Charles Darwin and the Insurance Company Board

As a New Zealand taxpayer – and therefore collectively on the hook for a possible $0.5 – $1.0 billion support package (read ‘bailout’) – I was delighted to see that the Government has appointed an experienced insurance professional, John Pritchard, to the board of AMI Insurance.

It may come as a surprise – as it did to me when I read AMI’s latest annual report – to find that not one of the existing board members appears to have a background in either insurance or risk … unless you count the ownership of racehorses in the latter category. I know, and have considerable respect for, some of the directors: an outstanding retired banker, a leading former retailer, a successful market gardener, and so on. But nobody about whom I could find any experience in the industry in which AMI operates.

Going one step deeper, the Chief Executive’s own earlier career was mainly in banking, not insurance. When you look at the executive management team, you see Heads of Customer Division, Customer Experience, Marketing and Products, all of which helps us to understand how the company has been so successful in growing market share over the last decade, from a relatively small Christchurch-based insurer to one of the leaders nationwide.

However, nobody in the top team has a title that suggests deep involvement in risk management. You have to delve to what appears to be at least third tier to find someone described as Actuarial Team Leader.

I doubt whether anybody could have foreseen the destruction caused by the seismic bombs that hit Christchurch last September and more tragically on 22 February. But a part of risk management is about assessing events of low probability but high impact.

Much of AMI’s business was, not surprisingly, centred on Christchurch, where it had acquired a large share of the House and Contents insurance market, and a disproportionate concentration of its portfolio. And I have read that its reinsurance rates were among the industry’s lowest. Not being from the industry, I wouldn’t have a clue about appropriate reinsurance levels, but I do understand a little about concentration of risk.

What bothers me is that I’m not convinced that anybody else on the board would have had much more knowledge, so would not have been in a strong position to ask whether the reinsurance rates were too low for the high concentration of the company’s exposure.

My daytime business is ‘Building boards into leading teams’, and I’m the last person to suggest that everyone at the board table should come from the same industry background. To the contrary, I believe that having a range of backgrounds and perspectives is vital in achieving effective board oversight. However, having nobody at the board table with a background in the industry seems to defy common sense – because directors must be sure they are receiving the information they need in order to make good decisions. If you don’t have somebody with experience, you won’t know what you don’t know.

Without knowing the background, I can only make some assumptions about AMI’s board practices and (lack of) evolution. The Chairman has been on the board for about twenty years and several of the other directors have been there for a long time, while the CEO was appointed more than 15 years ago.

I’d imagine that some of those relationships had grown quite comfortable during the good times of rapid growth. One of the dangers when this happens is that a director who wants to ask hard questions, challenging the strategy and management’s assumptions, can feel increasingly uncomfortable and isolated if he (at AMI they’re all ‘he’) starts to ‘rock the boat.’ This is why it’s so important that a healthy board culture doesn’t just accept, but insists on dissenting views being aired.

I’d also guess that, as the business grew rapidly, the board’s priorities reflected its experience in growing businesses and satisfying customers, and didn’t focus adequately on changes to its risk exposures or concentration of its portfolio.

The lack of board turnover, combined with the directors' industry backgrounds, seems to have resulted in a failure to grasp the increasing significance of such agenda items, in line with AMI's changing position in a rapidly changing world. As Charles Darwin observed (see my earlier post on his anniversary a couple of years ago):

• It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.

A failure to recognize this at AMI’s board table over many years may well cost you and me up to a billion dollars. Let’s hope Mr Pritchard can make enough of a difference to prevent this from happening.

A small bouquet

A small bouquet today for the vigilance of New Zealand's much-maligned AvSec employees - those people who run the scanners, and tickle you under the armpits with their metal detectors when you're getting onto a flight: I've just returned from a 10 day overseas trip, with repeated baggage checks through Singapore and Abu Dhabi on the way back.

After 24 hours en route, I reached the scanner at CHC, for the final leg to WLG... "May I look in your bag please sir." In my carry-on was the old Swiss Army knife that I always travel with (you never know when you'll find a horse with a stone trapped in its hoof), but invariably - until now, it seems - I've made sure it was in my checked baggage. I know I used it in Dubai earlier in the week (I can't remember why... a camel with an embedded stone?) and I must have dropped it back into the wrong bag.

Even better, Mr AvSec let me keep my knife - it's within domestic flight tolerances, but not international (no - I didn't ask the logic of that).

