March 12, 2009
Great post by Credit Trader on how AIG misunderstood the risks it was taking. The risk wasn’t that the Securities they were insuring would default but rather that the collateral requirements on event triggers would bankrupt them.
What is completely mysterious is why is AIG even entertaining the claims. There are well documented fraudulant cases being uncovered in the mortgages that were sold.
In personal insurance cases if there is any violation of the insurance contract, the insurance company can simply refuse to make the payment. If any false information was provided even unwittingly the insurance would not pay-out. Doesn’t the same hold for these kinds of contracts?
Enquiring minds wish to know!
Update:Well they are suing Countrywide for false declarations.
March 4, 2009
We all have a tendency to over-invest in insurance. We simply assume that somehow having someone else promise us a bail-out we can go ahead and stop worrying.
But as AIG’s 61.7 billion dollar loss and it’s reasons covered in NYT show, lots of people bought Credit Default Swaps from AIG assuming that if the companies or Securities defaulted they would be able to cover their ass. Now the only thing that is keeping these people afloat is the forbearance of the US Treasury.
A similar pattern also emerges if we look at individuals. Most buy too much insurance, starting from 3 year warranties on computers to buying insurance on car wind shields. We over-consume insurance by trying to shift the risk, but the real issue is uncertainty in aspects of our life.
A better approach instead of buying insurance would be to create emergency savings which you put aside at the beginning of the year and use it as and when the need arises. When your laptop crashes, when your mobile phone gets stolen or you just have a rough year.
The great thing about this approach is that unlike insurance premiums you can roll this over if there was no need in a particular year.
The Emergency Fund can be broken into the following proportions
- 30% in gold (mostly 10g coins as they are easy to carry)
- 30% in 3 month rolling FDs
- 20% in a Bank Current Account
- 10% in Blue Chip Stocks
- 10% in Cash in Hand
Roughly about 10% of the value of the electronics and household goods should be enough.