Industry Analysis
- Property and Casualty Insurance Industry
Prepared by:
Jennifer Goldberg
Page
I. Property and Casualty Insurance Industry Analysis
A Industry Boundaries 1
C. IndustrT Growth 4
E. Cost Structure 13
F. Distribution Systems 15
A. Company Overview 25
B. Corporate Strategy 29
C. Performance Analysis 33
2. Non-FinancialMeasures 40
D. Strategy Outlook 44
A. Industry Boundaries
The insurance industry is comprised of firms that provide countless forms of risk
financing, risk transfer, claim management and loss prevention products. The various products, as
well as the customers served, define the segment of the industry in which the firm competes. The
focus of this analysis is the property and casualty segment of the insurance industry.
The property and casualty segment provides insurance products relating to an insured's
interests (a) in property rights, (b) as a party to a contract, or (c) arising from the legal liability for
bodily injury or property damage to others (Williams 6). This segment is commonly divided
between commercial and personal lines of coverage based on the type of customers served.
Personal insurance covers individuals for non-business related exposures (i.e. resulting from home
and personal auto ownership). In contrast, commercial insurance includes, "all governmental
bodies and nonprofit private organizations, as well as all profit-seeking business firms"
(Malecki 5).
property and casualty business capturing 40.5 percent of the market. The table on the following
page provides the breakdown of 1994 market share by the leading nations as complied by Swiss
Reinsurance@Sept.8,|996)Japancapturedthesecondlargestpercent
share, yet their share is less than half the size of the U.S. share.
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Industry Segments: As noted, the industry is segmented based on the customers and
products served. The following exhibit compares segment distribution of both personal and
Private auto insurance coverage (liability and physical damage) dominates the products
sold in terms of the percentage of premium written. It is also the only area in the industry
A lack of product differentiation and innovation exists within these industry segments.
Due to regulatory mandates and internal underwriting guidelines, most carriers traditionally avoid
deviations from standardized contract language. For example, an auto or general liability policy
contains substantially the same provisions across all carriers. Further, Workers' Compensation
Market Share of Industry Leaders: The top ten property and casualty insurers represent
nearly 40 percent of the industry's 1995 total net written premium volume of $259.8 billion. As
shown in the table on the following page, State Farm is the market leader, capturing twice the
market share of the next competitor. Beyond the high concentration of premium within a few
The remaining market share is distributed among 2,400 other property and casualty
companies (Farinella 1996). Beyond the top four insurers, no other carrier in the industry captures
more than 3 percent of the total market. Yet, that small share represents substantial premium
volume. All of the top 50 insurers in the industry posted net written premium of $1 billion or
more.
All of the largest carriers compete nationally (a few globally) and all are multi-line insurers
providing numerous types of insurance products to both personal and commercial insureds.
However, the two largest, State Farm and Allstate, are dominated by domestic personal lines
business.
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C. Industry Growth
While the compound annual growth rate in premium from 1984 to 1993 was 8.09 percent,
annual premium growth rates in the property and casualty industry have been on a downward or
stagnant trend since 1997. Since 1987, annual growth has never been higher than 6 percent
(|Iugget 1996). Between L994 and 1995, the median growth rate declined from 5.8 percent to
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5.3 percent The following chart illustrates the premium levels of stock companies in the property
Cyclical Growth: Historically, the industry premium growth patterns have been cyclical,
following closely with interest rate levels in the general economy. The relationship between
industry premium levels and interest rates is due to the significant impact investment activity has
on industry profit.
In terms of the basic economic supply and demand model, demand for insurance is fairly
stable and inelastic. It is primarily a function of economic growth, inflation rates and the need to
protect assets (lrlugget 1995). The supply curve, however, moves closely with interest rates.
Rising interest rates entice insurers to provide more insurance at the same price, due
to the
premium investment returns.
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Other Growth Factors: Beyond the interest rate effect noted above, most analysts cite a
major factor causing low premium growth is the over abundance of competition that causes
premium price pressures. The excess supply compared to demand is keeping premium growth
levels low.
Future Growth Predictions.' Standard & Poor's estimates net written premium growth
will be relatively flat at approximately 3 to 4 percent in 1996 (Coyle L996). Best Review concurs
and notes that "given the strategic and financial challenges facing the industry, premium growth is
first half of 1996, shown in the chart on the following page, were met with mixed reviews by
analysts. Net written premium was up 3 percent from the first six months of 1995, the period
experienced relatively few catastrophe losses and consolidated surplus increased almost 13
percent. However, pre-tax operating income and investment income decreased -8.9 and -1.2
percent, respectively. Further, the net gain is due to a 128 percent increase in realized capital
gains. Standard & Poor's expects the industry to continue it practice of "harvesting capital gains"
to support poor underwriting results (Coyle 1996). They predict realized capital gains to double
In the industry overall, underwriting margins have been hard to sustain. Competition
continues to force many companies to slash prices to unprofitable levels. Personal auto and
workers compensation have been among the better performing sectors of the industry recently,
but even in these segments, fierce competition prevents sizable profit growth (Coyle 1996).
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companies (Colden 1996). The total return to investors in the property and casualty industry for
the second quarter of i996 was a very medio cre 7 .4 percent. As one analyst noted, "An investor
can get the same return from investing in U.S. Treasury bonds . . . and lose no sleep through fears
Histoicsl Profttability: As the chart on the following page indicates, operating margins,
return on assets and return on equity have not changed significantly over the past 7 years
indicating no real change in operating or investment efficiency within the industry. The compound
annual growth rate (CAGR) for return on equity declined 2.36 percent, while return on assets
increased less than one percent. Operating margins have been stagnant at around 5 percent.
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industry affect the overall industry profitability (Aaker 1996). Using Michael Porter's industry
structure analysis, the following examines the four primary factors that influence profitability:
intensity of competition, potential competitors, substitute products and customer power. Porter's
fifth factor, supplier power, is omitted in this analysis as external supply requirements are
insignificant within the industry. External supplier power is not viewed as a key determinant of
industry profitability.
1) Rivalry Among Existing Firms: As noted previously, over 2,400 ccmpanies compete
in the property and casualty industry. While a large percentage of the market share is
concentrated within a few firms, significant excess capacity exists as the remaining competitors
The table on the following page illustrates the relative size of the firms in the property and
casualty industry based on number of employees within each firm. The data reflects that while the
industry is comprised of primarily small firms (i.e. under 250 employees), the greatest market
share is with large firms. Only 7.8 percent of all firms employ over 250 people, yet these larger
firms capture over 71 percent of the market. Further, only 2 percent of all firms in the industry
employ between 1,000 to 9,999 people each, yet they attain almost 48 percent market share.
