Exclusive Memoir

In Memoriam: Liam McGee

Recalling the turnaround at The Hartford, in his own words.
By: | July 1, 2015 • 12 min read
Liam McGee CEo The Hartford

Part One of an exclusive two-part memoir written before McGee’s untimely death in February.

In the wake of the Great Recession, it’s tempting to think that the surviving banks and other financial service companies have gotten a severe wake-up call.

Surely they’ve become very different companies now. They must have overhauled their controls and their strategies to prevent themselves from carrying so much risk in the future.

I’m hopeful that things have changed, but my own experiences have sobered me on this point. Organizational overhaul is possible, but it is difficult.

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When I became CEO of The Hartford in October 2009, soon after the company nearly collapsed, I was struck by the organization’s resistance to major change. I didn’t find a sense of urgency.

We ultimately succeeded in restoring the company’s strength, and it is now well positioned for future growth. But it was much more challenging than I expected.

Good Intentions Gone Bad

Founded in 1810, The Hartford Financial Services Group was one of the largest property and casualty insurers in the United States in the 1990s. That’s when the managers in the company’s small life insurance business started offering variable annuities.

Let’s start with how The Hartford got in such a mess.

Their initial success in this new product category led to a major push, to the point where the company became an industry leader and a stock market darling. But as the annuity marketplace became crowded, the company tried to maintain its growth with riskier products and expansion to overseas markets, supported in turn by a riskier investment portfolio.

The financial crisis of 2008 brought this all to an end, and the stock price fell from $100 all the way to the low single digits. Only a $3.4 billion capital infusion from the federal government’s Troubled Asset Relief Program, coupled with $2.5 billion in crisis capital from the big European insurer Allianz, kept the company going.

From the outside, the turnaround of The Hartford might look pretty simple. In the short term, we got a lift from the recovery in the financial markets.

We also had a successful capital raise in March 2010. That allowed us to pay off TARP and gain breathing room to work on the underlying problem. (We paid off Allianz a year later.)

We then determined that the company’s balance sheet was simply not big enough to absorb the risk in the annuity business, so we stopped issuing new policies. The remaining life-related activities were not strong enough to survive on their own, so we sold those off to better-capitalized companies that specialized in those areas.

We refocused around our historic expertise in property and casualty insurance, which had languished during the run-up in annuities. The company is now in a solid capital position, with much better risk-management capabilities and a more collaborative senior executive team. It’s poised for sustained growth.

Rule of thumb: Financial services firms are just not equipped to handle revenues rising much faster than the rate of GDP growth.

Like other financial services companies that sank in 2008, however, the story is more complicated. Let’s start with how The Hartford got in such a mess.

It had lots of smart, talented people who understood risk. The people in variable annuities started off doing just what they were supposed to do: exploring opportunities. When the product became a hit, they understandably built up a process to ramp up sales domestically.

Then they went overseas, including a decision to enter Japan without hedging the currency risk. Executives in headquarters, delighted at the profitable growth, encouraged them, while investors cheered.

Prompted by The Hartford’s successes, competitors entered the markets and offered even riskier annuity products. It was the same story that played out elsewhere in the run-up to the financial crisis, with subprime lending, collateralized debt obligations and other financial innovations that got out of hand.

Liam McGee CEO of The Hartford 2009-2014

Liam McGee
CEO of The Hartford
2009-2014

Soon, the company was growing faster than it could add infrastructure to support the added size. It didn’t keep up with risk management and technology platforms in the life business, because all the spare capital went directly into new annuity programs.

Rule of thumb: Financial services firms are just not equipped to handle revenues rising much faster than the rate of GDP growth.

The complexity was the biggest challenge, as The Hartford was suddenly a multi-line business, not a P&C-dominated company with a few smaller operations.

Each division was watching over its own risk in the narrow sense, but management did not develop a strong risk management function at the corporate level. It couldn’t aggregate the risks from the separate divisions.

Meanwhile the rapid growth in the company’s annuity and other life businesses meant that the company had to build up its investment portfolio quickly. It had a lot of liquidity to invest.

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But the investment management division’s incentives were geared to maximize return, not to balance risk versus reward. The division lacked the tools to properly assess the risk it was taking or to see how it correlated to risks embedded in the annuity products that were being sold.

