In all the commentary and discussion about the source of AIG’s problems I’ve yet to read or hear what may be the most important contributor – the company’s culture.
There’s no question AIG was long considered one of the world’s best run insurance companies. AIG is legendary for its intramural hypercompetitiveness. The company would rather one of its subsidiaries lose an account or prospect to another internal subsidiary than to an outside firm. The rewards (up till now) for winning those competitions have been huge – the top execs at AIG become Starr Partners, a highly lucrative status.
AIG’s hundreds of subsidiary companies compete against each other for insurance business, talent, resources and recognition. The rules are few, but ironclad – chief among them return an underwriting profit (make sure the combined losses and admin expense is less than premiums). All investment income accrues to the parent organization, where various investment entities compete to deliver the best results.
By several accounts, one result of this business model has been a consistent under-investment in non-revenue driving IT, and a lack of emphasis on paying claims. AIG was one of the first insurers to embrace the web to sell to consumers and small businesses; it also infuriated regulators and medical providers when it screwed up the consolidation of workers comp medical processing by eliminating regional processing centers. Bills were lost, repeatedly processed incorrectly, and paid to the wrong provider.
The company’s auto business has grown substantially over the last decade, yet many insureds are none too happy with the company. An article several years ago highlighted complaints from some of AIG’s commercial clients; here’s an excerpt:
“AIG was losing more than $210 million on auto-warranty claims, provoking the ire of the company’s longtime chairman and chief executive, Maurice R. “Hank” Greenberg, according to court documents. As a result, in mid-1999, a newly installed team at AIG’s auto-warranty division began to reject thousands of claims — including half of the claims that its own contractor, a claims-handling company, recommended be paid, according to court papers.”
I had the pleasure of working for AIG a bunch of years ago. At that time, AIG’s CEO and Chairman, Hank Greenberg, used to have Presidents’ meetings every month where the presidents of AIG’s subsidiaries would present (very briefly) a summary of how their business was doing. My sub was not doing particularly well, which is probably why I was asked to attend the meeting representing my boss’s boss.
Greenberg started at one end of the large U shaped table, with the first of about 25 presidents. After the brief presentation (two minutes or so) he’d grill them – with the temperature on ‘sear’. Fortunately, I was second on the flame, and still in shock when he asked me who I was and what I was doing there. After about thirty seconds of my babbling, he dismissed me as too low in the hierarchy to be worth his time and moved on.
I proceeded to watch as a couple dozen middle aged execs went thru their inquisition sessions. Most seemed to be doing a pretty good job, delivering solid results and expanding revenues, and a couple were doing very well. Despite that evident success, all were scared, several terrified, and at least a couple so distressed that I found them in the men’s room throwing up.
Although Greenberg departed several years ago, according to several insiders this culture still exists – the hypercompetitiveness, coupled with huge rewards for success and caustic tongue lashing from your superiors for anything but success. The combination of the two may have contributed to the company’s recent problems. Execs who are scared of their bosses are not likely to be first in line to tell them that the great investment in mortgage-backed securities or rate swaps has blown up. The turmoil in the executive suite may have distracted top management from tracking these issues as closely as they should have. The constant hectoring from Greenberg (after he was kicked out as a result of Spitzer investigation) certainly soaked up C-suite bandwidth that would have been well-applied to assessment of investment strategy.
That’s not an excuse, but may be a lesson.

AIG may not be alive and well, but it is still functioning. That’s the good news.
The real news is the source of the financial lifeline thrown to the big insurer – the state of New York. Gov David Paterson has authorized AIG to access $20 billion in capital currently locked up in subsidiary companies to increase the company’s liquidity (free cash on hand). The Governor’s permission essentially gave AIG more capital from internal sources, capital that the company had been desperately seeking (with little luck) from outside backers.
The $20 billion is half of the company’s immediate cash needs; sources indicate the firm is also looking to sell assets to come up with the other $20 billion. Tops on that list may be the General American, the auto insurance business, and AIG’s aircraft leasing subsidiary, long one of the company’s most profitable ventures, which would generate between $7 and $14 billion in proceeds.
The problem with selling International Lease Finance Corp. (the aircraft finance arm) is it is very profitable, generates lots of cash, and is particularly advantageous for AIG due to tax matters. ILFC buys aircraft and leases them to airlines, taking deductions for depreciation and other expenses that it can use to offset earnings – deductions that are more valuable for AIG than they would be to another owner.
AIG would very much like to hold onto ILFC, and it is just possible it will be able to do so. The Fed hired Morgan Stanley to help figure out what to do about AIG, and at this point it looks like the recommendation, and possible short term solution, is for Morgan to put together a pool of capital from JPMorgan Chase and Goldman Sachs to help AIG survive the current liquidity crisis.
And just to make the situation even more difficult, reserves for claims from Ike will also be hitting AIG’s financial statements in the next few weeks. While it is too early to tell precisely what AIG’s exposure may be, the company is one of the ‘second tier’ carriers in terms of property market share in that area, a position that will likely result in substantial claims costs.

