Eight months ago I reported AIG was buying business – slashing prices for property and casualty insurance coverage in an effort to hold on to current customers and hopefully land a bit of new business. Now comes a report from Bloomberg that analysts have confirmed what some brokers and most of their competitors have known for months – Chartis (the name of AIG’s core insurance business unit that’s been separated from the rest of the ‘old’ AIG) has been accused of ‘aggressive’ pricing by analyst Todd Bault of Sanford C Bernstein, a charge that’s been leveled for months by Chartis’ competitors.
Simply put, it appears that about a year ago AIG execs decided to cut prices on liability, workers comp, and some other lines of insurance to retain business and generate cash flow to prevent the company from going under. It worked then, but at a cost that’s becoming apparent now.
There’s a lot to consider here – the possible impact of AIG’s alleged pricing actions on extending the soft market; effect of underpricing on reserve adequacy; and consequences for the likely spinoff/sale of Chartis. I’ve discussed most of these topics here on MCM, but to save you the trouble of clicking thru, here’s the summary.
First, I’d be remiss if I didn’t acknowledge that AIG execs are denying the charges, with AIG Chief Financial Officer Robert Schimek claiming their rivals’ charges “reflect a big degree of frustration by the marketplace that they’ve been unable to unseat the Chartis organization in the vast majority of business.” That’s not exactly true, as AIG reported insurance sales dropped 13% in the most recent quarter while the combined ratio increased to 105.2, results significantly worse than those of competitors Liberty, ACE, and Chubb.

Reserve adequacy
Last winter, I heard from sources ranging from headquarters staff at large competitors to several brokers around the country that AIG was quoting rates for P&C coverage that had only a ephemeral relationship to the actual cost of risk. The sense then was AIG was doing anything it could to add premium, and thereby build up the companies’ financials. AIG’s desperate effort to add premium dollars, staved off deeper financial trouble, but as I noted back in March, “the shortsightedness of this approach will become obvious. Even more obvious than it is today. Claims will come in, reserves will be needed to fund those claims, and it is possible, if not likely, that there won’t be enough capital to fund future claims.”
Soft market
AIG’s pricing actions, to the extent that they were ‘real’, were but one of several factors contributing to the depth and duration of the current soft market . But those actions can’t be discounted; as one of, if not the, largest writers of property and casualty insurance in 2009, any discounting by AIG would send tremors thru the entire industry. The company had long been known, and highly respected, for its underwriting expertise. When brokers and risk managers received quotes from AIG at very attractive rates, many likely turned to the other carriers bidding on their business and said something along the lines of “if AIG can charge me this, why can’t you?” Sure, some, or most, knew that AIG’s pricing may not have been realistic, but all’s fair in love, war, and insurance, and using one company’s bid to beat down another’s is common practice.
Chartis sale
According to Bloomberg, “AIG shareholders and the federal government face considerably more uncertainty than they may have anticipated,” Bault said. “AIG would likely have to take some kind of reserve charge” before selling its Chartis property-casualty business or holding a public offering for the division.” That sale will be a key piece in the ‘taxpayer repayment program’; we’ve kept AIG from going under, and if we are going to get our money back, a sizable chunk will have to come from the sale of Chartis. I noted last month that the disposition of AIG’s assets was proceeding rather well, and should have added a reminder about the pricing issue.
What does this mean for you?
If you work for Chartis, know that I wrote this with reluctance. As I said in November, AIG’s destruction was the result of poor management oversight and a wildly out-of-control finance unit. The women and men who work at Chartis and most of the other AIG companies do a very good job, work very hard, and take justifiable pride in their work. Here’s hoping their talent and abilities are enough to overcome poor decisions by their erstwhile superiors.

