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Running Head: Strategic planning in AIG

Term -Paper Strategy Analysis: American International Group FARLEIGH DICKINSON UNIVERSITY MADS 6612.83: Strategic Management PROFESSOR: RONALD CALLISSI

Prabhdeep S Minhas Student Id: 1548155

Strategic management Executive Summary The term paper is commissioned to examine the strategic management/planning in the

American International Group. The research draws attention to the strategies, which led to the collapse of the organization in the year 2008; due to which the federal government had to bail it out of debt. The following part of the paper gives an insight on the alterative/proposed strategies that should be adopted, benchmarked to China Life Insurance. The strategies, which led to, the collapse of the organization mainly consisted of exploitation of the relaxation provided in the investment restraints by the government, lack of transparency between the various departments of the organization, underappreciated and unmotivated employees in the non-insurance selling departments and poor risk management system. Looking at the problems listed above, it is recommended that AIG look up to a successful insurance organization such as China Life Insurance; which it is benchmarked with. The solution to the problems include the use of issue-based strategic planning, setting up a better risk management techniques using hedge-funds and non-derivatives, eliminating the classification system amongst the employees and spread equality to motivate the employees, and increasing the communication vertically and horizontally in order to decrease the opacity between various departments. The paper concludes by stating the fat that strategic planning/management is a complex task, and that the complexity depends on the varying organizational goals over time. It is important that AIG immediately addresses the intrinsic issues of the organization, rather then focusing on long-term profits.

[STRATEGIC MANAGEMENT] 3 Table Of Contents

1. Introduction 2. Organizational Background 3. SWOT analysis 4. Current strategic structure 5. Alternative Strategies 6. Conclusion and Summary 7. References

Strategic management INTRODUCTION

The sole purpose of creating a strategy is to define the organizational vision and goals on a long term. Strategic planning as a deliberative, disciplined approach to producing fundamental decisions and actions that shape and guide what an organization (or other entity) is, what it does, and why. (Bryson, M., pg.-25). This vision thus helps to paint a future picture, relative to which the organizational productivity and individual actions can be analyzed and compared to. Every organization has a mission statement and a set of goals, but a very few of them are able to strategize successfully for a massive growth over the years. Several benefits of strategic planning include better decision making, financial stability, enhanced organizational effectiveness, higher legitimacy, better collaborative relations, increased public value and stakeholders value. Strategic planning involves a number of steps to be followed one after the other, in an iterative loop; starting from mission statement, defining objectives, strategizing, implementation and then finally evaluation. The reason I chose to write the paper on the Software development department of American International Group or more commonly known as AIG, is because it is basically an Insurance company and devotes much of its resources and focus to the Claims Department, Financial Department, Sales Department, Marketing, Customer Service and Human Resources. Because of this there are several problems, which the IT development department suffers because most of the times its being neglected. The second reason for the topic was that AIG has been through very critical times of financial crisis, during the recession period. The company declared bankruptcy back then and was then financed by the federal government to support its survival. Very recently, the

[STRATEGIC MANAGEMENT] 5 organization bailed itself out by paying out he federal government an amount of $182 billion (Protess, B., Merced, M., 2013). The organization is fresh out of a deep downfall and needs to review its strategies and build a stronger vision for a flourishing future growth. ORGANIZATIONAL BACKGROUND: The organization roots to an insurance organization founded by Cornelius Vander Starr in a two room offices, from Shanghai in China in the year 1919. In the early years, the company had only focused on nothing more then selling personal insurance and was the first US organization to sell insurance in communist lands of China. But the entire perspective was altered; when the management of the USs lagging stock was handed over to Maurice Greenberg in the year 1962(Canavan, K., 2013). The organization took a major leap and started practicing new techniques and strategies under the management of Greenberg. Starr handed over the baton to Greenberg in the year 1968, and the organization went public in 1969 (AIG, 2013). The strategies adapted by Greenberg were very unconventional in nature, and the vision he developed for the organization did not turn out to be very successful on the long run. After the management was taken over by Greenberg, AIG shifted its focus to the high-margin cooperate coverage. AIG insured Muhammad Ali's title bouts, the first ostrich farm in Texas and the construction of Washington, D.C.'s metro system (Canavan, K., pg-2). The companies grasp on the insurance market was very strong and they held assets which had a value of more than one-trillion dollars in the early years of twenty-first century (Hobs, J., Pg.-2, July 2007). But over the years, when the global financial crisis had hit the economy, the foundation of the company gradually began to

Strategic management

tremble and its existence had become questionable. Finally, the American International Group was bailed out and taken over by the Federal Reserve in the year 2008, because of the loans they were unable to pay off. SWOT ANALYSIS:

STRENGTHS Strong infrastructure. Good client tel. Strong network. Global leader of insurance provider. Brand building sponsorships. Expanding global collaborations. Wide diversity in the employees.

WEAKNESSES Failure to abiding the state mandated investment policies. Most focus on only the insurance department. Residential market mortgage exposure. Limited resources to other departments. Lower employee retention in IT dept.

OPPORTUNITIES Collaborating overseas. Expansion in developing countries in Asia. Stepping up to financial services and asset management. Particular demographics in United States. Higher rate of Acquisitions.

THREATS The new imposed regulations. Huge losses due to natural catastrophes. Economical crisis and recession in the global market. Unmotivated employees and lower productivity in noninsurance departments. Bad credit history.

The AIG group is one of the worlds leading insurance provider and financial institution, has been operational in more than 130 countries globally. The organization has tremendously strong infrastructure and was named to be the second largest insurance

[STRATEGIC MANAGEMENT] 7 company in the world after China Life Insurance. The organization is also very prominent on the front of sustainable collaborations with some of the largest organizations throughout the world. Apart from these, AIG has favorable demographics in the United States and United Kingdom. The wide spectra of employee ethnicity and diversity are also the other strong pursuits of the organization; which promotes different language skills, higher productivity, creativity and a positive reputation. Despite of all the positives, there are major weaknesss the organization possesses which are responsible for holding it back. The biggest weakness of this organization is its inability to abide by the state mandated investment acts and policies, and relying more on short-term profits rather then the long-term sustainability. Other then this, AIG has always been focusing the most of its attention and resources on just the Insurance department, and has been neglecting the other departments all along. This leads to lower productivity of the employees in the other departments like the Human-resource, IT, marketing and customer service; because they are not motivated enough. Immense numbers of opportunities are available to the organization because of their strong network and the successful collaborations with other companies, throughout the globe. Apart from that, expansion into the developing economies such as India and China can be very successful on a long-term. This is because, the markets in these countries are now open to new investments and the economies and developing on a rapid pace. The biggest threat to any insurance company is the major financial losses that they might have to suffer due to the natural catastrophes; which means for having them to pay huge amounts of money to its clients. Also, the organization managed to earn quite an amount of bad reputation because of their fallout in the year 2008, and the government

Strategic management

had to bail them out and take over. This kind of reputation can be problematic in the future collaborations with other companies. CURRENT STRATEGIES: The organizational strategies in case of AIG were much focused on the only factor of building more partnerships domestically and internationally, whereas the intrinsic factors of maximizing the growth and productivity were ignored. What is still unclear to a lot of folks are the incentives and the conditions, which led to its collapse few years ago. The chairman of the Federal reserve of the United States, Mr. Ben Bernanke stated, AIG exploited a huge gap in the regulatory system. There was no oversight of the financial products division. This was a hedge fund, basically, that was attached to a large and stable insurance company. (Canavan, K., pg.-4, 2013). So one of the foremost reasons for the collapse was not abiding by the state mandated regulations. The deregulation took place because of a federal act called, Commodity Futures Modernization Act (CFMA) of 2000, which let organizations like AIG to make the huge trades or investments even if they were very risky to follow through. This meant that the government had no longer the authority to intervene and prohibit such deals, trades or investments made by the AIG. Although, this type of ignorance cannot be blamed at the CFTC (Commodity Futures Trading Commission) or the government, because it is itself the organizations fault to not been able develop a vision and foresee their risks being involved with the trades. The fall of AIG was caused primarily by its non-insurance divisions, because of the inability to shatter much spotlight on these departments. This was a result of the inadequacy of transparency between the different departments in the organization. All the different departments worked independently and the managers were too overconfident to

