Commercial and Industrial Insurance in the United States: the Corporate Governance Reforms - Research Paper Example

Ethics and ethical practices have become difficult to monitor in the corporate world. Several damages on the investors of the US corporations forced the authorities to devise codes of conduct and compliance has been made mandatory. The disasters such as Enron, WorldCom, AIG or Marsh – in each case the brunt of the disaster fell on the investors or the share-owners of the company who became the victims without even a warning to withdraw their funds (Donaldson, 2007). It is believed that the corporate governance reforms have focused on realigning the incentives between the managers on the one hand and the shareholders on the other. AIG is a publicly traded insurance group, headquartered in New York City, having global operations including the United States. They are listed on the New York stock exchange apart from exchanges in Tokyo, London, Paris and Switzerland (Auto Insurance, 2009). They are world leaders in international insurance operations with presence in more than 130 countries through more than 100 US and foreign subsidiaries (Free Advice, 2009). AIG serves commercial, institutional and individual customers for property and casualty insurance, life insurance, retirement services, financial services and asset management services. They offer services in general insurance, life insurance, retirement services, financial services and asset management. Formed in 1967, AIG came to be the fourth biggest business in the world as per the Global Forbes 2000 list of 2006 (Insurance Auto, 2009). However, the company was originally started in 1919 by Edwin Cornelius Vander Starr in Shanghai, China. It then expanded into other countries and areas including Asia, Latin America, the Middle East, and Europe. When they entered the US in 1960s they changed their business to corporate coverage from personal insurance. All the holdings were subsequently transferred to man named Hank Greenberg in the US. Greenberg believed that independent brokers were better than agents and he also believed that underwriting profit was the key to turning real profits in the insurance company. Greenberg became the CEO when Starr retired. AIG has 97,000 workers and over 714,000 independent agents and brokers for providing customers with all they need (Insurance Auto, 2009). They were devoted to customer satisfaction and towards achieving this goal they maintained personal relationships with each of their customers. The company maintains personal relationship with its customers and they are the biggest underwriters for commercial insurance and industrial insurance in the United States. Their financial growth can be attributed to new markets and new channels of distribution. They have customers ranging from individual to corporate and institutional customers. AIG insures the property of 94% of the Fortune 500 companies and is the owner of the biggest aircraft in the world (Clark, 2009). It is also the world’s largest insurer against property damage and the top provider of retirement annuities for school teachers and health care workers. Greenberg had spent half a century building AIG into a large international conglomerate. However, since everyone was involved in high-risk high-reward gambles on subprime debt (LaCapra, 2009), AIG too swapped against the subprime mortgages and this pushed the otherwise profitable company to the brink of bankruptcy (Amadeo, 2009). Initially, AIG was cautious in 2005 but they had already entered the market through vehicles called credit-default swaps. Those assets offered a hedge against big subprime bets made by major banks across the globe. Banks involved included Merrill Lynch, Goldman Sachs, UBS, Bank of America and CitiBank. By the fourth quarter of 2007 losses started pouring in. in such deals AIG lost more than $10 billion in 2007 and $14.7 billion in the first six months of 2008 (Fox, 2008). This cut into the company’s capital reserves. Mortgages started to default and AIG was forced to raise capital. The moment stockholders became aware of this fact, they started selling their shares which made it even more difficult for AIG to cover the swaps. Fraud charges were also levied by the Securities and Exchange Commission in 2006. AIG also approached the Federal Reserve’s discount lending window for funds but they were turned down. Problems started escalating and the investors lost confidence. Share prices and credit ratings started falling. AIG approached several investors but were turned down. Finally regulators offered capital at 11% interest rate against a huge equity stake to the federal government (LaCapra, 2009). However, being crippled by policies and in trying to protect the banks against