Island Adventures With AIG

It isn't hard to see what piqued regulators' interest in its dealings with offshore reinsurers.
By Matthew Goldstein ,

Updated from 8:08 a.m. EST

An examination of several offshore companies that did business with

American International Group

(AIG) - Get Report

shows why regulators have a hard time believing that deals between the two sides are the product of robust negotiation and risk-transfer.

Federal and state regulators are just beginning to sift through a string of complex transactions with a hodgepodge of offshore companies for evidence of possible earnings manipulation by the nation's biggest insurer. Just days before Hank Greenberg agreed to step down as AIG chairman, regulators sent off another round of subpoenas seeking additional information about AIG's offshore deals.

Regulators are looking for evidence these deals had no legitimate business purpose and that the transactions were just a way for AIG to move poor-performing insurance contracts off its books. AIG is suspected of controlling some of these tiny reinsurers, even though they were ostensibly incorporated as independent entities in the island nations of Bermuda and Barbados -- two countries known for their lax tax laws and corporate secrecy.

A determination that AIG either secretly controlled or exerted undue influence over these reinsurers would force the New York company to consolidate their assets with its own and restate its financial statements for the past several years. Indeed, the company released a preliminary determination Wednesday that several of the companies were under its control. (To see that story,

click here.)

In Wednesday morning trading, AIG was down 96 cents, or 1.7%, to $57.24.

To date, much of the regulatory scrutiny has focused on three little-known reinsurers:

Union Excess Reinsurance

,

Richmond Insurance

and

Pillar Insurance

. Regulators also are said to be interested in a handful of other Caribbean-based reinsurers.

Of the three reinsurers, the least is probably known about Union Excess. But what

TheStreet.com

has learned about the insurer may explain why regulators and AIG's own attorneys are particularly concerned about Union Excess' degree of independence.

Incorporated in Barbados, Union Excess appears to have no stand-alone office of its own. The Barbados division of corporations lists Union Excess' office as that of

Chancery Chambers

, a seven-person law firm in Bridgetown, the capital of Barbados.

A receptionist for Chancery Chambers referred a phone call about Union Excess to Andrew Ferreira, an attorney in the office. Ferreira did not return several phone calls.

Also not returning phone calls was Trevor Carmichael, the law firm's sole principal. Carmichael was a former director of

Coral Reinsurance

, a defunct Barbados insurer that surfaced almost 10 years ago in a scandal that raised similar ownership and control issues about AIG.

Back in 1996, Delaware insurance regulators questioned AIG's relationship with Coral Re, suggesting AIG had effective control over it. The regulators contended that AIG's many transactions with Coral Re weren't negotiated at arm's length and the reinsurer's liabilities should have been included on AIG's balance sheet.

AIG denied the allegations, and state regulators concluded their inquiry without imposing any penalty on AIG. Coral Re shut down in 1999. It's believed that Union Excess was formed soon after Coral Re ceased operations.

In investigating AIG's offshore business dealings, regulators have gone back to take a fresh look at the Coral Re scandal because of the similarities to the issues raised by the current inquiry.

Richmond, meanwhile, also has considerable ties to AIG. The big insurer owns a 19.9% equity interest in the firm.

Munich Re

, the German based reinsurer, owns a 49% equity stake in Richmond. The other owners are unknown.

A Bermuda insurance registry lists AIG as Richmond's "management company." The only published telephone number for Richmond is the general number for AIG's Bermuda offices. All three of Richmond's top executives also are high-ranking AIG executives in Bermuda.

Pillar's ties to AIG appear the most tenuous of the three insurers. The four-year-old reinsurer is a wholly owned subsidiary of Imagine Group, a subsidiary of

Brascan

(BNN)

, a Toronto-based asset management company. A Pillar executive says AIG has no equity interest in the firm.

"There is no ownership issue with relation to AIG," says Brad Huntington, Imagine Group's president and CEO. Huntington confirmed being contacted by regulators about the firm's dealings with AIG.

What intrigues regulators about all three reinsurers is the fact that AIG was either the main, or sole, U.S. insurance customer of each outfit. That's unusual because each reinsurer was set up as a so-called "rent-a-captive" firm, an entity that by its very nature is intended to do business mainly with corporations looking to purchase low-cost self-insurance coverage in a tax-friendly haven.

In fact, rent-a-captives are usually set up by an insurer or a group of insurers as way to provide additional coverage to corporate customers. In effect, a company buying coverage from a rent-a-captive acts as its own insurer by getting to "rent" the capital of the insurers behind the enterprise.

In return, the "sponsors," or the insurers fronting the enterprise, get a fee for "renting" out their capital. A 2004 report prepared by the Bermuda Insurance Institute, lists AIG as the "sponsor company" of Richmond.

But it appears AIG may have turned the rent-a-captive world on its head by using these tiny reinsurers for its own benefit.

Huntington says it's "rare" for an insurance firm the size of AIG to purchase reinsurance coverage from a rent-a-captive. Typically, when an insurer such as AIG buys reinsurance coverage, it turns to one of the big global re-insurers,

Ace

(ACE)

, Munich Re,

Swiss Re

and

Partner Re

.

Reinsurance is a policy between insurers in which a reinsurer assumes all or a portion of the risk of loss on an underlying insurance policy. Reinsurance coverage enables a primary insurer to free up capital so it can underwrite more policies and reduce the reserves it needs to cover potential claims.

In theory, there's nothing wrong with what AIG did as long the reinsurance deals it negotiated with Union Excess, Richmond and Pillar were arm's-length transactions. However, if regulators find AIG had effective control over these outfits, it could jeopardize the favorable accounting treatment these deals were given.

It would appear AIG and its investors could have something to worry about.

On Monday, lawyers for AIG told regulators and prosecutors that $1.5 billion in reinsurance transactions between AIG and Union Excess may need to be added on to AIG's books because the insurer may have had effective control over the Barbados-based company. Investigators suspect deals with other offshore entities could raise similar problems.

Determining AIG's control over one of these offshore entities is no easy task. But the deeper you dig, the ties between AIG, Union Excess and Richmond are hard to deny.

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