1
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
FOR QUARTER ENDED JUNE 30, 2001 COMMISSION FILE NUMBER 1-8787
---------------------
AMERICAN INTERNATIONAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 13-2592361
(STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
OR ORGANIZATION)
70 PINE STREET, NEW YORK, NEW YORK 10270
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (212) 770-7000
NONE
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT.
---------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES [ X ] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of June 30, 2001: 2,331,306,414.
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2
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED BALANCE SHEET
(IN MILLIONS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2001 2000
----------- ------------
ASSETS:
Investments and cash:
Fixed maturities:
Bonds available for sale, at market value (amortized
cost: 2001 -- $109,366; 2000 -- $89,461)............ $111,101 $ 89,631
Bonds held to maturity, at amortized cost (market
value: 2000 -- $12,053)............................. -- 11,533
Bonds trading securities, at market value (cost:
2001 -- $823; 2000 -- $838)......................... 822 846
Equity securities:
Common stocks (cost: 2001 -- $6,257;
2000 -- $6,371)..................................... 5,738 6,125
Non-redeemable preferred stocks (cost:
2001 -- $1,312; 2000 -- $1,166)..................... 1,215 1,056
Mortgage loans on real estate, net of allowance
(2001 -- $92; 2000 -- $87)............................ 7,330 7,127
Policy Loans........................................... 2,862 3,032
Collateral and guaranteed loans, net of allowance
(2001 -- $40; 2000 -- $40)............................ 2,079 2,084
Financial services and asset management assets:
Flight equipment primarily under operating leases,
net of accumulated depreciation (2001 -- $3,098;
2000 -- $2,723)..................................... 21,674 19,325
Securities available for sale, at market value (cost:
2001 -- $16,995; 2000 -- $14,636)................... 17,027 14,669
Trading securities, at market value.................. 6,523 7,347
Spot commodities, at market value.................... 316 363
Unrealized gain on interest rate and currency swaps,
options and forward transactions.................... 10,746 10,235
Trading assets....................................... 7,503 7,045
Securities purchased under agreements to resell, at
contract value...................................... 17,700 14,991
Other invested assets.................................. 18,017 13,394
Short-term investments, at cost (approximates market
value)................................................ 6,295 5,831
Cash................................................... 248 256
-------- --------
Total investments and cash...................... 237,196 214,890
Investment income due and accrued......................... 2,423 2,420
Premiums and insurance balances receivable, net of
allowance (2001 -- $189; 2000 -- $170)................. 12,898 11,832
Reinsurance assets........................................ 24,132 23,135
Deferred policy acquisition costs......................... 10,564 10,189
Investments in partially-owned companies.................. 362 251
Real estate and other fixed assets, net of accumulated
depreciation (2001 -- $2,266; 2000 -- $2,101).......... 3,602 3,578
Separate and variable accounts............................ 30,551 31,328
Other assets.............................................. 11,463 8,954
-------- --------
Total assets.................................... $333,191 $306,577
======== ========
See Accompanying Notes to Financial Statements.
