1.0 OverviewLargest insurer across the globe, with market value of US$172.24 billion in 2009. AIG is engaged in general insurance, life insurance and retirement services operations and also provides financial services and asset management services (Datamonitor, 2009). Its financial services business includes commercial aircraft and equipment leasing, capital markets operations and consumer financing (www. globalmarketsdirect. com). In 2008, AIG witnessed liquidity concerns due to higher than anticipated capital losses in multi-sector credit default swaps. The company suffered capital losses of US$30,482 million during the first three quarter of the fiscal year ending 2008 (www. globalmarketsdirect. com).
The high capital loss has worsened AIG’s capital position and the company, in order to regain its market position, had to seek a bailout program from the US Treasury and the Federal Reserve to resolve its capital issues through a bridge loan of US$85 billion (Datamonitor, 2009). £ in millions20082007200620052004CAGRNet Premiums Earned45072.139626.240271.838632.3363675.51%Total Premiums Earned45072.139626.240271.838632.3363675.51%Net Investment Income6596.914300.614146.912408.910079-10.05%Realized Gains (Losses)(45386)(7527.3)57.5187.424n. dTotal Revenue5993.454997.661529.659770.453310.6-42.10%Net Income(53592)3098.17623.25756.75370.6n. dBasic Normalized EPS(258.66)39.1861.0644.3342.13n. dTotal Debt13437988440.276064.764094.950574.527.67%Total Liabilities56178647852944847544662037578610.58%Long Term Debt Issued61262.551572.838543.436847.117187.637.40%Source: OneSourceThe net debt for AIG in 2008 stood at £134.3 billion, with CAGR of 27.67% (2004-2008). The company recorded total revenue of US$11,104 million in the fiscal 2008, against US$110,064 million in the previous year, representing a decrease of 90% year on year (Datamonitor, 2009).
Further, the company incurred a net loss of US$99,289 million in 2008 compared with a net profit of US$6,200 million a year ago (Annual Report, 2008). The weak performance was due to the unexpected loss in net investment income, net realized capital gains and unrealized market valuation losses (Annual Report, 2008). Fall of AIG was the biggest failure of corporate governance and business losses in a decade’s time. Higher credit default swaps exposure for AIG hampered its long-term sustainability in 2008.
US$ in billionsCredit Default SwapsEquity derivative outstandingCurrency outstanding2001 69,207.30 918.87 02002 101,318.49 2,191.57 2,455.29 2003 142,306.92 3,779.40 3,444.08 2004 183,583.27 8,422.26 4,151.29 2005 213,194.58 17,096.14 5,553.97 2006285,728.14 34,422.80 7,178.48 2007 382,302.71 62,173.20 9,995.71 2008 403,072.81 38,563.82 8,733.03 CAGR34.92%88.75%n. dSource: www. isda. orgBottom line: The total credit default swap market grew to US$403,072 billion, with CAGR of 35% in 2001-2008. Credit default swap was the second fastest growing segment in United States.
In 2008, the segment stood at ten times of equity derivate outstanding (www. isda. org). In 2008, AIG sold credit default swaps worth US$527 billion i. e. 1.3% of total marketspace (www. isda. org). High credit default swap exposure was the primary cause for AIG’s fall and one of the biggest corporate failures in 2007-2009. 2.0 Research QuestionHow to prevent corporate failures such as AIG in future? In our case study we would highlight the following: Cause-Effect analysis of credit default swaps trapLapse of financial regulationsPropositions to reduce corporate failures such as AIG in future3.0 Cause-Effect AnalysisAccording to Basel II regulations for global banking industry every financial institution should maintain particular capital reserves depending upon bank's loan book (Stansberry, 2008).
The riskier the loans a bank owns, the more capital it must keep in reserve. Bank managers naturally seek to employ as much leverage as they can, especially when interest rates are low, to maximize profits (Stansberry, 2008). AIG used to offer banks a way to get around the Basel rules via unregulated insurance contracts, known as credit default swaps (Stansberry, 2008). Thus it could be termed as lapse in financial regulations across United States and globally.
Another issue with AIG’s insurance contracts or credit default swaps was unregulated by U. S treasury. The unregulated credit default swaps weren’t required by AIG to put up any capital as collateral as long as it maintained a triple-A credit rating (Annual Report, 2008).