The Federal Reserve Bank of New York added another $38 billion to the AIG bailout pot today, bringing the total taxpayer infusion into AIG to nearly $125 Billion. But today’s bailout offers another thing to worry about that was not generally attended to in the first round of the AIG bailout/takeover. It now appears that policyholders’ money may be at risk.
As the Fed notes in it’s press release and AIG in its release, the subsidiaries that need this new money are domestic life insurance companies, rather than the London-based financial arm of the company that had appeared to be at the center of the AIG debacle to date. Today’s $38 billion bailout is to cover losses that resulted from stupid and dangerous investments that AIG made with cash collateral that it now needs to pay back to borrowers who are returning loaned securities.
(These financial instruments that AIG was playing with are head-ache causing, but, essentially: the company would loan stocks to hedge funds and other investors and the funds/investors would give cash in an amount slightly greater than the value of the stock as collateral. At a later date, the fund/investor would return the securities to AIG which would then return cash collateral, minus some fees.)
Colin Barr at Fortune Magazine gives a clear explanation of the greed-driven (my words, not his) risks, the AIG life insurance subsdiaries took that got them to this place:
It emerged in June
that AIG had broken from the time-honored practice of investing the
proceeds of securities loans in Treasuries and similarly risk-free,
liquid assets, and instead invested them in subprime-related securities
in a reach for higher yields. When the market for subprime mortgages
collapsed, the collateral pool eventually lost 18% of its value –
sticking the securities lending accounts with billions in losses.
The starting point here is that insurers make the bulk of their money by investing our premiums before they need it to pay a claim. It appears, from some of the stories, that AIG was investing huge amounts in the stock market (or securities of some sort) and then loaned at least $78 billion worth of those stocks in exchange for cash collateral. Then — here’s where greed and stupidity amplified the problem — AIG apparently gambled the collateral away on subprime bets. When the stock borrowers started returning the loaned shares and asking for their money back, AIG didn’t have it.
At some point, AIG might have to use money reserved for paying claims to, instead, repay hedge funds and, potentially, policyholders might not be able to count on AIG when they make a claim. Theoretically, the Fed’s bailout means that AIG doesn’t need to dip into insurance reserves, but who knows?
And this brings up another question: do other insurers make their insurance holdings available for securities lending? And how much of their portfolio is exposed to the stock market? Back in the days of Enron, Consumer Watchdog issued a report about hundreds of millions of dollars in losses sustained because of insurers’ holdings in the crop of corproate calamities (Enron, WorldCom, Adelphia, etc.) Maybe AIG was flying solo on this, but we better check with other insurers to make sure this isn’t the leading edge of an entirely different threat to policyholders.