After this spring’s ugly display of ignorance in the form of public pillorying of undeserving AIG personnel, what happened to AIG?
Well, hard as it is to believe, mostly good stuff. There was a big push to sell assets in the spring, a push that, for very good reason, didn’t result in many sales. That’s a good thing, as buyers were looking for fire-sale prices, and for a while it looked like the Feds were eager to dump as much of AIG as possible regardless of the financial consequences. It’s our good fortune the sales didn’t happen then.
To date the company has sold off assets amounting to about $8 billion, while also reporting solid financial results for the last quarter – and in anybody’s book, $1.8 billion is pretty solid.
The company that brought down the giant, AIG Financial Products, is slowly being unwound, with credit derivative exposure reduced by some seventeen percent since January 1 of this year – but it’s still $1.3 trillion.
And the new CEO promises that taxpayers will be reimbursed, and AIG will arise again. At least the stock markets took heart, pushing the company’s value up some 30% on the strength of not much more then Benmosche’s cheerleading.
Earlier this year, AIG sold auto insurer 21st Century to Zurich’s Farmer’s division for $1.9 billion, got a quarter-billion dollars for AIG Private Bank Ltd. and $680 million for AICredit, while netting $1.1 billion from the public offering of shares in reinsurer Transatlantic Holdings Inc.
Still on the books are American International Assurance Co. (valued at $25 billion) and American Life Insurance Co., ($18 billion) and Chartis’ book value is about $38 billion. And according to Reuters, AIG’s Taiwan life unit Nan Shan Life “could attract a bid of about $2 billion”, and AIG is in talks to sell two Japanese life insurers, AIG Edison Life Insurance Co and AIG Star Life Insurance.
One of the pricier assets still on the block is airplane owner International Lease Finance Corp, which has been valued anywhere from $2.5 to $8 billion. The tight credit markets appear to be the obstacle to a deal for now.
Against those assets, AIG owes the taxpayers about $88 billion as of June 30, 2009.
Meanwhile, the core insurance business has a new name – Chartis – and a bit of a new attitude. The Chartis folks I’ve spoken with are happy to be out, away and on their own, without the derivative mess looming over them like the merchant of death. There are still lots of hard feelings, but less handwringing and more of a ‘we’ve got work to do’ attitude. And internally they are getting the work done, making progress on a number of fronts particularly in underwriting and claims.
I’d expect to see Chartis go to an IPO in the next couple of years, after the credit markets loosen up and valuations start to climb. While taxpayers may not get all of our money back, a little patience and a lot of hard work on the part of AIG folk past and current may minimize the damage.
Here’s hoping that those same politicians who insulted, degraded, denigrated, and verbally assaulted AIG execs back in the spring are adult enough to commend these folks if and when they deserve it.
Holding your breath?

With yesterday’s announcement that AIG is pressing forward with the creation of AIU Holdings, the move to separate the ongoing insurance operations from the rest of the AIG businesses is well on the way.
As I noted over a month ago, the AIU Holdings entity will likely be offered in an IPO, or at least a substantial minority share will be sold to the public. This just makes sense, as it allows AIG to sell a very big, profitable, solid operating unit for the best possible price.
Last year the component pieces of AIUH accounted for about $38 billion in total revenue, provided a broad range of property and casualty insurance, and operated in most countries around the world.
The separation of AIUH from related companies (e.g. International Lease Finance, United Guarantee) is taking a bit longer than the Feds or AIG board would like, but the time is needed to extricate AIU Holdings from its closely related sister companies, thereby reducing the concern about potential future liabilities thereby making the new entity more attractive to potential entities. While ILFC is a potentially very attractive asset and will likely sell for close to $10 billion, United Guaranty is a mortgage insurer...and has to be split off to allay fears among potential buyers about the real estate industry.
The announcement followed last week’s $1.9 billion sale of AIG’s auto insurance business to Farmers, a subsidiary of Zurich Insurance. The disposition of other assets is not moving very quickly – in general their value is decreasing due to decline in revenues as policyholders move to what they perceive to be more stable, safer insurance companies. Notably, AIG failed to sell some of its overseas insurance operations earlier this year, and has now decided to hold onto the units and consolidate them with other businesses.
The decision made by the Board and the Federal government back in early March to halt the firesale has proven (so far) to be the right one. This has allowed the businesses to be separated out, thereby reducing concerns on the part of buyers and potentially increasing proceeds from the sale.
That said, what will drive value will be the economy; if it grows, more insurance will be sold and investment returns will increase. If it continues to fall, so will the value of AIG’s component pieces.

