Kill AIG Now
As the once highflying American International Group (AIG) enters its second year as a ward of the American taxpayers, the unique, perhaps questionable, nature of its business strategy has begun to place additional strains on the nation’s insurance and financial systems. If the government wants to shield taxpayers and the rest of the insurance industry from the problems that AIG poses, it should work to break up the company and remove the drag its continued existence places on the economy. Anything else—even strategies that might return a little more of the public money invested in the company—is likely to promote the very type of financial markets instability that policymakers used to justify their partial takeover of AIG in the first place.
Understanding AIG’s ills and the unique risks its continued existence poses to America’s financial system requires some understanding of its history. Founded by Americans in China in 1919, the company first blazed new trails by selling insurance in Asian markets where it hadn’t previously existed. Its record of innovation continued. Starting in the late 1960s under the leadership of charismatic, controversial CEO Maurice R. “Hank” Greenberg, the company became one of the first insurers to reinvent itself as a financial services supermarket. For a time, it seemed to work: A $1,000 investment in the company in 1990 was worth almost $20,000 in 2000 during the dot-com bull market. (Today it would be worth about $270.) While many competitors opened their own banks, investment houses and the like, AIG grew largely by buying other companies.
Although a number of other companies sold a product line-up similar to it, Greenberg’s AIG developed a uniquely confusing structure largely as a result of its acquisitive ways. When it collapsed in the fall of 2008 due to some terrible bets it made on credit default swaps, AIG consisted of over 1,500 legal entities, 71 America-based operating subsidiaries, and perhaps 50 brands. (State Farm, the insurer that does the most business in the U.S., has 12 U.S.-based operating subsidiaries and one brand.)
Although odd looking on paper, this structure gave AIG a strong competitive advantage and promotes economic instability now. It “worked” for two reasons.
First, the company was—and still is—largely “regulator proof” and able to engage in risky, high-return investments that state regulations mandating conservative financial strategies closed to most of its competitors. Like all other insurers, AIG is regulated separately by each jurisdiction where it operated and small state-level regulatory operations couldn’t always “follow the money” in a behemoth like AIG. The credit default swap trades that famously brought down the company were only one example of its exotic, high-flying investment strategy: the company also backed “rocket scientist” quantitative hedge funds and built ski resorts.
Second, many AIG subsidiaries—particularly those in highly priced competitive businesses—took a very hardnosed attitude towards paying policyholder claims. Although some of the horror stories about the company probably stemmed from resentment of financial success -- then New York State Attorney General Elliot Spitzer launched a sometimes demagogic crusade against it -- the overall strategy appeared to be the mostly legal although hardly consumer-friendly game plan of always interpreting contract language in ways that maximized corporate profits. AIG denied car repair warrantee claims to people who attached trailer hitches to their vehicles, held consumers with damaged homes to the absolute minimum payouts allowed under contract language, and, California courts found, engaged in “roundtable” meetings where executives targeted expensive disability claims for policy termination. Paying as little as possible, in turn, let AIG skimp on the reinsurance (insurance for insurers) and keep more money for dividends, salaries, and acquisitions. And the company’s enormous portfolio of isolated brands let some parts of AIG be downright cruel to their own customers without the company taking a big hit to its overall reputation.
Together, these strategies—make more on money investment income and pay less of it out to policyholders—made it reasonably easy for the company to under-price competitors and grow to an enormous size as a result.
Needless to say, however, competitors considered these strategies underhanded when the company belonged to private stockholders and downright loathsome now that it’s partly taxpayer owned. “Everybody has a story about AIG under-pricing,” says Bradley Kading, the President of the Association of Bermuda Insurers and Reinsurers, which includes a lot of companies that compete with AIG subsidiaries. “It’s something you hear a lot.” Ted Kelly, CEO of Liberty Mutual is more blunt, accusing AIG of “overly aggressive pricing” in Congressional testimony.
