BOW WAVE 461

Bow Wave Issue 361--AIG Edition

news and views on trade, insurance and risk

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Wavy Line	sam@wavyline.com
(c)2008 WavyLine.com	Issue No 461 22 Sep 08
Published free of charge to Readers
Editor: Sam Ignarski
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In this issue:

1. Welcome
2. Reflections on the fate of AIG
3. AIG--the Reasons Why
4. AIG on the Block?
5. Hurricane Ike
6. And Finally...

1. Welcome

Poem of the Week

The Flower Boat

The Fisherman's swapping a yarn for a yarn
Under the hand of the village barber,
And here in the angle of house and barn
His deep-sea dory has found a harbor.

At anchor she rides the sunny sod
As full to the gunnel with flowers a-growing
As ever she turned her home with cod
From George’s Bank when winds were blowing.

And I know from that Elysian freight
She will brave but once more the Atlantic weather, When dory and fisherman sail by fate
To seek for the Happy Isles together.

Robert Frost From The Youth’s Companion (1909)

(Many thanks to John Dolan for sending this one in-ed)

New Readers this week include:-

Transport insurance broker Frank Heinrich-Jones
YC Wong of Helen Insurance Brokers in HK
James Norwood of BMT Sea Tech
Jacqueline.Veneman of the Port of Amsterdam
Anne Kulesa of Thomas, Thomas & Hafer in Bethlehem, PA

News of Readers

Simon and Richard Chan of Sun Mobility Brokers in Hong Kong are holding Seminar in conjunction with the with the Hong Kong Shippers' Council on the
Maritime Code of the PRC on 28OCT08.

Contact them for further details at:-

gm@sun-mobility.com

Readers Write

From Adam Greaves in Dubai:-

Dear Sam,

I read with interest the posting in the Maritime Advocate Archive referenced in Bow Wave Issue 460.

I worked as a P&I correspondent in Spain from the year 1990 through to 2000. I also provided claims services to a major liability insurer for the through transport industry, that may be well known to you.

The ship agent had always been liable for cargo damage on board the vessel, as a result of the way the ship agent was described in the Spanish Commercial Code of 1885.

This made life easier for freight forwarders and their insurers when it came to recourse action against the vessel, as they could sue the ship agent.

In 1997 a law was passed making amendments to the 1992 Law of Ports and Merchant Marine. One of these amendments specifically stated that the ship agent would not have to assume the ship owner's cargo liabilities.

I remember discussing this with Manuel Vicens Matas, the legal advisor to the Federation of Spanish Freight Forwarders Associations. I asked him if he thought this would make life more difficult for the forwarder.

He replied that the 1997 law was flawed, since an article of the Commercial Code could not be repealed by a subsequent law of a lower order. The Commercial Code itself would have to be changed. He felt that it was only a matter of time before the courts declared the Commercial Code to be valid despite any subsequent laws.

It has taken 11 years, but it seems that Mr Vicens Matas has been proved right.

The ship agent is now right back where he was 11 years ago.

Contact Adam at:-

correspondents@galadarilaw.com

From Peter Rogers at ITMU

Re Bow Wave Issue 460, interesting as always, but you got it slightly wrong on ITMU. We have never written US Ports and Terminals since our start up in 2002. The scars of some earlier ventures into that area have never quite healed over.

(We stand corrected--ed)

Note from the Editor

This week's edition is largely devoted to the fall of AIG, once the largest insurance company in the world, now a ward of the US Federal Government.

The company was so large, its marine insurance activities barely registered as a Specialty Business. All the same the AIG was always a force to be reckoned with whenever it abated its internecine control struggles and concentrated on business.

Enjoy!

2. Reflections on the fate of AIG

The AIG has been a settled part of the insurance scene for as long as I have been watching it. It was huge, centralised and driven by a singular and dominant personality. It nearly always evoked fear in the minds of competitors. If you were a specialist in a niche business, the AIG in theory could crush all your efforts and skills simply by rousing itself and taking an interest in what you were doing at the time.

I can remember many years ago losing a leading Malaysian terminal to the AIG. We braced ourselves for some sort of tempest but none came. Why not? Possibly because of the convoluted need for the approval of an underwriter in New York, possibly because of the tendency of the company's various parts and various people to wage war on each other, possibly because the big man or one of his trustees showed no enthusiasm for the category. Or the underwriting policies and controls on cash and people were so mind-numbing they discouraged too much limb-climbing in operating companies.

How did this giant go from dominance to federal basket case in no more than a few years? There seem to have been the following way markers.

In the beginning the growth of the company was based on a vision for Asia, a huge doestic market, a driven personality running a culture of fear in the middle of a global web of local offices.

