Why Feds Shouldn't Regulate Insurance, Nor Own Insurers

Insurance is complex by nature.  Anytime one brings in a third party to be a protector/guarantor against adverse events, it creates some weird dynamics.  Now, a few of the states, including the best of them, New York, have been regulating insurance for a long time.  But the Feds have not dealt with insurance in any significant way, because that role has been ceded to the states.

With the failure of AIG (AIG), and it getting acquired by the Feds, the questions of regulation have taken on new significance.  I have written before about the Federalization of insurance regulaton, indicating some indifference about who regulates it, but pointing out the difficulties — what an effective insurance regulator needs to learn.

The following is personal to me in four ways:

• I used to work for AIG (’89-’92)
• My main local paper is the Baltimore Sun (though I don’t subscribe, because of lack of value)
• Elijah Cummings is my Congressman, at least since the last gerrymander. (Hey, give him credit, he voted against the bailout.)
• I have interacted with many insurance regulators of varying abilities over the last 20+ years.

Elijah Cummings and some other congressmen have gotten offended over seemingly extravagant expenses over conferences, particularly for agents/representatives of the company.  Now, as a young actuary, I would sometimes say, “Why do the agents get to go to all of the fun conferences?”  Not true — only the top agents went to those conferences, and it was a reward that would stimulate extra performance (and the real reward was bragging rights — the companies often made money off of conference-type rewards).  Actuaries are nice, and all that, but the ability to sell product, particularly in life insurance and annuities, is rare.

When the government gets involved in industry, the incentives become messy:

A1) We need to do a lot of mortgage workouts for the good of mortgage payors and those in residential real estate.

A2) We need to minimize the cost of the mortgage bailout to the taxpayer.  Or, we can’t borrow that much.

B1) We must reduce tobacco smoking in our state; it is harming our dumbest citizens.

B2) But we issued tobacco bonds against the recent settlement with the tobacco companies.  We can’t afford to lose revenue.

C1) We’ve got to crack down on shady life insurance sales practices.  Too many people are getting cheated.

C2) That insurance company employs a lot of people in our state, and they are located in the district of the head of the commerce committee.

D1) Gambling has introduced new forms of addiction to our state, and perhaps organized crime as well.

D2) We can’t afford to give up the tax proceeds from gambling — the schools depend on it.

Have I made it clear?  Politicians want political results, and they want tax revenues, which are often opposed to each other.  They aren’t typically businessmen, so they don’t understand the trade-off.  Rather, they swing from one to the other, as political convenience dictates.

And so in this situation, I would say that the amounts in question are rather nominal.  Why fuss over the conferences?  Rewarding top performers is important, and if you don’t do that, you will lose business, and the government will lose on its “investment” (what a word ) in AIG.  Most companies have conferences like AIG, and I can tell you, they will think twice about coming under the government’s umbrella for that reason, as well as many other reasons that have political significance, but harm corporate performance.

State legislatures took time to build up expertise in insurance regulation.  Some more so like New York (we should move the NY regulators to DC if we federalize), and some less so.  Congress doesn’t have the vaguest idea about what to do with insurance and AIG.  The ignorant statements of Rep. Cummings are a great example.  Ed Liddy has only been on the job for less than two months.  Why call for his head?  Insurance companies are complex organizations where most significant things are planned a year in advance or so.

Now, so do I like the AIG bailout?  No, perhaps we should have let the holding company fail, and the underlying insurance subsidiaries would have been fine.  Some CDO holders would have been hurt, but what are you doing dabbling in CDOs, anyway?  And why didn’t you question why so much of your CDO exposure was AIG guaranteed?  When only one company guarantees much of the business, that is a bad sign (underpricing).

But seeing the ruckus here, this is why it is bad for the government to own an insurance company.  All of the incentives are confused, which will lead to a greater failure, and more expense to the taxpayers.

Comments

[I weep for ...:]

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INSURANCE
Knee-jerk Populism Part II
Posted by Tim Reason | CFO.com | Europe
November 12, 2008 2:00 PM ET
After writing a blog post at work yesterday about the AIG junket that wasn't , I was fascinated, and horrified, to go home and watch all the actual TV coverage.

This total non-story made it onto just about every news outlet you can imagine, including segments throughout the day on CNN. The height of ridiculousness was that AIG CEO Ed Liddy was forced to go on Larry King Live — as the first guest — to defend this ordinary conference against charges of being an executive boondoggle. (CNN realized midway through the day what a joke this story was and began inserting some balance into its reports, but couldn't stop pumping it in advance of the Larry King show.)

