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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