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Factors beyond excess capacity also contribute to the intense competitive rivalry in the
industry. Low product differentiation among competitors encourages price competition. Further,
high fixed costs and substantial exit barriers intensifr the competitive nature of the industry.
Casualty insurance loss payment obligations extend out over many years. The long tail of these
loss obligations to insurer's represent the largest barrier to exit for a casualty insurance company.
As noted, the largest firms in the industry capture the largest market share. However, it is
not clear that these same firms enjoy significant economies of scale. The 1994 operating margins
and profit margins (segmented by asset size) for only those firms in the industry that earned
From this data, larger size does not appear to be correlated with superior operating and
investment performance. The largest firms in the industry experienced significantly worse returns
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on assets and equity than the small and mid-sized firms and had inferior operating and before tax
profit margins.
Before Tax Profit Margin 9.2 8.5 8.7 I 1.5 7.t 58 5.8
industry. As noted, large operating expenses contribute to low operating margins across the
industry,
In addition, significant barriers to entry exist. Insurance products are very standardized
which makes product differentiation for a new entrant difficult. A certain degree of customer
loyally exists which further acts as a barrier to entry. Establishing the required operating
infrastructure also forms a barrier to entry. Insurance company operation require significant
automation for such operations as policy issuance, premium billing and collections, claim data
reporting, and client / broker database management. The cost of building this automation
infrastructure is extremely high. Further, establishing and training alarge services staffto
accommodate diverse client needs is expensive in term of both dollar outlay and time in training.
Large capital investment requirements fbrm one of the most significant barriers to entry.
Financial solvency of the nation's insurance companies is critical. Therefore, tremendous capital
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investment requirements are placed on new entrants. State statutes govern the investment
insurer solvency. The responsibility for monitoring compliance with the statutes is placed with
each state's insurance regulators. The state regulators periodically examine the insurer's financial
position to ensure that the stringent capital requirements are being met, both in terms of adequacy
Beyond the barriers noted above, the lack of prior liabilities provides new entrants a
decided advantage over existing competitors. A recent insurance industry study indicates that
there has been a slight shift in demand from established insurance companies to new entrants into
the property and casualty insurance industry due to the absence of prior asbestos and
environmental liabilities. New companies are not required to set up costly reserves for prior
liabilities which allows new market entrants to exploit price advantages over those carriers that
are limited outside of the insurance industry. However, it is estimated that the current reinsurance
industry capacity for U.S. catastrophe risks is less than $20 billion, an amount some fear is
As an alternative to the traditional insurance market, the private financial market, with
over $17 trillion in financial assets in the U.S. alone, is often cited as a source of substitute capital
(Mooney 1996). However, to date, the capital markets have played only a minor role in providing
a substitute to the financial protection of the property and casualty insurance industry. The
primary reasons contributing to this lack of competitive pressure from capital markets are
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described in a September 1996 National Underwriter article entitled, "Capital Markets Developing
a). A mismatch between investor preferences and insurance market needs: Capital
market products are typically structured as "investments", where the investor puts at risk a sum of
money in return of an expected stream of earnings. In most investments, the risk of losing the
entire principal is very low. Catastrophic risks are very different from the risk prospects of the
normal investments. If investors chose to finance losses from a catastrophe, they are putting their
entire principal at risk. The risk associated with losing the entire invested principle is undesirable
for the typical investor and is a key factor in the limited supply of capital market products for
b). Higher capital market isk premium: Based on the basic risk and return model,
investors faced with the risk of a total loss of invested principal demand a high risk premium. To
date, capital market investors have cautiously entered the insurance market at low levels of
investment and have demanded a substantially higher risk premium than that of insurance industry
reinsures that are widely available at the lower investment levels. Consequently, the higher priced
capital market products have been rejected in favor of the more reasonably priced reinsurance
products.
4) Consumer Power: At initial glance, it appears insurance buyers have little power in
insurance negotiations. Within the heavily regulated insurance industry, state insurance
commissions have authority over the pricing of insurance. Insurance rating organizations exist
that actuarially determine insurance rates that reflect the risk of the insured to the insurance
company. Insurance companies use these rates as the basis for the premiums charged. All rates
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and rating plans must be either filed or made available to the state insurance commissioner
(Williams 690).
The power the consumer has in the insurance buying process is largely determined by the
customer's size. Typically, the larger the account, the more power and influence they have in the
buying process. Unlike smill insurance consumers, larger customers are able to take advantage of
loss sensitive rating plans that tie their premium to their own loss experience. Further, they are
able to take advantage of deductible and coinsurance options that further reduce their premiums.
The negotiating stance of larger accounts is also superior to small accounts. Larger
companies are typically more sophisticated insurance buyers, often having professional risk
managers on staffthat administer the insurance program. In addition, they typically utilize an
insurance broker.
Unlike insurance agents that have a contractual obligation to represent both the insurance
company and the insured, the insurance broker represents the interests of only the insured. The
superior negotiating stance fbrces the insurance company to negotiate beyond the "boilerplate"
contracts used for smaller insureds. However, it is important to note that while the broker is not
directly representing the insurance company, it is illegal for either the broker or insured to
E. Cost Structure
An insurance company's costs are typically broken down into loss and expense dollars.
These costs are typically compared to premium dollars collected to provide both a loss ratio and
an expense ratio. A loss ratio is the total amount paid to cover insured losses divided by total
premium. The expense ratio is the total amount of expenses the company incurs divided by total
premium. The loss and expense ratios added together represent the combined ratio.
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The exhibit that follows illustrates the loss, exp.ense and combined ratios for the property
and casualty industry from 1984 to 1993. While the industry experienced a relative reduction in
expenses, as evidenced by the -1.05 percent ten year compound annual growth rate (CAGR),
there were periods of great increases and subsequent decreases over the period.
What is of interest is that the total amount of loss and expenses paid by the companies in
the industry are greater than the premium collected. On the surface, this would indicate that for
every dollar of premium collected in 1993, the industry incurred a net loss of 7.3 cents. However,
this is omitting a very important part of company revenues: investment income. The loss and
expense components are referred to an underwriting results, whereas the investment returns
derived from the investment of premium and surplus dollars are called investment income.
