The AMI bailout, which could amount to a $1 billion taxpayer-funded underwriting deal, is not because the company was badly managed or was inadequate for most circumstances.
AMI is a mutual insurance operation, which means it has no capital other than the surpluses its policyholders pay in but do not take out, plus any interest earned on that money. In other words, every policyholder gambles on a risk that nothing will happen rather than it will.
In any actuarial business, where future commitments can be charted with some degree of certainty, it is possible to form a working business model.
The Labour Party, which has called for the Government to resign over its handling of the South Canterbury Finance receivership, ignored this basic rule when expanding ACC to cover a wide range of new ailments without giving it the financial capability to do so.
Similarly, when (former Finance Minister) Michael Cullen agreed to guarantee all the country’s retail bank and most other deposits at the height of a financial crisis, he was not doing so to make a billion-dollar payout.
Instead, he was preventing a run on the banking system.
Safety blanket
Similarly, the AMI bailout is a safety blanket to stop a similar run in confidence; this time on insurance policy payments.
No journalist who has covered the business scene since the rise of the non-banking financial sector believes (Labour’s Finance Spokesman) David Cunliffe’s conspiracy theory that a touted South Canterbury Finance rescue plan would have been better than a receivership.
The Government paid out to investors who believe, like Mr Cunliffe, in financial fairies. They, like him and AMI policyholders, should be grateful that a group of heavily taxed workers and employers remain to fund a government that can still deliver the goods when disaster strikes.
The policyholder support package will be used only as a last resort if the company’s own reserves have been exhausted, unless the Crown believes it is in the public interest to take control sooner.
This would involve the Government investing up to $500 million in AMI, with the right to take ownership and assume control of the company.
The full extent of the claims AMI faces will remain unclear for several months; it would depend on the scale of damage in Christchurch, which is still uncertain.
However, it is possible that the Company could face losses in excess of $500 million, or indeed, they could be less. If the loss were to be greater than $500 million, the Crown would stand behind the claims.
Nevil Gibson is Editor-in-Chief of the National Business Review. The above appeared as a part of his online Insight column.
The AMI Support Package:
The Crown’s policyholder support arrangement of up to $500 million provides the Company with a platform from which to explore further recapitalisation options.
AMI has paid the Crown $15 million up front establishment fee for the support package. AMI has issued convertible preference shares to the Crown, but the Crown has not yet paid for them. AMI tells us that if payment is required, it may not need to happen for two years.
Payment of up to $500 million will happen only if AMI’s own resources are depleted below the level that is prudent for an insurance business, or if the Crown decides it is in the public interest to make a payment.· In exchange, the Crown could take ownership of AMI and have control of the board.
If the arrangement is called on by AMI, it can later exit the support arrangement by repaying the Crown, along with any dividends owing.
The Support Package will
Provide financial backstop for policyholders so that the rebuilding of Christchurch is not jeopardised by potential solvency or liquidity issues.
Preserve AMI’s existing contracts, including its reinsurance arrangements Provide flexibility for AMI and the Crown going forward.
The Unpaid Convertible Preference Shares issued to the Crown are a last resort. The shares will be paid for only if the company exhausts all other options or if the Crown believes it is in the public interest to take control sooner.
These shares give the Crown the right to any dividend payments, ahead of ordinary shareholders. This is what the “preference” part of the shares involves, having preferential treatment ahead of other shareholders, who will not get any dividends, while the Crown has a shareholding.
Dividends paid to the Crown will be at the Official Cash Rate plus an additional 5.5%. The unpaid convertible preference shares allow the Crown to take ownership of AMI, if necessary, by making a partial payment of $100 million. The convertible preference shares allow them to be converted to ordinary shares.
Crown Fees
AMI has paid $15 million fee to the Crown for this support arrangement. The fee is not refundable, even if the Crown never pays AMI for the shares. AMI will reimburse the Crown for the costs of developing and implementing the support arrangement.
Exit Arrangements
If it becomes clear that AMI can pay all likely claims by policyholders, or if AMI arranges other appropriate sources of capital, AMI will:
Ø Redeem the shares it has issued to the Crown, if they haven’t been paid for, or
Ø If the shares have been paid for, AMI will repay the Crown along with any dividends owing, and then redeem the shares
Risk Management
The Crown will soon appoint a Director to AMI’s board and an observer to key governance or management meetings. If at any stage the Crown makes a payment for the shares, or if AMI breaches certain conditions, the Crown can replace all of AMI’s directors. AMI has also agreed that its service levels will meet or exceed industry standards and that it will comply with prudential requirements established for insurance firms by the Reserve Bank.
