Artificial Ignorance is the new AI. Perhaps the most ironically named firm in history, Situational Awareness, leveraged 4:1, collapsed on the unpredictable development that stock prices could decline. They were absent from class the day the laws of gravity were taught. However, the Jack and the Beanstalk belief in stocks coupled with high leverage carves a risk arc that is impossible to ignore. Much like the USS Tang, a submarine sunk by its own torpedo in WWII, Situational Awareness positioned itself perfectly for a rapid implosion. Situational promoted the myth that its founder was the Nostradamus of AI. Perhaps Icarus better fits the bill. PT Barnum would have been envious of the CIO’s self-promotion. Leopold Aschenbrenner, a 24-year-old academic star, had an employment history which included working for FTX Future Fund team, a group run by now imprisoned CEO, Sam Bankman-Fried, then being fired by OpenAI and wearing dark turtlenecks, the garb of genius. Naturally, he opened a hedge fund, Situational Awareness, which astonishingly grew to $45 Billion in one year and then lost $35 Billion. If you cannot expect great investment results from a 24-year-old recently fired AI researcher, who can you count on? Ignoring both the risks of enormous leverage and the volatility of momentum stocks are the kinds of errors you would never see in an experienced 25-year-old.
Artificial Ignorance of risks has migrated to the insurance business. The beauty of an insurance business is the customer pays for the service before a service is rendered. This financial benefit endows insurance companies with large hordes of cash to invest in advance of having to pay any claims. Insurers have two primary ways to earn profits: 1) investment income and 2) underwriting profit. Insurers also sell a form of guaranteed investment contracts (GIC’s), where rates of return to investors are set at say 6% and any yield above 6% is a profit spread to the insurance company. Traditionally, insurers would match an investment’s maturity that yields above the GIC rate with maturity of the GIC contract. This represents another profit stream for insurers. However, the presence of large amounts of investable cash, supposedly governed by regulations on taking investment risks, often creates temptations leading to criminal acts or to self-dealing which are not remediated by saying “Rumpelstiltskin”.
In the criminal acts arena, both Greg Lindberg of Global Banking Insurance Group and Martin Frankel of Franklin American Life Insurance Co. were infamous. Each of them was convicted of fraud for using company cash for personal spending. Frankel added a mystical element to his activities by relying on astrology to make trading decisions. The latest insurance investigation to emerge involves Mark Walter and Guggenheim, which used the capital from its insurance companies to purchase professional baseball, basketball and soccer teams. The issues being surfaced involve lack of disclosure, exceeding limits on permitted intracorporate lending and personal benefits. The NY Times, in its finite wisdom, has classified this as a private equity problem, while it clearly is not, as Walter’s insurance empire is in no way a PE firm. PE has acquired insurance firms for the benefits mentioned above, but there is no record of mainline PE abusing their duty in their companies. Walter’s entities reported in June that they had forgotten to classify $21 Billion in loans as “loans to affiliates.” Using an insurance company as a personal ATM is frowned upon by the regulators. The drama will play out over the next several months, but points to these ever-present risks. Warren Buffet and William Berkley both used insurance company cash to build great enterprises, but they both painted between the lines. Directors, managers and regulators should be watching this form of asset management.
I’m Rob Morris and I approved this blog.