Insurance is complex by nature.? Anytime one brings in a third party to be a protector/guarantor against adverse events, it creates some weird dynamics.? Now, a few of the states, including the best of them, New York, have been regulating insurance for a long time.? But the Feds have not dealt with insurance in any significant way, because that role has been ceded to the states.
With the failure of AIG, and it getting acquired by the Feds, the questions of regulation have taken on new significance.? I have written before about the Federalization of insurance regulaton, indicating some indifference about who regulates it, but pointing out the difficulties — what an effective insurance regulator needs to learn.
The following is personal to me in four ways:
- I used to work for AIG (’89-’92)
- My main local paper is the Baltimore Sun (though I don’t subscribe, because of lack of value)
- Elijah Cummings is my Congressman, at least since the last gerrymander. (Hey, give him credit, he voted against the bailout.)
- I have interacted with many insurance regulators of varying abilities over the last 20+ years.
Elijah Cummings and some other congressmen have gotten offended over seemingly extravagant expenses over conferences, particularly for agents/representatives of the company.? Now, as a young actuary, I would sometimes say, “Why do the agents get to go to all of the fun conferences?”? Not true — only the top agents went to those conferences, and it was a reward that would stimulate extra performance (and the real reward was bragging rights — the companies often made money off of conference-type rewards).? Actuaries are nice, and all that, but the ability to sell product, particularly in life insurance and annuities, is rare.
When the government gets involved in industry, the incentives become messy:
A1) We need to do a lot of mortgage workouts for the good of mortgage payors and those in residential real estate.
A2) We need to minimize the cost of the mortgage bailout to the taxpayer.? Or, we can’t borrow that much.
B1) We must reduce tobacco smoking in our state; it is harming our dumbest citizens.
B2) But we issued tobacco bonds against the recent settlement with the tobacco companies.? We can’t afford to lose revenue.
C1) We’ve got to crack down on shady life insurance sales practices.? Too many people are getting cheated.
C2) That insurance company employs a lot of people in our state, and they are located in the district of the head of the commerce committee.
D1) Gambling has introduced new forms of addiction to our state, and perhaps organized crime as well.
D2) We can’t afford to give up the tax proceeds from gambling — the schools depend on it.
Have I made it clear?? Politicians want political results, and they want tax revenues, which are often opposed to each other.? They aren’t typically businessmen, so they don’t understand the tradeoff.? Rather, they swing from one to the other, as political convenience dictates.
And so in this situation, I would say that the amounts in question are rather nominal.? Why fuss over the conferences?? Rewarding top performers is important, and if you don’t do that, you will lose business, and the government will lose on its “investment” (what a word 😉 ) in AIG.? Most companies have conferences like AIG, and I can tell you, they wil think twice about coming under the government’s umbrella for that reason, as well as many other reasons that have political significance, but harm corporate performance.
State legislatures took time to build up expertise in insurance regulation.? Some more so like New York (we should move the NY regulators to DC if we federalize), and some less so.? Congress doesn’t have the vaguest idea on what to do with insurance and AIG.? The ignorant statements of Rep. Cummings are a great example.? Ed Liddy has only been on the job for less than two months.? Why call for his head?? Insurance companies are complex organizations where most significant things are planned a year in advance or so.
Now, so I like the AIG bailout?? No, perhaps we should have let the holding company fail, and the underlying insurance subsidiaries would have been fine.? Some CDO holders would have been hurt, but what are you doing dabbling in CDOs, anyway?? And why didn’t you question why so much of your CDO exposure was AIG guaranteed?? When only one company guarantees much of the business, that is a bad sign (underpricing).
But seeing the ruckus here, this is why it is bad for the government to own an insurance company.? All of the incentives are confused, which will lead to a greater failure, and more expense to the taxpayers.
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UPDATE 1PM 11/13/08? Adam corrects me below.? Cummings voted against the initial bailout bill, and for the final bailout bill.? Thanks for the correction, Adam.
Agree completely to the contradictions cited by you.
