AIG stated that it cannot fail. It appears that a confidential document leaked out which had AIG describing its exposure and possible consequences in the event of its failure [nothing we didn't really know though]. A lot of people are skeptical about AIG’s “systemic risk”; however, if Lehman Brothers was any indication, it is that such a phenomenon exists. Here are some of the remarks and comments made in the 21 page article [link to the article].
One of the first remarks in the article is the following:
” The failure of AIG would cause turmoil in the U.S. economy and global markets, and have multiple and potentially catastrophic unforeseen consequences. “
AIG also claims that
” its industry brethren sell and service not just the traditional property and casualty and death benefit life insurance policies, but accident and health coverage, pension and retirement policies, and a variety of wealth accumulation vehicles, such as annuities. “
Imagine if millions of pension and retirement policies where people have been paying premiums for years became worth nothing. This means that besides having your 401(k) wiped out, your pension and retirement policy could potentially vanish.
AIG also mentions about its possible affect on other insurers. This is the excerpt:
” If AIG were to fail notwithstanding the previous substantial government support, it is likely to have a cascading impact on a number of U.S. life insurers already weakened by credit losses. State insurance guarantee funds would be quickly dissipated, leading to even greater runs on the insurance industry. “
This means that the problem is not only the millions of policies that AIG holds. There is also the problem of other insurers failing and thus creating a domino effect that would collapse the whole insurance industry.
AIG says that it has written more than 81 million life insurance policies to individuals worldwide with a face value of $1.9 trillion. So, to put it in perspective, that’s $1.9 trillion of future expected wealth that would be wiped out.
Beyond AIG’s insurance exposure, it also has the possibility of affecting a bunch of other sectors. AIG has about $1.6 trillion in notional derivatives exposure. The unwinding of this portfolio would create enormous downward pressure in the derivatives market.
To summarize, we can see that the collapse of AIG could create a lot of problems and panics.
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