As I noted earlier, word in the market is AIG is aggressively pursuing P&C business, working very hard to hold onto current customers and aggressively cutting prices to get new ones. This is at least in part the reason premiums in the fourth quarter dropped by 22%.
AIG is the largest writer of workers’ comp, the primary provider of all P&C insurance to the Fortune 500 (97% have at least part of their insurance program with AIG), a major player in transportation where it is the prime insurer for many airlines, shipping, and trucking companies, probably the largest writer of construction wrap-up policies, and a major source of capacity in the excess and catastrophic market.
While I don’t know what the big insurer is doing in all these markets, I do know that they are aggressively slashing prices on both new prospects and renewals in the commercial markets in an effort to hold on to customers and add as many new ones as possible. Anecdotally, this is happening in Florida, Connecticut, Texas and New York; it may well be occurring elsewhere.
This runs counter to a piece in today’s WorkCompCentral. Regulators have been watching AIG for signs of potentially severe price cutting, and according to WCC:
“Orice M. Williams, the GAO’s director of Financial Markets and Community Investment, told the House Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises on Wednesday that her agency is in the middle of reviewing the AIG financial bailout. The analysis includes investigating how receiving money from the Federal Reserve Bank of New York and the U.S. Treasury Department has affected competitiveness in the commercial property/casualty market.
“According to some of AIG’s competitors, federal assistance to AIG has allowed AIG’s commercial property/casualty insurance companies to offer coverage at prices that are inadequate for the risk involved,” Williams told the panel.
But she said GAO so far has failed to confirm those allegations.
“State insurance regulators, insurance brokers and insurance buyers said that while AIG may be pricing somewhat more aggressively than in the past in order to retain business in light of damage to their parent company’s regulation, they did not see indications that this pricing was inadequate or out of line with previous AIG pricing practices,” she said.”
Brokers I’ve spoken with indicate the price-cutting is taking the form of AIG underwriters aggressively quoting most of the business submitted by brokers. In the past, AIG could be highly selective, using its acknowledged expertise in underwriting to carefully pick the risks it deemed worthwhile, and ignoring the rest.
No more.
Pressed by an urgent need to generate capital, several contacts indicate AIG seems to have all but abandoned underwriting discipline (at least in the commercial markets in the states noted above).
Meanwhile, many of our elected officials are screaming about the payment of bonuses that amount to one-tenth of one percent of all taxpayer investment in AIG. This is political grandstanding at its worst – and most counter-productive. Instead of fighting over who said what when to whom how, they should be watching more closely the business practices of the largest insurer ever to be publicly owned. Instead of calling for the offing of their heads, our politicians should be ensuring AIG continues to operate intelligently – and for the benefit of its shareholders, who are mostly we taxpayers. It is encouraging that Williams and her colleagues are watching this closely, but my sense is the price-cutting is more prevalent than her findings indicate.
What does this mean for you?
AIG may well generate more cash over the short term. And in the worst case, increase the chance that they will fail over the long term; in the best case, reduce the company’s value to future buyers thereby slashing the return we’ll get on our investment.

No, they’re not eating cake or fiddling while Rome burns – but that’s the impression you’d get from watching TV or listening to the radio talking heads. I’m referring to the AIG execs currently in the pillory for accepting bonuses after losing $43 billion last year.
This is a rather significant digression from MCM’s headline topic, but one that is so topical that I spent most of yesterday doing television interviews on the subject. Yesterday morning I tried to make the point to Fox Business News viewers that 116,000 AIG employees not working for AIG Financial Products should not be tarred with the same brush used to paint AIGFP’s 450-odd workers. AIGFP lost $43 billion last year, or about a hundred million dollars per employee – likely a record for any erstwhile-profit making enterprise.
On Nightline last night, about fifteen minutes of interview were left on the editing room floor in favor of two sound bites – one of which had me noting that the AIGFP execs should not take their bonuses, as they did not, by any civilized measure, earn them.
Easy for me to say. In fact, this statement came after several minutes of back and forth wherein I described the high-pressure environment, the relentless competition, the brutally stressful world that is AIG senior management – not as a justification for getting bonuses for blowing $40 billion, but rather to show that individuals who survived in that environment very likely felt they had earned their financial rewards. Here’s an earlier post describing the cultural roots of the problems.
At the end of all the hysteria and hand-wringing, the bonuses are due and payable. Not paying them would result in litigation and further delay in cleaning up the mess. To date AIGFP has reportedly closed out fully a quarter of its CDS positions; in all liklihood this would not have happened if the staff was fired/shot/drawn and quartered. As AIG’s owners the faster they fix this the better for us.
Yes, the Obama Administration should do everything it can to limit those bonuses, but not at the expense of successfully winding down AIGFP’s positions. Lets be adults here, and to quote the President, not ‘govern out of anger’ but rather out of intelligence. Sure, it makes great politics, but that doesn’t get we taxpayers a dime of our investment back.
Cool, calculating, careful thought will.