Like a sales force rewarded for gross revenue, not profitability, the managers didn’t fully factor risk into their investments. As a result, like many investors, they went after riskier assets, especially securities backed by commercial and residential real estate — right before the real estate market crashed.

The Hartford’s organization was inevitably influenced by the mood in financial services generally. People were dazzled by complex new packages of securities that managed risk in creative new ways. So the real estate bubble didn’t bother The Hartford’s executives as much as it should have. They tolerated more risk than they would have otherwise.

When one of your businesses is thriving, it’s hard for anyone at headquarters to tell it what to do.

Still, there were certainly smart people who understood that The Hartford had bitten off more than it could chew. In 2007, the company decided not to match competitors that were adding even riskier elements to their variable annuities. And well before the crash, some executives were urging the company to cease selling annuities or to sell the life business to a better-capitalized rival.

But decisions were deferred by leaders who understandably couldn’t give up on the money machine. When the company finally accepted the seriousness of the situation, the economy tanked.

It’s easy to blame headquarters for failing to assess risk at the corporate level. But you have to remember that throughout its history, The Hartford had had a fairly narrow product line.

When one of your businesses is growing fast, you want to put your resources first into supporting that business directly. That leaves less time and energy to put into setting up new resources at the corporate level. Assessing aggregate risk is a complex undertaking that requires sophisticated tools and staff.

It’s a political as well as a resource challenge. When one of your businesses is thriving, it’s hard for anyone at headquarters to tell it what to do. And traditionally, the business unit CFOs had much more power than their corporate counterpart, who was more of an adviser than a boss.

After all, even larger insurance companies had trouble understanding their risk as they diversified. When AIG got in trouble in 2008 because of its complex financial products, regulators struggled to capture the total risk and calculate how much capital the company needed to regain its footing.

For headquarters, allowing a successful product line to keep expanding is one kind of decision, a pretty easy one. But reining in that same product line because of risk on the corporate level is a much harder decision that inevitably invites pushback from the managers whose bonuses depend on the business.

Insurance involves long time horizons, so people like to deliberate and study a problem carefully. You can always find a relevant issue to justify a delay. Combine that with a headquarters staff less powerful than the businesses it’s supposed to oversee, and you inevitably end up with a kind of “states-rights” mentality that refrains from making tough calls.

Don’t Assume You Have a Burning Platform

Turnarounds may be tough, the thinking goes, but at least people will be open to changes. They know their company is in trouble, so you’ll get less of the political resistance you usually find when you push a major initiative.

That’s certainly what I thought. When I was offered the CEO position in September 2009, the company was in such bad shape that I almost didn’t accept.

Even with the TARP bailout to cover some of the toxic assets and buy some time, I worried that the unprofitable annuity policies, especially in Japan, would destroy the company’s insurance ratings and therefore its ability to compete.

The problems were so severe, and so clear to me from the outside, that I assumed the organization shared my anxiety. I had very little background in insurance, so I figured I got the job because the directors wanted a fresh start. At least I would have a burning platform.

Boy was I wrong. Many senior executives didn’t think things were so bad. They blamed the troubles on the deep recession coupled with some excesses in variable annuities. Now that they had the TARP and Allianz money, they figured they needed to make only incremental changes and just ride out the inevitable economic recovery.

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After all, they had had such an impressive run of profitable growth until 2007. It was hard to give that up and fashion a new strategy. At a minimum, they argued, difficult decisions should be deferred to give the economy time to improve and rectify our situation.

The company’s siloed structure also kept people from seeing the big picture. Executives could focus on their individual product lines and customer bases, rather than the macro financials.

At the same time, the size of the overall company insulated them from threats in the marketplace. How could a big, 200-year-old institution like The Hartford really be in dire straits?

People weren’t outright opposed to changing the strategy. I found several plans filed away when I arrived. Almost every kind of move had been looked into. But I still remember those early meetings, where we would talk for hours about a change. And then people would want to go back and study the issue further. I wanted to move forward, but the organization didn’t share the same urgency.

Start Changing Everything

The first thing I did was to focus on the immediate challenge: boosting our capital levels in order to withstand the continuing volatility in the market. As an insurer, we had strict rules in place to protect policyholders. Once we were able to raise capital, in March 2010, I was eager to focus on the strategic issues.

