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From Chapter One, The Link Between Great Management and Bottom-line Profits
American International Group
AIG was that actuarial’s complaint—the statistical anomaly. It was a big insurance company that was still growing at a gallop, making money in good times and bad. Not many insurance companies could say the same over the last quarter of the twentieth century, which is what made AIG so cool and consistent. In other words, it was an investor’s dream.
When analyzing the quality of a company’s management, it’s natural to start at the top. Not every CEO gets to be a national media star, so it can take a bit of legwork to learn how a company is run. The process is certainly easier when there’s continuity in the executive suite.
Investors who prize continuity hit the jackpot with American International Group. What has set it apart over the years has been management’s insistence that growth take place away from the commodity segment of the business. Every single CEO of AIG felt the same way: both of them, that is.
Two Strong Leaders = One Great Company
From 1919 to the present day American International Group (AIG) has had only two CEOs, Cornelius “Neil” Starr and Maurice Greenberg, and it’s been the better company for it. The latter is bombastic and the former was reticent, but outward personalities aside, their philosophies have reflected the same values, and given AIG a distinct corporate culture. Most of all, the romance of the insurance giant, incongruous as that phrase may be, is a deep involvement in business all over the world.Since the day AIG opened its first two-room office in Shanghai in 1919, overseas revenues have been central to the business, and accounted for about 50 percent of operating income from 1988 to 2000. The company stock was not only an insurance play, but for an individual portfolio, it also offered one-step global diversification.
Both Starr and Greenberg were alike in believing that every center in the business is a profit center, or should be. One arm could not be expected to make up for another. Greenberg in particular has long believed that innovation is essential to AIG’s growth. The company, therefore, cast a wide net, including the more mundane property-and-casualty, marine, life, and auto insurance, of course, but it also would offer the more exotic, such as insuring children in day care against kidnapping and Internet websites from hackers. With so many types of policies and different entities to sell them, “innovation” has translated into a corporate structure so complicated that AIG could be called a corporate spiderweb, woven of as many as 300 subsidiaries.
To say that Greenberg wanted AIG to grow would be an understatement; by his own confession, he has thought nothing else ever since he took over in 1968. One year into his tenure, he oversaw AIG’s first public offering of shares. The stock thrived on Greenberg’s dictum for the company—earnings growth of nearly 20 percent per year. It was easier to say than to do, but from 1968 to 1998 AIG found ways, ridding the books of lagging businesses and starting or acquiring ones with glowing potential. By the mid-1980s, the company easily hit Greenberg’s target, as assets grew by an average of 34 percent from 1984 to 1988, while in each of the four preceding years growth in earnings followed at an average clip of 27 percent. During that time, the stock price languished, due to the pessimistic perception of the whole property/casualty sector. Smart investors may have been accumulating AIG stock, but the price didn’t really start to move until 1988. That year, with Asian markets booming, Wall Street looked for companies poised to benefit. AIG was belle of the ball.
Americans were hearing a great deal about the accelerating overseas economies of the Pacific Rim and AIG offered a ride along with those “tiger” economies. The stock, which had made precious little progress between 1985 and 1988, burst out, showing that insurance could still be a high-growth industry when it encompassed practically the whole world.
From 1988 to 2000, AIG stock increased from a price (adjusted for splits) of $4.85 to $110. A $10,000 investment would have been worth $226,804 after a dozen years. Even more intriguing for investors, AIG was surefooted. The stock moved upward without a noticeable downturn or even a plateau. In that sense, it only reflected the company, which turned a profit even in years when the earnings reports of other property-and-casualty companies were laid waste by hurricanes or other natural disasters. While AIG stock easily outstripped the S&P 500 (average of large companies), as well as its own brethren in the insurance sector, it also stayed ahead of the NASDAQ average. AIG was one of the anomalies of the 1990s bull market, which was largely propelled by nascent high-tech companies: it was old company, old economy, but decidedly high-growth nonetheless.
One of the things that helps distinguish AIG is its origins. In 1919, fresh from service in World War I, twenty-seven-year-old Berkeley grad and lawyer Neil Starr went to Shanghai looking for opportunity. He found it, all right, in a nation of millions unable to buy their own life insurance.
The Chinese people were going uninsured because the British companies that dominated the business in China wouldn’t consider selling life insurance policies to native Chinese. The only logical reason for the English position was that actuarial tables (which predict average life spans) did not yet exist for the Chinese population. These tables are key, because normally the people who issue policies depend on tables in order to set rates. So, Starr saw quite a business. He founded American Asiatic Underwriters (AIG’s predecessor) and established a pattern when he extended his company to include life insurance for Chinese nationals, estimating longevity and setting rates that ensured a profit.
