COPING WITH FINANCIAL AND ETHICAL RISK AT AMERICAN INTERNATIONAL

GROUP (AIG)
(A Managerial Ethics Case Study)

Submitted by:
Acob, Priceljoanmar
Agustin, Jervis
Basilonia, Ken
Bustamante, Patricia M.
Sumudivila, Misty L.

San Beda College, Manila

Graduate School of Business

BACKGROUND OF THE CASE

OVERVIEW
American International Group, Inc. (AIG), incorporated on June 9, 1967, is an
insurance company. The Company provides a range of property casualty insurance,
life insurance, retirement products, mortgage insurance and other financial services
to customers in over 100 countries and jurisdictions. The Company operates
through two segments: Commercial Insurance and Consumer Insurance, as well as a
Corporate and Other category. Commercial Insurance has three operating
segments: Property Casualty, Mortgage Guaranty and Institutional Markets.
Consumer Insurance also has three operating segments: Retirement, Life and
Personal Insurance. The Company's Corporate and Other includes the Company, as
well as certain legacy assets and run-off insurance businesses. The Company
groups its insurance-related legal entities into two categories: Non-Life Insurance
Companies and Life Insurance Companies.
AIGS CULTURE
AIGs Mission-Vision Statement is as follows:
"As a global financial services organization, we have committed our resources to
developing products and services that address the needs of our clients as well as
promote a corporate culture that values integrity, diversity, innovation and
excellence."
While AIGs slogan is a short, memorable catch phrase, tagline or motto used
to identify a product or company in advertisements, and perfectly encapsulates
AIGs corporate culture on a few words. The advertising slogan, or business slogan
most associated with American International Group, is:
"We know money."
AIGs corporate culture can be often credited to its CEO of 38 years, Maurice
Hank Greeneberg. He is the key player in shaping the modern face and corporate
culture of AIG. Critics and stakeholders alike often characterize him to be autocratic
in his drive to expand the company into an international powerhouse. Hence it
resulted in certain corporate cultural identifiers for AIG, which are as follows:

Involved in a high- stakes risk-taking scheme supported by managers and

employees that appeared entirely focused on short term financial rewards.
Focused on a reward system that placed little responsibility on executives
who made very poor decisions
They offered cash awards and other perks to thirty-eight executives and a
retention program with payments from $92500 to $4 Million for employees
earning salaries between $160K and $1M.

BRIBERY AND CONIVANCE

Given their corporate culture and mindset, one thing led to another. In the
early 2000s the Securities and Exchange Commission found that AIG dealt with
finite insurance deals contracts that covered specific amounts of losses rather
than unexpected losses of indeterminate size and what appeared to be loans (since
premiums were structured to match policy payouts and eliminate risk) rather than
genuine risk allocation vehicles. It was discovered through the federal inquiry
conducted, that Maurice Hank Greenberg (CEO, AIG) might have been personally
involved in creating bogus reinsurance transactions with General Re to fraudulently
boost AIGs reserves.
In 2008, during the wake of AIGs financial meltdown, the SEC leveled
charges of fraud against Greenberg, resulting from circumstance surrounding his
departure. In order to settle the charges that AIG manipulated financial statements
in 2005, the company paid SEC $1.6 billion in 2006, and Greenberg agreed to pay
an additional $15 million in 2009.
CAUSE OF AIGS FINANCIAL WOES
AIGs financial dilemma that resulted to the 2008 bailout, were cause by a
typed of derivative called Credit Default Swaps (CDSs). CDS are financial products
that transfer the credit exposure (risk) of fixed-income products between parties.
The buyer of a credit swap receives credit protection, whereas the seller of the swap
guarantees the creditworthiness of the product. The risk of default is transferred
from the holder of the fixed-income security to the seller of the swap.
AIG issued the swaps and promised to pay these institutions, if the debt
securities defaulted. However, these insurance contracts became essentially
worthless because many people could not pay back their subprime mortgages and
AIG did not have the credit worthiness for the big collateral call.
AIGs Financial Products Unit was the source of the bulk of the companys
troubles. They were initially formed to trade over-the-counter derivatives, which
was perfectly times to ride the derivatives market boom. This Unit aimed to
mitigate or hedge risk. Thus, they used short selling as a means of to increase their
investment returns. This involved betting that the stock price of the company will
change during a specified period of time.
Derivatives are financial contracts or instruments whose value is derived from
something else, like commodities (e.g. corn, wheat, etc.), stocks, bonds, and home
mortgages. Gains or losses from derivatives come from correctly betting on the
movement/fluctuation of the values of these commodities.

