Risk managers dig deeper to uncover insurer flaws; Seek to hedge risks through diversification

ROBERTO CENICEROS

A year after the near-failure of American International Group Inc., risk managers say they have adjusted their insurance programs and increased their scrutiny of insurers’ financial position.

In fact, they are looking beyond the insurer to scrutinize its parent company.

Many say AIG’s fall was a wake-up call, forcing them to diversify their insurance programs by moving some coverage to other insurers. They also moved portions of their programs so they could sleep better at night knowing their insurer would be around.

Fred O. Pachón, vp of risk management for Santa Barbara, Calif.-based Select Staffing Inc., transferred his employment practices liability coverage from AIG to Zurich Financial Services Group, he said.

“I did not want to risk it,” Mr. Pachón said. “In the employment/staffing world, we are a prime target for discrimination and sexual harassment claims, etc. So we must be sure that the carrier will be there if and when the day comes. Diversification was the second consideration in this case.”

Yet diversification emerged as a top lesson, several risk managers said.

“I think the take-away from the whole AIG situation is the reinforcement of diversity within a risk manager’s insurance portfolio,” said Lance J. Ewing, vp of risk management for Harrah’s Entertainment Inc., in Memphis, Tenn.

Even risk managers who were not AIG customers said they now look much closer at their insurers and react faster to changes in their financial position.

“If there’s an insurance company that’s having a dramatic stock price decline, that can raise flags,” said David Adler, director-risk management for Portman Holdings L.L.C. in Atlanta. Portman did not buy coverage from any AIG units for its insurance program.

“The example I would raise is XL,” Mr. Adler said.

Not long after AIG’s troubles became known last year, “XL lost a considerable amount of its stock price,” Mr. Adler said. “In that situation, we immediately went through our portfolio of coverage and confirmed that we did have an environmental liability policy with XL. We alerted management and went into more frequent monitoring of XL. Since it was a three-year policy, we also negotiated with XL that should its rating drop, that we would be entitled to a pro rata refund in the event that we chose to replace the coverage.”

Insurers also have changed their behavior, said Steve Wilder, vp-risk management at Walt Disney Co. in Burbank, Calif. They have reacted to his department’s increased scrutiny of their financial position with a new eagerness to share information.

“Interestingly, some insurers have now been very proactive in sharing their financial information,” Mr. Wilder said. “What happened to AIG is not a good thing for anyone, but the result and how we are doing business now makes more sense.”

Disney re-evaluated its comfort level with the aggregate amount of coverage placed with any one insurer and that led to some coverage shifts, although Mr. Wilder declined to provide details.

More than before, though, delving deeper into insurers’ financial strength has led to closer relations with them, he said.

AIG’s problems were “a wake-up call for us to be conscious of the counterparty risk that we have with all the insurance companies we work with,” Mr. Wilder said. “In many cases, we have actually talked to their CFO or treasurer, someone who can help us better understand where they are.”

Disney’s scrutiny now includes scheduled reviews of an insurer’s stock price, credit default swap activity, and information available from Moody’s Investors Service and Standard & Poor’s Corp., Mr. Wilder said.

Claims payment, including the length of time before all losses are paid, also is getting greater scrutiny for signs that something might be amiss, said a risk manager for a Fortune 500 company who asked not to be identified.

Although policy diversification is much more important now, he still must weigh increased costs and rival insurers’ global capabilities against the benefits of diversifying the company’s coverage, the risk manager said.

Other considerations in maintaining coverage with AIG, which now has its insurance brands under the Chartis banner, also are at play.

“One of the reasons we stay with Chartis is because of the relationships and amount of information that they provided to us in the risk management community after they dropped the ball on how to handle crisis management,” Mr. Ewing said. “When their company first imploded a year ago, they didn’t handle the public relations crisis as well as I thought they should have. But they got a second swing at the ball and did exceptionally well in keeping us informed as to how they were righting the ship in these turbulent waters,” he said

“We as a company have made no major changes in the amount of business of we do or not do with Chartis, and they continue to pay claims, which is what we buy the insurance for in the first place,” Mr. Ewing said.



Humana Inc. also maintained its AIG insurance, said Carolyn Snow, director, insurance risk management, for the Louisville, Ky.-based health insurer.

“We work with them primarily in the executive risk area and, prior to our last renewals, we had a meeting between the senior management of both companies,” Ms. Snow said. “We felt that the core group was still financially stable and we still had confidence in their management. We did some shifting in the upper levels, but kept them on the program.”

Monitoring insurers’ financial strength has always been important, so few real changes in due diligence have occurred, Ms. Snow said. “But we try to stay continually aware of company changes and probably pay more attention to little things than we might have in the past.”

Other risk managers said AIG’s problems reinforced the need for their profession’s established practices.

Enterprise risk management became increasingly important, said Jane A. Keegan, enterprise risk manager for the Port of Oakland in California.

Not only is AIG involved in her insurance program, the company and its units have been major purchasers of the Port of Oakland’s tax-free municipal bonds and provided a commercial short-term investment program. In addition, an AIG unit won a bid to develop a port terminal project.

While an array of AIG units have been involved in numerous business undertakings, before the conglomerate’s weaknesses became apparent, risk managers evaluated only the strength of AIG insurance units rather than scrutinize the entire company business operations, said Scott B. Clark, risk manager for Miami-Dade County Public Schools.

Certain rating agencies on which the insurance industry relies still review only the strength of individual insurance units without evaluating a parent company’s entire operations, Mr. Clark said.

“The risk management community really has to start looking...at what is behind the insurance companies...so we can evaluate just what kind of risk we are getting into above and beyond the insurance contract,” Mr. Clark said.

Senior Editor Mark A. Hofmann contributed to this report.

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