Industry the April 2011 issue

The Gravity of the Situation

How Peter Eastwood kept key people in his orbit and Lexington afloat after the AIG debacle and Kevin Kelley’s departure.
By Ed Leefeldt Posted on April 1, 2011

John Doyle, head of American International Group’s Commercial Insurance, was calling to tell Eastwood, then the senior executive of Lexington’s Healthcare Division, that his boss, Kevin Kelley, had just quit as chief of Lexington Insurance, AIG’s surplus lines group. Doyle wanted Eastwood, all of 41 years old, to take over, to save AIG’s former crown jewel and its 1,400 employees. But as Eastwood boarded the plane on Dec. 9, 2008, for the return trip to Lexington’s headquarters in Boston, he wondered: “Will I be the only one left in the building?”

Fresh Meat

Kelley’s departure was unexpected, abrupt, but understandable. Over the course of three decades at Lexington, he had turned it into one of AIG’s most profitable groups, a huge company in its own right. Then, through no fault of his, the world’s largest insurer imploded.

Kelley’s mentor, AIG CEO Hank Greenberg, was booted out after being accused of fraud by New York State Attorney General Eliot Spitzer. Greenberg had taken AIG far beyond the realm of insurance with his calamitous foray into credit default swaps, but he was also the stiff backbone that held the far-reaching empire together. Now AIG was an ailing patient on a federal respirator, with a $182 billion taxpayer bailout.

On the flight back to Boston, Eastwood feared the worst was yet to come.

Building a successful insurance business is about attracting and keeping talented people. Kelley, who had already hired away his second-in-command, would no doubt try to cherry-pick the best of Lexington’s staff for his new job as head of a Bermuda insurer. Other top-notch and equally frustrated employees might find positions elsewhere. “A dozen competitors looked at us as fresh meat,” recalls David Bresnahan, who now heads Lexington’s casualty division.

As the poster child for the corporate greed that caused the collapse of Lehman Brothers and Countrywide Financial and brought on the worst financial crisis since the Great Depression, AIG would spiral downward, with executives facing death threats by phone and by mail. The company logo was sandblasted off its New York City headquarters, and its chief executive was humiliated by Congress in televised hearings. The far-flung tar and feathers would cover Lexington, which was already facing another year of lower earnings, cutthroat competition and a recession.

Worse still, Kelley chose to leave just prior to the new year, when 23 treaties with Lexington’s reinsurance partners were due to be renewed. Now Eastwood would have to convince these major international companies—and everyone else—that Lexington was still on solid ground.

A Seat at the Table

If there is a road to redemption for AIG, GM and other battered American companies, it just might pass by Lexington’s brown-hued headquarters in the financial district of Boston. Responsibility for redeeming the companies will rest on the shoulders of former mid-level executives such as Liam McGee, who jumped from Bank of America to CEO of The Hartford, and Eastwood, who learned the trade by serving 17 years in the trenches. By assuming leadership in the midst of crisis, they’ve had to learn new lessons just to survive.

“I believe strongly in the concept of a team,” says Eastwood, who turned 44 in January. “Today we communicate better, there’s more transparency and collaboration. We give people a level of ownership, a seat at the table.”

I believe strongly in the concept of a team.

To be sure, all of Eastwood’s efforts won’t end the recession or slow down the fierce competition for every dollar. And AIG is still in the throes of a government bailout. But his role is eerily similar to Winston Churchill’s when he became prime minister of England in the darkest hours of World War II. Churchill could not have won the war, but he could have lost it. Now, more than two years into a difficult tenure, it’s safe to say that Eastwood hasn’t lost either. And for that reason, he and the others who saved Lexington may someday be studied at business schools.

The Non-Admitted

Surplus lines insurance is the blowout valve for the “admitted” market, property-casualty insurers that are licensed to sell in a particular state. But when companies face risks these admitted insurers can’t or don’t want to handle—hurricanes, oil rig fires or management meltdowns—they turn to “non-admitted” insurers like Lexington to provide the huge financial backstop they require. During the past 20 years, as terrorists struck and hurricanes slammed the Gulf Coast, this surplus market expanded six-fold at a time when the admitted market only doubled.

