Defense Base Act Compensation Blog

The Modern Day DBA Casualty

The Implications of AIG’s cost cutting

Posted by defensebaseactcomp on December 2, 2009

“Claims will come in, reserves will be needed to fund those claims, and it is possible, if not likely, that there won’t be enough capital to fund future claims.”

From Managed Care Matters

by Joe Paduda

Eight months ago I reported AIG was buying business – slashing prices for property and casualty insurance coverage in an effort to hold on to current customers and hopefully land a bit of new business. Now comes a report from Bloomberg that analysts have confirmed what some brokers and most of their competitors have known for months – Chartis (the name of AIG’s core insurance business unit that’s been separated from the rest of the ‘old’ AIG) has been accused of ‘aggressive’ pricing by analyst Todd Bault of Sanford C Bernstein, a charge that’s been leveled for months by Chartis’ competitors.

Simply put, it appears that about a year ago AIG execs decided to cut prices on liability, workers comp, and some other lines of insurance to retain business and generate cash flow to prevent the company from going under. It worked then, but at a cost that’s becoming apparent now.

There’s a lot to consider here – the possible impact of AIG’s alleged pricing actions on extending the soft market; effect of underpricing on reserve adequacy; and consequences for the likely spinoff/sale of Chartis. I’ve discussed most of these topics here on MCM, but to save you the trouble of clicking thru, here’s the summary.

First, I’d be remiss if I didn’t acknowledge that AIG execs are denying the charges, with AIG Chief Financial Officer Robert Schimek claiming their rivals’ charges “reflect a big degree of frustration by the marketplace that they’ve been unable to unseat the Chartis organization in the vast majority of business.” That’s not exactly true, as AIG reported insurance sales dropped 13% in the most recent quarter while the combined ratio increased to 105.2, results significantly worse than those of competitors Liberty, ACE, and Chubb.

Reserve adequacy

Last winter, I heard from sources ranging from headquarters staff at large competitors to several brokers around the country that AIG was quoting rates for P&C coverage that had only a ephemeral relationship to the actual cost of risk. The sense then was AIG was doing anything it could to add premium, and thereby build up the companies’ financials. AIG’s desperate effort to add premium dollars, staved off deeper financial trouble, but as I noted back in March, “the shortsightedness of this approach will become obvious. Even more obvious than it is today. Claims will come in, reserves will be needed to fund those claims, and it is possible, if not likely, that there won’t be enough capital to fund future claims.”

Soft market
AIG’s pricing actions, to the extent that they were ‘real’, were but one of several factors contributing to the depth and duration of the current soft market
. But those actions can’t be discounted; as one of, if not the, largest writers of property and casualty insurance in 2009, any discounting by AIG would send tremors thru the entire industry. The company had long been known, and highly respected, for its underwriting expertise. When brokers and risk managers received quotes from AIG at very attractive rates, many likely turned to the other carriers bidding on their business and said something along the lines of “if AIG can charge me this, why can’t you?” Sure, some, or most, knew that AIG’s pricing may not have been realistic, but all’s fair in love, war, and insurance, and using one company’s bid to beat down another’s is common practice.

Chartis sale
According to Bloomberg, “AIG shareholders and the federal government face considerably more uncertainty than they may have anticipated,” Bault said. “AIG would likely have to take some kind of reserve charge” before selling its Chartis property-casualty business or holding a public offering for the division.” That sale will be a key piece in the ‘taxpayer repayment program’; we’ve kept AIG from going under, and if we are going to get our money back, a sizable chunk will have to come from the sale of Chartis. I noted last month that the disposition of AIG’s assets was proceeding rather well, and should have added a reminder about the pricing issue.

What does this mean for you?

If you work for Chartis, know that I wrote this with reluctance. As I said in November, AIG’s destruction was the result of poor management oversight and a wildly out-of-control finance unit. The women and men who work at Chartis and most of the other AIG companies do a very good job, work very hard, and take justifiable pride in their work. Here’s hoping their talent and abilities are enough to overcome poor decisions by their erstwhile superiors.

Joe Paduda’s blog and original article here

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: