The AIG Reserve "Surprise"

Recently, AIG reported posted a $5.6 billion charge to strengthen reserves in their Property/Casualty book of claims (WC, D&O, Medical Malpractice, Commercial Auto, etc.). This led to the weakest quarterly results since the financial crisis in 2008 when the Federal Government elected to rescue AIG from certain bankruptcy by providing them with a $185 billion taxpayer bailout.

After placing aside, the $5.6 billion for reserve strengthening, AIG reported a $3 billion quarterly loss. This is equivalent to about $3 per share loss. 

What was more disturbing to the financial markets (and most likely the Claim Execs at AIG) was that the organization took a $3.6 billion charge to strengthen reserves in the year earlier quarter. At the time, it was widely believed that this substantial reserve boost would ameliorate any reserve inadequacy issues and obviate the need for such a charge in the future. Surprise, surprise.

Predictably, the market responded to the news by pummeling AIG’s stock share price, which deteriorated by 9% (to $60.65). 

The core of the issue is inadequate reserves not only on a book level, that devolves to an individual claim level problem. AIG CEO Peter Hancock advised Wall Street that deteriorating trends in frequency and severity on the commercial auto book, higher costs of medical mal actions and resolutions, and other main P/C lines were the cause of the claim reserve problems. To provide an aegis of protection in the 4^th quarter of 2016, AIG elected to buy additional reinsurance from a Berkshire-Hathaway unit, costing approximately $10 billion.   

A root cause analysis of the issue AIG points to problems involving basic claim investigations, and the ability of the Claims Department to translate factual developments into accurate financial consequences on a per claim basis. If claim level reserves are accurate, the need for billions of dollars in charges for corporate reserve strengthening becomes moot.

Traditionally, insurance carriers deal with an under-reserved book of business through the IBNR (Incurred but Not Reported) reserve augmentation process. From an industry standpoint, and as a term of art, IBNR signified the claims that have already occurred but which had not yet been reported to the company. During the last four decades or so, IBNR simply became any overall reserve boosting exercise an insurance company performed at year end to shore up what they believed to be inadequate claim reserves (i.e. not reflective of probable ultimate cost of each claim).

The problem always gestates at the individual claim level. If the inchoate trend is not aggressively identified and ameliorated, there will be pejorative financial consequences at some point.

AIG is no neophyte when it comes to P/C claim adjusting and management. Yet they were gob smacked with a significant charge dedicated to reserve strengthening. What leads to such deleterious financial surprises?

The answers are rather pedestrian. Investigations that are superficial, tardy, and incomplete. Lack of current medical status in bodily injury claims. Adjusters that are overwhelmed with volume and under-trained as to the significance of insufficient reserve development. Supervisors with too many cases on their diary to make a positive difference. Use of the telephone as the primary investigation tool. A failure to control litigation and costs pertaining thereto.  Inability to determine the optimal time to pursue cost-effective resolutions.

To be sure, AIG is not the only insurance carrier with this issue, but their recent $5.6 billion charge to augment reserves, on top of the $3.6 billion in 2016, makes it obvious there is a systemic problem at a very base level in AIG’s claims handling efficiency (or lack thereof).

Once a trend of this magnitude manifests itself, there is no facile fix. The problem did not happen overnight, and an authentic repair is a multi-year affair at best. It cannot be attempted unless senior management is dedicated to true amelioration which costs not only time, but substantial money (hiring more adjusters and supervisors, training them properly, and having an active and effective QA audit process is not inexpensive to corporate overhead, at a time when AIG is attempting to reduce its expense load). However, to let the problem fester, or attempt to address it with a superficial plan, is a recipe for disaster. 

When the mechanics of each claim line is considered, it seems improbable that case reserves can be so inadequate. For example, WC involves fixed indemnity rates, and medical costs that are only to treat the compensable injury. Commercial Auto has policy limits, and once liability is established, it should not be exceedingly difficult to determine resolution costs.  Medical Malpractice claims also have policy limits, and it is normally evident (assuming the investigation is timely and adequate) whether a claim should be settled or proceed to trial, and the costs associated with the plan of disposition. Despite these observations, the problems are real and have quantifiable financial consequences (in this most recent instance for AIG, $5.6 billion).

Regrettably, there is no short cut to remedying a problem of this nature. Unfortunately, the roadside is littered with half-hearted efforts by bankrupt and acquired insurance companies that did not learn the need for quickly and decisively identifying the fundamental problems and applying the requisite money, time and manpower to ameliorate the rot.

I’m sure Hank Greenberg is sitting in his office at CV Starr and wryly smiling.     

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About the Author:

John D'Alusio has over 30 years experience in P/C insurance with executive management positions in administration, field operations, and claim technical areas. Mr. D'Alusio has had many articles published in industry periodicals, and is also a contributing author to the LexisNexis published, “Complete Guide to Medicare Secondary Payer Compliance.”  He writes a monthly column for Risk & Insurance Magazine and is a quarterly columnist for AMComp Magazine.

His Risk & Insurance column is located at:

http://www.riskandinsurance.com/workerscomp.jsp 

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