DE LA SALLE LIPA College of Business, Economics, Accountancy and Management Accountancy
CASE STUDY:
Coping with Financial and Ethical Risks at American International Group (AIG)
Presented to: Mrs. Maria Theresa M. Magsino
Presented by: Leader: Patricia Diangkinay Secretary: Michelle M. Culabat
Members: Gleziel A. Catapang Johanna Alyssandra N. Munoz Leona Marie S. Rubis Roeschelle Anne B. Tiongson
August 2014
I.
INTRODUCTION
American International Group (AIG) was founded in 1919, in Shanghai, by Cornelius Vander Starr. Expansion across Asia and in the United States in 1926 was led by the success of AIG. American International Group provided insurance risk coverage to insurance companies in a way to disperse liabilities. AIG charges insurance companies a premium in order to allow them to spread their risk so that they can sell insurance policies and grow more rapidly. In 1968, Maurice “Hank” Greenberg took over as CEO. AIG grew exponentially during his tenure. By the end of the 1980s, the company had become the largest underwriter of commercial and industrial coverage in the United States and the leading international insurance organization. He was the key player in shaping the modern face and corporate culture of the company but critics called him autocratic in his drive to expand the company into an international powerhouse. In spite of Greenberg’s active networking, the early 2000s found AIG under investigation by the Securities and Exchange Commission for its “finite insurance” deals. A federal inquiry later found information that Greenberg might have been personally involved in creating bogus reinsurance transaction with General Re to fraudulently boost AIG’s reserves. In 2005, Greenberg was forced out as CEO. Martin Sullivan succeeded him and held the CEO position for three years, followed by Robert Willumstad for three months. Willumstad was forced to step down in 2008 in the wake of the corporation’s meltdown. The current CEO is Edward Liddy, the former CEO of The Allstate Corporation. The SEC leveled charges of fraud against Greenberg resulting from the circumstances surrounding his departure. In order to settle the charges that AIG manipulated financial statements in 2005. Immediately before American International Group’s (AIG) collapse, they had exposure to $64 billion in potential subprime mortgage losses. The perfect storm formed with the subprime mortgage crisis and a sudden sharp downturn in the value of residential real estate in 2008. Since much of the speculations in the Financial Products unit was tied to derivatives, even small movements could result in catastrophic losses. AIG’s troubles leading up to the 2008 bailout were, at the heart, caused by a kind of derivative called credit default swaps (CDSs). The company issued the swaps and promised to pay these institutions, AIG’s counterparties, if the debt securities defaulted. However, AIG did not have a large enough safety net to weather the subprime mortgage collapse. The government took the drastic step to bail out the company, providing the funds to purchase the CDOs that were being held by banks, hedge funds, and other financial institutions, and in the process ended up with 79.9 percent ownership of AIG.
II.
STATEMENT OF FACTS AND PROBLEMS/ ISSUES
The corporate culture at American International Group (AIG) had been involved in a high-stakes risk-taking scheme supported by managers and employees that appeared entirely focused on short-term financial rewards. AIG diversified insurance business, one unit, AIG Financial Product, was the source of many of the company’s woes. This unit was founded by Howard Sosin in 1987. When Sosin joined AIG he was given an unusual deal: a 20 percent stake in the unit and 20 percent of its profits. While AIG can be described as a conservative global conglomerate selling insurance policies to businesses and individuals, the Financial Products unit was staffed by quantitative specialists with doctorates in finance and math who, it seems, were very willing to take risks. In the late 1990s under the leadership of Joseph Cassano, AIG Financial Products ramped up its business of selling where dealings were risky. American International Group (AIG) used CDS as a kind of insurance policy on complex collateralized debt obligations (CDOs). The company issued swaps and promised to pay these
institutions, AIG’s counterparties, if the debt securities defaulted. However, AIG did not have a large enough safety net to weather the subprime mortgage collapses. These insurance contracts became essentially worthless because many people could not pay back their subprime mortgages and AIG did not have the creditworthiness for the big collateral call. AIG was able to make these CDO deals with a very small fraction of actual money on hand. In spite of the risk, the company involved itself in bad mortgage lending by financial institutions that did not have sufficient capital to cover the loans, which in turn had bought this type of insurance from AIG that created an unstable financial environment. The loans and CDOs were often sold to people who could not repay their debt. CEO Greenberg became concerned about this unit’s derivative dealings and asked a group to shadow its trades. While American International Group (AIG) made billions of dollars in profits and managers received millions of dollars in compensation for selling these so-called insurance policies, it turned out to be a high-risk house of cards. The tools, CDOs and CDSs (Credit Default Swaps), were used recklessly and failed to assess systemic risk of counterparties not measuring their own exposures and not paying their obligations.
