Bailout Effect: AIG Underpricing Commercial Coverage
“[Bailout money] allows unhealthy insurers to grab more market share in the short term at levels that are unsustainable in the long term.”
-David Sampson, head of the Property Casualty Insurers Association of America
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File this one under what moral hazard and unintended consequences produce: The legitimate, non-structured finance/hedge fund run Life Insurance competitors have a legitimate complaint. Why is AIG underpricing Commercial Coverage? They argue, persuasively, I might add, that its due to the government subsidy AIG has received.
Yet another example of how bailouts cause all manner of consequences in the marketplace. Legitimate and well run companies find themselves at a serious competitive disadvantage when firms like AIG are showered with billions of dollars in reward for their horrii management and bad behavior.
Bloomberg reported that
“American International Group Inc., the insurer that got four bailouts from the federal government, has been the subject of complaints from rivals who say the firm is underpricing commercial coverage, a regulator said. Competitors have said AIG was able to charge lower rates after getting government help, said New York Insurance Superintendent Eric Dinallo in an interview with Bloomberg Television today.
“We worry just as much about low pricing as high pricing,” because the industry needs to have enough capital to pay claims that may emerge years after policies are sold, Dinallo said. AIG, based in New York, sells coverage protecting companies against lawsuits, property damage and worker injuries.
Insurers including Hartford Financial Services Group Inc. have also applied for capital from the federal government, seeking to join more than 500 financial institutions that have received about $300 billion in government funds. Other insurers have complained that government aid gives a competitive advantage to the weakest firms at the expense of those that don’t need extra capital.”
Moral hazard not only encourages more bad behavior from poorly run firms, it punishes the good behavior of well run firms.
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Sources:
Property Casualty Insurers Association of America
http://www.pciaa.net/web/sitehome.nsf/main
AIG Competitors Complained About Rates, Dinallo Says
Erik Holm and Margaret Popper
Bloomberg, March 5 2009
http://www.bloomberg.com/apps/news?pid=20601087&sid=aUvHrNCkKj1g&
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March 10th, 2009 at 7:23 am
And quite possibly the unintended consequences of Rush Limbaugh wanting Obama to fail is that he will succeed… causing Limbaugh’s advertisers to fail and have to turn to the gov’t for a bailout, which will also have unintended consequences…
March 10th, 2009 at 7:33 am
Government bailouts are becoming increasingly unacceptable in all of Europe…size-wise that is…
http://www.nytimes.com/2009/03/10/business/worldbusiness/10germany.html?_r=1&ref=business
Leery of Debt, Germany Shuns a Spending Spree
In a year, we may find out if further Keynesian stimulus is right or wrong…just a big lab experiment…we will go forward, and the socialist democracies of Europe will pull back…
…Interesting, ain’t it?
March 10th, 2009 at 7:40 am
It should not be forgotten that (unscientific) polls indicated that Americans were something like 70 percent AGAINST the bailouts when the first one was passed. That’s enough to pass a friggin Constitution amendment, IIRC.
Legistlators decided to vote with their real constituents (again) and the bailouts commenced. With voters largely forgetting this (and this will certainly be the case), the Congress is beyond reproach.
…destroyed from within.
March 10th, 2009 at 7:42 am
my brain was spinning most of the night on the notion of yesterdays news ..
mergers / acquisitions / hostile takeovers .. and in a like mindset bailout prop ups
it seems this financial nuclear power plant you all created is bound to spin until it melts down
what part of “to big to fail is to big to fight” do you not UNDERSTAND
this all feels like Hitlers Germany all over again … but its not a country or a dictator .. its a corporation and its collective minds
whats the figure of wealth destruction reported yesterday . 35T 50T & in which currancy … I figured out years ago stock certificates were creating the power of currency .. didn’t you all ???
March 10th, 2009 at 8:01 am
Congress should pass a law nullifying all CDSs， Let the idiot half of all the idiot corporations fail, and move on to fixing health care. Seriously, the only reason any of this “systemic risk” exists is because people made unregulated trillion dollar bets on things that were unlikely to happen, then called those bets liquid reserve capital.
If I go to Vegas and place a million dollar bet with a bookmaker at 100,000:1 odds that the british gov’t won’t devalue the Pound by more than 40% over the next two years, then cry about the sky falling when the bookie doesn’t pay me me 100,000,000,000 dollars, should the US Treasury help the bookie pay me back?