Loss expenses are variable costs; the greater the sales volume the greater the loss and
pre-loss prevention measures (i.e. loss control engineering), post-loss claim management, as well
as loss financing techniques such as reinsurance and insured retentions. Other expenses are
considered fixed in nature. While it was noted that it is not evident that economies of scales exist
to reduce all types of costs, large companies can be more price competitive due to their ability to
F. Distribution Systems
Property and casualty insurance is sold either directly from the insurance carrier or
through an intermediary. Most property and liability insurance in the United States is sold
through an intermediary within the insurance agency system, either an independent or exclusive
agent (Iluebner l2). Both types of agents act on behalf of both the insurer and the inured in the
insurance transaction. The independent agent has contractual arrangements with many insurance
The insurance dgent is contrasted to the insurance broker that represents the insurance
buyers, but has no contractual commitment to the insurance carrier. Most large commercial
property and casualty insureds utilize insurance brokers to represent their interests in the
banks. While most analysts feel the greatest opportunities for bank based insurance distribution
lies with life insurers, there are opportunities for personal lines and small business property and
casualty insurance due to relationships most banks have with these customers (McDaniel 1996).
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Dun & Bradstreet estimates 197,000 insurance agencies and brokerages exist in the U.S.
employing over 1.3 million people (D&B Market Place 1996). As indicated in the following
table, 88.4 percent of agencies and brokerages employ less than ten employees. However, 60.7
percent of the market share is achieved by larger offices with staffs of 10 or more people.
Strikingly, the largest agencies with 50 or more represent 1.6 percent of the total number of
searching for ways to improve earnings profitability. An article in the July 1996 Best's Review
cites the steps companies in the industry are taking to improve results. The most common trends
Increasing the carrier's retentions in core line of business and purchasing less
savings.
According to a study by Conning & Co., since the beginning of 1995 there have been 68
mergers and acquisitions in the property and casualty industry (Auns 1996). Most experts in the
industry expect the consolidation trend to continue as companies try to control expenses. In a
recent survey of 149 insurance company CEO's, 49 percent believed their companies were likely
to make an insurance acquisition in the next 10 years (Lonkevich 1996). Another 25 percent
However, some industry leaders see drawbacks that may slow the current merger trend.
They note that there are hidden (and not so hidden) costs associated with the merger itself. For
example, people and systems integration between companies is costly and extremely time
consuming. Systems development philosophies and architectures are not standardized in the
improve efficiency and control the billions and billions of pieces of data accumulated, stored and
shared throughout the insurance network (i.e. information shared between customers, brokers and
carriers). According to one major insurance brokerage, Sedgwick North America, "greater
efficiency, through use of technology is helping the industry increase its productivity and vitality"
An example of new technology in the industry is the $30 million plus World Insurance
Network (WIf| that has been designed as an electronic communication link between brokers,
underwriters, and risk managers. WIN is being financed by six top insurance brokers: Alexander
& Alexander, Aon, Johnson & Higgins, Marsh & Mclennan, Sedgwick and Willis Corroon. The
network hopes to get the 30 largest property and casualty insurance corporations in the United
States, the United Kingdom and Europe as users in the next 12 to 18 months (Katz 1996). Each
targeted release ofthe system has a stated goal. In general, the objective is to cut errors and
turnaround time for communication through electronic data interchange and to begin to set global
It is not know where the Internet technology will take insurers in the future. However,
the technology is already being used by agents and brokers to provide quick access to rates, as
well as a means of communication between customers, brokers and insurance companies during
the premium negotiation and claim adjr:sting process. In addition, the Internet offers an ideal
platform for carriers to provide marketing support by offering links to web pages containing
Legislative Developmenfs: Several key pieces of legislation face the property and
casualty industry. The October 7, 1996 edition of Business Insurance highlighted important
pending issues:
The key success factors in the industry are the assets and skills that provide a basis for
successful competition (Aaker 1996). While Standard & Poor's outlook for the industry as a
whole continues to be negative, they predict success for those companies that are able to
advantage (Coyle 1996). These sentiments are shared by most analysts and follow closely with
Michael Porter's generic overall cost leadership and differentiation strategies. Some key success
factors leading to a sustainable competitive advantage are comrnon to both strategies, while
Financial Strength: No matter what the insurance carrier's strategy, a key success factor
is its financial strength. The company must be viewed as a reliable market. Otherwise, agents and
clients will take their business to other carriers and regulators will move in to force corrective
action.
Unfortunately, the financial outlook for several firms in the industry is described as "poor"
by most industry analysts. In one analyst's opinion, "insurance prices are under increasing
pressure and contract terms and conditions are being subjected to varying degrees of tinkering ...
causing an increase in the polarization between stronger and weaker companies in the industry."
(Picoult 1996).
1996). He cites future success depends on building productive, low cost distribution systems that
Unfortunately, this is not the approach consistently followed by many carriers. As cited by
one industry analysts, "carriers and agencies often work almost independently of each other, using
broad based communication and prospecting efforts, but only achieve sporadic results . . . and
carriers often promote their products by developing expensive brochures and sending them to
agents without regard to the agency expertise or availability of accounts in a particular territory"
(Cunningham 80).
In Shumrak's opinion, a "market driven, customer oriented and capital focused distribution
based on matching the most appropriate distribution methods and channels to each targeted
customer segment. The approach is based on the following simple, yet often overlooked, steps:
Step I: Evaluate Existing Distribution Channels: Analyze each agent's value and
expertise and reward the best, provide incentives for the mediocre and remove the worst or those
Begin by actively cross selling the unfilled needs of current customers. Cross selling lowers the
per account acquisition investment. Creating an integrated marketing approach across several
product lines helps to ensure ail of the client's needs are address. Further, by building an
integrated distribution process, the time frame required to successfully develop productive
approaches to acquiring new customers is shortened due to the reduction in marketing effort
redundancies.
