Discipline was not a hallmark of the American insurance industry of the 1960s. Greenberg set out to change that. He addressed a problem that plagued businesses across America in those days and seemed acute in the insurance industry: the “three-martini lunch.” Agents, whose business was heavily based on entertaining prospects and clients, often drank during lunch, sometimes followed by a nap in the afternoon. Nor were brokers, managers, or executives immune to such habits. Underwriting quality, of course, suffered, ultimately reducing profits. Though lacking authority to control independent agents, for his own employees, Greenberg developed four simple and unambiguous rules: (1) do not drink at lunch; (2) if you drink at lunch, have only one; (3) if you have more than one drink at lunch, do not come back to the office that day; and (4) if you come back to the office after drinking more than one, do not come back to the office ever again.
Disciplinary rules extended well beyond those applicable to lunchtime libations, of course, encompassing underwriting profit, expense control, risk analysis, calibrated pricing, and error minimization. Discipline was imperative in making the acquisitions Greenberg and his team were about to negotiate.
Opportunity first knocked in early 1967, when a corporate raider named Louis Roussel bought 10 percent of the stock of the New Hampshire Insurance Company. New Hampshire held licenses in 27 countries, with leading positions in Europe, and represented a 15 percent share of the American International Underwriters (AIU). Roussel, a New Orleans banker, told the press he wanted to relocate the company from New Hampshire to Louisiana and to refocus its operations domestically rather than abroad. New Hampshire’s chairman relayed this news to Manton, who promptly alerted Starr.
Starr called Greenberg, stressing that the loss of New Hampshire from membership in the AIU would be a significant blow to the organization. Aside from its substantial role in the AIU, Greenberg liked New Hampshire because of its strict underwriting standards. It boasted a record of never suffering an underwriting loss. Further, its expense ratio was low compared to other agency members, though still high by Greenberg’s standards. Starr asked Greenberg to do whatever it took to prevent Roussel from taking over New Hampshire, including having American Home buy his stock. Greenberg upped the ante on this opportunity, envisioning not only buying Roussel’s 10 percent, but having American Home gain control by acquiring additional shares on the open market or from incumbent management holding significant shares. In parlance that would be common in corporate America years later, Louis Roussel was preparing a “hostile takeover bid” for New Hampshire, and Greenberg was ready to play the “white knight.”
Greenberg had met Roussel before, when the banker visited New York to peddle bonds for a Louisiana bank he was running. Few others in town bothered to meet Roussel, but Greenberg valued making new business contacts and was happy to get acquainted. Though Greenberg bought no bonds, he established a relationship. So Greenberg paid Roussel a visit, flying to New Orleans to catch up. At dinner, Roussel began to discuss his interest in New Hampshire, apparently ready to reveal his strategic plans. But Greenberg cut Roussel short, emphasizing his own interest in the company. He advised that going forward would involve a fight for control of the insurer. Both knew such competition would drive the bidding up. Greenberg offered to avert such profit-erosion by buying Roussel’s 10 percent then and there. He asked Roussel to sleep on it that night and come up with a buyout figure. The next morning Roussel named a price and Greenberg accepted.
The price gave Roussel a profit on his stake. Though Starr and Youngman bickered about whether the price was fair, Greenberg was confident in his figure. Within a few weeks, New Hampshire’s stock traded significantly above the deal’s purchase price. Greenberg then negotiated with a grateful New Hampshire management the sale of enough additional shares to form a majority. This acquisition thus kept a valuable AIU member in the fold—an important goal, and the one Starr held dear. In addition, the transaction consolidated control of a business with the kind of attention to underwriting quality that Greenberg valued. And no radical operating changes were necessary.
A second opportunity to expand ownership over AIU members arose when National Union Fire Insurance Company of Pittsburgh ran into difficulties. A venerable firm controlled by the Mellon family and owned by citizens across Steel City, its president had tried to turn it around by entering into new insurance lines. To do that, National Union approached Colby & Hewitt, a Boston insurance brokerage firm held by the Hewitt brothers, which owned the Lexington Insurance Company, an insurer of unusual risks. It wrote insurance protecting cattle owners against rustlers, rock concert promoters against star laryngitis, salmon farmers from aquatic hazards, and sports stadiums against the risk that half-time contestants might actually make a basket from half court and win a large cash prize.1 National Union bought Lexington, paying for it with a 20 percent block of National Union’s stock.
By 1967, National Union was ailing nearly as badly as American Home had been, dragging the Lexington subsidiary down with it. Greenberg diagnosed National Union as having the same disease he had cured at American Home: heavy reliance on an agency system with high expenses and a whopping combined ratio (the percentage of premiums absorbed by both expenses and policy losses covered) of 114 percent.2 Ideally, that figure should never exceed 100 percent. The danger to the Starr organization was familiar, too: National Union was also a long-time AIU member, with a 10 percent membership interest holding licenses in 30 countries. Starr was again concerned about the survival of the AIU; Greenberg wanted to own Lexington.
At a meeting in Puerto Rico of the Young Presidents Organization, a network of corporate leaders under 40 years old, Greenberg ran into one of the Hewitt brothers. The Hewitts were unhappy with how the family’s National Union investment was performing, as its stock price sunk from $46 in 1964 to $17 by late 1967.3 Sensing opportunity, Greenberg invited the Hewitt brothers to New York for lunch, joined by Starr, Youngman, and Manton.
Discussion turned to the stock. One brother asked what American Home would offer for it and Greenberg gave his answer. Oddly, Starr then piped up, cocking his lantern jaw: “That price is much too low. He’s just trying to steal the company from you.”
The two brothers were flabbergasted, as was Greenberg. They looked at each other, then at Greenberg, then back at each other and then tried to resume eating. The rest of the meal was awkward, as Greenberg sought to recover the negotiations from Starr’s gaffe. The Hewitt brothers called Greenberg later that night, asking about Starr, “Is he for real? We’re perfectly happy with the price you offered, which is a fair price.” Greenberg quickly chalked up Starr’s comment to his generous spirit and returned the Hewitts’ attention to the business at hand.
Greenberg and the Hewitts agreed to close the deal at the price Greenberg proposed, transferring the 20 percent stake in National Union, along with considerable sway in its boardroom. The toehold persuaded Starr that nurturing the investment was desirable to protect its economic value and essential to preserve the company’s overseas licenses for the AIU. Greenberg began to commute between New York and Pittsburgh on round-trip flights nearly every day for two months, offering assistance and discussing a deal to acquire majority control of National Union.
Back in New York in late 1967, Greenberg explained the opportunity to John J. Roberts, a seasoned international insurance executive then managing the AIU in Europe and the Middle East. He had become acquainted with the Starr organization in the Philippines as World War II ended and completed his tour of duty as a liaison Army officer in the Manila war crimes tribunals. Roberts, who had many friends on Wall Street, recommended that Greenberg retain Morgan Stanley, the investment bank, to develop and finance offers to buy more National Union stock. Morgan Stanley’s team would be led by partner Edward Matthews, whom Greenberg would later recruit to come work for him directly.
As Morgan Stanley began to value National Union, Greenberg prepared to obtain approval from American Home’s board of directors. Most board members seemed supportive, but not all. When the board met, a few directors expressed doubts about the deal and signaled that they might oppose it. One, a prominent businessman whose opinions were influential, argued that American Home was doing well and that the company should build on that strength rather than venture into something new, especially given the uncertain state of National Union’s business. Another director worried that acquiring an additional company would spread management too thin. Listening to these reactions at the board meeting, Greenberg was mentally preparing his response, ready to insist that the transaction must be done.
Before Greenberg could begin, Starr spoke up. He had become ill recently, was looking pale, and relying on an oxygen tank to aid his breathing. He had been sitting quietly, listening to the arguments on both sides when he rose to speak. “This is an important acquisition and I believe that it represents a very good value for us,” Starr said in a weak voice as the room fell silent. “Hank has been doing an excellent job running American Home and building this business. He has negotiated a very good deal for us in this acquisition of National Union.” Before concluding, Starr became emotional: “If you do not support Hank on this one and vote for the deal, I would advise Hank to leave the company and use his extraordinary talents where they will be appreciated.” Starr sank down into his chair. The board voted unanimously to approve the acquisition of National Union.
