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Downsizing: a CFO's strategy.

It's painful, true, but downsizing has become a necessity among many large companies. Is there a right way and a wrong way to downsize? Read how Aetna Life & Casualty's CFO helped lead the firm's reorganization.

NEARLY EVERY FINANCIAL EXECUTIVE IS faced with downsizing initiatives in today's turbulent corporate world, but few take a proactive stance to help their line executives identify where the cutbacks should be made and how they should be handled in line with future business needs.

Aetna Life & Casualty's CFO, Patrick W. Kenny, is one of the exceptions. He has presided over both a major reorganization to a business unit structure and a cost-reduction campaign to trim 7,400 jobs from Aetna's bottom line. The net result will be about $300 million annual pre-tax savings once the programs are fully implemented. The initiatives have cost Aetna $156 million after tax over the past two years.

Kenny, who has been CFO for nearly five years, led the committee that pulled together cost-efficiency initiatives in 15 business units to develop a coherent downsizing plan for the company. The key to his success involves delegating a significant amount of financial responsibility to business unit-level "CFOs."

Here's Kenny's story.


What's the level of downsizing at Aetna?

KENNY: We've actually had two different initiatives. The first was a top-down reorganization, announced in October of 1990, involving 2,600 employees. During that process, we eliminated our divisional structure and replaced it with a strategic business unit (SBU) structure. It resulted in a charge to third-quarter 1990 earnings of $60 million after tax, with projected annual savings of $100 million pre-tax.

The second initiative took a bottom-up approach. Each of our 15 new SBUs has the mission to be as cost-efficient and streamlined as possible. So the SBUs began a series of initiatives in 1991 to examine their operations and make reductions where appropriate. These initiatives culminated this year with the announcement in June that Aetna would eliminate 4,800 jobs by the end of 1993. The four primary areas affected are property-casualty claim operations, property-casualty field operations, information technology and our health plans.

FINANCIAL EXECUTIVE: What were the financial impacts of the second reorganization?

KENNY: In the second quarter of 1992, we took a charge to earnings of $96 million after tax ($145 million pre-tax), and when the savings are totally realized--that is, all people are off the payroll by the end of 1993--we expect to see annualized pre-tax savings of about $200 million.

FINANCIAL EXECUTIVE: What motivated the SBU heads to trim their staffs ?

KENNY: We have an operating philosophy that says that we want to be the best of the breed in the businesses we're in. We define that as either being one of the top three companies in that market or having some other purpose for being in the market, such as being an adjunct to one of our other businesses. To achieve this, each business unit head has to decide what he or she has to do to become best of the breed.

The secret of this is not to do the same things with fewer people. Doing the same thing with fewer people is probably not going to optimize customer service. The secret is to reengineer the processes, conducting business differently and with fewer people.

FINANCIAL EXECUTIVE: How are you able to do business with fewer staff members?

KENNY: Here's an example: In the past our claims operations were divided between our personal lines and our commercial lines, and we did the work in 65 claims offices around the country. Now we'll do it with 22 service centers handling both personal and commercial property-casualty claims with a new, fully automated claims system that puts the customer in contact with the claims adjuster much faster than in the past.

People call an 800 number and personal computers, connected via local area networks, receive the calls. Before that, the business was diffused between two lines, 65 locations and two different claims systems. The reengineering of the claims operations lets us process relatively the same number of claims, but with fewer people.


What's the ultimate goal of these downsizing efforts?

KENNY: To become more profitable and to better serve our customers. We want to streamline the work process by consolidating certain functions and manage costs more aggressively. Besides consolidating claims operations, we've been downsizing the company in unprofitable lines of business, too, such as workers' compensation.

FINANCIAL EXECUTIVE: What has your role been?

KENNY: My role was to challenge the SBUs. We went back to some of the SBU heads and asked, "Can you really do business with this many fewer people, and, if so, why? Are you going to be able to achieve the same levels of service?"

In some cases, we went to not only the SBU head, but also to his or her boss, the group executive, and asked, "Are you satisfied that the SBU can achieve its plan over the course of the next couple of years given the planned downsizing?"

The most important question of all was: "What other resources of the company are you going to need to achieve the goals you've set for yourself? Technology? Additional human resources of a different kind? Training? More or less capital? Are you going to be freeing up capital or eating capital?"

FINANCIAL EXECUTIVE: Why were you chosen to head that group?

