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Strategic P lanning Reports

Industry Analysis
- Property and Casualty Insurance Industry

Comp any Analysis


- American International Group, Inc.

Prepared by:
Jennifer Goldberg

Fu(illing the requirements for:


Management 580 - Strategic Planning
Management 596 - Independent Study (2 credits)

Profes s or Hale Bart lett


University of lllinois at Chicago

December Il, 1996


fable of Contents

Page
I. Property and Casualty Insurance Industry Analysis

A Industry Boundaries 1

B. Actual and Political Industry Size 1

C. IndustrT Growth 4

D. Industry Structure and Profitability 6

E. Cost Structure 13

F. Distribution Systems 15

G. Industry Trends and Developments t6


H. Industry Key Success Factors l9
I. Outlook for the Industry 23

II. Company Analysis - American International Group, fnc. 25

A. Company Overview 25

B. Corporate Strategy 29

C. Performance Analysis 33

t. Financial Performance Measures 33

2. Non-FinancialMeasures 40

D. Strategy Outlook 44

Works Cited 45-46


Jennifer Goldberg 1

I. Properfy and Casualfy fnsurance


lndustry Analysis

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).

B Actual and Potentid fndustry Size


World Market Share: The United States has by far the largest share of the world's

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.
Jennifer Goldberg 2

Property and Casualty Insurance


Leading National Markets
Premiums *
Country (U.S. $ Billions) World Share Percentage
United States 342.7 405
Japan 129.0 t52
Germany 77.0 9.1

United Kingdom 42.1 4.9


France 40.7 4.8

Italy 22.8 2.7


Canada t7.4 2.0
Netherlands t4.3 1.7

Spain l3.9 1.6

Australia 1 1"8 1..4

Jource: Nafional Underwriter, September 9, 1996 (* Includes Reinsurance Premiums)

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

commercial property and casualty premium in 1988 and 1993.

Property and Casualty Insurance Industry


Product Line Distribution
by Direct Premiums Written
1988 1993 Difference
Private Auto Liability 20.20% 24.5001 4.30o/"

Private Auto Physical Damage t4.20% t4.t00/ -0.1001


Workers Compensation 12.90% t2.60% -0.3001

Other Liability 9 40% 7.4001 -2.0001


ommercial Package 8.70% 7 20% -t.5001
Homeowners 8.5A% 8.90% 0.4001
Commercial Auto Liability 5.8001 s.00% -0 80%
Commercial Auto Physical Damage 2.60% z.g00l 0.20%
Reinsurance 3.70o/o 4.r0% 0 40%
Other Premium t4.00% 13.40o/" -0.60%
Total t00.00% t00.0001 0.00%
Source: A.M. Best
Jennifer Goldberg 3

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

experiencing any significant growth in premium.

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

coverage must conform precisely to each state's statute.

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

leading carriers, competition is fierce for the remaining market share.

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.
Jennifer Goldberg 4

Property and Casualty Industry


Market Share of Top Industry Leaders
Net Written
1995 Premium Market
Rank Company Name (oo0) Share
I State Farm Group 33,309,972 t2.82%
2 Allstate Insurance Group 17,494,668 613%
J CNA Insurance Group 9,263.539 3.57%
4 American International Group 8,504,236 3.27yo
5 Nationwide Group 7,644,009 2.94%
6 Farmers Insurance Group 7.468.037 2.87o/o
7 ITT Hartford lnsurance Group 5,676,282 z.t8%
8 Liberfy Mutual Group 5,385,322 2.07y,
9 Zurich Insurance Group - U.S 4,534,347 t.75%
[0 USAA Group 4,5L7,860 1.74%
ll Aeura Life and Casualty 4,I76,707 I 6I%
l2 Berkshire Hathaway 3,837 ,459 t.48%
l3 Chubb Group of Insurance Companies 3,813,20C t.47%
L4 St. Paul Group 3,766,10r t.45%
t5 Travelers Insurance Group 3,686,rL2 l.42Vo
16 Kemper lnsurance Companies 3,235,257 1.25%
l7 American Financial Group 3,069,542 1.18%
l8 General Re Group 2,963,519 1 14%
l9 Fireman's Fund Companies 2.96 1,8C I t.14%
20 Progressive Group 2,874,696 T.1I%
AII Others Combined L2t,6I7.344 46.8t%
Iotal 259,800.000 100.00%
Source: Best's Review, July 1996

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
Jennifer Goldberg 5

5.3 percent The following chart illustrates the premium levels of stock companies in the property

casualty industry and the annual percent change in volume.

Properfy and Casualty Industry


(Stock Companies)
Premium Volume
Annual
Earned Percent
Year Premium Change
I 993 158,457 4.50%
1992 t5l,60l 0.80%
l99l 150,464 2.20%
1990 147,288 3.80%
I 989 141,851 2.10%
I 988 138,964 5.90%
t987 131,232 12.80%
1986 116,296 27.10%
l 985 91,482 16.30%
1984 78,671
l0 Year CAGR: 8.09
Source: A.M. Best

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.
Jennifer Goldberg 6

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

expected to remain at low growth levels in 1996" (Farinella 1996)

D. Industry Structure and Profitability


Recent Operating Results: The property and casualty industry operating results for the

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

from the end of 1995 to year end 1996.

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).
Jennifer Goldberg 7

Property and Casualty Insurance Industry


Six Month Operating Results
($ Millions)
First Half Percentage
1995 t996 Change

Net Written Premium 129,739 133,620 3.0%


lncurred Loss and ALE 99,870 r03,264 3.4%
Statutory Underwriting Gain (Loss) (7,e07) (8,24e) -4.3%
Net Underwnting Gain (Loss) (9,184) (9,284\ t.t%
Pre-Tax Operating Income (Loss) 9,289 8.464 -89%
Net lnvestment lncome Earned 18,184 17,961 t.2%
Net Realized Capital Gains 2,643 5,934 124.5%
Net lnvestment Gain 20,827 23,895 r4.7%
Net Income (Loss) After Taxes 9,348 ll,714 25.3%
Surplus (Consolidates) 2r0,448 237,389 12.8o/o

ombined Ratio 106.4 106.4 0.0%


Source: National Underwriter, September 23, 1996

The market softness translates to a gradual deterioration of earnings for insurance

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

of hurricanes, earthquakes and an unpredictable litigation system" (Sclafane 1996).

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.
Jennifer Goldberg 8

Property and Casualty Industry


Historical Profitability
Year Ending lll: 1990 l99l t992 1993 1994 1995 t996 CAGR
Operating Margin 5.20o/a 5.40% s 20% 5.60% 4.40o/o 4.9001 5.0001 -0 65%
Return on Assets 2.t0% 2.60% ?..50% 2.90% 2.500/ 2A0% 2.20% 0.770/,
3.0001 4.0001 4.00% 4.70% 3.2001 3.00% 2.60% -2.360/"
Return on Equity
\ource: Almanac of Business and Industrial Financial Ratios 1996

Structure and Competitive Intensity: The structure and competitive intensity of an

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

vie for market share.

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.
Jennifer Goldberg 9

Property and Casualty fnsurer Distribution by Size


Average Number
Number of of Employees Percent of Market
Employees per Category Businesses Share
I I 4.40% 0.20%
2-4 2 18.80% t.00%
5-9 6 13.90% 5.20%
L0-24 t5 12.70% 4.50%
25-49 34 r0.40% 3.00%
50-99 67 9.00% 290%
t00-249 l5l 9.30% 10.20Y"
250-499 336 3.80% 12.30%
500-999 669 r90% 9.s0%
1,000-9,999 2,072 2.00% 47.90%
Over 10,000 t4,333 0.t0% t.50%
Unlmown nla 13.70% 1 80%
Total r00.00% 100.00%
\ource: D&B Market Place

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

positive net income are shown on the following page.

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
Jennifer Goldberg l0

on assets and equity than the small and mid-sized firms and had inferior operating and before tax

profit margins.

