New York-based American International Group Inc., the parent of hundreds of property and casualty and life insurance operations globally, has begun to consider what assets it will sell in order to pay off its US$85-billion bridge-financing loan from the U.S. Federal Reserve Board. But AIG’s Canadian subsidiary is not likely to be on the sell list immediately, according to analysts.

Anthony Diodato, group vice president for property and casualty insurance at the ratings agency A.M. Best Co. in Oldwick, N.J., could not discuss any specific asset sales but says AIG’s larger business units are likely to be on the selling block first. In the days surrounding AIG’s turmoil during the week of Sept. 14, Diodato had been in conversation with senior managers at AIG.

“I don’t know if AIG is going to be selling P&C companies or life companies,” says Diodato, who was in Toronto recently for Best’s annual conference. “Managers have not spoken about that publicly. They could look at big blocks of business — entire legal entities and whole organizations — and I think that’s the approach they’re going to take.”

AIG is paying 11.25% interest on the Fed loan. So, notes Diodato, the debt AIG owes grows significantly daily. “Senior managers are going to look at valuable assets on which they can get a good return,” he says. “They’re going to want to be able to get the cash back quicker and pay off the debt obligation to the U.S. government.”

AIG Life Insurance Co. of Canada, the Toronto-based subsidiary, is a small to medium-sized player in Canada. It contributed $20 million in net income to its parent for the second quarter ended June 30, according to data filed with the Office of the Superintendent of Financial Institutions. AIG Canada retains about $2.5 billion in assets.

During the course of the run on parent AIG’s stock in mid-September, Peter McCarthy, president and CEO of AIG Canada, issued a statement to advisors and other business partners about the quality of the Canadian unit’s balance sheet.

“It is important to note that the credit market exposure is largely concentrated in a few U.S.-based finance- and mortgage-related businesses of AIG Inc.,” he said in the statement. “Although AIG Inc. faces short-term liquidity pressures, it differs from other financial institutions that have been under pressure in that it has strong, well-positioned businesses in diverse markets around the world and a deep asset base.”

The statement continues: “The important message that we want to convey to you and our policyholders, who are looking to us both for reassurance, is that their AIG Life of Canada policies are safe.”

Parent AIG incurred the liabilities in its financial products division, AIG Financial Products Corp., which has posted losses of more than $15 billion in the first half of 2008. According to Diodato, the liabilities were in a combination of products, including collateralized debt obligations with subprime mortgage exposure, but were mostly in a portfolio of credit-default swaps, or CDSes.

CDSes are effectively a form of commercial insurance that a company can buy to bolster its ability to acquire debt. Company A can pay premiums to a CDS manufacturer such as AIG Financial Products to back its debt and effectively transfer part of the risk of default to the CDS manufacturer through the instrument. In turn, CDSes trade on the open market, with spreads on the bonds widening or narrowing as the chance of default rises or falls.

GROWING LIABILITIES

(Incidentally, Toronto-based Fairfax Financial Holding Ltd. reported in September that it had realized a gain of $1.65 billion on its portfolio of CDSes, some of which included CDSes on AIG. The insurance conglomerate still holds unrealized CDSes worth more than $600 million in the market as of Sept. 22, when it reported the gain.)

As the number of bond defaults grew, so, did AIG’s liabilities; as its capital became strained, Best, Standard & Poor’s Corp. and other ratings agencies downgraded AIG’s financials, which further accelerated the decline in AIG’s stock price.

Best’s analysts are not certain of the size or the character of AIG’s CDS exposure. They say it is fair to assume that some of the CDSes would have been contracts on the credit notes of Lehman Brothers Inc. and Bear Stearns & Co. Inc., the two New-York-based investment banks that have failed recently, as well as a host of others. Many of these investment banks, including Merrill Lynch & Co. Inc. and Goldman Sachs Inc., are heavily leveraged, with balance sheets weighed down by short-term debt that is tied to the ailing U.S. mortgage industry — which they cannot trade, as nobody wants them.

@page_break@AIG’s financial product division had been extremely profitable for the parent company for many years. But all the business equity it has built up has been destroyed in the past 18 months, says Ken Frino, a colleague of Diodato’s at Best and group vice president covering the life and health side of the insurance industry.

Yet, Best supports the statement by AIG Canada’s McCarthy that AIG’s Canadian subsidiary and, indeed, many of the parent company’s global life and health insurance operations are healthy as independent units.

“In its life operations,” Frino says, “these legal entities are well capitalized relative to the risks that they have.”

AIG’s global life and health assets are larger than those in its P&C operations, he adds, and its capital and surplus are about equal: “In terms of operating performance, life and health has been a bigger contributor to financial results.”

If AIG Canada is not for sale now, that’s not to say it will not come under scrutiny from management later on. The subsidiary simply has not grown at as fast a pace as some of AIG’s other life and health operations, says Frino.

No doubt, there would be bidders for the operation. On the day that the Fed provided its relief to AIG, AXA Canada Inc. president and CEO Jean-François Blais showed the same interest any CEO might. “AXA has grown mostly from acquisitions,” he say, “and we are always on the lookout for opportunities.”

This past summer, AIG Canada had stiffened its backbone in advance of the launch of a segregated fund lineup with a guaranteed-income contract. It hired several regional sales and marketing personnel and, at the time, McCarthy said that AIG Canada was one of a few insurance manufacturers in this country that was well capitalized enough through its parent to be able to offer the product type. AIG Canada did not return phone calls from Investment Executive about the outlook for those plans now.

AIG Canada has strong distribution relationships with many independent managing general agents, while its main competitors — Sun Life Financial Inc., Manulife Financial Corp. and Great-West Lifeco Inc. — tend to have strong relationships with the insurance specialists at the independent and bank-owned investment dealers. IE