Casualties Of The Meltdown 

« Back to The Top 10 Stories of 2009

The casualties of the meltdown were many, mostly outside the insurance industry.  Among the largest to be hit within the business were AIG and ING.

AIG was in the news all year long, effectively becoming the symbol of the excess that brought the financial system close to collapse in the fall of 2008.  What follows are two of dozens of stories the NU staff has written over the past year on developments at AIG.  The first story relates a recent deal with the New York Fed that affects two key AIG subsidiaries.  The second story looks at miscalculations made in the fall of 2008 by the Fed regarding AIG and its bailout.

We advise readers to check our website frequently for other stories in the continuing saga.

Another casualty of the meltdown was ING, which was forced to restructure itself.

AIG’s Recent Deal
On Dec. 1, 2009, AIG, Inc. announced that it closed on two transactions that reduce the amount it owes to the Federal Reserve Bank of New York to $17 billion, from $42 billion.

AIG said that it has completed previously announced plans to reduce its debt to the New York Fed by $25 billion by giving the New York Fed preferred equity interests in newly formed subsidiaries.

The transactions will help AIG wait until the time is right to sell its American International Assurance Company Ltd. and American Life Insurance Company subsidiaries, AIG says.

AIG is using the AIA and ALICO transactions to cut the balance owed on a New York Fed credit facility.

As a result of the transactions, the total amount available under the facility has been reduced to $35 billion, from $60 billion, AIG says.

After AIG finishes paying off the credit facility debt, the AIG Credit Facility Trust will continue to hold a preferred voting interest in AIG, according to AIG Chairman Robert Benmosche.

The trust now has a 79.8% interest in AIG through the ownership of Series C Preferred Stock.

“We continue to focus on stabilizing and strengthening our businesses, but expect continued volatility in reported results in the coming quarters, due in part to charges related to ongoing restructuring activities, such as the previously announced loss that we expect to recognize in the upcoming quarter related to our announced agreement to sell our Taiwan-based life insurer Nan Shan,” Benmosche said in a statement.

To implement the AIA and ALICO transactions, AIG put the equity of AIA and ALICO in separate special purpose vehicles in exchange for interests in the SPVs.

The New York Fed is getting preferred interests with a $16 billion liquidation preference in the AIA SPV and a $9 billion liquidation preference in the ALICO SPV.

The liquidation preference of the preferred interests represents a percentage of the estimated fair market value of AIA and ALICO.

AIG holds all of the common interests in the SPVs. If the SPVs take in more cash from selling the AIA and ALICO stakes than they must pay to the New York Fed, AIG will get to keep the excess cash.

Until AIG divests a majority of its common interests in AIA and ALICO, AIG will continue to include AIA and ALICO results in its financial statements, the company said.

The Fed’s Miscalculations
Federal Reserve System officials started out underestimating the cost of bailing out American International Group Inc., according to the Office of the Special Inspector for the Troubled Asset Relief Program.

Because of the miscalculations made back in September 2008, and because the Fed acted more as a source of financing for AIG, New York, than as a regulator, the Fed wound up paying more than it should have to close out the collateralized debt obligations underlying AIG’s credit default swaps portfolio, SIGTARP officials conclude in a new report.

The Fed provided AIG with access to more than $85 billion Sept. 17, 2008, in exchange for 79.9% of the company’s stock.

One obstacle that kept the Fed from getting the Sept. 17 deal done quickly was a private deal that AIG negotiated with J.P. Morgan Chase & Company, New York.

AIG accepted a J.P. Morgan offer for a deal that called for AIG to pay an 11% interest rate on a $75 billion loan. When that deal fell through, the Fed inherited it and added another $10 billion to the total.

The Fed did not realize until later that the interest rate was punitive and that the deal would have to be renegotiated, SIGTARP officials wrote.

The government also underestimated “the enormous impact that rating agencies had on the AIG bailout,” officials wrote.

AIG’s AIG Financial Products unit sold $72 billion in CDOs to counterparties without holding the reserves that a regulated insurer would have had to maintain if it had written an equivalent amount of insurance coverage, officials wrote.

The AIG credit default swaps debacle indicates the importance of transparency when the government interacts with a private firm, officials wrote.

But Fed and Treasury Department officials believed that failing to bail out AIG “posed considerable risk to the entire financial system and would have significantly intensified an already severe financial crisis and contributed to a further worsening of global economic conditions,” officials write.

Fed and Treasury officials were mostly concerned about the impact on the American retirement system, “and determined that AIG’s failure would have a global retail impact,” notably on stable value funds and variable rate annuities, officials wrote.

To guarantee a minimum return, stable value fund issuers usually wrap the funds in insurance contracts. About $38 billion of stable value fund wrap contracts issued to more than 200 wrap contract counterparties would have been at risk if there had been no bailout, officials wrote.