There have been many complaints about the $150 billion pumped into AIG by we taxpayers, from the Fed Chairman, Senators, individuals, and MCM readers.
AIG is not too big to fail; it is too ‘connected’ to be allowed to fail. AIG provides the underpinning for many pension funds and retirement plans; its financial instruments guarantee the returns for pensioners. It backs up the investment of many banks. It owns many of the airlines’ airplanes, planes that might be repossessed if AIG goes under. AIG insures many Fortune 500 companies, and is among the largest writers of workers comp in the nation. It is a large individual auto insurer as well.
An article in today’s LATimes lays out a few of the myriad ways AIG is involved in the economy and individuals’ lives. It also describes how we got here:
” Beyond the more or less predictable consequences of letting a company like AIG go down are the murkier possibilities known as “systemic risks” — most of them arising from AIG’s rush in recent decades into all sorts of highly speculative businesses that were a huge departure from the staid world of insurance.
Some experts say what these ventures have done is make an AIG or a Citigroup that’s “too interconnected to fail.” And it’s not just the size that would matter. AIG’s interconnectedness with other companies, markets and economies is so huge and convoluted that it’s almost impossible to foresee what all the consequences of collapse would be.
The prime example of this problem is about $500 billion in unregulated credit default swaps held by AIG. Those complex financial instruments are essentially insurance policies taken out on mortgage-backed securities and other assets. The swaps were designed to pay out money to buyers who got caught in exactly the type of financial crisis taking place right now.
In essence, AIG was committed to insuring hundreds of billions, if not trillions, of dollars in investments. When the housing market crashed and the economy nose-dived, those investments tanked as well. And AIG was liable for the losses — a liability so large that it is now overwhelming the rest of the company, including the still-profitable parts.
What’s worse, because credit default swaps were unregulated and the layers of transactions so arcane that they are difficult to understand clearly, the true cost is essentially impossible to measure with certainty. Once the dominoes began to fall, no one knew where the process would end.”
What the Feds have done with the latest re-configuration of the bail out is to buy time – months during which the company can sell off assets, write down losses, and separate out the still-viable businesses from the essentially-bankrupt. As I predicted a week ago, the domestic insurance business will in all likelihood be spun off, raising billions to begin the repayment process. The Asian businesses will be carefully packaged for sale, a step necessary when potential buyers backed out ten days ago. The auto and life business will also be separated, sanitized, and sold off.
The resulting funds will go a long ways to paying us back. Not all the way, but a long way.
That’s all good. What isn’t good is AIG’s desperate effort to add premium dollars, an effort that by several accounts is leading the company to abandon all pretense of underwriting. Sources from headquarters staff at large competitors to several brokers around the country indicate AIG is quoting rates for P&C coverage that have only a ephemeral relationship to the actual cost of risk. The sense is that AIG is doing anything it can to add premium, and thereby build up the companies’ financials.
So, down the road – say in a couple years, the shortsightedness of this approach will become obvious. Even more obvious than it is today. Claims will come in, reserves will be needed to fund those claims, and it is possible, if not likely, that there won’t be enough capital to fund future claims.
What does this mean for you?
A very tough market to sell into – for now. By mortgaging its future, AIG is guaranteeing it will survive for a while, and may well be assuring its eventual demise.

That’s how NYS Insurance Commissioner Eric Dinallo characterized AIG’s derivative business during testimony yesterday. Mike Whitely of WorkCompCentral reported on the Senate hearings this morning, saying:
“American International Group’s financial products unit amassed a portfolio of shaky credit default swaps, futures and other derivatives with a notional value of $2.7 trillion before regulators stepped in to stop the bleeding last September, New York Insurance Supt. Eric Dinallo said Thursday.
“For context, that is equal to the gross national product of France,” Dinallo told the U.S. Senate Banking, Housing and Urban Affairs Committee. “Losses on certain credit default swaps and collateral calls by global banks, broker dealers and hedge funds that were counterparties to these credit default swaps are the main source of AIG’s troubles.”
There are lots of moving pieces here, but the most current problem is the inability of AIG to sell off assets to meet credit obligations. I discussed this issue in a series of interviews on Fox Business News earlier this week; the video is here and here.