The absolute nadir was the original, breathlessly reported exclusive undercover investigative report by the Phoenix ABC affiliate. If you thought it was impossible to make something as excruciatingly boring as a 3-day insurance conference sound like an orgy at the Playboy Mansion, well, just click the video.

(Way to go, ABC15 reporter Josh Bernstein. Stay tuned for his story six months from now on why the bottom suddenly fell out of the Phoenix conference business.)

Or simply click on the slideshow to see the AIG executives "sitting poolside, drinking coffee, while other people attending the conference were in meetings." Coffee? Good grief! What a debauched bunch these insurance executives are. And how odd that they don't attend training sessions describing products that they designed!

Despite the fact that these guys were meeting in suits and ties at a table, surrounded by briefcases overflowing with work folders, other media outlets quickly began reporting that they were "lounging by the pool." Speaking from personal experience, having a meeting in the pool area of a conference hotel with your work colleagues in a dark business suit and tie in the hot sun is closer to a waterboarding than a boondoggle on the spectrum of creature comforts. The only reason anyone does this at all is that they're desperate for fresh air after days of inside meetings.

As AIG has admitted, it has behaved abominably in the past. Issuing billions in credit default swaps? That's terrible risk management. AIG executives hunting quail in the English countryside? That's a boondoggle. Putting on conference for financial planners that sell your product? That's good marketing.

The inability of the media, the government, and the public to distinguish between corporate excess and ordinary business is the result of the very same financial illiteracy that got us into this mess in the first place.

Most media outlets took great glee in reporting that this supposed "executive day spa" took place at the same time AIG's original bailout was revised. But most failed to note why it was revised: the terms were so onerous that they put AIG at risk of failing anyway. That's hardly good for taxpayers.

And pouncing on this company every time it attempts to conduct normal business anywhere other than an IHOP (as one CNN anchor suggested) is also a great way to make sure the bailout fails and we taxpayers never see that money again.

2008 Nov 13 01:37 PM

[Jackson Cash:]

Insurance = Crock of elite protectionist $hit that artificially drives prices upward.

When you say regulate, I say do away with mandated insurance (such as auto, etc).

2008 Nov 13 01:50 PM

[Obama is Bu...:]

Why do you think sales people are "producers", but actuaries are not? Why do the exceptional sales people get to go to a fancy vacation/conference -- but the best performing actuaries are simply told "Well, you are just doing your job"?

The U.S. over-valuing of sales people, and complete neglect of all other positions, is a big contributing cause of the current crisis. If Wall Street had placed equal importance on risk management as it did on sales, would they have caused the damage they did?

The Shallowest Generation (to quote another article on Seeking Alpha) has over-estimated the value of sales, and completely neglected everything else. Its not that sales are unimportant -- but they are only PART of the picture.

Wall Street failed because they thought sales were important, but risk management was not. GM (and Ford and Chrysler) are failing in spite of having a great dealership / sales network -- their products stink because the engineers were told they were unimportant.

Simple common sense here folks: sales people need something to sell. Period. No buts. The Shallowest Generation has completely neglected everything other than sales -- we are a nation of spin and promos, with no product substance underneath.

AIG should be canceling their sales vacations-- they should be giving fancy trips to risk modelers who can help get the company out of the mess the sales force created yester-year.

The best engineers / risk managers / product development staff in general need to be told, and SHOWN, that they are as important to a company as sales -- because they are. AIG and GM are textbook cases of what happens when sales are emphasized at the neglect of everything else.

2008 Nov 13 02:49 PM

[Tony Petroski:]

Actuaries: You have a right to complain about the "producers," but don't forget us claims people.

2008 Nov 13 11:10 PM

[sumosama:]

good article. thanks for illuminating the dichotomies.

2008 Nov 14 10:58 AM

[calderaranch:]

David:
As part of full disclosure, I was an AIG Regional VP during your years with the organization.
We ran many agent events from golf outings to cocktail parties. As you know, the objective was to create "face time" for our underwriters, claims staff and loss control engineers with both top agents and those that we wanted to develop.
The staff were the arrows in my quiver and as good as they were at their jobs, they needed the guidance of the marketing department to hit the proper target at the proper time.
Every event ran on a budget that rolled up to an annual amount established in the prior year budget period and that cost was evaluated against production change when establishing the following year's marketing budget.
You are right to be concerned about the Feds involvement in the running of a public company after all these are the folks who condition their managers to "use it or lose it" with regard to budgeted funds.

