Wednesday, September 17, 2008

Insurance company management is all about controlling risk

It's not often that I find something I totally disagree with on National Review's blog The Corner, but today I came across something incredible.

In a comment about the AIG bailout, Mark Hemingway wrote in part:

". . . AIG underwrites a massive amount of credit default swaps — which are very similar to insurance contracts for debt instruments. While I wouldn't say AIG couldn't have done anything to avoid their predicament, in some important respects, AIG's financial burdens were not created through their own mismanagement so much as being left holding the bag on these contracts after the failings of its customers. . ."

My comment on this is that AIG is an Insurance Company. The core business of an Insurance Company is to insure risks. The essential core of insuring risks is to avoid taking on so much of any one kind of risk as to put at risk the company's ability to survive the failure of any one type of risk. Insurance companies justify their existence and make their profits precisely by being responsible for "holding the bag" when the risks they insure go bad. AIG's management thus failed in not exercising the prudence which is the most essential characteristic of an insurance company. If that isn't mismanagement, I don't know what is.

Note that Mr. Hemingways comment above was made within a longer post about the wisdom of the government bailout of AIG and of statements by Joe Biden and Sarah Palin on that bailout. As it happens I don't know enough about the details of how AIG's failure might have affected other imprudent and mismanaged companies, so I can't comment on the wisdom or otherwise of his entire post beyond saying that his argument seems reasonable to me. You can read his entire post for yourself at:


Anonymous said...

I was watching the news and they were saying that AIG was given a bridge loan. The condition of the loan was that they are going to have to unload a lot of their subsidiaries (which are doing quite well) in order to repay the loan.

I'll bet that AIG could have unloaded these subsidiaries a while ago without government intervention; but they didn't. I'm assuming they were expecting a bailout of some sort and decided to throw their lot in with the government.

We have to be consistent about letting businesses fail; otherwise, they will never start to manage their companies responsibly.

Sully said...

"I'll bet that AIG could have unloaded these subsidiaries a while ago without government intervention; but they didn't."

I'm no expert on it, but my sense is that they've been in a bind for a while. If they started to sell off assets the market would have sensed that they were in trouble, and that odor itself would have quickly led to more trouble.

My beef with AIG's management is that they should never have let themselves get into such a box. They forgot that they were supposed to be a conservatively run company.

I had a sense of that a while back because I'm a bit familiar with a subprime mortgage company (Wilmington Finance), which AIG owns. Wilmington Finance did all the stupid things in pursuit of growth that caused other subprime mortgage companies to fail last year. AIG provided the deep pockets that kept Wilmington Finance afloat, but doing that was the kind of thing that finally added up to AIG itself being in trouble.

I hope the government loan is not a bailout of the shareholders and management, but I fear it is.