Does AIG’s Self-Dealing Pose Systemic Risk?

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, American International Group (NYSE: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.

About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

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1 Comment on Does AIG’s Self-Dealing Pose Systemic Risk?

  1. 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.)

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