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After AIG: Which Insurer Is Next in Line for a Federal Handout?

PRU is next

ING and AEG are not in such great shape (each has substantial US buysiness), and have received funds from their parent-domicile government.

MFC (Manulife) was unhedged on its variable annuities and lost it's AAA rating


Just like investment banks looking for alternate ways to generate revenues (and securitization markets opening a new universefro fees), insurers also found alternate ways, such as variable annuities, etc.

Well with "life insurance" companies (pure life insurance, annuities, some health, Long-term care, etc) the contracts are of a long term and are priced/sold once, so if you make a mistake it's with you for a long time.
Compare that to Propertty & Casualty companies which offer insurance typically on a one-year term basis, and re-price it each year... provides more control.

Life insurance is a much lower ROE business than P&C.

Why does Warren Buffett buy P&C insurance entities primarily (vs Life insurance)? Hmmm, could it have anything to do with the above items

Next In Line for Bailout? Life Insurance Companies

Oh, on bailouts... they are like a dangling this pacifier or carrot in front of the citizen-taxpayers/inve... They give false hope and prolong the inevitable. The market hates uncertainty.

Sure, it is difficult to estimate the amount needed for this/that problem, and amounts have been increased.

Obama indicated he wanted to clean up the economic mess. Letting a company go bankrupt is more straight-forward, and allows the private sector to determine how/what should re-emerge (instead of some complex administration of some pot of money collected from taxpayers).

Next In Line for Bailout? Life Insurance Companies

Some important items have been overlooked on Variable Annuities:

1. The earlier product designs of Variable Annuities hardly charged anything for the guaranteed benefits.

2. Some of the earlier contracts permit "partial withdrawals" without reduced the death benefit proportionally. I refer you to Prudential stock brokerage firm's analyst report "Money For Nothing and Your Insurance For Free" In that report they mention HIG, LNC, and others having such flawed contracts.

3. Insurance companies were supposed to hedge, but some did not eg. Manulife - MFC until more recently

4. Many insurers hedged/targeted an assumed S&P 500 average way higher than previous levels... and they are still way off... for example at the earnings reports over th past 6 weeks insurers have said they expect / assumed a S&P500 index 900-950 on avaerage for 2009. They are waaaaaaay off on their assumption. Currently 2 months well below that number and its unlikely there will be several months above that level, so that the average assumption comes about. Why? The S&P 500 companies were expected (about 5-6 weeks ago) to earn $50-60 in 2009. P/E multiples are expected to be 10-15. Ok, let's take the maximum of those P = E x p/e ratio = 60 x 15 = 900. How will this AVERAGE of 900-950 come about? No way, they are waaaayy under-reserved.

5. Hedging costs. Volatility has increased making options more expensive. And the speed at which things are occuring makes hedging activity more frequent. The range (severity) is also increasing. I forget the exact numbers but in late 2008, AXA mentioned hedging costs of HC for a whole year (2007 i think) and in just one quarter of 2008 the hedging costs were 3x HC. Holy guacamole! Oh, yah, that's right, I forgot, all of this was foreseen when pricing these Variable Annuities contracts.
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On the point about insurers having a natural hedge because insurers cover death risk and risk of outliving the expectation. Well, wait a second:
1. Back to Variable Annuities. Look at the designs and how many contracts are perfectly designed? Also, some contracts may 'convert' or 'transform' where both risks may not be present.
2. On products other-than-Variable-An... let's say a whole life policy + an immediate annuity. Sounds good in theory, but what about practice: How many insurance companies have sold these two types of products to the same insured, in the proper proportion so as to be risk neutral? How many companies administratively know what risks they have on each insured? Wasn't there a concern in the industry for some time of "back-to-back" policies where the same insured buys life insurance from one insurer and buys the annuity from another insurer? Oh, and on those immediate annuities, how much underwriting is conducted... isn't it true a lot less underwriting is done on the annuity side?

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Moving onto Fixed Annuities, another area of concerns:
1. Minimum interest rate guarantee during the contract. Did anyone some years back predict interest rates at today's low levels? The investment spread (rate earned minus rate paid to policyholder taking into account guarantees say from 2% to 5%) has narrowed significantly eating into profits.

