Okay, I said it: perhaps we’re being too harsh on AIG.
Sure, the company has some serious problems, and its liquidity crisis of 2008 will remain one of the worst business disasters of all time. But since then, AIG has somehow morphed from a deeply troubled company into an avatar of all things wrong with the corporate world. And while I won’t suggest we forget (or even forgive) AIG of the policies and actions that nearly tanked the world economy, we must resist the urge to make this company into things that it is not.
Villainization, while it may make us feel good, usually distracts us from the complexities of a situation we must somehow address. It’s easy to say that any given problem came about because somebody — that guy! over there! — was a greedy jerk. It’s far more difficult to see problems in a wider context, to understand how those problems came about, to address those problems on their own terms, and to take meaningful action to try to prevent those problems from arising again. But when we look at the magnitude of the AIG situation, we can take no other course of action. To do otherwise invites disaster to repeat itself. And really, who in their right mind would want to see a stock implosion like this one again in their lifetime?
This brings me to an editorial yesterday called “Kill AIG Now” by Eli Lehrer of the Heartland Institute, over on the Frum Forum. The Frum Forum is a right-leaning political site, and the Heartland Institute is a think tank that describes itself as a think tank for free market solutions to public policy problems, but a cursory look around the site shows that its views on environmentalism, healthcare and other issues aligns it with the remnants of the GOP trying to stake a claim in Obama’s world. On the whole, Lehrer writes some pretty interesting op-eds, but I don’t always agree with his interpretation of the facts, and that is certainly true here.
Before I go one word further, however, a moment of transparency is needed. AIG has been a generous advertiser on this blog’s parent media outlet, Risk Management magazine, and of Risk Management‘s parent, the Risk and Insurance Management Society, a trade association for risk managers — people who often buy very large amounts of insurance from companies such as AIG, and who are among the first to be hurt whenever a major insurer drops to the ground. The P/C wing of AIG, which has been re-branded as Chartis, is also a sponsor and an advertiser.
This next part is sure to draw a few hoots from our more cynical readers, but I’ll say it anyway: I’m not writing this article because we have a relationship with AIG and Chartis. I’m writing it because as I read “Kill AIG Now,” it seemed like another example of using commonly held half-truths about AIG — a firm nobody is in a rush to defend -— to promote agendas that don’t really reflect the reality of the situation.
This may sound like a joke coming from a journalist in this day and age, but I think that the truth is more important than somebody’s agenda. And to that end, I’d like to point out some problems I have with Lehrer’s editorial, because if we succumb to the temptation to cherry pick facts about AIG to support our arguments for other things, then we distort what AIG was, is and will be. And in so doing, we lose our grip on how AIG self-destructed, and we lose sight of how we can keep such a thing from happening again. So it is important to be fair when we talk about AIG. It is more than important. It is critical. And so we begin.
I first began raising my eyebrows over Lehrer’s comments on AIG’s Byzantine structure. There is no denying it, the company is a massive patchwork of subsidiaries that seems like a massive corporate Gordian knot. Given the company’s financial troubles, one might conclude that perhaps its labyrinthine inner workings played a part in that. And indeed, Lehrer makes such a suggestion, but it raises a question far bigger than the one it answers.
Although a number of other companies sold a product line-up similar to it, Greenberg’s AIG developed a uniquely confusing structure largely as a result of its acquisitive ways. When it collapsed in the fall of 2008 due to some terrible bets it made on credit default swaps, AIG consisted of over 1,500 legal entities, 71 America-based operating subsidiaries, and perhaps 50 brands. (State Farm, the insurer that does the most business in the U.S., has 12 U.S.-based operating subsidiaries and one brand.)
Although odd looking on paper, this structure gave AIG a strong competitive advantage and promotes economic instability now. It “worked” for two reasons.
First, the company was—and still is—largely “regulator proof” and able to engage in risky, high-return investments that state regulations mandating conservative financial strategies closed to most of its competitors. Like all other insurers, AIG is regulated separately by each jurisdiction where it operated and small state-level regulatory operations couldn’t always “follow the money” in a behemoth like AIG. The credit default swap trades that famously brought down the company were only one example of its exotic, high-flying investment strategy: the company also backed “rocket scientist” quantitative hedge funds and built ski resorts.