1
3
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED BALANCE SHEET -- (CONTINUED)
(IN MILLIONS, EXCEPT SHARE AMOUNTS)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2001 2000
----------- ------------
LIABILITIES:
Reserve for losses and loss expenses...................... $ 40,842 $ 40,613
Reserve for unearned premiums............................. 12,904 12,510
Future policy benefits for life and accident and health
insurance contracts.................................... 40,333 38,165
Policyholders' contract deposits.......................... 51,211 47,209
Other policyholders' funds................................ 3,488 3,475
Reserve for commissions, expenses and taxes............... 3,132 2,807
Insurance balances payable................................ 3,645 2,380
Funds held by companies under reinsurance treaties........ 1,851 1,435
Income taxes payable:
Current................................................ 184 197
Deferred............................................... 2,798 1,873
Financial services and asset management liabilities:
Borrowings under obligations of guaranteed investment
agreements............................................ 14,977 13,595
Securities sold under agreements to repurchase, at
contract value........................................ 10,736 11,308
Trading liabilities.................................... 4,839 4,352
Securities and spot commodities sold but not yet
purchased, at market value............................ 6,574 7,701
Unrealized loss on interest rate and currency swaps,
options and forward transactions...................... 7,948 8,581
Trust deposits and deposits due to banks and other
depositors............................................ 2,179 1,895
Commercial paper....................................... 4,139 4,259
Notes, bonds and loans payable......................... 25,216 17,923
Commercial paper.......................................... 2,179 1,705
Notes, bonds, loans and mortgages payable................. 2,845 2,749
Separate and variable accounts............................ 30,551 31,328
Minority interest......................................... 1,541 1,465
Other liabilities......................................... 15,246 8,086
-------- --------
Total liabilities................................. 289,358 265,611
-------- --------
Preferred shareholders' equity in subsidiary companies.... 1,178 1,347
-------- --------
CAPITAL FUNDS:
Common stock, $2.50 par value; 5,000,000,000 shares
authorized; shares issued 2001 -- 2,475,663,919;
2000 -- 2,475,663,919.................................. 6,189 6,189
Additional paid-in capital................................ 2,564 2,668
Retained earnings......................................... 37,289 34,304
Accumulated other comprehensive income (loss)............. (1,856) (2,136)
Treasury stock, at cost; 2001 -- 144,357,505;
2000 -- 142,950,798 shares of common stock............. (1,531) (1,406)
-------- --------
Total capital funds............................... 42,655 39,619
-------- --------
Total liabilities and capital funds............... $333,191 $306,577
======== ========
See Accompanying Notes to Financial Statements.
2
4
CONSOLIDATED STATEMENT OF INCOME
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ----------------
2001 2000 2001 2000
------- ------- ------ ------
General insurance operations:
Net premiums written................................. $ 9,920 $ 8,730 $5,055 $4,504
Change in unearned premium reserve................... (456) (221) (313) (102)
------- ------- ------ ------
Net premiums earned.................................. 9,464 8,509 4,742 4,402
Net investment income................................ 1,423 1,323 707 660
Realized capital gains (losses)...................... (58) 9 (37) (3)
------- ------- ------ ------
10,829 9,841 5,412 5,059
------- ------- ------ ------
Losses and loss expenses incurred.................... 7,091 6,394 3,519 3,306
Underwriting expenses................................ 1,877 1,676 983 869
------- ------- ------ ------
8,968 8,070 4,502 4,175
------- ------- ------ ------
Operating income..................................... 1,861 1,771 910 884
------- ------- ------ ------
Life insurance operations:
Premium income....................................... 7,355 6,665 3,849 3,387
Net investment income................................ 3,872 3,411 1,951 1,740
Realized capital losses.............................. (21) (58) (3) (29)
------- ------- ------ ------
11,206 10,018 5,797 5,098
------- ------- ------ ------
Death and other benefits............................. 3,313 2,695 1,944 1,448
Increase in future policy benefits................... 3,961 3,949 1,763 1,890
Acquisition and insurance expenses................... 1,926 1,725 1,023 894
------- ------- ------ ------
9,200 8,369 4,730 4,232
------- ------- ------ ------
Operating income..................................... 2,006 1,649 1,067 866
------- ------- ------ ------
Financial services operating income.................... 701 585 372 304
Asset management operating income...................... 211 210 100 106
Other realized capital losses.......................... (17) (6) (5) (2)
Other income (deductions) -- net....................... (105) (122) (59) (62)
------- ------- ------ ------
Income before income taxes, minority interest and
cumulative effect of an accounting change............ 4,657 4,087 2,385 2,096
------- ------- ------ ------
Income taxes -- Current................................ 765 712 403 404
-- Deferred............................. 604 501 301 219
------- ------- ------ ------
1,369 1,213 704 623
------- ------- ------ ------
Income before minority interest and cumulative effect
of an accounting change.............................. 3,288 2,874 1,681 1,473
------- ------- ------ ------
Minority interest...................................... (123) (121) (54) (66)
------- ------- ------ ------
Income before cumulative effect of an accounting
change............................................... 3,165 2,753 1,627 1,407
------- ------- ------ ------
Cumulative effect of an accounting change, net of
tax.................................................. (6) -- -- --
------- ------- ------ ------
Net income............................................. $ 3,159 $ 2,753 $1,627 $1,407
======= ======= ====== ======
Earnings per common share:
Basic
Income before cumulative effect of an accounting
change.......................................... $ 1.35 $ 1.19 $ 0.69 $ 0.61
======= ======= ====== ======
Net income........................................ $ 1.35 $ 1.19 $ 0.69 $ 0.61
======= ======= ====== ======
Diluted
Income before cumulative effect of an accounting
change.......................................... $ 1.34 $ 1.17 $ 0.69 $ 0.60
======= ======= ====== ======
Net income........................................ $ 1.34 $ 1.17 $ 0.69 $ 0.60
======= ======= ====== ======
Cash dividends per common share........................ $ 0.074 $ 0.067 $0.037 $0.033
======= ======= ====== ======
Average shares outstanding:
Basic................................................ 2,333 2,317 2,332 2,313
------- ------- ------ ------
Diluted.............................................. 2,358 2,343 2,358 2,339
------- ------- ------ ------
See Accompanying Notes to Financial Statements.
