AIG's Cash Crisis Stokes Fear

Published on 09/22/2008 via Investment News

Financial advisers could soon find themselves paying more for AIG's variable annuities.

American International Group Inc.'s cash crisis, which rattled the global financial system last week, will likely lead to the sale of the company's variable annuities unit. If that happens, a new owner could ratchet up costs that aren't contractually guaranteed, experts said.

"At the end of the day, and especially if the markets continue sliding, the costs and prices of these very-long-dated guarantees will have to increase," Moshe A. Milevsky, an associate professor of finance at York University in Toronto, wrote in an e-mail.

Scott J. Witt, founder of Witt Actuarial Services LLC in New Berlin, Wis., agrees.

"When people think of variable annuities, they think of traditional accumulation and that everything is in a separate account," he said. "But riders are handled with a company's general account, so those features are more impacted by insolvency or the threat of it."

Although the cost of a rider is usually delineated in an insurer's sales and marketing material, it isn't fixed and may go up under certain conditions. In other words, a guaranteed-lifetime-withdrawal benefit may be marketed as costing 0.7% but could go up to 1.5%.

"How those elements are handled with the buying company is the thing to figure out," Mr. Witt added.


To be sure, regulators will keep a close eye on how policyholders are affected by the sale of AIG's variable annuity business, Steve Davis, partner at Philadelphia-based Stradley Ronon Stevens & Young LLP.

"Nobody knows what the new helmsmen might do with these companies, if anything, but in the event of a sale or other change in control, there is a state statutory framework to protect policyholders," he said.

AIG sold $4.7 billion in variable annuities in the United States during the first six months of the year, making it the ninth-largest seller during that period, according to LIMRA International Inc. of Windsor, Conn. It also ranked as the No. 1 seller of all U.S. individual annuities, posting $10.9 billion in sales during the first half.

After the New York-based insurance juggernaut was brought to its knees early last week, seeking capital to stave off falling credit ratings and collateral demands, the Federal Reserve Bank of New York threw it an $85 billion lifeline late Tuesday night.

The money, a 24-month term loan, bought AIG time to spin off assets and certain businesses to repay the government. That move also gave the federal government ownership of 79.9% of the company and led to the replacement of chief executive Robert Willumstad with Edward Liddy, former CEO of Allstate Corp. of Northbrook, Ill. "My sense is that when the dust settles, the 'new' management will start an orderly sale of the non-core assets of AIG," Mr. Milevsky wrote. "They will slim down to a transparent property and casualty company, which is their bread and butter, and most powerful brand."


Units on the auction block likely will include the VA business, which includes AIG SunAmerica Life Assurance Co. of Los Angeles, and Variable Annuity Life Insurance Co. of Houston.

Possible bidders include Manulife Financial Corp. of Toronto, which already owns John Hancock Financial Services Inc. in Boston, according to a research note from analyst Mario Mendonca of Genuity Capital Markets in Toronto. Major insurers in China, Europe and Australia, plus other domestic large-cap carriers could also be interested, according to a note from Thomas Gallagher and Michael Zaremski, New York-based analysts with Credit Suisse Group of Zurich, Switzerland.

Hedge funds and private-equity firms also may be ready to scavenge parts of AIG, observers said.

Rising costs are not advisers' only concern involving the possible sale of AIG's VA business.

Pasquale J. Sacchetta, president of CFIG Wealth Management of Westport, Conn., is worried that the company that acquires that business also could tamper with investment allocations — if those allocations are not contractually guaranteed.

"If you use certain riders, the company can become more conservative or more aggressive because they want to recoup their money," he said.

Other advisers expressed concern about the quality of the company that buys AIG's variable annuity business.

The financial strength of the purchasing entity, as well as the amount it pays for the unit, will play a role in the strength behind the policies, Mr. Witt said.

"All of that is affected by the purchase price, and that will affect the way the buyer treats the block of business," he added.

The eventual owner of the annuities business and how the business will be split still are unclear, but the industry anticipates potential buyers to emerge soon.

"The company has a gun to its head in the form of a usurious loan at 8.5% over Libor," said Sean Egan, founding principal at Egan-Jones Ratings Co. in Haverford, Pa., referring to the London Interbank Offered Rate. "The sooner they can pay it off or minimize future takedowns on the loan, the better off they'll be."