But, there’s no hard evidence that AIG has systematically broken the law through its pricing. (Because insurance consists of a promise to pay at a future time, it’s illegal to sell an insurance policy at a price that doesn’t provide reasonable assurance that the company selling it will be able to pay claims.) Investigations from the National Association of Insurance Commissioners and the Government Accountability Office both found that AIG is not using taxpayer bailout funds to under-price competitors in an illegal fashion. On the other hand, a late November analyst report from Sanford Bernstein sent AIG’s stock tumbling with the suggestion that several parts of the company lacked the resources to pay likely claims. Whatever the case one thing is clear: AIG—buoyed by government support—has continued to compete vigorously on price because the company was built to do so.
And this isn’t very good for the economy. Although less damaged than other financial sectors (only one large insurer other than AIG, the Hartford, has taken significant government funds) the normally predictable profits have vanished at many companies. Even more disturbing, 2009 will mark the first ever three year contraction of the property and casualty insurance industry on record.
And AIG’s management team, understandably dedicated to the company’s survival, seems to be carrying out the same strategy that made the company big in the first place. While competitors have picked off a few of AIG’s most profitable and well-regarded subsidiaries, most of AIG has remained intact. And even if the company manages to make money—it did last third quarter of 2009 but still seems likely to show a large yearly loss—it will never be worth anything close to its bull market highs. Most likely because it understands the source of the company’s competitive advantage, AIG’s management team has proven reluctant to sell subsidiaries that could be used to pay back the taxpayers the $40 billion the company still owes to public entities. In October, indeed, AIG managers canceled plans to sell its major Japanese businesses even though a number of buyers had expressed interest. But even massive sales won’t make taxpayers whole: the company’s total market value in early November of 2009 (at its recent stock high point) was only about $5 billion. The complex interconnections between AIG subsidies and their continued exposure to risks that the company as a whole took, furthermore, make them unattractive when offered for sale on their own. Indeed, private buyers don’t seem to exist for many parts of AIG: the company’s largest single debt repayment has come from its December 1st “sell” of two subsidiaries to the Federal Reserve Bank of New York which had already bailed it out. This, of course, does nothing to reduce the public sector liability for the company.
Since the credit default swap problems that initially generated AIG’s corporate crisis is long over—all of the counterparties involved have been made whole—there’s no reason to think that the end of AIG would seriously ripple the financial services market overall.
In fact the opposite is so: getting rid of AIG would almost certainly promote stability. Left to its own devices, AIG has every reason to keep on making envelope-pushing investments and treating its customers poorly. These things are destabilizing. Since the corporate structure has remained the same since the government bailed it out, it could well need yet another bailout. Along the way, it’s presence as a vigorous price competitor with nothing to lose will result in additional price pressure within while its service practices will lower the bar on service elsewhere. Were it still a private company, these practices might well be a desirable way to encourage efficiency. As a taxpayer ward, however, AIG has no business engaging in cutthroat, limits-pushing, arguably predatory practices even if doing so doesn’t violate any laws.
If it wants to solve the problems that AIG poses, the government should put the company out of its misery. Even if the company remains in existence forever, its total debts will never be paid back because they are based on valuations of the company that assumed its strategy would result in long-term growth that never came. The money AIG lost is gone.
If it actually wants to promote economic stability, the reason it intervened in the first place, Congress and the Federal Reserve should call in the loans and encourage the breakup of AIG into several freestanding, multi-line insurers that compete with one another. Any subsidiary or group of that can stand on its own should have to offer shares to the public and turn some of the IPO proceeds over to the taxpayers. As part of this process, investors and the government would also have to do a long-overdue full accounting of AIG’s finances and determine if the company has any yet-undisclosed ills. (Such an accounting still hasn’t been done.)
Whatever happens with the IPOs, new AIG spinoffs would start out with relatively clean balance sheets—an acknowledgement that AIG’s total debt will never be paid back. Going forward, public entities would have no role in running them. As private companies, they could pursue any business strategy their managers chose. But, as smaller, more legible entities, they would have a much harder time hiding money and engaging in AIG-like investment strategies. Smaller brand portfolios would also limit their ability to play hardball with their customers like the old AIG.
There’s no perfect, elegant solution to the challenges that AIG poses. Taxpayers will never see all of their money returned. But leaving AIG intact is simply a bad idea.