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Back to basics: Fixing Allianz

Tough, disciplined, intensely focused, Allianz's CEO Michael Diekmann is putting his haus in order.

Michael Diekmann relishes the opportunity to challenge himself. As an undergraduate law student at Georg-August-Universität Göttingen in the early 1980s, he made two major canoe trips through the Canadian wilderness. His treks took him across the Algonquin Provincial Park in Ontario and along the routes of the Grass River in Manitoba and the Churchill River in Alberta. Then he launched his own adventure-travel publishing company to tell the tale. His book, Wildnis Privat -- Der Ratgeber für Kanutouren in Kanada (Private Wilderness -- the Guide to Canoe Tours in Canada), provides a practical guide to everything from finding the right canoe and outdoors gear to cooking al fresco in the wild.

This ability to take on a long and formidable task with hardheaded practicality should stand the 49-year-old Diekmann in good stead as he faces an even more daunting challenge: turning around the fortunes of Allianz, the once-proud German insurer that has been reeling from a series of disasters, some natural or unforeseeable and some of its own making. The September 11, 2001, terrorist attack on New York and Washington, D.C., was the costliest single event in the history of the industry, generating an industrywide bill estimated at $19 billion. In Europe severe winter storms in 1999 and the worst floods in a century in 2002 hit Allianz's core business, European property and casualty insurance. The company also faced heavy losses on asbestos-related claims in the U.S.

Those calamities took a heavy toll on the entire insurance industry, of course, but Allianz compounded its woes with its domestic strategy. Massive investments in German stocks cost the company dearly when the DAX index plunged by 44 percent in 2002, the worst decline of any major equity market. And the breakneck expansion efforts of Diekmann's predecessor, Henning Schulte-Noelle, exacted a heavy price. The company's ill-timed E24 billion ($21 billion) purchase of Dresdner Bank in 2001, designed to turn the group into a bancassurance powerhouse selling everything from mutual funds to insurance, saw Allianz pay top dollar to gain a huge loan exposure to corporate Germany just as the economy was starting to slide into recession.

The bill for this string of disasters has been enormous. Just six weeks before Diekmann took over as chief executive last April, Allianz posted a loss of E1.17 billion for 2002, the company's first since World War II.

Diekmann likens the market conditions that humbled Allianz to a natural catastrophe but characteristically declines to make excuses. "In the end our investors don't care if we are hit by a perfect storm," he tells Institutional Investor in his first international interview since taking the top job. "They want us to come through it. We are not completely through."

Diekmann hasn't wasted any time attacking Allianz's problems. Even before he formally took over as CEO in April (his appointment was announced four months earlier), he persuaded institutional shareholders to back a E4.4 billion rights issue, the second largest ever in Europe, to shore up the company's battered capital base. The proceeds of that issue, combined with a recovery in equity markets, boosted Allianz's capital position at the end of the third quarter to a surplus of E8.5 billion above regulatory minimum levels, from a deficit of E1.7 billion at the end of 2002.

Diekmann also helped recruit Herbert Walter, the highly regarded head of retail banking at Deutsche Bank, to take over the Dresdner unit last March. By shutting branches and eliminating more than 15,000 jobs, or close to 30 percent of the troubled bank's workforce, Walter slashed Dresdner's operating loss to E69 million in the first nine months of 2003, from E1.5 billion in 2002.

Such moves have stopped the spread of the rot at Allianz, cheering investors. The company's shares have surged some 170 percent from the March 2003 low of E38 to just over E103 late last month. So far, so good. But Diekmann's ambition goes well beyond simply repairing the damage he inherited. He wants Allianz to achieve a profitability and market rating commensurate with its vast global presence and to make the company a genuine rival to the world's biggest and, by many, most admired insurer, New York­based American International Group.

Given Allianz's status as the dominant insurer in its domestic market, the third-biggest insurer in France and the biggest international insurer in Asia, and its top-five ranking in no fewer than 20 countries around the world, Diekmann has some strong cards to play. "There is a huge difference in terms of the market capitalization of AIG and Allianz today," he says. "But I think if you look at our revenue base and you look at our potential, there is no reason why we shouldn't be in the same league."

To fulfill that ambition, Diekmann must change the very culture of Allianz. Under Schulte-Noelle, who remains Allianz's chairman, the company combined global aspirations and acquisitiveness with weak financial discipline. Revenues grew rapidly, but profitability lagged behind, and Allianz increasingly relied on investment returns rather than profitable pricing to make money in its core insurance business. The bear market cruelly exposed those flabby habits.

