Sunday, May 26, 2002

I thought this week I'd write in my Tribune column about insurance underwriting and corporate accounting, if only for the sex appeal. I know, I know, a cheap way to drive readership. But the Halliburton story is telling; nobody should take a fiscal projection from either Bush or Cheney seriously, based on the track record in both public and private life.

East Valley Tribune, May 26, 2002

Name the business, its insurance premiums are zooming. Costs for coverage required of tenants under leases, or borrowers under mortgage loans, or for contracts or licenses, has increased tremendously over the past two years.

Nonprofit organizations are particularly hard-hit. A southeastern Arizona hospital closed its obstetrics department. A national nonprofit, with a substantial endowment and excellent reputation, gets quoted an essentially contingent premium, where policy costs equal claims paid. Insurers are delaying their quotes, so many businesses only will get policies--and learn their costs--at the last minute.

It’s far different from a decade ago, when casualty insurance was extremely competitive. Companies vied for business, and even the largest had limited pricing power. A booming stock market encouraged insurers to bid aggressively, because companies made healthy returns investing premiums before paying future claims.

Now, with rising stock prices merely a memory and weaker insurers retrenching, customers faced restricted choice and higher prices even before Sept. 11 changed many insurers’ risk calculus.

Ten years ago, with the economy in recession, businesses faced far lower costs for one essential--insurance--than today. Businesses could expand and create jobs more easily, because they had a lower cost structure. But unlike 1993, rising insurance costs today will restrain the economic recovery.

Rapidly rising insurance premiums mean either that America under George Bush is far riskier than when Bill Clinton was president, or that the 1990’s insurance market really didn’t reflect the true costs of the risks assumed, so insurance companies must now catch up. At The Tribune, where it’s an article of faith not requiring any actual evidence (heck, even if the evidence actually is to the contrary) that Bush is better for national security than Clinton, it must mean the latter.

In other words, the market got it wrong. Despite all the money riding on their analysis, insurance companies seriously misjudged these risks and therefore mispriced their products.

No real surprise; most underwriting and accounting decisions depend on today’s judgment about future events, and the more distant those events, the greater the risk of getting it wrong. Which makes this past week’s disclosures in The New York Times about an analogous accounting judgment during Dick Cheney’s tenure as CEO of Halliburton--his prior gig before the vice presidency--so very, very interesting.

Before 1998, whenever a customer disputed how much money it would pay for cost overruns and change orders on a construction project, Halliburton recorded revenue only after resolving the claim. Until the customer agreed, the company couldn’t say for certain how much (or how little) it eventually would receive.

In 1998, Halliburton faced Wall Street skepticism about its merger with Dresser Industries and year-to-year declines in both sales and revenue. Under Cheney’s leadership, Halliburton--with approval of its auditor, Arthur Andersen (natch)--changed its accounting for these claims, and started estimating future results and booking as revenue today what the company guessed it would recover from the disputed amounts down the line. The change let Halliburton double its 1998 pretax operating profits.

This convenient change--which Paul Brown, chair of the NYU Business School accounting department called “clearly a way of pumping up revenues”--and Cheney’s dreadful Dresser merger finally have caught up with Halliburton. The company’s stock has fallen by more than 50 percent since Cheney left. In fact, Halliburton stock today sits below its price on Oct. 1, 1995, when Cheney became CEO, while the S&P 500-stock index, despite recent losses, is still up 86 percent since then.

That’s Dick Cheney’s record as a businessman. Remember, last year we bought a tax cut based on 10-year revenue projections from these guys. Ouch!

No comments: