What Can Insurers Do To Clean Up The Corporate Governance Mess?
The $60 billion bankruptcy of Enron last December was the opening act in what has since become one of the greatest and most serious tragedies in the financial history of the United States.
What began as an ethically-challenged relationship between a corrupt energy trader and its shredder-happy auditor has mushroomed into a crisis that has engulfed the entire market for U.S. equities.
Make no mistake, the current crisis in corporate governance–which has since sucked dozens of publicly traded corporations into the ignominy of Chapter 11–has shattered the publics faith in Wall Street and cost insurers tens of billions of dollars.
So serious is this breach of faith that U.S. stocks are likely to finish 2002 down for the third year straight. The last time that happened was 1939-1941, the years bridging the Great Depression and World War II–arguably one of the darkest periods in this countys history.
The stench emanating from the executive suites and boardrooms of dozens of major U.S. corporations has become too strong to ignore. The blinding greed of too many CEOs–at the expense of their shareholders, creditors, employees and investors–is a national embarrassment, and its cost to the U.S. economy is beyond quantification.
What can insurers do to help clean up this mess? A lot, as it turns out. And thats good news because its in our industrys own best interests and the best interests of policyholders to fix whats wrong in Corporate America as quickly as possible.
As an industry, we are heavily exposed to the fallout from the crisis in corporate governance. Life insurers are highly exposed to investment risk. Property-casualty companies have a mixture of investment risk and insurance risk arising from directors and officers programs sold on the besieged companies, as well as exposure from entity and fiduciary liability covers.
In the raucous national debate over corporate governance, our voice as an industry can and must be heard.
Weve earned our place in the debate by virtue of sheer size. Insurers are among the largest institutional investors in the U.S. In fact, life and non-life insurers in 2001 had a combined total of $3.3 trillion in financial assets under management (see accompanying charts). Of that, 80%, or $2.7 trillion, was held in the form of corporate equities or corporate debt.
Translation–as an industry we have enormous clout, but also an enormous personal financial stake in cleaning up Corporate America. The collapse of Enron alone, for example, produced investment losses across the insurance industry totaling $3 billion.
As an industry we also have a sacred fiduciary responsibility to our policyholders. Does this awesome responsibility, which involves the management of funds to pay for everything from a widows annuity to losses stemming from the next terrorist attack, oblige us to aggressively seek the ouster of management that has a bad year or two?
The answer to this is no. What about when management drives a company into the ground because of self-dealing, deceit and fraud? The answer, once again, is no.
Institutional investors, including insurers, are required only to prudently manage the assets that have been entrusted to them. While this requirement implies the performance of due diligence in advance of any investment, it does not imply that institutional investors assume what amount to operational duties in corporations with dysfunctional management.
Institutional investors can fulfill their fiduciary responsibilities by simply selling stock in the troubled company. Indeed, some insurers in recent months appear to have done exactly this by shifting assets into municipal bonds and asset-backed securities to lessen their exposure to equities market risks.
During ordinary times, punishing poorly performing companies by selling their stock is probably sufficient, but these are not ordinary times. A compelling, albeit controversial argument can be made that insurers should use their clout as major shareholders to help purge dysfunctional corporate boards and corporations of unqualified, incompetent and conflicted directors, officers and managers.
Insurers are not generally known as activist shareholders. But institutional investors in general are becoming increasingly restive over the crisis in corporate governance, and some have begun to take matters into their own hands.
Consider, for example, the recent actions of the California Public Retirees Retirement System (CalPERS), one of the largest institutional investors in the U.S. and the owner of roughly three million shares in Enron stock.
Weeks before Enrons bankruptcy filing in December, the chairman of CalPERS Investment Committee publicly accused the energy companys senior management of “self-dealing.” His scorn extended to the companys board of directors, which he accused of having “failed in its responsibility to monitor the activities of Enrons corporate officers.”
The solution, according to CalPERS, was obvious: “[T]he interests of shareholders are best served by retiring all of the current directors from involvement in Enrons successor entities.” In other wordsthrow the bums out!
And thrown out they are. Under pressure from pension funds and labor unions, Enron announced in late May, for example, the “retirement” of two board members who became directors during a period when the companys board was waiving conflict-of-interest policies that allowed the creation of complex partnerships that contributed to the companys bankruptcy.
One director was the president of a cancer center, the other a retired executive and board member of a major financial services firm itself being sued by Floridas state employee-retirement plan for buying large blocks of Enron stock even as the company stumbled toward bankruptcy. They are being replaced by an experienced electric-utility executive and a risk management expert.
By forcing out less-qualified board members with serious conflict-of-interest problems, and replacing them with unconflicted and experienced individuals, activist shareholders certainly seem to be taking steps in the right direction.
CalPERS and a few other state-employee retirement funds have historically not been shy about throwing their weight around–neither have pension funds managed by labor unions. It could well be time for insurers to join them.
As a united force, insurers could be nearly as influential as retirement funds or pension plans. As a practical matter, however, insurance is a highly fragmented industry that faces a number of obstacles in presenting a united front on this issue for a variety of reasons.
First, insurance is an extremely competitive, state-regulated business with literally thousands of players, most of them small, regional mutual companies that may feel their voice is too small to be heard. Investment strategies at large national companies with large blocks of voting shares in troubled companies differ significantly.
Organizing this disparate group for the purposes of speeding corporate governance reforms would be a challenge, though trade associations could be enlisted to facilitate this task.
Second, because insurers are generally prohibited by state law from accumulating more than one percent of their invested assets in securities of any single corporation (to limit investment risk and encourage diversification), the influence of any given insurer is automatically handicapped.
Third, many insurers will feel that selling a troubled stock is the necessary and sufficient action required to protect the financial interests of the firm and uphold its fiduciary responsibility to policyholders.
Institutional investors, including insurers, are among the few non-regulatory organizations that can help bring a speedy end to the current crisis in corporate governance in America today.
Some, like CalPERS, have concluded that working actively to purge corporations of self-dealing directors and officers is entirely consistent with their core fiduciary responsibility to prudently manage funds entrusted to them.
Why shouldnt insurers come to the same conclusion? Relying on the government to police the boardrooms of America (not to mention crooked auditors and heavily conflicted stock analysts) has clearly fallen well short of the mark.
If shareholders remain complacent, the likes of Al “Chainsaw” Dunlop of Sunbeam, Ken Lay from Enron, and Worldcoms Bernie Ebbers will be left with even more time to enrich themselves at our expense.
Robert Hartwig, Ph.D., is senior vice president and chief economist at the Insurance Information Institute in New York. He can be reached at email@example.com.
Reproduced from National Underwriter Life & Health/Financial Services Edition, June 24, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.