3
5
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
------------------
2001 2000
------- -------
Cash Flows From Operating Activities:
Net Income.................................................. $ 3,159 $ 2,753
------- -------
Adjustments to reconcile net income to net cash provided by
operating activities:
Non-cash revenues, expenses, gains and losses included in
income:
Change in:
General and life insurance reserves.................... 2,480 3,008
Premiums and insurance balances receivable and
payable -- net........................................ 199 (759)
Reinsurance assets..................................... (997) (324)
Deferred policy acquisition costs...................... (375) (383)
Investment income due and accrued...................... (3) (106)
Funds held under reinsurance treaties.................. 416 14
Other policyholders' funds............................. 13 273
Current and deferred income taxes -- net............... 592 383
Reserve for commissions, expenses and taxes............ 325 (33)
Other assets and liabilities -- net.................... 436 (894)
Trading assets and liabilities -- net.................. 29 (1,898)
Trading securities, at market value.................... 824 521
Spot commodities, at market value...................... 47 153
Net unrealized gain on interest rate and currency
swaps, options and forward transactions............... (1,144) (1,159)
Securities purchased under agreements to resell........ (2,709) 1,123
Securities sold under agreements to repurchase......... (572) (482)
Securities and spot commodities sold but not yet
purchased, at market value............................ (1,127) 1,023
Realized capital losses................................... 96 55
Equity in income of partially-owned companies and other
invested assets........................................ (291) (45)
Depreciation expenses, principally flight equipment....... 631 557
Change in cumulative translation adjustments.............. (311) 4
Other -- net.............................................. (238) (71)
------- -------
Total Adjustments......................................... (1,679) 960
------- -------
Net cash provided by operating activities................... $ 1,480 $ 3,713
======= =======
See Accompanying Notes to Financial Statements.
4
6
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)
(IN MILLIONS)
(UNAUDITED)
SIX MONTHS
ENDED JUNE 30,
----------------------
2001 2000
-------- --------
Cash Flows From Investing Activities:
Cost of fixed maturities, at amortized cost matured or
redeemed............................................... $ -- $ 581
Cost of bonds, at market sold............................. 15,864 11,813
Cost of bonds, at market matured or redeemed.............. 3,282 3,748
Cost of equity securities sold............................ 2,897 2,811
Realized capital losses................................... (96) (55)
Purchases of fixed maturities............................. (27,252) (21,075)
Purchases of equity securities............................ (2,905) (3,093)
Mortgage, policy and collateral loans granted............. (1,559) (1,103)
Repayments of mortgage, policy and collateral loans....... 1,572 904
Sales of securities available for sale.................... 1,825 2,894
Maturities of securities available for sale............... 1,002 1,102
Purchases of securities available for sale................ (5,180) (4,273)
Sales of flight equipment................................. 68 79
Purchases of flight equipment............................. (2,804) (2,146)
Net additions to real estate and other fixed assets....... (271) (240)
Sales or distributions of other invested assets........... 3,061 2,279
Investments in other invested assets...................... (3,229) (2,676)
Change in short-term investments.......................... (464) 588
Investments in partially-owned companies.................. (110) --
-------- --------
Net cash used in investing activities....................... (14,299) (7,862)
-------- --------
Cash Flows From Financing Activities:
Change in policyholders' contract deposits................ 4,002 2,161
Change in trust deposits and deposits due to banks and
other depositors....................................... 284 (190)
Change in commercial paper................................ 354 975
Proceeds from notes, bonds, loans and mortgages payable... 12,224 5,537
Repayments on notes, bonds, loans and mortgages payable... (4,842) (4,447)
Proceeds from guaranteed investment agreements............ 9,201 3,772
Maturities of guaranteed investment agreements............ (7,819) (2,871)
Redemption of subsidiary company preferred stock.......... (185) --
Proceeds from common stock issued......................... 49 85
Proceeds from subsidiary company preferred stock issued... -- 350
Cash dividends to shareholders............................ (174) (155)
Acquisition of treasury stock............................. (217) (920)
Other -- net.............................................. (66) 34
-------- --------
Net cash provided by financing activities................... 12,811 4,331
-------- --------
Change in cash.............................................. (8) 182
Cash at beginning of period................................. 256 132
-------- --------
Cash at end of period....................................... $ 248 $ 314
======== ========
See Accompanying Notes to Financial Statements.
