AIG Needs New Policies

Martin Sullivan, Hank Greenberg's successor as CEO, needs to move fast and furious to clean up the insurance giant's messes

By Diane Brady

As Wall Street welcomes Martin J. Sullivan, the third-ever CEO of American International Group (AIG ), one thing looks clear: The company he inherits has to change. The problem isn't with the core business. Even amid the storms of scandal and Mother Nature last year, the insurance and financial services giant managed to surpass expectations by reporting record profits of $11.05 billion on sales of $98.6 billion.

Instead, the problem lies with the archaic management style and opaque business practices of Sullivan's former boss, the legendary Maurice R. "Hank" Greenberg, who resigned under pressure on Mar. 14. For almost 40 years, no one challenged Greenberg's iron rule. While the 79-year-old chairman, president, and CEO delivered great results, he was frequently bellicose, known to yell at staffers with such intensity that at least one insider jokingly compared his tenure to a reign of terror.

More significant, he was slow to embrace efforts to improve corporate governance, even characterizing the expenses of the Sarbanes-Oxley law as "an enormous burden" last year.


  Now investors have reason to question if AIG's financial results were really as strong and steady as they seemed. Investigations launched by the Securities & Exchange Commission, New York State Attorney General Eliot Spitzer, and other regulators give them reason for pause (see BW Online, 3/16/05, "An SOS from AIG?").

The most recent allegations say in 2000, Greenberg himself authorized a deal in which AIG designed what regulators charge constituted an essentially fake reinsurance policy for General Re Corp. that artificially boosted AIG's reserves by $500 million. That move helped appease investors who considered AIG's reserves too low. "He personally asked for this," says a source close to the investigation. "He was doing something to defraud investors by cooking the books and changing the outcome."

Sullivan, 50, a witty charmer who eschews his predecessor's confrontational style, has promised to cooperate fully with regulators. He says he won't "ignore the issues that we have." Good thing. His "to do" list is already quite full.


  For starters, Sullivan has to take a hard look at insurance industry practices and products -- like one known as "finite risk reinsurance" that has regulators circling yet again, mere months after AIG paid $126 million to settle other investigations.

While the findings of the latest investigation remain to be determined, they do raise concerns about whether AIG may have used other techniques to elevate results in the past, especially given its record of consistently outperforming industry peers. Sullivan should lead the industry in scrapping esoteric financial products that can confuse investors about a company's true financial health.

A far harder job for Sullivan: yanking this mystery-shrouded organization into the 21st century by pushing for greater transparency and a stronger board. About half of the AIG board is independent, and the company did strengthen that contingent with the addition of former Merrill Lynch (MER ) executive Stephen L. Hammerman earlier this month. But investors like the AFL-CIO would prefer to see a two-thirds majority of truly independent directors.



  "One item that Sullivan should place high on his agenda: breaking down two little-known Byzantine private entities, Starr International and C.V. Starr & Co. These companies, which hold shares in AIG, seem to do little more than grossly enrich senior executives while making it tougher to figure out the firm's true cash flows.

Starr International, in which Greenberg still holds a directorship, is much like a private partnership used to compensate senior managers. Getting a stake equates with winning entrance to an elite club. C.V. Starr & Co. is essentially a broker that does business with AIG. Several of its board members are also senior AIG executives, including Greenberg and Sullivan. Both entities stay largely immune from public scrutiny but have drawn the ire of shareholders and regulators alike.

"This just defies common sense," says North Carolina State Treasurer Richard H. Moore, who recently urged the SEC to investigate AIG's relationship with C.V. Starr. The arrangement encourages self-dealing, according to investors who are currently suing AIG. Other critics argue that the opaque nature of its transactions with AIG could help the public company smooth out earnings. In any case, notes Moore, such entities "destroy, or taint, [AIG's] reputation, whether it's deserved or not."


  Last but not least: Sullivan should speed up the exit of Greenberg, who currently plans to stay on as nonexecutive chairman and, within the private entities, can still exert enormous control. AIG has benefited from Greenberg's strategic smarts and relationships, but it doesn't need them any longer. Having him hang around could make it tougher to speed through reform and restore the confidence of investors.

AIG's stock has already fallen to 20% off its high last year. Credit agencies like Standard & Poor's have put AIG on negative watch, while Fitch Ratings downgraded it from the much-vaunted AAA to AA+. "Are all these events and issues consistent with a AAA-rated company? Our conclusion was no," says Julie Burke, a Fitch managing director. "Things that were acceptable a few years ago are not acceptable now."

Sullivan has inherited a strong global franchise, but he also heads a company that bears the stamp of Greenberg, a brilliant but tone-deaf autocrat who continued to complain about increased regulation even as AIG was immersed in scandal. Says Patrick McGurn, of Institutional Shareholder Services: "Was there a reform he ever put in place that he liked?"

Investors can only hope that Greenberg's successor will embrace the reforms needed to bring AIG into the 21st century.

With Louis Lavelle and Marcia Vickers in New York

Brady is a senior writer for BusinessWeek in New York

Edited by Amey Stone