Founded primarily to do business in China by Cornelius Starr (by all accounts both a good person and terrific businessman), insurance giant AIG has long been among the largest property and casualty insurers in the world.
That history may have a final chapter, written this week. Some reports indicate AIG may not make it past Thursday. At this moment the stock is trading at $12 a share, down 30% today and 83% from its 52 week high. The share price is now trading well below the company’s (reported) book value of $29 a share. That book value appears to be highly suspect, as it includes $20 billion in subprime mortgage securities, carried on the books at a discount of 31%.
The fall of AIG has a human dimension that is rather close to home; I worked at AIG in the mid-eighties, and know a number of individuals who continue to get their paychecks from the company. Most have a good chunk of their savings in the company’s heretofore terrific employee stock plan – savings that have all but disappeared as AIG craters. AIG’s senior management is rough, brutally competitive, arrogant – and historically very successful. That success has been delivered by the company’s 116,000 employees, many of whom now find their previously rosy financial future has been destroyed.
To show how fast things move, AIG stock is now at $5.89, fifteen minutes after I started this post.
The trigger for a collapse would be the threat by ratings agencies to downgrade AIG’s credit rating – a move that would allow AIG’s counterparties to pull their capital and business out of the company. Many of AIG’s insureds require the company to maintain an “A” rating from AM Best or similar rating agency, and if the rating declines the policyholders have the right, and in some cases the legal obligation, to cancel their coverage and move it to an A rated firm.
2008 has been awful for AIG – the company lost over $18 billion so far, due in part to the drop in value of the company’s investments in mortgage-backed securities and other credit-related investment declines. The credit market collapse – which has affected several big banks, Merrill Lynch, and Lehman Brothers, is also hammering AIG.
I’ll be thinking about the potential implications of this mess more later today, especially for what it may mean for the soft market and what parts of the company may be sold off by an acquirer.
In the meantime, it may well be that a collapse of AIG would cause the insurance market to harden rather quickly, as current policyholders scramble to obtain coverage, brokers push their clients to buy only from insurers with very low credit risk exposure, and insurers raise rates to add capital to bolster their financials.

The periphery of the trade show floor at RIMS is where you’ll find innovators – new companies, with new ideas and concepts, new solutions to old problems, all described by their owners, founders, and top execs. To give credit where credit is due, this isn’t my observation but rather one made by friend and colleague Peter Rousmaniere.
The choice spots on the exhibit floor are occupied by the seniority; RIMS assigns spots according to how many years an exhibitor has been attending, These spots are taken up by the big carriers, brokers, software suppliers, and managed care firms. Not a lot in terms of innovation here, although there are a couple of interesting new solutions to old problems.
Medata’s at RIMS with a new booth, new team, and renewed commitment to customer service. Long hampered by a (to be generous) lackadaisical approach to customer service, Medata is back, looking to take advantage of the turmoil in the market created by Coventry’s aggressive push to consolidate share; ACS’ acquisition of CompIQ; and the sale of FairIsaac’s bill review unit to Mitchell Medical.
Coventry is promoting a medical triage/first notice/network direction product that they’ve been working on for over a year. Early indications are the service can help reduce frequency – significantly. Kudos to the 900 pound gorilla; although the product looks a lot like Medcor’s version (which was developed earlier) at worst it shows Coventry knows a good thing when it sees it.
Medcor’s service combines the best of nurse triage, first notice and provider network direction, reducing the number of calls the payer (or its designees) need to make and the calls the injured worker needs to answer.
Datacare has a unique data aggregation platform, enabling payers to capture and integrate all documents in one location and automate links between UR and bill review – an all-too-often ignored but nonetheless critical part of the medical management process.
Paradigm has been in business for 15+ years, but this is the first year they’ve exhibited at RIMS. The company’s newest offering is a chronic pain program, which has shown strong results after a five-year development effort.
More tomorrow after my feet recover.

