C. later granted AIG another $37 billion in credit. Then, on November 10, The government sweetened the deal with a restructuring agreement: AIG will cover part of the loan by giving the U.S. government $40 billion worth of newly issued shares of stock, and the L.C. will extend AIG's time to repay the loans from two years to five years and reduce the annual interest rate from 8.5 percent to 3 percent.

The catch-phrase of the day, repeated by commentators on several news networks, was that AIG was simply "too big to fail." The logic being that the holding company and its 73 U.S.-based insurance subsidiaries, 176 financial service companies, and other domestic and foreign subsidiaries held such a huge share of the market that the company's failure would be disastrous for the world economy.

As AIG Hawai'i's Web site puts it, its parent got into trouble, because it "took on more risk than it could handle when investing in collateralized debt instruments, such as credit derivative swaps on mortgage-backed securities. When the U.S. housing markets experienced a downturn, these risky investments lost a lot of money for the AIG holding company."

If a sale of those companies happens, it will be the job of Schmidt's state agency to assure that their Hawai'i customers are protected.

A balancing act

"Anyone who acquires AIG Hawai'i would, number one, have to have my approval," Schmidt says. "I'm going to require that they have sufficient funds in their surplus and reserve in capital assets to pay any claims of their policy holders as they come due. That's a fundamental part of insurance company regulation. I have the authority to require them to maintain sufficient reserves and to forbid them from making loans or risky investments that might impair the financial status of the company."

Schmidt contends that those strong state regulations kept the insurance companies healthy while the parent company's federally supervised financial service companies tanked on toxic investments. Ironically, Schmidt says there has been a concerted push in Congress to move the insurance companies out from under state supervision as well.

"In the past year, they had over 80 bills in Congress, proposing some form of federal regulation of insurance," he says. "Particularly the large life insurance companies and some of the property and casualty insurances have been pushing hard for an optional federal charter, which is similar to how banks are regulated, that would allow large insurance companies to choose to have a license to be regulated by the federal government or to have a state license and be regulated by state regulators."

The facts of current history make it clear that too much regulation set in stone is a bad idea, he explains.

Which brings up another regulatory question: Is it a good idea to let larger corporations buy smaller ones until the nation ends up with a company that's "too big to fail"?

"That's a very interesting question," Schmidt says. "I do believe that AIG's failure would have had a devastating effect around the world. … I do think it was appropriate to step in and help them get back on their feet and stabilized the market."

But he notes concerns that L.C. bail-out money may be used by some companies to buy up others, and he questions whether that would be "the proper use of taxpayers' money."

When a stronger company acquires a weaker one, it does shore up the stockholders in the weaker company, at least temporarily. But with business consolidation, the greater and greater segments of the economy are gambled on the judgment of fewer and fewer managers.

"The answer is that you need a mix," Schmidt believes. "You need to have regulations and government programs that encourage smaller entrepreneurial companies that come up with new ideas, new ways of doing things, while being closer to the consumer—while providing regulations for the larger companies that allow efficiency of operation. It's a balancing act … it's not a one-and-done kind of solution, where you implement the solution, you're done and you walk away. The market is dynamic, and the government and regulation also have to be dynamic and have to adjust."