Accounting problems at AIG, threats of criminal prosecution from New York A.G. Eliot Spitzer, and the removal of one of the more powerful CEO/Chairmen in the financial services industry. Exciting stuff on which Wharton has some thoughts in a recent article available online.
"The heart of the problem: No one can be sure how big the scandal will grow, because it involves business relationships, insurance products and accounting practices so arcane that few people understand them -- including a controversial product known as 'finite insurance.' This is an obscure product that seems to have been used in ways other than what it was intended for," said Stephen H. Shore, professor of insurance and risk management at Wharton.
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The article notes the routine nature of reinsurance between insurers, and the loan-like effects of finite reinsurance. But accounting for finite reinsurance is a gray area.
From the article: "The issue in this deal, as in many finite insurance contracts, is whether AIG was providing insurance coverage or receiving a loan. To be insurance, AIG would have to assume a risk of loss. An industry rule of thumb known as '10/10' says the insurer should face, at a minimum, a 10% chance of losing 10% of the policy amount for the contract to be considered insurance."
"In the absence of that degree of risk, the premiums transferred from General Re to AIG, and repayable later, would be a loan. AIG would then not be able to count the $500 million in premiums as additional reserves, as it had."
The article reports that on March 30, AIG's directors concluded that the GenRe transaction was not properly classified as insurance. As a result of the reclassification as a loan, AIG said it would reduce its reserves by $250 million and increase liabilities by $245 million.
The article notes the use of Bermuda and Barbados reinsurers that were held forth as independent reinsurers when in fact they had sufficient connections to AIG that its account records should have been consolidated with AIG's.
Wharton compared the offshore transactions to those found in the Enron investigation, but on a smaller scale. Time will tell if those uncovered so far are the bulk or the tip of the iceberg.
Accounting for the Abuses at AIG - Knowledge@Wharton
Posted by dougsimpson at April 7, 2005 05:03 PM