George Osbourne comes to power only to inherit a losing battle.

European Union financial ministers have agreed today to begin what are sure to be long and potentially onerous negotiations regarding tough new rules proposed for any “alternative investment” vehicles that originate outside of the EU, but are sold to EU customers. What this means in plain English is that because of a widespread perception across the EU (particularly in Germany) that unrestrained actions in the hedge fund and equity markets significantly contributed to the global credit crisis of 2008, the EU now wants to make sure that hedge funds and equity funds play by much stricter rules in the future so they cannot create the kind of systemic risk the world’s financial markets are clearly vulnerable to.

The United Kingdom has opposed his move, mainly because the majority of the alternative investment vehicles targeted by the EU are hedge funds and equity funds originating from the London financial market. Any restriction on how these vehicles are created, bought and sold represents a significant risk to London’s multi-billion pound hedge and equity market.

The agreement to negotiate new rules was seen as a setback for the UK’s new Chancellor of the Exchequer, Gordon Osbourne. Osbourne came to his post as part of the national shakeup last week, when the Conservative-Liberal Democrat bloc took power. For Osbourne, this was a battle already too far gone, and he has said as much. It says much of an administration that has the wisdom to know when it’s time to make a stand and when it’s time to die on one’s sword. One week in against a surging tide of poplar European opinion is probably not the time to die on one’s sword.

Robert Peston, of the BBC, notes in his blog that the new regulations essentially would require UK hedge funds to either be a whole lot more transparent with how and where they raise their money (since many are, in fact, domiciled in the Cayman Islands), or they can domicile in Europe proper, but be subject to a whole lot more regulation. It is the kind of situation that ultimately comes down to more annoyance than real regulation towards the “hedgies” (I love that term), leaving Peston wondering why the EU is even bothering. Good point.
In the meantime, financial institutions in the United States would do well to observe what is happening in Europe with an eye toward the future. Financial regulatory reform (read: using tomorrow’s laws to fix yesterday’s problems) is by no means a done deal Stateside, and the death of real knowledge on the part of the public and the legislature regarding how the modern financial system works is a recipe for some truly unhelpful lawmaking. Financiers, take heed.

Listen up! This man knows risk.

Black Swan events, as defined by Taleb, have been referenced in over 600 books, according to Taleb’s website, and even Taleb himself is under a self-imposed media blackout until May, when the second edition of The Black Swan is released in May with over 100 pages of new content (On Robustness and Fragility). I cannot wait to get a copy.

If you are attending RIMS 2010 Boston, then run, do not walk, to this event and hear this man speak. He has forgotten more about risk than most experts and consultants will ever know. In the meantime, I’m going to leave you with an article he recently published in the Financial Times, entitled “Ten principles for a Black Swan-proof world.” Good stuff.

See you this afternoon. He’ll be speaking at the luncheon event, which runs from 12:30 to 2:00. Afterwards, he’ll be signing books at the RIMS booth from 2:15 to 3:00. Be there.

Bailey noted that contingencies amounted to having a “second master” which led to inherent conflicts of interest. But Plumeri put an even finer point on the topic when he attacked the notion that contingencies needed only transparent disclosure to avoid a conflict of interest. “Just because you’re transparent,” Plumeri said,” does that mean it’s okay for you to do these things?”

Plumeri and Bailey’s position on contingencies has not changed in the five years since this became a hot button issue for risk managers and their insurance industry counterparts. but what today’s announcement does is show that Willis is no longer willing to comment on the issue only when it arises in the media.it intends to make this a nonstop topic of conversation to anybody who is willing to listen. And if Willis has its way, there will be plenty more people listening and thinking about this in the near future.

For RIMS, which also opposes contingencies, Willis’ new websites adds a welcome resource to the body of literature and communication on this issue. And as Plumeri has shown, he and Willis is not going to let this topic go away any time soon.

“You have to have principles,” Plumeri said. “And in this particular case, these prinicples are not negotiable.”

Plumeri noted that Willis does charge higher standard commissions to make up for revenue it loses were it to accept contingencies. He went on to say that certain structural problems that lead to possible conflicts of interest — such as the reality that any one insurance company client is likely to be more valued to a broker than any one end consumer of insurance — Plumeri said that so long as the insurance intermediary does its business in a fully transparent way and always does what is in its client’s best interests, those structural problems tend to settle themselves.