And what does this have to do with a corporate governance blog? Not a lot, except to show yet again the triumph of substance over form: Homeland Security departments can develop all the questionnaires, body scanners and x-ray strip technology they like, but unless someone actually looks at the screen it seems a futile investment of effort, overtime and taxpayers' dollars.

Long live balanced risk assessment... and those of us who fly regularly.

Travel safely.

Running the company or asleep at the wheel? The director's duty of care

A couple of weeks ago, I discussed whether it was possible to run a company by consensus. The emphasis was on ‘consensus’. In the last few months, however, we’ve seen more people asking the question we’d like to be able to take as read: whether the directors were actually running the company at all.

The last six months have seen more spectacular company failures than most of us have ever seen before. And let’s be honest: a government bailout is actually a failure - just ask the traditional shareholders in British or American financial institutions or US car makers. Closer to home, we’ve seen a string of failures in New Zealand finance companies. Now the shareholders and investors with some of these companies are looking for their day in court, and perhaps for some vindication, even if they may not get their money back.

First, though, another moment of honesty: it’s not a crime for a company to go broke. It’s just a part of the free enterprise system that companies come and go. Sometimes a company fails because a major supplier or customer goes out of business; sometimes the bad news just becomes overwhelming. The law acknowledges this and directors won’t be legally on the hook.

But where the law does become interested is usually in one of two areas: were the directors asleep at the wheel, or did they continue trading when they should have known the cause was hopeless?

I’d like to think about the former, what we call the director’s ‘duty of care’ (the general legal requirement is to act ‘in good faith’ and ‘with reasonable care, diligence and skill’ in what the director believes to be the best interests of the company). Most directors I work with are very aware of this duty and I suspect that the general level has increased recently.

But there’s still the notable exception - for example most of us can name at least one director who regularly fails to read their board papers before arriving at the meeting (although it’s a while since I’ve seen a director blatantly rip open their courier pack as they sat down). In this case, how can they possibly understand the issues or know what’s going on?

Worse still, and one that gets my blood boiling, is the director who consistently fails to turn up for board meetings: I’m not talking about a director who misses one or two meetings a year - we can all get sick or have to travel overseas - and I’m happy to say that I’ve seen less of it in recent years.

But one notable exception jumps to mind. The pattern is familiar - a last minute phone call just before the meeting starts, to tell us about an unexpected visitor he has to see; or a family member who urgently needs to be taken to hospital. Given the pattern of the last few years, he must have a huge family, or they all have a genetic predisposition to sudden serious illnesses - and, thinking about it, he must be the only family member who can drive too. In a case like his, I’d describe it not so much as reasonable care that's lacking, but a total abrogation of his duty as a director.

While a company is doing well, the absent or ill-prepared director may not seem too much of a problem. But a company is entitled to the benefit of its directors’ collective wisdom. My guess is that, if it goes to court (which will occur only if things have gone horribly sour), the judge is likely to decide that that entitlement was retrospective: in other words the board meetings a director failed to attend in earlier years will count against him or her.

And I haven’t even discussed those directors who turn up for the board meeting, enjoy lunch (in fact are often good company), nod sagely at everything that’s said and never contribute an original thought or worthwhile question of their own...

Ah well, back to that latest courier pack for another evening’s reading. Did I hear someone say, ‘Get a life, Richard’?

Paying dividends - a director's duties

If you've taken any interest in financial markets over the last year (and if you either borrow money or have some to invest, it would be a good idea - especially now - to take an interest), you'll know that a number of finance companies in New Zealand have found themselves in difficulties.

You're also likely to have heard various commentators allocating blame. Some commentators have known what they're talking about, but others we might describe, charitably, as having less than a full understanding.

I thought it might help to explain some of the basic duties of directors in these situations (remembering that I'm a company director, not a lawyer, so I'm drawing any inference as an informed layman, rather than a legal expert), so you'll be in a better position to judge the facts:

1. Dividends

In general terms, dividends are income that shareholders receive as a return on their investment, usually paid from the company's tax-paid profit. Section 52 of the Companies Act says that the Board of directors may authorise the payment of a dividend if it is 'satisfied on reasonable grounds that the company will, immediately after the distribution, satisfy the solvency test' - together with a few other conditions.

So what's the 'solvency test'? For this we look at Section 6: '... A company satisfies the solvency test if -
(a) The company is able to pay its debts as they become due in the normal course of business [my italics]; and
(b) The value of the company's assets is greater than the value of its liabilities.'

My guess would be that finance company deposits which fall due on a particular date would be classed as 'in the normal course of business'. In determining the value of the company's assets, 'the directors must have regard to the most recent financial statements of the company ... and all other circumstances that the directors know or ought to know ...' [again, my italics].

Even allowing for the tidal wave of changes in financial market conditions, and the precipitous decline in reinvestment rates (the amount of deposits that are renewed when they fall due, rather than being repaid to the investor), which has led to the liquidity difficulties of some finance companies, these provisions in the Act should prompt some searching questions of a few people who are known to have been paid large dividends in the not too distant past.

2. Reckless trading

There's another Section (135) in the Act, entitled 'Reckless trading' which may also turn out to be relevant. Under this, a director 'must not agree to the business of the company being carried on in a manner likely to create a substantial risk of serious loss ...' to the people the company owes money to.

The Act provides various defences for people charged under these Sections, so you can expect any legal actions to be lengthy, strongly contested, affairs and, naturally, to be far more complicated than this simple explanation.

But I hope that, after reading this, you will be better able to form your own view of the actions and responsibilities of various parties likely to feature in the news in coming months.

Does absolute power corrupt absolutely?

Last week British retailer Marks & Spencer faced attacks from shareholders and members of the financial press, when Chief Executive Sir Stuart Rose was promoted to Executive Chairman.

23% of shareholders abstained or voted against Sir Stuart's re-appointment to the Board because they considered it went against good governance principles to have one person holding both positions, Chief Executive and Chairman.

This is an old debate and I think it's very easy to over-simplify it - right or wrong. The real answer, as always, is much more complex and depends on the substance rather than the form of the appointment.

If we start with what we're trying to achieve - a successful company - we can find case studies that both support and oppose the appointment.

In many large American companies (which Marks & Spencer is not, of course), the roles are combined. This has often been quoted as one of the weaknesses that led to the fall of companies like Enron and Worldcom. I think it's always a risk if one person holds too much power in an organisation, but the American system provides balance by having, usually, one or two other positions in addition to the Chairman and CEO: we usually find a President and Chief Operating Officer and, since Sarbanes-Oxley, the position of Lead Independent Director. So, in practice, this 'standard' American model builds in some real checks and balances on each individual.

What really matters is not so much the Board's structure, but how (and if) Board members fulfil their roles adequately. There's plenty of evidence to show that the difference between effective and ineffective Boards comes down to how Board members act, whether they deal with the tough issues and have the necessary debates, and that this matters far more than details about the Board's structure. If you've got the right behaviours in the boardroom, you can deal with deficiencies in the Board's structure or composition. But not vice versa.

As has been in the case in several of my previous 'posts', it comes down to the substance of the matter, not just the form.

Marks & Spencer will be an interesting case to watch. As an English company, it would not be typical to have the President/COO and the Lead Independent providing balance. However, my guess is that the Deputy Chairman and other Board members will be very conscious of their obligations to perform: perhaps we'll have material for another comment in a couple of years.

I learned about succession from that

They say we learn best from our mistakes ... some people would say that explains why I never stop learning.

I was reminded the other day of one of the biggest boardroom mistakes of my career. If it's any comfort - which it wasn't to me - it was in an area that many boards fail to deal with well, board succession; or in this case choosing a successor for the Board Chair.

I had been Chair of a medium-sized non-profit organisation for about six years and we had agreed it was time for a change, for both the Board and me. First, breaking all my own rules (see my recent post 'How do we fill his boots now he's gone?'), I agreed to lead the succession process. Without realising it at the time, that alone probably restricted our search criteria to people I thought would be good for the role.

After defining the attributes we were after, we developed a list of possible targets. Our preferred choice, from what we knew of the people, was a just-retired highly-successful Chief Executive who we knew had a passion for our sector. Although several of us had met him a few times, none of us could say we really knew him. (Does anybody hear warning bells yet?) I was given the job of phoning him to ask if he'd be interested.

To my mild surprise, he told me this was his first approach to join a Board since his retirement and yes, he was flattered and delighted to be asked. Abbreviating a long story, we felt that we'd 'got our man', so we didn't approach any of the other candidates (I think that's still quite normal, especially with non-profit Boards, because I think there is an understandable reluctance to approach people for voluntary roles, only to say 'sorry' to them later).

Well, he joined, was elected Chair and I left the board. I've never believed in hanging around once you stop being the Chair: it's the governance equivalent of 'Dead Man Walking', when you don't want to be there and you know nobody else wants you around either.

From almost his first meeting, the appointment was a disaster. He started behaving as the 'super-CEO', over-ruling the employed CEO, getting involved in management details and barely including the rest of the Board in most decisions. Get the picture? Much to the Board's credit, they realised very quickly the damage this was causing and he was a very short-term Chair of that Board.

So what did we (or I) learn from all that?

First, there are very good reasons for checking references. We've seen several public examples of what happens when nobody did. Only a few months after these events, someone I knew quite well asked me quietly, but obviously in frustration, why I hadn't checked with him (yes, I know, there's a small thing about Privacy Law as well). He told me - too late of course - that the person in question was a superb CEO, but terrible to work with as a director, because he could never remove his CEO 'hat'. However big the reputation, we need to check whether it is relevant to the role we're considering: it's a big change in approach from being a CEO to joining a Board as a non-executive member (even as Chair), where effective decision-making comes from building consensus, and where we don't manage the business hands-on.

This example showed me that checking those references is vital, even for a voluntary, non-profit position, because the consequence of not doing so can be disastrous.

Secondly, should I have been involved in the process at all, considering it was my successor we were looking for? In an ideal world, I don't think so. Perhaps I was so keen to move on that I allowed (possibly even encouraged) some short cuts in the process. In retrospect, if I hadn't been involved, the rest of the Board might have been more rigorous in interviewing and checking references, rather than letting me influence the appointment too much. In my defence, none of the other Board members showed a lot of enthusiasm for putting in the time that was needed to find someone and make the appointment.

On the scale of how wrong things can go, this was possibly not too bad. But the lessons were clear, and more importantly they taught me that we've developed some good basic principles of how Boards should do things.

These principles have evolved through other people's mistakes: disregard them and people will be learning from yours!

Good governance? Lessons that come close to home

I thought you might enjoy this from that renowned bastion of good governance, the Russian government. First Deputy Prime Minister Shuvalov was quoted in a recent edition of The Moscow Times.com, extolling the virtues of high corporate governance standards:

"If Russia is to become a major financial center, we need to embrace evolving corporate governance standards," Shuvalov said.

Deputy Prime Minister Zhukov backed this up:

"We want to be seen as a country with a good deal of responsibility in business..."

So I suppose that means it's all OK then. Remember though that this comes at a time when the State seems determined to take control of BP's Russian subsidiary through political, rather than market, channels (throwing in challenges such as heavy back taxes and visa problems for company employees). Perhaps this real-life tussle gives a truer picture of the current state of commercial affairs there.

As a result, I found another comment in the same article, on the role of government-appointed directors to state-owned company boards, rather more plausible:

"Very often, the time they devote to reading documents on the situation in the company amounts to the time they spend in a traffic jam on their way to a board meeting."

Yes, I know, it could never happen here. I hope not. But I'm still dismayed at the number of Board courier packs I see ripped open for the first time on the early-morning flight to the meeting - never mind that the papers are on view up the aisle for anyone to read. The director has at best 30-45 minutes to skim their papers; they can't hope to have a full grasp of the issues they'll be dealing with a few hours later.

If you're going to do this job properly, minimising the risk to yourself and the rest of your board, as well as the company, you need to know what's in those papers: not just the content, but you need enough time to think about the issues they raise.

If you don't, you just might end up in the position of the board of the New York Stock Exchange (other side of the Atlantic this time) a few years ago: thanks to their Board members not reading their papers in advance, they ended up having to pay their departing CEO about $US140 million (oh, and it was a not-for-profit).

Happy reading!

Why me? What do I need to know?

A friend of mine phoned a couple of weeks ago to tell me he'd been invited to join the Board of quite a large company. He was keen on the opportunity - and the company - and told me he was meeting the Chairman the next day. What were some of the questions he should ask to help him decide whether to accept?

Some of you will already have noticed one positive feature in this: it's natural that we should be delighted by an invitation like this. As an experienced company director once said to me: 'It's never a bad day when you're invited to join a Board.' After all, it's a compliment to one's (perceived) skills and experience. But, as he went on, 'I thank them for the invitation, I enjoy the moment and I'll start my due diligence tomorrow.'

In this case, I think my friend's best move was to resist the temptation to accept the offer immediately, or, as I see so often, to put up no more than a token display of modesty or questioning.

It's easy to fall into this trap in the glow of the moment, but you need to stop and consider what you'll be getting into. Companies legislation is usually quite 'binary' about responsibilities of directors - you either are or aren't a director - so you need to understand that, legally, you carry the full weight of directors' responsibilities from the day you sign on (there's no allowance for 'training wheels').