In the end the company was based on the iron will of a very old man, it had no succession plans, it burnt some of its goodwill and hold on the imagination by engaging in corrupt practices in the US market, it engaged in a fatal embrace with the insurance of financial services bonds and securitised debts and it leveraged all its capital 11 times over in the unwise but alluring world of financial engineering. It is almost as if the ordinary world and challenges of orthodox insurance was insufficient to satisfy a voracious appetite for profits and growth.

For some years I watched the AIG and its activities fairly closely. In its prime I soon noticed that although the company inspired respect,fear and even awe, it had no hold on anyone's affection. I have yet to meet a former employee who enjoyed working for the company. Maybe I will hear from one as a result of this short item in Bow Wave.

But so far as I can tell a hard,cold organisation built up through the post war years by doing many things right in the modern insurance industry is going to the federal knacker's yard, to be broken up and sold off, raising barely a thought of pity or regret in the eyes of beholders. Insurance is a people business. If you skimp on the humanity and instead concentrate on the numbers and money you may end up like Hank Greenberg being haunted by the 21st century's version of Marley's ghost.

Sam@WavyLine.com

3. AIG--the Reasons Why

The Motley Fool has a characteristic piece by Andrew Sullivan which seeks to give a short description of what went wrong. Here is an extract:-

...Insurance is terribly simple, as long as you follow the Three Rules:

1. Price your risk correctly.
2. Invest conservatively so you can pay out claims when they come due.
3. Don't do anything else....

...But AIG self-destructed not because it screwed up in its insurance business. It didn't fall into the trap of mispricing risk, as so many other insurers over the years have done. It also invested premiums fairly conservatively. So it followed Rules 1 and 2.

Where it slipped up was in Rule 3. See, the folks at AIG thought they were so smart at insurance that they could start other capital-markets businesses ... including proprietary asset management in things such as commodities, currencies, energy, interest rates, and the selling of default swaps on collateralized debt obligations (CDOs).

This strategy worked beautifully -- for a while. AIG created a separate business segment called Financial Services to trade in the aforementioned assets. This business had $204 billion in assets at year-end 2007, up from $60 billion in 1998.

Operating income surged from $900 million in 1998 to $4.4 billion in 2005. Some of the moves it made were brilliant, such as the purchase of ILFC, an aircraft-leasing business. But the other trading businesses were the Medusa that turned the whole company to stone.

Let me make one thing clear: Proprietary trading isn't bad, in and of itself. Warren Buffett engages in it. But just like atomic weapons in the wrong hands, proprietary trading can do a lot of damage. The problem is when you start to get aggressive and don't heed proper risk -- when you start to speculate instead of invest.

And there's one other critical ingredient for disaster.

The "L" word

As in "leverage," the sharp knife in corporate seppuku dramas. Leverage is, by my estimation, the No. 1 reason why companies fail.

And compared with its peers, AIG had one of the sharpest knives around. Here's how its leverage (assets to equity) stacked up against other insurance operations as of December 2007:

* AIG: 11 to 1.
* Markel (NYSE: MKL): 4 to 1.
* Berkshire Hathaway (NYSE: BRK-B): 2 to 1.
* Montpelier Re (NYSE: MRH): 2 to 1.
* Travelers (NYSE: TRV): 4 to 1.
* White Mountains Insurance (NYSE: WTM): 4 to 1. * Chubb (NYSE: CB): 4 to 1.

I would love it if someone gave me a rational, believable explanation of why leveraging your equity 11-to-1 is a good thing for an insurer. The sole job of an insurance CEO is to ensure that his or her company stays in business; the CEO's job has nothing -- absolutely nothing -- to do with growing profits every year in a steady, smooth line...

Read the whole piece at:-

http://www.fool.com/investing/general/2008/09/17/aigs-failure-is-so-much-bigger-than-enron.aspx

4. AIG on the Block?

Our friends over at the Global Broker and Underwriter have this to say in their weekly e-zine called A Week in the Market:-

AIG rescue will prompt asset sale

Troubled AIG’s deal with the US government has secured its short term future but it looks unlikely to halt the sale of assets as the group looks to restructure operations for the long term.

AIG’s woes have been well documented over the past year but after the bullish statements from new CEO Bob Willumstad, the position reached a point where the Federal Reserve had to step in to underwrite an $85 billion loan to deliver the liquidity the group needed to meet the growing crisis it faced.