Plumeri himself noted that ClientsBeforeContingents.com was unlikely to overturn the New York insurance office’s recent overturning of a ban on contingent fees. Nor was it likely to spur other states to outlaw the practice. But what he did hope it would do is cut through a widespread public apathy on the topic, fueled by ignorance on how contingences are structured, how they came into being, and what they really mean to the insurance buyer. By providing third party whitepapers, an opportunity for the public to comment, and frequent content updates from Willis itself, Willis is banking on crowdsourcing public opinion on a matter that has failed to find a convincing legislative or regulatory remedy.

“We have a responsibility to do it honestly, fairly and transparently,” Plumeri said of insurance broking. “Because without community there is no insurance, and without insurance there is no community, and I think we have a responsibility to do the right thing.”

You can read more about the website here.

Sure, the company has some serious problems, and its liquidity crisis of 2008 will remain one of the worst business disasters of all time. But since then, AIG has somehow morphed from a deeply troubled company into an avatar of all things wrong with the corporate world. And while I won’t suggest we forget (or even forgive) AIG of the policies and actions that nearly tanked the world economy, we must resist the urge to make this company into things that it is not.

Villainization, while it may make us feel good, usually distracts us from the complexities of a situation we must somehow address. It’s easy to say that any given problem came about because somebody — that guy! over there! — was a greedy jerk. It’s far more difficult to see problems in a wider context, to understand how those problems came about, to address those problems on their own terms, and to take meaningful action to try to prevent those problems from arising again. But when we look at the magnitude of the AIG situation, we can take no other course of action. To do otherwise invites disaster to repeat itself. And really, who in their right mind would want to see a stock implosion like this one again in their lifetime?

This brings me to an editorial yesterday called “Kill AIG Now” by Eli Lehrer of the Heartland Institute, over on the Frum Forum. The Frum Forum is a right-leaning political site, and the Heartland Institute is a think tank that describes itself as a think tank for free market solutions to public policy problems, but a cursory look around the site shows that its views on environmentalism, healthcare and other issues aligns it with the remnants of the GOP trying to stake a claim in Obama’s world. On the whole, Lehrer writes some pretty interesting op-eds, but I don’t always agree with his interpretation of the facts, and that is certainly true here.

Before I go one word further, however, a moment of transparency is needed. AIG has been a generous advertiser on this blog’s parent media outlet, Risk Management magazine, and of Risk Management’s parent, the Risk and Insurance Management Society, a trade association for risk managers — people who often buy very large amounts of insurance from companies such as AIG, and who are among the first to be hurt whenever a major insurer drops to the ground. The P/C wing of AIG, which has been re-branded as Chartis, is also a sponsor and an advertiser.

This next part is sure to draw a few hoots from our more cynical readers, but I’ll say it anyway: I’m not writing this article because we have a relationship with AIG and Chartis. I’m writing it because as I read “Kill AIG Now,” it seemed like another example of using commonly held half-truths about AIG — a firm nobody is in a rush to defend -— to promote agendas that don’t really reflect the reality of the situation.

This may sound like a joke coming from a journalist in this day and age, but I think that the truth is more important than somebody’s agenda. And to that end, I’d like to point out some problems I have with Lehrer’s editorial, because if we succumb to the temptation to cherry pick facts about AIG to support our arguments for other things, then we distort what AIG was, is and will be. And in so doing, we lose our grip on how AIG self-destructed, and we lose sight of how we can keep such a thing from happening again. So it is important to be fair when we talk about AIG. It is more than important. It is critical. And so we begin.

I first began raising my eyebrows over Lehrer’s comments on AIG’s Byzantine structure. There is no denying it, the company is a massive patchwork of subsidiaries that seems like a massive corporate Gordian knot. Given the company’s financial troubles, one might conclude that perhaps its labyrinthine inner workings played a part in that. And indeed, Lehrer makes such a suggestion, but it raises a question far bigger than the one it answers.