Now Diekmann wants Allianz to get back to basics, which is what he calls his program of change. First and foremost, that means restoring discipline among the group's legion of insurance underwriters. They complacently wrote new business almost regardless of cost during the go-go years of the '90s, when Allianz was awash in capital. But today, says Diekmann, "our capital position has changed, and we have to cut our cloth accordingly." He also promises to rein in Allianz's far-flung subsidiaries by cutting off capital to businesses that don't meet demanding new profitability targets.

Longer term, Diekmann must show that bancassurance, the cross-selling of banking and investment products that inspired the Dresdner acquisition, is a profitable business model and not just a grandiose vision. Despite a high degree of skepticism in the market, there are some positive signs: Allianz Dresdner Asset Management has increased its share of mutual fund inflows in Germany.

Allianz also needs to decide the future of Dresdner Kleinwort Wasserstein, the bank's investment banking arm. Diekmann has given DKW a provisional lease on life by pledging to support it for the next two years, but many bankers and investors believe that Allianz will eventually have to sell the unit or merge it with another second-tier player.

By focusing on the nuts and bolts of the business, Diekmann aims to enhance Allianz's capital base, streamline the group's complex structure and dramatically improve profitability. "I see no reason why we shouldn't sharply improve our profitability," says Allianz's co­chief financial officer, Paul Achleitner. Allianz would need to almost double its return on equity, to 15 percent, to match AIG's rate of return. That would help Allianz, which trades at a price-earnings ratio of only eight, close the valuation gap with its American rival, which has a multiple of 13.

Will Diekmann succeed? The bad habits of the bull years will be difficult to erase. It would be all too easy for the regional barons of Allianz to slip back into their complacent old ways now that its capital crisis has faded and equity markets have rebounded. Allianz also remains highly exposed to the sputtering German economy, which capped a decade of underperformance last year by recording its first annual output decline since 1993.

But Diekmann, although relatively unknown outside Allianz, has a record of success in turning around results at troubled subsidiaries in Australia and the U.S., where he ran Allianz's operations before becoming CEO. His easy charm and openness, a welcome change from the secretive, behind-the-scenes style of his predecessor, have gone down well with investors.

"He is much more easy to communicate with than Schulte-Noelle," says Helmut Hipper, portfolio manager at Union Investment in Frankfurt, one of Allianz's biggest stockholders, with a stake of 3.7 million shares worth $465 million. "It's too early to call him a success, but he seems determined."

ALLIANZ'S SITUATION IS HARDLY UNIQUE IN THE insurance industry. Most insurers relied increasingly on investment returns for profits during the bull market of the 1990s and were caught out badly when stocks tumbled. After the September 11 terrorist attacks, many industry powers -- including Munich Re Group, Zurich Financial Services, the U.K.'s Royal & Sun-Alliance Insurance Group and France's Scor Group -- tapped their shareholders for fresh capital. But Allianz was more complacent than most of its competitors. Its humbled circumstances today are a far cry from its globe-trotting swagger in the 1990s, when Schulte-Noelle used the group's dominance in Germany -- the world's third-largest economy -- to expand abroad.

In 1991, his first year in charge, Schulte-Noelle put Allianz on the map in the U.S. by buying Fireman's Fund Insurance Co. for $1.1 billion. Six years later he made his biggest insurance deal by acting as a white knight and paying $4.6 billion to seize Paris-based Assurance Générale de France from the hands of Italian rival Assicurazioni Generali. In 1999 he added Asian outposts to Allianz's empire by establishing businesses in China and Vietnam and buying First Life Insurance Co., South Korea's fourth-largest insurer.

The high point of the acquisition spree came in 2000 when Schulte-Noelle snapped up $291 billion-in-assets U.S. fixed-income manager Pacific Investment Management Co. for $3.3 billion and listed Allianz's shares -- then touching record highs of E380 -- on the New York Stock Exchange. The group's momentum appeared unstoppable.

Schulte-Noelle also recruited a bold new CFO, Paul Achleitner, a star Goldman, Sachs & Co. investment banker, in 1999. Achleitner promised to turn Allianz into a shareholder-friendly company by unwinding its plethora of stakes in Germany AG, a legacy of the Rhineland model of capitalism that used a network of cross-shareholdings to finance the country's postwar recovery. Achleitner's strategy aimed to strengthen Allianz's focus on its core insurance and asset management businesses while unleashing billions of surplus capital.

In February 2000, emboldened by the group's seemingly limitless ascendancy, Schulte-Noelle and Achleitner announced their biggest and boldest move yet. Allianz would give its 25 percent holding in Dresdner Bank to Deutsche Bank, enabling the two banks to form a corporate and investment banking powerhouse. In return, Allianz was to claim some glittering prizes from Deutsche, including the Deutsche Bank 24 retail bank network and mutual fund powerhouse DWS Investments. The proposed deal heralded a profound restructuring of German finance, with Allianz pulling the strings and gaining powerful new distribution channels for its insurance and asset management products.