In surplus lines insurance, size matters. As the biggest, with a capital base of $40 billion, Lexington became the go-to guy. So this surplus giant has flags planted practically everywhere: real estate, universities, healthcare (the unit Eastwood headed before his promotion), catastrophe, even YMCAs and ski resorts.

The disadvantage: Lexington competes with almost everyone, making it a huge target. There’s constant tension with admitted carriers, who would like to keep as much business as possible. “As long as the admitted market is soft, growth for the surplus lines will be challenged,” says Celent Research Services analyst Donald Light. Among its heavyweight opponents are ACE, Travelers and Zurich.

In short, more capital is chasing less risk. Eastwood’s challenge was, first, to keep his people on track and, second, to make them run faster so they wouldn’t be outdistanced by smaller, nimbler players—such as his former boss.

Fingerprints on Everything

Like almost everyone else at Lexington, Eastwood didn’t know that Kelley would wind up at a potential rival. Kelley is an imposing six-foot two-inch marathon runner whose fierce temper mirrors that of his mentor, Hank Greenberg. “He treats golf like a battlefield,” Leader’s Edge said of Kelley in 2009. His 33-year career started in 1975, when Lexington wrote less than $60 million in premiums. Kelley made Lexington into the dominant surplus lines insurer.

“He was the kind of person whose fingerprints were on everything,” says Sanjay Godhwani, who now heads Lexington’s property division.

A dozen competitors looked at us as fresh meat.

When Doyle asked Eastwood to take over, Eastwood admitted to a moment of shock. But his instantaneous answer was a resounding yes. Part of the reason, Eastwood says, was his loyalty to AIG, his first and only employer, and to Lexington, where he’d worked since 2003. Another was his close relationship with Doyle.

But part of it was also that Eastwood is a “tough, savvy guy,” says Dean Klisura, who heads Marsh & McLennan’s U.S. risk practices. Klisura has seen Eastwood in action since the 1990s, when he faced down the chief executive of a fraud-ridden company who thought he was paying too much to insure its directors and officers against lawsuits. Eastwood set him straight.

Mother Teresa Meets Machiavelli

Setting Lexington straight would require dueling sides of Eastwood’s personality. He had to be both Mother Teresa and Machiavelli.

The morning after Eastwood took the job, Kim Briones got a 6:30 a.m. phone call. Known as the mother hen of Lexington, Kim was the person in human resources whom everyone trusted, but she was working for another insurer. Now Eastwood wanted her back, part of his effort to stabilize the staff.

He started in typical Eastwood fashion: “Hey, buddy. How ya’ doin’?” Then he explained the challenge. By early January, Briones was back at Lexington, and she was instrumental in bringing other people on board. “Peter’s a huge reason why I’m here,” she says. “He makes you work harder and smarter. You expand to meet his expectations.”

Eastwood’s next step was to hold a webcast on Dec. 19 to explain what had happened and what would happen.

“In the middle of a crisis, a few things need to be done,” Eastwood says. “First you have to remove doubt and create certainty. Make sure people know who we are, what they can expect from us and what we expect from them.”

With a change of this magnitude, you start at the top and secure the management team.

He started with: “This is a moment that can be defined by the one who left or the 1,400 who stayed. Ten percent of life is what happens to you. Ninety percent is what you do about it.”

But Eastwood knew his words alone weren’t enough. He invited other top Lexington executives to speak; in fact, he insisted on it. While it was smart to “give people a seat at the table,” as he’s fond of saying, it was also a way to put his top managers on record supporting the company and confirming that they, too, would stay. “With a change of this magnitude, you start at the top and secure the management team,” he says. “Then you ask them to secure their employees.”

Holiday Cards

Other changes were in store. Eastwood would never criticize Kelley or Greenberg, who divided his company into “silos” that competed against each other and reported directly to him. But Eastwood’s management styles provides a clear contrast. Last Christmas, he sent hundreds of holiday cards with personal notes to staffers, telling them how important they were to the organization.

Eastwood kept Lexington’s five divisions but overlaid them with new “industry focus groups” to get them talking to each other. Karen O’Reilly, Lexington’s chief innovation officer, is part of that effort. “We try to see which groups are under pressure, what developing trends suggest and then create products that respond,” O’Reilly says.