5
7
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(IN MILLIONS)
(UNAUDITED)
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- ----------------
2001 2000 2001 2000
------ ------ ------ ------
Net income.............................................. $3,159 $2,753 $1,627 $1,407
Other comprehensive income:
Unrealized appreciation (depreciation) of
investments -- net of reclassification
adjustments........................................ 358 (579) (625) (594)
Deferred income tax (expense) benefit on changes... (209) 199 190 222
Foreign currency translation adjustments(a)........... (313) 4 (215) (45)
Applicable income tax benefit on changes........... 68 24 46 5
Cumulative effect of accounting change, net of
tax(b)............................................. 179 -- -- --
Net derivative gains (losses) arising from cash flow
hedging activities................................. (123) -- 17 --
Deferred income tax expense on changes............. (19) -- (13) --
Cumulative effect of accounting change, net of
tax(c)............................................. 339 -- -- --
------ ------ ------ ------
Total................................................. 280 (352) (600) (412)
------ ------ ------ ------
Comprehensive income.................................... $3,439 $2,401 $1,027 $ 995
====== ====== ====== ======
---------------
(a) Includes immaterial derivative gains and losses arising from hedges of net
investments in foreign operations.
(b) Consists of derivative gains and losses arising from the adoption of FASB
133.
(c) Represents the unrealized appreciation arising from the transfer of the
bonds held to maturity portfolio to the bonds available for sale portfolio
in connection with the implementation of FASB 133.
See Accompanying Notes to Financial Statements.
6
8
AMERICAN INTERNATIONAL GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
JUNE 30, 2001
(UNAUDITED)
a) These statements are unaudited. In the opinion of management, all
adjustments consisting of normal recurring accruals have been made for a
fair presentation of the results shown. All material intercompany accounts
and transactions have been eliminated. For further information, refer to the
Annual Report on Form 10-K of AIG for the year ended December 31, 2000.
b) Earnings per share of AIG are based on the weighted average number of common
shares outstanding during the period, retroactively adjusted to reflect all
stock splits.
Cash dividends per common share reflect the adjustment for a common stock
split in the form of a 50 percent common stock dividend paid July 28, 2000.
The quarterly dividend rate per common share, commencing with the dividend
paid September 14, 2001 is $0.042.
c) Cash flow information for the six month periods ended June 30, 2001 and 2000
is as follows:
2001 2000
------ ------
(IN MILLIONS)
Income taxes paid......................................... $ 703 $ 718
Interest paid............................................. $1,563 $1,187
d) Segment Information:
The following table summarizes the operations by major operating segment for
the first six months and second quarter of 2001 and 2000 (in millions):
OPERATING SEGMENTS
----------------------------------------
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ------------------
2001 2000 2001 2000
------- ------- ------- -------
Revenues(1):
General Insurance................................... $10,829 $ 9,841 $ 5,412 $ 5,059
Life Insurance...................................... 11,206 10,018 5,797 5,098
Financial Services.................................. 2,100 1,870 1,075 975
Asset Management.................................... 611 593 299 296
Other............................................... (17) (6) (5) (2)
------- ------- ------- -------
Total............................................. $24,729 $22,316 $12,578 $11,426
======= ======= ======= =======
Operating income:
General Insurance................................... $ 1,861 $ 1,771 $ 910 $ 884
Life Insurance...................................... 2,006 1,649 1,067 866
Financial Services.................................. 701 585 372 304
Asset Management.................................... 211 210 100 106
Other............................................... (122) (128) (64) (64)
------- ------- ------- -------
Total............................................. $ 4,657 $ 4,087 $ 2,385 $ 2,096
======= ======= ======= =======
-------------------
(1) Represents the sum of general net premiums earned, life premium
income, net investment income, financial services commissions,
transaction and other fees, asset management commissions and other
fees, and realized capital gains (losses).