III.
AREAS OF CONSIDERATIONS
Maurice “Hank” Greenberg was the CEO of American International Group (AIG) for 38 years. He was the key player in shaping the modern face and corporate culture of the company.As what the critics have told, Greenberg is an autocratic or a dictatorial in his drive for the company’s expansion into an international powerhouse. Greenberg championed innovative products that insure almost any type of risk. Over the years, they strive to be the best company, not just in United States but in the whole world. The problem arises mainly because of the company’s corporate culture that had been involved in a high-stakes risk scheme that appeared entirely focused on short-term financial rewards. AIG used CDS as a kind of insurance policy on complex collateralized debt obligations (CDOs). In spite of the risk, the company involved itself in bad mortgage lending by financial institutions that did not have sufficient capital to cover the loans, which in turn had bought this type of insurance from AIG that created an unstable financial environment. While AIG made billions of dollars in profits and managers received millions of dollars in compensation for selling these so called insurance policies, it turned out to be a high-risk house of cards. These tools, CDSs and CDOs, were used recklessly and failed to assess systematic risk of counterparties not measuring their own exposures and not paying their obligations. AIG has also provided incentives or rewards to take risks. AIG culture was focused on a rewards system that placed little responsibility on executives who made very poor decisions. Although they produced losses, a number of managers were selected to receive bonuses. The company also offered cash award and other perks to the executives and retention program with payments from $92,500 to $4 million for employees earning salaries between $160,000 and $1,000,000. AIG asserted that these types of payments were necessary to keep the top employees of AIG. The ethical ramifications of the rewards doled out in the face of excessive risk-taking and possible misconduct has been highly criticized by most stakeholders.
IV.
IDENTIFICATION AND EVALUATION OF ALTERNATIVE COURSES OF ACTION
1. Strengthening risk management capabilities Advantages: Proper management of risk cost less and prevents waste of time. This can help be prepared for everything that may come during the course of the business. This can assure the investors that risks are forecasted thus the top management can do better decisions to the company. Proper execution of decisions in risk management will lessen the possibility of bankruptcy that might result a loss on the company.
2. Increase Transparency Advantages: It will help AIG to restore their credibility and positive image in the eyes of customers, investors and stakeholders. To have a neutral decision for better management. To be able to avoid autocratic leadership inside the organization. 3. Neutral Decision Making Advantages: To keep the stakeholders more interested in participating in any decision will have to make. To avoid autocratic leadership inside the organization. Good relationship of every decision makers such as stakeholders can build trust and understanding amongst team members resulting for the better future of the organization. Having a neutral decision-making can maintain corporate governance within the organization. To keep the business on its right track and to achieve the company's goal 4. Take actions in improving the corporate culture Advantages: Corporate Culture can be more ethical if it applied in such way that the employees and shareholders are benefited on the right system. To keep customers and employee’s loyalty To maintain ethical values in the organization If a certain problem occurs, the employees eradicate that the problem and the operations keep on going without any further delay. The employees have most importance on getting more results and work done within the time limit. 5. Reserve Requirement Regulations Advantages: There will be enough money to cover the insurance that the clients bought from them in case catastrophic event. The company would be ready if a financial crisis occurs in the country.
V.
