Editor's note: This article discusses events that led to the collapse of AIG. Unless otherwise noted, all references to AIG relate to the holding company, not the property/casualty insurance company now branded Chartis.
By JACK ROBERTS, the former editor-in-chief of Risk & InsuranceŽ, is managing principal of the New Street Group and
MATTHEW KAHN, the publisher and executive editor of Risk & InsuranceŽ.
NEW YORK --The story of AIG's relentless rise and rapid near-collapse is one of extremes, but the lessons are applicable to businesses of all sizes and in all industries.
For those in the risk and insurance management profession, the critical lesson of AIG is the importance of what could be called "risk leadership," and the fundamental tenet that the CEO must be the risk leader.
Under former Chairman and CEO Maurice "Hank" Greenberg, AIG was a bastion of corporate dominance reaching a market value of more than $160 billion, posting consistent profits and becoming the leading global insurance company.
At the center of Greenberg's 40-year tenure was an "obsession with risk," as one colleague said, with Greenberg defining his role in his own words as "the chief risk officer" of an "enterprise risk company.''
"You can't push off the question of leadership to anyone else but yourself," said Kevin H. Kelley, CEO of specialty insurer Ironshore, who spent decades at AIG working with Greenberg before leaving for Ironshore nearly three years ago. "A CEO needs to look at all of the business, understand how they relate to one another, and conclude what would happen if the business turned and produced an unexpected loss."
The CEO's behavior and strategy is critical to how a company handles the daily challenges of risk, and either assures its long-term success, or seals its eventual failure.
Risk leadership consists of: creating a risk-aware culture; implementing a long-term compensation structure that rewards risk-informed decision-making; and understanding at a granular level the daily business that balances opportunity and downside risk.
It's hard to find a better archetype of a risk leader than Greenberg, now chairman and CEO of Starr Companies, a diversified financial services company.
In an interview at his Manhattan office with Risk & InsuranceŽin July, Greenberg, 86, discussed a range of issues focused on risk management and risk leadership, including the growth of Starr Companies, his career in insurance, and tenure at AIG.
A RISK-AWARE CULTURE
S. Michael McLaughlin, who heads Deloitte Consulting's U.S. life actuarial insurance practice, said the "CEO sets the tone for the organization." The CEO, he said, "needs to encourage risk-intelligent decisions."
"Hank is a very conservative guy and he is always concerned about downside protection," said Kelley, who worked closely with Greenberg while at AIG.
"You have to build a culture within an organization." Greenberg said. "That culture begins with a focus on understanding and mitigating downside risk."
Kelley, former CEO of Lexington Insurance Co., AIG's excess and surplus lines powerhouse, said strategic risk leadership, especially at an insurance company, requires that you must know, in terms of exposures, "the connecting correlations of all your operations."
Greenberg understood those correlations, said another longtime colleague and executive at AIG. "The critical point is that Greenberg is an enterprise risk manager," the colleague said. "He understands the organization holistically. Specifically, on particular risks, you must know the number--where do you not want to go. He knows that number."
Greenberg said, "You don't want to roll your company up with undefinable risk. You have to understand the risk. The insurance industry is the only industry where you never really know the results at the end of the year. You may think you know, but you don't. The tail on a risk could be 10 years, so you don't really know."
So how do you mitigate that seeming lack of understanding? "Experience is very valuable to be able to predict those costs," he said.
"I don't want to wake up one morning and say 'What happened?' " Greenberg said.
Felix Kloman, a former Towers Perrin partner and a well-known commenter on the subject of risk, said, "Organizations can easily become risk averse. You want them to take on risk in the future and too often risk management defines risk as a negative outcome."
Kloman said that Greenberg is the exception. "Hank is much more of a risk-taker. The CEO coordinates and encourages intelligent risk-taking."
Greenberg, who gives nearly equal importance to identifying and acting on opportunities with upside potential as he does with limiting the downside, draws upon his own experience and analytics in his decision-making.
A Chicago native, he's a decorated U.S. Army veteran of World War II and the Korean War. Using the G.I. Bill, he earned a law degree in 1950 from New York Law School, before getting his start in the insurance industry.
Last year, Greenberg gave $20 million to his alma mater. It was the largest gift in the school's 120-year history. The money, given through the Starr Foundation, will be used for scholarships and other legal programs.
A risk decision, he said, is a "combination (of factors). You are always looking for new opportunities. New opportunities come with new risks. It's the one thing I look for out there all the time."
"The biggest challenge is to get the CEO to think long-term and really do long-term planning. CEOs tend to be myopic and those short-term incentives ought to be structured to encourage long-term thinking," said Howard Kunreuther, co-director of the Wharton Risk Management and Decision Processes Center and James G. Dinan professor of decision sciences, business and public policy.
"The CEO can play a critical role in this process and Hank Greenberg has always been a forward-looking CEO," Kunreuther said.
Kloman said, "CEOs focus on the day-to-day issues and what will happen in the next year or two." But, because most CEOs are on the job for only five to seven years, on average, that tends to give them a very short-term view.
Greenberg is different. His long tenure at AIG alone gives him a long-term view, Kloman said.
The CEO and the board set the company's compensation strategy, which can be the key incentive that provokes long-term corporate employee behavior--both risky and conservative.
"Ultimately, I do believe that consistency of management produces extraordinary results," Kelley said. "If you want to keep good people, people who achieve success, you have to get people to stretch themselves. Hank has an ability to push you to a level you wouldn't have reached on your own. That's what leadership is all about."
Greenberg said, "Leadership can't be discounted. A good leader makes people perform better than they would otherwise." Greenberg demands hard work. "You lead from the front, not the back," he said.
Greenberg said he looks for "people who understand the business and take pride in what they do. They have to know the basics of what this company is. (They have) to know what is expected of them. And they have to live up to those expectations and beyond."
To do that, he said, compensation has to be "long term. Long term. Long term."
At AIG, management compensation was based on long-term options in the privately-owned CV Starr, which had the effect of deferring the ultimate benefit until the executive retired from AIG.
"Some of the stock of CV Starr was used as an incentive program for senior AIG people," Greenberg said. "It paid off only on long-term performance. Yet, we also had the interest in the public company, AIG. We had the best of both worlds--the responsibility of the public company and the entrepreneurship of the private company."
Today, the Starr Companies remain privately-owned, giving Greenberg the ability to continue his long-term incentive compensation strategy. "You pay your people (well) obviously. You provide some bonuses," he said. "But long-term compensation should be the basis and it should not be based on short-term performance."
Deloitte's McLaughlin emphasized the importance of long-term compensation in a risk strategy. "If there are strong incentives to perform in particular areas, and if all the incentives are aligned without a penalty for failure, this can increase the riskiness of the organization.
"Incentive compensation plans have a direct relationship to the behavior of the organization and how it addresses risk. The CEO needs to be mindful of that," McLaughlin said.
BALANCING OPPORTUNITY AND RISK
For the CEO to make intelligent risk-based decisions, the flow of information throughout the organization up to the CEO must be effective. At Wharton, in the wake of the current economic crisis, Kunreuther said they are conducting a study of CEO behavior.
"The CEO needs to get information from several sources," Kunreuther said. "Too often, there are internal issues that will never come to the attention of the board and CEO. You have to have the kind of dialogue that discovers what went wrong. This can be done in an informal or formal way. But that mechanism must both shield and reward employees."
"In today's large and complex organizations, it's nearly impossible to have knowledge about risk," Kloman said. "Certainly the CEO can be knowledgeable, but he has to rely on the management staff and structure. If he only gets that information from the executive vice president, then it has been through too many filters."
The process, Greenberg said, is ongoing. "You live in a changing world. There are changes going on all the time. Your job is to have people around you who understand the business that we are in and can recognize new opportunities as they begin to emerge. As they do, then we focus on them and determine whether it is an insurance opportunity or not," he said.
Kelley said identifying the opportunities "is the fun part. But you have to be from the business to understand the opportunity." That requires, Kelly added, disciplined leadership that really knows the business, and almost an instinctive view of opportunity.
Kelley said, "Hank's instincts are superb."
Colleagues give scores of examples of Greenberg quickly looking over pages of data, and then immediately identifying the key piece of information that could be at the root of a bigger problem. That applied equally to current performance and his analysis of long-term opportunity.
Greenberg has the ability "to find out if it wasn't working and then get out," said a colleague at Starr Companies. "Managers have a vested interest and won't make that decision. That's where the CEO, and Hank, comes in."
Kelley sees Greenberg's gift of getting critical information right away as a major asset. "Hank understands the gestalt of a problem. If he felt you were on track, he'd let you solve it. If not, he made sure you got help.
"He isn't afraid to use back-channels," Kelley also said. "And he didn't care if you didn't like it." He always said, 'If you can get it by me, you can get it by anybody.' "
Greenberg said, "We have meetings. We have a constant flow of information.We meet on a weekly basis. For example, (at AIG) we wrote credit swaps, but we limited what we wrote. And the ones we wrote were not the worst risks. We didn't write the subprime ones."
If Greenberg had stayed at AIG, that policy would not have changed, he said. In March 2005, Greenberg resigned from AIG under pressure from his board of directors. At the time, he and the company faced heavy criticism from Eliot Spitzer, then the New York attorney general.
"We would have either hedged or discontinued writing the swaps," he said. "There is only so much we would have taken." And that strategy works the same for any risk. A risk strategy must include the willingness to get out of a line of business, if the risk becomes too dangerous, clearly a characteristic of Greenberg's tenure as AIG's CEO.
ENTERPRISE RISK MANAGEMENT
Too often, Kloman said, "the insurance industry seems to be bogged down in avoiding risk. It ought to be taking risk. The whole way risk management is interpreted and structured is woefully backward. There is no sense of a risk having a positive outcome and it's very hard to change the minds of insurance executives."
McLaughlin explains that in his view risk management and enterprise risk management have several components: The quantification of risk, the culture of the organization, and how the organization plans to respond to risk.
He said, "All these factors are determined by the CEO.''
In a sense, McLaughlin said, the "CEO manages the risk portfolio. What risks offset each other? What risks reinforce each other? Geographic diversification, in today's world, is not necessarily offsetting, for example. The organization needs to buy into the CEO's strategy for how to integrate these risks into decision-making."
Greenberg is skeptical about enterprise risk and the insurance community. "For a CEO, I'm not sure that half of them understand enterprise risk.
"You have to understand the risk. For example, if you're writing something in the energy field, you have to understand that business. If it's a construction area, who is the contractor? What kind of workers are there? What are the plans?"
At bottom, he said, "you can't substitute for good management and good judgment. You can talk about that a thousand different ways. If you have a CEO that doesn't live up to the job, don't blame everything else. It's his job."
And, Greenberg added, "You need the judgment of the CEO. He's the chief risk officer."
October 15, 2011
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