Property and Casualty Industry


Performance Based on Size
Total Asset Size (000)
1,001 5,001 t0,00 r 25,001 50,001 100,001 250,001
To
5,000 10,000 25,000 50,000 100,000 250,000 and over

Retum on Assets 9.8 8 9.2 74 6.1 5.4 3

Return on Equity 18.7 t7.7 15.3 13.7 12.3 9.2 5.t


Operating Margin 9.3 8.7 9.2 12.5 7.9 57 7.7

Before Tax Profit Margin 9.2 8.5 8.7 I 1.5 7.t 58 5.8

Jource: Almanac of Business and Industrial Financial Ratios 1996

2) Potential Competitors.' Low industry profitability dissuades new investment in the

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
Jennifer Goldberg 11

investment requirements are placed on new entrants. State statutes govern the investment

requirements placed on insurance companies, as well as other regulation designed to protect

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

in claim paying reserves, as well as premium investment activity.

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

must post these reserves @ Sept. 8, L996).

3) Threat of Substitute Products; The ability to provide substantial financial protection

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

insufiicient to cover a catastrophic loss such as a hurricane or earthquake in a major metropolitan

area (Mooney 1996).

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
Jennifer Goldberg 12

described in a September 1996 National Underwriter article entitled, "Capital Markets Developing

Slowly as an Insurance Supplement".

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

insurance related risks.

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
Jennifer Goldberg 13

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

misrepresent the nature of the risk to the insurance company.

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.
Jennifer Goldberg l4

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.

Property and Casualty Industry


(Stock Companies)
Premium Volume
Annual Expense Annual Combined Annual
Loss Ratio Percent Ratio Percent Ratio Percent
Year (%) Change (%) Change (/") Change
1993 81.03 -9.3Yo 26.3 -0.809.'o 107.33 4.50%
t992 89.3 8.4Yo 26.5 0.4004 I15.8 0.80%
1991 82.4 -l.3Yo 26.4 150% 108.8 2.20%
1990 83.5 0.zYo 26 0.00% 109.5 3.80%
1989 83.3 4 40% 26 t 20% 109.3 2.10%
1 988 79.8 0.60% 25.7 t.60% r 05.5 5.90%
1987 79.3 -4.30% 25.3 0.80Yo t04.6 12.80%
1986 82.9 -8.40% 25.1 -3.t0% 108 27.t0%
l 985 90.5 0.60% 25.9 -7.50% 116.4 -1.40%
1984 90 28 n8
l0 Year
CAGR: I 12% -0.69% 1 05%
Source: A.M. Best
Jennifer Goldberg l5

Loss expenses are variable costs; the greater the sales volume the greater the loss and

associated claim adjustment expenses. Insurance companies control losses by utilization of

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

spread their fixed expenses across more clients.

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

companies, while the exclusive agent represents only one insurer.

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

insurance buying process.

Increasingly, insurers are recognizing the distribution opportunities available through

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).
Jennifer Goldberg l6

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

companies, yet achieve a 33 .6 percent market share.

Insurance Broker Distribution by Size


Average Number
Number of of Employees Percent of Market
Employees per Category Businesses Share
I I 12.3% 3.00y"
2-4 2 6350% 22.7%
5-9 6 12.60% 13.604

t0-24 t4 6.s0% t6.504


25-49 32 2.20% r0.6%
50-99 64 1.0% 9.6%
100-249 r43 0.40% 8.20%
250-499 331 0.10% 6.70%
500-999 634 0.10% 3 40%
1.000-9,999 1,779 0.01% 4.60%
Over 10,000 0 0.00% 0.0%
Unknown nla 1.40% 1.r00
Average 6 r00.00% r00.00%
Source: D&B Market Place 1996

G. Industry Trends and Developments


With the stagnant growth in the property and casualty insurance industry, carriers are

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

are listed on the following page.


Jennifer Goldberg l7

Increasing the carrier's retentions in core line of business and purchasing less

reinsurance, thereby increasing premium to cover expenses and generate investments.

Expanding expense reductions and improving underwriting efficiencies to control costs.

Concentrating capital on more profitable lines of business.

Engaging in acquisitions and consolidations to enhance results and provide cost

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

indicated they were likely to sell during the same period.

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

industry and are not always compatible (Hoffrnan 1996).