What, then, are some of the things you need to find out before you accept?

Let me add that this is not a comprehensive list - nor 'expert advice' - and that you need to apply your own 'care, diligence and skill' (the typical legal description of the duty of directors) in assessing what information you need - and how much is enough for you to make your decision. I'm also not talking here about the basic information you should obtain, such as what you can find from trawling the website or strategic/business plans, or your assessment of the organisation's financial position (please remember that cash is what pays the bills, so pay particular attention to where the cash is coming from and how reliable those sources are).

One thing you might do is to ask to read the Board's Minute book. A review over the last couple of years should give you a good sense of how the organisation works, its strategy (whether it has one and how well it's working), financial performance, major challenges, quality, clarity and consistency of decision-making, and many other things that will help your understanding of the organisation. And if the Chairman is reluctant to let you see the Minute book, ask yourself why - and whether this is an organisation and team you really want to be a part of.

As with everything here, what matters to you in all this is how the future looks, not just past performance.

1. Why me?

I think this is one of the most useful questions of all and the answer can tell you a lot. If it's along the lines of, 'Well, we've asked seventeen other people; they've all said no, and we can't think of anyone else ...' (it won't be quite this obvious, but make sure you read between the lines), you might want to look elsewhere. But if the answer is, 'We've got these issues ahead of us and we think that your background in [insert details here] will give us that perspective we need at the Board table,' then you may just have stumbled right onto the main things you'll be expecting to deal with, if you accept.

2. How well can I work with these people?

How many people join a Board without even meeting the people they'll be spending their time with? You don't need to be best friends with them, or even agree with them all the time (if fact if you do, then perhaps you're not the best person to bring a fresh perspective), but, to be effective, you must be able to work constructively with them. You must share a common vision for where the organisation is heading and be comfortable with how it does things (its values and culture). So, at the very least, meet the other Board members, the Chief Executive and top management team: you need to know them and they you.

3. What are the big trends, opportunities and threats facing this business, and what are the Board's big priorities for the next year or so?

You don't just want the answers: you need to know how well the current Board has thought about these things. If you're not happy with the answers, this may not deter you from joining, but at least you know what one of your early priorities will be.

4. How good are relationships with key stakeholders?

It may be pointless to join a Board which has fallen out with its major shareholder or key customers, because chances are that you'll be dealing with some pressing issues, not of your making, in the near future - unless, of course, it's the key shareholder who wants to appoint you to help address the problems.

5. Is the organisation aware of any significant legal action (actual or pending)?

Similar in a way to the previous point: this is not so much about any personal liability - since you may (note - may) be protected against actions that preceded your arrival (please make sure you understand what your actual position is). But, if the issues are significant, they will almost certainly be a serious distraction for the Board, and get in the way of progress in your core business.

6. What's the time commitment?

Don't underestimate this. My rule of thumb is 'three for one': in other works, if we have a four-hour board meeting each month, I'll mentally 'budget' twelve hours a month (say about a day and a half) for the role - four for the meeting itself, four for preparation (reading the papers and doing what else you need to keep up with the issues - wider reading, networking and so on), and the other four for all the other things that you get involved in, such as informal discussions with the Chairman, representing the Board at customer functions, visiting company facilities ...

To do this job properly requires you to put in time and effort. And if you don't, then not only will you be letting down the organisation and your fellow Board members, but you're potentially exposing yourself to greater risk because you won't have as good an understanding of what's going on as you should have.

7. Do I really want to do this?

This is a vitally important question - which you need to ask yourself rather than anyone else. I've found that you need more than director's fees (don't even think about 'status' - that's largely a myth!) to keep you motivated as a Board member: you need a 'burn' that you really want to play a part. Unlike an executive role, where you're in the business every day, as a Board member you may only be involved a few days a month.

I believe you need a sense of excitement and a desire to make a difference in order to keep you engaged. I've found from experience that, if that's missing (perhaps it's a sector that doesn't really excite you), then you may go through the motions, and you may even play a full part at Board meetings. But you probably won't do much more than the minimum and, quite soon, you'll start to regard that courier delivery of next month's Board papers as another chore, rather than opening a window on the next exciting episode.

As you may guess, I've written this from experience of mistakes I've both seen and made. I hope it helps with your 'due diligence'.

If, after all this, you go ahead and join that Board, as I hope my friend will, then good luck with the job ahead ... I trust you will enjoy making a difference as part of your organisation's top decision-making body.