Cooking the Insurance Books

In October, New York Attorney General Eliot Spitzer filed suit against the world's largest insurance broker, Marsh, accusing it of rigging bids and receiving kickbacks in order to defraud clients such as other corporations, city governments, school districts and individuals of billions of dollars through inflated premiums.

"Greedy trial lawyers were the usual excuse for premium increases. Now we know that greedy corporations also have a starring role," Spitzer said, accusing several insurance companies as co-conspirators in making phony or inflated bids and paying kickbacks to the brokerage to get business.

Spitzer also announced that two executives from the insurance conglomerate American International Group (AIG) had already confessed to related criminal charges. But his investigations into AIG may have only scratched the surface. A paper trail stretching back a decade reveals that AIG used offshore shell companies to skirt the law.

The current scam which Spitzer has uncovered works like this: Marsh, an insurance broker, is supposed to find the best insurance policies for its clients from a wide range of companies. Instead it steered the policies to companies such as AIG that agreed to pay kickbacks. It solicited phony competitive bids for insurance contracts to deceive customers into thinking there was real competition for their business. Marsh made $800 million on kickbacks in 2003 alone - over half its $1.5 billion profit. With a 40-percent share of the global insurance brokerage market, its fraud drove up prices for everyone.

AIG announced that its senior managers were not aware of the bid-rigging. But the family ties of three of the alleged co-conspirators make the claim hard to believe. The head of the Marsh brokerage was Jeffrey Greenberg, 53, the head of AIG is his father Maurice (Hank) Greenberg. A former AIG staffer told CorpWatch, "Greenberg is legendary as a hands-on person. Nothing happens in the company without him dealing with it. He knows the names of the elevator operators."

Another accused collaborator is Hank's other son, Evan, 49 who just happens to run ACE Ltd., another of the companies allegedly involved in the complex scam.

Jeffery has resigned in disgrace, but so far the family patriarch is holding onto his executive seat. During a conference call with investors, he said, "I have never discussed business with Jeff or with Evan. . . . We get together on a very rare occasion. But we never discuss business. We play tennis occasionally." Still, fallout from the scandal has already cut $24 billion from AIG's $150 billion market capitalization and knocked 12 percent off its stock price.

Lax Regulators Give AIG a Free Pass
At Spitzer's press conference, New York State Insurance Superintendent Gregory V. Serio said: "This has gone from an inquiry into failure to disclose compensation to an active investigation of bid rigging and improper steering. This certainly proves the adage that where there is smoke, there is fire."

But AIG's comportment could not have been much of a surprise to Serio, who was New York's deputy insurance superintendent in the late 90s. That's when New York and three other states gave the powerful company a pass on some very questionable practices. If they had paid attention to the smoke then, perhaps this billion-dollar fire wouldn't have ignited.

In the late 90s, four state insurance departments New York, Delaware, Pennsylvania and California were aware that AIG was moving debt off its books via the use of an offshore shell company it secretly set up and controlled. But despite clear evidence of wrongdoing, no sanctions were ordered.

Insurance companies normally insure themselves by laying off part of their risk to reinsurance companies, so if a claim comes in above a certain amount, the reinsurance company will pay it. Insurance companies use re-insurers to reduce some of their risk and because state laws require them to keep a certain amount of capital available to pay out claims. If they have reinsurance, that amount can drop. If they have enough good reinsurance, they get a credit for that against their losses. The reinsurer, of course, has to be an independent company; the risk isn't reduced if it's just moved to another division of the same company.

In the mid-80s, two of AIG's reinsurers failed. The bankruptcy liquidators paid creditors, including AIG, over several years but meanwhile the amount owed was liable to show up as unacceptably high levels of debt on the AIG books.

Trevor Jones, an insurance investigator who for 20 years has run Insurance Security Services in London, explained, "Hank [Greenberg] decided to set up Coral Re [a reinsurance company] to move the debts he couldn't claim as assets into this other company... No other real company would play ball, because you are fiddling the accounts, moving your bad debts off your books."