AIGs Financial Products Unit ramped up its business by selling swaps that
covered debt that was back up by mortgages, which is called Collateralized Debt
Obligations (CDO). The swaps issued by AIG were backed by $440 billion worth of
obligations. AIG was able to make these CDO deals with very small fraction of actual
money on hand. The company was involved in bad mortgage lending by financial
institutions that did not have sufficient capital. The loans and the CDOs were often
sold to people who could not repay their debt. AIG did not exercise due diligence in
determining the credit worthiness of its borrowers, in attempting to gauge the
chance of default. This can be summed up by the 5 Cs of Credit, namely:
Character, Capacity, Capital, Collateral, Conditions.
Greenberg heard news of this, and asked the Unit to shadow its trades. AIG
sold credit protection on CDOs by writing pieces of paper that stated that AIG would
cover the losses in the case these obligations went bad. AIG failed to assess
systematic risk of counterparties, by not measuring their own exposures and
recklessly using their CDOs and CDSs. In addition, prior to 2008, derivatives were
not widely understood by the public, mass media, regulators, and many other
executives who were providing the oversight for their use.
AIGS LACK OF TRANSPARENCY
Prior to the financial meltdown of 2008, the outside auditors of AIG
(Pricewaterhouse Coopers) were excluded from the conversations on the evaluation
of derivatives. AIGs executives Mr. Cassano and Mr. Sullivan, continued to assure
investors and auditors that AIG had accurately identified all areas of exposure to the
U.S. residential housing market, and they established their confidence on their
evaluation methods.
This situation is similar to the Enron case wherein, its executives claimed they
did not know that Enron used derivatives and off-the-book balance sheet
partnerships that caused it demise.
AIGS RISK APPETITE
AIG corporate culture promoted speculative risk-taking. The company was
centered on a reward system that placed little responsibility on executives who
made poor decisions. Despite of losing $40 billion in 2008 and after receiving more
than $152 billion in federal rescue funds, AIG publicly claimed that 38 executives
received cash awards and perks and a retention program with payment from
$92,500 to $4 million, while employees received salaries ranging from $160,000 to
$1 million.
These rewards were doled out in the face of excessive-risk taking and in the
middle of a financial crisis, showing utter neglect to their stakeholders.

AIG entered the financial products market without truly understanding the
complexity of the financial products that they were selling. Their losses stem from
market wagers that were essentially bets on the performance of bundles of
derivatives linked to subprime residential mortgages.
AIGs activities clearly indicate that managers and traders were focused on
financial rewards.
They lost the importance of strong moral principles, and
compliance programs that respect their stakeholders.
AIGS BAILOUT
AIG suffered from lack of liquidity. They did not have enough capital to repay
investors who are asking for their money back. To prevent a string of bank failures,
the government doled out $182 billion taxpayer money, over the course of a month,
in order to create a line of credit for the company and buying AIG stock. This ended
up with the US governments 79.9% ownership of AIG thus, making the US
government a senior partner in a special-purpose entity that will receive interest
and share liability in the ownership of these tainted instruments. However, the US
government did not do the same for the Lehman Brothers.

AFTERMATH
It was revealed that the $165 million of the bailout money went to the
bonuses of the employees of the AIGs failed Financial Products Unit. The company
has also given more than 2,000 employees cash incentives to stop them from
quitting.
Former CEO Greenberg, maintains his innocence. He insists that the upper
management was the root cause of the collapse. He cited excessive leveraging and
mar-to-market accounting practices as the causes of the collapse. Same with the
Enron case, mark-to-market accounting is, assigning a value to a position held in a
financial instrument based on the current market price for the instrument.
Two-thirds of the company was auctioned, resulting for disappointing prices
for AIG.
KEY PEOPLE
Maurice Hank Greenberg

He was the CEO of AIG for 38 years and was a key player in shaping
the modern face and corporate culture of the company.

He was always known for utilizing his contracts and influence to help
advance the company.
He aggressively lobbied for laws and rulings favorable to AIG.
He was involved with international policies and helped the US
government to secure information and develop back-door channels for
classified dealings. Due to this, AIG was given the benefit of the doubt
when regulatory agencies came questioning the companys doings.
He championed innovative products that insure almost any type of risk,
including internet identity theft and hijacking.
He might have been personally involved in creating bogus reinsurance
transaction with General Re to fraudulent boost AIGs reserves.

Martin Sullivan & Robert Willumstad

The both succeeded the position as CEO, respectively. Sullivan for 3

years after Greenberg, and 3 months for Willumstad but he was forced
to step down in 2008 in the wake of the corporations meltdown.