March 10th, 2009 at 8:35 am
My My. Wasn’t it just yesterday that a few comments took me to task for being too cynical. Heaven forfend. If it’s not illegal, it must be ok. Just ask AIG. I think I’ll find something to steal today, but, it won’t really be stealing if I can find a loophole that allows me to get away with it. Where should I look?
March 10th, 2009 at 8:40 am
BTW, I think it’s time for Timmy to show some leadership or stand aside for another to do it. He’s had enough time to get a message out. I’m a patient soul, but his welcome is starting to wear thin. I want to see something that makes the future look a little brighter, other than subsistence macro economics. Now.
March 10th, 2009 at 8:42 am
BR-
Absolutely fascinating, thank you for the information. I wish I was an executive at Citibank, Merrill, or AIG. If we succeed due our reckless and irresponsible levels of risk, I make a fortune. If we fail, I still make a fortune. That’s capitalism?
March 10th, 2009 at 8:47 am
Interesting that BB is now speaking about resolving banks and even broached the subject of special procedures for resolving too-big-to-fail institutions. Of course, he’s only nibbling around the edges, but it is a bit of a change.
March 10th, 2009 at 8:48 am
I don’t know about anybody else, but I’ve really had enough of this continual looting. That those guys would start to game the government was absolutely predictable from day one. In fact, it was predicted often on blogs like this one.
Time to start getting on the horn to congresspersons. Again.
March 10th, 2009 at 8:49 am
While I agree with the good insurer / bad insurer approach to AIG, this complaint has been made by a competitor so we all should stop treating it as fact.
The idea that a commercial underwriter is suddenly feeling the wind of the bailouts at his or her back when underwriting risk is something I’m having a hard time with. Cyclical contractions and expansions in P&C underwriting aggressiveness based on performance on the investment side are longer term and driven by asset ratios.
The bigger question is, if the bailouts actually have provided AIG with an asset/liability ratio that is past being healthy and into a position that allows their underwriters to be aggressive, then it obviously is time to stop the bailouts and maybe claw them back. Could that be true? Really?
March 10th, 2009 at 8:53 am
-David Sampson, head of the Property Casualty Insurers Association of America
……Er…..This guy wouldn’ t have an agenda would he?
March 10th, 2009 at 9:12 am
File this one under: Why communism doesn’t work.
PS Citigroup made money in the first 2 month of 2009 IF you don’t count their losses!!!!
March 10th, 2009 at 9:18 am
My brother is a commercial insurance underwriter at a premier insurance company and this is EXACTLY what he told me the other day…he specifically mentioned that AIG and Hartford were undercutting their rivals.
March 10th, 2009 at 9:21 am
wnsfr:
What we are probably actually seeing is an exagerated form of the normal insurance cycle. Taleb discusses it in one of his books and it has been discussed in other works.
1. Companies underprice risk to compete on price.
2. Eventually, they sustain losses because of the underpricing.
3. When they realize the losses, we see headlines and tv news stories about the “malpractice crisis” or an “insurance crisis.” Surprisingly, these crises always seem to occur when there is an inverstment market decline and the rosy assumptions about returns on investments which were supposed to cover claims do not pan out.
4. Rates get jacked up and/or companies go out of business with the excuse that that claims and/or lawyers or someone else is to blame.
5. The survivors started the cycle over.
Obviously, artificially keeping insurers in business despite mispricing distorts the cycle.
March 10th, 2009 at 9:22 am
This is why I’m opposed to certain types of “nationalizations” of banks. If we reconstitute these behomoths then we’ll end up with healthy institutions that will have an unfair advantage over the banks that “made it through.”
We need full breakups via the nationalization process. The surviving banks should be able to bid on Citibank’s various customers and businesses lines around the world. The good parts must go to the winners…the bad parts must be written off…..
March 10th, 2009 at 9:29 am
Generally, Americans do not realize how much government subsidies factor in the development of their economy and their future, for better or for worse. The Republicans, a.k.a. CNBC, constantly wave the flag of “free markets”, but we would lose most of the oil we consume if taxpayers do not supply oil companies costly military protection such as through our Navy’s Fifth Fleet (not to mention a $3 trillion Iraq War), and we would not have ONE kilowatt-hour of nuclear power without the government investments of the past and our continuing subsidies in disaster insurance indemnification and nuclear waste disposal. The cost of your “free market energy sources” is much, much higher than you realize. Much of the U.S. economy has always had government intervention, but that intervention became obscene and corrupt in the last decade of Fascist rule. Our “bailout nation” culture got to the point where we carved out pieces of traditional military activities such as logistics, engineering, and even combat, and outsourced those to private, for-profit companies such as KBR and Blackwater (now Xe), and made extremely wealthy men out of Republican cronies.
