Federal Financial Assistance: Preliminary Observations on Assistance Provided to AIG
Published: 2009-03-18T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Board of Governors of the Federal Reserve System (Federal Reserve) and the Department of the Treasury (Treasury) have made available over $182 billion in assistance to American International Group (AIG) to prevent its failure. However, questions have been raised about the goals of the assistance and how it is being monitored. Also, because AIG is generally known for its insurance operations, questions exist about the effect of the assistance on certain insurance markets. This statement provides preliminary findings on (1) the goals and monitoring of federal assistance to AIG and challenges to AIG's repayment of the assistance; and (2) the potential effects of the federal assistance on the U.S. commercial property/casualty insurance market. GAO's work on these issues is ongoing. To date, we have reviewed relevant documents on the assistance and ongoing operations of AIG, as well as documents issued by the Federal Reserve and Treasury. We also interviewed officials from these organizations as well as industry participants (competitors, brokers, and customers) and insurance regulators, among others.
section_title: What GAO Found
paragraphs: Federal financial assistance to AIG, both from the Federal Reserve and Federal Reserve Bank of New York through their authority to lend funds to critical nonbank institutions and from Treasury's Troubled Asset Relief Program (TARP), has focused on preventing systemic risk that could result from a rating downgrade or failure of AIG. The goal of the assistance and subsequent restructurings was to prevent systemic risk from the failure of AIG by allowing AIG to sell assets and restructure its operations in an orderly manner. The Federal Reserve has been monitoring AIG's operations since September, and Treasury has begun to more actively monitor AIG's operations as well. Although the ongoing federal assistance has prevented further downgrades in AIG's credit rating, AIG has had mixed success in fulfilling its other restructuring plans, such as terminating its securities lending program, selling assets, and unwinding its AIG Financial Products portfolio. For example, AIG has made efforts at selling certain business units and has begun an overall restructuring, but market and other conditions have prevented significant asset sales, and most restructuring efforts are still under way. AIG faces ongoing challenges from the continued overall economic deterioration and tight credit markets. AIG's ability to repay its obligations to the federal government has also been impaired by its deteriorating operations, inability to sell its assets and further declines in its assets. All of these issues will continue to adversely impact AIG's ability to repay its government assistance. As part of GAO's ongoing work related to the federal assistance provided to AIG, GAO is reviewing the potential impact of the assistance on the commercial property/casualty insurance market. Specifically, GAO is reviewing potential effects of the assistance on AIG's pricing practices. According to some of AIG's competitors, federal assistance to AIG has allowed AIG's commercial property/casualty insurance companies to offer coverage at prices that are inadequate for the risk involved. Conversely, state insurance regulators, insurance brokers, and insurance buyers said that while AIG may be pricing somewhat more aggressively than in the past in order to retain business in light of damage to the parent company's reputation, they did not see indications that this pricing was inadequate or out of line with previous AIG pricing practices. Moreover, some have noted that AIG has lost business because of the problems encountered by its parent company. As GAO evaluates these issues, it faces a number of challenges associated with determining the adequacy of commercial property/casualty premium rates, especially in the short term. These challenges include the unique, negotiated nature of many commercial insurance policies, the subjective assumptions involved in determining premiums, and the fact that for some lines of commercial insurance it can take several years to determine if premiums charged were adequate for the related losses.

section_title: Letter
paragraphs: I appreciate the opportunity to participate in today’s hearing to provide  preliminary observations on the federal government’s assistance to the  American International Group (AIG)—a large financial conglomerate with  an estimated 70 U.S. insurance companies—and the potential impact of  this assistance on U.S. insurance markets, especially the commercial  property/casualty insurance market. As you know, the Board of  Governors of the Federal Reserve System (Federal Reserve) and the  Federal Reserve Bank of New York (FRBNY) provided assistance to AIG  in September 2008 following its rating downgrade, which had prompted  collateral calls by its counterparties and raised concerns that a rapid  failure of the company would further destabilize financial markets.  However, AIG’s condition continued to decline, and in November 2008 the  Federal Reserve and the Department of the Treasury (Treasury) under the  newly created Troubled Asset Relief Program (TARP) announced plans to  restructure AIG’s federal assistance to further strengthen its financial  condition and, once again, prevent the failure of the company. On March 2,  2009, the Federal Reserve and Treasury provided additional assistance and  further restructured the terms, which raised questions about the ongoing  viability of the company and the likelihood that the federal assistance  could be repaid.