The grand plan fell through, however. Dresdner Bank chairman Bernhard Walter balked when news of a plan by Deutsche's investment bankers to "torch" investment bank Dresdner Kleinwort Benson leaked to the press.

Stymied in his attempt to gain new distribution outlets, Schulte-Noelle eventually bought Dresdner for a whopping E24 billion in July 2001. It was a neat piece of financial engineering, with Allianz swapping its 14 percent stake in HVB Group for the 24 percent that Munich Re and related companies held in Dresdner and Munich Re's 40 percent holding in life insurer Allianz Leben.

But to skeptics, Dresdner and its fund management arm, Deutscher Investment Trust, looked like a poor second best to Deutsche 24 and DWS. The deal also saddled Allianz with the unwanted baggage of Dresdner's corporate and investment bank. Rather than pulling the strings as puppet meister in chief of German finance, Allianz looked like a spurned lover on the rebound.

Meanwhile, as Schulte-Noelle was preoccupied with his frenetic deal making at home, trouble was brewing in Allianz's core insurance business. Strong investment returns and tax breaks helped group profits rise by 22 percent in 2000, but the group's underwriting loss widened to E201 million from E123 million a year earlier. Even with the rise in earnings, the group's return on equity was a modest 7.5 percent, far below AIG's 15.3 percent and trailing France's Axa Group, Allianz's main European rival, at 9 percent.

The problem started at the top. Despite his macho dueling scar, Schulte-Noelle was no alpha-male CEO. He acted more like a feudal king surrounded by overmighty nobles as his global empire sprawled. The barons of the group's insurance fiefdoms in France, Italy and the U.S. excelled at special pleading, explaining how local conditions meant their operations could never be as profitable as those in the German heartland. While AGF's combined ratio, the measure of claims and expenses as a percentage of premiums earned, was allowed to soar to 110 percent, in Germany the figure was 94 percent.

"Under Schulte-Noelle the king didn't rule Allianz," says Michael Huttner, J.P. Morgan's London-based European insurance analyst.

ONLY THE NINTH CHAIRMAN IN ALLIANZ'S 114-year history, Diekmann is cut from a very different cloth from Schulte-Noel and his predecessors. He brings to the job hard-nosed experience at whipping poorly performing subsidiaries into shape. A senior investment banker in Frankfurt who knows Diekmann well says that the word that best sums him up is schonungslosigkeit. "It is an unbending, uncompromising bloody-mindedness, and it is very much regarded as a virtue," the banker says. Diekmann's discipline and determination offer the best prospect of actually achieving Schulte-Noelle's vision of Allianz as a global insurance and asset management powerhouse.

For the first five years after graduating from Göttingen, Diekmann ran his publishing house. In 1988, frustrated by an inability to compete with global rivals, he took a job at Allianz as executive assistant to the head of the Hamburg office. It was, he says, the first opportunity that caught his eye.

Diekmann enjoyed a fast-track career at Allianz, displaying acumen and an appetite for selling. Within two years he was head of sales in the Hamburg office, and by 1994 he was running sales for the whole of his home state of North Rhine­Westphalia. That appointment suggests he was marked as a potential successor at an early stage by Schulte-Noelle. The state is Germany's largest, with 13 million residents, and ranks as Europe's fifth-largest insurance market. Schulte-Noelle ran Allianz's business there on his way to the CEO suite.

In 1998, Diekmann was put in charge of the Asia-Pacific region and given a seat on the Allianz board. It was in Asia that he achieved his first big turnaround success. First, he expanded the group's footprint in Australia, acquiring the 32 percent of Manufacturers Mutual Insurance that Allianz didn't already own and delisting its shares. A midsize player in the rapidly consolidating Australian market, MMI was on its way to posting a loss of E60 million that year. Diekmann immediately closed down MMI's reinsurance arm and overseas joint ventures, stanching losses that the Asian economic crisis threatened to aggravate. He also brought in a new managing director, Terry Towell, who oversaw what would become a textbook Diekmann turnaround, merging divisional back offices and infrastructure, tightening claims management and stiffening underwriting controls with the introduction of new pricing models.

By 2000 the company was back in the black with a E29 million profit. Then Diekmann moved to build market share by acquiring the retail business of failed Sydney-based insurer HIH Insurance in 2001. The renamed Allianz Australia Insurance boasts one of the best underwriting performances of the group. Its combined ratio, the key metric of the property/casualty business, stands at 94.3 percent. (It earned E74 million in the first half of 2003.)

