How AIG Failed????

Again!

Well, lemme not get into a statistical model. Its boring and complex and million better pages are available online.
As a practitioner of Risk Management and working in a P&C insurance firm, what puzzles me is that, how the hell can somebody insure such a speculative risk????
Interestingly, in March 2001, Lehman Brothers came out with a paper called "Structured Credit Research."
This one exhaustively explains the mathematical models, risks and market size of default swaps.
It simply says "Credit derivative swap is an efficient transfer and re packaging of credit risk."
How efficient, we all know now.
Simply put, can AIG insure us when we play in casino? No.
On the face of it, if someone says, AIG insured default of borrowers, it sounds simple and normal course of business. But, what if that product is traded like any other commodity?
The mathematical models which show the percentage of loss uses the Credit Rating of the securities. The variation between AAA bond to B bond on default probability in 10th year is 0.67% to 44.57%. Can you imagine?
Mathematically, it says you need 0.67 cents if your exposure is on AAA and 44.57 cents if your exposure is on B for a dollar. Well, no one guarantees that AAA will be AAA forever. This is the biggest bet/speculation AIG had taken, and miserably failed when the housing bubble burst.
Interestingly, its P&C business is still vibrant and profitable. Ironically, few of the basic principles of insurance have been forgotton by one of the most successful insurance giants!

Well this what will happen when you make underwriters trade!