Posts Tagged ‘AIG’

Is Anyone Surprised, Really?

Sunday, June 14th, 2009
The View From My Office Window

The View From My Office Window

In the first edition of Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (John Wiley & Sons, Inc., second edition, paperback, August 2009), published in 2002, I wrote that you should consult with professional and trade associations and others in the small business community to learn of their experiences in selecting an insurance carrier. Certain companies have good reputations of service in the small business market, while others are best avoided. I also wrote that there were two insurance companies that were particularly difficult to deal with for Lower Manhattan small businesses to get their 9/11-related claims paid. So I was not altogether surprised to read in the news media that “AIG was playing hardball on paying claims” to the passengers of USAirways Flight 1549. Could it be argued that AIG’s tough stance on claims relates to its present financial difficulties?


In the current edition of the book, I shared the experience of “Ariel Goodman, whose small business was based in the World Trade Center. Ariel also lived in an apartment building directly facing the World Trade Center. Following the terrorist attacks, the Department of Health condemned her apartment building. What was doubly unfortunate was that her business records were backed up at her home and her personal records were backed up at her office. Within the space of a few minutes, she lost both simultaneously…Ariel, by the way, founded From the Ground Up, a nonprofit association of Lower Manhattan small businesses affected by 9/11.” Ariel needed her commercial insurance policy to file her claims. Obtaining a copy from her accountant was not an option, as her accountant’s office was also located in the World Trade Center and he had not thought to back up his records offsite. Her insurance company denied her commercial claims and when she sought to protest their decision, repeatedly refused her requests over several months to furnish her with a copy of her policy. I advised her to send a copy of her written request to the New York State Insurance Commissioner, to make the regulators aware of her struggle with her insurance company. That did the trick.

You already guessed it: her insurance company was AIG.

That, in my opinion, is the problem for AIG. Aviation insurance is an anomaly in that insurers are typically not obligated to pay claims unless there is proof of negligence on the part of the airline. In this case, no finding of negligence has been made. At the same time, because of the sheer size of potential aviation liability claims, such coverage is typically syndicated among a group of insurers with one insurer acting as the lead underwriter. If the lead insurer pays claims that it is not obligated to pay, it faces problems of its own with the other insurers in the syndicate. An insurance company with a pristine reputation might be able to explain this phenomenon to angry passengers. They could show how paying claims that they are not obligated to pay raises the cost of coverage for everyone. It is just that if there are those who believe that the insurance company knowingly denies legitimate claims and then, on top of that, owes its continued existence to a massive taxpayer bailout of the reckless behavior of its senior executives, well, don’t expect much sympathy.

Without Precedent!

Wednesday, May 27th, 2009
Unusual Case

Unusual Case

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (John Wiley & Sons Inc., second edition, 2008), I wrote that the cash flows of an insurance operating company could not be diverted for other corporate purposes, thus providing some security for the policyholders. Last week, lawyers representing a group of policyholders of American International Group Inc. (AIG) filed a lawsuit in California Superior Court against the company, its executives and its auditor, PricewaterhouseCoopers. The policyholders allege that AIG had improperly diverted capital from its insurance operating companies, thereby undermining the critical asset for claims payment. State insurance commissioners are supposed to prevent this from happening; specifically, holding companies cannot extract capital from their insurance subsidiaries, no matter how much pressure they are under. However, the policyholders who are plaintiffs in this lawsuit alleged that AIG had pledged the cashflows of its insurance subsidiaries to repay the Federal Reserve Bank for the government bailout funds. This is absolutely without precedent and raises some troubling questions with respect to the regulatory responsibilities of the state and federal governments.  I will be following this case with great interest.

Plus Ça Change

Saturday, March 21st, 2009
The Best Plans

The Best Plans

I had a rather unusual experience with the medical examination required for me to travel for the United Nations Capital Development Fund. On behalf of my first business, Childs Capital LLC, I had accepted an assignment to serve as the Senior Policy Advisor to the United Nations Advisors Group on Inclusive Financial Sectors. This was a follow-on initiative to the UN’s International Year of Microcredit with the goal of expanding access to finance for the poorest people in the developing world. I traveled a great deal for the UN on this assignment, working on projects in Kenya, India and elsewhere. The UN requires medical clearance prior to beginning the contract, including an echocardiogram, which I had performed at the New York Downtown Hospital. The doctor expressed concern about the abnormal results and wondered if I was stressed about anything. Indeed, I was! Next door to the hospital was a construction site with dynamite chargers going off every 3.5 seconds. (I know; I was counting while lying on the examining table with the electrodes attached to my chest.)

After 9-11, billions of dollars in stimulus aid went to subsidize construction projects in Lower Manhattan, apparently in the belief that “if you build it, they will come”. The site adjacent to New York’s Downtown Hospital was to become the Beekman Tower, a Frank Gehry-designed luxury rental building in Lower Manhattan with about 900 apartments.  This was part of a grand plan to make the financial district a “24-hour community”. I could never understand why anyone would want to live in this area. Even now, after all of the billions of dollars that went into these schemes, it is very difficult to buy a newspaper on a Sunday morning in that neighborhood or to find a restaurant that keeps its kitchen open past nine in the evening. It seemed to me the height of arrogance that one would think that central planning would work here where it has failed everywhere else. I was never convinced that policymakers in New York or Washington were any smarter than their counterparts in Moscow, whose economic plans have long since been discredited.