We formulated a rough strategy as follows. We wanted to be in businesses with growth prospects, where we could invest and increase profits. But these businesses had to generate capital over time, not consume capital. And third, they had to lower the overall market volatility for the firm.

Which businesses should we sell, in what kind of package, and when? We needed to find a buyer at a good price. And how were we going to unload the Japan albatross?

By those standards, the life business didn’t make sense. The only way we could make the credible guarantees we needed for a competitive annuity business was through a much bigger boost in our capital ratios. That wasn’t going to happen.

The annuities really belonged in the hands of a scale player. As for individual life insurance and other products in the life division, we didn’t have a strong enough market position to expect much growth. The annuities really dominated the division.

Meanwhile, we still had a core competency in property and casualty. Parts of that business had atrophied because the company had put most of its available capital into the annuities business, but it was still performing reasonably well with a strong market position. It also came with ancillary businesses in employee benefits. So we formulated a clear strategy to return to the company’s historic focus on property and casualty.

I was eager to move forward, but we couldn’t, for two reasons. First, like most financial services companies in multiple businesses, the company’s position was so complex and market-dependent that the structure couldn’t change quickly.

Which businesses should we sell, in what kind of package, and when? We needed to find a buyer at a good price. And how were we going to unload the Japan albatross?

Second, I didn’t think the existing senior team was capable of such a major shift. They had just gotten too used to the old ways, and would have difficulty with major changes.

So we set the overall direction, but we couldn’t carry it out immediately. We were also hoping to get some short-term benefit from the “green shoots” of economic recovery that people were talking about in early 2010. Our mix of businesses wouldn’t work in the long term, but in the short term they could improve their numbers and get us a better purchase price down the road.

Meanwhile, I realized we needed to get to work overhauling the company’s culture. We needed to make the company more decisive, and make people think outside their own silos.

That latter point really came home to me when all the senior managers in the company got together to discuss the big issues. It seemed an obvious thing for a Fortune 100 company to do. But it turns out they never did.

When we held our first gathering of the top 50 or so executives, most of them didn’t understand the point of it all. Many had never met their counterparts in different business lines. “What did all of this corporate talk have to do with me?”

To get everyone focused on the whole company, we launched the “One Hartford” campaign. Executive bonuses got flipped around so people couldn’t get big payouts unless the company as a whole prospered. Division-level results still mattered, but the priorities were clear.

Without that foundation, people wouldn’t be willing to speak out on problems that affected The Hartford as a whole. We wouldn’t get the support we needed for carrying out the new strategy. We might still be able to restructure the company, but it would fall into the same kind of trap in the next recession.

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We also developed significant risk management capabilities. The board established a risk committee composed of all the directors, and it convened at each quarterly board meeting. I established a chief risk officer position, reporting directly to me as CEO.

Working through an internal committee of all our senior leaders, the CRO, CFO and I established credit, market and other risk tolerances, and presented scorecards on each at every board meeting. We now understood the risks in each of our businesses and in our investment portfolio, and how those risks correlated.

Part Two of Liam McGee’s account of turning around The Hartford will be published online by Risk & Insurance on Wednesday, July 15.

Liam McGee led The Hartford from 2009 through 2014. He passed away in February, 2015.
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Risk Insider: Beaumont Vance

Risk Management Kills

By: | July 1, 2015 • 3 min read
Beaumont Vance is an executive risk manager. He has managed strategic risk for Fortune 100 firms for the past 15 years. His multidisciplinary approach weaves together such disparate fields as quant modeling, statistics, behavioral economics, biology and game theory into practical solutions and insights.
Topics: Risk Insider

It seems a noble goal of risk management to not only help an organization to survive large losses, but also to save lives. Unfortunately, human beings are not always good at judging risk, especially where death is involved. Risk management can kill you.

Of course, death by risk management is not a catchy headline.

Shark attack, however, is a great headline.

This summer the press picked up the story of two shark attacks in the same day in North Carolina. The risk managers of the world leapt into action. One news story covered one agency that is patrolling the beaches of the Carolinas with drones.

So what could possibly be wrong with pouring resources into the prevention of shark attacks?

