The case of Poe Financial Group: Great power and great responsibility
Imagine you are the founder of a family business that grows to become the third-largest private insurer in the state of Florida. Your company has more than 300,000 policies that generate more than $500 million of gross written premiums annually and is on a path to grow further with increasing exposure to hurricane and other forms of catastrophic risk. You are ambitious and even see taking the company public someday. Because you own 32% and you gave each of your five grown children 12% of the company, you have the power to promote either a serious or a shallow corporate governance culture. Since you know your children would never vote against you, you have the power to choose your board of directors, influence board processes, choose the CEO and dictate the strategic direction of the company, including decisions around growth and risk. How wisely would you use these powers? How seriously would you take corporate governance?
Such was the situation in 2004 for the Poe Financial Group (PFG), parent company to three insurance companies serving the Florida market. Four 2004 Florida hurricanes later, after huge losses, PFG decided to "double down" and take on more growth and risk in 2005. Following four more Florida hurricanes (in 2005), the Poe insurers were ordered into liquidation. What was the price tag? According to the Department of Financial Services, "the insolvency of the Poe insurance companies represents the largest insurance insolvency in Florida's history." The insolvency necessitated the payment by the Florida Insurance Guarantee Association of $1.2 billion in claims, requiring the state to approve a special 2% tax surcharge to help cover the bill. Other stakeholders were also losers, including employees who lost jobs, vendors who lost contracts and investors who lost wealth. In December 2015, all litigation matters in this case were finally settled, representing years of legal costs.
The purpose of this article is not to point fingers at any particular decision maker, but rather to constructively learn from some of the major governance decisions that were made. The Poe case is an example of the high costs of not adopting a serious corporate governance culture. Could these costs have been avoided? Would the Poe companies be thriving today if corporate governance had been taken seriously? We believe the answer is yes, and we highlight three important governance decisions that were subject to the power of the founder.
Who should serve on the board?
A major governance decision involves board composition. If you were the founder, what portfolio of talents would you want on the board? Would you consider the strategic direction of the firm? Would you want the talent necessary to staff and lead the audit, compensation, nominating and governance, and other committees? Would every board member need to understand his or her duties as a director? Would you want your directors to be independent-minded and willing to speak their minds and influence decisions? If the answer to these questions is "yes," you would be using your power to promote a serious corporate governance culture.
In the case of PFG, nine board members were elected in April 2004. There was no nominating and governance committee; the founder, who had a very weak understanding of corporate governance, made the nominations. Hence there was no process in which an "ideal" board portfolio of talents and experience was identified. Instead the founder invited his five children and his brother onto the board in addition to the non-family CEO and one independent director. None of the directors had catastrophic insurance experience, although this represented a significant strategic direction for the company. Most board members did not understand their board duties—including the founder, who named himself chairman of the board. There were also no processes in place to educate board members on their duties or governance documents, such as committee charters with written duties and responsibilities. The founder was relatively financially illiterate, as were many board members. According to deposition evidence, none of the Poe children would have voted against their father, and he had a record of not taking advice from the sole independent director. In short, the de facto result was a dysfunctional board with limited qualifications, greatly lacking in governance education and processes, whose decisions were dominated by an unqualified chair.
Who should be the CEO?
Many board experts agree that perhaps the most important decision a board makes is the hiring of the CEO. Would a well-qualified board consider the strategic direction of the company when making the CEO decision? Would it be prudent to seek a candidate with successful experience as a CEO, including experience with insurance and catastrophic risk? Would such a CEO need strong governance skills and the personality to be an independent-minded leader? If there were no viable internal candidate for this position, might the board form a search committee for an external candidate? We believe a company with a serious governance culture would adopt a rigorous decision-making process. At PFG there was no evidence of board deliberation on this decision. Deposition testimony reflects that the founder in 2004 simply asked a CPA he had worked with for years to assume the CEO position. The new chief executive had no successful track record in the CEO position, no catastrophic risk experience and limited appreciation of corporate governance—and, arguably, he lacked the character to disagree with the founder on major issues.
Who should serve on the audit committee?
Florida state statutes require every controlled insurer to have an audit committee consisting of independent directors. Presumably the state believes the insurer's loss reserves number to be so important that, by statute, the audit committee is required to meet with management, the independent auditors and the independent casualty actuary to ensure the adequacy of the insurer's loss reserves. This makes sense, since strategic decisions on growth and risk are affected by the amount of capital an insurance company has to cover its expected losses. How would a company that took its corporate governance seriously staff such an audit committee? Would all the committee members be independent and financially literate? Would there be a designated financial expert? Would membership include experience with catastrophic risk and both GAAP and statutory (insurance) accounting? Would the audit committee chair have significant experience with audit committee processes and promote a culture reflecting a serious and professional committee tone? Would he or she devote time between meetings to engage in effective interaction with the CFO and other parties to ensure the "right" agenda, with the "right" materials and the "right" expertise at meetings?
At PFG there was an audit committee on paper, but in effect there was no functioning audit committee. There was no audit committee charter. There was limited evidence that the committee ever met, and, if they did, it was just once during the year. The CFO, typically the primary management contact with the audit committee, revealed his lack of understanding of audit committee processes when he testified that they "maybe" met once per year and justified that by saying they had few audit committee decisions to make. There was no designated audit committee chair. The members were not independent and included the founder (relatively financially illiterate), the CEO and two of the Poe children. Their inactions suggest that none of them understood the duties and responsibilities of the audit committee.
Benefits of a strong governance culture
We believe that the "right" board would have engaged in the "right" processes to hire the "right" CEO. With a culture of strong governance at both the board and management level, the board would have made better decisions with higher-quality information. When the founder, who controlled the board, made the decision to continue aggressive premium growth after the 2004 storms, he did so against the advice of the one independent director and with flawed information. For example, the year-end 2004 loss reserves were significantly underestimated, making the insurance companies appear healthier than they actually were. When this came to light in May 2005, this would have been an important red flag for PFG's governance processes. The "double down" decision would have likely appeared to be even more imprudent to a well-qualified board, who may have well insisted on a shift in growth strategy prior to the first 2005 storm in July. A serious governance culture would have enabled the board to protect the value of the corporation.
What makes this case different from household-name cases such as Enron is that the power to either take corporate governance seriously or consider it to be a shallow chore lay in the hands of one person, the founder. This is not unusual for a family business. We believe the PFG case highlights the prudence of promoting a serious corporate governance culture and the potential astronomical costs when this responsibility is shirked. As the famous line from the Spider-Man movie states: "With great power comes great responsibility."
Carla Barrow, Esq., served as counsel for the Department of Financial Services in the civil case against PFG. James G. Tompkins, Ph.D., is the director of the Corporate Governance Center at Kennesaw State University and served as the corporate governance expert witness in the matter (firstname.lastname@example.org).
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