2. Policyholder activity during economic times. Usually, as interest rates rise policyholders are more prone to cancell their contracts to obtain higher rates on a new contact. Vice verse, as rates fall, they hold onto existing contracts because of the contract's higher rate. HOWEVER, many consumers are hurting financially in this economic climate and some contracts have a MVA (market-value adjustment) cost which is negative which means no cost for the policyholder to cancel the contract. One company identifying this activity as noticeable and affecting its financial results is FFG in their current earnings report.


Many more issues. I'll stop here for now.

Bank of Montreal's AIG Acquisition Favorable but Not Transformational

"Holes" ... watch out BMO and all Canadian banks with US exposure, if the commercial loan market (strip malls, retails stores, etc) starts defaulting or declaring bankruptcy . eg. look at Circuit City, apparel retailers like LIZ/ANN/TLB, lesser known/non-listed exchange companies, etc

Great Depression Not Imminent, But Inevitable

Rakesh,

Several comments, and though i will focus on points of disagreement / over-generalization, i do agree that insurance (or assurance) is one (vs the only) ingredient.

1. Inevitability. Suggests certainty, though tht is one scenario...another scenario could be a long drawn out recession.

2. Depression. One government (USA) has stated they will do everything in its ability to prevent certain crises. Seems they will do just about anything to avoid the "D" word, even providing a credit guarantee.

3. Who is the insurer or guarantor of last resort? I asked this question at an industry meeting in 2005 as there was fast consolidation in the reinsurance market. Investment banks had stepped in for some aspects of risk. Really what is needed is an entity to cover all risks of an enterprise (Enterprise Risk Management). Well, not even a government is a guarantor, technically, but entities do put some faith in some governments. So, although market forces/risk pricing would suggest otherwise, governments will find a way...and defer the problem to future generations.

4. Discussion of "non-actuarial" risks. Actuaries (some) are quite versed in analyses/calculations of investment risks, particularly within the past 10 years. Actuaries may not be as prevalent within the investment banking / pricing market, but they do possess knowledge to be so.

5. Pricing of CDS's and other derivatives. These securities are rather illiquid., and with relatively few transactions, pricing may vary widely. Pricing based on a computer/statistical distribution model over several scenarios might be great in theory, but what we are dealing with here are events (and economies) beyond those 2 standard deviations or 95/99% confidence intervals. We have these 'extreme' events which are now moreso the norm (extremes vs norms in weather/climate patterns is an analogy). Pricing needs to be done on an extreme event/scenario basis.

6. Economies will not function without insurance? Yes, insurance is needed for international trade and for certain industries. But some industries in domestic economies may not have such requirement.

7. Credit economy vs Cash economy. Have you visited developing nations? Many of these nations work on a cash basis, and those economies function. Insurance (or assurance) is provided via substantial funding of actual cash/cash equivalents vs. trade credit/ credit derivatives. Yes, there would be a significant hit to economies transitioning to lower-leverage environments and significant change in standard of living, but it may not lead to a Great Depression.


Though i've focused more on points of disagreement, your article is informative, and therefore appreciated.

Always good to hear both sides, and with all these people on CNBC, etc saying, the market has bottomed (and repeating it seemingly several times per hour), there still are significant issues out there. Governments may continue to pump money at the problem, but they haven't resolved the underlying causes, and the problems will be passed to future generations.

AIG: America's Insurance Giant

Private enterprises (pension funds, etc) have been hammered.... we just do not know the magnitude!!

Consumers/common investors will hear about financial exposures (losses) that stock-public companies have because of SEC reporting requirements, but there are significant losses in pension funds, etc.

of course, the consumer/common investor does not hear/see about these enterprises. Oh, and of course, that's in the future, but in a greedy, aggressive, short-term focused society, it is probably only a small % that gives a damm (intentional spelling).

so, the pension funds will be under-funded , amd then they have the following choices:

1. walk away from the fund declaring it insolvent (that has happened in UK/England, but not sure if can do that in USA)

2. add more money to the fund, but where will the money come from?
(a) additional higher % contributions
(b) smaller benefits per month (in the base amount and/or less indexing to inflation or none at all!)
(c) delaying the benefits' payout (eg. working longer)
(d) capping the benefits at some age (instead of the whole remainder of life)


In #2, this is the same situation faced by the USA's Social Security pension benefits scheme ... and the politicians in USA are afraid to make the tough decisions... most likely becuase of politics and looking to be the bad guy making one of the tough calls

But then again, at least the USA nation has a social security system.... some nations in better fiscal shape (eg China) have no social security system as such, so its citizens suffer as well.