The assistance provided to AIG has also raised questions among AIG’s  competitors about whether the assistance provided to AIG’s parent  company is being used to benefit its insurance companies. AIG’s  competitors have argued that the assistance has allowed AIG’s insurance  companies to price coverage aggressively compared to the premiums  being charged by the rest of the market, thereby providing AIG with a  competitive advantage, particularly in commercial property/casualty  insurance markets.
My statement today focuses on the preliminary results of our ongoing  review of the federal financial assistance to AIG and its impact on the U.S.  property/casualty insurance market, initiated at the request of Ranking  Member Bachus (full committee) and Chairman Kanjorski  (subcommittee). Specifically, I will discuss (1) the goals and monitoring of  the federal government’s assistance to AIG, the associated setbacks, and  challenges to AIG’s repayment of this assistance and (2) the potential  effects of this federal assistance to AIG on the U.S. insurance market,  especially the commercial property/casualty market.
To achieve these objectives, we analyzed publicly available reports,  congressional testimonies, and other documentation issued by the Federal  Reserve, FRBNY, Treasury, Securities and Exchange Commission,  Congressional Research Service, and rating agencies. We also conducted  numerous interviews with officials and staff from the Federal Reserve,  FRBNY, Treasury, three state insurance regulators with major roles in  regulating AIG’s insurance companies, the National Association of  Insurance Commissioners (NAIC), five insurance brokers, four large  commercial property/casualty insurers that compete with AIG, two  reinsurers, three rating agencies, two industry observers, and an  association representing purchasers of commercial property/casualty  insurance. Finally, we consulted with a group of actuaries to discuss our  methodology, bolster our understanding of insurance markets, and  evaluate what we heard from others.
We conducted our work from January 2009 to March 2009, in accordance  with all sections of GAO’s Quality Assurance Framework that are relevant  to our objectives. The framework requires that we plan and perform the  engagement to obtain sufficient and appropriate evidence to meet our  stated objectives and discuss any limitations in our work. We believe that  the information and data obtained, and the analysis conducted, provide a  reasonable basis for our preliminary findings and conclusions.
subsections: section_title: Background
paragraphs: AIG is a holding company that, through its subsidiaries, is engaged in a  broad range of insurance and insurance-related activities in the United  States and abroad, including general insurance, life insurance and  retirement services, financial services, and asset management. The AIG  organization includes the largest domestic life insurer and the second  largest domestic property/casualty insurer, and it has a large foreign  general insurance business. It also has a financial products division, which  has been a key source of AIG’s financial difficulties, particularly AIGFP,  which engaged in a wide variety of financial transactions, including  standard and customized financial products.
subsections: section_title: AIG’s Financial Problems Mounted Quickly
paragraphs: From July 2008 to August 2008, ongoing concerns about AIG’s securities  lending program and continuing declines in the value of super senior  collateralized debt obligations (CDO) protected by AIGFP’s super senior  credit default swap (CDS) portfolio, along with ratings downgrades of the  CDOs, resulted in AIGFP having to post additional cash collateral, which  raised liquidity issues. By early September, collateral postings and  securities lending requirements were placing increased pressure on the  AIG parent company’s liquidity. AIG attempted to raise additional capital  in September but was unsuccessful. It was also unable to secure a bridge  loan through a syndicated secured lending facility. On September 15, 2008,  the rating agencies downgraded AIG’s debt rating three notches, resulting  in the need for an additional $20 billion to fund its additional collateral  demands and transaction termination payments. As AIG’s share price  continued to fall following the credit rating downgrade, counterparties  withheld payments and refused to transact with AIG. Also around this  time, the insurance regulators no longer allowed AIG’s insurance  subsidiaries to lend funds to the parent under a revolving credit facility  that AIG maintained and demanded that any outstanding loans be repaid  and that the facility be terminated.
section_title: Overview of Federal Assistance Provided
paragraphs: Ongoing instability in global credit markets and other issues have resulted  in over $182 billion in federal assistance being made available to AIG.  First, in September 2008, the Federal Reserve created the Revolving Credit  Facility, which was intended to stabilize AIG by providing it with sufficient  liquidity and enabling AIG to dispose of certain assets in an orderly  manner while avoiding undue disruption to the economy and financial  markets (see table 2). The original amount available under the facility was  up to $85 billion. While the amount borrowed reached $82 billion, the debt  was reduced by the proceeds from AIG’s sale of preferred shares to  Treasury as well as repayments from the Fed Securities Lending  Agreement and the Commercial Paper Facility. As of February 18, 2009,  AIG had $38.8 billion in debt outstanding under this facility.
