“We felt there was some possibility of AIG having some trouble,” he explained, noting that AIG's stock price had dipped to about $25 or $30 at the time from a high of $70 over the past year. That drop and a simple gut feeling prompted him to raise the issue of backup plans with Southwest and the retailer on the Southwest account.

“My job is to protect the client against the worst-case scenario,” he said. Mr. Taffae described the “moral dilemma” he wrestled with at the time. “Nothing had really happened. It was too early to start ringing any bells,” but there was a potential that something would.

On the other hand, the client and the brokers had good long-term relationships with AIG, Mr. Taffae said, noting that the carrier writes the aviation coverage as well. In addition, the D&O policy that was up for renewal was a very sophisticated one–page after manuscripted page.

“We didn't want to lose that,” he said, adding that AIG has been Southwest's insurer at least since he came on board eight years ago–”and probably from the beginning.”

“AIG has had the reputation of being one of the strongest companies in the world. You always look to them as quality paper,” he said. The downfall of Bear Stearns in the spring did raise questions about whether issues arising from mortgage-backed securities could affect the insurance community–”especially insurance carriers like AIG providing insurance to back that.”

Mr. Thorn observed, “We were thinking this might be a minor hiccup or a temporary problem, but still in the back of our minds was the question, what if it's not? What if it's a sign of more to come?”

Jaimie Hayne, CEO of Catto & Catto LLP in San Antonio, Texas, a partner in the Assurex Global network, is the retail broker on the Southwest account. AIG “had just come off the downgrade from “A-double-plus” to “A-plus,” he said, referring to A.M. Best's mid-June downgrade of AIG's domestic life and retirement subsidiaries.

(A.M. Best dropped the property-casualty insurance company ratings, which had been at “A-plus” since May 2005, to “A” on Sept. 15, 2008.)

While the June downgrade gave credibility to more dire prospects that Mr. Taffae had warned others to prepare for, the idea that what happened to Bear Stearns could happen to AIG, “we really thought was a very, very remote possibility,” Mr. Hayne said.

“We had no intention–and we have no intention of trying to move from AIG. They've done an outstanding job for all of us,” the retail broker said.

Mr. Thorn agreed. The relationship with AIG “is not something we wanted to throw away just off the bat,” he said. A creative “outside-of-the-box solution” from Mr. Taffae, however, “allowed us to have our cake and eat it too,” Mr. Thorn said, noting that he and Southwest's CFO and treasurer unanimously agreed to pursue Mr. Taffae's solution.

Mr. Taffae refers to his solution as a “supercontinuity option,” expanding on the term, “continuity,” which in the liability insurance world refers to making sure that coverage is consistently maintained without gaps as the insurance is renewed each year.

(For a detailed discussion of continuity, see a related article in this edition of E&S/Specialty Lines Extra.)

A key feature of the supercontinuity option, he said, is language stating that it will only be available if A.M. Best downgrades the financial strength rating of any AIG insurance subsidiary to “A-minus” or lower. This protects the carrier against moral hazard–the possibility of the buyer announcing a multimillion-dollar claim and the desire to accept the alternative tower.

In the event a downgrade does occur, “I just send an e-mail” to get the alternative program done, Mr. Taffae said, noting that in this event, AIG has agreed that its participation would be cancelled pro-rata and the new tower would go into effect.

Mr. Taffae said the solution is a triple-win, because it allows AIG to stay on the renewal, while giving an alternative to the board and executives of Southwest and a solution for the brokers.

“The quickest way to get fired is not to protect my client,” he said.

Mr. Thorn added, “We keep the relationship with our partner, AIG, but we don't risk the protection that we're getting–from our D&O program.”

Confirming that the tower of coverage is well in excess of $100 million, Mr. Thorn and Mr. Taffae explained that the wholesaler was able to get a quote from another carrier partner on the program–an “A-plus” carrier that Southwest found particularly attractive–that would step into AIG's lead role immediately and with very similar terms, if AIG's rating falls.

“It is never in the insured's best interest to go in to negotiate terms and conditions or premiums at a time of crisis. Anytime you can pre-negotiate when things are still okay, you're better off,” Mr. Thorn said.

While coverage terms are not precisely the same as the renewal terms with AIG, Mr. Taffae pointed out that the backup carrier was making a two-year commitment.

“The terms are acceptable,” Mr. Taffae said, noting that if it chooses, Southwest could invoke this option eight months from now (12 months after the renewal) and the carrier would be committed to providing 12 months of coverage.

“We had to negotiate and underwrite and broker a deal that has a lifespan of 24 months in a changing environment.” He said, pointing out that the airline industry has some significant challenges related to fuel costs.

Besides avoiding the need to work against the clock if AIG's rating falls further, Mr. Thorn is comforted by the prospect of having two companies to choose from going forward. “I could replace AIG with another insurance company, but how do I know they're not the one next week having the problems?”

Mr. Taffae, who said he has placed four other D&O programs with supercontinuity options–for AIG and another troubled carrier in the past three months–noted the fee for the alternative is 1 or 2 percent of the total premium.

While Mr. Thorn described paying the moderate fee as a “no-brainer,” Mr. Taffae said that when the policy comes up for renewal, he intends to remind AIG that the client paid extra to stay with the carrier in the event of a turnaround, when any threat of a demise becomes extinct. “I think that shows a good partnership,” he said.

Mr. Thorn, who spoke with National Underwriter three days after an $85 billion federal government credit facility was announced to ease liquidity issues at AIG's parent company, said that at a meeting of Southwest's board a day before the interview, members said they wanted to “take a watch and see approach” to the D&O alternative, claiming, “We'll try to stick by our friend [AIG] as long as we can.”

As for the upcoming renewal of Southwest's aviation program, he said the airline will spread its risk to as many companies as possible. That way, “if any one of them fails, only a small percentage of the risk is placed with it.”

Giving a retailer's perspective, Mr. Hayne said his firm spent last week fielding a lot of phone calls and proactively making phone calls to those clients that might not be as connected as others, depending on whether they were personal lines or commercial lines clients.

“We're trying to keep them up to speed with what's going on and trying to keep them from panicking. There's no reason to do that at this point,” he said. “At the same time, we're making sure that we're exploring our options for our clients–if they're looking for an option.”

He added, “We're encouraging everybody to wait and see what happens before making any drastic decisions, because AIG [does] a very good job in a lot of areas and places coverages that are difficult to find elsewhere.”