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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.


Related Commentary

AIG: Ain’t It Great!!


How Does One Lose $125 Billion?

  • Thomas Catton

    Sheer ignorance about insurance company operations etc.
    AIg has far more capital / assets that all of the major companies in the US. Internal reinsurance etc is irrelevant as long as the sums invested / reserved/ in surplus etc far outweigh the potential losses.

    Look at the numbers:
    the surplus (i.e. equity) above and beyond all the fully reserved & undiscounted insurance-related liabilities. AIG $26 billion
    Travelers (21.2b)
    Hartford (12.9b)
    Chubb (12.5b)
    Liberty Mutual (11.3b)
    Zurich, (6.5b)
    Ace (4.6b)
    XL (2.2b.)

    • Larry Doyle

      Thomas…thanks for the data. The question begs then why AIG needs any government support. Assuming the surplus is accurately reported as you attest, perhaps those potential liabilities are not being accurately reported. Thoughts?

      • JM


        Unfortunately you are just a sheep following the rest of the herd. The point is and always has been (if you opened your eyes) that it was never the insurance operations that had the problem. It was the wall street type idiots like you in Financial Products that caused a liquidity issue in the parent AIG’s operations. If you want your posts to reflect fact and not idiotic banter then don’t follow the lead of tabloids like the NY Times that apparently couldn’t find a source with real factual knowledge if they bit them in the face. You should go speak to the NAIC (National Association of Insurance Commissioners)who essentially discredited the story that the NY Times ran today about AIG’s insurance operations. The link to the NAIC’s website is below — in case you care to do a fact check.

        • Larry Doyle


          Welcome to Sense on Cents!!

          A few questions and comments…

          1. Given your personal assessment of me, perhaps you can refresh my memory as to when we met for you to feel so confident in making that characterization. Did I stiff you on a trade? If so, sorry about that. Oh well. let’s move on from the personal to the professional.

          2. Under the “for what it is worth category,” I have been writing about the insurance industry in general and AIG specifically since last Fall. If you care to review any or all of that work, type “insurance” in the little white search box in the upper right hand corner of any page here at Sense on Cents. I always welcome being corrected because it elevates my game. Mere aspersions don’t do a lot for me, but that’s life.

          2. Thanks for the link to the NAIC site. I looked and checked, but found NO facts. I found a STATEMENT from an organization that is literally fighting for its life. How so? From the NAIC’s own site:

          The mission of the NAIC is to assist state insurance regulators, individually and collectively, in serving the public interest and achieving the following fundamental insurance regulatory goals in a responsive, efficient and cost effective manner, consistent with the wishes of its members

          The simple fact is the regulatory oversight of the insurance industry is being questioned right now. Will it shift from the state level to the federal level? I addressed this last January in an interview and continued to highlight this point this week. The interview from January, “Got Insurance? 529 Plans? Financial Aid? Read On,” was with a longstanding and HIGHLY regarded professional in the insurance industry. His take on regulation?

          LD: Sean, can you address how the insurance industry is regulated?
          SD: The insurance industry is regulated by 50 separate state insurance offices. Each of those offices is responsible for the oversight of insurance business done within their state. Some states are very disciplined in this process, for example New York has very strong oversight. Other states are clearly lacking in the professional expertise to properly oversee insurance business within their state. Each state insurance commissioner is appointed by the respective governors. Each state insurance office is funded by a tax on the premiums written in that state. For example, New York imposes a 4% tax on each policy written in the state. An emergency fund is also put in place to address potential funding problems with individual companies.

          LD: So even for large, nationwide insurance companies such as Prudential, each of those offices are regulated on a state by state basis?
          SD: Yes, because each state office has the ability to maintain its’ own employees and collect tax revenue in the process. I believe the federal government is very interested in gaining an increased stake and foothold in regulating the insurance industry. It will take a large problem that the states can’t handle or don’t properly handle.

          How about total reserves at the state level to handle potential failures of insurance companies? Can you shed some light for us on that? My understanding is they are in the range of $10 billion. I welcome your refuting me on that piece of data.

          No doubt that AIGFP is the center of the disaster within AIG but given the level of financial despair within this organization I have little doubt that AIG’s subs are also severely challenged. In fact, it would be naive to think otherwise.

          Thanks for continuing the dialogue. I sincerely mean it. All I hope to achieve is full and total transparency on any topic that is addressed.

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