AIG Fallout: Pricing and Risk Management
The failure of AIG creates the appearance of the financial crisis reaching beyond the banking and securities industries into the heart of the insurance industry. And yet, as those within the industry understand, this is a misleading impression: the AIG debacle had more to do with the insurance industry reaching into securities than the other way around. Hence the eerie spectacle of AIG's insurance subsidiaries humming away profitably on their side of a regulatory wall, while the holding company suffocated in the adjoining room, so to speak, choked for cash as its credit default swap business' assets plunged in value. However, the failure of the largest insurance company in the world cannot fail to affect the industry to one degree or another. One possible consequence is that the flight of AIG's customers could cause at least a temporary stiffening in the P&C market.An Advisen briefing written by David Bradford, the firm's executive vice president and editor-in-chief, speculates that if there is a "stampede" by AIG policyholders spooked by the holding company's failure, it would likely precipitate a "sudden, short-term uptick in commercial insurance rates." In the absence of such a reaction, the briefing continues, "prevailing soft market conditions are unlikely to be affected."
Customers may cool down, but a study by the Insurance Journal showed that their initial reaction was alarm. Of 1,000 agents and brokers surveyed, 44 percent said their policyholders had requested they shift their account to another carrier, and 62 percent said they expect to place less business with AIG. Commenting on the survey, Datamonitor analyst Jonathan Steiman says that even if these policyholder sentiments prove durable, a shaky economy may yet blunt their potentially beneficial effects on pricing. If AIG policyholders remain calm, the soft market will surely endure. As the Advisen's Bradford puts it:
AIG's losses under credit default swaps have no impact on statutory policyholders' surplus, which equates to "supply" in the insurance supply-and-demand equation. The insurance industry remains overcapitalized, which barring a massive natural catastrophe should continue to exert downward pressure on rates at least through 2009.
In short, there doesn't seem to be much of a silver lining to the present financial cloud, at least for the insurance industry. At least those of us connected to the industry can take comfort that things aren't worse - as today we witness the largest bank failure in history, with Washington Mutual joining the bone yard of fallen titans.
If there is one glimmer of benefit resulting from the AIG debacle and the financial crisis in general, it is that it is likely to accelerate the evolution of risk management technology solutions. Earlier this year, a Datamonitor survey of 200 global insurers found that 61 percent of life insurers and 47 percent of non-life insurers said they were planning to increase investment in risk management and compliance systems in 2009. "While these are healthy figures, Datamonitor anticipates even greater spending in light of the recent events," says Jonathan Steiman, in an Olympian understatement.
In a recent note I commented that risk modeling technology can be used to mask reality as well as reveal it. However a more sophisticated blend of art and technology will be indispensable to the development of a more comprehensive and secure approach to risk management. That in turn will power not only a more efficient insurance industry but a less vulnerable financial services industry overall, as we rebuild from the ruins of the present catastrophe. Prudent regulation will play an important role in averting future folly-induced financial disasters but, as Datamonitor's Steiman argues, technology will play a critical role in reshaping the way financial institutions manage risk:
...next-generation risk management systems must be able to quickly capture and evaluate complex transactions from every corner of the enterprise. In short, vendors have an opportunity to differentiate themselves by grasping the new realities of risk and designing relevant solutions.An Advisen briefing speculates that if there is a "stampede" by AIG policyholders spooked by the holding company's failure, it would likely precipitate a "sudden, short-term uptick in commercial insurance rates." In the absence of such a reaction, the briefing continues, "prevailing soft market conditions are unlikely to be affected."
Anthony O'Donnell has covered technology in the insurance industry since 2000, when he joined the editorial staff of Insurance & Technology. As an editor and reporter for I&T and the InformationWeek Financial Services of TechWeb he has written on all areas of information ... View Full Bio
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