AIG's claims over life insurer fragility irk sector

By Lilla Zuill

NEW YORK, March 12 (Reuters) - AIG's recent claims that its collapse could threaten not just banking counterparties but also decimate the broader U.S. life insurance industry are alarming but also largely unproven.

The contention was made in a presentation to U.S. regulators in late February on the eve of the third iteration of the U.S. government's rescue of American International Group Inc -- the globe insurer whose collapse has cost taxpayers up to $180 billion.

But while the report may have strengthened AIG's plea for the government to put another $30 billion at the insurer's disposal, it may have been based more on alarmist guesswork than a realistic risk scenario.

"Will AIG take down the industry? Categorically no, and to suggest that is irresponsible and inaccurate," said Citigroup analyst Colin Devine. "The (life insurance) industry is facing some tough times but that is regardless of what happens at AIG."

AIG, until recently the world's largest insurer, was rescued by the U.S. government last September as losses on toxic mortgage bets taken by a financial products unit nearly drove the holding company into bankruptcy.

At the time, the U.S. Treasury and Federal Reserve deemed it necessary to save AIG to protect millions of banks and others that had bought guarantees on debt from AIG Financial Products, fearing losses that would send shocks through already sick financial markets.

The U.S. government has continued to fund the insurer since, mindful of the turmoil created by Lehman Brothers' collapse two days before the initial AIG rescue.

AIG warned in the presentation to regulators that an AIG collapse could have a "cascading impact on a number of U.S. life insurers already weakened by credit losses."

To make matters worse, state insurance guarantee associations, set up about 40 years ago to ensure policyholder obligations are met, would "be quickly dissipated, leading to even greater runs on the insurance industry," AIG told officials, as it was seeking greater federal funding.

But AIG's troubles did not stem from any of its insurance units -- which operate in about 140 countries around the world

-- and even a bankruptcy would not necessarily lead to the -- and even a bankruptcy would not necessarily lead to the closures of any subsidiaries.

Joe Belth, professor emeritus of Indiana University and editor of Insurance Forum newsletter, said it was misleading for AIG to draw any parallels between troubles at the parent company and insurance businesses.

"I don't like to even think of AIG the holding company as an insurance company because that blurs an important distinction," he said. Belth said there were numerous examples of insurance holding companies collapsing while insurance units continued to operate, pointing to Conseco's (CNO.N) failure in 2002 as an example.

To be sure, the failure of a company of AIG's size would be unprecedented, and likely made much worse by the fact that its business included investment and financial products arms, raising the prospect of broader ramifications than in previous insurance company failures.

AIG, in the presentation, said its assessment of "potential consequences (from its own failure) are inherently judgmental and, to an extent, speculative."

The company had no further comment.

SAFEGUARDS

U.S. life insurers' stocks have fallen dramatically since last year, as investment losses have eroded capital, triggering some credit rating downgrades, and raising investor fears that some companies may not survive.

The Dow Jones U.S. life insurance index .DJUSIL has fallen nearly 80 percent in the last six months. Apart from investment losses, investors have also been concerned about the hit to companies that sell variable annuities, a popular retirement product linked to stock markets, especially those that guarantee withdrawal benefits.

There have been no recent failures of large, publicly traded life insurers. But things may get uglier.

"The first quarter of this year we expect will be the worst quarter in the (life insurance) industry's history," said Citigroup's Devine.

Still, some companies remain strong, and may be in a position to assume policy obligations if weaker rivals fold. State guarantee funds also are there to cover, within limits, shortfalls between assets and policyholder liabilities.

Devine named MetLife Inc (MET.N), the largest U.S. life insurer, Principal Financial (PFG.N), and Unum Group (UNM.N) as being among the companies he expects will remain financially stable.

In 2009, state guarantee associations have the ability to assess member companies to cover the net liabilities of failed companies up to a maximum of $8.8 billion.

That means policyholder obligations could likely be met, although the process can drag out.

"There has never been an instance where the guarantee association failed to pay 1 cent of its obligation," said Peter Galanis, president of the National Organization of Life & Health Insurance Guaranty Associations, or NOLHGA.

The guarantee associations have successfully dealt with large failures in the past, including Executive Life and Mutual Benefit in the early 1990s. Galanis said he expects that to remain the case, barring deterioration beyond expectations.

(Reporting by Lilla Zuill; editing by Richard Chang)

((lilla.zuill@thomsonreuters.com;+1 646 223 6281)) Keywords: AIG/LIFEINSURERS

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