Watchdogs with Eyes Wide Shut As investigators pore over the books of aig, it's becoming clear that for years regulators failed to detect lapses

Where were the watchdogs? State and federal investigators are examining the accounts of insurance giant American International Group Inc., drawing out super-investor Warren Buffet and sparring with ousted AIG Chairman and CEO Maurice Greenberg.

But the feverish enforcement activity obscures the fact that AIG's admitted misstatements — so far worth, by the company's estimate, $1.7 bn to shareholders — and other industry transgressions went undetected by many of the same agencies, in some instances for 14 years or longer.

What's emerging from the probes is a portrait of failed regulation. Unlike banking or Wall Street, which answer to federal regulators, the $1.2 trillion insurance industry is overseen by small, usually obscure state offices.

Outgunned by the insurance giants, state commissioners, interested in pleasing voters, usually focus on such consumer issues as taking complaints on auto and homeowners' insurance.

Many admit that they're out of their depths on sophisticated financing deals with offshore reinsurers, like those that fogged AIG's books and snarled Berkshire Hathaway Inc.'s General Re Corp. subsidiary in disputes from Memphis to Melbourne. '"State regulators are doing their best but they are not equipped to police multistate or international scams," says Jay Aughtman, a lawyer who represents insurance regulators in Tennessee and other states.

The obvious solution: national regulation. But even absent a strong new federal agency, current watchdogs can do more. The Securities and Exchange Commission must use its broad authority to review filings of public companies to focus on insurers' financial reporting until it's confident the industry has cleaned up its act.

Auditors, too, must become more vigilant. The suspect deals at AIG bear an eerie resemblance to special purpose entities that brought down Enron. Like the SPEs, the reinsurers AIG used were supposed to be independent — but were in fact closely linked to the parent company.

Accounting-rule writers must also move faster to clarify standards for ''structured finance" — a category that includes off-balance-sheet SPEs and the reinsurance that AIG allegedly used to beef up its numbers.

Insurance is a devilishly complicated business, and the industry often plays by no-holds-barred rules. "Insurance is like the Wild West — it makes Wall Street seem quite orderly and gentlemanly," says an analyst. It's also increasingly sophisticated industry in which players take advantage of every international loophole available to move operations offshore in order to decrease scrutiny and cut tax liabilities.

In this high-stakes business, regulators can't afford to be caught napping. When they snooze, investors lose.

Business Week

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