Second, in November 2008, the Federal Reserve and Treasury announced  additional assistance to AIG and restructured its original assistance. On  November 9, 2008, the Treasury announced plans to use its Systemically  Significant Failing Institutions (SSFI) Program, under TARP, to purchase  $40 billion in AIG preferred shares. This purchase allowed AIG to reduce  its debt outstanding to the Federal Reserve and enabled the Federal  Reserve to reduce the amount available under the Revolving Credit  Facility from $85 billion to $60 billion. On November 10, 2008, the FRBNY  announced plans to lend up to $22.5 billion to Maiden Lane II LLC, a  facility formed to purchase residential mortgage-backed securities (RMBS)  from the U.S. securities lending investment portfolio of AIG subsidiaries.  When this facility was established, it replaced an interim securities lending  agreement with the Federal Reserve. Also on November 10, FRBNY  announced plans to lend up to $30 billion to Maiden Lane III LLC, a  FRBNY facility formed to purchase multi-sector CDOs on which AIGFP  had written CDS protection. In connection with the purchase of the CDOs,  AIG’s CDS counterparties agreed to terminate the CDS contracts.
Most recently, on March 2, 2009, the U.S. Treasury and FRBNY announced  plans to further restructure the terms of the assistance. Consistent with  earlier assistance, this was also designed to enhance the company’s capital  and liquidity in order to facilitate orderly restructuring of the company.  The restructuring of the assistance would, among other things, provide the  government with interests in two AIG foreign life insurance companies, as  well as certain cash flows from certain domestic insurance companies,  each in exchange for reducing AIG’s Revolving Credit Facility balance. The  assistance also would include a new Treasury equity capital facility that  would allow AIG to draw down up to $30 billion as needed over time in  exchange for newly issued non-cumulative preferred stock to the U.S.  Treasury. Treasury and FRBNY would also exchange the previously issued  Series D preferred stock for Series E preferred stock that would more  closely resemble common stock and provide for non-cumulative  dividends. To date, AIG has not drawn against this facility.
As noted above, some federal assistance was designated for specific  purposes, such as reducing the loan outstanding to the Federal Reserve or  for purchasing specific assets, such as CDOs and RMBS. Other assistance,  such as that available through the Federal Reserve Revolving Credit  Facility, is available to meet the general financial needs of the parent  company and its subsidiaries. Some of the assistance also places  restrictions on actions that AIG can take while it has loans outstanding to  the federal government or as long as the federal government has an  ownership interest in AIG assets, as well as restrictions on executive  compensation. Executive compensation restrictions for TARP recipients  were also included in the American Recovery and Reinvestment Act of  2009, which was enacted on February 17, 2009. In general, the restrictions  prohibit    bonus and incentive compensation payments to certain employees,  depending on the amount of TARP assistance received;    golden parachutes; and    compensation plans that encourage risk-taking.
See appendix I for a detailed chronology of events.
section_title: Federal Efforts Have Focused on Maintaining and Monitoring AIG’s Solvency, but AIG Faces Challenges in Repaying Federal Assistance
paragraphs: Federal assistance to AIG has been focused on preventing systemic risk  from a potential AIG failure and monitoring its progress, but AIG faces  challenges in repaying the assistance. Federal Reserve and Treasury  officials have said that a failure of AIG, potentially triggered by further  credit downgrades or additional collateral calls, would result in liquidity  concerns for other financial market participants. A disorderly failure of  AIG would not only create difficulties for AIG’s counterparties as  described, but could further erode confidence in and uncertainty about the  viability of other financial institutions. This, in turn, would further  constrict the flow of credit to households and businesses, potentially  deepening and lengthening the current recession. If the ultimate goal is  avoiding the failure of AIG, the Federal Reserve and Treasury have  achieved that goal in the short-term. However, maintaining solvency has  required federal assistance beyond that provided in September and  November 2008, and rating companies have stated that their current  ratings are contingent on continued federal support for AIG. AIG and  federal regulators acknowledge that there may be a need for further  assistance given the significant challenges AIG continues to face.  Therefore, more time is required to determine if the goal will be fully  achieved in the long-term.
