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AIG Meltdown Offers Many Risk Management Lessons
As the world watched the insurance giant AIG implode this week, there are risk management lessons galore. Whether corporate
1. Stick to your knitting. The insurance subsidiaries engaged in traditional life and P&C insurance activities were, and still are, financially sound. AIG’s troubles came from its expansion into "esoteric forms of insurance known as Credit Default Swaps. These were sold to banks and other investors by AIG Financial Products Corporation, not the property/casualty insurer subsidiaries. When the financial products unit guaranteed collateralized debt obligations which were linked to subprime and Alt-A mortgages, they exposed the entire company to inordinate financial risk as the housing market deteriorated. If AIG had simply stuck to its core competencies in writing traditional lines of insurance, this collapse would not have occurred," one risk manager said.
2. Insurance ratings can be misleading. Most insurance brokers recommend mainly A-rated carriers. However, AIG had stellar ratings and was only downgraded slightly by two rating agencies on the Monday before its meltdown. It had billions in policyholder surplus, but as pointed out in #1, the problems with AIG stemmed from its financial activities.
3. Don’t chase extraordinary results. Insurance executives at publicly-traded companies are under tremendous pressure to beat Wall Street’s earnings expectations and grow shareholder value. However, being too aggressive in chasing extraordinary results, like AIG did in becoming active in the derivative markets, can ultimately backfire, and spectacularly so. Insurance executives must have the courage and discipline to focus on the fundamentals of the traditional insurance business, even if the return-on-investment is not that spectacular. The goal should be long-term stabilization, not short-term profits. Privately held companies in
4. Risk managers should have their noses in their organization’s financial tent. As the dust settles from this, and it may be years before it does settle, people will ask “Where was risk management in all this?” This speaks volumes to having your organization’s risk manager a C-level executive.
5. When things go badly, they can do so quickly. Keep your eye on your total financial picture and organizations upon whom you rely, whether they are your insurance carriers, your customers or key suppliers. As the economy continues to become more global and interconnected, distant problems can impact local operations.
6. It isn’t over until it’s over. According to Paul Springman, COO of Markel Corporation, we may be headed for “the perfect storm” if natural catastrophes increase, subprime fallout continues and reserves from low insurance prices of the past three years continue to “impact insurance carriers’ balance sheets.” He reminds insurance organizations to review their “current real operating results,” not a bad idea for any organization.
7. Some risks cannot be avoided. According to a London risk manager, “Prior to September 11, 2001, there was nobody who would have refused to take office space in the World Trade Center in case two passenger planes hit it, and similarly, there's no way [a risk manager] would have gone to their CEO a month ago and said they'd like to reduce their exposure to AIG ‘just in case’."
8. Since some risks cannot be avoided, implement a contingency plan. Organizations with significant AIG paper are scrambling to enact contingency plans in the event AIG and its subsidiaries’ underwriting appetites change suddenly.
9. Expect more Federal regulation of insurance. As one risk management consultant said, with the Federal government now the majority owner of the world’s largest insurance company, you don’t have to look too far down the road to see the outcome.
The AIG meltdown will continue to impact businesses holding AIG paper. Paraphrasing Betty Davis, for those in the financial industry, “Fasten your seats belts, it’s going to be a bumpy ride.”