One result: O’Reilly stopped swinging for the fences. Lexington, which once grossed more than $1 billion in premiums from new products, curtailed its dreams for the first year or so after Eastwood took over. It stepped away from a proposed “pandemic” product to focus on ideas its agents could sell, such as insuring medivac helicopter pads. “These new products differentiate us from competing insurers and give the brokers something to talk about with clients,” O’Reilly says. “A good example of that is our new Spoliation Insurance that provides liability coverage for the accidental destruction of court evidence that could change the verdict.”

Don’t Be Defined by the Media         

Honesty, even about the bad stuff, is another Eastwood hallmark, extending back to when he was still heading healthcare. One former reporter remembers how he led an effort to get doctors to admit their mistakes and apologize to patients. Eastwood thought this made good business sense, given that malpractice suits occurred less frequently and were less costly when doctors showed remorse.

It still makes good business sense. AIG’s flaws were out there for everyone to see. But what Eastwood and Lexington’s staff could do is show where Lexington was impacted by AIG—and where it wasn’t.

It was a process that started at the top. “Peter says, ‘Speak to your staff. Don’t let the newspaper speak for you,’” Godhwani says. “You should be comfortable enough to challenge those above you to make sure you understand and then relay it to your clients.”

The AIG bailout was the biggest obstacle. Eastwood and Lexington needed to explain that their unit had nothing to do with the credit default swaps that led to the breakup of the AIG holding company, that Lexington is regulated by the state of Delaware and other states where it operates, and, most important, that its ability to pay claims is secure.

Even though Lexington lost its A-plus rating from A. M. Best in September 2008, it has hung onto its single A rating. Executives also bristle at assertions that taxpayer subsidies from the bailout allow them to compete at lower rates.

“Conversations with clients that used to be one hour have expanded to two hours, and now we have multiple conference calls,” says Chris Horton, who runs Lexington’s London office. “The upside is that it gives us more time with our customers.”

No one knows this better than Eastwood. During the first 10 months of his tenure, he made 56 business trips, logging almost as much time in the air as on the ground to explain Lexington to clients worldwide.

“It’s been a humbling process,” he admits.

Stand Up Straight

But too much humility isn’t good either. “Every time we kept a client, we told our staff,” Godhwani says. “You’ve got to keep showing that you are confident.”

Lexington has a lot to be confident about. It remains the biggest surplus lines carrier, with a record of not retreating even from turbulent markets where it has taken losses. Lexington’s legacy is that it was there when others weren’t. After Hurricane Katrina, its willingness to cover New Orleans helped the ravaged city rebuild.

As a result, most of its clients and business partners have stayed. “We had a longstanding relationship with Lexington going back 25 years, and we have no difficulties in continuing it,” says Hans-Dieter Rohlf, Hannover Re’s chief underwriting officer for the North American property casualty division. “We expect it to outlast the financial challenges…as well as the soft market.”

Eastwood claims that Lexington “turned the corner” in 2009. He says he devoted much of his second year to finding new business rather than retaining staff.

AIG’s future also looks brighter as it sells off its side businesses and gets out from under the government’s thumb. It was the fourth-best performer in the S&P 500 in 2010, leading the insurance industry to its best year in the market since 2003. It’s fair to say, however, that, while Lexington may have benefited from AIG’s rebound, it has also been a major contributor. Property and casualty will be AIG’s largest business in the future, and Eastwood is confident that Lexington will remain part of a revitalized AIG.

And with good reason. Lexington represents nearly a third of AIG’s U.S. property-casualty business, and it has a huge book of renewals to protect it against the gremlins that often come from writing new business in bad markets, when insurers often take on bad risks.

Ultimately, as AIG sells off many of its life insurance and foreign units, Lexington is likely to become a bigger and more important piece of a smaller pie.

Extra Innings

Unfortunately, the good news isn’t necessarily reflected in improved earnings. In fact, Eastwood doesn’t see a lot of positives for the whole economy. This recession, he notes, has lasted longer than any downturn since the Great Depression. “This was the fourth year of negative growth for the surplus insurance industry,” he says.

But when the market does turn, his corner of the world is likely to heat up a lot faster than other parts of the industry. The surplus market has more freedom in how it writes policies and what it charges than the admitted market. That tends to make it a “force multiplier” when things improve.