Construction on the foundation of the Beekman Tower began in 2006. Now, in 2009, construction is not finished and the real estate developer has cut this tower from 76 stories to 38, one-half of the height originally planned for this luxury rental building. “Given the current economy, we are conducting a study to assess costs, risks and overall timing,” announced the real estate developer in a written statement. “Work is continuing on the building including on the school and we should have some conclusive answers shortly.” The developer added that work will continue on the lower stories, but added that no additional floors will be added pending an evaluation of costs. Just last year, Forest City Ratner, the real estate developer, obtained $680 million in financing for this project, which was the largest construction loan in its history. It was seen as one of the few projects in New York City that was bucking the overall real estate meltdown as construction continued.

Now, of course, the world has changed. The financial system of the U.S. is effectively insolvent. Certain of the largest employers in the financial district, such as Merrill Lynch, no longer exist. Others, such as AIG, are struggling. Lower Manhattan faces an economic crisis more severe than that caused by the events of 9-11. The irony is that resilient small businesses in the financial district, including my own, were displaced for these “grand scheme” projects that were never really viable in the first place. So now we will create jobs, expand the tax base and support local charities in communities other than Lower Manhattan, leaving behind these half-completed construction projects. The Beekman Tower is not the only Lower Manhattan construction project that has run into trouble. AIG is attempting to arrange a sale-leaseback of two of its Lower Manhattan office buildings, an arrangement that is becoming increasingly popular in a soft real estate market. Both the New York Times Corp. and Citigroup have arranged sale-leaseback transactions for certain of their properties. And the developer of the properties at the World Trade Center site, Larry Silverstein, is reported to be seeking a bailout from the New York Port Authority, which has cash flow problems of its own.

Small businesses were displaced to make way for the New York Times Corp. to build its spectacular new headquarters, in an abuse of eminent domain seizures following the Supreme Court’s landmark Kelo decision. I wonder how different things would be in Lower Manhattan if market mechanisms had been allowed to work through the post-9/11 recovery, if public subsidies to large corporations had not been granted and if the small businesses, which continue to create jobs, would have been left to do our work in peace. These lessons appear to be lost on our policymakers in Washington as they seek to defend the latest outrage in corporate welfare and federal bailouts.

P.S. Nobel Prize-winning economist Gary Becker gave an insightful interview in which he argued that many of the government’s stimulus programs, to mitigate the impact of disaster, are counterproductive.

What Happens to Insurance Companies in a Financial Crisis?

Wednesday, September 17th, 2008
New York Stock Exchange, A Photo I Took Not Far From My Office

New York Stock Exchange, A Photo I Took Not Far From My Office

On Monday, I was in the Wall Street area where the mood was decidedly somber. I was standing at one of the street food vendors buying lunch when I saw CNBC anchor Dylan Ratigan leaving the New York Stock Exchange and entering the Wall Street subway station. CNBC interrupted its ordinary broadcast that evening to provide programs with experts discussing the concerns about the safety and soundness of our Wall Street institutions with specific reference to Lehman Brothers and AIG. Later that evening, one of the cable television networks (NOT CNBC) featured a guest commentator urging that the federal government “rescue” AIG because it is the world’s largest insurance company and policyholders must be paid. For people in the Gulf Coast and the Mid West recovering from Hurricanes Ike and Gustav and the associated flooding, the failure of an insurance company at this time is the last event they want to contemplate. Let’s try to separate the facts from the cable television theatrics to examine what the real issues are.

When insurance companies write business, they collect premiums and set aside required reserves to cover future losses. That is the first layer of protection for the policyholders: those reserves are set aside for their benefit. They are not available to retire other financial obligations of the company. Second, states have policyholder guarantee funds for life insurance companies to provide an additional level of security in the event of insolvency. Third, insurance companies pay premiums for reinsurance coverage, which provides an additional layer of capital available to pay claims. In the event that an insurance company becomes insolvent, the reinsurance company is not relieved of its obligation to pay the claims to the ultimate beneficiaries – the policyholders. What would happen in such an event is that the state insurance commissioner would establish a trust and appoint a trustee to oversee the orderly liquidation of the insurance company. The reinsurance company, or companies, as insurers often buy layers of capital protection from multiple sources, would pay their required claims into the trust in lieu of to the insurer and the trust would pay the policyholders. Finally, the insurance commissioner would likely to try arrange the sale of the insurance company’s operations to a financially sound insurance company which would then assume all of the liabilities for the policyholders it would acquire (along with the associated reserves).

With specific reference to AIG (American International Group), it has many subsidiaries operating in many different financial sectors, some of which are insurance companies. But the assets and the liabilities of these businesses are not fungible. The assets of its property-casualty insurance companies, for example, are held separately from certain of its other businesses that have exposures to the sub-prime mortgage market. More broadly, with respect to any corporate restructuring, there are different classes of constituents that have claims against a company should it go into bankruptcy: employees, creditors, suppliers and vendors, stockholders and, if the company is an insurance company, policyholders. In all cases, the policyholders’ claims are senior and superior to all others. They will be paid first. The cable television commentators I observed on television appeared to have confused the risks for the policyholders with those of the stockholders, bondholders and employees. They are certainly not the same. Nevertheless, the financial crisis underscores the importance of the advice we gave in the first (published in 2002) and second (published in 2008) editions of the book: consider the financial strength and claims paying ability when selecting an insurance company.