I won’t argue that AIG might be overly complex, structure-wise.
However, to suggest that AIG kept such a structure because it allowed it more ability to sidestep state insurance regulators overlooks a larger issue: the structure of U.S. insurance regulation itself.
Not surprisingly, the National Association of Insurance Commissioners opposes the formation of a federal insurance czar, or even the Optional Federal Charter RIMS endorses because — and this is just my opinion here — it would strip them of the power they have enjoyed for so long. Never mind that the 50-regime system we have is loathed by insurers because it creates extra compliance costs and administrative headaches, to have a federal system to streamline things would somehow fail to serve the industry and the consumer, by the NAIC’s reckoning.
One thing is for sure, though, a simplified regulatory landscape indeed would make it much more difficult for another AIG to take advantage of loopholes. But frankly, to blame AIG for working an obviously broken system is a bit like blaming a dog for eating your lunch when you’ve laid it on the floor. First things first: overhaul insurance regulation. Somehow, given the political leanings of Heartland and Frum, i doubt there will be much call for that, however. We’ll see.
Point the second: AIG’s claims history. Hoo boy.
Second, many AIG subsidiaries—particularly those in highly priced competitive businesses—took a very hardnosed attitude towards paying policyholder claims. Although some of the horror stories about the company probably stemmed from resentment of financial success — then New York State Attorney General Elliot Spitzer launched a sometimes demagogic crusade against it — the overall strategy appeared to be the mostly legal although hardly consumer-friendly game plan of always interpreting contract language in ways that maximized corporate profits.
I have covered insurance journalism for about 15 years now, and if I have learned just one thing, it is this: every single insurance company out there either takes a “very hardnosed attitude toward paying policyholder claims” or they are chastising themselves for failing to do so. AIG may have played hardball, but to demonize them for it is ridiculous, given how much this is merely standard industry behavior. As the discipline of underwriting eroded across the board (especially during the 1990s) and as companies no longer could rely on their investment income to keep them going, they routinely turn to claims reduction as the last line of defense.
AIG is no different in this.
And if Lehrer has a bunch of consumer testimonials to say that AIG behaved in a bastardly fashion, then guess what? Ask any resident of the Gulf Coast what they think of their insurance company, and you’ll probably get an earful of language that cannot be repeated in front of polite company.
I also like how Lehrer insinuates that AIG was perhaps acting illegally even though it could not be proven as such. This, my friends, is yellow journalism, pure and simple. If AIG’s claims patterns were in fact illegal, then I cannot believe in a legal environment as rapacious as the United States that such rascalism would not have been dragged out into the light and flogged in public. For all of his vigorous prosecution, not even Eliot Spitzer went after AIG for claims, he went after them for dodgy accounting.
Point the third: pricing.
But, there’s no hard evidence that AIG has systematically broken the law through its pricing. (Because insurance consists of a promise to pay at a future time, it’s illegal to sell an insurance policy at a price that doesn’t provide reasonable assurance that the company selling it will be able to pay claims.) Investigations from the National Association of Insurance Commissioners and the Government Accountability Office both found that AIG is not using taxpayer bailout funds to under-price competitors in an illegal fashion. On the other hand, a late November analyst report from Sanford Bernstein sent AIG’s stock tumbling with the suggestion that several parts of the company lacked the resources to pay likely claims. Whatever the case one thing is clear: AIG—buoyed by government support—has continued to compete vigorously on price because the company was built to do so.
First off, again with the insinuation of wrongdoing. If AIG has practiced illegal pricing, then either acuse them of it or don’t. But reading Lehrer, I get the feeling that he’s taking a cheap shot at a firm widely perceived to be up to no good by a public (and a government) that really has no idea how any insurance company works, let alone one as large and as complex as AIG.
But, I digress.
The real point here is that AIG practices scorched earth pricing, ostensibly to force its competition to price at uneconomic levels, forcing them to endure pains that AIG can absorb much more easily. If this is the case, then we certainly aren’t hearing of it at the consumer level, as there has not been a single statewide push for rate rollbacks that made note of how artificially low rates were in the first place.