KENNY: It was a diverse group, and it involved a lot of financial and communication issues. For example, we had to determine at what point in time we had a disclosable event. When did we have an accounting event? Since the reorganization cut across a number of the areas that report to me, it ultimately fell into my bailiwick.

FINANCIAL EXECUTIVE: Was there any catalytic event that caused the reorganizations?

KENNY: Before the first reorganization, the company had been organized in a divisional structure. The infrastructure had grown up. Divisions had taken on lives of their own. The only way to get rid of the infrastructure and move the business closer to the customer was to blow up the divisional structure.

Before the 1992 cost-reduction initiative, the SBUs had been in existence for about a year. They were looking at their business plans for the rest of 1992 and 1993 and decided they needed to take some actions. We also had the corporatewide initiatives I mentioned earlier, like going from 65 claims offices to 22 service centers and going from separate commercial and personal property-casualty field operations to combined field operations.

FINANCIAL EXECUTIVE: How do you decide how to go about making these changes?

KENNY: In a company that has a best-of-breed approach to the allocation of capital, you're always going to have these sort of analyses. It just so happens that in the second quarter of 1992 we pulled a number of these initiatives together and administered them and policed them on a corporatewide basis.

But as businesses change and as capital gets allocated differently, then SBUs will have to adjust or go out of business. We have a saying around here that if you don't perform up to the financial standards that we expect, we'll wish you well and send you on your way, but we won't give you any of our capital.

FINANCIAL EXECUTIVE: Where did this best-of-breed philosophy come from?

KENNY: It's a relatively new concept for us. It's probably three or so years old. We've always done competitive analyses. Everyone does that. And everybody does benchmarking. The question is, what do you do with the results? If you do a competitive analysis and you determine you're number 10 in the marketplace, but you're in the richest market in the world with the highest rates of return, that might be the best use of your capital. But if you're in a business where you're number 2 in the marketplace but have only a 5-percent return on capital, maybe you should take the money away from that business.

We do have one business that has made consistent rates of return in excess of 20 percent but isn't in the top three of its marketplace. We figure that's still capital well invested.

FINANCIAL EXECUTIVE: What are the chief financial considerations of downsizing?

KENNY: The most important is, what sort of cost savings is this going to generate in the future? And what is this going to do to your business? How is this going to position you? If downsizing means you're going to eliminate your marketing force in an area, that may not be the wisest thing. It may have very good short-term financial results, but in the longer term you put yourself out of business.

FINANCIAL EXECUTIVE: How do you weigh the hit you're going to take for reducing staff?

KENNY: If you're going to take a hit to earnings, not produce any long-term benefits and let the cost grow back to the previous level, then you're not really accomplishing anything. You've shifted costs that you were going to incur in the next two years into a severance charge today. Your next two or three quarters might look good, but then the savings go away. There have to be long-term savings.

FINANCIAL EXECUTIVE: Do you have downsizing experts on staff?

KENNY: No. One of the considerations we had was that Aetna had never done anything like this before October of 1990. We'd never dealt with eliminating that many positions at one time. We established a template in the first reorganization that spelled out how we'd approach this type of situation in terms of our human resources policy and ethical and legal considerations.

The first wave was carried out by a personnel committee, which looked at the plans submitted by the group executives to make sure the right people were picked for the right jobs. But it was a top-down exercise. We took the same template and applied it on a business unit-by-business unit basis the second time.

FINANCIAL EXECUTIVE: Was early retirement part of your program?

KENNY: No. People whose jobs were eliminated or who lost their jobs were given a severance package. We decided against an early retirement program because, based on our inquiries of other companies, much of the time the wrong people accept early retirement.

FINANCIAL EXECUTIVE: How did you deal with morale problems?

KENNY: In the second exercise, some business units weren't affected at all, so their morale wasn't a major factor. In the other areas, we tried to communicate as quickly as possible so the affected people knew early on where they stood and what stage the company was at in the decision-making process. For example, a business unit would announce it would eliminate 200 jobs, but those 200 jobs wouldn't be eliminated until the end of the year or the beginning of the next year and the business unit wouldn't determine who would be affected until that time.

What you typically find is that, when there's uncertainty overhanging an area and rumors are rife, productivity declines. When communications are straightforward, to the point and definitive, you get higher productivity. You're never going to stop the "watercooler effect"--people standing around the watercooler discussing what's happening and wondering if their jobs are going to be eliminated. But if you can minimize it through direct, honest, open communication, you're much better off.