That success earned Diekmann a bigger challenge. In 2002 he was appointed regional CEO for the U.S., where Fireman's Fund had been a persistently poor performer even before Allianz acquired it a decade earlier. The subsidiary lost E357 million in 2001 alone. Fireman's was exhibiting some of the worst excesses of the group. Its combined ratio of 128 percent reflected the embarrassing reality that underwriting losses had topped $1 billion.

Diekmann took dramatic action, slashing 2,900 jobs out of 8,000 (including the CEO's) and severing relations with unprofitable customers. Surety, which provided insurance for building contractors, was cut, as was an auto warranty business and a unit specializing in investing in captive insurers. Functions that had been divided along business lines, such as human resources and IT, were centralized.

Fireman's losses ballooned to E666 million in 2002 because of a E496 million write-off for future asbestos claims. Allianz pumped in $730 million in new capital, but the turnaround had started.

Fireman's is still some way from financial health, but Diekmann's medicine is working. It is now a business that is focused on insuring affluent homeowners, commercial and marine properties and agribusiness. Fireman's writes almost the same amount in gross premiums, $4.2 billion last year, as it did in 2000, with a staff that is 36 percent smaller.

Overall, p/c losses in the U.S. narrowed to E237 million in the first nine months of 2003, from E920 million a year earlier, and Fireman's made a small profit from continuing operations. The combined ratio for ongoing business improved dramatically, to 91.7 percent, in the same period, compared with a whopping 108 percent a year earlier.

Jeff Post, Fireman's CEO, credits the turnaround to Diekmann's management style. "You can only change the culture of an organization from the top down," says Post. "Michael was instrumental in allowing us to get traction. Our results were frankly terrible, but Michael knew that the good people needed to be rewarded to reinforce the change we were pursuing. He's a very dynamic guy who will drive that sort of change throughout Allianz. He's not afraid to be radical. But most important, he is not a micromanager. He puts the right people in place and then makes sure that they deliver. If they don't, he will take action."

DIEKMANN'S RIGOROUS BACK-TO-BASICS CAMpaign is echoed across the top echelons at Allianz, even by erstwhile rivals like Achleitner, who had been recruited by Schulte-Noelle in 1999 to reshape the company. Initially, Allianz shares experienced an "Achleitner bubble" as investors eagerly anticipated windfall profits from the unwinding of the group's cross-shareholdings, and Achleitner seemed a shoo-in to succeed Schulte-Noelle. But as the Dresdner deal soured, so did the fortunes of its architect. Allianz needed an insider untarnished by the Dresdner acquisition to succeed Schulte-Noelle and go to shareholders for the E4.4 billion rights issue, and Diekmann was the ideal candidate.

Today Achleitner is an enthusiastic proponent of Diekmann's strategy. Friends say he is content for now to serve as co-CFO, taking charge of strategy and communicating Allianz's message externally while fellow co-CFO Helmut Perlet is the inside man, enforcing Diekmann's financial discipline within the group. Moreover, Achleitner is determined to see the Dresdner deal vindicated.

"This has been a group driven by top-line revenues. Now we are driven by bottom-line profits. Nowhere is that more important than in p/c," says Achleitner. "We have to stop thinking of p/c as an asset-gathering business. It is not. P/c needs to make money on a stand-alone basis. If there is any additional investment return, then that is gravy."

One of the biggest remaining problem areas for Allianz is its French subsidiary, AGF. The French market is highly competitive, with a thriving mutual sector challenging global players like Axa and Allianz, but Diekmann is determined to reduce AGF's combined ratio to 100 percent this year, from 112 percent in 2002.

Diekmann set up a steering committee in Munich last year to keep a close eye on the goings-on at AGF. The committee, headed by regional chief and Allianz board member Detlev Bremkamp and including Diekmann's top enforcer, co-CFO Perlet, is making sure that new business is written at a combined ratio of under 100 percent. Allianz has also tightened claims procedures. AGF's sales agents used to handle claims, a clear conflict of interest that allowed them to pamper favored clients. But in 2002 the company set up a central unit to process claims, and the claims ratio, which measures the percentage of incurred claims to premium income, fell to 78.5 percent in last year's third quarter, from 84.1 percent a year earlier. And Diekmann's remedial efforts have received an added boost from a general firming in p/c rates. Premiums in some of AGF's business lines rose by as much as 40 percent in 2002, in part as a result of the global "hard" market cycle for p/c insurance that followed the terrorist attacks on the U.S. in September 2001.

