Does AIG’s Self-Dealing Pose Systemic Risk?
Posted by Larry Doyle on July 31, 2009 8:04 AM |
While our equity markets are making new highs for the year, I cautioned readers the other day “No Time for Complaceny on Insurance and Money Fund Exposures.” On the insurance front, I specifically highlighted:
Experts Call for Fed Involvement in Insurance Industry — but to Different Degrees; InvestmentNews, July 29, 2009
Members of Congress are being urged to create — at a minimum — a new regulatory body within the federal government to focus on the insurance industry. “There is some systemic risk in insurance requiring a regulator,” said Travis Plunkett, legislative director of the Washington-based Consumer Federation of America, who was part of a panel of experts testifying today at a Senate Banking Committee hearing on modernizing insurance regulation.
“In order to fully understand and control systemic risk in this very complex industry, the federal government should take over solvency and prudential regulation of insurance as well.
Where may this systemic risk within the insurance industry originate? None other than our ward of the state, AIG. We are reminded of the massive systemic risk, if not potential illegal business dealings, occurring at AIG in this morning’s New York Times, which reports After Rescue, New Weakness Seen at AIG:
The dozens of insurance companies that make up the American International Group show signs of considerable weakness even after their corporate parent got the biggest bailout in history, a review of state regulatory filings shows.
Over time, the weaknesses could mean trouble for A.I.G.’s policyholders, and they raise difficult questions for regulators, who normally step in when an insurer gets into trouble. State commissioners are supposed to keep insurers from writing new policies if there is any doubt that they can cover their claims. But in A.I.G.’s case, regulators are eager for the insurers to keep writing new business, because they see it as the best hope of paying back taxpayers.
While insurance in general is a pure statistical risk management business, in AIG’s case writing new business and collecting new premiums to pay off current outstanding liabilities amounts to a Ponzi scheme orchestrated by Uncle Sam.
Further evidence of the AIG charade is displayed in the massive self-dealing between AIG divisions. While AIG representatives and government officials would have us believe all of AIG’s problems were centered in the AIG Financial Products division, The New York Times reports:
state regulatory filings offer a different picture. They show that A.I.G.’s individual insurance companies have been doing an unusual volume of business with each other for many years — investing in each other’s stocks; borrowing from each other’s investment portfolios; and guaranteeing each other’s insurance policies, even when they have lacked the means to make good. Insurance examiners working for the states have occasionally flagged these activities, to little effect.
Nothing is wrong with spreading risks to other companies, a practice known as reinsurance, when it is carried out with unrelated, solvent companies. It can also be acceptable in small amounts between related companies. But A.I.G.’s companies have reinsured each other to such a large extent, experts say, that now billions of dollars worth of risks may have ended up at related companies that lack the means to cover them.
Who has risk here? All of AIG’s creditors, including policyholders, bondholders, and Uncle Sam himself.
Where is this headed? As The Times reports and I totally agree:
If A.I.G.’s incoming premiums shrink, he warned, “the whole thing’s going to collapse in on itself.”
“Eventually, there’s going to be a battle between the policyholders and the feds,” said Thomas D. Gober, a former insurance examiner who now has his own forensic accounting firm that specializes in insurance fraud. “The Fed is going to say, ‘We want our money back,’ but the law says, ‘Policyholders come first.’ It’s going to be ugly.”
Do not get complacent.