Christopher Ingraham of the Washington Post published an excellent blog, “The animals that are most likely to kill you this summer.” In it he showed the statistics from the Centers for Disease Control on death by several animals.

It turns out that, on average, one person per year is killed by a shark. Twenty people per year are killed by cows, and 52 are killed by deer (excluding car accidents!)

Unfortunately, human beings are not always good at judging risk, especially where death is involved. Risk management can kill you.

I looked, but could not find any governmental agency monitoring murderous deer via drone. In fact, it is hard to imagine someone shouting “DEER!” and hordes of people running from the park screaming and dragging their children to safety like a scene from the movie Jaws.

The truly interesting thing about Mr.Ingraham’s article was how readers reacted. Most felt that he had twisted the facts and was “lying with statistics.” He was not.

The reason readers felt that his statistics had to be false was because of something called cognitive bias. A cognitive bias is like a bug in a computer program, only it affects how our brain processes probabilities around outcomes where risk and reward are involved.

The specific cognitive bias involved here (there are over 200 of them) is called availability bias.

Here is how it works: If a person is asked to judge which is more likely to occur — death by shark attack or death by deer attack — their brain starts searching for memories of these events. Whichever event can be called up first is deemed as being more likely. In this case, it is almost impossible to image a murderous deer pouncing on its unexpected victim. So the brain decides quickly and subconsciously that shark attack must be the more likely event.

After the 9/11 attacks, people were bombarded with images of the planes smashing into the Twin Towers. As a result, the most available risk in their minds was a plane crash.

In order to avoid the risk of death by plane crash, many people chose to drive instead of fly. As a result, auto deaths increased by well over 3,000.

In the end, the seemingly prudent choice to drive instead of fly killed more people than the 9/11 attacks.

In other words, risk avoidance killed more people than the terrorists.

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Sponsored: Lexington Insurance

Pathogens, Allergens and Globalization – Oh My!

Allergens and global supply chain increases risk to food manufacturers. But new analytical approaches help quantify potential contamination exposure.
By: | June 1, 2015 • 6 min read
Lex_BrandedContent

In 2014, a particular brand of cumin was used by dozens of food manufacturers to produce everything from spice mixes, hummus and bread crumbs to seasoned beef, poultry and pork products.

Yet, unbeknownst to these manufacturers, a potentially deadly contaminant was lurking…

Peanuts.

What followed was the largest allergy-related recall since the U.S. Food Allergen Labeling and Consumer Protection Act became law in 2006. Retailers pulled 600,000 pounds of meat off the market, as well as hundreds of other products. As of May 2015, reports of peanut contaminated cumin were still being posted by FDA.

Food manufacturing executives have long known that a product contamination event is a looming risk to their business. While pathogens remain a threat, the dramatic increase in food allergen recalls coupled with distant, global supply chains creates an even more unpredictable and perilous exposure.

Recently peanut, an allergen in cumin, has joined the increasing list of unlikely contaminants, taking its place among a growing list that includes melamine, mineral oil, Sudan red and others.

Lex_BrandedContent“I have seen bacterial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant.”

— Nicky Alexandru, global head of Crisis Management at AIG

“An event such as the cumin contamination has a domino effect in the supply chain,” said Nicky Alexandru, global head of Crisis Management at AIG, which was the first company to provide contaminated product coverage almost 30 years ago. “With an ingredient like the cumin being used in hundreds of products, the third party damages add up quickly and may bankrupt the supplier. This leaves manufacturers with no ability to recoup their losses.”

“The result is that a single contaminated ingredient may cause damage on a global scale,” added Robert Nevin, vice president at Lexington Insurance Company, an AIG company.

Quality and food safety professionals are able to drive product safety in their own manufacturing operations utilizing processes like kill steps and foreign material detection. But such measures are ineffective against an unexpected contaminant. “Food and beverage manufacturers are constantly challenged to anticipate and foresee unlikely sources of potential contamination leading to product recall,” said Alexandru. “They understandably have more control over their own manufacturing environment but can’t always predict a distant supply chain failure.”

And while companies of various sizes are impacted by a contamination, small to medium size manufacturers are at particular risk. With less of a capital cushion, many of these companies could be forced out of business.