2008 Nov 14 11:49 AM

[daniel3582:]

I don't understand why you would suggest canceling sales trips... are the salesmen the ones who put these policies into play? Are the salesmen the people who came up with the risk models? Are the salesmen the ones who continued to let the destructive policies run their course, even as it became clear that it was a bad idea?

I think not. The salesmen were good employees; they did what they were told. And, while you might have the benefit of 20/20 hindsight, it was probably not so clear to the salesmen what they were actually doing. If they didn't perform, they were fired. Plain and simple.


On Nov 13 02:49 PM gramps2 wrote:

> Why do you think sales people are "producers", but actuaries are
> not? Why do the exceptional sales people get to go to a fancy vacation/conference
> -- but the best performing actuaries are simply told "Well, you are
> just doing your job"?
>
> The U.S. over-valuing of sales people, and complete neglect of all
> other positions, is a big contributing cause of the current crisis.
> If Wall Street had placed equal importance on risk management as
> it did on sales, would they have caused the damage they did?
>
> The Shallowest Generation (to quote another article on Seeking Alpha)
> has over-estimated the value of sales, and completely neglected everything
> else. Its not that sales are unimportant -- but they are only PART
> of the picture.
>
> Wall Street failed because they thought sales were important, but
> risk management was not. GM (and Ford and Chrysler) are failing
> in spite of having a great dealership / sales network -- their products
> stink because the engineers were told they were unimportant.
>
> Simple common sense here folks: sales people need something to sell.
> Period. No buts. The Shallowest Generation has completely neglected
> everything other than sales -- we are a nation of spin and promos,
> with no product substance underneath.
>
> AIG should be canceling their sales vacations-- they should be giving
> fancy trips to risk modelers who can help get the company out of
> the mess the sales force created yester-year.
>
> The best engineers / risk managers / product development staff in
> general need to be told, and SHOWN, that they are as important to
> a company as sales -- because they are. AIG and GM are textbook
> cases of what happens when sales are emphasized at the neglect of
> everything else.

2008 Nov 15 09:51 AM

[Obama is Bu...:]

daniel -- I suggested canceling the sales trips and replacing them with trips for actuaries or risk managers. The last thing AIG needs now is more sales -- it doesn't have the balance sheet to support more policies, and it clearly doesn't have the risk management systems in place.

Longer term though -- I was complaining about the over-emphasis on sales. I was very specific in saying that sales are not unimportant -- but that they are only PART of the business.

Too many inept managers focused 110% on sales and completely neglected everything else. This led to absurd levels of hubris on the part of sales staff, many of whom were glorified phone operators (many salespeople add lots of value, but during the "boom" many did not).

When a salesman "produces", how can you be so arrogant as to suggest that 100% of the credit should go to the salesman? If the firm has a reputation for not processing claims properly, clients won't do business. Clearly, some of the credit for the sale should be going to the claims processing people. If the firm doesn't manage risk well, than the firm will collapse and won't be able to pay claims -- so clearly, some of the credit must go to the risk management / actuaries. I could go on and on about other departments, but the basic message is this: it takes teamwork for a firm to be successful. Sales people often get very confused and think they are the whole team. During the boom, many big firms actually were so stupid that they labeled back office personnel as "cost centers" because they didn't bring in revenue like the head in the cloud sales force. If the rest of the team doesn't do its job, then you sales guys have nothing worth selling. The rest of the team must be recognized for its contribution as well.

It is ridiculous for talentless CEOs to fall over backwards for their top performing sales people -- but then not make a similar fuss over the top performing people in other departments. I have to keep saying this because the current thinking is so out of touch: if the rest of the staff doesnt do their job, YOU HAVE NOTHING TO SELL.

Sales people are simply worthless without something to sell. That's really just common sense-- but inept CEOs of late have forgotten. They focused 110% on sales and completely neglected everything else. Wall Street collapsed because moron CEOs forgot to reward risk management people. GM and Ford collapsed because they have neglected everything from cost controls to new product design.

Sales are important, and cannot be neglected... but so are many other facets of a business. The current crop of worthless CEOs forgot that. We have all seen sports teams where one player thinks he is God's gift to whatever sport -- coaches that are dumb enough to play along and neglect the rest of the team end up like AIG or GM or Lehman or Bear.

In the long term, there needs to be a balance ... but in the short term, most of these companies are going to have to over-compensate and over-emphasize risk management, and under-emphasize sales.

So short term: yes, cancel the sales trips. Long term, successful firms will recognize outstanding contributors throughout the firm.

2008 Nov 15 04:41 PM