What could help things improve are two governmental initiatives. One is the “Nonadmitted and Reinsurance Reform Act of 2010,” part of the Dodd-Frank financial legislation passed last year. It will give more companies easy access to the surplus lines market. The other is Solvency II, which will force insurers operating within the European Union to raise their capital requirements by 2013. This could reduce their appetite for risk and create more opportunities for surplus insurers like Lexington.

So Eastwood’s battle is far from over. “We’re early in a game that’s likely to go into extra innings,” he says.

And with all the challenges, pressures, meetings and hectic travel schedule, what keeps him up at night?

“That’s easy,” he says. “I have three children under the age of five.”

Nuclear Business Fallout

While there is always a small threat of a radioactive leak or meltdown from a nuclear reactor—Japan’s is the third major plant failure since Three Mile Island in Pennsylvania in 1979—the fallout for property-casualty insurance is small.

While there is always a small threat of a radioactive leak or meltdown from a nuclear reactor—Japan’s is the third major plant failure since Three Mile Island in Pennsylvania in 1979—the fallout for property-casualty insurance is small.

Because of the sheer expense and risk of building nuclear power plants, nuclear power plants built in the United States come with a federal government backstop. The private market covers the first $375 million of a plant’s exposure. After that, a pool set up by the 104 plant licensees in the U.S. handles the next $12.6 billion. Beyond that, or if there is a failure on their part, the government takes over. Japan covers its nuclear risk in similar fashion.

But government involvement doesn’t mean claims are handled quickly. According to the Nuclear Regulatory Commission, litigation arising from the Three Mile Island accident was finally resolved in 2003—24 years after the plant’s partial meltdown.

Some critics of nuclear energy have argued that because American reactors are so old—the average age of U.S. reactors equals the age of older Japanese reactors—they potentially are more dangerous. But much of the U.S. uses a different technology than the Japanese. So while the direct cost of a nuclear accident is no major threat to insurers, ensuing losses can be.

“There are two phases to these cat losses,” says David Pagoumian, CEO of Napco, a property wholesaler brokerage. “There’s the initial capital loss,” Pagoumian says, referring to the earthquake and flood devastation, and then there is business interruption.

Since Japan is a huge global trade player, “some trading relationships may take business elsewhere, maybe China,” Pagoumian says. That will have a direct affect on coverage for business interruption and global supply chains here in the U.S. and elsewhere.

Although nations such as Japan have newer plants, the U.S. remains the world’s largest supplier of commercial nuclear power. As a result, the scope of potential business interruption following a U.S. nuclear accident similar to the Fukushima Daiichi reactors could be sizable if an accident were to occur on U.S. soil.

It Could Happen Here

In the 1960s and ’70s, nuclear power was seen as the answer to America’s energy needs. Reactor after reactor was built, until more than 20% of U.S. electricity was provided by atomic power.

Atomic power lost its cachet after the Three Mile Island plant threatened the Eastern Seaboard with a “China Syndrome” meltdown in 1979. The far worse disaster at Russia’s Chernobyl reactor, in 1986, created an even more distrustful climate for nuclear energy, at least in the U.S. The country’s only nuclear reactor under construction, the Watts Bar plant in Tennessee, was begun in 1973.

That scenario was just starting to change when the tsunami hit Japan’s Fukushima Daiichi reactors, knocking out not only the reactors themselves, but also the backup cooling systems which shut them down safely. The horrific scenes seem to have squelched a renaissance in atomic energy that had been backed not only by Republicans, but also by environmentally minded President Obama. Since 2007, there have been 16 license applications to build 24 new reactors, according to the World Nuclear Association, and even during the recent crisis, Obama still endorsed nuclear power as a “clean energy source” that would “secure America’s energy future.”

Southern California Edison’s San Onofre plant is near the Pacific Ocean in San Diego County—vulnerable to a tsunami. Pacific Gas & Electric’s Diablo Canyon plant hovers near a fault line. The plant was built to withstand a 7.5 earthquake. The Japanese earthquake registered 9.0, and the San Francisco earthquake of 1906 was about 8.0.

Illinois, which has 11 nuclear reactors even though it sits on the New Madrid fault, experienced an 1811 earthquake so severe that the Mississippi River ran backward. Virginia’s North Anna nuclear power plants, about 70 miles southwest of Washington, D.C., also sit on a fault line.

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