The Rise and Fall of AIG Custom Case Solution & Analysis

1. Evidence Brief: Business Case Data Researcher

Financial Metrics

Total Assets: Exceeded 1 trillion dollars at the peak of operations before the 2008 crisis.
Net Loss: Reported a record 99.3 billion dollar loss for the full year of 2004.
Credit Default Swap (CDS) Portfolio: AIG Financial Products (AIGFP) wrote over 440 billion dollars in CDS contracts.
Subprime Exposure: Approximately 58 billion dollars of the CDS portfolio was tied to multi-sector collateralized debt obligations containing subprime mortgages.
Collateral Calls: Goldman Sachs and other counterparts demanded billions in collateral as mortgage bond ratings dropped.
Government Intervention: Initial credit facility of 85 billion dollars from the Federal Reserve, eventually expanding to a 182 billion dollar total bailout package.
Securities Lending Program: Suffered losses exceeding 20 billion dollars due to liquidity mismatches in reinvested cash collateral.

Operational Facts

Corporate Structure: AIG functioned as a massive insurance conglomerate with over 70 state-regulated US subsidiaries and numerous international units.
AIGFP Unit: Operated out of London and Connecticut with fewer than 500 employees but generated a disproportionate share of corporate profits.
Regulatory Oversight: Primarily regulated by the Office of Thrift Supervision (OTS), which lacked the capacity to monitor the complex derivative trades of the financial products division.
Credit Rating: Maintained a AAA rating for decades, which allowed the firm to issue CDS without posting initial collateral.

Stakeholder Positions

Maurice Hank Greenberg: Former CEO who built the firm through aggressive global expansion and strict internal controls; departed in 2005 amid accounting investigations.
Martin Sullivan: CEO during the initial subprime expansion; focused on maintaining the growth trajectory established by his predecessor.
Joseph Cassano: Head of AIGFP; maintained that the CDS portfolio carried zero risk of actual economic loss.
Robert Willumstad: Chairman and later CEO who attempted to address the liquidity crisis in mid-2008.
US Treasury and Federal Reserve: Acted as the lender of last resort to prevent systemic global financial collapse.

Information Gaps

Specific internal risk models used by AIGFP to justify the zero-risk assumption are not fully detailed in the case text.
The exact communication logs between the OTS and AIG leadership regarding the systemic risk of the CDS portfolio are missing.
Detailed breakdown of the 20 billion dollar securities lending loss by specific asset class is not provided.

2. Strategic Analysis: Market Strategy Consultant

Core Strategic Question

The primary strategic dilemma: How can a global insurance conglomerate manage a high-alpha financial derivatives unit without compromising the solvency of its regulated insurance subsidiaries?
The secondary problem: Failure to recognize that a AAA credit rating is a fragile operational asset, not a permanent competitive advantage.

Structural Analysis

Applying the Value Chain of Risk analysis reveals a fatal flaw in the AIG model. The firm treated the CDS portfolio as an insurance product without applying insurance-grade actuarial rigor. The PESTEL framework highlights a regulatory vacuum where the OTS was ill-equipped to oversee a global derivatives powerhouse. The core issue was an agency problem: AIGFP employees received massive bonuses based on mark-to-model profits, while the parent company bore the tail risk of mark-to-market losses.

Strategic Options

Preliminary Recommendation

AIG should have pursued structural ringfencing in 2005 immediately following the departure of Hank Greenberg. The reliance on the parent company balance sheet to backstop AIGFP created a single point of failure. By decoupling these units, the firm would have forced AIGFP to operate under market-standard collateral requirements, naturally limiting the size of the CDS portfolio to a manageable level. This would have preserved the core insurance business which remained fundamentally profitable.

3. Operations and Implementation Planner: Implementation Roadmap

Critical Path

The survival of the firm depends on an immediate pivot from profit maximization to liquidity preservation. The following sequence is mandatory:

Month 1: Immediate suspension of all dividend payments and executive bonus accruals to preserve cash.
Month 1: Formation of a Liquidity Crisis Task Force reporting directly to the Board, bypassing AIGFP management.
Month 2: Comprehensive audit of all CDS contracts to identify triggers for collateral calls based on rating downgrades.
Month 2: Engagement with Goldman Sachs and other major counterparts to negotiate structured collateral schedules.
Month 3: Initiation of fire-sales for non-core international assets to build a 50 billion dollar liquidity buffer.

Key Constraints

Counterparty Contagion: The interconnectedness of the CDS market means that one default triggers a domino effect across the global banking system.
Regulatory Fragmentation: Navigating the demands of 70 different state insurance commissioners while managing a federal liquidity crisis.
Talent Retention: The risk of key personnel at AIGFP departing during a restructuring, leaving no one to manage the complex unwinding of derivative positions.

Risk-Adjusted Implementation Strategy

The implementation must assume that market conditions will deteriorate further. A contingency plan must be established for a federal backstop. This involves preparing a transparent asset-valuation book that can be handed to the Federal Reserve on 24-hour notice. The firm cannot rely on private capital markets which are effectively frozen. Execution success will be determined by the speed of asset divestiture in the Asian life insurance markets, which remain the most liquid and valuable segments of the portfolio.

4. Executive Review and BLUF: Senior Partner

BLUF — Bottom Line Up Front

AIG collapsed because it treated a catastrophic tail risk as a statistical impossibility. The firm effectively sold insurance against a global housing market decline without holding capital reserves. The management failed to realize that their AAA rating was their only product; once the rating was questioned, the business model became insolvent. The recommendation is to immediately execute a controlled liquidation of non-core assets to satisfy collateral demands, while preparing for a total structural separation of the financial products division. The current path leads to a total loss of shareholder equity and a systemic threat to the global economy.

Dangerous Assumption

The single most consequential unchallenged premise was that residential mortgage-backed securities across different geographies would not default simultaneously. This assumption of non-correlation ignored the systemic nature of the US housing bubble and rendered the risk models at AIGFP useless.

Unaddressed Risks

Securities Lending Risk: The analysis focuses heavily on CDS, but the securities lending program is a massive liquidity drain. If cash collateral is tied up in illiquid mortgage bonds, a run on the bank by lending counterparts is inevitable. (Probability: High; Consequence: Terminal).
Political Backlash: Any government intervention will come with draconian terms that will effectively wipe out existing management and shareholders. (Probability: Certain; Consequence: High).

Unconsidered Alternative

The team failed to consider an early voluntary Chapter 11 filing for the AIGFP subsidiary specifically. While complex, an isolated bankruptcy of the derivatives unit could have potentially shielded the regulated insurance entities from the immediate collateral calls, forcing counterparts to the negotiating table under bankruptcy court protection rather than demanding immediate cash payments.

Verdict

APPROVED FOR LEADERSHIP REVIEW

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Write

Option	Rationale	Trade-offs	Resource Requirements
Aggressive De-risking (2007)	Exit the CDS market as subprime defaults began to rise.	Loss of high-margin revenue; potential early termination penalties.	Specialized liquidation team; significant cash reserves for settlements.
Structural Ringfencing	Legally and financially decouple AIGFP from the insurance subsidiaries.	Protects policyholders but removes the AAA rating benefit for AIGFP.	Complex legal restructuring; capital reallocation.
Capital Infusion and Transparency	Raise 20-30 billion dollars in private equity before the crisis peaked.	Significant shareholder dilution; loss of executive control.	Investment banking consortium; full disclosure of derivative exposure.