The results of these measures are starting to show. AGF's combined ratio declined to 103.5 percent in the first nine months of 2003, from 112.3 percent a year earlier. "AGF is delivering because Diekmann is leaning on the CEO [Jean-Philippe Thierry]," says J.P. Morgan's Huttner. "My feeling is that under Diekmann, Allianz executives know they have to deliver. The new mood isn't, 'We'll let France be run in a French way,' it's 'France has to deliver or else.' The group has become quite ruthless, and that is just what was needed."

Diekmann is reining in his subsidiaries using the carrot and stick of capital allocation. The group's insurance, banking and asset management divisions pay the group a dividend at the end of each year. A new Group Risk Controlling unit, based in Munich and headed by Raj Singh, analyzes risks across the group and then helps Diekmann and co-CFO Perlet decide where best to deploy the group's capital. "What we do in Munich is look at the priorities of the group and ensure dividends are distributed to the areas we believe offer the best chance of generating returns," says Diekmann.

Diekmann has another tool for enforcing underwriting discipline. Schulte-Noelle set up Allianz Global Risks in January 2002 to centralize the underwriting of insurance for multinationals at group headquarters in Munich. Previously, Allianz subsidiaries around the world would write separate coverage for the local arms of, say, DaimlerChrysler. With no uniform underwriting rules across the group, the result was a tangled mess of unprofitable insurance relationships with some of the world's largest corporations. Allianz Global Risks inherited an insurance portfolio with an astonishing combined ratio of 140 percent.

Steve Schleisman, a former AIG executive who heads the global unit, imposed uniform underwriting rules and renegotiated coverage with existing clients. Allianz Global Risks has also enabled the group to leverage its buying power in negotiating reinsurance for its exposure. After the first nine months of 2003, the combined ratio for the business had plummeted to 94.5 percent. Allianz is finally making money again on its biggest clients.

Overall, the combined ratio for all of Allianz's p/c insurance improved to 96.9 percent in the first three quarters of last year, from 102.2 percent a year earlier. "There is no reason why we cannot drive the combined ratio of the entire p/c business down to the levels we enjoy in Germany," says Achleitner. That would imply an overall combined ratio of 94 percent, an improvement that would pay off handsomely on the bottom line. Each percentage-point fall in the combined ratio for p/c business adds some E300 million to the group's earnings.

Another sign of change at Allianz is the axing of far-flung subsidiaries. In 2003 alone Achleitner and Perlet have sold more than a dozen noncore businesses, including Allianz Life Re in the U.S. and operations in Brunei, Chile and the Philippines. The disposals raised E1.9 billion and released E900 million in risk capital. "We don't believe in being all over the globe for the sake of it," says Achleitner. "We will choose where to compete on the basis of where we can make money."

Achleitner also has been quietly toiling away to unwind Allianz's web of cross-shareholdings, which was so dense that the group's stock traded like an option on the DAX index during the bull market. The group has unloaded more than E20 billion in German equities over the past two years, including a 20.5 percent stake in HVB, an 8.2 percent stake in Deutsche Börse and a E4.4 billion, 38.4 percent stake in Beiersdorf, the maker of Nivea hand cream, which was acquired by a consortium headed by Hamburg-based coffee retailer Tchibo, controlled by the Herz family, in October.

"We are not interested in playing a role in German industrial policy," says Achleitner. "We are a portfolio investor."

The results of this good housekeeping can already be seen where it counts, on the bottom line. Allianz's net profit in the first nine months of 2003 rose to E421 million after a loss for the equivalent period in 2002 of E974 million. P/c revenues rose 5.2 percent, and life and health 13.5 percent. Dresd-ner Bank turned in a modest loss of E69 million, compared with E1.6 billion in the previous year.

Despite the improvement, Dresdner remains Diekmann's biggest headache and strategic challenge. The bank's 2002 loss plunged Allianz into the red that year and forced the departure of Dresdner CEO Bernd Fahrholz. Turning the bank around won't be easy. Germany's sluggish economy and overcrowded banking sector, overrun with state-owned Landesbanken and mutually owned savings and cooperative banks, makes it devilishly hard to eke out a profit, as HVB and Commerzbank demonstrated by posting record losses in 2002.

"Dresdner is an intractable problem," says Union Investment's Hipper. "It is a fact that it is very hard to make money in German banking. I am far from convinced that Dresdner will ever contribute much to Allianz. Axa's model is better. It doesn't own a bank."

Diekmann is determined to prove the skeptics wrong. He insists that the bank's retail branch network is essential for Allianz's ambition of selling mutual funds and other investment products in Germany. "Dresdner is a strategic investment," he says. "We simply couldn't service clients purely from an insurance agent network."