For the National Union acquisition, Morgan Stanley, led by Matthews, arranged the funding. It created a new subsidiary, which it called American International Enterprises, and used it to obtain credit from Chase Manhattan Bank. Locating the shares was more difficult, as there was no central registry in that era for National Union shares. Following the standard practices of the day, Morgan Stanley bankers contacted brokerage firms that had sold small stakes in National Union to customers. Matthews and his several colleagues had the delicate task of persuading shareholders that the company was failing financially, yet they were being offered a decent price for their shares.4 Those efforts delivered another 37 percent of the stock, bringing the total to a solid majority of 57 percent.
Starr’s generous spirit, evident at the lunch table with the Hewitt brothers, showed in more amusing ways during the deal to acquire National Union. In Pittsburgh, commuting from New York, National Union provided Greenberg with car service—a vintage Checker taxicab driven by Bernie, the company’s maintenance manager. Greenberg would invariably tip Bernie $10 or so (about $40-plus in today’s dollars), depending on how much time travel to and from the airport took, significant tips for that era. After one National Union board meeting, Starr joined Greenberg in Bernie’s Checker cab out to the airport. In those days, the company paid each director a stipend of about $100 per meeting—paid in cash tucked inside a paycheck envelope. Stepping out of the cab, Starr gave his packet to Bernie. Ever after, when Bernie picked up Greenberg at the airport, he asked, “When is Mr. Starr coming to town?”
American Home was about to report a substantial profit in 1967. Good news, of course, but also incurring a large tax bill at a time when the company’s capital position still needed strengthening. Fortuitously, right at year-end, Greenberg got a call from Guy Carpenter, another legendary figure in the insurance industry whose name still graces the reinsurance firm he founded. Carpenter, with whom Greenberg developed a productive working relationship, reported an opportunity to acquire Transatlantic Company, which had a loss that, if acquired by year-end, would offset much of American Home’s profit. The offering price was less than the tax savings, so American Home jumped at the opportunity, which the board quickly ratified, and the deal closed on time. Though not otherwise particularly substantive at the time, Transatlantic would serve as a useful reinsurance vehicle decades later.
American Home’s rising profitability was due in large part to an organizational innovation Greenberg implemented called the profit center model, which would become a distinctive hallmark of all businesses in the organization. The concept refers to assigning full profit and loss responsibility for a business area to a single manager. At many insurance companies in the 1960s and 1970s, it was common for various departments to blame each other for business setbacks: agents blaming underwriting, underwriters blaming budgeting, the budget department blaming claims management—and so on. Greenberg decided that each manager should bear the full burden and earn the full benefits of his top-to-bottom operation across that business, whether underwriting, budgeting, claims—the whole insurance operation. In the profit center model, underwriting profit was the sole determinant of success. Managers responded, and a culture of expense management and underwriting rigor emerged.
To implement the profit center model, Greenberg held regular budget meetings: weekly with the handful of most senior executives, monthly with a larger group that oversaw the entire company, and quarterly with each manager. These meetings, which could last for hours, were a component of the company’s internal audit function. Emerging problems could be identified promptly at the highest levels and solutions devised to correct them. All business functions were represented—actuarial, accounting, internal audit, underwriting—to review the budget plan thoroughly for the year-to-date. Managers thereafter lived with those budgets. That made accountability the essence of the profit center model.
The upshot was to grow people who understood the full range of the business, not merely parts of it. Due to the profit center model and this tight system of internal audit, employees across the organization—at American Home, National Union, New Hampshire, the AIU—energetically developed, tested, and promoted new products in niche areas to cover emerging risks. These companies insured everything from the boxer Muhammad Ali against accidental death during title bouts to the construction of the Washington, D.C., subway system, to a top-secret communications satellite called LEASAT that Hughes Aircraft built for the U.S. Navy.
One opportunity arose when the chairman of Marsh & McLennan, a leading broker of large-scale commercial risks, paid Greenberg a visit in 1968. He suggested venturing into a budding market in insurance covering corporate directors and officers (later called D&O insurance). Greenberg had a vague understanding of this concept, and it was just the kind of thing he liked to pursue: a novel niche product that could be priced reliably in relation to the risk, at a profit, and whose risk could be spread around to other firms using reinsurance. The Marsh executive explained that only a very small market in D&O insurance existed through Lloyd’s.