Step 3: Evaluqte the distribution system for selling the "right product" for the "right
cttstomer": The same sales methods are not effective for all products and customers. Therefore,
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the correct sales method should be carefully analyzed and selected for selling the targeted
Quality of Staff: Insurance is a service versus a consumer product that can be seen or
touched. Therefore, the people providing the service are an insurance companies greatest revenue
producing assets. Jerry Choate, Allstate's chairman and chief executives officer, feels so strongly
"employees have to come first, before even customers or shareholders. Before you can deliver
world-class service, you have to deliver world-class training. Well trained employees are essential
His opinions are shared by Frederick Dopfel, a director of Centre Reinsurance Co., who
feels that the highest-quality employees will be the way companies differentiate themselves in the
future. He feels companies such as Microsoft Co. that utilize a horizontal structure of highly
talented problem solvers will be the insurance industry's model for the future Q-onkevich 1996).
Flexible and EfJicient Service at Lowest Price: Based on a research study by the
Quality Insurance Congress (QIC), the insurance industry is falling behind other financial services
business in satisfying the customer and there is a "battle cry from the consumer for improved
products and low cost quality service" (Pasher 1996). According to the study, customers want
their carriers to provide "innovative value" and "low hassle" service, and for insurers to be
In a separate study conducted for the National Association of Independent Insurers, the
key factors driving insurance sales were also found to be low price and service speed and
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efficiency (Lonkevich 1996). The sun'ey results indicated that insurance buyers are not satisfied
with a choice of low cost product or quality service. Instead, they want both.
Expense ContainmenL' Standard & Poor's cites that thinner margins and lower premium
growth will force companies to become more creative in reducing expenses (Coyle 1996). They
cite that companies who are successful in obtaining meaningful expense reductions will likely to
Travelers I Aetna Property Casualty Corp. CEO, Robert Lipps, feels that cutting expenses
is a vital element in a successful management plan (Prince 38). He instills the philosophy that "no
expense is too small to question". Due to this emphasis, Traveler's has limited company
subscriptions to newspapers and magazines, reduced by half the number of cares leased by the
director for Salomon Brothers, a key success factor for firms in the industry includes moving
away from the "commodity lines" mentality and stop striving to be "all things to all people"
(Sclafane 1996). Standard & Poor's notes that successful multi-line carriers are rethinking their
strategy of attempting to serve all markets with all types of coverage and are instead taking a
focused strategy to targeted niches (S&P Stock Reports 1996). Another industry analysts defined
the strategy in this way, "rather than first building a'great generic product' and then trying to sell
it to as many markets as possible, reverse this process and build each product for well-defined,
due to over capacity and a lack of product differentiation. Further, nearly all buyers have a good
understanding of available products and services due to the similarity across carriers. Buyer
The industry's maturity is also evidenced by low product innovation and stable demand.
While insureds may decide to stay with a carrier they like regardless of minor price differences,
name recognition and reputation tend not to positively impact the premium the carrier is able to
charge.
It is unclear how profitability can come to the thousands of participants in this industry.
Industry competitors must adopt a strategy that incorporates the necessary industry key success
Some will pursue overall cost leadership strategies by building on their size, experience
and efiiciencies to reduce distribution, salary and other overhead expenses. A low cost advantage
can provide profitability in this highly price competitive environment. A low cost strategy is also
favorable in this industry due to the large market of high volume sales where there are significant
barriers to entry. However, in order for this strategy to work, participants must keep up with the
rapidly changing technology trends noted earlier, as well as the desires of the market.
products and services from others in the industry. Such a strategy appears difficult given the price
pressures and current lack of perceived product differentiation in the industry. However, by
targeting a niche in the market, gearing all efforts toward product innovation to meet market
needs and being willing to accept a smaller market share, a differentiation strategy can be
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successful. A market of insureds exists that is looking for specialty coverages, unique terms and
customized services. The key is identifying the segment's special needs, developing a product and
The fallout in the industry will likely come from those that attempt to be all things to all
insureds and those that attempt to follow a combination of both the low cost and differentiation
strategies. Unfortunately, these two strategies run counter to each other. Firms that attempt to
do both will likely accomplish neither. Investments in either product innovation or efficient
operations are costly endeavors. Without mastering either, costs will increase without an
company with a clear understanding of the industry's structure and a well defined and
A. Company Overview
American International Group (AIG) is a United States based holding company of an
international pool of insurance companies. AIG is the largest underwriter of domestic commercial
property and casualty insurance coverages, the fourth largest domestic property and casualty
group writer overall (i.e. personal and commercial combined), and the largest U.S. based
international insurance organization (Standard & Poor's' 1996 Claims Paying Ability Report). Its
member companies write property, casualty, marine and life insurance in approximately 130
countries and jurisdictions, and engage in a range of financial services businesses (PRNewswire
1996). The following table lists the pool companies that comprise the American International
Group:
History: AIG is a company founded on a strong entrepreneurial spirit. AIG was formed
when Cornelius Starr, an American business person, began the company's first insurance agency in
Shanghai in 1919. In 1921, Starr began selling life insurance to Chinese and through the years
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established insurance offices around the world. He opened the company's first office in the United
States in New York in 1926 to provide insurance for American companies with risks outside the
U.S. In 1967, Starr passed the company over to his successor, Maurice Greenberg. By 1972,
Greenberg established AIG as a holding company for Starr's worldwide collection of insurance
companies. Greenberg still leads AIG as the company's Chairman and Chief Executive Offcer.
Strategic Business Units: AIG's business units in the United States are primarily focused
on property and casualty insurance, but the company has continued its strong emphasis in life
insurance abroad. Income from foreign operations accounts for approximately 52 percent of the
company's pre-tax incorne (WSJ.com October 3,1996). The company's primary business units
and associated operating thrusts are described in the company's 1995 AnnualReport as follows:
a) Domestic General :
Domestic Brokerage (DBG): DBG markets property and casualty insurance products
through brokers to iarge corporate buyers and other commercial customers. 90 percent of AJGs
domestic premium is from the DBG. This business unit follows differentiation strategy. They are
a leader in developing and marketing specialty products and services for difficult to place classes
Domestic Personal Lines: AIGs domestic personal lines business unit consists of both
mass marketing and specialty auto divisions and follows a low cost strategy. The division
company plans to selectively grow its U.S. personal lines portfolio, principally private passenger
b) Foreign General:
The Foreign General Group comprises AIGs overseas property and casualty operations
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that the company touts as the most extensive foreign network of any insurance organization.
AIG's Foreign General unit markets a full range of property and casualty products to both
consumer and commercial clients. The global network of licenses and affiliations that the company
has created is very unique in the insurance industry. Most feel this network would be very
difficult to duplicate, given the difficulty of entering different jurisdictions with unique laws and
c) llorldwide Life:
Greenberg considers AIG's life insurance operations one of the company's "crown jewels".
