It's usually in October that the stock market decides to go haywire. This year, it chose September. With the demise of the Lehman Brothers, the disappearance of Merrill Lynch into Bank of America Corp., and the sudden crash of American International Group, Inc. (AIG), one wonders if anyone in Washington, D.C., or our state insurance departments for that matter, even knows where the store is or who is managing it. Of course, like all aspects of life, it boils down to one word: risk. As adjusters, we know all about risk. We witness the monumental losses that risk can produce on a daily basis. Yet we can do little about it except pay the claims. Wouldn't a bit of mandated risk management be a good idea?
The financial world has suddenly been turned upside down. AIG, which was on the verge of bankruptcy, is now owned by the government. How could that be? Your resident image-smasher has been dealing with AIG for more than 40 years. In fact, early on in my career, the third claim I settled was for AIG. I've visited its New York headquarters; dined with an AIG representative in Beijing; handled claims for and against the company; met old Maurice (Hank) Greenberg several times; and always thought of AIG as the solid gold standard insurer of the world.
Novel News?
But as we all know, images not only get tarnished, they get smashed. The Pennsylvania Railroad was once known as the "Standard Railroad of the World" before merging with New York Central and becoming the disastrous Penn Central, which ultimately required government bailout. During more than 35 years of insurance journalism — usually only as a part-time occupation — I can say that few insurance-related stories have escaped my notice or my pen. In reviewing Iconoclast columns of years past, some dating back to 1975, I must note that few of September's events have not happened before. Let's not panic. The sky is not falling. What is and should be falling, however, are the fat cats of Wall Street who got us into this mess. The news channels correctly cite "greed" and "mismanagement," but it runs much deeper than that.
In large part, this debacle can be attributed to a failure to understand history. Instead of cranking out thousands of MBAs who obviously can't find the executive broom closet let alone the restroom without Donald Trump's guidance, our business colleges and universities — think Harvard, Stanford, and Columbia — need to start emphasizing ethics and history.
Our young CEOs, top executives, and corporate risk managers need to understand that what earns a buck today may bankrupt us tomorrow if we keep doing it over and over again. That's what happened in the mortgage business. When credit was cheap, many of those searching for a slice of the American Dream purchased a house in the suburbs with a low down payment and an adjustable-rate mortgage with a balloon payment down the road. The banks and brokerage firms were getting rich. The year-end Christmas bonuses seemed to prove that Santa Claus was alive and well and living on Wall Street. But he wasn't.
Near Collapse at Lloyd's
It was only a decade or two ago that there was a similar financial crisis at the venerable Lloyd's of London. Many American "names" learned the hard way that "absolute liability" for what one underwrites means just that, right down to the underwear. What caused the upheaval? Well, the answer lies in a few young, inexperienced underwriters in London who were willing to write something called "financial guarantee" coverage. But then the world's financial markets had indigestion, and the claims started coming in. At one point, everyone listened when E. F. Hutton spoke. By the late 1970s and early 1980s, however, E. F. Hutton had croaked, just like Lehman Brothers. The underwriters who insured the uninsurable nearly croaked, too.
Then along came a new game called derivatives, which vaguely resemble a Ponzi scheme. What would happen is that, hypothetically, I would consult a big insurance company (like AIG) and ask for insurance, just in case Mrs. Smith can't pay her mortgage, the value of the collateral in her house declines, and I lose money on my share of the mortgage. AIG might then respond and agree because, well, it has lots of cash and can afford to assume such a risk. The only problem was that this big insurer should have known better. The derivatives were so spread around that nobody knew who owned what.
It's Right There, in the Bible
It's an ancient underwriting rule that one cannot insure a risk that is incalculable. This explains why private insurers don't underwrite flood insurance. It is not an insurable risk. The insurance industry, by becoming a peg in the giant world of finance, neglected its role of being a different kind of institution: namely, one that protects and spreads risks it both knows and understands. One need only look to Proverbs to find the best underwriting rule ever written: "Render up his garment, he who is surety for the stranger." In other words, if the insurer is unaware of the risk, then it will lose its proverbial shirt. AIG obviously did not know the risk it was insuring. Thus, the company lost its shirt, and taxpayers — via the Federal Reserve — are now in the laundry business trying to wash that shirt white again.
Somehow all of this ties together. Banks are weak because the dollar is weak. The nation is in debt because we're borrowing money to pay for a war on terrorism that we don't seem to be winning because the oil we need is so expensive. The reason the oil is so expensive is because of the Organization of the Petroleum Exporting Countries (OPEC) and because Venezuela is mad at us. The picture should be clear: we now own AIG. The good parts — National Union Fire, Lexington, American Home, and all of the other great and historic AIG names — will be auctioned off to other insurers.
But what about the other insurers that are also now part of the big Wall Street financial world, dithering about their next multi-million dollar bonuses? Have they, too, perhaps been dabbling in the derivatives market? Will they, too, inevitably come begging to the Federal Reserve or the Treasury Department for a loan? Nearly all of the mutual funds and annuities where much of our retirement money is located had AIG stock. That's worthless now. But as taxpayers, we still own the thing.
Reading a Financial Report
Thousands of financial advisors believed that AIG was a safe bet. Otherwise, the mutual funds and institutional investors wouldn't have purchased its stock. So, did these advisors ever look at AIG's records? Did our state insurance regulators audit those records? Or if they did, was AIG's kitchen busy "cooking" the books? Aren't our state regulators supposed to uncover that kind of deception and take appropriate measures to correct it before a problem arises? Maybe the U.S. Senate is correct: We need a federal insurance regulator to replace the "good old boys" in the state capitals. After all, Best's Review reported in its September issue that state regulation costs insurers $1.5 billion annually. Did policyholders get our money's worth? What about that Sarbanes-Oxley Act, which requires top executives to sign off on the annual reports? Maybe our new administration will fix it all for us. Let's hope so. K
Ken Brownlee, CPCU, is a former adjuster and risk manager based in Atlanta, Ga. He now authors and edits claim-adjusting textbooks.
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