Buying BNB is not the solution to CLICO Barbados situation

My friend, Avi, a pretty good economist and Bajan of long heritage, has been following and analysing financial markets for some time, and has a well-earned reputation. He has put his mind to the matters facing the Barbadian financial sector, in particular, ways through the problems that may face a major player in the investment sector. His points were published as a letter yesterday (see Advocate, March 20, 2009), and he allowed me to reissue it here.

An important aspect he highlights is the higher risks that would be entailed if an insurance company's assets were sold to a bank.
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Buying BNB is not the solution to CLICO Barbados situation
3/20/2009

I HAVE found the attention placed on repurchasing BNB at this time a little odd. I have been involved in a few financial rescues and in my experience it is always best to start with what is the problem we are trying to solve.

What is the problem that would be solved by a repurchase of BNB or an encouragement of local interests to buy BNB? The whole issue of “local interests” is a hornets’ nest. Is Sagicor local?

It has a large degree of foreign owners of its shares. It is headquartered in Barbados, but then again so is BS&T. Is that local? Moreover, it seems to me that if the private sector has cash burning a hole in its pockets it should put it aside to stop job losses. Let’s not see a return to the early 1990s. The critical test that any repurchase needs to pass is can we do something better with the money. Today, saving jobs seems a better use of the money to me.

In terms of Clico, the problem the Government has to solve is well summarised by the Governor of Trinidad & Tobago’s description of the company as exhibiting a high degree of transactions between companies in the group, a risky investment strategy and a high-debt strategy – three things that insurance companies should not do. This means in the Barbados case that the asset values of the insurance company have fallen below prudential levels in circumstances, different than before, where the Barbados subsidiary can no longer rely on support from the Trinidadian parent or from quick sales of local real-estate assets.

What is the solution to this problem? Below are a list of solutions to this problem with the least cost to tax payers at the top and the highest cost at the bottom:

1. The Government can request that the central bank accept as collateral for liquidity loans, a wider class of assets, including prime real-estate from a wider class of institutions such as insurance companies. (The central bank would have to quickly acquire some expertise in real-estate assets, which it may second from the private sector.) Lending money without security would be irresponsible.

2. The Government could take “conservatorship” of the company over the short-term to guarantee policy holders and make those adjustments required to ready the company for a future private sale or initial public offering. This is a form of “Chapter 11”. I suspect those adjustments would include a more conservative investment and management style.

3. The Government could take control of the insurance company to guarantee all policy holders and to run-off the insurance company. Tax payers would take a hit were the assets to prove insufficient as they are likely to.

4. The Government could cajole the private sector to purchase assets, at a high-price on the basis that there will be a government guarantee if the assets were subsequently sold below this price after, say, five years. In essence the buyer would be paying for the government guarantee and the company would receive the proceeds from that guarantee. How do you ensure that those proceeds go to back Barbadian claims?

5. The Government could offer to buy some of the prime real-estate assets at a long-term price, with the proceeds ear-marked to the satisfaction of Barbadian policy-holders. This price would have to be estimated using a long-term economic valuation and not an historic accounting valuation. This would gift the company cash but again, you would have to ensure that this cash was only available to back Barbadian claims or it would be used indirectly to fund Trinidad’s $10bn statutory deficit.

Ideally these steps should have been done quickly. Following the recent injunction in Trinidad, all of these steps now require some international negotiation.

Repurchasing BNB by national interests is only a solution to the problem if we want BNB to buy Clico assets at a price BNB could not recover themselves and so would not do otherwise and therefore, it would mean a transfer of losses from an insurance company to a bank. That would be highly dangerous as banks are systemically more exposed than insurance companies.

Professor Avinash D. Persaud,
Emeritus Professor of Gresham College and Member of the UN High Level Task Force on International Financial Reform.