Turning that vision into reality is the job of Herbert Walter. The 49-year-old banker is smoother than the felt on a Bavarian tracht hat, but Allianz didn't hire him for his manners. It was Walter's record in restoring profitability at Deutsche Bank's German retail division that attracted Allianz's attention. He accomplished that task by closing 700 branches, slashing 3,000 jobs and emphasizing Internet banking. Now he's applying the same formula at Dresdner.

Within five months of joining Dresdner last March, Walter announced 15,700 job cuts, almost one third of the head count, and the closing of 33 branches (on top of the 260 Fahrholz had shuttered). He aims to trim E1 billion, about 12 percent, from Dresdner's cost base by 2005, with half of the savings coming from IT, back-office and administrative functions. "It's not easy to make money," says Walter. "But if you get the model right, you can."

That model calls for paring Dresdner's corporate loan book and restructuring the bank as a retail distribution machine for Allianz. Work on the corporate loans began in 2002 under Fahrholz when Dresdner hived off E35 billion of nonperforming loans and other unwanted assets into an internal restructuring unit, essentially a bad bank that dare not speak its name. The unit had shed E11 billion of those dud assets by September 2003 and posted an operating loss of E383 million for the first nine months of the year. Allianz is seeking to accelerate disposals in order to wind up the restructuring unit by 2006. Just last month it announced the disposal of E1.9 billion worth of North American loans, its largest transaction to date.

Allianz also has imposed some much-needed discipline at Dresdner Kleinwort Wasserstein. Costs at the investment bank soared because of lucrative retention bonuses signed in the wake of the aborted merger attempt with Deutsche. The most notorious paycheck went to Timothy Shacklock, the head of investment banking, who took home a whopping £26 million ($39 million) in 2002.

Andrew Pisker, who joined DKW from BNP Paribas in 2000 as head of fixed income, has moved aggressively to rein in the excesses since he was named chief executive in October 2002, replacing Leonhard Fischer, now CEO of Winterthur Group. The bank reduced costs by 40 percent and head count by 26 percent in 2002 and 2003. Among investment banks in London, only Credit Suisse First Boston under John Mack has cut more brutally. DKW's cost-cutting, combined with a strong performance from its European fixed-income division, which was the biggest book runner of European covered bonds last year, helped the firm contribute E282 million in operating earnings in the first nine months of 2003.

Even with the turnaround, however, DKW's future remains uncertain. With 6,500 employees, the firm is roughly the same size as Barclays Capital, but rather than focusing narrowly on debt markets as Barclays does, DKW still wants to be a full-service investment bank for European clients. "We think we can compete in our own backyard with the big Americans," says Pisker.

Diekmann gave DKW a conditional vote of confidence in August by committing E2.3 billion of capital to the investment bank for two years. After that all bets are off. Many investors have a hard time seeing a role for an investment bank in Allianz's largely retail strategy. An alliance between DKW and another midsize European investment bank, such as the corporate and investment banking division of Société Générale, has long been mooted. DKW is being disentangled from Dresdner (and Allianz) in a project headed by chief operating officer Baudouin Croonenberghs. Once that is complete, it is just possible that a bank or even the market will inject the capital Allianz is loath to provide.

"We don't have a predisposition about where the capital comes from," says Pisker. "We are not talking to anybody. But I am happy to spend time with any firm that has an interest and is serious, whether they are in London, Paris, New York or Frankfurt."

The real test for Dresdner is in retail distribution. Achleitner points out that banks distribute 80 percent of mutual funds in Germany and typically claim some two thirds of the fees paid by retail investors. "We bought a bank to capture those profits," he says.

The retail strategy is already showing some signs of paying off. Allianz Dresdner Asset Management captured 19 percent of flows into German mutual funds last year. Before acquiring the bank Allianz took just 4.2 percent of inflows. In 2003 ADAM ranked third in terms of new fund inflows, up from fifth in 2002. The Dit Total Return Bond Fund was Germany's biggest-selling mutual fund in 2002, raising more than E800 million. In 2003 ADAM had three of the ten top-selling fixed-income mutual funds, more than any other group. Fully 80 percent of all fund inflows at ADAM are through Dresdner branches. The branches are also responsible for 25 percent of Allianz's new insurance business in Germany.

"A merger is always a difficult process, and it did take a little while for Dresdner to deliver what we expected, but it is delivering now," says Joachim Faber, who heads ADAM and sits on Allianz's management board. "Our friends at Dresdner have proved quite adept at selling our funds. In 2003 we had net inflows of E3.5 billion, of which E3 billion came from Dresdner branches. Dresdner has always been regarded as an advice bank and a securities bank and has quite an affluent customer base, so that is good news for us."

