Credit Crunch – Issue of Funding - Insurance Companies & Banks

During AIG’s meeting with investors on 5th December 2007 , Martin Sullivan commented “AIG does not rely on asset-backed commercial paper or the securitization markets for its funding. We have the ability to hold devalued investments to recovery _ that's very important."

Martin’s comment really highlights a critical distinction between an property and casualty insurance company and a commercial bank or mortgage thrift and why I believe this credit crunch will have a lesser impact on the former rather than the later. Two qualifications here , firstly I am limiting my comments to property & casualty insurers not bond and mortgage insurers and secondly some property and casualty insurers have weaker balance sheets than others and will be impacted to a greater extent by current credit conditions.

Insurance companies mostly fund their debt purchases from the pool of policyholder premiums they collect, known as the float. They are not dependent on the commercial paper or securitization market, like Capital One that securitizes its credit-card receivables, nor do they depend on GSEs like Fannie or Freddie to raise more funding for the business, like Countrywide.

An insurer can’t suffer a “run on the bank”. E-trade and Countrywide have both faced this potential scenario recently. Both companies have been forced to publicly defend their liquidity in the press and to shore up their balance sheets with dilutive capital raisings.

For insurers generally, funding using insurance premiums is all fine and good provided you are underwriting with the strictest discipline. Float is a wonderful thing provided it comes with a zero cost!

Disclosure: I own AIG shares