So AIG went to elaborate lengths to set up a shell company in Barbados, where capital requirements and regulation was minimal compared to the U.S., where American regulators couldn't readily discover AIG's involvement and where, as an added incentive, it could move money out of reach of U.S. taxes. Some high-level corporate executives were persuaded to front for a company into which AIG could "cede" insurance.

Goldman Sachs and Robert Rubin
Coral Re, a Barbados reinsurance company, was launched with a private sale of shares organized by Goldman Sachs, then headed by Robert Rubin, who would become President Clinton's Treasury Secretary and is now chairman of the executive committee of Citigroup. A confidential memorandum, (which Goldman Sachs ordered investors not to copy and to return on demand) told why the company was formed. "AIG's interest in creating the Company is to create a reinsurance facility which will permit its U.S. companies to write more U.S. premiums. For a U.S.-domiciled company, a high level of surplus is required to support insurance premiums in accordance with U.S. statutory requirements. The statutory requirements in Barbados are less restrictive."

A no-risk deal was offered by Goldman Sachs to selected investors who lent their names and credibility in exchange for guaranteed return of $25,125 in the first year and $45,225 each subsequent year. They were L. Donald Horne, chairman of Mennen Company; Charles Locke, chairman of Morton Thiokol; Kenneth Pontikes, former chairman of Comdisco; David Reynolds, chairman of Reynolds Metals; John Richman, former chairman of Kraft; and Samuel Zell, chairman of Itel Corporation. They didn't have to put up any money: they got financing from Sanwa Bank of Chicago secured by the Coral Re shares, a guarantee of enough dividends from Coral Re to cover the interest, and agreement they could hand off the shares and debt whenever they chose.

Rubin buddy Bill Clinton, then governor of Arkansas, may also have thrown his weight behind the project. The Arkansas Finance and Development Authority (ADFA), headed by a man who went to work in the Clinton White House, became lead investor, although state law banned it from buying stocks.

The new company was not a legitimately independent business. For investors, there was no money at risk; the board of directors never made a decision; and Coral Re had no office of its own but was managed by American International Management, a subsidiary of none other than AIG.

Eventually, the scheme unraveled. State insurance examiners look at company books every five years. "In 1992, Delaware examiners auditing Lexington [an AIG subsidiary] smelled a rat," a former regulator from one of the four investigating insurance departments told CorpWatch.

AIG initially refused to provide Coral Re documents to the examiners, and it took them a couple of years to nail the connection. When AIG finally supplied Coral Re's financial papers, the regulator was incredulous. He said, "The books were definitely cooked. I remember three years in a row [in the early 90s] their pretax income came out to an even number. It was like somebody said 'show $250,000 pretax income.' I've been looking at financials for 35 years and have never seen pretax numbers come out even." The figures were 1987 $1.1 million; 1988 $1.555 million; 1989 $0.8 million.

The Regulatory Record
The Delaware report on AIG, finally issued in October 1996, suggested that Coral Re "may be an affiliate" of AIG. It described how AIG played an integral role in the creation of Coral Re; that the purpose for creating Coral Re was to reinsure risks for AIG companies; that virtually all of Coral Re's business originated from AIG units; and that Coral Re was managed by AIG subsidiary American International Management Co. Ltd. It concluded that the arrangement with Coral Re did not transfer risk, and it had to come off the books.

AIG insisted, in the face of overwhelming evidence, that Coral was independent. The regulator told CorpWatch, "It's clear AIG formed that company. They denied it, because if they owned it, it would be affiliated and they would not be able to take credit for reinsurance. Delaware should have suspended them, but did nothing."

New York and Pennsylvania also investigated, had similar experiences with AIG stonewalling, and reached similar conclusions.

The New York report on three AIG companies said the deal with Coral Re was "window dressing" and didn't "transfer underwriting risk," so AIG shouldn't take credit for it. New York described an accounting slight-of-hand which mirrors what indicted Enron officials did to change loans into earnings. In 1991, AIG insurance companies borrowed $190 million from an affiliate, AIG Funding Inc., but reported the loan as a sale to AIG Funding of their accounts receivable, ie. the money owed them by Coral Re. Presto, a loan became revenue, and balance sheets showed no loss.

