Insurance Market Woes Continue
December 2008
One of the great old blues men, Big Bill Broonzy,
sang, "Trouble in my mind, I'm blue, but I wouldn't be blue always, 'cause the
sun's gonna shine in my back door sometime." It might take some time for the
sun to shine on this industry. We haven't seen the worst, and the best may be
awhile in coming.
by Peter
M. Polstein
It surely has been a rather interesting 3 months since I last wrote on the
woes of the marketplace in "The
Demise of the Current Insurance Market." Those woes have turned into a critical
question of capital adequacy which will impact our industry for the foreseeable
future.
Worst-Case Scenario
It is unfortunate that one needs to continually pick on the AIG, but let's
face some realities and assume that it is still possible, under a worst-case
scenario, that the insurance group on a worldwide basis may not be able to continue.
We all understand the implications of this. We all have continued to follow
the machinations of the government, in one form or another, of providing two
quite different economic packages, the latest being some $150 billion in assistance.
Yet, there remains the intrinsic problem of attempting to ascertain what AIG's
actual liabilities are in their backing of collateralized debt obligations (CDOs)
whose default swaps have incurred in excess of $50 billion in loss. Various
financial analysts, as well as Fitch, have reported a wide discrepancy in the
estimated value of those instruments in which AIG has guaranteed. There appears
to be no question that these guarantees far exceed the present government package.
With the current financial marketplace in turmoil, the current lack of investment
capital, and the short- to mid-term potential of little change, it is undoubtedly
going to impact severely on the potential for AIG to sell any of its assets.
The sale of its assets will not be an easy task under the best of circumstances.
Much of the business underwritten may not suit the appetite of many suitors,
continuing to employ management may be alien to the philosophy of the buyer,
and authenticating reserves will not be a simple task.
I have previously suggested that one of its major assets, its plane-leasing
business International Lease Finance Corp. (ILFC), should be a fairly easy sale.
Apparently, an investor group has made an offer in conjunction with the current
management, and hopes to close in early 2009. The potential value is in the
vicinity of $8 to $10 billion.
It was reported November 20, 2008, that a Chinese investment group might
be interested in purchasing a substantial portion of American Life Insurance
Company (Alico) for between $5 and $10 billion, if the deal closes. You may
remember Alico, some 6 days after the Fed's initial investment of $85 billion,
received an $845 million infusion to prop up the company, whose primary capital
base appeared to be AIG common shares. One has to wonder how regulators let
a capital base become impaired by common shares.
AIG management continues to espouse the idea that AIG will be able to continue
to retain its core business, this despite what would appear to be continued
severe losses to its bottom line which look to continue well into 2009, and
with the realization that no one has yet to gain any subjective knowledge as
to the ultimate impact.
All of the above does not contemplate the multiple suits brought against
the Group, continued market perception of creditworthiness, and the yet-to-be-answered
questions of who knew what, when did they know it, and what are the actual potential
long-term and short-term liabilities. Interestingly, no one has yet to inquire
as to how regulators, in general, specifically let the industry as a whole end
up in the condition it finds itself in at this juncture of history.
Continued Hard Times and Hard Market
If no one will agree to the premise that we are facing a potentially very
difficult and quickly changing marketplace, let me be the first to first to
tell you that pricing is changing now and will continue to support a hard marketplace.
Fitch reports a 77 percent drop in profit after tax, excluding AIG, with the
fourth quarter indicating ongoing difficulties.
For those who have not enjoyed a hard market, it will be an interesting experience,
and those who have, you know the drill. The industry is nowhere near being out
of the loss potential of default swaps and other exotic instruments, which brings
me to return to some thoughts that I posted in my June 2008 article, "Insurer
Financial Security Is Not a Rating," relative to security.
With the advent of almost every domestic and foreign insurance/reinsurance
company sustaining unrealized or realized losses from a variety of instruments,
as well as those which are normal to the industry, there is beginning to be
a substantial concern among some senior executives within the broking/agency
fraternity that their firms may be placed in jeopardy from potential errors
and omission suits emanating from nondisclosure to the client base of security
issues.
There will be some who say, "Come on Pete, this is a bit off the wall, really."
Well, when you're the last person standing in a bar fight, you aren't necessarily
the winner.
It is obvious, that many of the so-called analytical folks may not have quite
the handle on what does or does not constitute rating. Simple reading 10Ks or
similar documents does not necessarily, as we now know, provide a pure picture
of risk. Brokers/agents need to implement a critical look on those insurers
with whom they conduct business, much more than relying on the rating agencies.
Too often over the years, we have seen highly rated insurers end up insolvent
in manner of weeks.
We also need to be concerned over potential reinsurance problems, and perhaps,
it might be wise to limit placements to net by the risk taker, on the assumption
that the reinsurance industry has taken equal losses and may well be in jeopardy.
During the past half decade, nonperforming reinsurance has grown exponentially
to 25 percent. It will be fascinating to see what that number becomes by the
end of 2008 and 2009.
Conclusion
Am I suggesting that we micromanage the business of placing risk? Yes I am,
and I believe that in doing so, it will provide professionalism that supports
the current environment, and will hopefully keep you all out of rather ugly
suits.
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