subsections: section_title: Federal and State Monitoring Efforts Are Focused on AIG Solvency
paragraphs: We asked Treasury and the Federal Reserve how they were monitoring  AIG’s progress toward reaching the goals of the federal financial  assistance and AIG’s compliance with the restrictions placed upon it as a  condition of receiving the assistance. According to Treasury and Federal  Reserve officials, the agencies are working together to monitor AIG’s  solvency by reviewing the reports required by the terms of the financial  assistance, and the Federal Reserve is in contact daily with AIG officials  regarding AIG’s liquidity needs and their efforts to sell the company’s  assets. AIG regularly files several reports with FRBNY, including daily  cash flow reports, reports identifying risk areas within the company, and  daily liquidity requests/cash flow forecasts, allowing the Federal Reserve  to monitor AIG’s liquidity. Also, AIG has a divestiture team that meets at  least weekly with the Federal Reserve to discuss potential sales deals,  including bids from potential buyers, financing, and other terms of sales  agreements, so that the Federal Reserve can monitor AIG’s efforts to sell  its assets.
The Federal Reserve and Treasury said that they are monitoring the  various federal agreements with AIG, and these agreements place  restrictions on AIG’s use of the funds. For example, the Federal Reserve  monitors restrictions on the Revolving Credit Facility, including whether  AIG has inappropriately paid dividends or financed extraordinary  corporate actions like acquisitions. According to Treasury officials, it is in  the process of finalizing new executive compensation requirements based  on the American Recovery and Reinvestment Act of 2009, and will begin  monitoring AIG’s compliance with those regulations once they are in  place. This is an area we will continue to monitor as part of our broader  TARP oversight.
State insurance regulators are responsible for monitoring the solvency of  insurance companies generally, as well as for approving transactions  regarding those companies, such as changes in control or significant  transactions with the parent company or other subsidiaries. For example,  regulators told us that AIG’s insurance companies, like all insurance  companies, file quarterly reports with them. Since AIG began receiving  federal assistance in September 2008, regulators also said that AIG’s  insurance companies have been submitting additional reports on their  liquidity, investment income, and statistics on surrender and renewal of  policies, sometimes on a daily or weekly basis. The various regulators also  coordinate their monitoring of the companies’ insurance lines. State  regulators also evaluate potential sales of AIG’s domestic insurance  companies. NAIC formed a working group designed to expedite any  regulatory approvals required for asset sales, with a goal of completing the  approvals within 45 days of filing for a sale.
section_title: AIG Faces a Number of Challenges to Its Ability to Repay Its Federal Funds
paragraphs: AIG’s restructuring has hinged on efforts in three areas: (1) terminating its  CDS portfolio, (2) terminating its securities lending program, and (3)  selling assets. Federal assistance was targeted to the first two areas that  posed a significant risk to AIG’s solvency—AIGFP’s CDS portfolio and the  securities lending program—and the risks from both activities appear to  have been reduced, but some risks remain. One arrangement, Maiden Lane  III—the FRBNY facility created to purchase CDOs—has purchased  approximately $24.3 billion in multi-sector CDOs (with a par value of  approximately $62 billion), which were the assets underlying the CDS  protection that AIG sold. Concurrent with the purchase of the underlying  CDOs, AIGFP counterparties agreed to cancel the CDS written on the  CDOs, thus unwinding significant portions of AIGFP’s CDS portfolio.  According to AIG, some arrangements did not qualify for sale to the  facility, generally either because the counterparties did not own the  instruments on which CDS were written or because they were in  denominations other than U.S. dollars. As of February 18, 2009,  approximately $12.2 billion in notional amounts of CDS remained with  AIG. According to AIG, these remaining CDS continue to present a risk to  AIG, as further losses from these assets could require additional funding. A  second FRBNY facility—Maiden Lane II—purchased approximately $19.5  billion in RMBS and other assets related to the securities lending program.  Both the Maiden Lane II and Maiden Lane III facilities allow AIG to  participate in the residual proceeds after the FRBNY loan has been repaid.  However, AIG faces other potential losses from other investments.
