Surety insurers should not be seduced by high premiums into underwriting financial guarantees, according to a Standard & Poor's report, which describes a lawsuit brought by J.P. Morgan Chase & Co. against 11 insurance companies as a "wakeup call" that is symptomatic of a wider industry problem."As professionals, you're supposed to look a gift horse in the mouth occasionally," states Tom Upton, a director with S&P's insurance ratings group.
The surety coverage at issue in the $1 billion court case purportedly guaranteed gas deliveries from Enron Corp. to Mahonia Ltd., an energy-trading business of J.P. Morgan Chase & Co., but the insurers contend the underlying delivery contracts were masking loans-that Enron received advance payment for gas which it never intended to deliver because, through a complex circular transaction, it was both the shipper and receiver of the same quantity of gas at around the same time.
It highlights the danger "when the insurance world takes on risk from the banking world," said Mark Puccia, a managing director with S&P's insurance ratings group. "Banks are sophisticated in managing credit risk, but that's less often the case with insurers. There's a real concern insurers are accepting risk they're less familiar with."
Puccia further warns of "other very large exposures where insurers are now recognizing they have taken on surety business with many of the same risk characteristics as financial guarantees, especially in the oil and gas transmission area."
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