Our goal was this: Within 48 hours of the announcement of the second reorganization, we would have talked to every single employee, whether affected or not. With the exception of some third-shift technology people, who we didn't want to call in during the day, we achieved that goal.

FINANCIAL EXECUTIVE: Traditionally, in reorganizations that involve getting closer to the customer, corporate staff is the first to go. Was that true in this case?

KENNY: Corporate staff is always a concern. If it doesn't become a concern, then someone's taking his eye off the ball. In this case, the technology unit is clearly corporate staff and about 15 percent of the positions we eliminated came from that unit. But most of the reduction came from the business units.

We have ongoing reengineering of staff units, and as a result of the first reorganization, we reduced our staff. We also have certain units, such as our internal audit department, that are just not subject to cost-cutting reorganization. That doesn't mean we don't subject them to expense control measures and so forth. It just means we're not going to cut off our nose to spite our face and eliminate a critical function. The reality is that when this company didn't have a strong internal audit department, we couldn't monitor controls as effectively.

FINANCIAL EXECUTIVE: How do you decide what's untouchable?

KENNY: Some of the "untouchables" are determined by the chairman and the board. Internal audit is an example. Other matters are decided by either a group executive or a business unit head. For example, downsizing the tax planning unit, in my mind, wouldn't be very cost effective in today's environment, given the myriad of tax codes. While it is a cost center, it ultimately is a savings center as well. When you're going across business units, you'll have three or four executives getting together with the group executive to make decisions.

FINANCIAL EXECUTIVE: If you're always examining the corporate staff, is there an idea that corporate can be smaller?

KENNY: As you go to the SBU concept and apply financial standards to the performance of the business units, a couple of things happen. The business managers are going to have a thirst for greater financial information and financial analysis. In the past, they've turned to corporate. What we've done is give each business unit a financial/accounting/planning person whose responsibility is to help develop, analyze and monitor the business plans of the various SBUs. Essentially, that person is the chief financial or chief planning officer for that business unit. He or she reports to the business unit head with a dotted-line report to the corporate controller.

To put all of this into perspective, 90 percent of our costs are generated by the SBUs, only 10 percent by the corporate areas.

FINANCIAL EXECUTIVE: How do you solve any problems caused by fewer corporate staff?

KENNY: You prioritize. You ask yourself, what are the have-to-haves and what are the nice-to-haves? Then you decide how much you can afford. The affordability question then becomes a joint decision of both corporate and the SBU. If you design a new reporting system for financial information, the SBU might want to have a lot of bells and whistles in it and that will drive the cost.

We just put in a new general ledger system that was paid for at corporate but allocated back. All of the user requirements, all the bells and whistles, came from the business units. They'll have to factor these costs into their product pricing at some point.

FINANCIAL EXECUTIVE: What financial measures do you use?

KENNY: Return on equity is our major driver right now. But the critical part of return on equity is not the pure mathematical exercise. It has to be more timeframe justified. We might be in a business that's making a 10-percent return on equity today, but we have a plan that will project it into 15 to 20 percent over three years. You have to be prepared to define your timeframe when you define your expectation level. The reason for that is some of our businesses are in startup phases, some are more mature. The marketplace is changing. The mature ones have a much shorter timeframe.

We also use other measures that are more immediate indicators of business direction as opposed to long-term profitability or enhancement. For example, we're in the process of downsizing our automobile and workers' compensation businesses. Measures like policies-in-force for auto and covered payroll for workers' compensation are nearer-term indicators. You can use those as barometers of short-term achievements versus your longer-term goal.

FINANCIAL EXECUTIVE: In this delegation of financial authority, how do you keep a new SBU manager on target?

KENNY: We look at these indicators monthly and quarterly. We try to put them all together. If somebody's goal were to downsize his or her operation by 15 or 20 percent, we could look at the other indicators to make sure the unit is moving in that direction. If a manager had to downsize 10 or 15 percent to achieve a 15-percent return on equity, but he or she wasn't showing any downsizing, it would be very hard for the unit to see the improvement in return on equity.

FINANCIAL EXECUTIVE: Is there training for the business unit executives to become acclimated with the financial responsibility?