ADAM is also making significant inroads into the institutional fund market. When Allianz created its asset management arm in 1998, more than 90 percent of its E350 billion in assets came from the group's own insurance business. But Allianz has broadened its asset management expertise and client base with a string of acquisitions, beginning with Pimco, the preeminent U.S. bond manager, in 2000. Faber believed that U.S. expertise was essential to gain credibility with European companies looking to build up funded pension schemes. Later that year, Faber bought San Diego, California­based growth equity specialist Nicholas-Applegate Capital Management, which brought in an additional E36 billion in assets. The Dresdner acquisition in 2001 added Dresdner RCM Global Investors and German mutual fund business Deutscher Investment Trust.

Today ADAM manages a cool $1.1 trillion, making it the world's second-largest fund manager after UBS. The majority of the funds -- some $620 billion -- are from third parties. Fully 77 percent of third-party funds come from outside Europe, primarily the U.S. But Allianz is counting on European pension reform to drive growth in its home region.

Enrollment in so-called Riester pensions, tax-advantaged retirement plans introduced in Germany in 2002, has been modest. Individuals have bought only 1.2 million Riester products, but Allianz sold 650,000 of them. The company also is capturing a more than 40 percent share of Riester saving schemes sponsored by companies and unions, according to ADAM figures. Three million Germans are now covered by these schemes, which are loosely modeled on U.S. and U.K. institutional defined contribution funds. Though asset flows so far are only E3 billion a year, they are projected to reach E30 billion by 2008. For Achleitner, ADAM's success alone justifies Allianz's acquisition spree.

"As an insurer, we perhaps had the opportunity to participate in the individual retirement account part of the Riester reform," he says. "But we would not have won corporate institutional business. Riester shows why it is important to build in flexibility, to be able to take part in Europe's long-term savings revolution as an insurer, as a fund manager, as a bank, whatever local conditions demand."

The gains in asset management are undeniable, but were they worth the cost of the Dresdner purchase? The jury is still out. "Maybe I'm wrong, maybe I'm impatient, but it will take ten years for anyone to know if this acquisition was worthwhile," says Union Investment's Hipper.

Diekmann is under no illusion that he has that much time. Turning around Dresdner and transforming Allianz's insurance business into a profitable rival to AIG are formidable challenges, with no guarantee of success. But under Diekmann it's unlikely the group will fail for lack of effort.

"This company is not shy of ambition," he says. "No senior manager here wants to work in a company that isn't ambitious. No one is saying, 'Let's get this crisis behind us so we can spend more time playing golf.' We are more hungry and more entrepreneurial than at any time I have been with Allianz."

Talking tough with Michael Diekmann

Michael Diekmann's ascent to the top of Allianz has been vertiginous. But after eight months in the top job, he already has a clear vision of where the insurer is headed. In an interview in his office at Allianz's Bauhaus-style headquarters in Munich, Diekmann offers Senior Editor Andrew Capon a frank assessment of Allianz -- past, present and future -- punctuated by sips of coffee and the occasional puff on a cigarillo.

His route to the executive suite at Allianz has entailed a fair bit of globetrotting, which has given him eclectic tastes. He professes a love for African music, but at the moment he is learning the rather more sedate charms of ballroom dancing so he can partner his daughters.

Institutional Investor: You talk about restoring operational discipline to Allianz. What progress has been made?

Diekmann: It is going quite well. This organization is more open to change now than at any time in the past because there is more pressure on the bottom line. Two years ago it would not have been possible to ask group companies to give up autonomy on underwriting multinational business. But it is clear that if our clients are multinational, we have to deal with them in that way. That has changed. The real issue is ensuring that the right people are running the businesses. We then have to make sure we align those businesses to the strategy of the group rather than have them running purely local businesses.

We don't intend to run these businesses from Munich because we don't know what's best for our customers in Italy or India. But we do set the framework. We have introduced a clear structure where we say that at the end of the year, you pay the group a dividend, which equals your cost of capital. Whatever else is earned on top can be used to develop the business. What we do in Munich is look at the priorities of the group, look at the macroeconomic environment and run a capital-allocation model where the dividends are redistributed to the areas we believe offer the best chance of generating returns.

Turnaround stories have a simple narrative. What is the next chapter for Allianz Group?

A turnaround of this magnitude is not something that gets done in 12 months. This turnaround will continue into 2004 and won't be completed, including Dresdner Bank, until the end of 2005. I have tried to caution investors and analysts that this turnaround will take some time.