The counterparties included trustees and investment managers of company retirement plans and 401(k) plans, including the biggest, best known mutual funds and the retirement plans of the biggest public companies.

In addition, institutional investors and money market funds would have taken a $20 billion hit if commercial paper issued by AIG had failed, officials wrote.

But the decision to bail out AIG as a company put constraints on what the Fed could do when it closed out the CDS counterparty deals, officials wrote.

“The Federal Reserve Bank of New York was confronted with a number of factors that it believed limited its ability to negotiate reductions in payments effectively, including a perceived lack of leverage over the counterparties because the threat of an AIG [failure] had already been removed by the FBNY’s prior assistance to AIG.”

In the fall of 2008, as the rating agencies were threatening to downgrade AIG and its CDS, counterparties were demanding high interest rates to keep the AIG CDS.

The New York Fed decided at that point that it had to buy out the CDS counterparties under terms favorable to the counterparties, SIGTARP officials wrote.

New York Fed loans to AIG, and moves to buy assets through special financing vehicles, “effectively transferred tens of billions of dollars of cash from the government to AIG counterparties even though senior policy makers contend that assistance to AIG’s counterparties was not a relevant consideration in fashioning the assistance to AIG,” SIGTARP officials wrote.

But the New York Fed believes that the government will ultimately be made whole despite the New York Fed’s weak bargaining position, officials wrote.

On Sept. 30, AIG’s loan balance was $19.3 billion, and the fair market value of the portfolio the Fed bought from AIG’s counterparties was $25.3 billion.

But, “while the FBNY may eventually be made whole on its loans to the [special financing vehicle], it is difficult to assess the true costs of the Fed’s actions until there is more clarity as to AIG’s ability to repay all of its assistance to the government,” officials write.

ING Will Split In Half
ING Groep N.V. announced at the end of October that it intends to split its banking and insurance operations, divest itself of the insurance operations, and find a new home for its ING Direct USA Internet banking unit.

In a late November vote, shareholders overwhelmingly supported the restructuring plans, ING said.

ING, Amsterdam, would end up being about as half as big as it used to be, with a focus on banking outside the United States. To get rid of the the insurance operations and the U.S. Internet banking business, ING may sell some businesses to other companies and sell other businesses to  the public through stock offerings, according to ING CEO Jan Hommen says.

One of the companies that merged to form ING in 1991 entered the U.S. insurance market in 1966, by acquiring Life of Georgia. ING became a much bigger presence in the U.S. insurance market in 1997, when it acquired Equitable Life Insurance Company of Iowa, Des Moines, Iowa. In 2000, the Dutch financial services giant further expanded its presence by acquiring ReliaStar Financial Corp., Minneapolis, and the financial services operations of Aetna Inc., Hartford.

ING sold Life of Georgia to a unit of Prudential P.L.C., London, in 2004, and it recently announced plans to sell ING Re’s U.S. and Canadian group life, accident and health reinsurance business to Reinsurance Group of America Inc., Chesterfield, Mo.

But ING is still a significant presence in the U.S. retirement services, life insurance and rollover annuity markets.

ING says it came up with the current restructuring plan in an effort to implement a "Back to Basics" streamlining initiative, eliminate "double leverage," and pay the Dutch State back for the rounds of government financial support that ING has received since the current financial crisis began.

ING also came up with the plan to satisfy European Commission fair competition requirements, Hommen says.

“Negotiations with the European Commission on the restructuring plan have acted as a catalyst to accelerate the strategic decision to completely separate banking and insurance operations,” Hommen says.

Originally, combining banking and insurance services helped provide capital efficiency and earnings stability, but today, “the widespread demand for greater simplicity, reliability and transparency has made a split the optimal course of action,” Hommen says.

Hommen says ING will try to carry out the restructuring plan in a way that supports the interests of customers, employees, and “providers of capital.”

While the insurance divestiture is under way, the ING insurance business will focus on the life and retirement services businesses in markets such as the United States, the Benelux region, Central Europe and Latin America, ING says.

To get European Commission approval for the restructuring plan, ING must divest the heavily promoted ING Direct USA business by the end of 2013.

“ING regards the operation as a very strong franchise,” ING says.

While the ING Direct USA divestiture is in progress, “ING will ensure that it continues to grow the value of the business and offer a superior customer experience,” the company says.

Once the restructuring is completed, the 2013 balance sheet for the operations that are still under the ING umbrella will be only about 45% as big as the balance sheet for the same operations in September 2008, ING estimates.

But, if the operations grow as expected, the balance sheet for those retained operations may be just 30% smaller than they were in September 2008, ING says.