The AIG Fallout and Consequences

In the early 1990s, I was the first to warn of nearly all major insurance company failures.* And today, in the wake of the AIG crisis, I warn of three major ramifications:

#1. The labyrinthine world of derivative linkages:

Among the 15 institutions cited as partners of AIG, two are among the five largest players in the U.S. derivatives market, with great vulnerabilities to derivatives losses overall, and one other is likely also be heavily involved:

• Bank of America, NA. For each dollar of its risk-based capital, B of A has $1.78 in credit exposure to derivatives counterparties, including AIG and many others. In addition, the bank has $2.48 trillion in notional value credit derivatives, almost all of which are the high risk, often toxic, credit default swaps with multiple partners, including AIG.

• HSBC Bank USA (the U.S.-based affiliate) is exposed to even larger credit risk, with $6.64 of credit exposure to derivatives trading partners per dollar of capital. It has $1.15 trillion in the high-risk credit default swaps.

• JPMorgan Chase. Although not cited as one of AIG’s derivatives partners, it is virtually impossible for derivatives blow-ups to bypass JPM, the largest player, with over 50 percent share in the U.S. commercial bank derivatives marketplace. It has a credit exposure to derivatives trading partners of $4 per dollar of risk-based capital. Plus it holds $9.2 trillion in the high-risk credit default swaps.

#2. Annuities. In the early 1990s, two million U.S. life and annuity policyholders were caught with cash value in failed insurers, with annuity holders suffering severe losses. Today, we anticipate an even larger number of victims due to

(a) larger and broader market losses in both equities and fixed instruments,

(b) the growth of annuities that guarantee principal value in a falling equities market.

#3. Other insurers.

Based on our analysis of TheStreet.com ratings (formerly Weiss ratings), other large insurers also vulnerable to failure include:

Ambac Assurance Corp. (WI)
Bankers Life & Casualty Co. (IL)
Conseco Life Insurance Co. (IN)
Indiana Old National Insurance Co. (VT)
Jefferson National Life Insurance Co. (TX)
Lumbermens Mutual Casualty Co. (IL)
Medical Liability Mutual Insurance Co. (NY)
Mortgage Guaranty Insurance Corporation (WI)
Nuclear Electric Insurance Ltd (DE)
PMI Mortgage Insurance Co. (AZ)
Standard Life Insurance Co. of Indiana (IN)
Washington National Insurance Co. (IL)

These ratings are based primarily on the risk each insurer is taking in its investments and business operations as a percent of capital. Insurers are put through stress tests that compare their target capital (the total capital they should have to cover each line item in their balance sheet) vs. their actual capital. Plus, the ratings review a series of other risk factors.

* A 1994 study by the U.S. Government Accountability Office (GAO) (http://archive.gao.gov/t2pbat2/152669.pdf) concluded that Weiss Research far outperformed all of the nation’s major rating agencies, including Standard and Poor’s, Moody’s and A. M. Best, in warning of future life and health insurance Co. failures, including the failures of Executive Life of California, Executive Life of New York, Fidelity Bankers Life, First Capital Life, Mutual Benefit Life of New Jersey, and others.