The announcement today of the largest ever quarterly loss in US history hit the market hard, and will result in massive changes at AIG. These changes will include continued efforts to sell off assets, transfer of more control to the Federal government, and the spin off of domestic insurance operations.
A town hall meeting for all employees hosted by CEO Edward Liddy is in process even as I type this, and there are several key takeaways so far. First, the company will combine the American International Underwriters and Commercial operations units into one entity to be called AIU Holding; it will include 44,000 employees and operate in130 countries; this latter is somewhat surprising, but sources confirm AIU Holdings will retain foriegn P&C operations. The new entity’s CEO will be Christian Moore. This is a bit of a surprise as many employees expected Nicholas Walsh (the current AIU leader) to head up the new business. Moore is currently President and CEO of AIG P&C group; Walsh will be vice chairman and the chair will be named later.
At this point AIG has not publicly announced how they will handle employee stock, but the company is looking to implement increases in compensation and pay bonuses in March as previously announced. These comp changes are pending approval of the Feds, who will be consulted before any plans are finalized. Sources did indicate there appears to be some effort to establish a mechanism to provide stock and/or options to employees of AIU Holdings, but no details were available.
Liddy did not announce extensive staff reductions. However, earlier internal communications asked managers to take a look at their budgets and see where they can cut. No goals were provided; management was just asked to reduce wherever possible.
Beyond that, no other new news came out during the call, but Liddy did say that ‘the goal is to keep as many people as possible’.
Given the company’s desire to demonstrate it is doing all it can to raise capital, do not be surprised if there is movement on this fairly quickly. As I noted last week, these operations are profitable and solid, and as soon as the credit markets return to something approaching normalcy, there will be plenty of folks willing to buy into what is a strong business.
What does this mean for you?
That would be a good move. Operations could continue, policyholders would be protected, and a big chunk of money given back to the taxpayers.

Hurricanes, both meteorological and financial, may well bring an end to what has been one of the softest of markets.
Gustav, Ike, and their to-be-named seasonal relatives have hammered the reinsurance markets, with Lloyd’s of London recently announcing losses totaling $12 – $18 billion for the season’s first two major storms. Lloyd’s also suffered from a dramatic reduction (>60%) in investment earnings, even though the vast majority of the syndicates’ funds are invested in government securities. The combination of storms and poor investment returns cut Lloyd’s members’ earnings in half.
The role Lloyd‘s plays in the international insurance market is a bit obscure to those not immersed in the P&C world. P&C insurance companies write policies for fire, auto, oil wells, pipelines, environmental liability, airplanes, and just about every other physical and financial risk you can think of (and many you can’t, such as credit default swaps). They don’t want all the risk themselves, so they pay part of the premium they collect to other insurance companies, called reinsurers, to take part of the risk off their hands.
When reinsurers raise rates, primary insurers are forced to do the same. That’s likely to happen; Lloyd’s (which is actually a group of individuals and companies and not a single entity) members will certainly want a better return on their capital than they are receiving today. That and the potential for higher losses from future storms will cause them to raise premiums and be more cautious about the risk they take – both measures that will force primary insurers to follow suit.
While reinsurer rates and coverage terms are key, they are not the only factor likely to turn the market. The demise of AIG and write-downs at other insurance companies with exposure to the credit markets make it critical that insurers raise more funds to bolster declining capital. The best way to do that is to charge new customers more, and sock away some of that additional cash (hopefully in investments that mere humans can actually understand).
The other technique is to reduce their exposure by being more careful about the risks that they do write.
Expect workers comp premiums to rise, along with property rates. Premiums for longer tail lines, like WC, liability, environmental impairment will likely increase further faster than sort-tail lines, but we can expect insurance rates to increase across the board.
The P&C market has been soft for several years. Those days look to be over.

Jon Coppelman of Workers Comp Insider fame has a very funny take on how Hank Greenberg would have led AIG’s executive session discussion of the $75 billion loss.

Jon’s talent is lost on us here; he clearly needs a literary agent!