Greenberg agreed that demand for D&O insurance in the United States would soon rise dramatically. So he promptly hopped a Pan Am flight to London to investigate. During the 1930s, Lloyd’s introduced insurance to cover corporate directors for personal financial liability. At the time, corporations were prohibited by law to indemnify those officials for such costs. But there were not many grounds on which corporate officials could be held liable either. After all, directors were seen merely as business advisers; officers were rarely targets of lawsuits.5 As a result, the insurance was not considered necessary.
In the late 1960s, attitudes toward corporate directors began to change as shareholders and governments came to insist that directors bear responsibility for corporate stewardship. Courts started to interpret laws more liberally to impose personal financial liability on directors and officers. Public sentiment swung in favor of the accountability movement after the 1970 failure of Penn Central Railroad, a collapse on a scale akin to that of Enron Corporation’s disintegration three decades later, and leaving similar regulatory and legal changes in its wake.6
On his trip to London, Greenberg discovered that there was only one Lloyd’s syndicate handling D&O insurance and the market was tiny. After a long meeting with the syndicate manager, the manager said he would be delighted if American Home would help develop the market, noting how its distribution system was vaster than anything London could match. The syndicate also agreed to reinsure related risks. American Home soon launched this groundbreaking D&O product. Experience over several years was required to fine-tune how to price this insurance, but underwriters gradually refined the pricing correctly and the product succeeded. American Home became the market leader in D&O insurance. As it and a half-dozen followers promoted the product, more directors and officers requested the coverage as part of their recruitment packages. The coverage soon became the industry staple that it remains today, when total industry premiums in the U.S. average $7.5 to $10 billion annually.7
The growth and wide-scale legitimacy of D&O insurance met some resistance and attracted controversy. Critics objected that coverage undermines the original objectives of the campaign to promote more active director oversight rather than having directors who merely provide advice.8 American Home noted that corporate officials perform for a multitude of professional and personal reasons, and that the desire to avoid lawsuits is likely not the most important motivator. Some lawsuits, often those brought by lawyers working for contingent fees, are brought more for their settlement value than the merits warrant. In addition, the policies do not cover egregious behavior.9
Contemporary insurance firms promoted D&O policies through advertising. An amusing example, by the insurance broker Johnson & Higgins, ran in the Wall Street Journal in 1968. Warning of astronomical personal liability for directors, it depicted a board gathered around a table with a duck seated at the head. The caption: “Are you a sitting duck?”10 The ad was a bit of Madison Avenue hyperbole, of course, as the perception of liability risk is often greater than the reality, enabling D&O underwriters to generate an underwriting profit reliably. Thanks to American Home executives, the tiny market they found in the late 1960s grew dramatically over the decades.
As American Home pioneered D&O insurance, underwriters elsewhere at 102 Maiden Lane were pioneering a variation on this coverage called errors and omissions (E&O) insurance. E&O insurance, which covers professional liability arising from mistakes and lapses, was initially launched for realtors and interior decorators. The product grew rapidly as National Union offered it to a broader range of professionals, from accountants, doctors, and lawyers to tanning salons, kidney dialysis centers, and travel agents.
The forces driving the expanding E&O market were familiar: as lawyers representing plaintiffs developed new theories of legal liability and judgments were rendered, people demanded new insurance coverage—and insurance companies developed it. As plaintiffs’ lawyers grew increasingly aggressive, insurance policies, in tandem, became more creative. Many types of coverage, especially professional malpractice insurance, became practically mandatory to cover legal risks. A pattern emerged: if a big lawsuit arose, posing a new legal theory and resulting in a big money judgment, underwriters at American Home, National Union, or New Hampshire would develop insurance to cover it.