Last week it was the World Health Care Congress (perhaps the best conference I’ve ever attended in terms of content and quality). This week it is RIMS, the annual property and casualty get together, where brokers schmooze and vendors vend and risk managers are feted by carriers, TPAs, managed care firms and consultants.
Here’s what I’m looking for at RIMS 2008. New and different approaches to managed care, approaches that are not merely based on discounted care, but outcomes. And not just lip service or ‘we’re seriously studying this’ but programs that are in place, working, and delivering results.
Straight talk from vendors – what they can, and cannot, do. Results they’ve been able to deliver, and the keys to that performance. (Knowing that vendors can’t be successful unless payers work cooperatively with them)
Evidence that payers are not just talking about outcomes and smaller networks and ‘the right docs’ but actually doing something.
New trends, products, ideas, and companies – something that has been in short supply in this industry for too long.
Stay tuned.

As I reported last week, the softening market will inevitably lead to a significant increase in the number of mergers. Add another deal to the list.
In a deal just announced, Liberty Mutual is buying Safeco, the Seattle-based P&C carrier, for $6.2 billion in cash. The transaction is valued at $68.25 a share, and marks the second major acquisition by Liberty in the last few months.
Safeco will be part of Liberty’s Agency Markets business, a venture that was initiated by Liberty Chairman Ted Kelly several years ago. Prior to that, Liberty was a direct writer, and only sold thru its captive sale force (disclosure – I sold for LM for several years). The Agency Markets unit has been quite successful in helping Liberty land clients that would not buy direct, but had strong relationships with brokers.
Safeco joins America First, Indiana Insurance, Montgomery, Ohio Casualty, Peerless, Colorado Casualty, Golden Eagle, and Liberty Northwest as well as Wausau and Summit Holding.
The current financial state of the P&C market makes it highly likely, and I would even say inevitable, that more deals get done, and soon. There is more capital out there than places to park it, and with organic growth difficult and very expensive (the market is soft enough, and even Liberty can’t keep cutting prices forever) insurers looking to grow are going to have to do so thru acquisition.

The laws of supply and demand are making their impact felt in the P&C insurance industry – there is just too much capital chasing too few risks. Industry watchers have been surprised by how quickly P&C insurance premiums are dropping. For the first time since 1943, total premiums actually dropped last year – a result of price cutting by insurers and a worsening economy.
Profits are not falling as fast as revenues, but there have been significant declines, with the latest numbers indicating the P&C industry’s 2007 after-tax profits dropped 5.8% from 2006 to 2007. The net impact of the decline in revenue and profit is a 2007 return on equity (actually policyholder surplus, the industry’s proxy for RoE) of 12.3%, compared to a Fortune 500 RoE of 13.9%.
Yet capital still loves the insurance industry. It is still generating a profit based solely on underwriting (not taking into account investment returns), a happy event all too rare in the P&C business. And many in the industry are talking about how this time will be different, because they have better information, are more disciplined, will underwrite better, and won’t repeat the mistakes of the late nineties. Just like they said last time.
What’s this all mean?
Over the short term, better pricing for insurance buyers, and better coverage terms as well.
Continued blood-letting in the TPA market, which is getting uglier by the minute as normally self-insured risks buy insurance for less than their TPA’s loss pick. (Tough time for CorVel to get into the TPA market…)
And a significant increase in the number of mergers. Cochran Caronia published an insightful study last year linking the M&A cycle to the insurance cycle (and presented same at last summer’s AMCOMP conference). In that report, they predicted a 10-15% price drop for P&C insurance this year – so far, that looks spot-on, adding credibility to their forecast. Cochran expects reinsurers to invest in MGAs and buy or merge with primary carriers.
Primary carriers will also acquire other insurers and/or buy up MGAs to “capture the incremental underwriting income.” Liberty Mutual’s purchase of Ohio Casualty a year ago, and HCC’s acquisition of Kendrick and Associates are but two examples.
When will this stop? If reinsurers get hit hard (think hurricanes), there is a man-made disaster, or the world-wide economy picks up steam quickly, things could turn. Until then, insurers will slowly bleed themselves until they can’t take it any more.
Then the market will start to rebuild itself, on the rubble of the insurers who were convinced that this time they would be smarter.

The relatively mild hurricane seasons of the past two years and the lack of other catastrophic weather events has been largely responsible for the significant profits generated by reinsurers. Indications are the happy days of low losses and high profits are ending, as reinsurance premium rates are on the decline.
That’s good news for primary carriers, and also for policyholders – companies, governments, taxpayers, and individuals – for two reasons.
Declining premium rates mean primary insurers spend less on reinsurance. In turn, primary carriers’ profits increase, and/or they cut their policyholders’ premiums.

Continue reading Why reinsurance rates matter