The federal assistance has allowed AIG to undertake restructuring efforts,  which continue. As of September 2008, AIG was to wind down the  operations of AIGFP and sell certain businesses. In October 2008, the  company announced plans to sell some of its life insurance operations and  other businesses. AIG is continuing to wind down AIGFP but expects the  process to take at least several years in order to avoid further losses given  the current market conditions. AIG has been unable to sell its insurance  assets for prices it deems acceptable given the general state of the global  economy. As a result, the plan has been modified, and the federal  government will now assume an ownership interest in some of AIG’s life  insurance companies. The federal government’s ownership stake will be a  percentage of the fair market value of these companies based on  valuations acceptable to the Federal Reserve. In addition, AIG plans to  consolidate its commercial property/casualty insurance operations in a  free-standing entity and potentially offer an equity interest in part of this  new entity to public investors.
Asset sales have been difficult, not only because tight credit markets are  limiting buyers’ ability to obtain the capital needed to purchase the  companies, but also because of challenges faced by AIG in retaining key  employees, who contribute to the value of the company. In addition, the  timely sale of CDOs and RMBS held by the Federal Reserve facilities will  be challenging, not only because it may be difficult to value those assets,  but because many are tied to home values, which have been in decline.
AIG’s ongoing financial problems have resulted in additional assistance  and restructuring of the terms of the original assistance, and AIG faces  numerous, significant challenges to its ability to repay federal assistance in  the future. AIG’s ability to repay the federal government hinges on it  remaining solvent and effectively restructuring the organization, including  the sale of subsidiaries. The federal government recouping its assistance  also depends in part on FRBNY being able to obtain a satisfactory return  on the sale of the CDO- and RMBS-related assets purchased by Maiden  Lane II and III.
AIG’s ability to pay interest and dividend payments has been and may  continue to be a challenge because its ability to make payments is  dependent on the profitability of AIG operations, which face a number of  hurdles. As of December 31, 2008, AIG insurance subsidiaries had  statutory capital levels that exceeded the minimum requirements.  However, damage to AIG’s reputation has made it difficult for its insurance  companies to maintain current business and write new business. In  addition, profitability is also dependent on the overall state of the  economy—many of AIG’s insurance premium sources are tied to  economic activity, such as payroll—and its insurers, especially its life  insurers, depend on strong investment returns. To the extent the overall  economy is experiencing difficulty, it will present challenges to the  profitable operations of AIG’s insurance companies. While recent federal  assistance has been restructured to reduce AIG’s interest and dividend  payment requirements, it is too soon to tell whether further assistance or  further restructuring will be needed in the future.
section_title: Some of AIG’s Competitors Claim that AIG’s Commercial Insurance Pricing Is Out of Line With Its Risks but Other Insurance Industry Participants and Observers Disagree
paragraphs: We are examining the potential effect of federal assistance to AIG on the  insurance market, particularly AIG’s pricing practices within the  commercial property/casualty market. Market participants (actuaries,  regulators, brokers, customers, and insurance companies) we talked with  indicated that, foremost, insurance premium rates follow an insurance  underwriting cycle that is generally characterized by a long period of “soft  market” conditions, where premium rates are relatively low and  underwriting standards are less stringent, followed by a much shorter  period of “hard market” conditions, where premium rates flatten or  increase and underwriting standards are more stringent. They explained  that starting with the September 11, 2001, terrorist attacks and continuing  until late 2003 or early 2004, the commercial property/casualty market was  in a hard market, but since this time the markets have softened and  premium rates have been declining. For example, according to the Council  of Independent Agents and Brokers (CIAB) surveys, quarterly changes in  commercial property/casualty premium rates have been negative (falling)  for all commercial line accounts since the second quarter of 2004 (except  for catastrophe-exposed property lines in early 2006), and while the  magnitude of the changes leveled off in the last quarter of 2008, the  average quarterly premium rate change was still negative in that period.
