As AIG Struggles Through Financial Crisis,
AIG’s Insurance Company Subsidiaries
Continue to Do Business with Separate Operating Identities
And their Assets Protected by Law from AIG’s Creditors

By Albert B. Lewis

From my experience as New York Superintendent of Insurance and counsel to a law firm that specializes in directors and officers liability insurance, I know that many existing and potential customers of the AIG insurance companies will have concerns about how the liquidity crisis of the parent company might impact the financial security of the operating insurance company subsidiaries. Clients will want to know whether the assets of the AIG insurance companies are protected from the liabilities of the parent company and its non-insurance affiliates.

State Regulation of Insurance Holding Company Systems

The AIG insurance companies are regulated by state law and their affairs overseen by state insurance commissioners. Those laws are designed in part to assure that regulated insurance companies are operated on a financially sound basis and their assets are protected from the financial problems of non-insurance affiliates. The insurance company subsidiaries are not subject to federal bankruptcy laws, as would be AIG and its non-insurance company subsidiaries.

All states have enacted insurance holding company statutes which authorize insurance departments to regulate the inter-company transactions involving insurance companies within holding company structures. The various state statutes are generally patterned on the Model Act adopted by the National Association of Insurance Commissioners (“NAIC”), the NAIC Insurance Holding Company Regulatory Act.

These statutes provide state insurance departments with the regulatory power and responsibility to ensure that the assets of insurance companies are held separate from the other entities within the holding company system. AIG cannot legally enter into any material transaction with its insurance companies subsidiaries, without the approval of the state insurance regulators. For example, approval is required for inter-company reinsurance, loans, management contracts, asset sales or swaps or other similar transactions. The assets of the insurance companies are maintained to support the insurance business underwritten by those companies and may not be hypothecated or intermingled with the assets of any non-insurance affiliates.

The President of the NAIC, Sandy Praeger, issued the following statement on September 22, 2008 in response to the financial issues facing AIG:

“The No. 1 job of state insurance regulators is to make sure insurance companies operate on a financially sound basis. If needed, we immediately step in if it appears that an insurer will be unable to fulfill the promises made to its policyholders. This includes taking over the management of an insurer through a conservation or rehabilitation order, the goal being to get the insurer back into a strong solvency position.

State regulators have numerous actions they can take to prevent an insurer from failing. Claims from individual policyholders are given the utmost priority over other creditors in these matters – and, in the unlikely event that assets are not enough to cover these claims, there is still another safety net in place to protect consumers: the state guaranty funds. The funds are in place in all states. If an insurance company becomes unable to pay claims, the guaranty fund will provide coverage, subject to certain limits.

It is a state insurance regulator’s responsibility to protect policyholders and ensure a healthy, competitive market for insurance products. Strict solvency standards and keen financial oversight – based on conservative investment and accounting rules – continue to be the bedrock of state–based insurance regulation.”

Consequently, holders of policies issued by an AIG insurance company subsidiary should not be concerned that the insurance company’s assets would be available to shore up AIG’s balance sheet or to pay or secure AIG’s non-insurance corporate debts. AIG cannot legally enter into any material transaction with the insurance companies that would upstream assets for a non-insurance use without the approval of the insurance department.

The Impact of an AIG Bankruptcy on the Insurance Company Subsidiaries

The financial problems of AIG and its non-insurance subsidiaries should not expose the insurance companies’ assets to pay or secure any corporate liability of AIG or its non-insurance subsidiaries. Federal bankruptcy law does not pre-empt state insurance law where licensed insurance companies are concerned. If AIG were to be the subject of federal insolvency proceedings, the reach of a debtor-in-possession or federal receiver would not extend to the assets of the AIG insurance company subsidiaries. Only the stock of the insurance companies would be included in the AIG federal bankruptcy estate. The federal court’s jurisdiction would extend only to the exercise of the rights of AIG as shareholder of the insurance companies.

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During my tenure as New York Superintendent of Insurance, and my membership in the NAIC, I had experience in the regulation of insurance companies which were part of large complex holding company systems. I played a consequential role in the development of the legislation and regulatory protocols which were put in place to allow for efficient and effective regulation by the states of the insurance subsidiaries of these large diverse corporate structures. I believe that the state regulatory system in place serves to protect the integrity of the insurance companies it regulates, maintaining the assets of the insurers for the corporate purposes of the insurance companies themselves, separate and apart from those of other companies in an insurance holding system.

D’Amato & Lynch has handled D&O coverage issues for over 40 years. Al Lewis, a former NY Superintendent of Insurance and Of Counsel to the firm, has prepared the following article to assist Directors and Officers and their insurance brokers in understanding issues they face in today's market.

Please call me at (212) 909-2006 with any questions you have relating to this topic.