Joseph Cassano

He was AIGs executive, and Head of AIG Financial Products.

AIG Financial Products specialized in derivatives and other complex
financial contracts that were tied to subprime mortgages or
commodities.
Financial Product unit was staffed by quantitative specialists with
doctorates in finance and math who, it seems, were very willing to take
risks.

Edward Liddy

Was recruited to the AIG post by Henry Paulson, the Treasury Secretary at
that time.
Liddy became CEO of AIG in September 2008, succeeding Robert B.
Willemstad.
As CEO of AIG, Liddy received a salary of just $1, but also received $460,000
to cover "housing, travel, taxes and legal fees".
Liddy garnered national headlines in October 2008 for defending a
controversial $440,000 AIG retreat for top-performing insurance salesmen at
the luxury St. Regis Resort in Monarch Beach, California. The retreat, which
was held shortly after the U.S. government rescued AIG from insolvency with
$84 billion in loans, included $200,000 for rooms, $150,000 for meals and
$23,000 for the spa. In testimony before the U.S. House Oversight
Committee, Liddy stated that such retreats "are standard practice in our
industry." During the U.S. presidential debate on October 7, 2008, Democratic

presidential nominee Sen. Barack Obama mentioned the retreat and said,
"The Treasury should demand that money back and those executives should
be fired.
In light of the AIG bonus payments controversy, Liddy urged employees to
return $165m issued in bonuses to them, suggesting doing the "right
thing" and returning at least part of the bonus is preferable to legal action,
noting honoring contractual commitments is at the heart of what we do in
the insurance business. While Liddy called the bonuses distasteful in an
appearance in the House of Representatives, it later transpired that Liddy had
accelerated more than a quarter of AIG Financial Products bonuses by three
months.
Liddy announced on May 21, 2009 that he would resign as AIG Chairman and
CEO when replacements were found, suggesting that the two roles be split. In
August 2009,Robert Benmosche took over as CEO and Harvey Golub as
chairman.

Attorney General Eliot Spitzer

On May 26, 2005, Spitzer filed a civil complaint against Maurice R. "Hank"
Greenberg (Chairman and CEO) and Howard I. Smith (ex-CFO of AIG), alleging
fraudulent business practice, securities fraud, common law fraud, and other
violations of insurance and securities laws. Despite tough talk on a television
news show, Spitzer declined to bring any criminal charges against Greenberg,
and two of the civil charges were dropped in September 2006. [1] Four civil
charges, 'the heart of the case', remain outstanding.

Gary Gorton

He is a finance professor at Yale University.

He was paid by AIG consulting fees for developing computer models to gauge
risk for more than $400 billion in complicated credit default swaps.

Howard Sosin

He founded AIGs Financial Products Unit in 1987.

When he joined AIG, he was given an unusual deal: A 20% stake in the unit,
and 20% of its profits.

PROBLEMS ABOUT THE MANAGEMENT

There is a lack of accountability on how the funds were used.

They dont have enough backup plan for their investment as an insurance
company they must be well educated with risk.
They placed billions of dollars at risk through speculation on the movements
of various mortgage pools, and the bottom line is that these are no actual
securities backing these speculative positions on which AIG is losing money.
They lost their underlying mission, the importance of strong moral principles,
and good compliance programs that respect stakeholders.
They were not transparent, as executives Mr. Casssano and Mr. Sullivan,
continued to reassure investors that they are still profitable and their model/
evaluations were accurate.
ETHICAL DILEMMA

Given the corporate culture of AIG, was it appropriate for the government to use
taxpayers money to purchase 79.9% of the struggling insurance company?
The pressing question here is: What would have happened if the Government
did not bailout AIG? If the US Government did not bail out AIG, critics say that there
would have been a repeat of the American Great Depression in the 1920s. It would
have caused the complete failure of the largest US banks like Citi, Goldman Sachs,
and JP Morgan, as well as the collapse of the US Banking and insurance industry,
which make up 7% of the US GDP. This would go as far as affecting real economy,
particularly manufacturing, retail, and healthcare. It would result to mass business
failure, mass unemployment, and the freezing up of capital markets. AIG was Too
big to fail. The financial giants were all interconnected and have the same assets
and shouldered the same risks.
If AIG was not bailed out by the government, it would also have a severe
effect on the global economy. The US would have no functioning financial system,
which would mean that they will not have the ability to produce or ship goods
globally. Energy in the form of oil would have stopped shipping, electricity
generation would have been cut, massive food shortages might occur, etc. AIG has
insured so many contracts that their own default would have triggered business
failures, which would have a domino effect on the global scale. In general, the
bailout was more about maintaining the political-economic status-quo. It was an
Individual vs. Community type of Conflict.
The government is mandated to protect its people. In this case the US
Government had to do what it had to do to protect their citizens livelihoods and
economy. Hence, the bailout is an attempt at Unitarianism which is the highest
benefits for a society with the lowest social costs.
However, the bailout kept the toxic assets in the system. Hence, this caused an
uncertainty over the value of these assets which led to a prolonged economic
stagnation. People were conservative or risk-averse to invest after the bailout