Although a number of other companies sold a product line-up similar to it, Greenberg’s AIG developed a uniquely confusing structure largely as a result of its acquisitive ways. When it collapsed in the fall of 2008 due to some terrible bets it made on credit default swaps, AIG consisted of over 1,500 legal entities, 71 America-based operating subsidiaries, and perhaps 50 brands. (State Farm, the insurer that does the most business in the U.S., has 12 U.S.-based operating subsidiaries and one brand.)

Although odd looking on paper, this structure gave AIG a strong competitive advantage and promotes economic instability now. It “worked” for two reasons.

First, the company was—and still is—largely “regulator proof” and able to engage in risky, high-return investments that state regulations mandating conservative financial strategies closed to most of its competitors. Like all other insurers, AIG is regulated separately by each jurisdiction where it operated and small state-level regulatory operations couldn’t always “follow the money” in a behemoth like AIG. The credit default swap trades that famously brought down the company were only one example of its exotic, high-flying investment strategy: the company also backed “rocket scientist” quantitative hedge funds and built ski resorts.

I won’t argue that AIG might be overly complex, structure-wise. However, to suggest that AIG kept such a structure because it allowed it more ability to sidestep state insurance regulators overlooks a larger issue: the structure of U.S. insurance regulation itself.

Not surprisingly, the National Association of Insurance Commissioners opposes the formation of a federal insurance czar, or even the Optional Federal Charter RIMS endorses because — and this is just my opinion here — it would strip them of the power they have enjoyed for so long. Never mind that the 50-regime system we have is loathed by insurers because it creates extra compliance costs and administrative headaches, to have a federal system to streamline things would somehow fail to serve the industry and the consumer, by the NAIC’s reckoning.

One thing is for sure, though, a simplified regulatory landscape indeed would make it much more difficult for another AIG to take advantage of loopholes. But frankly, to blame AIG for working an obviously broken system is a bit like blaming a dog for eating your lunch when you’ve laid it on the floor. First things first: overhaul insurance regulation. Somehow, given the political leanings of Heartland and Frum, i doubt there will be much call for that, however. We’ll see.

Point the second: AIG’s claims history. Hoo boy.

Second, many AIG subsidiaries—particularly those in highly priced competitive businesses—took a very hardnosed attitude towards paying policyholder claims. Although some of the horror stories about the company probably stemmed from resentment of financial success — then New York State Attorney General Elliot Spitzer launched a sometimes demagogic crusade against it — the overall strategy appeared to be the mostly legal although hardly consumer-friendly game plan of always interpreting contract language in ways that maximized corporate profits.

I have covered insurance journalism for about 15 years now, and if I have learned just one thing, it is this: every single insurance company out there either takes a “very hardnosed attitude toward paying policyholder claims” or they are chastising themselves for failing to do so. AIG may have played hardball, but to demonize them for it is ridiculous, given how much this is merely standard industry behavior. As the discipline of underwriting eroded across the board (especially during the 1990s) and as companies no longer could rely on their investment income to keep them going, they routinely turn to claims reduction as the last line of defense. AIG is no different in this.

And if Lehrer has a bunch of consumer testimonials to say that AIG behaved in a bastardly fashion, then guess what? Ask any resident of the Gulf Coast what they think of their insurance company, and you’ll probably get an earful of language that cannot be repeated in front of polite company.

I also like how Lehrer insinuates that AIG was perhaps acting illegally even though it could not be proven as such. This, my friends, is yellow journalism, pure and simple. If AIG’s claims patterns were in fact illegal, then I cannot believe in a legal environment as rapacious as the United States that such rascalism would not have been dragged out into the light and flogged in public. For all of his vigorous prosecution, not even Eliot Spitzer went after AIG for claims, he went after them for dodgy accounting.

Point the third: pricing.

But, there’s no hard evidence that AIG has systematically broken the law through its pricing. (Because insurance consists of a promise to pay at a future time, it’s illegal to sell an insurance policy at a price that doesn’t provide reasonable assurance that the company selling it will be able to pay claims.) Investigations from the National Association of Insurance Commissioners and the Government Accountability Office both found that AIG is not using taxpayer bailout funds to under-price competitors in an illegal fashion. On the other hand, a late November analyst report from Sanford Bernstein sent AIG’s stock tumbling with the suggestion that several parts of the company lacked the resources to pay likely claims. Whatever the case one thing is clear: AIG—buoyed by government support—has continued to compete vigorously on price because the company was built to do so.

