The US Intel Investment Is Bad News For Insurers

Most of you have likely seen the news about the government taking a 10% stake in Intel. There are a lot of significant concerns raised by this action, but one issue, admittedly more local, I haven’t seen mentioned is the likely insured losses it creates.

It’s probably worth doing a quick summary of the underlying facts before diving into the main event. How did we get here?

The CHIPS Act

Intel was awarded $8.9B in grants by the Biden administration under the CHIPS Act. While I don’t like the idea of government subsidies to large industries (see how well it’s worked for US automakers over the decades), there was nothing untoward about Intel taking the money.

Many of their competitors, including those domiciled overseas, also took billions of dollars from the government. Importantly, there was nothing in the legislation that suggested there were strings attached to the grants.

Would I have attached some strings? Yes (more on that below), but those were not the terms agreed to.

Now, Trump retrospectively wants to change the terms of the contract. There is no legal basis I am aware of for doing so. Yet, Intel agreed to anyway.

Intel gave the US government 433M shares at $20.47 which equates to the $8.9B in grants received. In other words, it means Intel now has been awarded $0 under the CHIPS Act.

It would seem if Intel no longer wanted the money they could have just paid it back. If they didn’t have the resources to do so, they could have done a private financing to repay it (more on that below too).

But there is no apparent reason that they should have awarded the government $8.9B in stock with nothing received in return.

To make things worse, the “$8.9B” is a bigger backdating scandal than the options pricing nonsense from the past that claimed a number of CEOs (including in the insurance industry). The $20.47 price agreed to is about 20% below the market price.

So, in reality, Intel gave up $11B of stock to keep $9B in grants. How does this make any sense???

Insured Losses

There are several potential areas of insured loss, including some I probably haven’t considered yet. Let’s start with the most obvious one.

D&O

The only reason a CEO would give out $11B of stock and receive nothing in return is if there were some personal gain in it that offset the neglect of his fiduciary duty to the shareholders.

In this case, Intel’s CEO got to keep his job by caving to Trump. So much for representing the shareholders’ interests.

Even if someone wants to debate that there is some long term benefit to giving away $11B, there is the objective mathematical fact that this offering is immediately dilutive to shareholders and they got no say in the decision.

This is about the easiest D&O suit that ever existed! You have a CEO who screwed the shareholders for personal gain and a derelict board that did nothing to stop him.

I don’t know how big a D&O tower Intel buys, but I would guess it’s in the nine figures. It’s a total loss.

And that may not be the end of it. There is plenty of speculation that Trump won’t stop at Intel. Each future seizure of equity is another limit D&O loss. This could easily get into the billions.

Sure, maybe contracts at Jan 1 can put in new exclusions for expropriation, but will buyers accept that?

Political Risk

Speaking of expropriation, let’s call this what it is. Just because Intel agreed under duress, doesn’t change the outcome. Lots of people take plea deals to crimes they didn’t commit or even sign false confessions because of the threat of something worse.

We have now introduced expropriation risk into the US market. This will surely lead to political risk claims.

It is a bit less straightforward than the D&O though as to how this will play out. It’s hard for Intel to make a claim since they “voluntarily” agreed to this. Perhaps there is a way to prove it was done under duress, but that would require being willing to risk the wrath of the President.

So, if Intel won’t file, maybe this isn’t really a concern? That depends.

Shareholders arguably have a claim of expropriation. 10% of their company was stolen from them. However, individual shareholders don’t buy political risk coverage, so no exposure there.

What about the bondholders? They tend to have covenants that protect them from actions like this. But they can sue the company directly for damages.

I don’t believe there is an applicable cover that would pay either the bondholders when a covenant is violated or the corporate when they have to pay damages for violating a covenant.

So I’m still striking out here it seems.

Or maybe not? What about competitors of Intel? If the government acts in a way that favors Intel and thus hurts their business, do they have a claim?

I am not aware of contingent political risk covers, but I wouldn’t be surprised if there are bespoke contracts that pay out if a company is harmed by the government expropriating a competitor.

After all, that is the definition of a political risk. Surely somebody writes cover for it?

I do know the pol risk market is very opaque and there are likely some surprising coverages out there that are newly at risk. They may not be hit specifically by the Intel situation, but future government interference in markets likely will lead to losses.

And obviously the rate on line charged for US risks is far, far lower than in global hotspots.

What Intel Should Have Done

I mean obviously they should have said no and found a new CEO, but beyond that, they should have raised new capital to pay back the government.

Some might argue it would have been too hard to raise that much. Maybe it would have been, I’m not sure, but it wouldn’t have been an unprecedented raise.

But let’s say for some reason it wasn’t feasible. Were they backed into a corner?

No, they could have done what we used to see a fair amount of in the insurance industry (especially in Europe) – the rights issue!

They could have let existing shareholders buy new stock up to 10% of their current holdings at a discount to the current price.

If you think about it, they sort of did a bastardized version of a rights offering with government. They offered a large stake at a discount to the current price.

However, they left out the piece where you only offer that to existing shareholders.

It is arguably not to late to remedy this. Why not do a rights offering to pay off the government?

What The Government Should Have Done

As I noted earlier, I don’t think it is great public policy to be giving handouts to favored industries. But if you are going to do so, the government should at least capture some of the upside.

This is what made the much hated TARP bailouts so successful. Under TARP, the government wisely took warrants that let them participate in any future upside.

If this was done for the Tesla EV subsidies imagine how much Tesla stock the government would own! Instead, they let Elon collect the subsidies and capture 100% of the valuation upside. Idiotic!

So yeah, I’m a big fan of warrants in return for handouts. The original CHIPS Act should have given the government warrants in any company who took funding.

They didn’t need to be onerous, but if the government gives away $1B and the stocks goes up 25%, maybe it should make $100M?

If it had taken this approach, companies may have been more thoughtful with the size of their requests.

On a side note, some loyal readers may recall my criticism of reinsurers who funded insurance startups. If you were going to take the risk of elevated losses, you should have received warrants to capture any upside in the stock.

It’s the same principle. If you are going to fund a highly risky venture, you don’t cap your upside while risking 100% downside. That’s a foolish way to run a company and/or a government.

Underwriting In An Uncertain World

Insurers are used to accepting uncertainty, so more political risk in the US isn’t something they can’t adapt to.

However, the challenge is most other high severity lines have higher rates on line to account for the unknown. Lines like D&O, pol risk, trade credit, surety, etc. have very, very low ROLs but still high severity risk.

Furthermore, there is a high risk of correlated frequency in these lines. D&O tends to spike in bear markets due to the frequency of severity. A concerted effort by the government to interfere with free markets could definitely lead to a new round of elevated frequency.

Similarly, if first world countries begin acting like their third world peers, the level of political risk frequency would likely be something the market has never seen before. It’s one thing to manage exposure in Argentina. It’s quite another to manage a spike in events in the largest economy in the world.

Honestly, underwriters should have begun preparing for this risk ten years ago, but perhaps got lulled into a sense of complacency when nothing bad happened the first time around.

If that’s the case, the best time to start making changes was yesterday and the next best time is today. Hope is not a strategy!