AIG Bailout: An Embarrassment for the American Insurance Industry

Late Tuesday night, the Federal Reserve Board announced an AIG bailout to the tune of $85 billion, according to CNN and other news outlets. The Federal Reserve Bank will fund the AIG bailout by providing the ailing insurer with a line of credit. The purpose of the AIG bailout is to allow the insurer time to sell off assets in a calm, orderly manner rather than the panic selling that would have to happen if the company still faced bankruptcy. Announcement of the AIG bailout didn't stop hundreds of people this morning in Singapore lining up at the offices of AIA, the Asian subsidiary of AIG, to cancel their policies and get refunds.

Bailout or not, the failure of AIG continues to shake global equities markets to the core. Insurance companies are required to keep funds in reserve to cover extraordinary claims payouts and other business risks. In the United States, life, health, and property insurers are regulated at the state level. Each state's regulations and level of oversight is different. AIG is regulated in New York State. Clearly, regulators had no idea how shaky AIG had become or they might have stepped in earlier to protect policyholders.

Why the AIG bailout is shocking is that it highlights that the insurance industry has no structure of self-regulation. A failure of one insurer impacts confidence in the entire industry, and a program where the insurance industry helps faltering members would restore that confidence.

This structure is in sharp contrast to the Canadian insurance model. All banks, insurance companies and pension funds in Canada are regulated by the Canadian federal government through the Office of the Superintendent of Financial Institutions (OSFI). OSFI requires significant detailed reporting from each insurer outlining assets and claims histories. It is OSFI's job to ensure that each insurer has enough financial resources to avoid a situation like the AIG buyout. Insurers also commit a percentage of their profits each year to an industry association which would use the funds to prop up an individual insurer in financial trouble.