[STRATEGIC MANAGEMENT] 9 tackle the organizational problems as an effective and cohesive team. Canavan K. (2013) mentions the fact that, Edward Liddy, who became chief executive officer of AIG in September 2008 (after the federal bailout), noted at the time that his new company was too complex, too unwieldy, and too opaque for its component businesses to be well managed as one entity. Apart from these, another loophole in the strategic planning was poor and irrational risk management techniques. By the end of 2007, AIG had a total of $562 billion in unhedged (Hobs, J., 2011). Being an insurance firm, it was very unlikely for the organization to hold a huge amount of money without holding an asset against the possible financial losses in the future. However, the firm knew Gorton's models didn't account for all sources of risk, and yet they never asked him to design alternatives. (Carrick, M., Smith, R., Pleven, L., 2008). The poor risk management techniques and inadequate sources being involved represent how complacent the organization had become. Complacency leads to failure; which it did. As mentioned earlier, the leading insurance organization had focused majority of its concern, resources and effort into the insurance sector; which led to other departments suffering its side effects. The employees in the other department had to work with the minimum available resources, pushed deadlines and inadequate rewards. The interdepartmental opacity further leads to these situations being unnoticed. Such factors lead to the unmotivated employees in the workplace; directly affecting their productivity and output. Furthermore, a ranking system had been developed in the company where more rewards were provided to the employees on the top. AIG employees will be ranked on a scale of 1 to 4, with higher bonuses going to those with better rankings. U.S. Treasury

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official Kenneth Feinberg had previously criticized AIG for its pay practices (Lublin, J., Serena, N., 2010). These kinds of strategies are not reliable for the purpose of a long-term vision; but instead may cause instability. ALTERNATIVE/PROPOSED STRTAGIES: Due to the lack of a strong vision and fundamentally inadequate strategic planning, AIG; an organization which once held over one trillion dollars worth of assets in hand, was brought down to its knees. Although the United States federal government prevented the bankruptcy of the company by bailing them out of the debt, but it required the urgency to establish new strategies, organizational goals and more complex planning for the future. And inspite of the fact that the organization managed to pay back the government the money, which was invested initially for bailing it out of debt; certain things still have to change in order to sustain the growth in the future. First and foremost, in the current state of matters, it is required that the organization focuses more on issues-based strategic planning, and not on goal-based strategic planning. Issues-based strategic planning is more commonly used by organizations in a dynamic or competitive marketplace and examines specific issues facing an organization, e.g. finances, competition, marketing, staffing (Mastrodonato, P., pg.-4). Similar to China Life Insurance; which had all their resources invested at resolving the regional and cultural barriers in their social system, in order to sustain themselves in the market. Private Insurance companies were not a part of the culture of ancient China, and were more strongly opposed by the Chinese government. So, it was essential to prioritize and overcome the cultural resistance to survive rather then spending organizational time and resources in increasing the sales.

1 [STRATEGIC MANAGEMENT] 1 The second most important approach would be introducing a new complex form of risk management, since it was one of the major causes of the companys initial failure. Rationality in the investments is a very important tactic and it is highly vital for the insurance companies to hold an asset against the investments they are about to make, in order to minimize the risk. Although, holding a derivative asset, as a security is not a smart choice, because the value of the derivative assets depends only on the assets they are dependent upon. The audit department of China Life Insurance conducts various kinds of auditing, accounting and basic accounting appraisal such as economic liability auditing, financial revenue and expenditure auditing and key investment auditing independently or jointly every year. This is beneficial to further safeguarding the thorough implementation of the regulations of the Company, thus reducing operational risk (Chan, S. (2009). China life has involved employees and officials from the topbottom hierarchy in the risk management teams, and the board of directors reviews the risk assessment reports on a regular basis. On average, organizations lose forty percent of the potential nancial value of their Strategies due to poor performance and talent management of their employees (Mankins and Steele, 2005). The lack of transparency, whether it is between the different layers of hierarchy, or inter-departmental always leads to misalignment of the organizational goals to the individual goals of the employees. The fact that all the employees, irrespective of their department, and working together as effective and efficient teams are more likely to drive the organizational strategies more successfully. With greater transparency, individual performance and contributions to the organization become more evident (Bergrenn, E., Mateo, S., pg.-416, (2007). Evidently in the case of China life, strategies