We are in three global business segments: asset management, life insurance and property/casualty insurance. We remain committed to develop and grow all three businesses. The banking business is more or less concentrated in Germany. I would also expect a much stronger performance from our equity asset management businesses. At the moment our big profit driver is fixed income. From 2005 onward we believe we will show more proof that an integrated financial services model, spanning banking, insurance and asset management, really works. We will develop a more comprehensive product set. We are confident that this is the right model in Germany. Whether this will prove to be a model that works throughout Europe we will have to see. It depends on client behavior. And to be ready to answer the demands of our customers, we need to be flexible and fast to adapt.

Dresdner is obviously still a major concern for investors. Why does Allianz need to own a bank when Axa, say, does not?

Dresdner is a strategic investment. It might be a burden now, but I'm convinced it will be an asset in the future. We said at the time of the acquisition that we were unlikely to see the benefits for three or four years, and we said that long before the turmoil in financial markets. What we perceived in the late 1990s was a major shift in the behavior of clients. These clients just don't accept that insurance companies have any competency in offering capital-market-tailored products.

Clients are happy to buy protection from insurers, and even savings products, but anything more complex, they look elsewhere, principally to banks. Clients want the whole spectrum of products, tailored to their needs. We simply couldn't service clients purely from an insurance agent network. Nothing that has happened since tells me our perception was wrong, but ultimately only time will tell.

Secondly, the economics of owning distribution make sense. Ask anyone who distributes insurance or fund management through a bank if they think it is a great arrangement. You will get a sharp answer. Distributors squeeze all of the margin out of manufacturers; it is a fact of life.

What went wrong? To what extent were external factors responsible for the problems at the group, and to what extent did Allianz make poor decisions?

September 11, 2001, is the starting point to consider the position not only of Allianz but the whole insurance industry. This transforming event happened in the midst of integrating with Dresdner. Here we did make a mistake. We spent too much time integrating operationally while our risk management systems were not fast enough to appraise the risks accumulating on the banking side and the insurance side and view them in a comprehensive way.

At that time, our equity gearing was too big. About 30 percent of our assets were invested in equities, and there was a concentration of those assets in Germany. If you add to that corporate bond exposure in insurance portfolios and the credit exposure of the bank, it gives you some idea of the very complex risk position we had and why the market downturn hit us so hard.

These factors combined with the nat cats [natural catastrophes], especially in Europe, and another development that hit everybody in the industry, asbestos claims in the U.S. You could call it very unfortunate. You could call it the perfect storm. But in the end our investors don't care if we get hit by a perfect storm, they want us to come through it.

We have taken steps to control and understand our risks at a group level. Now, of course, some investors are saying wouldn't it be nice if we increased our exposure to equity. In fact, we are still quite heavily geared, with about 15 percent exposure. But the portfolio is far more diverse now. We have sold stakes in German companies such as Munich Re and Beiersdorf, and we have a far more diversified, risk-controlled portfolio. Some people might say it would be nice to ride the equity markets up with a high gearing, but what we have done is strike a reasonable balance between risk and reward.

How difficult is it to wean people in the p/c business from a top-line, revenue-driven mentality?

Quite difficult. It has taken us at least two years. This is not just an Allianz problem; it is an industrywide problem. And it isn't just a question of retraining underwriters. All the incentive systems were geared toward top-line growth.

The German p/c business is pretty close to E10 billion of revenue; the U.S. life business is pretty close to E10 billion in revenue. Three years ago all the incentive systems, all the compensation systems, were geared around those sort of targets. This has been completely changed. I haven't heard a single person talk about their E10 billion revenue target any more. Not one person. The whole organization is now bottom-line focused.

Is the same discipline applied across the organization, in all the regions?

There are new goals for everybody. In the past people might come to Munich and say, "Well, my regulatory framework really doesn't allow me to hit this target. Can you accept 10 percent less?" I can't accept this. Our shareholders don't care about a tricky regulatory situation. If a market doesn't allow a business to come up with the returns we want, then perhaps too much group capital is being used, and we should look at it. If there is a better use of group capital in another market, then we should use that capital there.

Is Allianz still an ambitious company? Do you want to take on AIG?

We are enormously ambitious. There is a huge difference in terms of the market capitalization of AIG and Allianz today. But I think if you look at our revenue base and you look at our potential, there is no reason we shouldn't be in the same league. That's the top league.

This company is not shy of ambition. No senior manager here wants to work in a company that isn't ambitious. No one is saying, "Let's get this crisis behind us so we can spend more time playing golf." We are more hungry and more entrepreneurial than at any time I have been with Allianz.