Time to put an end to AIG’s misery

Sometimes, it seems like AIG’s crisis couldn’t get any worse.

After all, what was once the world’s largest insurance company has already consumed over $120 billion in taxpayer funding, paid big bonuses to some of the very executives that helped run it into the ground, and attracted so much anger that its employees have been warned not to wear company apparel in public.

 In fact, however, two factors—AIG’s own activities in the insurance market and the stability of its state-regulated insurance business–suggest that the AIG crisis will probably get worse before it gets better. 

Ever since the government first infused capital into AIG, the company has cut rates on a variety of products. Many other insurers have cried foul but none has proven that AIG has violated any laws requiring “rate adequacy.” (Because insurance is worthless if insurers can’t pay claims, it’s illegal to charge too little for an insurance policy.)

But accusing AIG of violating existing laws probably misses the point. Due to the massive cash infusions it has received from taxpayers, AIG probably can keep its promises. And that present an even bigger problem: AIG’s continued presence in the market destabilizes its competitors.

 Major U.S. insurers like Allstate and the Hartford have reported massive losses in the wake of AIG’s collapse and the overall insurance industry has begun to shrink for the first time since record-keeping started.

 A partial or complete shutdown of AIG could actually revive the fortunes of some of its troubled competitors but, so long as AIG exists as a government owned entity, prospects for an industry-wide revival seem grim.

And it gets worse. Officially, AIG’s problems exist as a result of massive bad bets in its London-based investment division and, on paper, AIG’s subsidiaries that sell automobile, life, homeowners, and commercial insurance appear healthy.

 But they may have more problems than the company has indicated. These subsidiaries, 71 in all, receive regulation at the state level and nobody except the company’s executives has a full picture of their financial health.

 Even with capital markets in trouble, AIG should have found buyers for many of them and used the funds raised to pay back taxpayers. So far, however, it has sold only one U.S.-based insurance business.  And this may mean that the subsidiaries have yet-undisclosed problems.

 Why else would investors remain on the sidelines for so long? AIG’s mind-bogglingly-complex structure, indeed, should worry everyone. State Farm, which has more U.S. customers than AIG, makes do with only eight subsidiaries.

 The complexities of AIG’s subsidiaries and the interrelationship may ultimately mean that the supposedly localized problems afflict the entire company. On the surface, AIG’s structure has a lot in common with another high-flying company that had a big fall—Enron.

A collapse of state-regulated AIG subsidiaries could be a major problem for virtually all Americans. When a state-regulated insurer collapses, all states have mechanisms called “guarantee funds” that allow them to impose special taxes called “assessments” on almost every type of insurance policy to cover the cost of an insurers’ collapse. If a wholesale collapse of AIG’s state-regulated businesses took place, these assessments alone could cost a typical household over $1,000 a year.   

AIG’s looming problems have no easy solution. Bankruptcy under current laws may not make sense for AIG since simply forcing the company into immediate liquidation would almost certainly precipitate the collapse of its state-regulated businesses.

 But AIG needs to undergo reorganization process. At minimum, AIG company should lose its taxpayer lifeline and sell its state-regulated insurance subsidiaries at auction in order to repay whatever it can to taxpayers.

 So long as it exists in its current form, it should not be able to continue efforts that undercut its competitors and, if the subsidiaries turn out to have problems of their own, the federal government should look for ways to minimize or eliminate the burden on state taxpayers. (It could probably do this at no cost to the taxpayers by giving state guarantee funds a claim on AIG’s best assets.)

AIG, quite simply, deserves to be put out of its misery. The federal government made a mistake in “helping” the company to survive and further efforts to avoid the company’s demise will probably make things worse.

Eli Lehrer is a senior fellow at the Competitive Enterprise Institute.