Another hallmark of Starr’s young company was that its staff was exclusively Chinese. Foreign companies in China nearly always employed their own imported managers and salesmen. Starr hired locals. As his company expanded into other Asian nations and into other types of coverage, he continued the practice of relying on native-born employees. In the late 1920s, Starr, by then married to the daughter of a Canadian missionary, returned to the United States to build up the center of his empire. He purchased several of the insurance companies that his agency represented and started new firms, too, most of them with an overseas connection. During World War II, he was especially aggressive in South American markets previously dominated by German and Italian firms. Privately held, the burgeoning insurance conglomerate made a millionaire of Neil Starr, but he began to neglect it somewhat in the late 1950s, when he had a personal crisis. (He was devastated when his wife left him for a Russian painter.)
Neil Starr’s companies, which would assume the name American International Group in 1967, were global long before most other American financial firms started to look overseas. The difference was patience, as Starr and his colleagues learned the intricate art of insurance on a mosaic of more than a hundred countries. They took the time to understand local customs and to navigate regulations that baffled many U.S. firms. One of the toughest challenges was retaining sharp employees in developing economies, where AIG training often made a worker worth more than even AIG could afford to pay.
The Next Generation
Even though AIG had thousands of policies, offered by hundreds of subsidiaries, the man Neil Starr tapped to replace him believed that the behemoth was basically quite simple. Maurice Greenberg, nicknamed “Hank” after the Detroit Tigers ballplayer of that name, grew up on a farm in upstate New York. He earned a law degree between stints in the army during World War II (in which he landed with the Rangers during the D-Day invasion) and the Korean Conflict. After distinguishing himself in a domestic insurance subsidiary, he was picked as president of AIG. “Sometimes I find a man who has an inner fire, a man who is perfectly in his métier, his orbit,” Starr once said of his ability to choose executives, “and when I do, I back him.”
Hank Greenberg’s zeal for new businesses led AIG to pioneer coverage in many new areas. It insured satellites, offshore oil rigs, and computer networks; it protected companies against the cost of environmental cleanup and corporate directors from shareholder lawsuits. A subsidiary called AIG Political Risk wrote insurance against kidnapping and extortion. With the help of consultants such as Henry Kissinger, AIG continued another tradition, pushing across forbidding political boundaries.
AIG sought permission in 1992 to stage a homecoming and reestablish operations in mainland China, from which foreign businesses had been barred when the Communists took power in 1949. Hank Greenberg stepped up as the lead salesman and worked the prospect tirelessly. Meanwhile, his company quietly cultivated favor by investing heavily in a Shanghai office complex. AIG also took the initiative to locate a set of windows stolen long before from the Summer Palace in Beijing, buying them for $500,000 from a European collector and restoring them to the palace as a gift to the Chinese people.
“It took almost a decade and a half to open China for AIG,” Greenberg wrote. “It took dozens of trips. Most CEOs I know who want to open a foreign company want to meet with the leader of that country once. After that, they believe they’ve done all that’s required. It doesn’t work that way.”
Net income, which was $17.2 million when Greenberg took over in 1968, grew to $50 million in 1975. By 2000, it was $5.64 billion.
INVEST IN SKIING?
Anyone looking over the long list of assets of American International Group (AIG) might wonder why one of the world’s most potent insurance companies owned a ski resort in Vermont. However, this was no investment fad: AIG had owned Mount Mansfield in Stowe for more than forty years. The reason was twofold: first, Cornelius Starr liked to ski. Second, Maurice Greenberg liked to ski.
The AIG Decision
The value in AIG stock was its record of growth. In financial terms, the company was the eternal youth of the industry, chalking up each new record as though it was only just starting. The decision points for buying the stock in 1988 related to the future and just how long the company could continue its insistent rate of expansion.
Overall, the property/casualty industry stagnated in 1986–1987, but not AIG. Some investors noted that it was writing fewer policies and worried about its growth slowing in the future. That idea was blown away in 1988 when AIG continued to record increased earnings on its crafty strategy.
“We look for markets without a lot of competition,” said AIG’s longtime vice chairman, Thomas Tizzio. The company’s philosophy was to actively seek areas in which it could offer coverage that was otherwise unavailable. Furthermore, it simply left fields that were overcrowded. Investors could see the effect of the company’s choosy standards in the margins it was able to maintain. Investors who picked AIG out of the pack were rewarded with a stock that increased by more than twenty times from 1988 to 2000.
Acquisitions extended the types of businesses in which AIG was engaged, but insurance remained the most important revenue stream. The deterioration of Communism in the Soviet bloc enhanced prospects for the expansion into Eastern Europe and Central Asia. At the same time, the Asian market was more enticing than ever, especially with a return to China in the offing. In the two fastest-growing Asian nations, the Philippines and Japan, AIG subsidiaries either led the market or came up second.