Emergence of New Technology: Technology improvements are constantly developed to

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"

(Sedgwick Home Page).


Jennifer Goldberg i 8

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

standards for processes and information (Katz 1996).

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

consumer information and services (Waterhouse 1996).

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:

o A Comprehensive Overhaul of the Superfi.rnd's Liability System


o Reform of the Occupational Safety and Health Administration (OSHA), including
OSHA's role in the employer community in such things as ergonomics standards.
o Continued Product Liability and Tort Reform
o Taxation of OflShore Captive Insurance Companies
o Bank Insurance Licensing Legislation
Jennifer Goldberg 19

H. Industry Key Success Factors

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

demonstrate a sustainable competitive advantage because of either a niche strategy or expense

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

others are specific to the individual strategy selection.

1) Key Factors Common to Any Strategic Thrust:

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).

Distribution System Management: H. Michael Shumrak, an actuarial, marketing and

management consultant, feels a key to success is a productive distribution system (Shumrak

1996). He cites future success depends on building productive, low cost distribution systems that

match carefully defined market segments.


Jennifer Goldberg 20

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

strategy" is required in order to develop a sustainable competitive advantage. This approach is

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

that do not share the same target market.

Step 2: Constantly Re-examine the Customer Acquisition and Cross-Selling Processes:

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,
Jennifer Goldberg 2l

the correct sales method should be carefully analyzed and selected for selling the targeted

customer's desired products.

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

about that importance of a quality staffthat he is quoted in National Underwriter as stating,

"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

to provide service to customers and value to shareholders" (Lonkevich 1996).

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).

2). K.y Factors Specific to Overall Cost Leadership Strategic Thrust:

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

"customer-intimate" in tailoring products to the customers needs.

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
Jennifer Goldberg22

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

continue to do so through staffreductions, elimination of operational redundancies, technology

improvements and consolidation.

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

company and reduced office space used by the home office.

2).Key to Differentiation Strategic Thrust:

Tailored Product Offerings to Segmented Msrkets: According to Michael Smith, a

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,

ready-made customer segments and buying situations" (Shumrak 1996).


Jennifer Goldberg 23

I. Outlook for the Industry


The property and casualty industry is in a mature life cycle stage. Prices are constricted

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

sophistication increases with the size of the client.

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

factors in order to survive.

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.

Other competitors will follow a differentiation strategy by attempting to distinguish their

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
Jennifer Goldberg 24

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

service and pricing it at a level that will generate a profit.

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

adequate return on investment.

Profitability is available in this mature industry. However, to achieve it will take a

company with a clear understanding of the industry's structure and a well defined and

meticulously executed strategy for the future.


Jennifer Goldberg 25

II. Company Analysis


American fnternational Group, Inc.

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:

American International Group


Percent
Pool Company of Whole
),iational Union Fire lnsurance Co. of Pittsburgh, PA 36.t
A.merican Home Assurance Co. 34.2
Commerce & Industry Insurance Co. 9.5
lnsurance Co. of the State of Pennsvlvania 9.4
New Hampshire Insurance Co. 5

Birmingham Fire Insurance Co. of Pennsylvania 48


AIU Insurance Co. I
Iotal 100

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
Jennifer Goldberg 26

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

of business by offering some of the largest capacity available in the marketplace.

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

continuously strives to utilize advanced technology to achieve operating economies. The

company plans to selectively grow its U.S. personal lines portfolio, principally private passenger

auto, though a variety of nontraditional distribution methods.

b) Foreign General:

The Foreign General Group comprises AIGs overseas property and casualty operations
Jennifer Goldberg 27

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

customs (S&P Feb. 1996)

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.

d) Specialty and Agency Companies:

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

America (1995 Annual Report).


Jennifer Goldberg 28

fl Minority Ownership in Other Insurance Operations:

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.