Historically, manufacturing executives were hindered in their risk mitigation efforts by a perceived inability to quantify the exposure. After all, one can’t manage what one can’t measure. But AIG has developed a new approach to calculate the monetary exposure for the individual analysis of the three major elements of a product contamination event: product recall and replacement, restoring a safe manufacturing environment and loss of market. With this more precise cost calculation in hand, risk managers and brokers can pursue more successful risk mitigation and management strategies.


Product Recall and Replacement

Lex_BrandedContentWhether the contamination is a microorganism or an allergen, the immediate steps are always the same. The affected products are identified, recalled and destroyed. New product has to be manufactured and shipped to fill the void created by the recall.

The recall and replacement element can be estimated using company data or models, such as NOVI. Most companies can estimate the maximum amount of product available in the stream of commerce at any point in time. NOVI, a free online tool provided by AIG, estimates the recall exposures associated with a contamination event.


Restore a Safe Manufacturing Environment

Once the recall is underway, concurrent resources are focused on removing the contamination from the manufacturing process, and restarting production.

“Unfortunately, this phase often results in shell-shocked managers,” said Nevin. “Most contingency planning focuses on the costs associated with the recall but fail to adequately plan for cleanup and downtime.”

“The losses associated with this phase can be similar to a fire or other property loss that causes the operation to shut down. The consequential financial loss is the same whether the plant is shut down due to a fire or a pathogen contamination.” added Alexandru. “And then you have to factor in the clean-up costs.”

Lex_BrandedContentLocating the source of pathogen contamination can make disinfecting a plant after a contamination event more difficult. A single microorganism living in a pipe or in a crevice can create an ongoing contamination.

“I have seen microbial contaminations that are more damaging to a company’s finances than if a fire burnt down the entire plant,” observed Alexandru.

Handling an allergen contamination can be more straightforward because it may be restricted to a single batch. That is, unless there is ingredient used across multiple batches and products that contains an unknown allergen, like peanut residual in cumin.

Supply chain investigation and testing associated with identifying a cross-contaminated ingredient is complicated, costly and time consuming. Again, the supplier can be rendered bankrupt leaving them unable to provide financial reimbursement to client manufacturers.

Lex_BrandedContent“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet. Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”

— Robert Nevin, vice president at Lexington Insurance, an AIG company


Loss of Market

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While the manufacturer is focused on recall and cleanup, the world of commerce continues without them. Customers shift to new suppliers or brands, often resulting in permanent damage to the manufacturer’s market share.

For manufacturers providing private label products to large retailers or grocers, the loss of a single client can be catastrophic.

“Often the customer will deem continuing the relationship as too risky and will switch to another supplier, or redistribute the business to existing suppliers” said Alexandru. “The manufacturer simply cannot find a replacement client; after all, there are a limited number of national retailers.”

On the consumer front, buyers may decide to switch brands based on the negative publicity or simply shift allegiance to another product. Given the competitiveness of the food business, it’s very difficult and costly to get consumers to come back.

“It’s a sad fact that by the time a manufacturer completes a recall, cleans up the plant and gets the product back on the shelf, some people may be hesitant to buy it.” said Nevin.

A complicating factor not always planned for by small and mid-sized companies, is publicity.

The recent incident surrounding a serious ice cream contamination forced both regulatory agencies and the manufacturer to be aggressive in remedial actions. The details of this incident and other contamination events were swiftly and highly publicized. This can be as damaging as the contamination itself and may exacerbate any or all of the three elements discussed above.


Estimating the Financial Risk May Save Your Company

“In our experience, most companies retain product contamination losses within their own balance sheet.” Nevin said. “But in reality, they rarely do a thorough evaluation of the financial risk and sometimes the company simply cannot absorb the financial consequences of a contamination. Potential for loss is much greater when factoring in all three components of a contamination event.”

This brief video provides a concise overview of the three elements of the product contamination event and the NOVI tool and benefits:

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“Until companies recognize the true magnitude of the financial risk and account for each of three components of a contamination, they can’t effectively protect their balance sheet,” he said. “Businesses can end up buying too little or no coverage at all, and before they know it, their business is gone.”

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This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Lexington Insurance. The editorial staff of Risk & Insurance had no role in its preparation.




Lexington Insurance Company, an AIG Company, is the leading U.S.-based surplus lines insurer.
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