Reflections on the AIG Bailout

This Wednesday was a historic day in the insurance industry as the Federal Reserve agreed to an $85 billion bailout of AIG. It was also a historically busy day for many of the industry's analysts as everyone from clients to those (ahem) no-good-media-types that were looking to get their questions answered. Fortunately, a few had time to speak to I&T.In the insurance technology space, analysts wouldn't say that Enterprise Risk Management (ERM) technologies could have prevented the financial crisis that many companies find themselves in, but some did suggest that the current situation should serve as compelling evidence of the need for wider adoption of ERM and analytical tools, as well as better corporate governance around risk.

"One thing we have to keep in mind is that AIG is such a huge, diverse, complex, decentralized organization. In that regard, you could almost say that they are one of a kind," says TowerGroup's Karen Pauli. "Some of this doesn't have to do with technology. It has to do with AIG's appetite for risk in the past and the development of their unique product offerings in a very unusual way."

Even so, Pauli says that insurers should regard the AIG bailout as a lesson around the need for ERM technology. Despite financial difficulties, it will be important for insurers to avoid cuts in predictive analytics projects that help improve decision making and add a certain level of objectivity to the process.

"Technology wouldn't make everything perfect, but ERM technology coupled with analytics and strong corporate governance could have made a difference in AIG's ability to detect all the places where they were exposed to subprime issues," suggests Pauli.

"The biggest impact [of the AIG bailout] will be on insurers strengthening the technology solutions, and staff skill sets, which allow them to understand their financial market risks -- of their investment portfolios, for asset/liability matching, and for hedging various guarantees embedded in their products," adds Donald Light, a senior analyst in Celent's insurance practice.

Analytics could play a large role in that strengthening, but insurers need to commit to objective processes, says Deloitee's John Lucker, who discussed the subprime mortgage crisis in broader terms, rather than addressing AIG specifically. "A vast body of practical and accepted research exists for how credit and financial health correlate and cause certain business and individual behaviors," Lucker explained. "It is well established that effective use of these insights can be predictive of a variety of business situations or outcomes. When companies disregard or deviate from these insights, any subjectivity or randomness in their actions can cause an adverse result - it's the objectivity of the properly designed analytics that helps to smooth decisions to a more favorable overall outcome."

(Aside: As my colleague Anthony O'Donnell pointed out earlier, objectivity is required in not only a firm's commitment to risk models, but in how those models are conceived.)

Perhaps, as a result of continuing financial woes and the AIG wake-up call, insurers will rededicate themselves to ERM and gathering the data necessary to make those models viable. Previously, it's possible that more could have been done.

"In the past, insurers and reinsurers who asked for too much information about risk were considered too hard to do business with," Lucker says. "Recent events make it clear that understanding individual components of business is vital and essential. We're seeing now that knowing more about risks through more robust data and advanced analytics can result in better underwriting, pricing, book management, and ERM. And some insurers and reinsurers are becoming more willing to ask for more data by insisting that producers do a better job of gathering data about risks as well, sometimes without regard for ease of doing business concerns, because in some cases there is too much money and risk at stake."

TowerGroup's Pauli, meanwhile, says that gathering the data isn't the problem so much as it is turning that data into useful information. "Most carriers ask [for] an excruciating amount of information anyhow. The leaders augment that with information available from vendors. It's not necessarily asking for more data. It's aggregating that data to solve actual business problems," Pauli says.

To avoid further turmoil, Pauli says that insurers will have to restore some of the discipline that has left their organizations. Years of good results have left most carriers well capitalized and with their reserves in good shape. That's a good situation to be in, for sure, but one that has led to less stringent underwriting and pricing practices.

"People have lost their discipline. You need predictive models and analytics and you need to bring those things to decisioning so that people won't get 'creative,'" Pauli says. "At the carriers that have brought that into their organization, executives can sleep at night. The ones that are doing things manually or in siloed environments are not."In the insurance technology space, analysts wouldn't say that Enterprise Risk Management (ERM) technologies could have prevented the financial crisis that many companies find themselves in, but some did suggest that the current situation should serve as compelling evidence of the need for wider adoption of ERM and analytical tools, as well as better corporate governance around risk.