“Entrepreneurial” is an expression often used to imply a certain autonomy of the divisions; at AIG, it has gone much further ever since the reorganization of 1967–1968 when Greenberg took over. At any given time upper management in effect owns at least 30 percent of the company. It is a unique arrangement, giving AIG some of the best characteristics of a professional partnership. AIG’s top 300 employees receive the right to buy dividend-rich shares in a related company that holds, among other things, a substantial stake in AIG. Meanwhile, the top 40 employees are offered similar shares, but of a much higher grade—each block yields dividends of over a half-million dollars annually. The bonus shares, which have to be surrendered when the employee leaves, represent holdings of almost one-third of AIG’s stock. Significantly, the company is always in the hands of people with a real stake in its performance.
At Home Abroad
The factors ruling against the purchase of AIG in 1988 were led by a general uncertainty about the insurance sector. However, as is often the case, the dullness of a sector isn’t necessarily a bad thing and does not affect every stock within it. AIG was different from most other insurance companies: at once more daring in its pursuit of uncrowded businesses and more conservative in its own money management. In addition, AIG was assiduously steering clear of insurance that it considered overregulated, notably health insurance.
Smart investors judge stocks in a sector as much by what makes them different as by what makes them similar. AIG was a case that rewarded people who took the trouble to learn why it was not like other insurance companies.
The AIG formula made a clear profit on underwriting. That is, it managed to earn money on that basic insurance business of selling policies and paying claims. Surprisingly, AIG is one of the few companies that does so consistently. In the 1980s, U.S. property-and-casualty insurers as a group paid out much more money in claims than they took in through premiums. Their idea, which worked most of the time, was that investment profits on accumulated premiums would more than make up for underwriting losses.
AIG, on the contrary, considered that its revenue would expand in a more stable way if it made a profit at each end of the insurance business: underwriting and investment. Rough stretches are inevitable in the investment climate (making for setbacks in a company’s portfolio), as well as the earthly climate, causing natural disasters such as hurricanes that result in losses in the underwriting business. Because the company scrutinized claims closely, sometimes withholding payment, it has occasionally been charged with skirting obligations on technicalities. However, financial conservatism on all fronts consistently earned AIG the highest possible ratings from agencies that grade insurance companies.
One cloud that hovered over the decision to buy AIG stock in 1988 remained for the entire span through 2000. As of this writing, it is talked about still. Hank Greenberg has never indicated any plans to retire or name a successor. “There is only one Royal Highness around here,” said vice chairman Tizzio, referring to Greenberg. Like monarchs who live long lives, condemning the eldest heir to a life of harrowing boredom, Greenberg has watched a whole generation of likely successors move on to leadership at other companies. Greenberg’s vim is as legendary as his highly effective management. However, investors worried about the overall leadership of a company as powerful as AIG resting so precariously on the shoulders of one man.
The rise in AIG’s stock price that started in 1988, or indeed with the IPO nineteen years before that, stalled for the first time in 2000. The price-to-earnings ratio, which was running about double the industry average as it grew to 16 in 1996, soared to more than 20 in 1998 and past 36 in 2000. It was a heady ratio for a financial company, where a number under 10 would be more typical. Over a long span, AIG justified investors’ faith, but a change in conditions was inevitable.
A high price-to-earnings ratio is a hungry number that must be fed with great news every year, if not every single quarter. In the bearish market of late 2000, AIG’s stock couldn’t push higher, even while the company posted another year of double-digit growth at 11.5 percent: great for any other big insurer, only good for AIG. Investors were also cautious because of AIG’s exposure to the slumping Asian market. Ironic, since Asia was once what made investors run to the stock.
Another factor in AIG’s pause was an acquisition spree in 1999–2001. Investors tend to be petulant and expect companies to keep making money without ever spending any of it. AIG’s purchases were widely praised for their strategic value, especially in bolstering the company’s presence in the lucrative business of financial planning. In the long range, AIG was undoubtedly better off. However, the market moves on short headlines, not long reports. So in 2000, though AIG was still a healthy company, inviting to long-term investors, it was not perceived as a growth stock.
Ensuring future profits . . . Even a competitive, price-oriented business such as insurance can have pockets of profitability. Make sure to hook up with managements intent on finding those niches.
Variety is the spice . . . AIG is constantly coming up with new product offerings. You can’t get 20 percent growth by standing still.
When in Rome . . . Both CEOs believed in the importance of understanding local economies.
Management . . . Only two CEOs, both great. The big question mark: Who will take over next?
1919 Neil Starr founds American Asiatic Underwriters in Shanghai.
1926 Starr establishes a base in the United States.
1950 China operations cease.
1967 Company renamed AIG.
1968 Hank Greenberg succeeds Starr as CEO.
1969 Initial public offering.
1975 Net income $75 million.
1987 Net income $1 billion.
1993 Returns to business in China.
1994 Net income $2.17 billion.
2000 Net income $5.64 billion.