What is the AIG Value? 3 / 2 /2009

At this point AIG, and frankly many more insurance underwriters, finds itself in a horrific situation. Let me try to distill this into a simple discussion and answer why. Insurance companies make money by leveraging premium payments (they call it "investing") with the knowledge that, year to year, they will pay out an average of 100% of those premiums in claims. I'll repeat that, Insurance companies make money by leveraging premium payments (they call it "investing") with the knowledge that, year to year they will pay out an average of 100% of those premiums in claims. Some companies, the more conservative underwriters (Berkshire Hathaway for example) routinely pay out in the low 90% of premium receipts annually. The idea is to invest the premiums in very very low risk investments and pocket the difference (the underwriter's operating profits) and use these profits in enhance the underwriting capabilities next year, or to launch new lines of business.

But in the case of AIG and even Berkshire this year their investments with these premiums proved to be anything but low risk. It seems that cash and gold were the only "investments" that could be made this last year. So this requires highly liquid assets on the balance sheet to cover the shortfall. In the case of Berkshire, they had the highly liquid assets to cover the shortfall. In the case of AIG, they did not. So the government stepped in to cover their shortfall.
Why?

By this point each of us recognizes that AIG had extraordinary laxes in internal oversight. So extraordinary that many of their so called derivative strategies were in fact adding additional leverage to their balance sheets in a strategy which transferred risk to their shareholders and, as we will see to their insured, then paid big bonuses to executives and insurance salesmen.

BUT after bonuses are paid, AIG still had to pay claims. THE LARGEST OF WHICH WERE INVESTMENT AND BOND RELATED INSURANCE. Yes, AIG for a premium would insure returns on financial instruments. What do you think their exposure was in those insurance underwritings this year? And finally, when you add up all the banks, investment banks, pension plans, mutual funds, and other financial institutions that were covered in a downturn by AIG policies by AIG and its AAA rating (considered ridiculous my most industry experts) you face a systemic collapse in realized losses and redemptions in the investment world causing a ripple effect that creates immediate recession if not long term depression.

How was this mega house of cards created? Its simple, Fraudulent Accounting Practices. If value is misrepresented in order to justify a AAA rating, and that AAA rating forms the basis for the insured parties to further extend their balance sheets, the risk to the financial system grows geometrically, that's exponentially to some.

The Board members and executives of all of these companies have failed all of us, many have thrown their fiduciary responsibilities into the trash by ignoring questionable accounting practices to save their share price and save their bonuses and annual stipends.

This is criminal, not negligent. And worse, at AIG the executives in charge saw this coming 2 years ago and made little effort to stop it, in effect to insure the liquidity of their own enterprise.

So where is the AIG value - gone and hopefully gone forever. This was not value adding to our economy, this was gaming our economy for the benefit of their executives.

Build value every day - even in the face of shocking public company behavior.

Brad van Siclen