One major trend that has existed in the insurance industry over the past several decades is increased specialization. This is true globally, but is most true in the US. In general, being good at one area of the insurance business does not confer significant advantages in other areas. This is true in underwriting, which is a specialized talent in each area of insurance. It is also true in market. Cross-selling opportunities across lines of business are not great enough to justify the effort. There are small consolidation advantages in shared corporate staff, and it may be cheaper to finance a large organization than two smaller ones, but those are slim advantages to conglomerate over. In general, we do not expect an increase in the number of major conglomerates; rather, the trend is toward increasing specialization, with increasing scale within a company’s area of specialization.
The most successful conglomerates have tended to be holding companies that allow individual operating companies to act with little coordination. They require results from the subsidiaries, and intervene when the holding company does not get results. The holding company directs the allocation of capital to the businesses that offer the best prospective returns. In one sense, some insurance conglomerates invert the insurance model; they are essentially investment companies, with insurance liabilities issued to provide funds to invest in favored projects. With ordinary insurers liability issuance leads the process.
The excellent performance of the conglomerates group is unique to two companies that are large and do it particularly well: AIG and Berkshire Hathaway. As these companies get larger, it will be increasingly difficult for them to achieve above average performance. It will also be more difficult to do as well without their unique current leaders.
Bringing it to the Present
Well, when I wrote about this in 2004, I had not yet focused on the growth of debt inside AIG. The firm I was with owned AIG, and sold into the flood of buying that occured when AIG was added to the Dow.
But I can adjust my views. Before the time Greenberg was being shown the door, I was bearish on AIG because I thought that leverage was too high, far greater than the rating agencies should allow, which explained why AIG credit traded more like a single-A credit. I also reflected on my prior days at AIG with more insight than when I was younger, and wondered if it might not be possible that the accounting at AIG was very liberal. While working there, I was involved with uncovering five reserving errors, each of which should have led to a hiccup in earnings, and in one case, a severe loss. But the earnings kept going up.
When I have written things like this, I have never gotten flak from people inside AIG; rather, I get e-mails from people inside AIG that have had similar experiences. Part of the problem was the culture of fear. When telling the truth is initially derided with force, even if it is eventually accepted if you are strong enough, you will get few people taking the risk to tell the truth.
But without Greenberg, AIG was doomed in the short run. No one else could manage it, even if it was crooked in some ways. The truth withheld re-emerged, and those in charge got whupped for the sins of Greenberg.
But what of insurance conglomerates generally? I don’t recommend them, because synergies are few, and focus is necessary for most effective insurance companies.