default on loans and derivatives, AIG has crashed $61.7bn (£43bn) into the red with the biggest corporate loss in US history (Clark, 2009). The company received federal funds because the government thought it was too large to be allowed to fail. Too many people and too many institutions depend on this company. Their London office added to the chaos because they dealt in complex transactions. The London office provided insurance on securities which was once considered low-risk, such as mortgage-related assets at the height of the property boom. AIG cheated state governments of large sums of money for injured workers’ benefits. In addition, they even showed finance deals as re-insurance deals and off-shore affiliates used to disguise capital losses (SD, 2006). These were discovered by the general counsel Michael Joye who brought it to the notice of the CEO. Joye had recommended that all illegal activities should stop and all employees involved in fraudulent activities should be fired. However, these recommendations were ignored which forced the counsel to leave the corporation. These were then discovered thirteen years later by the New York District Attorney. Greenberg had to resign under pressure from inside the company and from the customers. This was because had basically engaged in unethical deals which were exposed as soon as he resigned (Insuranec Auto, 2009). Number of scandals came to light and in 2009 Greenberg wants to sue AIG for securities fraud (Clark, 2009). According to him, material misrepresentation and omissions had caused him to acquire shares as part of various deferred compensation plans at an inflated price. This later caused him to lose nearly all his investments after AIG’s losses became known. There are two forces that influence corporate governance reform - Sarbanes-Oxley style regulatory initiatives, internal corporate compliance and ethics programs (Donaldson, 2007). However, neither of these initiatives has been successful in protecting corporation from compliance violations. The companies draw up elaborate compliance programs but they have been at the centre of corporate scandals. AIG too suffered as the pressure on the executives to compromise ethics increases slightly in the presence of corporate codes of ethics and ethics training program. To bring about a turnaround, AIG must liquidate its insurance assets. Even during the most profitable years, they could produce income of only about $10 billion (WSJ, 2009). AIG has received $180 billion as bail-out funds and they now need to value their subsidiaries. It is uncertain whether these subsidiaries can find buyers and at what price or whether they will ever be able to return the money to the government. Currently the US Treasury and the Federal Reserve are restructuring their lifeline to AIG by reducing interest payments and providing fresh capital. Thus, it can be seen that pressure of corporate governance norms force4s employees to engage in unethical practices. However, this may be the opinion of a few or it may be an escape but the fact is that the company did engage in unethical practices. The government needs to reconsider the strict norms. At the same time, at AIG, the employees that had anything to do with scandals have to be ousted and the company has to start on a new footing. Strict measures have to be taken against anyone engaging in such practices. Reference: Amadeo, A. (2009). What Is AIG? Retrieved online 14 October 2009 from http://useconomy.about.com/od/businesses/p/AIG.htm Clark, A. (2009). AIGs $61.7bn crash sends markets plunging. Retrieved online 14 October 2009 from http://www.guardian.co.uk/business/2009/mar/02/aig-insurance-loss Donaldson, T. (2007). Closing reflection ‘‘Ethical blowback’’: the missing piece in the corporate governance puzzle – the risks to a company which fails to understand and respect its social contract. Corporate Governance, 7 (4), 534-541 Fox, J. (2009). Why the Government Wouldnt Let AIG Fail. Retrieved online 14 October 2009 from http://www.time.com/time/business/article/0,8599,1841699,00.html Free Advice. (2009). Review: AIG Insurance. Retrieved online 14 October 2009 from http://insurance.freeadvice.com/reviews/13/info/AIG+Insurance/ Insurance Auto. (2009). AIG Insurance. Retrieved online 14 October 2009 from http://www.insuranceauto.org/AIG_Insurance LaCapra, L. T. (2009). AIG Ex-CEO Breaks Down the Final Days. Retrieved online 14 October 2009 from http://www.thestreet.com/story/10603344/7/aig-ex-ceo-breaks-down-the-final-days.html SD. (2006). Strange bedfellows. Strategic Direction. 22 (10), 9-12 WSJ. (2009). For Next AIG Chief, Its Not About Insurance. Wall Street Journal. Retrieved online 14 October 2009 from http://online.wsj.com/article/SB124344597724159229.html Read More