Life operations comprise an extensive worldwide life insurance network that accounts for
approximately 30 percent of AIGs total pretax income. AIG's life insurance strategy focuses on
the strength of the network, their name recognition, agency force, product line and client service.
Fee-based services are provided by these agents and service managers. They earn
commission income from premiums generated for AIGs insurance companies and generate
revenue from technical and supporl services such as claims adjustment and cost containment.
e) Financial Services:
AIG selectively targets its financial services business, both domestically and overseas.
AIG's financial services strategy is to target businesses that compliment their core insurance
business and those where they can add value and achieve a competitive advantage by capitalizing
on their high ratings, global network, entrepreneurial culture and financial structuring expertise.
Their current financial services focus includes establishing capital funds for major overseas
infrastructure projects and direct equity investments in Hong Kong, Russia and countries in Latin
AIG's holds minority interests in several reinsurance and excess liability insurance
operations around the world. While providing capacity for AIG's core business, these operations
also provide a source of revenue lor the company. Operating income from these businesses rose
46 percent in 1995.
The following chart provides the i995 total operating income contribution of each of
these business segments. Investment results are combined within the operating income of each
segment. The property and casualty lines provided by the Domestic General (combined personal
and commercial lines) and Foreign General segments represent the majority of the company's
operating income.
(17 6VQForeignGeneraI
(13 @ Minority0wned
B. Corporate Strategy
AIG summanzed their strengths, strategic objectives, corporate goals and vision for the
"Our strong balance sheet, stable and diversified earnings streams, healthy cash
flow and sound underwriting policies are invaluable assets which we protect and
nurture. They are the tenets for our business philosophy, the foundation of our
strategy, and they define our success. AIG has cultivated the ability to respond
quickly to changing customer needs and marketplace conditions and opportunities.
We are and strive to remain the most efficient company in our industry, as
measured by the expense ratio. Our markets are global, and our people are
encouraged to seek out new opportunity wherever it lies. AIGs priorities for the
future include building on our strengths to remain the premier global insurance and
financial services firm and the company of choice for our clients, whether they be
global corporations or individuals. "
AIG's corporate strategy is best described as an overall cost leadership strategy controlled
aggressively by Greenberg. The cost leadership strategy is designed to capitalize on the industry's
competitive price pressures and AIG's relatively high market share. However, the company's size
and diversification lends itself to a differentiation strategy in selected business units. The
Cost Controls.' AIG operates under very tight cost controls. The company strives to
control distribution costs by building a close relationship with their brokerage distribution
network. In addition, the company is able to more readily attract business and reduce acquisition
costs by ceding a greater proportion of its business relative to other insurers (S&P 1996).
Further, AIG relies heavily on technology advances to keep its stafflean (Boroughs 1995).
Jennifer Goldberg 30
centers (AIG Home Page). Uniike other companies in the industry, each profit center is required
to maintain an underwriting profit and is not allowed to rely solely on premium investments to
generate income. Greenberg reiterated the importance of this strategic philosophy in his
comments in the 1995 Annual Report, "IJnderwriting is our main business and we adhere to the
goal of achieving an underwriting profit. This in embedded in the culture of AIG and is in sharp
contrast to the market share strategies that have resulted in such large underwriting losses for
other companies. " Greenberg further notes that their profitable underwriting results and the
resulting superior ratings have made the company a "magnet" for business.
Prudent Investment Strategies.' Premium and surplus investments are a vital part of an
insurance company's operations and are a primary income source. AIG's invested assets totaled
$93 . 6 billion at year end I 995. According the company's I 995 Annual Report, their investment
strategy emphasizes protection of principal, diversification, liquidity and long term growth.
Further, they state that careful investment planning is carrier out in order to meet the expected
According to Standard & Poor's 1996 Stock Report, AIG's investment strategy has been
low risk, with most of the portfolio invested in high-quality bonds and short-term instruments. In
the company to write large shares of major risks. (AIG Home Page). AIG insures property and
casualty insurance on a "gross lines" basis in which the company underwrites the entire amount of
any size risk and obtains reinsurance for only the portion of the risk in excess of what it wishes to
retain (S & P February 1996). This is in contrast to other carriers in the industry that only
Jennifer Goldberg 31
provide insurance up to a certain retention limit and require the broker to obtain coverage
elsewhere for the remaining desired limits of insurance. By agreeing to insure the entire portion
of the risk (rather than just a portion of it), AIG attains greater control in the overall pricing and
negotiation of the program. Further, this strategy allows the company to better respond to
customer needs and to benefit from commission on the reinsurance that they place (S&P February
1 ee6).
product and service r"rnits to respond to changing consumer needs is a central strategy for AJG
(1995 Annual Report). Over the years, this has included the company's entrance into specialty
insurance coverages such as aviation insurance, mortgage guaranty insurance, fidelity, kidnap and
ransom, malicious product tamper, as well as the company's eventual market domination in
directors and officers and excess and surplus lines. AIG's strategy includes the targeted
Their targeted diversification strategy is designed to not only increase their customer base,
but also to expand operations into product lines that achieve higher returns due to the
unwillingness of other carriers to service these unique insurance exposures. Standard and Poor's
September 1996 Stock Report cites AfG's expansion into selected specialty coverages as a means
The company has been scaling back traditional property and casualty business in favor of
specialty lines coverages. Following the release of the third quarter 1996 operating results,
Greenberg noted that improved property and casualty results came from a continued focus on
higher margrjl specialty insurance lines (Scism October 24 1996). According to Greenberg, "We
Jennifer Goldberg 32
are aggressively pursuing opportunities in these classes, introducing new products that continue to
Corporate Risk Management Focus: AfG was among the first insurance companies to
establish unique risk management services for large companies. The tailored products and
services for the large commercial account market segment include technical expertise in national
account underwriting, loss control engineering and claim management. Their innovations in
products and services for large commercial accounts, such as difference in conditions coverage for
non-traditional perils and an emphasis on deductibles rather than first dollar coverage, attracted
the brokerage cornmunity and large corporate customers that required high capacity and
American postwar overseas business expansion is a key to the company's market leadership
operations in Latin America, Hungary, China, Poland, Vietnam, Pakistan and Romania. Hiring,
training and promoting local people to management position is also a partof AJG global strategy
Report. Standard and Poor's projects that AJG' significant level of commitment to revenue
generated outside of the U.S. will allow for continued strong growth as these international
C. Performance Analysis
According to an analyst at Prudential Securities, "AIG has probably the best long-term
record of any company in the insurance industry" (Boroughs 1995). AIG's strong performance is
the result of break-even underwriting results coupled with strong investment gains. The
company's strong financial results in 1995 placed the company first in earnings among insurance
and non-bank financial services companies, and their 1995 net income ranked 17th in the Business
Week 1000, which includes all U.S. corporations (AIG 1995 Annual Report).
