Insurer Financial Security Is Not a Rating
June 2008
Pardon me if I'm off again on a rant relative
to the current marketplace. Frankly, in my over 50 years in this business, it
is about as ridiculous and bordering on unprofessional as I've ever seen.
by Peter
M. Polstein
Perhaps, a more ominous side to this continued irresponsible underwriting
theology is the potential for some of those household names in our industry
to become less than creditable underwriters from a broking standpoint.
Security—one of the more dangerous potential errors and omissions components
of the brokerage industry—has been a sleeping child for lo these many years.
It has been well over 10 years or more since the last rash of insurers failed
due to a variety of reasons, yet the primary cause always returns to poor underwriting
and financial judgment.
Come on Pete, the industry has grown exponentially! But so has the potential
for financial loss, profitability, and greed resulting from both a lack of understanding
of so-called exotic financial transactional products and "If it's too good to
be true, it undoubtedly is."
Record Financial Losses—Not from Insured Losses
I am not going to pick per se on AIG, but here is a classic example of a
major insurer, whose overall financial capability and capacity appears to have
gone terribly wrong. Forget its overall market cap with shares descending from
$72 to a current trading level of under $35. Let's simply focus on financial
loss and the potential impact on what has been described as the largest and
most innovative underwriter in the world.
During the third quarter of 2007, AIG announced it has taken on an additional
$11.120 billion loss. From what? Unrealized market valuation losses on credit
swaps and impairment charges to its investment portfolio, with some assurances
that these losses were pretty much over. Then, its first quarter posts what
was described as the "largest ever quarterly loss" with an additional $9.110
billion in credit swaps and $6.90 billion in impairment to its investment portfolio.
These losses don't even take into consideration normal insured losses, which
were unaffected, for the most part, by any catastrophic claims. Yet, its overall
percentage of underwriting profitability decreased, while frictional costs continued
to rise, as it has over the past years. AIG isn't alone; almost every insurer
worldwide has "suffered" the same malady.
As an aside, none of the worldwide industry losses, nor analysts, take into
consideration the upcoming risk-based capital initiative which may well have
substantial impact on insurers curtailing their gross written capacity given
what may be insufficient capital adequacy.
So where does AIG turn? It goes to the capital marketplace to negotiate a
$20 billion bolster to the balance sheet, which some analysts report may not
be sufficient to afford capital adequacy to the holding company. Further this
infusion doesn't even contemplate the overall depreciated value of shares, nor
have the projected costs down the road of these deals which comprised of the
sale of equity, debt, and convertibles been considered.
If the potential for catastrophic loss during the 2008 hurricane season comes
to fruition, and depending on other underwriting considerations wherein catastrophic
loss can play a factor, does this become a potential test for regulators as
to the overall adequacy of AIG as well as those who have reported, who will
continue to report, and have yet to report financial loss.
The Role of Rating Agencies
Most of these losses throughout the financial industry are the fault of rating
agencies placing their reliance on the imprimatur of major financial transaction
institutions that backed this "junk," making it acceptable, if not ridiculously
rated paper.
Standard & Poor's has recently projected a "slowdown" in the industry, with
insurers "struggling" to maintain profitability, which will become nonexistent
if the marketplace continues this downward spiral of underwriting. It is wishful
thinking on its part, I believe, to point to strengthening of balance sheets,
when large numbers of insurers, including reinsurers, have taken substantial
loss. Trigger points in many instances have as yet to be hit and none of this
takes into consideration those "exotic" (not my description, theirs) sidecar
agreements.
Where Does This Leave Us?
As I pointed out in a prior article, "Insurance
Industry Sings the Back Door Blues," it might well be time to begin negotiating
longer terms on placements, and apparently there have been indications that
this is occurring. Further, there is some indication that the overall marketplace
is bottoming out, lacking a dramatic increase in rates, it will be a lengthy
process to bring the industry to any meaningful underwriting profit in the near
term. But that's hardly the point.
Is it incumbent on the brokerage industry to begin to accept responsibility
for security? Perhaps so, as who better than we knows the intricate workings
of the underwriting fraternity? Do we have more knowledge that the analysts
whose job it is to place our trust in their expertise? In the end, who will
be left standing as the deep pocket?
After having spent some 8 years in another life testifying in what had been
deep pocket allegations, I can surely attest to the fact that despite the glowing
reports and approval by regulators to whom we placed our trust, a significant
number of reinsurers went south due to their lack of underwriting expertise.
To wit, we were not a contributor, as was finally adjudicated by the court,
but at a fearful price.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author's employer or IRMI. Expert Commentary articles
and other IRMI Online content do not purport to provide legal, accounting, or other
professional advice or opinion. If such advice is needed, consult with your attorney,
accountant, or other qualified adviser.