25 March 2009

The Other White Meat

Non Sequitur, 25 Mar 2009

Contrast that with this self-aggrandizing whinge/protest from an AIG executive, which the NYT printed on its op-ed page. The real problem here is the underlying question, that Mr DeSantis never asks (and has probably never asked): What part of the "business of insurance" is it to be playing games with poorly understood derivative financial products? The "business of insurance" involves — at a deep economic level — the concept of risk-pooling. It's pretty damned obvious that AIG (among others) pooled risks it didn't understand... and then classified that pool as an "asset."

Yes, insurance companies need to invest the money that they get in premiums to help cover catastrophic losses in their risk pools; by the very nature of insurance, those catastrophic losses will happen, no matter how hard the insurance company tries to avoid paying the claims. However, putting a substantial portion of the assets that one is using as a reserve to pay those potential claims into yet another risk pool is just a bit disingenuous... and, frankly, stupid. Further, it's not just the credit-default swaps that are a problem for AIG; they're merely the claimants that can't be avoided any longer through overpriced insurance defense counsel. All of this is a problem before we get to "conflict of interest," which is something that AIG (and the rest of the insurance industry) clearly cannot spell without being beaten over the head with a few hundred lawsuits.

I can almost hear the "shareholder-primacy" crowd screeching in response that "an insurance company is just a business like any other, and it must be run to generate the maximum return to its shareholders." That's a nice argument, at least in theory; but it runs into two problems. First, one must define "maximum return" in a sensible manner; it does not necessarily mean "maximum return this quarter through accounting trickery without regard to long-term viability, asset growth, or indeed anything else." Second, though, an insurer is not "just a business like any other": It is a heavily regulated quasioligopoly in the ultimate business of being a pool, not a producer or facilitator. The insurance industry is one of the best possible examples of what Professor Bainbridge advocates as a "director-primacy" business, with the additional caveat that the directors have to understand the nature of their business.

I'll go with the "primitive aboriginals" on this one. Their argument is much more cogent... and at least it doesn't try to justify itself with dollar signs dancing on angels' heads.