because they were not sure what these toxic assets that remained in the market
during the bailout was actually worth, and they did not want to take any risks.
Hence, the bailout did not boost investor confidence.

CULTURE

ETHICAL MISCONDUCT

Hank
Greenberg
instilled the culture
of "bribery" to the
government
and
other institutions to
advance
the
company.

The
company
was
nonchalant
when
regulatory
agencies
questioned
the
company's
operations.
They showed disregard
concerning government
interventions
thinking
they are more powerful
than them.

The
culture
of
excessive
risktaking
and
depending heavily
on
computer
programs
and
academic
experts
without regard to
real-world
situations
and
threats.

AIG's management did

not carefully exercise
their
decision-making
responsibilities. Instead,
they
depended
on
computer
models
developed by scholars
without
taking
into
consideration
real-life
threats.

The AIG's lack of AIG excludes external

values and lack of auditors
from
transparency.
conversations
and
discussions
of
derivatives
which
blatantly
displays
misconduct and neglects
their responsibility of
transparency
and
accountability
to
its
stakeholders.
AIG's
culture
of The managers became
reward system and greedy, focusing more
reckless spending on large bonuses, cash
that placed little awards and other perks.
responsibility
on Even at the time of AIG's
executives
who bailout,
AIG
still
made very poor managed to pay $165
decisions.
million in bonuses of the
failed
Financial
Productions Unit.

WHAT COULD AIG HAVE

DONE DIFFERENTLY TO
PREVENT ITS FAILURE AND
SUBSEQUENT BAILOUT?
As the company grew, AIG
became
more
and
more
conceited
disregarding
government interventions. The
company should have integrated
in their policies that no one
should be above the law.
Somehow,
somewhere
repercussions will surely follow if
laws will be prohibited in favor of
the company.
The managers especially in the
AIG's Financial Products Unit
should have exercised due
diligence on the unregulated
derivatives they sell. They
should have considered risks
and threats. They failed to
observe
the
principle
of
conservatism in their decisions.
They did not grasp the potential
business consequences and the
social fallout that they may
eventually face.
External Auditors provide an
outsider perspective on the
company. They suggest controls
on the company's operations
specially those crucial ones and
ones that the company failed to
consider.
If
only
the
management didnt exclude the
external auditors, then maybe,
the bailout could have been
avoided.
The rewards system should have
been
performance-based
meaning taking into account the
decisions and output made by
the managers or staff in
determining the amount of
bonus they will receive.

PROBLEM EVALUATION

PROPOSED ALTERNATIVE/RECOMMENDATION
American Nobel Prize-winning Economist Paul Krugman thinks that the US
Government should have rescued the banks, but let the owners be accountable. The
problem was, the US Government offered bailout to AIG with no strings attached.
The public took the risk of the banks failing but the owners or the top management
profited, as it was evident in the $165 million dole out of the bailout money by AIG.
Economist Paul Krugman argued that government intervention was not enough, and
structural problems were deeper than they appeared. These problems are
ethical/moral problems that are engrained in the corporate culture of AIG.
Up to this day, the top management of AIG who used their influence to get
bailouts has stayed in place to still reap the benefits of the US taxpayers money.
Capitalism cannot work if the short-sighted/morally-skewed individuals are not
removed. Bank bailouts allowed unworthy management to remain in place, so that
the remaining assets would be put into good use and investor confidence will soar.
Our groups final recommendation is: The government should have
rescued/bailed out the banks, but let the top management be held accountable.
We think that this is the best ends-based resolution that will result to the long-term
greatest good.

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$85Billion Bailout; Central Bank Injects Cash as Credit Dries Up [Web log
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Fox, J. (2008, September 16). Why the Government Wouldnt Let AIG Fail? [Web log
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June 2016, from
http://content.time.com/time/business/article/0,8599,1841699,00.html

Gross, D. (2014, October 15). Remember the $182 Billion AIG Bailout? It Wasnt Just
generous Enough.
[Web log post]. Retrieved: 24 June 2016, from
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