AIG economist.com
Shine a light
Feb 28th 2002 | NEW YORK
From The Economist print edition
Can the world's biggest insurer continue with its old,
inscrutable ways?
HE MAY remain chief
executive of AIG for the
rest of this year—and quite
possibly next year, the one
after, and the one after
that. Even Maurice (“Hank”)
Greenberg, at 76, would
admit, though, that
actuarial tables point to a
shorter career in front of
him than behind. Rumours
about Mr Greenberg's health
raced through the insurance
world last week, in true
Kremlin-watching style,
after he failed to make a rare scheduled appearance at an insurers'
annual get-together in Bermuda. His absence, said his deputies,
was merely a case of the flu, but worried investors sent AIG's
share price down. Even after a tanned and rested Mr Greenberg
was hauled before analysts and hacks for a body check on
February 25th—he was not ill, he insisted, but merely
contemptuous of the Bermuda get-together's intellectual
content—the share price barely recovered. As it happens, the old
king has failed publicly to anoint a successor.
Concern about Mr Greenberg comes at an awkward time for AIG. It
has the largest share of America's commercial market and 85,000
employees, in 300 divisions, working around the world. September
11th created new levels of uncertainty for the group, even though
in the long run it should help to boost demand for insurance. Then
came Enron's collapse, which raised a whole raft of concerns
about corporate America: conflicts of interest on Wall Street,
impenetrable accounting, the offshore registration of corporate
vehicles, large financial exposures, unhealthy deference given to
celebrity chief executives, and high share valuations. Every one of
these concerns is germane to AIG.
AIG has a stockmarket valuation of $190 billion, making it second
among financial companies only to Citigroup's $225 billion. Some 17
years of rising profits have earned the company respect from
investors. Now caution is creeping in. Can AIG perform in a more
volatile world as well as it has in the past? Is there a cohesive
picture of what AIG does? Do Wall Street analysts offer an
impartial picture of AIG's prospects, given that their banks take in
and invest billions of dollars in insurance premiums from the
company?
The insurer certainly uses its muscle to shape how markets
perceive it. Ask somebody in the insurance world for his candid
view of AIG, and he looks palpably uncomfortable. Mr Greenberg's
charm often disarms, but he can terrify too. Share analysts foolish
enough to issue a critical comment about AIG get a blistering
phone call. If they are unlucky, they hear the criticism
second-hand, from their irate boss. Mr Greenberg says he
complains only when the facts are wrong, but he cannot recall a
critical report where the facts were right. The company's share
price has fallen by 30% since late 2000, yet no analyst, according
to First Call, has rated it a “sell”.
On valuation grounds alone, the faith placed by investors in AIG
invites scepticism. Consider some analysis done for The Economist
by Seabury Insurance Capital, a financial-advisory firm in New
York. It looked at each of AIG's main businesses: life insurance,
property-and-casualty insurance, asset management and a
catch-all called financial products, which includes the world's
biggest aircraft-leasing business. Each business was compared
with the best in its field, or, in the case of financial products, with
a hybrid of various top competitors. A composite valuation was
then reached. (Click here to download Seabury's full analysis.)
The result: if AIG were valued in line with its best competitors, its
stockmarket capitalisation would be almost $100 billion lower than
it is. If AIG were compared with insurers of similar size and
financial strength, the disparity would be even greater: $120
billion. For that to be justified, AIG's profits would have to grow
almost two-thirds faster each year than similar companies, for at
least the next 25 years.
To justify such investor confidence, you might also assume that
unusual clarity prevails about AIG's operations, accounting and
prospects. The opposite is true. Few large companies are more
inscrutable than Mr Greenberg's.
Black hole at the heart
On the face of it, AIG appears a quintessential American
corporation. A skyscraper in lower Manhattan serves as its
headquarters. Its board is stuffed with the great and good who
have represented America abroad: Barber Conable, former
congressman and president of the World Bank, Carla Hills, a former
trade representative, and Richard Holbrooke, recently United
Nations ambassador. The company's interests are often advanced
by the White House itself, most recently in China, whose
accession to the World Trade Organisation was complicated at the
last minute by European resentment of AIG's uniquely granted right
to have a wholly-owned subsidiary there.
In another way, it is not clear that AIG is an American company at
all. On top of many subsidiaries in countries where the company
sells insurance, more than 50 AIG entities, many with global reach,
are registered in Bermuda. A principle of America's securities law is
disclosure, including of corporate control and executive pay.
According to AIG's proxy statement, the only block of shares of
more than 5% of the company is a 14% stake, worth $26 billion,
the ownership of which is impenetrable. This stake plays a crucial
role at AIG in both compensation and control.
The owner of the block is recorded as Starr International, a
private company named after Cornelius Vander Starr, who in 1919
founded the group in Shanghai. Starr International is a private
company funded, in what Mr Greenberg calls an unprecedented act
of generosity, by the eight shareholders who owned AIG when it
went public in 1970. They put up $120m in AIG shares—the
difference between their book value and the offer price.
Some 800 AIG managers now own Starr.
AIG's proxy gives its home as a Bermuda
post-office box, yet according to the
company's thin file in Bermuda's registry,
the true home is another box, this time in
Panama. In other words, the ownership
structure of America's second-largest
financial institution is, for all practical
purposes, immune to many aspects of
American law and taxation.
