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 Greenbergs 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 AIGs 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 corporations 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 Groups (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.

AIGs 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, AIGs 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 companys 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, AIGs 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 units 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 companys 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 companys 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 employees 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 AIGs culture which involved the high-stakes risk-taking scheme, the AIG dont
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 dont 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 corporations 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 mission-
vision 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 companys corporate culture that had been involved in a high-
stakes 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 peoples
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


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American International Group, Inc. Retrived August 12, 2014, from http://www.aig.com.ph/_
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