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American International Group
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.
King Hank, fit and rested
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.
Copyright © 2002 The Economist Newspaper and The Economist Group. All rights
reserved.
End<{{{~~~~~~~~~~~~~~~
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