The winners? the bankers who are funding all these nations (with the governments of the nations being the face or "front" to the citizens).

AIG: America's Insurance Giant

David, i understand your article because i've done M&A, ALM, etc work and advocated both scenarios analysis and ERM. (no further comments on the reception of my advocations / suggestions).

I like that you have attempted to give examples that the "Main St" of "Any Town" can understand.

I disagree that financial guarantees should be illegal. Many sophisticated legal agreements exist, but they have not been "data-based" as most systems do not contain such flexibility. Companies do disclose the terms of such agreements, however, this is on a per transaction (capital raising, etc) basis.
Yes, sure, a company should provide a SUMMARY of such right, convenants, etc to which they are exposed...and i would like to see such company that has accurately recorded/maintained such exposure. And this would work for financings.... however....the very insurance products themselves that AIG sells provide rights/options/calls to policyholders and these and their value is not disclosed so readily (understandably) to investors.

On that item, i think your point might be more about disclosure vs if guarantees on financings are made illegal , then might as well make guarantees on insurance products illegal because those guarantees can cause significant financial hardship to insurers and investors sure don't know what exposures exist.

anyways, the USA government had and has been weakening the USA as a financial leader for quite some time ... actually the economic downturn was being helpful in some ways:
- lower oil prices
- reducing inflation
- strengthening a weak currency
- recently, other countries have begun to realize their economies were not so strong and not so independent of the USA system
- improving the relativeness of the markets, and reducing economic bubbles ... now if the EU would establish a more objective way of evaluating whether to reduce interest rates (yes, a lot of politics in the EU also, which result in a decision of "status quo") and then lower rates, that would be helpful

Crunching Numbers: Why I'd Buy AIG

1. Assets, Market, Liquidity
everyone talks about the value of the assets, which is good, to a point. Remember though that if there is no market (ie, no one wants or no one is large enough to buy your assets), then what is the value of those assets?

2. Liabilities
The assets are there to provide for the Liabilities... so what happens when

(a) AIG need to pay out claims??? They use their cash, which in effect increases the % of total assets which are less liquid.

(b) policyholders start to cancel their contracts which have significant surrender (cash) values??


Two quick comments on the analysis:
1. we are in a new era going forward ... historical assumptions not so applicable (though government could intervene to attempt to change assumptions)

2. when calculating Present Value, the interest (discount) rate used should be the rate that you as a investor demand as a return on your investment. If you are happy with 4.5%, then ok, but other investors want something like 15%.... try inputing 15% and see those PVs decline rather significantly !!

It's Time to Break Up AIG

David, so you have been reading the Yahoo message boards. Why not cut & paste some of what I've written there regarding splitting up the company, enterprise risk management, etc.
On the Yahoo message board, it was an eye opener to read of another aspect of the mortgage industry -- the appraisals themselves and how companies like an AIG (and others), can play hard ball / bully the appraisors and their firms. As the mortgage industry is scrutinized further perhaps issues like this will become more apparent and the "bully" advantage will decline.

Years ago there was talk in the industry of some insurers making money by not paying claims (or significantly delaying). Some other companies made money through "float" (accepting money as an intermediary and then holding it for a little while before paying it over to the party it should go to). How much additional income is still generated by the insurance industry through such practices?

Where was the ERM? Derivatives? that are illiquid? There is always a winner and loser with derivatives. Sure, just keep taking one side of a derivative trade, oh and be sure not to protect against losses through purchase of a security at, say, a 10% loss level. Oh, we never thought about it? Oh, there is no one offering that type of derivative of the magnitude of our portfolio? Oh, PwC said we had a material weakness because we did not record the credit quality of the business underlying the derivatives - who needs to know that? Oh, forget Kevin Costner, we are the Untouchables.

The competitive advantages that this company once had have been and continue to erode, just like the US dollar.