AIG Major Business Segments


distribdion based on 1995 Operating Income

(359@ Domestb General

(17 6VQForeignGeneraI

(13 @ Minority0wned

(12.1'7d F'rm nc's[ Se rv b e s

(l6VQ Agency and Service Fee


(315V)I-fe

Source:A IG 1995 A nnual


Jennifer Goldberg 29

B. Corporate Strategy

AIG summanzed their strengths, strategic objectives, corporate goals and vision for the

future in their 1995 Annual Report:

"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

following details the key success factors within AIGs strategy:

1). Financial Discipline:

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

Underwrtting Accountability: AIG's structure is organized around numerous profit

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

liabilities of the business operations.

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

their opinion, AIG maintains a conservative balance sheet position.

Reinsurance Utilization: AIG has established substantial reinsurance facilities enabling

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).

2) Strong Market Focus and Diversified Offerings:

Targeted DiversiJication and Innovative Products / Services.' Creating specialized

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

diversification into specialized financial services as another avenue for growh.

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

of limiting the impact of soft commercial lines pricing.

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

fuel our domestic growth".

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

specialized underwriting expertise (AIG Home Page).

Global Perspective.' Exploitation of untapped foreign markets and capitalization on

American postwar overseas business expansion is a key to the company's market leadership

abroad. Unprecedented ventures in emerging markets characterize AIG internationally, including

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

(AIG Home Page).

Greenberg, reiterated AIG's commitment to international expansion in the 1995 Annual

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

markets continue to mature.


Jennifer Goldberg 33

C. Performance Analysis

1. Financial Performance Measures

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

basis. Capacity to meet policyholder obligations is overwhelming under a variety of

economic underwriting conditions The AAA rating reflects AfG's leading

position in U.S. property and casualty insurance, consistently strong operating

performance and conservative balance sheet management."


Jennifer Goldberg 34

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,

"This rating affirmation reflects the group's sustained outstanding operating

performance, strong capitalization, disciplined underwriting approach and AIG's

recognized leadership position within global insurance markets. Further, the rating

acknowledges AIG's status as one of the nation's largest underwriters of

commercial and industrial coverages in which it maintains dominant market

positions in the national accounts market for large commercial specialty coverage,

including professional liability and excess and surplus business. Further, the rating

acknowledges AIG's substantial risk management product and service capabilities

and stable presence within its core markets that has reinforced its strong
relationship with brokers and customers. Finally, the group maintains a

high-quality investment portfolio, strong loss reserves position, and excellent

reinsurance protection that limits AIG's susceptibility to large losses. "

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

percent for revenue and 13.69 percent for net income.

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

the industry is 227 .4 percent.

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.

Price Earnings Ratio Comparison


on 1996 Calendar Year Mean

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

Source. Fitst Call Eamings EsfinBfes 11/24/96

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

the overall Dow Jones equity market index since 1992.


Jennifer Goldberg 39
Jennifer Goldberg 40

2). Non-Financial Performance Measures

Measurements of non-financiatperformance are largely subjective. Such dimensions as

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.

Fortune magazine attempts to measure companies' non-financial performance in their

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

their rank based on the evaluation criteria:

Corporate Reputation Ranking


American International Group
Rank Among
Overall Rank 10 Largest
Score out of Among all fnsurance
Reputation Criteria Possible 10 Companies Companies
Financial Soundness 816 31 I
Quality of Management 809 I
Long Term Investment Value 7.89 21 I
lnnovativeness 755 35 I
of Products / Services Offered 6.81 221 3

Ability to Attract / Keep Talented People 6.59 132


Communify / Environmental Responsibility 4.54 402 t0
Use of Corporate Asset 7 .57 28 I
Source: Fortune Magazine - Most Admired Corporations 1996

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.

Innovativeness: AfG rated number one in the industry in terms of innovativeness

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

God AIG was there."'


Jennifer Goldberg 42

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

acquisition costs averaged 3 percent of net premium writtenversus an industry average of 11

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

chart that follows.

Combined Ratio Comparison


AIG vs Industry

'5 110

U3
3 1oo

Y ear 1 986 1987 988 '1989 990 991 1992


1 1 1 1 993
I AIG 01 .2 99.5 94.4 100 99.6 100.4 102,4 101 1

B hdustry 06.9 103.3 103.9 108.6 108.4 108.6 118.4 107.2

e: Standard &Poo( (A IG Data), A M. Best (Indusrry

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

shrewd self interest".

