AIG got into deep financial trouble not because of the US state-regulated insurance business it was selling but because of the 'financial products' it was involved with internationally as well as in the U.S., the regulation of which it avoided. Its exposure on credit default swaps is immense and AIG deliberately exploited the absence of regulation on such products by carefully avoiding calling them what they really were: a form of insurance for which the purchaser paid AIG a premium. Calling them what they were would have inevitably exposed them to the attention of insurance regulators. The Bush administration, in thrall to a sophomoric conception of and belief in laissez-faire capitalism, did nothing.
US officials have tried repeatedly to explain to the public and to congress why AIG has to be saved from collapse. What it boils down to is that AIG is so connected to so many other financial institutions internationally as well as in the US via credit default swaps and various 'derivatives' that AIG's collapse could pull down big pieces of the international financial community and perhaps the system itself.
What has not been talked about publicly by U.S. regulators is the risk posed by AIG to the insurance business. In the US AIG insurance companies have more than 375 million policies with face amounts totalling $19 trillion. What would happen if many or most of those policyholders got so frightened by the continuous drumbeat of terrible financial news about AIG, the corporate holding company, that they started rushing to surrender their policies in separate and solvent AIG-branded life insurance companies?
Depending on the size of a rush to surrender there might well be insufficient funds to pay out surrender values even from industry guarantee funds which would have to be replenished by other life companies already weakened by the US financial meltdown, perhaps to the point that some of them would be so further weakened by loss of funds combined with their own policyholders' diminished confidence in their financial stability that several might be bankrupted.
What a mess. The U.S. life insurance industry (including the Canadian companies operating there) should be thankful that this aspect of the AIG financial disaster has not received much media attention. Edward Liddy, who became AIG's CEO in the fall of 2008, was quoted in the New York Times describing AIG as having "an interesting structure where you have an insurance company that works really well and on top of it is a holding company and the holding company's biggest asset is this huge hedge fund... It just doesn't make any sense to me."
The AIG meltdown since then would certainly support the idea that little "sense" was involved in the management of AIG or in government allowing the absence of regulation. Result: the unregulated AIG financial products business may pull down the regulated insurance part of the AIG structure. If this happens it is anybody's guess how much of the U.S. life insurance business may come tumbling down with it.
The US government now owns close to 80% of AIG. While it may well wish not to go above that level in order to avoid potential liability involving the AIG companies' 375 million in force policies, that is likely to be a faint hope. The latest government $30 billion infusion of cash to AIG will not be the last needed to prevent its collapse -- even if there is no 'run' on AIG by its many thousands of policyholders.