DECISION/ RECOMMENDATIONS/ BEST SOLUTION
After identifying and evaluating all the aspects which are in the list of the alternative actions, the consultants come up to incorporate the corrective actions to change the corporate culture of American International Group by requiring having their reserve requirement. Because of the AIG’s culture which involved the high-stakes risk-taking scheme, the AIG don’t have the reserve requirement which is a requirement for every insurance company to settle claims of the insured when catastrophic event occurs. The top management of AIG are thinking of high risk is also high in return. The reason of high demand for the AIG, the AIG don’t even think of possible losses to their company that may occur. In the perspective of insurance, the insurance company should have their reserve requirement which it is an estimation of claims that will be eventually paid for the loss occurred. Under the policy, the insurers are required to maintain reserves to guarantee that they have the ability to satisfy their obligations. The insurer must estimate a necessary amount in providing for all the claims and for the payment of all the losses.
VI.
IMPLEMENTATION/ COURSES OF ACTION
Knowing all the causes and facts of the problem of the AIG that was rooted from their culture of being a high risk takers and the drive of the top managers and employees to generate high earnings, I think the best thing that AIG should do is to go back first to its mission-vision that they have: "As a global financial services organization, we have committed our resources to developing products and services that address the needs of our clients as well as promote a corporate culture that values integrity, diversity, innovation and excellence. " In this, it talks about everything that would uplift the corporation’s integrity, that would awaken the top managers and employees, and that would help them regain back the image of the company. The top managers should be the first one to understand deeper and keep the missionvision of the company not only by mind but more so by their hearts. The top managers and employees should not forget why they were in the company. Every decision and transaction they would undertake, they should first see to it that it is in line with the reason of their existence. Also, they should hire employees that have a passion and concern for the company that would look for a long term effect of any decision it would undertake. Next is for the company to possess the character of being transparent in every dealings and whatever that is happening inside of the company. I would also want the AIG to hire more professionals and risk managers that would help them assess first the risk before the company issue any of its contract. Lastly, they should always keep on updating and involving everyone that is related to the business because it is very important to them to know what is really happening inside and for them to also contribute opinions and suggestions for the betterment of the company.
VII.
CONCLUSION
American International Group provided insurance risk coverage to insurance companies in a way to disperse liabilities. AIG was considered too big to fail. Developing an ethical company depends on its leader setting ethical standards and following them. Maurice “Hank” Greenberg was the CEO of AIG and critics called him autocratic in his drive to expand the company into international powerhouse. The problem arises mainly because of the company’s corporate culture that had been involved in a highstakes risk scheme that appeared entirely focused on short-term financial rewards. AIG engaged in unethical behavior by taking risk with unregulated investment products while using cash from the people’s insurance policies as collateral. AIG insured CDOs against default through credit default swaps. The chances of having to pay out on this insurance were highly unlikely, and for a while the CDO insurance plan was highly successful and believed that what it insured would never have to be covered. So when the financial market began to fall, the policyholders began to use their insurances but AIG could not cover up for all the insurances since they were out of reserve for this kind of events. To recover from such indemnities and to further enhance its business, they must strengthen risk management capabilities, because they are lacked the necessary controls to respond to the risk embedded in their business at they set aside adequate capital reserves to cover losses. The company has lack of access to its financial product unit so they must increase their transparency to the public that will help AIG to restore their credibility and positive image in the eyes of customers, investors and stakeholders; neutral decision making to avoid autocratic leadership inside the organization and take actions in improving the corporate culture.
Bibliography / References AIG warned of ‘lack of transparency’. Retrieved August 14, 2014, from http://www.telegraph.co. uk/finance/businesslatestnews/3154517/AIG-warned-of-lack-of-transparency.html AIG: What Went Wrong. Retrieved August 13, 2014, from http://www.businessweek.com/ stories/2005-04-10/aig-what-went-wrong American International Group Inc. (AIG.N). Retrieved Ausgust 12, 2014, from http://www. reuters.com/finance/stocks/companyProfile?symbol=AIG.N American International Group, Inc. Retrived August 12, 2014, from http://www.aig.com.ph/_ 3167_407957.html American International Group - Company Information and Profile of American International Group (AIG). Retrived August 12, 2014, from http://www.makingafortune.biz/list-ofcompanies-a/american-international-group.htm Business Ethics - Ethical Decision Making and Cases – Ninth Edition. Retrieved Ausgust 13, 2014, from https://college.cengage.com/business/course360/business_ethics_exp_ 1111746915/casestudy/casestudy_06.pdf
