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Lessons in Liquidity from AIG’s “Subprime” Struggles

Posted on | September 17, 2008

Sparked by AIG’s financial woes, it’s an understatement to say the financial marketplace has been rather upset the last few days.

And while the company’s troubles are serious and we all hope for a sound recovery, AIG’s experiences are something we can all learn from.

It is apparent the problems at AIG were created because of its involvement in a non-life insurance area of its investment portfolio — one that insures subprime mortgage loans.

Due to the mortgage meltdown, especially with subprime loans, AIG has had to use a lot of its cash for the protection of asset deterioration.

As I have always taught through my Missed Fortune strategies, the number one reason to manage equity successfully is to maintain liquidity. AIG has had to use most of its liquid cash to cover a segment of its business that was higher risk, and it has required more liquid cash than the company had available.

Hence, AIG has appealed for as much as $85 billion of additional cash to meet its obligations. It has plenty of assets to sell, but unfortunately, they are not readily liquid to convert to cash. Again, what do we learn from this?

It is important to maintain sufficient liquidity at all times.

I suggest the best way to do this is by keeping serious cash in maximum-funded insurance contracts. I feel the life insurance segment of AIG is still stable—especially because of guarantees and the cross-insuring between companies that protects cash values and death benefits in the event of insurance company insolvencies.

However, even though the insurance arm of AIG had a high Comdex score, it is still susceptible to volatility when the company’s investments are exposed to certain market risks. For this reason, at Missed Fortune we usually recommend life insurance companies that do not invest or insure in riskier markets—or, if they do, a very low percentage of their holdings are in such investments.

We look for and use companies that have a diversified portfolio that limits exposure to any particular industry, issuer, or type of asset.

Your True Wealth Takeaway

The most important lesson to learn from AIG’s current turmoil is to maintain liquidity — whether you are a personal investor or an institutional investor.

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*Life insurance policies are not investments and, accordingly, should not be purchased as an investment

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