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are broken down into denitive components, or goals, upon which individual employees can act; which makes it easier for the employees to achieve these goals, and thus successfully executing the strategy. Last but not the least, it is utmost essential that the organization enforces the most suitable criteria of rewarding system for the purpose of employee motivation. Pay for performance is a complex issue (Pfeffer and Sutton, 2006). In case of AIG, they had adopted the strategy of classifying the individual into different classes on the basis of their varying performance, and the employees only in the highest bracket were rewarded. Compensating employees with the same salary or pay rate, regardless of individual performance levels and their impact on strategy execution, is increasingly being recognized as a sub-optimal model (Fitz-enz, 1997). Employees in AIG, from each and every department should be treated with equality and be provided with similar incentives for motivation. Although, providing better incentives to the valuable employees sounds more logical theoretical, but it may create a sense of inequality amongst others, and tis demotivating them. Similar is the strategy of the Chinese in the China life insurance company; where their direct sales representatives are compensated through fixed salaries. So to sum up, I would say that AIG has been one of the leading insurance company of all times in the booming financial market, but let itself suffer the consequences of their own poorly executed strategies. The consequences were intensely fatal and lead to the collapse of the entire enterprise in the year 2008. The strategies, which according to me lead to this collapse, were the exploiting the use of lenient government policies, poor and simple risk-management system, lack of vertical as well as horizontal transparency between the employees and the different departments and overshadowed and unmotivated

1 [STRATEGIC MANAGEMENT] 3 employees in the non-insurance departments. Since, the organization managed to pick itself up and pay-off the government back; the initial strategies had to be dumped in order to enforce the new ones. First and foremost, applying issue-based strategic planning rather than goal-based strategic planning. Followed by a better risk management system, which includes making rational investments and securing the available resources through hedge funds. Thirdly, improving communication to enforce better information flow between the employees amongst different departments, in order to eliminate the opacity in the organization. Lastly, enforcing the most suitable rewarding system according to the need of the hour, in order to motivate the employees. These strategies focus at the shortterm issues; but those are the intrinsic factors, which need to be dealt with immediately. Strategic planning can be a tricky task and it has to be manipulated over the time according to the changing circumstances.

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Strategic management REFERENCES 1. Canavan, K. (2013). AIG Story' is Greenberg's own version; USA Today. Retrieved from EBSCOhost. 2. Hobs, J. ( 2011). Financial Derivatives, the Mismanagement of Risk and the Case of AIG. CPCU journal; p1-8. 8p. Retrieved from EBSCOhost 3. China law and practice (2010). China Insurance Regulatory Commission, Implementing Guidelines for Comprehensive Risk Management of Personal Insurance Companies; Vol 25, Issue 2. 4. Carrick, M., Smith, R., Pleven, L. (2008). Behind AIG's fall, Risk Models Failed to Pass Real-World Test; ol. 252 Issue 106, pA1-A16. 2p. 1. 5. Lublin, J., Serena, N. (2010). AIG Pay Plan: Rank and Rile. Wall Street Journal Eastern Edition; Vol. 255 Issue 34, pC1-C4. 6. Chan, S. (2009). Creating a market in the presence of cultural resistance: the case of life insurance in China. DOI 10.1007/s11186-008-9081-1. Retrieved from EBSCOhost. 7. Bergrenn, E., Mateo, S. (2007). Organizational transparency drives company performance. Vol. 26 No. 5, pp. 411-417. DOI 10.1108/02621710710748248. 8. Bryson, J. (2011). Strategic Planning for Public and Non-profit Organizations. Fourth edition