Insurance Ratings: Standard & Poor's is a leading source for insurance company financial
ratings. A primary insurance industry evaluation is Standard and Poor's rating of a carrier's ability
to meet its primary liability on the balance sheet - claim payment obligations. Standard & Poor's
defines the insurance claims paying ability rating as "an opinion of an insurance company's
financial capacity to meet the obligations of its insurance policies." Ratings range from the secure
range (AA'A5 AA, A BBB) to the vulnerable range (BB, B, CCC). AIG's pool companies
received the highest available rating (AAA:> Superior) in the latest February 1996 Standard and
Poor's Claims Paying Ability Report. The AAA rating is defined and justified in the report as
follows:
"Insurers rated AAA offer superior financial security on an absolute and relative
Another important rating is provided by Best's Ratings. AfG's superior (A++; Best's
Rating was afiirmed in 1996. Included in the glowing text of the rating report, Best's comments
that,
recognized leadership position within global insurance markets. Further, the rating
positions in the national accounts market for large commercial specialty coverage,
including professional liability and excess and surplus business. Further, the rating
and stable presence within its core markets that has reinforced its strong
relationship with brokers and customers. Finally, the group maintains a
Financial Performance Overviev,.' AIGs results for the first half of 1996 were positive.
Written premium increased and underwriting results remained profitable, as evidenced by a 96.38
percent combined ratio (S&P 1996 Stock Report). AIG's overall financial performance evaluation
for the past 10 years is shown in the Financial Performance Analysis exhibit is shown on the
following page.
American International Group, Inc.
Financial Arralysis
10 Yetrr
CAGR 1995 lj9A l99jt 1992 U91 1990 1989 1988 re87 le86
Reverue (000p00) 12-62% 25,814 22,3s9 20,068 18,389 16,884 15,702 14,150 12,844 11,021 8,876
7o Chrnge from Prior 15.70% 1,1.40% 9.10% 8.90% 7.50% 11.00% 10.20% 16.50% 24.20%
Nct lncome (000,0m) n.69% 2,510 2,176 1,939 1,657 1,553 1,442 1,361 1,209 1,033 791
9/" Changc from Prior 1530% 12.20% 17.00% 6.70% 7.70% 5.50% 13.10% 11.00% 30.60%
Totaf Asscts (000,000) 22.86% 134,136 114,346 l0l,0l5 79,835 69,389 58,143 46,143 37,409 27908 21,023
7o Chrnge from Prior l'1.30% 13.20% 26.50% 15.10% 1930% 26.00% 23.30% 34.00% 32.70%
LT Debt (000,000) 3L50% 13,938 12,614 10,956 9,518 7,591 6,780 4,061 2,823 1,958 1,270
o/o Change lrom Prior 10.50% 15.10% 15.10% 25.40% 12.00% 67.00% 43.90% 44.2U/o 54.20%
Equity (000,000) 16.95% 19,827 16,422 15,244 12,782 11363 9,904 8,405 6,963 5,728 4,845
7o Change from Prior 20.70% 7.7U/o 1930% 11j0% 15.70% 17.80% 20.7V/o 21.60% 18.20%
Industry
Retum on Equity 5.10% -2.73% 12.10o/o 13j0% 12.70% 13.00y6 1350% 14.60% 1630% 17.40% 18.00% 16.30%
7" Ch.rye from Prior -4.50% 4.10% -2.30% -3.70% -7.50% -10.40% -6.30% -3.30% 10.40%
Return on Assets 3.00% -7.40% 190% L90% L9V/o 2.10% 2.20% 2.50% 3.00o/o 320% 3.70% 3.80%
7n Chrnge from Prior 0.00% 0.00% -9.50% -450% -12.00% -16.70% -6.20% -13j0% -2.60%
Net Profit Margin 4.00% 4.55% 9.70o/o 631% 6.70% 5.40% 2.05% 397% 7.05% 6.74% 2.60% 6.50%
7" Ch.nge from Prior 40.40% 3.10% 24.10% 163.40% -48.40% -43.70% 4.60% 159.20% -60.00%
Eamings per Sharc 1325% 5.3 4.58 4.07 3.47 3.24 3.08 2.95 2.61 2.23 173
7o Change from Prior 15.70% 12.50% 17.30% 7.l0yo 5.20% 4.4U/o 13.00% 17.0V/o 28.90%
Debt to Equity Ratio 11j9% 10j0% 76.80% 71j0% 74.50% 66.2V/o 68.50% 483V/o 40.50% 34.20% 26.20%
7o Chanee from Pdor -1.76% -16.72yo -17.63% -9.41% 45.54% -5.99% -6.18% 20.68% -16.436/o -56.85%
Dota Source: Standatd & Poot's Stoeh Repotts for AIG (Septenber 2E, 1996) aru| 1995 AIG Annudl Repon
Jennifer Goldberg 36
Sales and Revenue: In the ten year period from 1986 through 1996, the company
experienced strong growth. Over the period, revenue and net income increased 192 percent and
217 percent, respectively. This represents a compound annual growth rate (CAGR) of 12.62
The net profit margin increased from2.6 percent in 1986 to 9.7 percent in 1995. While
both net income and equity have increased over the ten year period, the company's return on
equity has decreased from a high of 18 percent in 1987 to the current low of I2.7 percent in 1995.
AIG's revenue composition shifted slightly away from property and casualty business to an
increased life insurance share. The following illustrates the shift in revenue contribution over the
past 3 years:
Revenue Breakdown
1995 r994 t993
3eneral lnsurance 50% 53% 55%
Life lnsurance 40% 38% 36%
Agency Operations T% I% t%
Finaacial Services 9% s% 8%
Source: Standard and Poor's Stock Reports
Leverage: The company's debt position is significantly higher over the ten year period and
is much higher than the industry average. In 1986, the company's debt to equity ratio was 26.2
percent and increased to 70.3 percent at the end of 1995. AIG's debt to equity ratio relative to
Stock Performance. lnthe past 52 weeks, AIG's stock price experienced a low of $88"8
3/8
in May of 1996 due to interest rate concerns, but has since soared to a high of $116 in
November. The company's ten year stock performance is shown on the following page.