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

company's largest division (Business Week Sept. 30,1996)

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

Environmental Responsibility" category.


Jennifer Goldberg 44

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

has led for nearly 30 years.

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

environmental threats and capitalize on the opportunities available in their industry.


Jennifer Goldberg 45

Works Cited

Aaker, David. Developing Business Strateglr. New York: John Wiley & Sons, Inc., 1995.

Auns, Kristine. "ComebackKids." Financial World. 12 Aug. 1996: 50 (6)

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

Hofman, Mark. "congressionalwrap-up." Business Insurance. 7 oct. 1996: l

Katz, David. "World Insurance Network." National Underwriter.7 Oct. 1996.9

Lonkevich, Dan. "Lower Cost Drives Sales, Survey Finds. " National Underwriter . 2I Oct.
7996:3

Malecki, Donald S. CommercialLiability Risk Management and Insurance. Volume J. Malvern,


PA: American Institute for Property and Liability Underwriters, 19g6

McDaniel, Dave. "Bancassurance American Style." Best's Review. July 1996: 38 (a)

Mooney, Sean. "CapitalMarkets Developing Slowly as fnsurance Supplement." National


Underwriter. 2 Sept. 1996.33

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

Shumark, H. Michael. "Matching Distribution Systems to Markets Spells Success.,' Best's


Review. July 1996: 65

Stifl Ben. "When Needed, AIG Was There". lhe Wall Stres!_Jgurnal. (editorial) no pag. Online.
lnternet. 29 October 1996

Waterhouse, Steven. "Online Agencies Enjoy Competitive Advantages." National Underwriter.


2l Oct. 1996. 12
Williams, C. Arthur. Principles of Risk Manaeement and Insurance. Malvern, pA: American
Institute for Property and Liabiiity Underwriters, 1981 .

"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

"Three Execs Leave AIG". Business Insurance. 30 Sept. 1996.2


JENNIFER GOLDBERG
309 Wisconsin Avenue, No. 2N
Oak Park, Illinois 60302
(708) 386-5348

December 11, 1996

University of Illinois at Chicago


MBA Program
Attn: Jack McCord
815 West Van Buren, Suite 220
Chicago, A- 60607-3252

Re: Independent Study Project

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.

Please let me know if you have any questions. Thank you.

Sincerely,

cc: Professor Hale Bartlett

Enclosures
IHDEPENDEI{T STUDY PROPOSAL MBA PROGRAMS
The University of illinois at Chicago

Please prlnt or type all requested lnformatlon

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)

Submittlng your lndependent study prospectus


Prior to submitting this form, you must reach agreement with your supervising fao.rtty member on your proposed independent
study
topic. A thorough and detailed Prospectus must accompany this form. This prospectus must describe clearty and completely the
following aspscts of your study:

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.

Receiving credit toward your degree


You must submit a copy of your completed project, report, etc., to th€ M8A Programs oflice before degree credit may be awarded.
No more than 8 hours of independent study may be applied toward degree requirements.

Assignment of varlable credit


You may appty for up to four semester hours of credit for your independent study project. The amount of hours approved will
depend upon th€ scope of your project. A four hour independent study project should require the same amount of time and
commitment as a four semesier hour course.

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.

Signature and Date


\/\/
I
htrciy k t/
MBA Programs ll!-
Signature and Date

I'HE IJNIVERSTTY O€ IIJ-JIICXS AI CI]ICAGO


Jennifer Goldberg
Page 1

lndependent Study 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

Marketing, I have completed 36 of the 54 required semester hours including

Management 54C - Organizational Anaiysis and Practice, Management 541 -

Organizational Behavior and Management 590 - Seminar in Policy. I would like to

augment this course work with an lndependent Study project focusing on the strategic

planning process within an organization.

Objective of Study: I would like to participate in an independent study project to

expand my understanding of the strategic planning process and to develop a working

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

applied knowledge of strategic planning by preparing a company analysis report to

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

significant library research of popular literature, financial reports, as well as company

and industry profiles.

lndependent Study Project Evaluation: I have agreed with professor Barilett to

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.

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