7
9
The following table summarizes AIG's general insurance operations by major
reporting group for the first six months and second quarter of 2001 and 2000
(in millions):
GENERAL INSURANCE
-------------------------------------
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
----------------- ----------------
2001 2000 2001 2000
------- ------ ------ ------
Revenues:
Domestic Brokerage Group............................... $ 6,127 $5,195 $3,081 $2,694
Foreign General........................................ 3,058 3,161 1,498 1,610
Other.................................................. 1,644 1,485 833 755
------- ------ ------ ------
Total................................................ $10,829 $9,841 $5,412 $5,059
======= ====== ====== ======
Operating income before realized capital gains
(losses)(1):
Domestic Brokerage Group............................... $ 1,084 $ 974 $ 531 $ 515
Foreign General........................................ 591 502 292 241
Other.................................................. 244 286 124 131
------- ------ ------ ------
Total................................................ $ 1,919 $1,762 $ 947 $ 887
======= ====== ====== ======
-------------------
(1) Realized capital gains (losses) are not deemed to be an integral
part of AIG's general insurance operations' internal reporting
groups.
The following table summarizes AIG's life insurance operations by major
reporting group for the first six months and second quarter of 2001 and 2000
(in millions):
LIFE INSURANCE
--------------------------------------
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
------------------ ----------------
2001 2000 2001 2000
------- ------- ------ ------
Revenues:
American International Assurance Company Ltd. and Nan
Shan Life Insurance Company, Ltd. .................. $ 5,085 $ 4,676 $2,622 $2,408
American Life Insurance Company....................... 2,784 2,750 1,382 1,378
Domestic Life......................................... 2,862 2,364 1,449 1,198
Other................................................. 475 228 344 114
------- ------- ------ ------
Total............................................... $11,206 $10,018 $5,797 $5,098
======= ======= ====== ======
Operating income before realized capital gains
(losses)(1):
American International Assurance Company Ltd. and Nan
Shan Life Insurance Company, Ltd. .................. $ 779 $ 673 $ 416 $ 360
American Life Insurance Company....................... 438 372 228 190
Domestic Life......................................... 731 625 367 326
Other................................................. 79 37 59 19
------- ------- ------ ------
Total............................................... $ 2,027 $ 1,707 $1,070 $ 895
======= ======= ====== ======
-------------------
(1) Realized capital gains (losses) are not deemed to be an integral
part of AIG's life insurance operations' internal reporting groups.
8
10
The following table summarizes AIG's financial services operations by major
reporting group for the first six months and second quarter of 2001 and 2000
(in millions):
FINANCIAL SERVICES
----------------------------------
SIX MONTHS THREE MONTHS
ENDED JUNE 30, ENDED JUNE 30,
---------------- --------------
2001 2000 2001 2000
------ ------ ------ ----
Revenues:
International Lease Finance Corporation .................. $1,278 $1,157 $ 657 $607
AIG Financial Products Corp. ............................. 519 451 271 239
AIG Trading Group Inc. ................................... 59 135 20 62
Other..................................................... 244 127 127 67
------ ------ ------ ----
Total................................................... $2,100 $1,870 $1,075 $975
====== ====== ====== ====
Operating income:
International Lease Finance Corporation .................. $ 344 $ 310 $ 184 $171
AIG Financial Products Corp. ............................. 354 278 189 139
AIG Trading Group Inc. ................................... 14 35 7 13
Other..................................................... (11) (38) (8) (19)
------ ------ ------ ----
Total................................................... $ 701 $ 585 $ 372 $304
====== ====== ====== ====
e) Statement of Accounting Standards No. 130 "Comprehensive Income" (FASB 130)
establishes standards for reporting comprehensive income and its components
as part of capital funds. The reclassification adjustments with respect to
available for sale securities were $(96) million and $(55) million for the
first six months and $(45) million and $(34) million for the second quarter
of 2001 and 2000, respectively.
f) Accounting Standards:
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133 "Accounting for
Derivative Instruments and Hedging Activities". In June 2000, FASB issued
Statement of Financial Accounting Standards No. 138 "Accounting for
Derivative Instruments and Hedging Activities -- an amendment of FASB
Statement No. 133" (collectively, FASB 133).
