THE AIG SCANDAL

INTRODUCTION

“Too Big to Fail” refers to companies that are too important to the economy to just go away.

The American International Group was deemed as the “Largest Insurance Company in the
World” at their peak in early 20’s. They provided Life Insurance, Property Insurance, Casualty
Insurance, Annuities but the largest part of their operation is to provide insurance connected
to different financial instruments.

Cornelius Vander Starr a businessman from California that worked on a Chinese Insurance
Industries in Shanghai China.
At 27 years old, he started his small business as an underwriter (someone who is a part of a
financial organization, that evaluates and assumes, for a fee, another party’s risk in mortgages,
insurance, loans, or investments) the one to determine the level of risk and set prices for
lenders.

Years later, he started his own Life Insurance that worked directly with the public. Because
of the lack of competition as no one was willing to offer the kind of service A.I.G has, and his
own ability to set appropriate rates based on personal prediction made the business successful.
The Company continued to grow until 1967 wherein Cornelius stepped down and died the
following year.

Hank Greenberg (chosen by Cornelious to be his replacement). Under Hank the American
International Group flourished to the point in which it will potentially cause a Global Economic
Collapse.

There are 2 Major Event that happened concerning A.I.G

In 2005, The American Company was charged with Accounting Fraud, (The statement of
financial position of a company needs to be put out for the public to see and based on those
reports the public will decide whether or not they want to buy stock and invest in the company)
evidence of a bogus transaction with a reinsurance company who helped to made a reserve to
have an additional of $500 million in it. The following year AIG made a different transaction
involving illegally converting $200 million of underwriting losses into investment losses, although
the company was never doing badly in the market at that time. Eliot Spitzer the New York
Attorney General said “A.I.G was and is a solid company that didn’t need to cheat. It finds
itself in this position solely because some senior managers thought it was acceptable to
deceive the investing public and regulators”
After the accusations became public Hank left the company, in which in 2017 he admitted being
involved in the fraud as part of his $9 million settlement. The A.I.G Apologizes and Agrees to
$1.64 Billion Settlement

The Housing Crisis between 2006 – 2007

People are taking out loans at an incredible rate. Since the banks had so much money coming
in from these mortgages, they held values. The banks were able to bundle them together into a
security and sell it. You might be wondering how the A.I.G was involved in this, remember that
they offer insurance connected to different financial instruments. In this case they got heavily
involved in selling insurance policies mainly to the investment banks, that is basically saying “If
people defaulted mortgages A.I.G would pay them for it”. paying A.I.G to accept their risk.
Then the inevitable happened, the entire market collapsed. Many of the people were defaulting,
it turns out that many of them were buying subprime mortgages(the practice of lending money,
especially to buy a house, to people who may not be able to pay it back) with bad credit (they
have had difficulty paying back a loan in the past). Because many people are defaulting at the
same time A.I.G does not have enough money to honor the payments for the insurance policies.
And Because of their High credit rating (indicates that, in the rating agency's opinion, a bond
issuer is likely to repay its debts to investors without difficulty.), they were never forced to have
collateral associated with these insurance policies. In the end the US Government chose to bail
them out as A.I.G plays a large role in their economy. The Government took over 79.9% of the
company’s equity which can be converted into $85 Billion dollars of investment and gave the
company's executive an additional of & $170 Billion dollars to stay and help rebuild the
company.

PRINCIPLES

● Principle 10: ethical behavior is doing the right thing, and ethical dilemmas are
everywhere in finance

AIG, a leading insurance company, was found to have engaged in accounting fraud in 2005.
They falsified their financial records in order to draw in more investors. Their actions have
put them in a legal crisis, damaged their brand, created a monetary disaster, and forced
them to pay a $1.6 billion penalty.

● Principle 1: The Risk-Return Trade-off "We won’t take on additional risk unless we
expect to be compensated with an additional return."

In 2004 and 2005, The AIG company committed securities fraud risking their company
for its goal to gain finances from its investors and to generate more profit. But in 2005, The
SEC filed a case against AIG and their CEO, Hank Greenberg after investigating that there
are questionable transactions discovering that the AIG entered into a sham reinsurance
transaction with general reinsurance companies to add 500 million dollars loss to the
balance sheet. AIG also had a transaction with CAPCO reinsurance company to add almost
200 million of underwriting losses. This shows that the risk that the company takes did not
achieve its goal to generate profit instead it causes chaos to the company and this unethical
behavior leads them to losses and debts.
 ● PRINCIPLE 7: The Agency Principle “Managers won’t work for the owners unless it
is in their best interest”

The American International Group(AIG) Scandal in 2005. The AIG executives focus more
about making money quickly than the company's future. They took big risks that paid off but
then caused big problems later on. These benefits have created a sense of entitlement for
their own interest that leads to different issues like fraud and falsifying accounting records.

● Principle 9: All risks are not equal “Do not pull all the eggs in just one basket”

AIG's decision to emphasize CDS (credit default swap) so much, exposed the business to a
concentrated and highly correlated risk. These are just a handful of the significant risk
management errors that contributed to the company's downfall. AIG placed a large amount
of its capital in one extremely volatile market, instead of spreading its risk over several
markets. A company's financial problems were caused by concentrated losses from the
housing market crisis rather than distributed losses.

Links

A.I.G Scandal
https://youtu.be/cCQgl_oeXXc?si=EtJjJP_46LxWuDNh

High Credit ratings

https://www.investopedia.com/terms/c/creditrating.asp

Underwriter
https://www.investopedia.com/terms/u/underwriter.asp

Bad credit
https://dictionary.cambridge.org/us/dictionary/english/bad-credit

Subprime
https://dictionary.cambridge.org/us/dictionary/english/subprime