KENNY: Yes. Everybody comes to the job with a different level of financial acumen. Our responsibility as senior financial managers is to put into place programs that educate the business unit managers on how to use the pertinent data. For example, we've added to our management training some basic accounting and financial courses that enhance whatever knowledge the managers already have. More important, we have a series of four courses all of our SBU heads go through. They deal with things like: What does the analyst community think about their business? How does the analyst community behave? What's the view on "the Street"of the industry? Why doesn't the Street love us as much as we think they should or vice versa? That's one course.

Another course takes people through rating agencies: How do they work? What are their implications to our businesses? What does it mean if a company is downgraded? How does that affect our customers? And another course explains the regulatory environment, not just from a pricing and product standpoint, but what it means for overall solvency. How do the regulators look at the amount of capital we have ? We've put together this core of courses that we update as circumstances change.

As the senior financial person in the company, I view it as my responsibility to educate senior managers on financial matters that have a major impact on how they do business and on what the world thinks of how they do business. Some people come up the ladder on the pure business side and make all the money for the corporation. They suddenly get to the middle or senior level of management and don't understand the implications of financial considerations. It's not bad. It's just a fact of life.

Once I took two group executives to the NYSE to meet our specialist, go down to the floor of the Exchange and see how our stock is traded, and generally see why all this activity you see on CNN at 4:00 every afternoon occurs.

FINANCIAL EXECUTIVE: Does this help you in your dealings with the financial community?

KENNY: Definitely, because the environment affects the way the financial community does business, and the way the financial community does business affects the environment. The closer you can bring the two together, the more mileage you'll get from that relationship.

FINANCIAL EXECUTIVE: Was this training in response to the company's restructuring?

KENNY: No. The intensified training program began in 1988. Basically, it was Ron Compton, the president of the company at that time, who made it a major initiative.

FINANCIAL EXECUTIVE: How long does downsizing take?

KENNY: It depends upon the area. For example, you have to have the automated claims systems before you can reduce the number of service centers. So reductions will occur in one area first and then another. Technology will drive some changes in the business units, but the business units can't make the changes until the right technology is in place.

FINANCIAL EXECUTIVE: How small do you want to be?

KENNY: Much of it depends on the marketplace. We've said for two years that we no longer consider ourselves a multiline insurance company, but a multiniche insurance company. To some extent, external factors will define how big we are. Today, because of regulatory concerns in the insurance industry and concerns of the rating agencies, our industry is much more capital obsessive than it was before. When I became CFO on January 1, 1988, our debt-to-equity ratio was 15.5 percent. Our premiums-to-surplus for the property-casualty business was 2.9 to 1, and our surplus-to-liabilities for life insurance was 4.8 percent. The company was AAA across the board.

Now, our debt-to-equity is 13.0 percent, our premiums-to-surplus are 2.5 to 1 and our surplus-to-liabilities are 7.8 percent, and yet the company is AA.

FINANCIAL EXECUTIVE: How do you succeed in this environment?

KENNY: Let me tell you, it feels like we started out in January of 1988 running a race that we thought was a hundred-yard dash. But when we got to the 90-yard strip, somebody said, "Forgot to tell you this is a 220-yard race." The rules changed. So we had to suck it in and try to run a 220. And the rules may change again, with state versus federal regulation or a federal health program of some kind.

If you look at it from the federal point of view, there's been the S&L crisis, and clearly the Congress and regulators don't want to look at another industry-type crisis like that. So they constantly ask themselves: Is the insurance industry a candidate for a crisis like that? From the state point of view, there've been more insolvencies of insurance companies in the past decade than ever before and larger companies becoming insolvent. They're trying to design more sophisticated ways of analyzing companies before they become troubled companies. All of this pushes them toward a standard they can apply across the board, which makes no concession for one risk profile versus another. Let's face it. The regulator's life, too, is a lot more complicated than it was 10 years ago.

FINANCIAL EXECUTIVE: In the face of that, is the answer simply to try to stay cost effective?

KENNY: No. That's only part of it. We have an expression that our chairman came up with a few years ago: "We want to be quick, flexible and right." If you can be those things, generally you can correct any mistakes you make. You can put yourself in a position of not allowing capital to be entrapped. You can redeploy capital as opportunities present themselves.
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Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:Management Strategy; Interview with Aetna Life & Casualty chief financial officer Patrick W. Kenny.
Publication:Financial Executive
Article Type:Interview
Date:Nov 1, 1992
Previous Article:Last-minute tax tips: are you ready for April 15?
Next Article:Europe after Maastricht.

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