Plus, I find it strange for Lehrer to ping away on AIG’s pricing when, in other editorials, he excoriates states for not letting the market set its own prices for hurricane coverage. If we want a free market, then we can’t have it halfway, but that is just what seems to be proposed here. Free markets to give the government a pass on covering coastal risk, but not a free enough one to let a company like AIG throw its weight around like any other corporate apex predator might. What gives?
Lehrer even goes so far as to suggest that by competing on price, as it has and as it continues to do, AIG is depressing the entire P/C market, which is in turn hurting the larger economy. This is wildly oversimplistic and ignores the larger dynamics of the P/C pricing cycle. (For more on that, see Morgan O’Rourke’s market overview feature in our upcoming January/February issue if Risk Management)
All of this is diversionary, though. The ultimate point to be made here, is the one I disagree with the least, which brings us to point the fourth: what to do next?
If it wants to solve the problems that AIG poses, the government should put the company out of its misery. Even if the company remains in existence forever, its total debts will never be paid back because they are based on valuations of the company that assumed its strategy would result in long-term growth that never came. The money AIG lost is gone.
I am sure Lehrer isn’t the first to suggest that AIG be dissolved, nor will he be the last. And from a standpoint of getting government money back, perhaps dissolving AIG is indeed the only viable option.
But I wonder . . . is getting the money back really part of the strategy here? I think not.
AIG was saved because its complete downfall was seen as something that would so devastate world financial markets that the federal government had no choice but to step in, throw a king’s ransom (literally) at it and accept the lesser of two evils.
When you get right down to it, that’s what national governments are, truly the insurers of last resort.
The big difference now is that the United States actually owns an insurance company because of it. I don’t know what the Obama administration has in mind ultimately, but I do know that saving AIG was a good idea. You know what would be an even better one, though? Fixing our fractured regulatory system so that another AIG can’t happen.
Suggesting that the government is overstaying its welcome into private enterprise after buying up AIG at a time of crisis is short-sighted, plays to the already tired free market mantra that underpins general opposition to the Obama administration and deflects from the real issue of regulatory reform. AIG’s problems stemmed from a variety of sources — an out-of-whack financial services unit, a market environment that rewarded greed over prudence and a leadership that either looked the other way or truly did not know what was happening in its own shop. But these are the ills not just of AIG, but of the entire corporate environment of the last ten years.
If we want to focus on a meaningful solution here, we need to look to regulation, and how badly the U.S. insurance market needs it, and needs it now.
In an email response to Bill Coffin’s post, Eli Lehrer writes:
“Thanks for your thoughtful, well-considered response to my piece on
AiG. A few comments:
First, I am totally supportive of an OFC or something like it and
entirely agree it would help prevent another AIG. I think, however,
that AIG exploited the “broken” nature of the current system more than
any other company. Insofar as other large companies are complex, only
one “insurance” firm I can think of has a similar structure on paper
(Berkshire-Hathaway) and, unlike AIG, its business units are really
almost 100 percent freestanding so even it has a better reason for the
structure.
Second, on AIG’s claims payment. Sure, all insurers take a hard line
sometimes but I also think that few go to the lengths that AIG did.
(If they did, many more would have underwriting profits from HO
policies. But the industry as a whole doesn’t.) Different companies
have different reputations and AIG’s was/is one of the worst. I don’t
believe that most insurers go to the lengths that AIG did or do the
things it did. In my research for the piece I wrote, I found at least
a half dozen major newspaper and magazine stories about AIG’s overall
claims payment practices. I think that only ONE other large insurer
got a similar amount of ink for its claims practices. So AIG was and
is an outlier.
Third, my problem with AIG’s pricing and claims payment practices is
NOT that they exist but, rather, that the federal government
facilitates them. As I say in the piece, these practices would be fine
if AIG were a conventional company but I think its very questionable to
continue them with the company as a taxpayer ward. This is quite
consistent with what I have argued about hurricane/auto coverage: it’s
great for private companies to compete on price but state
owned/mandated residual market mechanisms shouldn’t compete with the
private market because they become de facto price control mechanisms.
One last point. I am a Republican and agree with the GOP on the great
bulk of issues. But my employer, the Heartland Institute, has no
connection with the Republican Party and proposes any number of things
that aren’t Republican policies and probably never will be. As an
organization Heartland is libertarian, not conservative.
Again, thanks for your comments and take care.”