First off, again with the insinuation of wrongdoing. If AIG has practiced illegal pricing, then either acuse them of it or don’t. But reading Lehrer, I get the feeling that he’s taking a cheap shot at a firm widely perceived to be up to no good by a public (and a government) that really has no idea how any insurance company works, let alone one as large and as complex as AIG.

But, I digress.

The real point here is that AIG practices scorched earth pricing, ostensibly to force its competition to price at uneconomic levels, forcing them to endure pains that AIG can absorb much more easily. If this is the case, then we certainly aren’t hearing of it at the consumer level, as there has not been a single statewide push for rate rollbacks that made note of how artificially low rates were in the first place.

Plus, I find it strange for Lehrer to ping away on AIG’s pricing when, in other editorials, he excoriates states for not letting the market set its own prices for hurricane coverage. If we want a free market, then we can’t have it halfway, but that is just what seems to be proposed here. Free markets to give the government a pass on covering coastal risk, but not a free enough one to let a company like AIG throw its weight around like any other corporate apex predator might. What gives?

Lehrer even goes so far as to suggest that by competing on price, as it has and as it continues to do, AIG is depressing the entire P/C market, which is in turn hurting the larger economy. This is wildly oversimplistic and ignores the larger dynamics of the P/C pricing cycle. (For more on that, see Morgan O’Rourke’s market overview feature in our upcoming January/February issue if Risk Management)

All of this is diversionary, though. The ultimate point to be made here, is the one I disagree with the least, which brings us to point the fourth: what to do next?

If it wants to solve the problems that AIG poses, the government should put the company out of its misery. Even if the company remains in existence forever, its total debts will never be paid back because they are based on valuations of the company that assumed its strategy would result in long-term growth that never came. The money AIG lost is gone.

I am sure Lehrer isn’t the first to suggest that AIG be dissolved, nor will he be the last. And from a standpoint of getting government money back, perhaps dissolving AIG is indeed the only viable option.

But I wonder . . . is getting the money back really part of the strategy here? I think not.

AIG was saved because its complete downfall was seen as something that would so devastate world financial markets that the federal government had no choice but to step in, throw a king’s ransom (literally) at it and accept the lesser of two evils. When you get right down to it, that’s what national governments are, truly the insurers of last resort.

The big difference now is that the United States actually owns an insurance company because of it. I don’t know what the Obama administration has in mind ultimately, but I do know that saving AIG was a good idea. You know what would be an even better one, though? Fixing our fractured regulatory system so that another AIG can’t happen.

Suggesting that the government is overstaying its welcome into private enterprise after buying up AIG at a time of crisis is short-sighted, plays to the already tired free market mantra that underpins general opposition to the Obama administration and deflects from the real issue of regulatory reform. AIG’s problems stemmed from a variety of sources — an out-of-whack financial services unit, a market environment that rewarded greed over prudence and a leadership that either looked the other way or truly did not know what was happening in its own shop. But these are the ills not just of AIG, but of the entire corporate environment of the last ten years.

If we want to focus on a meaningful solution here, we need to look to regulation, and how badly the U.S. insurance market needs it, and needs it now.

(Combined ratio essentially is how much it costs to make a buck. If your combined ratio is below 100%, you are making money on underwriting. If it is over 100% – which happens a lot with insurers – then you are losing money, mostly because your claims are outstripping your premiums.)

Ultimately, the companies that posted the largest net incomes were:

• Swiss Reinsurance America Corporation ($582.9 million)
• Everest Reinsurance Company ($271.0 million)
• TRC/Putnam Reinsurance Company ($270.0 million)
• Odyssey America Re/Odyssey Reinsurance ($219.5 million)

Conversely, the companies posting the worst negative incomes were:

• National Indemnity Company (-$291.9 million)
• Munich Re America Corp. (-$56.9 million)
• American Agricultural Insurance Company (-$50.9 million)
• QBE Reinsurance Group (-$16.8 million)

On average the entire group did rather well, posting a total net income of $1.3 billion and a total policyholder’s surplus of $74.1 billion, up $2 billion from this time last year.