The routine public filings that AIG posts
with American regulators are widely
considered to be unfathomable. When
challenged, AIG notes that it provides
abundant disclosure, including 40 pages
of densely written footnotes in its most
recent annual report, as well as extraordinarily detailed statements
with the Securities and Exchange Commission. But while the
company provides great gobs of information, it is all but impossible
to put them together. While AIG boasts of its dominance in various
business lines and countries, it discloses only the broadest loss
ratios. A source of its resilience is a willingness to reinsure about
one-quarter of its underwriting, so spreading risk, but no outsider
knows what business it keeps and what it cedes. Plenty of
opportunity exists, if not for creative accounting, then certainly
for inscrutability.
Part of the recent fall in AIG's share price can presumably be
explained by suspicions about sophisticated but opaque forms of
financial engineering. The insurer was hit with a $69m loss linked
to Enron, and it is now at the centre of a dispute over
off-balance-sheet partnerships held by PNC Financial, a regional
American bank. AIG is a large and growing participant in complex
derivatives markets. It says that derivatives play an important
part in reducing the company's overall risk. From the outside, all
that is clear is that AIG's credit exposure to derivatives is rising,
from $17 billion in 1999 to $33 billion in 2000, according to the
most recent annual report. Gross exposure has grown from $435
billion to $544 billion.
Any cracks in the confidence that AIG knows what it is doing in
derivatives would be highly damaging. The company has a triple-A
rating from Standard & Poor's, in part because a conventional
analysis of its balance sheet shows AIG to be well-capitalised. A
top-notch credit rating counts for much, particularly in skittish
markets like Japan, where local insurers are chronically weak. A
good rating gives AIG a low cost of funding. So it is a concern that
recent volatility in AIG's share price probably lowers other,
quantitative ratings that rely more on market data.
Brand values
So how does AIG make money? If it has a brand identity, it is one
better known among investors than customers. Indeed, AIG
operates under a welter of names: Lexington, National Union,
Audubon Indemnity, United Guaranty, Société Anonyme
d'Intermédiares Luxembourgeois, and so on.
The common thread is an aggressive approach. AIG is known as an
intense meritocracy, filled with people who come in early and leave
late. Base pay is low, but bonuses are tied to the company's share
price, which everybody at AIG seems to know at any time of the
day. Every department must present an annual budget to Mr
Greenberg himself. The scrutiny is brutal. Managers have been
known to ask for lower spending limits—in the hope of making
planned returns—only to have their requests rejected. Corporate
intelligence, too, is viewed as high art. Mr Greenberg himself calls
employees at every level to keep tabs on his own company. Often,
AIG appears to have better information about the workings of
other companies than the companies have themselves.
Prized employees are tied in with compensation agreements that
pay out chiefly at career's end. Millionaires among senior
management are commonplace; there are billionaires as well.
Corporate notions of loyalty to staff are strong. Stories circulate
of Mr Greenberg's own aircraft being sent to bring sick employees
for care at New York-Presbyterian hospital (home to the Greenberg
wing), and of his secretary evacuated from Lebanon in the midst
of war. Headhunters say that AIG employees are reluctant to get
in touch, partly for fear of being fingered as disloyal.
For some, nothing can compensate for Mr Greenberg's demands.
Among those who have left are his sons, Jeffrey, now chairman of
Marsh & McLennan, a giant insurance broker, and Evan, in charge
of reinsurance for Ace, a fast-growing company based in Bermuda.
Both were, at different times, considered Mr Greenberg's
heir-apparent. Mr Greenberg says only that there is a plan for a
successor; that he prefers him to be an insider; and that people
should stop asking questions.
It is a heated environment, in which opportunities are grabbed
quickly. AIG sells all the common insurance products, but it is best
known for specialised insurance, including policies for corporate
directors and executives, for political risk and for oil rigs—the
difficult markets, in other words, that Lloyd's of London once
dominated. Its response to disasters puts competitors to shame.
The destruction of the World Trade Centre cost AIG more than
$800m in claims. Within days, however, it had arranged a $500m
insurance line for foreign airlines that desperately needed coverage
if they were to continue to fly. As well as being fast, AIG is
efficient, with operating costs a quarter below the industry
average. That allows it to make what few other underwriters can:
a profit before adding investment income.
The flipside of AIG's reputation is the firm's sharp edge, most
evident in its treatment of claims. Many insurance brokers contend
that good customers justifiably pay more to buy insurance
elsewhere. Fighting AIG is not easy. Almost all the big law firms
count the company as a valuable client, and so cannot easily
represent plaintiffs. Mr Greenberg rebuts the criticism. “We would
not be the biggest if we failed to pay,” he says.
Playing hardball often works in insurance, but it has drawbacks
elsewhere. Last year AIG escaped paying out on a financial
guarantee, worth $182m, for a series of Hollywood films, a decision
that caused one of the rare defaults of a security rated triple-A.
The convention in the world of financial guarantees, just as for
bank letters of credit, is to pay first, and sue later. As a result,
says a participant, AIG is largely locked out of these markets.
At least for now. AIG is hardly inflexible: just look at Mr
Greenberg's swift response to the rumours about his own
impending demise. Now, AIG promises quarterly conference calls,
between Mr Greenberg and analysts and investors, to discuss
profits and give more detail on each of the insurance operations,
rather than just issue brief releases. Investors will get a day each
year to meet managers at AIG. Reassurances, sure. However, AIG
has yet publicly to anoint a successor, clear up its overseas
registrations, find a way to provide confidence in accounting for
derivatives, and persuade investors it is properly scrutinised by
regulators. In short, it has yet to give up being AIG.
Country Briefing:
United States
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