American Home’s team adapted rapidly to changing circumstances. On August 8, 1967, at 4:42 in the morning, two violent explosions awakened people across southwestern Louisiana.11 The Cities Service Oil Company refinery had burst into a raging fire, caused by a leak in a butane line rendered explosive when a southwest wind blew gas towards a furnace in an adjacent area. The refinery, which looked like a large bomb had blown it up, was damaged beyond repair. The facility was insured by a pool of insurance companies that had underwritten the policy using the so-called probable maximum loss method. This method refers to the greatest forecast amount of loss from a property’s destruction, assuming the proper functioning of protective devices, such as alarms, sprinklers, and fire departments. Actual losses to an insurance company covering the facility could exceed that amount, sometimes by substantial margins. At the Cities Service refinery, the engineers were wildly mistaken. The actual loss was twice the probable maximum loss, exhausting the insurance pool, and drying up capital for such risks.
Within hours of the explosion, Greenberg called Roy Williams, a smart young staff engineer, to discuss the loss and how C. V. Starr & Company might respond. First, the underwriting should change its key assumption, Williams said. Instead of probable maximum loss, underwriters should use the maximum possible loss, a much higher figure and therefore a more cautious calculation. An insurer adopting that position would know exactly how much it could possibly have to pay. Second, underwriters should work carefully with engineers and other technical experts to provide more rigorous analysis and evaluation of loss scenarios.
Greenberg ran these ideas by Manton, the insurance traditionalist who became persuaded by Greenberg’s independent and innovative approach to the business. Manton also liked these ideas, so Greenberg named Williams president of a newly created company, called Starr Technical Risks Agency, Inc. A new profit center, it would apply those underwriting and engineering principles in acting as agent for a group of insurance companies writing insurance on petroleum-petrochemical risks in the United States and Canada.12 The pool, officially announced on December 6, 1967, included both Starr companies and other U.S. insurance companies and was coordinated by American Home. Each member company had one seat on the pool’s board of directors, giving each a voice at the governance table.
Starr Tech brought the AIU’s vast global experience in underwriting and engineering oil risks to bear in running the pool. Though the AIU’s previous energy projects were located overseas, Greenberg figured that, from a technical perspective, project differences were scant. In fact, many overseas projects, particularly those in the Middle East, tended to be owned by the same oil companies, such as Cities Service, running stateside projects. In addition, the AIU then had decades of experience managing insurance pool operations. Starr Tech succeeded, gaining modestly at first and growing steadily thereafter. C. V. Starr & Company ultimately moved the business in-house, shifting from a pool/membership structure to direct underwriting of all the risks, backed by reinsurance.
With Greenberg on board, Starr’s businesses were taking a new shape. Executives continued to exhibit the traits that Starr prized and Greenberg sought out: fresh-thinking, self-reliant individuals prepared to make necessary changes and to be creative. The new shape this team would build became even clearer as Starr began to discuss who should succeed him at the helm upon his retirement. His decision would lead Greenberg to create AIG—and continue to lead changes in the insurance industry.
Notes
1. See “Taking Risks,” chap. 9, p. 6.
2. Ibid., chap. 7, p. 2.
3. Ibid., chap. 7, pp. 2–3.
4. Ibid., chap. 7, p. 3.
5. See Myles Mace, Directors: Myth and Reality (Cambridge, MA: Harvard Business School Press, 1971).
6. See Melvin Eisenberg, The Structure of the Corporation: A Legal Analysis (Boston and Toronto: Little, Brown & Company, 1976).
7. Cunningham e-mail from Chuck Dangelo, The Starr Companies, July 16, 2012.
8. See Tom Baker and Sean J. Griffith, Ensuring Corporate Misconduct: How Liability Insurance Undermines Shareholder Litigation (Chicago: University of Chicago Press, 2010).
9. Comment, “Law for Sale: A Study of the Delaware Corporation Law of 1967,” University of Pennsylvania Law Review 117 (1969): 861 (note 167) (referencing 1968 interview of R. Brian Jarman, Assistant Vice President, American Home).
10. Wall Street Journal (March 21, 1968): 6, cols. 4–6.
11. See Sam Tarleton and Wayne Owens, “Plant Fires Still Raging,” Lake Charles American-Press (August 8, 1967): 1.
12. See “CVSCO Forms Agency for Oil Risks,” Contact (January 1968).