Former CEO and now chairman and CEO of C V Starr, Maurice ‘Hank’ Greenberg had made efforts to pitch in and help to steer the AIG ship off the financial rocks in the weeks preceding the call for federal assistance. However in a letter written by Mr Greenburg to Mr Willumstad on September 16 it became clear that the approach seemed to have been ignored and, as one of the largest shareholders in the firm prior to the US government seizing a 79.9% stake, in his letter Mr Greenburg made his frustrations quite clear. He was told Mr Willumstad was concerned that any involvement by Mr Greenberg would see the CEO "overshadowed". The letter stated "I respectfully suggest to you and to the board that the continuing refusal to work together to save this great company is far more important than any concern over personal positions or perceptions."

Mr Greenberg expressed his dismay at the company’s fall from grace over the past 12 months. "In a little over a year I, and other shareholders, have watched the company that I helped to build over 35 years into the largest and most successful insurance company in history and one of the strongest and most profitable financial companies in the world lose over 90% of its value," he wrote. "Despite repeated assurances from management and the company that everything was under control, it is now clear nothing was under control."

He concluded the letter by stating: "I do not know whether or not it’s too late to save AIG. However, we owe it to AIG’s shareholders, creditors and our country to try. I remain ready to offer any assistance that I can and to meet with you and the board at any time. I ask nothing from the board except the opportunity to help.

"Since you became chairman of AIG you and the board have presided over the virtual destruction of shareholder value built up over 35 years. It is not my intention to point fingers or to be critical. My only point is that under the circumstances I am truly bewildered at the unwillingness of you and the board to accept my help."

If Mr Greenberg was dismayed at the collapse of the company, rating agencies have said that while the deal will secure the short term future there is little doubt that the firm will have to start the fire sale to recoup the capital it needs to meet the demands from creditors.

Fitch put the firm on an evolving credit watch saying the move had come about after the intervention of the US Federal Reserve, warning the situation has the ability to go either way as the company sought a way to restructure. The rating agency said: For AIG as a whole, Fitch views this transaction as a favorable development that alleviates near-term liquidity concerns and provides a source of funding for potential future collateral requirements that are primarily derived from AIG's AIG Financial Products Corp subsidiary. Additionally, Fitch believes that the agreement with the Federal Reserve provides a platform of stability for AIG's primary operating subsidiaries and significantly curtails substantive pressure on AIG to sell assets quickly to fund potential cash calls.

"These positives are tempered by the transaction's effective subordination of essentially all of AIG's senior debt and hybrid instruments," it added. "Loans under the facility are collateralized by all of AIG's assets and of its primary non-regulated subsidiaries and include the stock of substantially all of the regulated subsidiaries. Due to the comparative high cost, AIG has incentive to use the facility sparingly, though Fitch acknowledges that AIG will need to actively draw down on this facility over the intermediate term."

The rating firms said that in order to provide funds needed to service debt obligations, the for sale signs will have to go up and the expectation was that it would include some of the firm's key operations.

"Fitch believes that AIG will likely sell a significant number of its operating company subsidiaries, and that these sales may include subsidiaries that Fitch had previously viewed as core operations," said the statement.

"AIG needs to optimise operating company results under very difficult market conditions, in order to retain significant value in its subsidiaries that may be monetised in the future. Fitch believes any subsidiary would be considered for sale, and the ratings impact for any subsidiary that is ultimately sold would be greatly influenced by the credit quality of the buyer and terms of the sale."

Given the current share price and the need for liquidity market watchers believe that while areas such as its aviation business will be sacrificed if the money was right areas of its underwriting business could be hived off as part of the restructure.

http://www.globalbrokermagazine.com/weekly/subscribe.html

5. Hurricane Ike

The law firm of Cozens O'Connor has issued a good summary of the aftermath of this much anticipated storm in Texas.

http://www.cozen.com/cozendocs/outgoing/alerts/2008/inscov091508.pdf

6. And Finally...

Thanks to Paul Dixon for this one...

A college physics professor was explaining a particularly complicated concept to his class when a pre-med student interrupted him.

"Why do we have to learn this stuff for a medical degree?" the young man blurted out.

"To save lives," the professor replied before continuing the lecture.

In a few minutes, the student spoke up again. "So how does physics save lives?"

The professor stared at the student for a long time.

"Physics saves lives," he said, "because it keeps the idiots out of medical school."

P.S.

Another blue one from our South African correspondent R Mulcahy:-

A guy goes to the supermarket and notices an attractive woman waving at him. She says hello. He's rather taken aback because he can't place where he knows her from.

So he says, 'Do you know me?' To which she replies, 'I think you're the father of one of my kids.' Now his mind travels back to the only time he has ever been unfaithful to his wife and says, 'Are you the stripper from the bachelor party that I made love to on the pool table with all my buddies watching while your partner whipped my bottom with wet celery?

She looks into his eyes and says calmly, 'No, I'm your son's teacher.'

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