But why make a fuss over extra incentives in form of fancy conferences, cruises etc? Sure the politicians are playing to the galleries when they point fingers that way….YET: the salesforce gets richly rewarded on insurance products in form of high commissions.
Incentives over and above pay received have a corrupting influence. There is clear and present danger that products recommended to clients will be the ones offered by issuers with the most attractive “bonus”. I’ve seen too much of that in the advisor community and the client is the loser for it.
Maybe incentives work in non-financial industries.
I am totally convinced they corrupt and distort allegiances in insurance, investment advisory, investment banking. It is the one and only area that politicians playing to the gallery get my support.
Federalizing insurance regulation is a bad idea for a number of reasons. (1) it would add yet another a potentially gigantic unfunded obligation to the federal deficit; (2) it would raise systemic risk by narrowing the diversity of regulation — — recall that when AIG collapsed, there was considerable comfort in knowing that the traditional insurance subsidiaries — — as opposed to the parent company regulated by OTS — — were well-funded and safe because they were separately regulated by the states. This may have prevented a panicky run by policyholders to protect their cache values and annuities; (3) it would require repeal of the McCarran Ferguson Act, which provides a limited antitrust exemption to insurance companies to the “extent … regulated by state law.” The industry has developed many complex structures and interrelationships under McCarran Ferguson, and repeal at this point would throw the industry into total chaos. For example, it’s not clear how health insurers’s preferred provider arrangements with hospitals and doctors, which have played a crucial role in keeping medical costs down, would be treated if health insurers were subject to the antitrust laws. I’m sure there would be certain advantages flowing from the uniformity provided by having a single federal regulator, but on balance the advantages would be outweighed by these other factors.
Elijah Cummings did NOT vote against the bailout! He voted against the initial bailout, but supported the second one that passed. I confronted him in person and asked him why he voted for it because it gives Paulson dictator-like powers and he told me that he “hated” the bill. Why vote for it then?
Cummings wants to have it both ways. He voted FOR the bailout and now he acts all indignant about how the money is being spent. As a member of the House Oversight Committee, you would think he’d want to retain some oversight as to how the money was spent, but no, he ceded all that authority directly to the Sec’y of the Treasury.
Adam, you are right, and I was wrong. I thought I had checked his second vote, and I didn’t. Thanks for correcting me. I voted for Hargadon — tough sledding for any Republican in the Maryland gerrymander.
Why do you think sales people are “producers”, but actuaries are not? Why do the exceptional sales people get to go to a fancy vacation/conference — but the best performing actuaries are simply told “Well, you are just doing your job”?
The U.S. over-valuing of sales people, and complete neglect of all other positions, is a big contributing cause of the current crisis. If Wall Street had placed equal importance on risk management as it did on sales, would they have caused the damage they did?
The Shallowest Generation (to quote another article on Seeking Alpha) has over-estimated the value of sales, and completely neglected everything else. Its not that sales are unimportant — but they are only PART of the picture.
Wall Street failed because they thought sales were important, but risk management was not. GM (and Ford and Chrysler) are failing in spite of having a great dealership / sales network — their products stink because the engineers were told they were unimportant.
Simple common sense here folks: sales people need something to sell. Period. No buts. The Shallowest Generation has completely neglected everything other than sales — we are a nation of spin and promos, with no product substance underneath.
AIG should be canceling their sales vacations– they should be giving fancy trips to risk modelers who can help get the company out of the mess the sales force created yester-year.
The best engineers / risk managers / product development staff in general need to be told, and SHOWN, that they are as important to a company as sales — because they are. AIG and GM are textbook cases of what happens when sales are emphasized at the neglect of everything else.
David – I actually loved this post as there is an inherent difficulty in having government bail out insurance since the incentives are misaligned. This is a general problem in “socialist” governments and one of the reasons why they are not as efficient as more capitalist societies. I commented on this a bit on my blog at http://www.crackinsurance.com/2008/11/13/buy-insurance-with-government-backing-aig/
Please take a look. Thanks!