The Pennsylvania insurance department investigation also concluded, "There was no transfer of insurance risk."

The four states - Delaware, New York, Pennsylvania, and California - met in 1996 to coordinate their reports on AIG.

The Securities & Exchange Commission (SEC) also looked into the matter. The regulator said, "The SEC came to me; they wanted to know if we were going to rule they were affiliated. Then there would be penalties, because if AIG was affiliated with Coral and they hadn't disclosed it in 10k filings, that's a 'no-no' with the SEC."

It also would have been an issue for the Internal Revenue Service. If Coral Re was an AIG affiliate, it would have to pay taxes on its income. If it was "independent," that money came tax-free.

"But nobody had any guts; they wanted Delaware to say Coral Re is affiliated and use that to go after them. None of the agencies had the gumption to do it on their own," said the regulator. And AIG wasn't shy about its tactics. He said, "In 1996, AIG hired a private investigator to check into the background of the chief examiner in Delaware. The investigator actually told the department he was looking at the chief examiner at the request of AIG. It was intimidation. And Delaware officials allowed it to happen."

A Delaware examiner told the regulator. "When you do something with this company, they make it so difficult for you, so people just let it go."

Delaware reported what it found but didn't rule the companies were affiliated. "That would have meant hearings, endless hassles," the regulator concluded. And real punishment for AIG.

The New York Insurance Department said the violations of New York law were not serious enough to warrant a fine. Besides, an official said, it was hard to prove "control" of an offshore company -- which, of course, is the reason for going offshore. The delays and stonewalling allowed AIG to use Coral Re for more than eight years. By the time it had to shut it down, it didn't need it anymore.

Things have gotten tougher for the company since the Enron affair caused the SEC to look more serious about corporate corruption. In the current climate, these regulatory agency findings would probably prompt investigations by State Attorneys General, perhaps they still could. Last year, AIG paid a $10 million fine to the SEC for helping the Indiana wireless telecom company Brightpoint commit accounting fraud. AIG marketed a "non-traditional" insurance product aimed at "income statement smoothing," spreading a loss over future reporting periods. The SEC called such financial products "just vehicles to commit financial fraud" and said the insurance giant refused to give it subpoenaed documents, compounding its misconduct. The U.S. Justice department is currently investigating but has yet to file criminal charges.

Business Insurance, a trade publication, editorialized on the timidity of regulators for giving AIG "little more than a tap on the wrist" in exchange for "a promise not to do it again." "The message delivered here is that a company of AIG's power and complexity can afford to be openly hostile to state oversight and, in the end, have things pretty much its own way. That is a disheartening message, indeed," wrote the magazine's editors.

AIG spokesman Andrew Silver told CorpWatch that "AIG was not involved in the offer and sale of Coral Re's shares. That was done by Goldman Sachs, which approached potential investors with which it had relationships. AIG did not control or have an equity interest in Coral Re. The issue raised by the regulators was whether these transactions should be booked as a deposit account or an insurance account. The regulators concluded that real risk was transferred and that these transactions should be accounted for as insurance. AIG insurance subsidiaries eventually commuted their Coral Re reinsurance."

Goldman Sachs failed to respond to inquiries about its role in setting up Coral Re.

Asked how AIG could say the regulators concluded that real risk was transferred when Pennsylvania stated clearly, "There was no transfer of insurance risk," Silver declined to reply.

Lucy Komisar is an investigative journalist who is writing
a book about offshore bank and corporate secrecy. She received research assistance on this report from the Arkansas Committee. The committee was started in 1990 by University of Arkansas students, who, suspicious that Arkansas Development Finance Authority was selling more bonds than it could use to finance state projects, demanded the agency's documents under the Freedom of Information Act. It fought the case to the Arkansas Supreme Court before it got the papers describing the AFDA deal to buy shares of Coral Re.