The Truth About AIG and Pennsylvania’s P/C Markets

As problems began unfolding at American International Group last month, Pennsylvania Insurance Commissioner Joel Ario was tapped to be the vice chairman of a special task force of the National Association of Insurance Commissioners to oversee possible sales of the company’s 71 insurance subsidiaries. Ario is a long-time regulator, having formerly served as chief insurance regulator in Oregon, before being appointed Pennsylvania’s commissioner in June 2007. In this interview with Insurance Journal Associate Editor Ken St. Onge, Ario talks about the outlook for AIG, the debate over federal regulation and the condition of Pennsylvania’s insurance market.

You are going to be sitting on the task force looking into AIG-related issues. What are you looking out for?
Ario: It has consumed my last week, as it has of a number of regulators both at the state and federal level. The Federal Reserve agreed to loan AIG $85 billion. What that has to do with are problems that AIG had in the credit default swap market. Basically, the mortgage-backed securities that are causing so much trouble in our financial markets had nothing to do with insurance. The insurance companies within AIG are very strong, and their balance sheets are the same today as were a week ago, as they were a month ago.

So this all about a different part of AIG, but obviously it sweeps in the insurance business, and so we’ve been very involved. It’s really a testament to the strength of state regulation that the insurance companies are as strong as they are. They are part of the assets, and I think the federal government looked at when they loaned the $85 billion and said, ‘We are willing to loan money to deal with your credit problem here… because we have confidence that, if need be, you can sell many of those insurance assets and pay back the loans.’

Our interest is to make sure that whatever happens, the insurance companies that are strong today stay very strong whether they are sold and there is a new insurance company that takes the policy, or whether they are part of a new more streamlined AIG. In either case, the policyholders will be protected and we are going to insure that they are protected.

How does the loan from the federal government to AIG affect the debate over federal versus state regulation of insurance?
Ario: Well it’s interesting because there have been some broad sweeping statements saying, “AIG is a company that is in trouble, therefore, insurance regulation needs to be federal.” Nothing could be further from the truth. In fact, the parts of AIG that are in trouble here are the parts that were federally regulated, the holding companies regulated by the Office of Thrift Supervision — a federal entity — and not very well regulated, I might add. The insurance assets are the strong part of the company, they are what is going to be used to shore up the company and get them through this transaction. They were very well regulated at the state level.

So actually, the true story here is that the insurance regulatory system came through. It has very good protections for the company. We’ve acted in a coordinated way to deal with the situation. And so, this is a real victory for insurance regulation for anybody that takes more than five seconds to look at the details. But of course, some of our opponents want to sweep with a broad brush and say, “If there’s any problem in a big huge financial conglomerate, anywhere, it must mean that the insurance companies ought to be federally regulated.” It should be the exact opposite.

What property/casualty insurance challenges do you see in Pennsylvania?
Ario: The property casualty market in Pennsylvania is strong. We have a lot of companies writing both auto and homeowners policies, good competition in those marketplaces and good pricing for the consumer. Most of the issues that I deal with in those markets are at the margins: whether certain ratings variables should be used, or whether credit scoring is fair to consumers.

The challenges in the property and casualty markets are relatively minor, compared to the health markets where you have a real crisis of affordability of coverage.

Now, the one thing that would change that is if a big storm blew up the Chesapeake Bay or some other kind of natural catastrophe hit in Pennsylvania, then you’d have massive losses in the property and casualty markets like you’ve had in the case of Hurricane Katrina, and now Hurricane Ike, and other hurricanes. Those kinds of situations put property and casualty markets front and center on a commissioner’s radar screen. Absent that, I think I’m pretty comfortable with where the property and casualty markets are, and I can attend to more of the financial crisis with AIG and the health crisis in Pennsylvania.

Where do you stand on a national catastrophe plan? We’ve heard a number of plans proposed by some of the bigger property and casualty insurers; what’s your take?
Ario: Well I think there’s an argument to be made for this, and I think the argument goes like this: if we don’t have broad insurances coverages in the marketplace before a catastrophe… we end up with the federal government bailing people out after the fact.

It does make sense to insure as much of the loss in a storm as possible. Thank God, on 9/11 there were private insurers to come in pay for those losses and handle that. If the federal government had to set up a claims processing office for that catastrophe, it would have been much less efficiently handled. So, I do think there’s an argument for having a good insurance mechanism there.

That does get you into questions about spreading risks, and maybe state by state it’s not quite the right way to spread the risk. Having said that, what I say to people in Pennsylvania is the Pennsylvania population will be ardently opposed to a National Catastrophe Program, up and until the day there’s a big catastrophe, and then we’ll all be for it.

That’s just the way it works politically; there is not a big call for that kind of program in Pennsylvania. We want you to be careful, and again I think there are some arguments that can be made.

Certainly we were in favor of the Terrorism Insurance Bills after 9/11 after we saw what kind of potential there was for a major terrorist attack. Thank God we haven’t had one, but what potential there was for that; I think we needed terrorism insurance. Similar arguments can be made for some kind of catastrophe programs, but we ought to approach each of these issues with a skepticism about turning to Washington to regulate in these areas. I know I’m speaking on a day when Secretary Paulson’s going to become Czar Paulson, but I think we ought to be careful about those kinds of things.

Let’s switch gears a little bit. How’s the workers’ comp market in Pennsylvania?
Ario: Very good. We just had a 10 percent rate cut in our pure premium this year. We have a healthy, competitive market. Maybe the one market, if you’re looking for where there’s some news to be made on the Pennsylvania markets would be medical malpractice.?

We still have our Mcare Program, in which the doctors are responsible for the first $500,000 in coverage in the private market, and then the state covers the second layer. We have done very well with the medical malpractice market in the last five years in Pennsylvania.

But property and casualty markets are unpredictable. I can’t predict to you exactly when the current soft market is going to end in medical malpractice or in property and casualty. The one thing I will predict is that it will end. There will be another uptick at some point. We’re not on a downward glide for the next 50 years. We’re in a point now in the marketplace where, because of the reforms made in Pennsylvania and because of the broader trends, we’re able to potentially put the medical malpractice marketplace back into the private sector. That is, if we can get that done in this legislature. And the Governor would like to get that done

Is that the most important issue right now, getting at the medical malpractice situation?
Ario: Yes, right now today to return the medical malpractice market to the private sector in a way that also uses some of the money that has built up in our accounts that have to handle the marketplace when the government is so entangled in that market. We want to use some of that money to privatize the market, and some of the money to expand access to health insurance – that’s the governor’s proposal, and I strongly support that proposal. It’s one of the things that brought me to the state of Pennsylvania. If we can get that done, that would be the single best accomplishment I could have in the property and casualty markets right now.