As befits a risk professional, Europe's second largest financial services group, the French AXA Group, publishes an exemplary statement of the potential risks to its operations in its annual report. But stating the risks has not worked as a charm to prevent some of them from materialising.
Nor has this forthright acknowledgement of the risks disarmed the stock market. AXA is far from alone among financial services groups in suffering the effects of falling equity markets and claims from the terrorist attacks on September 11. However, between November 2001 and March 2002, AXA not only under-performed Standard & Poor's but also its rival Allianz.
Neither group has yet to regain its pre-September 11 price, but AXA showed a 12 month drop of 26% compared to 20% for Allianz. Allianz is generally seen as having a stronger balance sheet and less dependence on the performance of equity markets.
Under the voluntary corporate governance regime in France, AXA has no need to make any disclosure of risks. The system, based on a report of a working group of presidents of quoted French companies under Marc Viénot and published in July 1999, is actually silent on the subject of risk management.
Known as Viénot II, this report updated and expanded the first recommendations of the working group, which were published in July 1995. It concentrates on issues such as the separation of the role of the president and directeur general (chairman and chief executive), disclosure of directors' remuneration and the role of boards and committees.
For its part, the company states: 'Since the early 1990s, AXA's management has set up the structures and mandated the practices that pave the way for effective, transparent corporate governance.'
Among the risks AXA lists in its last published annual report, 2000, are these:
AXA Group began as a provincial, mutual insurer, and was transformed into a financial services giant through a series of acquisitions, from Equitable Life now Axa Financial in the US in 1987, France's UAP, Germany's Colonia Group, Belgium's Royal Belge, the Guardian Royal Exchange (GRE) in the UK and, most recently, Nippon Dantai in Japan. In 2001, it had total revenues of c74.8bn. About 70% of its business comes from life, health and savings products and 30% from general insurance and reinsurance.
The architect of this entity was Claude Bébéar. In May 2000, he stepped down, becoming chairman of the supervisory board. Henri de Castries, a graduate of France's elite grandes écoles, who joined AXA in 1989, took over as president of the management board at the age of 46. Following this smooth handover, Axa's share price continued to rise, peaking in mid-summer of 2001. When both Claude Bébéar and Henri de Castries were interviewed by the French fiscal authorities as witnesses in the investigation into alleged tax evasion by PanEuroLife, a briefly held group subsidiary, the market was unperturbed.
Share price falls
For a little while, AXA outperformed the market but, with heavy linking to equities, the price had already begun to descend quite sharply, as stock markets fell between August and September 11. From September 11 until September 21, the price plummeted. The low point came on September 21, the day that AXA increased its its initial loss estimate from the US terrorist attacks from $300-400m, pre-tax, to $550m, and the day when the AZF fertiliser factory at Toulouse blew up, killing 30 people.
Over about a month, the group had lost half its market capitalisation. The management acted. New people had already come into the group management during 2001, notably in the US company AXA Financial and the UK. Now, there were changes closer to home. Claude Tendil, who had been a member of the management board and CEO of AXA France Assurance, left the group 'to pursue other personal interests'. Six months later he was president and CEO of Generali France.
Another senior casualty was Jean-Marie Nessi, an actuary who had been head of AXA Corporate Solutions, the group's international insurance and reinsurance unit. The French newspaper, Le Monde, described the action thus: 'The new boss cut off the heads of the barons who were close to his predecessor.'
On 13 September, AXA announced an ambitious cost cutting exercise. In October, Henri de Castries indicated that in view of the decline of financial and capital markets, AXA aimed to reduce expenses by 10% or a minimum of c700m in 2002.
In early December, AXA issued a statement indicating that its 2001 earnings would be around c1bn lower than the market consensus. The reasons were the long term impairment of assets, lower fees on assets under management and deteriorating results in non-life insurance in the second half of the year.
Having already taken into account the comparative effect of the 2000 sale of US securities firm, Donaldson, Lufkin, Jenrette (DLJ), and the World Trade Center losses, the market did not like this news. The share price, which had recovered considerably, set off on another downward trend.
Analysts rarely recommend selling a stock, but Merrill Lynch in London reduced its intermediate term recommendation from 'strong buy' to 'neutral' in December. Commented Nicholas Byrne: "We had anticipated lower capital gains in the second half. However, we had not factored in the long-term impairment charge nor the substantially lower earnings for life and asset management. Nonetheless, we feel the company's comments on earnings potential in 2002 were of even greater concern."
On 14 March 2002, the 2001 results were announced. It was "a very difficult year, with the overall industry being shaken by the triple impact of a global economic slowdown, a fall in financial markets that affected companies' invested asset values and the September 11 terrorist attacks in the US," said Mr de Castries.
Net income was c0.5bn compared to c3.4bn in 2000, of which c1.4bn came from exceptional operations, including the sale of DLJ. Cash earnings, net income before exceptional operations and goodwill, were down by nearly half, from c2.292bn to c1.201bn. c704m of the deficit resulted from losses on assets and c561m was for World Trade Center claims.
Analyst Tim Dawson of Picter & Cie commented: "We believe that the events of last year highlighted the fragility of AXA group's business and earnings, a factor that investors ignored as the group's revenues and earnings rode high on the back of strong financial markets. In addition, investors' focus was on the group's generally successful M&A record and not on the rather lacklustre operational performance."
However, the bad news was no worse than expected, and the share price moved upward again. Merrill Lynch restored its recommendation to buy. "Our upgrade is not because we see strong growth in 2002. Underlying improvement should come from better underwriting and cost reduction", stated Nicholas Byrne
Andrew Goodwin at Commerzbank in London was more guarded. "The lack of negative surprises in AXA's results pleased the market. However, until there is clearer evidence that the group's efforts to improve returns are showing results, the shares are likely to continue to trade between c20-25."
Clearly, AXA's disclosure of operating risks cannot prevent short-term share price volatility, especially when the extent of the financial implications of the risks comes as a surprise to the market. Nevertheless, its frank statement provides the comfort to investors that the management is aware of the risks and, by implication, has procedures for managing them.
In the long term, shareholders will want to believe that the managementnot only acknowledges the risks, but manages them well. No management is able to say this objectively. Some countries require auditors to give an independent view on the quality of the risk management systems of the firm. But, in light of the revelations in the Enron affair, the stock market is likely to place more weight on evidence from financial performance than on formal statements.
Lee Coppack is market analyst, StrategicRISK, and an insurance and risk management freelance journalist