Industry participants also said that premiums charged by commercial  property/casualty insurers for a given coverage are influenced by several  factors that could allow one insurer to price lower than another on a given  risk and that AIG Commercial Insurance historically had been able to take  advantage of several of these factors. Such factors include a long history  of experience with complex risks, a lower operating expense ratio relative  to competitors, global operations that allow offsetting risks, and the ability  to leverage the size and the financial strength of the parent company to  write larger coverage amounts than competitors, in some cases without  the need to purchase reinsurance. It is not yet clear to what extent the  current financial difficulties the AIG parent company may have diminished  these advantages for AIG Commercial Insurance.
Some insurers we spoke with said that they had observed instances, in  some cases numerous instances, where AIG had sold commercial  property/casualty coverage for a price that these insurers believed was  inadequate for the risk involved. They cited examples where AIG  Commercial Insurance’s prices had decreased significantly from the prior  year’s price, when circumstances appeared to indicate that higher prices  were warranted. Some insurers said that they had brought several of these  instances to the attention of the relevant state insurance regulator.  Insurers expressed concern that while current market conditions would  dictate increased prices in most commercial property/casualty lines of  insurance, they believe that AIG Commercial Insurance has decreased its  prices. They added that when such pricing activity is combined with AIG  Commercial Insurance’s market power, AIG Commercial Insurance can  prevent prices from increasing and thus hurt other insurers’ ability to price  insurance at a cost adequate to cover the risk involved. The insurers said  they believed that AIG Commercial Insurance’s recent pricing behavior is  the result of its desire to retain existing business in the face of concerns  over the financial health of its parent company, and some suggested that  the federal financial assistance is providing them the means to do this. For  example, some suggested that AIG Commercial Insurance officials know  that the federal government will not let them fail, so they can charge very  low prices without fear of the consequences when the premiums collected  turn out to be less than the losses those premiums were meant to cover.  Some also suggested that buyers in the market are choosing to stay with  AIG Commercial Insurance because they also believe that the insurance  company is now backed by the federal government and that their losses  will ultimately be covered.
AIG told us that AIG Commercial Insurance has the biggest policyholder  surplus in the industry and that they are solvent and financially sound.  They maintained that they are charging prices adequate for the risk being  covered and that their commercial insurance rates have been mirroring  the overall trends in the current soft market. That is, they indicated that  their rates have been declining at an increasingly slower pace since the  fourth quarter of 2008, and in some cases have increased. They also cited  other factors that they said would indicate that they were not pricing  inadequately or taking market share from other companies. First, AIG  Commercial Insurance told us that they have actually been losing market  share because the financial situation of the parent company had impacted  the reputation of the AIG commercial insurance companies. In addition,  they cited instances where competitors were using the AIG parent  company’s financial problems as a way to discourage customers from  buying AIG commercial insurance coverage. Finally, AIG Commercial  Insurance provided us with examples of recent contracts that they have  lost to competitor bids that were below their own. However, AIG  Commercial Insurance acknowledges that these examples reflect the  nature of the business, not necessarily inappropriate pricing by the  competitors.
State insurance regulators, insurance brokers, and insurance buyers that  we have spoken to said that they have seen no indications that AIG’s  commercial property/casualty insurers are selling coverage at prices  inadequate to cover the risk involved:    State insurance regulators we spoke to said that they generally do not  closely watch commercial insurance rates because they may have been  largely deregulated by the states, as well as because of the highly  negotiated nature and complexity of many commercial lines of insurance.  However, they said that they investigate complaints about pricing  activities and monitor insurer solvency measures that would indicate  inadequate pricing—although in some lines the consequences of such  pricing may not show up in these measures for several years. State  regulators indicated that complaints of pricing inadequate for the risk  involved would need to be numerous enough to indicate a potential  systemic problem or would need to prove an intentional predatory  strategy from the part of a particular company. Based on what they have  reviewed, the regulators we spoke with said they have seen no indications  of inadequate pricing by AIG’s commercial property/casualty insurers.