These numbers shouldn’t be all that surprising, though. According to Guy Carpenter back in April, P/C reinsurers had tightened their rates during the 4/1 renewal season, with national programs rising between 10% and 14% on a risk-adjusted basis. Regional pricing also played a factor; the Northeastern U.S., for example, only saw about a 6% to 8% increase. The price jumps merely extended a rising cost of reinsurance that had already begun by January 1.

Meanwhile, the industry has also had a fairly light catastrophe year. Natural and man-made catastrophes cost insurers about $24 billion this year, compared to the $50 billion they cost last year. While Europe had an above-average year for cat losses (especially natural catastrophes), the calm hurricane season in the U.S. more than balanced things out in favor of reinsurers. This leaves the market well capitalized for whatever 2010 has in store. Hopefully it will be another quiet year, though reinsurance buyers are unlikely to endure additional price increases with a smile at the rate things are going.

The cast of Sesame Street for its 40th anniversary season. Photo Credit: Richard Termine

It hasn’t always been sure success for Sesame Street, however. In fact, its very conception, initial execution and ongoing criticism has been, in many ways, an ongoing experiment in intelligent risk-taking. For starters, the show was created at a time when people didn’t know if TV could even be used to educate, and it took some generous grants to research the premise, as well as some pretty forward-thinking corporate sponsorship to help get the entire project off the ground. During the show’s development, segements with the Muppets fared will with kids, but the live-action “street” segments did not, so the show’s creators decided to go against the advice of their experts and create street segments where live actors and Muppet characters interacted. A bold move for a show without any kind of precedent, really, but one that paid off. The show captured the imagination and the attention of its audience while also paving new ground in terms of television entertainment. True innovation at work.

But there have been other pitfalls, as well. In 1970, the show’s racially integrated cast got it banned from the airwaves (briefly) in Mississippi, its portrayal of female characters got it bad marks from the National Organization for Women, and its lack of Hispanic characters got it criticism from Latino groups. Critics such as journalist Kay Hymowitz have also rapped the show for being little more than a delivery mechanism for merchandising, and for putting on a lot of flashy programming with little educational content to back it up. The show has even gotten political flak through the decades, mainly because it receives government funding and conservatives knock the show for having a liberal bias. A recent spot where Oscar the Grouch, reporter for GNN, gets a call regarding POX News could not have helped.

Perhaps the show’s worst challenge has been obsolescence, and the greatest risk it took was reformatting to maintain its relevancy. Facing declining ratings in recent years, the show realized that it had kicked off a children’s programing revolution that changed how kids themselves watched TV. With so many shows that older kids could watch, and realizing that kids were watching the show from an early age, Sesame Street aimed its content at young pre-schoolers, a move roundly criticized by Gen-X parents who felt the show was being dumbed down. Things are still tougher for the show than before, as it is producing fewer new shows each year and currently ranks only as the 15th most popular children’s show in the United States.

But Sesame Street is still having the last laugh, longer-running by far than any other children’s programming, and with more Emmy awards (118) to its credit than any other show, period. At present, it is estimated that around 77 million Americans have watched the show, and even Oscar the Grouch is on permanent display in the Smithsonian Museum of American History. All this for a show that began so humbly four decades ago on the unproven notion that kids could actually get something worthwhile from TV, and that make-believe friends made out of colorful fur could be one’s ambassador to a world of reading, writing and arithmetic. Who says risks don’t pay off?

Alas, I digress. Murdoch has long advocated a pay model for fixing what’s wrong with the business of print media. He is onto something, at least in theory, when he says that if content is good enough, then people will pay for it. However, he seems to have overlooked a few things. One, The Wall Street Journal went this same route about a decade ago and was ignored in such droves that it eventually abandoned the practice. And this was at a time when online consumption of print media was a small fraction of what it is today, so expecting people to go full reverse against a much stronger freebie culture seems optimistic, to say the least.

And that is the situation for a respected media brand such as the Journal. What of the Post? From my own experience, the Post is best known for trumping the New York Daily News in sensational headlines, as well as providing train commuters with some light (read: brain-dead) reading to occupy them after a long day of work. I know my senior designer for the magazine reads Page Six on her lunch break; surely she can watch Hulu or read any other website when Rupert tries to charge her a buck a day or whatever the going rate will be.

