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By DAN REYNOLDS, senior editor of Risk & Insurance®

There was much grinding of teeth and yelling out of open windows into the streets in March when executives with AIG said that one of the reasons they intended to pay $165 million in retention payments to members of their financial products division was because they had signed contracts to do that very thing.

AIG's critics--and there are tens of millions of them, apparently--say, "Hang it, break the contracts and let the chips fall where they may. No one at this company," they say, "should be getting anything remotely resembling a bonus when the company has performed as poorly as it has and had to suck in tens of billions of dollars in public money to survive."

So, when is adherence to the letter of a contract the appropriate thing to do and when is it mere officiousness? That depends, of course, on the circumstances.

Insurers know as well as anybody that contracts are made to be broken. How do they know this: Because they break them every day.

If insurers paid every claim that their contracts with their customers bid them pay, they would cease to exist.

That's why there are entire law firms, and vast portions of many others, that devote all of their billable time to parsing the bits and pieces of insurance contracts to determine what the contract really says and what some judge or jury might say is an appropriate settlement under the circumstances.

Such names as the Washington, D.C.-based Covington & Burling LLP; the same city-based Dickstein Shapiro LLP; the Philadelphia-based Morgan Lewis; and their cousins employ literally hundreds of decently educated, well-dressed men and women with handsome wives and husbands and promising children who spend every waking working minute, outside of their obsession with their March Madness brackets and their weight, in divining these resolutions.

And what kinds of information do these wise graduates of our law schools bring to bear when arguing these cases? They, in the words of the great French film director Jean-Luc Godard, endeavor to "show us what is not seen." That is, they bring new information, in the form of legal briefs, that was unknown to their client at the time the contract was signed.

Examples of this sort of information are soil tests that show that the crumpled little Catholic elementary school in Western Pennsylvania was in fact constructed on top of pyrite that expands when it gets wet, or the results of investigations that show that hospital administrators covered up for a surgeon who committed what looked like covered medical malpractice but who was also fond of snorting cocaine when he felt sad and swallowing Oxycodone tablets when he felt uptight.

The architectures of legal and financial landscapes shift with each new piece of information. Underwriters know this just as well as anybody.

That too, I imagine, is why there was so much outrage when AIG executives pointed to contracts as the reason they might pay their friends and colleagues $165 million at a time when the company, by any free market definition, had ceased to exist.

Everybody who works with them for a living knows how insurance companies view contracts.

That's why AIG's statements about the retention payment contracts came across as so hypocritical and enraging to so many.

(Read Managing Editor Cyril Tuohy's Counterpoint on this topic.)

May 1, 2009

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