Insurance brokers we spoke with said that when helping a customer  obtain coverage, they see all of the prices and conditions offered by each  insurer placing a bid on that coverage. They also indicated that  commercial property/casualty insurance is competitive, and that in several  lines of commercial insurance, especially where large coverage amounts  are involved, prices offered by insurers can deviate significantly on the  same risk. For example, one broker said that insurers’ bids on large  policies regularly vary by as much as 20 percent below and above the  median bid. Several brokers told us that AIG Commercial Insurance has  historically priced aggressively in some lines, and that while in some  instances in the past several months AIG Commercial Insurance may have  priced more aggressively in order to retain certain customers, it did not  appear to be a widespread practice and was viewed as an expected  response given the reputational hit the company has taken. They also cited  instances where AIG Commercial Insurance has lost business because  other insurers’ prices were lower than theirs.
Insurance buyers, who also see all of the prices and conditions offered by  each insurer bidding on their coverage, said that AIG Commercial  Insurance is known to be competitive in some lines and that they have not  seen any indications of a widespread change in pricing by AIG’s  commercial insurers. They also said that they would recognize, and be  concerned about, an insurer charging suspiciously low rates for the  coverage because it would create a risk that the insurer would be unable  to pay the policyholder’s claim.
However, according to insurance regulators and other industry  participants, for many lines of commercial insurance, determining whether  prices charged by a commercial property/casualty insurer are adequate for  the risk involved pose a number of challenges:  In many lines of commercial insurance, in the case of very large risks as  opposed to routine policies, the terms of coverage, in addition to the price,  are often negotiated, resulting in unique policies. For example, the amount  of a claim the policyholder would be responsible for, and the collateral the  policyholder would be required to post to guarantee payment of this  amount, would be negotiated. Without knowing all the terms of an  individual policy, it could be difficult to determine the extent to which that  policy was priced adequately for the risk involved.
Insurers price policies based on predictions of future losses, which  contain a number of subjective assumptions about risk, interest rates,  litigation costs, and other costs. Underwriters may price a given risk  differently and still be able to defend the reasoning behind their  calculations.
The most concrete indication of systematic inadequate pricing comes  several years later, depending on how far into the future the losses  associated with the policies in question are realized. However, a company  may ultimately end up with higher-than-expected losses even if it charged  actuarially determined premiums using reasonable assumptions at the  time the policies were written.
In closing, the extent to which the assistance provided by the government  will achieve its goal of preventing systemic risk continues to unfold and  will be largely influenced by AIG’s success in meeting its ongoing  challenges in trying to restructure its operations. Likewise, it is too soon to  tell whether AIG will be able to repay its outstanding debt to the federal  government, which in large part depends on the stability of the overall  financial system. While we have found no evidence that federal assistance  has been provided directly to AIG’s property/casualty insurers, as has been  the case for AIG life insurers, AIG’s insurance companies have likely  received some indirect benefit to the extent that the property/casualty  insurers would have been adversely affected by a credit downgrade or  failure of the AIG parent. While we are continuing to complete our work in  the area, some of AIG’s competitors claim that AIG’s commercial  insurance pricing is out of line with its risks but other insurance industry  participants and observers disagree. At this time, we have not drawn any  final conclusions about how the assistance has impacted the overall  competitiveness of the commercial property/casualty market.
Mr. Chairman, this completes my prepared statement. I would be pleased  to answer any questions that you or Members of the Subcommittee may  have.
section_title: Contact and Acknowledgements
paragraphs: For further information about this testimony, please contact Orice M.  Williams at (202) 512-8678 or williamso@gao.gov. Contact points for our  Offices of Congressional Relations and Public Affairs may be found on the  last page of this statement. Individuals making key contributions to this  testimony include Patrick Ward (Assistant Director), Joe Applebaum  (Chief Actuary), Susan Offutt (Chief Economist), Silvia Arbelaez-Ellis,  Tania Calhoun, John Forrester, Dana Hopings, Jennifer Schwartz, and  Melvin Thomas.
section_title: Appendix I – Timeline of AIG Financial Difficulties Leading Up to Federal Assistance
paragraphs: July 2008 to August 31, 2008:    The super senior collateralized debt obligation (CDO) securities  protected by American International Group Financial Products’  (AIGFP) super senior credit default swap (CDS) portfolio continued to  decline and ratings of CDO securities were downgraded, resulting in  AIGFP posting additional $5.9 billion collateral.
AIG was doing a strategic review of AIG’s businesses and reviewing  measures to address the liquidity concerns in AIG’s securities lending  portfolio and to address the ongoing collateral calls regarding AIGFP’s  super senior multi-sector CDS portfolio, which as of July 31, 2008,  totaled $16.1 billion.
Early September 2008: These collateral postings and securities lending  requirements were placing increasing stress on the AIG parent company’s  liquidity.
September 8 to September 12, 2008: AIG’s common stock price declined  from $22.76 to $12.14, making it unlikely that AIG would be able to raise  the large amounts of capital that would be necessary if AIG’s long-term  debt ratings were downgraded.
September 11 or 12, 2008: AIG approached the Federal Reserve with two  concerns:    AIG had significant losses in the first two quarters of calendar year  2008, primarily attributable to AIGFP and decreasing values in their  securities, leading AIG to request to place large amounts of cash  collateral.
AIG’s investments in mortgage-backed securities (MBS) were very  illiquid. Consequently, AIG would not be able to liquidate its assets to  meet the demands of counterparties. Since AIG is not regulated by the  Federal Reserve, the agency was not aware of the company’s financial  problems.
Also, because AIG was facing a downgrade in its credit rating the next  week, it needed immediate liquidity help. Over the weekend, the Federal  Reserve was examining AIG to determine if it was systemically important,  meaning that its failure would have a broader effect on the economy. This  was the same weekend that Lehman Brothers went into bankruptcy.
September 12, 2008:    Standard & Poor’s (S&P), placed AIG on CreditWatch with negative  implications and noted that upon completion of its review, the agency  could affirm the AIG parent company’s current rating of AA- or lower  the rating by one to three notches.
AIG’s subsidiaries, International Lease Finance Corporation (ILFC) and  American General Finance, Inc. (AGF), were unable to replace all of  their maturing commercial paper with new issuances of commercial  paper. As a result, AIG advanced loans to these subsidiaries to meet  their commercial paper obligations.
September 13 and 14, 2008: AIG accelerated the process of attempting to  raise additional capital and discussed potential capital injections and other  liquidity measures with private equity firms, sovereign wealth funds and  other potential investors. AIG also met with Blackstone Advisory Services  LP to discuss possible options.
September 15, 2008:    AIG was again unable to access the commercial paper market for its  primary commercial paper programs, AIG Funding, ILFC and AGF. AIG  advanced loans to ILFC and AGF to meet their funding obligations.
AIG met with representatives of Goldman, Sachs & Co., J.P. Morgan,  and the Federal Reserve Bank of New York (FRBNY) to discuss the  creation of a $75 billion secured lending facility.
S&P, Moody’s, and Fitch Ratings (Fitch) downgraded AIG’s long-term  debt rating. As a result, AIGFP estimated that it needed in excess of $20  billion to fund additional collateral demands and transaction  termination payments in a short period of time.
September 15, 2008: AIG’s common stock price fell to $4.76 per share.
September 16, 2008:    AIG’s strategy to obtain private financing failed. Goldman, Sachs & Co.  and J.P. Morgan were unable to syndicate a lending facility.  Consequently, counterparties were withholding payments from AIG,  and AIG was unable to borrow in the short-term lending markets.
To provide liquidity, both ILFC and AGF drew down on their existing  revolving credit facilities, resulting in borrowings of approximately $6.5  billion and $4.6 billion, respectively.
AIG was notified by its insurance regulators that it would no longer be  permitted to borrow funds from its insurance company subsidiaries  under a revolving credit facility that AIG maintained with certain of its  insurance subsidiaries acting as lenders. Subsequently, the insurance  regulators required AIG to repay any outstanding loans under that  facility and to terminate it.
The Federal Reserve extended the facility to AIG to prevent systemic  failure. AIG had no viable private sector solution to its liquidity issues.  It received the terms of a secured lending agreement that FRBNY was  prepared to provide. AIG estimated that it had an immediate need for  cash in excess of its available liquid resources. That night, AIG’s Board  of Directors approved borrowing from FRBNY based on a term sheet  that set forth the terms of the secured credit agreement and related  equity participation.
September 22, 2008:    The inter-company facility was terminated effective September 22,  2008.
AIG entered into the Fed Credit Agreement in the form of a two-year  secured loan.
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