The CNBC / Republican definition of a free market is one in which THEIR favored industries are given a lifeline of taxpayer support. Anything else is socialism.
It is up to you people to fix your country. Thankfully, we postponed who picks up the check through our $11 trillion national debt. It will either be your children, grandchildren, and great grandchildren OR the rich people of this country. Make the rich pick up that check through much higher taxes on the wealthy, let the rich pay for their own damned subsidies, and vote Democratic the rest of your lives.
http://cnbcsucks.wordpress.com/2008/12/18/taxation-is-the-lifeblood-of-civilization-and-only-the-rich-can-pay/
March 10th, 2009 at 9:47 am
WordPress ate my first comment, so I will break down my thoughts to one idea:
This “looting” is obscene and corrupt. Thankfully, we still have a choice over who pays, because we deferred the bill through our $11 trillion national debt. You have a choice over who pays: your children, grandchildren, and great grandchildren OR the wealthy of this country. Since the top 10% own 80% of this country’s wealth, it will take many generations of the middle class to pick up the tab.
If you don’t want your unborn great grandchildren to pay for AIG, you support much higher taxes on the wealthy and you vote Democratic the rest of your life.
http://cnbcsucks.wordpress.com/2008/12/18/taxation-is-the-lifeblood-of-civilization-and-only-the-rich-can-pay/
March 10th, 2009 at 9:48 am
@ AT
Precisely.
March 10th, 2009 at 9:53 am
@ CNBC Sucks
FWIW – when contemplating/writing a long comment, I usually compose/review/edit on a desktop text processor app like Stickies, then copy-and-paste into WordPress. If WordPress “loses” my post, I can re-copy from Stickies and re-post.
March 10th, 2009 at 10:16 am
Protest march on Wall Street, April 3rd. “Save People, not Banks”. Leftback will be in attendance.
Feel free to protest the looting by joining this expression of free speech. The Spirit of ’68….?
March 10th, 2009 at 10:22 am
@batmando – Thanks. I use cut-and-paste to Word sometimes, but silly ole me expects WordPress to be foolproof.
Yeah, yuck it up, people.
March 10th, 2009 at 11:06 am
AIG is pricing low to retain customers and grow after the hit to their reputation. It isn’t directly tied to their subsidy. The funds from the govt’ are propping up loss reserves and pay banks and other counterparties not going to future reserves against new biz.
March 10th, 2009 at 11:40 am
I work for a property-casualty insurance carrier that competes with AIG in a couple of markets, but not many. For the most part, they write the largest companies, and we are middle-market. However, we have been hearing the same thing from our brokers. That AIG is doing whatever it takes to keep their business, they will not let it go to anyone, unless the client absolutely insists on moving it.
You can see it in the results that they announced the other day. In the property-casualty side, their premium writings were down 22% year-over-year, and 22% quarter over quarter. Yet they claim they aren’t losing customers. So if you aren’t losing customers, and your premiums are down 22%, I guess you’re cutting prices. The rest of the industry has seen premiums flat to down 2-4%.
It can also be seen in the property-casualty results. The metric that property-casualty insurance companies use is their combined loss and expense ratio. It measures the percentage of their earned premium that they pay out in both expenses and losses. If you are over 100, you are having an underwriting loss, under 100 an underwriting gain. After that, investment income or losses factored in. But for the insurance operations, it’s the combined ratio. AIG’s combined ratio last year was 116. The industry was about 95. The closest competitors that AIG has for that large account business is Ace Limited and Travelers. They were both at about 90. Historically, AIG was in the 90 range.
So AIG’s property-casualty insurance operations are deteriorating because the prices they’re now charging can’t support the losses they are incurring. So who do you think is going to be picking up the tab for that? If you pay taxes, it’s you.
March 10th, 2009 at 6:15 pm
seems very akin to the USPS using their First-Class Mail/Mailbox Monopoly to compete againt FedEx, UPS, et al. ..
March 10th, 2009 at 6:19 pm
though, differently, this is part of the War, by the connected, and the corrupt, on the, remaining, viable Franchises in the Economy.