-t
lAmerican lnternational Group I
I-m_rllmu-m..".mre#
Monthly Stck Pricss 1187 to 12196 E
Jennifer Goldberg 38
Other than slight downward blips over the period, the company's stock price has grown over 475
percent over the ten year period, representing an 18 percent compound annual growth rate.
Price Earnings Ratio: The company's price earning ratio is compared to the insurance
industry, the property and casualty sector of the industry and the equity market in general in the
following chart. Given that stock price is a reflection of future growth expectations, the higher
price earnings ratio indicates investors anticipate higher than industry or market earnings for AIG.
r 9.5
dlE
50
i ro.s
O
l5
a
o- 13.5
AIG lndudry Sector \/SJ/DJ
18.4 15.77 13.95 18.08
Total Return to Investors.' According to Standard &. Poor's stock evaluation of AIG, the
value of $I 0,000 invested in AIG ten years ago would be $29 ,456 today. This return to investors
is very favorable compared to both the insurance industry, as well as the stock market as a whole.
Total return is defined as dividend plus share price appreciation. As a means of comparing AIG's
total return results to that of the industry, the following Five Year Total Return exhibit compares
the company's returns to both the Dow Jones Property and Casualty Index and the overall Dow
Jones Equity Market Index (WSJ.com 1996). As the graph illustrates, the company performed
well above the Dow Jones P&C Index. Further, the company's total returns have been well above
customer satisfaction, product or service quality, employee relations and management quality are
difiicult to measure and depend largely on the perspective of the person conducting the
evaiuation.
annual "Survey of Corporate Reputations". As defined in the survey, reputation includes such
non-financiai performance measures as the way a company treats its employees, how much it
spends on research and development, and the strength of its management team.
The Fortune article cites that reputation is crucial to financial performance. They compare
it to the chicken and the egg, "It's not always clear which begets which, but it's awfully hard to
have one without the other. " A research study mentioned in the article attempted to measure
exactl.v hor.v closely reputation and financial performance are linked. The study reviewed the
assets, profits, and ten-year annual return to shareholder.q of the Fortune 1,000 and correlated
ihese and other financial indicators with companies' standings on the most admired list. It was
determined that size alone is not the sole factor. There was virtually no relationship between the
size of a company's assets and its reputation. However, financial performance, including measures
like total return and earnings growth showed a strong correlation with reputation.
The most crucial aspect of reputation as ranked bythe 11,000 executives, directors, and
analysts polled was quality of management, with quality of products or services a close second.
Both responsibility to the community / environment and innovativeness ranked at the bottom.
Companies are selected to be in the review based on their revenue size. Only the top ten
in revenue size in each industry group are chosen. In the 1996 review of 417 companies, AIG
Jennifer Goldberg 4l
ranked number one in the insurance industry and sixty-fifth overall. The following table outlines
Financial Soundness / Long Term Investment Value: AIG's financial review was
presented in the previous section. However, it is important to note that not only is AIG achieving
superior financial results. but more importantly, customers recognize and value their superiority as
reflected in their number one rankings within these financial performance categories.
reflecting that the company's strategic emphasis on product and innovation is valued by the
market. In an October 29, 1996 editorial in the The Wall Street Jou the writer from the risk
management community credited AIG with providing customers the products they needed when
no one else would, "Corporate America went through a horrible insurance crisis from 1985
through 1990, and I think all knowledgeable risk managers will say without reservation, 'Thank
Relative Cost: AIG also rated number one in "use of corporate assets". This superiority
is likely due to their relative cost advantages. A 1995 U.S. News & World Report article cited
that AIG's best protection against brutal price competition in the industry may be its cost structure
(Boroughs 1995). The company's expense ratio was 10 percentage points better than the industry
in 1994, due in largepart to its favorable acquisition costs relative to the industry. AIG's
percent (S & P 1995 Industry Survey). By keeping claims losses and expenses low, the company
has achieved a superior combined loss ratio as compared to its industry peers, as shown in the
'5 110
U3
3 1oo
Quality of Management and Ability to Attract and Keep Talented People: AIG also
ranked number one in both quality of management and the ability to attract quality staff Some
question whether AIG would edst as it does today without Greenberg. Fortune World's 1990
Jennifer Goldberg 43
review of the CEO's of the Year, cited that Greenberg's "iconoclastic approach makes AIG
singularly popular." They note that he has "no desire for the invisibility typical in the insurance
industry" and that "he regularly dives into public policy controversies, but not for altruism, but for
However, the article also cites that Greenberg has a reputation as a "difficult man,,. This is
likely the reason that the company has experienced significant turnover in its senior management
in recent months and why there is no clear successor to the 69 year old leader. In September
1996, three senior: executives resigned from the company. These announcements followed
the
earlier resignation of the executive vice president of company's domestic brokerage group, the
AIG's ultimate dedication to superior financial performance is often cited as the reason for
some rather hard edged employment practices. When a division or department does not perform
up to the objectives set for it, changes are made immediately. These changes often involve
employee layoffs, as evidence by AIG's recent decision to close their municipal derivatives
operation. As a pioneer in the derivatives business, AIG did not realize the desired returns from
the unit. To the surprise of most industry anaiysts, they disbanded the unit in early fall of 1996
and laid offall but the managing director of the nine member team (Reuters September 4, 1996).
Quality of Products and Services Offered: Based on the survey results, AIG's quality of
service performance does not match the quality of its financial performance. AIG ranked third in
the industry and 22lst overall in terms of "Quality of Products and Services". Further, they
ranked at the bottom in both the industry and overall ranking in the "Community and
D. Strategy Outlook
In a survey by Towers Perrin / Tillinghast, CEO's of commercial property and casualty
companies named AfG as the best positioned to meet the challenges facing the industry (Borough
1995). As previously noted, the company has developed clear strategies for each of its business
units. With an overall emphasis of financial discipline, the company is able to achieve superior
profitability in the face of a highiy price competitive environment. Further, AIG's openness to
targeted diversification opportunities allows the company to capitalize on emerging trends in the
environment.
