AIG, States Work Together to Raise Cash

American International Group(AIG Quote) is getting help from the insurance commissioners of New York and Pennsylvania in raising cash by swapping its subsidiaries' liquid assets for those that are difficult to convert into cash held by the parent company.

"If you have a policy with an AIG insurance company, they are solvent and have the capability to pay claims," said Sandy Praeger, president of the National Association of Insurance Commissioners and Kansas insurance commissioner, in a press release today. "Our job is to ensure they continue to have the ability to pay."

AIG shares slid today as the insurer met for a second day at the New York Federal Reserve Bank to discuss its capital-raising options after ratings downgrades. AIG was given permission by the New York state insurance commissioner to leverage the assets of subsidiaries to raise up to $20 billion, New York Gov. David Paterson said Monday.

Cramer: Market's Fate Rests With AIG

The New York state and Pennsylvania insurance departments are working with AIG to review transactions involving turning illiquid assets into liquid ones. "State insurance regulators will only approve this type of action if they are assured it is part of a total resolution of the liquidity issue at the parent company and fairly compensates its insurance company subsidiaries," Praeger said today.

AIG's New York and Pennsylvania insurance companies have about $120 billion in total assets, about half of which is Class 1 bonds. The regulators must ensure that any assets being exchanged are at least of equal quality or the financial strength of the insurers will be negatively affected.

With bond levels at a five-year high, this may be an opportune moment to sell. A vital function of all insurance companies is to purchase investments -- usually U.S. government and high-rated corporate bonds -- with maturities matched to the claims they expect to pay out over time.

An example of this would be to purchase a 10-year Treasury note timed to mature when a block of life-insurance policies are expected to pay out. However, the bonds could be sold at any point, making them liquid. In the current market, such bonds could be sold for a premium, and it is perhaps these assets that AIG will want to swap.

The problem is that the claim liability is still there and doesn't go away just because the bonds are sold. This means those bonds have to be replaced with something else that matures or pays out at the time that the expected life-insurance claims come due. If the bonds sell at a premium, that means replacing them would be expensive and theoretically wipe out the margin that the company earns on those investments during the 10 years until maturity.

In AIG's case, who knows what assets those bonds would be replaced with, when they would become liquid, and how long it would be before they could be matched to the insurers' claims liabilities. Again, this weakens the insurers.

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