I already did a Blog on the "BP Oil Spill", but here is a little different slant. I did one on "AIG" too and I will try to show how these two significant events are connected. I don't content that I am an expert on either oil or insurance, but I do know a little about statistics and decison theory. It seems to me that it was these last two areas where all the parties were less than fully competent. First, the "BP Oil Spill".
In my first Blog on the oil spill, I said that I have know for at least 40 years that the zone BP was drilling into in the Gulf was very high pressure gas. All petrolium engineers knew this and for that reason were very cautious about drilling into the zone. They knew that at the depth of 5,000 feet there was a very high risk of a blow out and that at that depth it would be difficult to impossible to repair. The bottom line is that our government who controlled drilling authorization in this high pressure zone sold BP the rights to drill there. Now here is where the statistics and decision theory comes into play. If the people on both sides were competent, they had to develop all the possible senarios that could go wrong and assign both probability and cost to each. The way this works, you figure out a bad event that could happen. You then estimate the chances of that event happening. For this example, let's say that the chances are one in one thousand. This is the groups best estimate, 1/1000. Next they calculate what the cost and total damages would be if that even were to occur. Again, let's say that it was $5 billion dollars. The final step is to calculate the "expected" cost of this one possible event if the drilling goes foreward. You multiply the two numbers together and you get $5 million dollars. This tells you that it would be worth while to spend upto $5 million dollars to eliminate the possibility of this event.
Now here is where an insurance company like AIG might come into the picture. BP has calculated that if this event were to occur it would cost the $5 billion dollars and they would like for someone else to share the risk. This is where AIG steps upto the plate and proposes that they will sell them insurance for the event for $7.5 million dollars. AIG is expecting to make a profit and thus charges more than the "expected" cost. See how it works?
The problem with all this is that all possible bad events are "not" on the list and often the estimate of the chances of an event happening are too "low". The "fix" if an event were to occur also need to have their chances of success estimated too and these appear to have been estimated too "high". Now all this is based on "estimates" because these are future events and now can be exactly sure. We know from the AIG fiasco that they estimated the chances of a real estate down turn with price deflation way too "low" and it bankrupted the company. explained in my earlier Blog why I thought AIG estimated the chance too "low".
The reason that I have dug into all these details is to show how the decision making must have been done by all the parties including our own government. What we all need to look for are the documents that support the above. We need to see the "list" of the bad events that could happen and the estimates of those chances. We also need to see their estimates of the cost of each event and the estimates for the chances of "fixing" them if they happened. My guess is that we will never see these figures and if we do I am sure the estimates and costs will be far too low. Notice that we have not seen any documents from the actuarials from AIG. The other problem that I have with our elected officials is that I am not sure they even know that these documents exist or should have existed. Most were elected because of their nice smile and smooth talk, not their competancy.