AIGs key challenge in the future will be the continuation of their prosperity without
Greenberg in control. While there are no reports of changes in the company's leadership, there is
not a clear successor after the 69 year old Greenberg eventually steps down from the company he
A central issue becomes the strength of the structure, culture, systems and strategies
Greenberg has put in place. Gven the company's strong performance to date, the company is well
positioned in these areas and has the sustainable competitive advantages to respond to
Works Cited
Aaker, David. Developing Business Strateglr. New York: John Wiley & Sons, Inc., 1995.
Boroughs, Don. "Building a Global Empire". U.S. News & World Report. g Ian. 1995: 40
Colden, Ann. "Insurers Report Hurricane Fran Packed a Punch". The Wall Street Journal i4 Oct.
t996
Coyle, Mathew. "Standard & Poor's 1996 Mid-Year Outlook for the P/C Industry". Focus. April
- June 1996.4-6
Cunningham, Sharon. "Carriers and Agencies Must Pool Their Talents. " Best's Review. August
1996.80
Farinella, Michael. "Soft Pricing, Competition Dampened 1995 Premiums." Best's Review. July
1996'.30-35
Fisher, Anne B. "Corporate Reputations 1996". Fortune. Online. Internet. 6 Sept. 1996
Huebner, S.S. Property and Liability Insurance. Englewood Cliffs, NJ: Prentice-Hall, Inc., 1982
Hoffinan, Dave. "Industry Must Shatter Merger Management Myths " Best's Review. August
1996:94
Lonkevich, Dan. "Lower Cost Drives Sales, Survey Finds. " National Underwriter . 2I Oct.
7996:3
McDaniel, Dave. "Bancassurance American Style." Best's Review. July 1996: 38 (a)
McGough, Robert. "Maurice Greenberg; His Iconoclastic Approach Makes AIG Singularly
Profitable." Financial World. 3 April 1990.79
Jennifer Goldberg 46
Nugent, Thomas. "Property and Casualty Insurance" Standard & Poor's Industry Surveys ed. 2
March 1995. 17-24
Pasher, Victoria. "Industry Urged to Listed Closely to Customers. " National Underwriter. 2g
Oct. 1996: 13
Picoult, Myron M. "Insurers' results hinge on good Use of Capital." Business Insurance. 30
Sept.1996
scism, Leslie. "ArG Posted Jump In Profit of l6Yo For Third period" The Wall Street Journal.
no pag. Onl-ine. Internet. 24 October 1996
Sclafane, Susanne. "Poor Market Dynamics Seen in Results. " National Underwriter. 23 Sept.
t996.3
Stifl Ben. "When Needed, AIG Was There". lhe Wall Stres!_Jgurnal. (editorial) no pag. Online.
lnternet. 29 October 1996
"American International Group, Inc.". Standard & Poorts Stock Reports. 28 Sept 1996
"American Insurance Group, Inc. Intercompany Pool". Standard & Poor's Claim paying Ability
Report. Online. Insurance News Network. Internet. Feb 1996
"American International Group, Inc". WSJ.com Company Briefing Book. n. pag. online
Internet. 3 Oct. 1996
"AIG shuts muni derivatives unit". Reuters America Inc. n. pag. Online Internet. 4 September
1996
"Insurance Market Trends and Developments. " Sedgwick National Brokerage Division Internet
Home Pase. no pag. 1996
"Japan Becomes the Lar-eest Overall Insurance Market in the World." National Underwriter. 6
Sept, 1996 49-52
Dear Jack:
Enclosed is a Strategic Planning Report for my two credit independent study project that I
completed this semester with Professor Hale Bartlett. The signed proposal is also attached as an
additional copy for your records.
Professor Bartlett is receiving his copy of this report today for review and grading. Note that this
report is an extension of a required written assignment in Professor Bartlett's Management 580
class.
Sincerely,
Enclosures
IHDEPENDEI{T STUDY PROPOSAL MBA PROGRAMS
The University of illinois at Chicago
Name
11 / /
--7o/ -1// c/ //
Social Security No. c /v- /^/- db/b Date // /b/?/-
Address 4:N
Day Phone Evening Phone (7 ca\ r" - s 3/6
=e
SupeMsing Faatlty l'"iember Da . L1r. i. -t>a.l ).] f Term Hours of Credit Requ€sted (1-4)
1. What is the objeaive of your study, and how does it relate to existing knowledge in the field?
2. What is your plan ol sludy - include information on research m€thodology, i.e., do you plan to use quantitative or qualitative
anatysis, an existing survey instrumsnt, review literature, etc.
3. Will your independent study project be evaluated on a research paper, project report, iinal examination, or an aiternative
method? lnclude detailed information on performance criteria.
After your supervising faculty member and appropriate department head have approved your prospectus, return this form and the
prospectus to the MBA Programs Office.
Approval
Please circulate this form and your prospectus to your supervising fao.ltty member and appropriate department head for approval
before submitting to the MBA Programs Office.
).-J
Supervlsing Faculty - I have read the accompanying prospectus and do not approve this proposal.
l,{aPprove Ll
Signature and Date 723-
Department Head -l accompanytng prospectus and
./\
approv€ I Oo not approve this proposal.
The following is an lndependent Study Proposal for a two (2) credit hour
lndependent Study project with supervising faculty member Professor Hale Bartlett,
Ph.D. As a part time MBA student with concentrations in Strategic Management and
augment this course work with an lndependent Study project focusing on the strategic
knowledge of the analytical tools and concepts used in strategic planning. Based on
preliminary discussions with Professor Bartleit, I can accomplish this and develop an
accompany the industry analysis report I will be preparing in Management 580 during
the upcoming fall semester. The purpose of both the company and industry analysisris
to (a) develop a knowledge of information sources, (b) review the social, legal
economic and technological forces that impact both the firm and the industry, (c)
establish an understanding of the basic characteristics, forces and trends of the firm
and industry and (d) analyze how these factors aflect the strategy of the firm.
Plan of Study: I will be using many of the same resources and tools required by
Jennifer Goldberg
page 2
Professor Bartlett to complete the Management 580 industry analysis. This wilt
include
devote several hours each week during the semester toward research and completion
of an approximately 15 to 20 page paper, due by the end of the Fall 1gg6 term. The
paper will be evaluated by Professor Bartlett based on the objectives and plan of study
noted above, incorporating any amenciments that develop during our discussions over
the semester.