The point is, I see where Rupert is coming from, but the world of media is changing too fast for a stark policy such as this to succeed. If he wants to restrict his online offerings, then simply don’t puiblish your entire print edition online. Make there be some exclusive content to the print edition and run the online version as a free loss leader to get people to subscribe. Or something like that. I can’t pretend to have all of the answers here, but I know that when the WSJ starts spamming me to buy its online version, I’ll be only too happy to tell them to unsubscribe me from their mailing list, too.

For a better take on this than I can muster, check out our cover story from earlier this year on old media and new opportunities. Clay Shirky’s the real expert on this, and if Murdoch was serious about protecting his investments, he’d bring on Clay as an advisor.

The Risk Management Monitor is proud to present its first episode of the RiskCast, a podcast featuring the latest talk, insight and analysis of risk management in the news. Presented by the editorial staff of the Monitor and Risk Management magazine, the RiskCast isn’t afraid to have fun while it covers the stories that matter to risk managers everywhere.

Join Bill Coffin, Morgan O’Rourke and Emily Holbrook as they discuss hybrid vehicles too quiet for their own good, what it takes to fight a pirate, the infamous Colorado balloon boy and much, much more. And don’t forget to subscribe to the RiskCast on iTunes (search RiskCast).

UPDATE: In discussing the current state of CNN, we mention its website’s appearance on the day after Michael Jackson died. Here is what it looked like with the 31 separate links to Jacko stories highlighted.

As Tampa Bay receiver Clifton Smith waited for the ball to land in his arms, he was leveled by a flying tackle to the head courtesy of Panthers safety Dante Wesley. To say this was a cheap shot grossly understates the term “cheap shot,” as the ball was nowhere near landing in Smith’s hands when he was hit. In fact, when you watch the video of the whole thing, it is clear that by the time Wesley had launched off the ground at Smith, Smith still did not have the ball.

The impact knocked Smith out cold for a good minute before he managed to get back to his feet and was taken off the field. As for Wesley, he was disqualified for the rest of the game and he was also later suspended by the NFL for another game.

This all comes at a time when the NFL is already under pressure to address concerns that the constant head impacts experienced by football players – even those at the college and high school level – are causing brain damage that can lead to early onset dementia, depression and suicide.

Be sure to check out the December issue of Risk Management, when we discuss this topic more fully in an article written by Emily Holbrook. In the meantime, Malcolm Gladwell wrote an outstanding article on this in The New Yorker that is not to be missed. Clearly, the issue of player head trauma has only a little emerging science behind it. But the science that is there suggests that the NFL, along with college and high school football, has a potentially game-breaking liability issue on its hands.

The drug violence of Rio’s favelas is nothing new. But the helicopter shoot-down was shocking, just as it was to hear of such incredible violence in a city that just a month before had been tapped over contenders such as Chicago and Tokyo to host the 2016 Summer Olympics.

In light of the recent gun battle, Brazilian officials have sent thousands of extra police into the slum to crack down on the violence and lawlessness there, but clearly, they face an uphill struggle. Even though the Olympics are several years away, the level of the security problem in the city will surely cast as much of a shadow over the coming games as terrorism fears did over the 2004 Olympics in Athens. At the moment, the U.S. State Department notes that Rio is a fairly dangerous city, crimewise, and that all of Brazil has a crime rate that is quadruple that of the United States. The Overseas Security Advisory Council echoes the State Department’s assessment of things, noting that the “Government of Brazil (GoB) is locked in an intense struggle against drug gangs for control of large areas of the Rio de Janeiro metropolitan area.” After this weekend’s carnage, even that assessment seems to be putting things mildly.

Hopefully, Brazil can marshall the resources and the will needed to address the security problem in a permanent fashion, rather than temporarily suppressing it or displacing it elsewhere. The Olympics have a nasty habit of costing its host cities far more in the long run than they bring in, revenue-wise. After this weekend’s Monkey Hill bloodbath, it might be tempting to wonder if money spent on stadiums and athlete villages should be first spent on keeping the poor sections of town free of machinegun fire.