FASB 133 requires AIG to recognize all derivatives in the consolidated
balance sheet at fair value. The financial statement recognition of the
change in the fair value of a derivative depends on a number of factors,
including the intended use of the derivative and the extent to which the
derivative is effective as part of a hedge transaction. The changes in fair
value of the derivative transactions of AIGFP and AIGTG are presented as a
component of AIG's operating income. The discussion below relates to the
derivative activities of AIG other than those of AIGFP and AIGTG.
On the date the derivative contract is entered into, AIG designates the
derivative as: (1) a hedge of the subsequent changes in the fair value of a
recognized asset or liability or of an unrecognized firm commitment ("fair
value" hedge); (2) a hedge of a forecasted transaction, or the variability
of cash flows to be received or paid related to a recognized asset or
liability ("cash flow" hedge); or (3) a hedge of a net investment in a
foreign operation. Fair value and cash flow hedges may involve foreign
currencies ("foreign currency hedges"). The gain or loss in the fair value
of a derivative that is designated, qualifies and is highly effective as a
fair value hedge is recorded in current period earnings along with the loss
or gain on the hedged item attributable to the hedged risk. The gain or loss
in the fair value of a derivative that is designated, qualifies and is
highly effective as a cash flow hedge is recorded in other comprehensive
income, until earnings are affected by the variability of cash flows. The
gain or loss in the fair value of a derivative that is designated, qualifies
and is highly effective as a hedge of a net investment in a foreign
operation is recorded in the foreign currency translation adjustments
account within other comprehensive income. Changes in the fair value of
derivatives used for other than the above hedging activities are reported in
current period earnings.
AIG documents all relationships between hedging instruments and hedged
items, as well as its risk-management objectives and strategy for
undertaking various hedge transactions. This process includes linking all
derivatives that are designated as hedges to specific assets or liabilities
on the balance sheet, or specific firm commitments or forecasted
transactions. AIG also assesses, both at the hedge's inception and on an
ongoing basis, whether the derivatives used in hedging transactions are
highly effective in offsetting changes in fair values or cash flows of
hedged items.
AIG adopted FASB 133 on January 1, 2001. In accordance with the transition
provisions of FASB 133, AIG recorded in its consolidated income statement
for the first six months of 2001 a cumulative effect of an accounting change
adjustment loss of $6 million. This loss represents the net fair value of
all previously unrecorded derivative instruments as of January 1, 2001, net
of tax and after the application of hedge accounting. AIG also recorded in
its consolidated statement of comprehensive income for the first six months
of 2001 a cumulative effect of an accounting change adjustment gain of $179
million. This gain represents the increase in other comprehensive income,
net of taxes, arising from recognizing the fair value of all derivative
contracts designated as cash flow hedging instruments, and to a lesser
extent, hedging instruments used to hedge net investments in foreign
operations.
AIG (excluding its two trading operations, AIGFP and AIGTG) uses derivative
instruments (principally swap and forward contracts) to hedge risk exposures
to interest rate and foreign currency risks. These risks arise primarily
from
9
11
available-for-sale fixed income securities, debt, policyholder account
balance liabilities associated with guaranteed investment contracts and net
investments in foreign operations. Other hedging activities, such as those
involving forecasted transactions or equity securities, are not significant.
During the first six months of 2001, there were no hedges that were
discontinued or otherwise no longer qualify as hedges under FASB 133. With
respect to fair value hedges, net income for the first six months reflected
a net $3 million loss from hedge ineffectiveness. With respect to cash flow
hedges, such ineffectiveness amounted to a net loss of less than $1 million.
During the first six months of 2001, there were minor reclassifications to
earnings from other comprehensive income under cash flow hedge accounting.
These reclassifications were connected to programs of synthetically
converting certain investment securities, debt issuances or policyholder
account balance liabilities associated with guaranteed investment contracts,
from a floating interest rate to a fixed interest rate. As at June 30, 2001,
the maximum amount of net derivative losses to be reclassified into net
income within the next twelve months is insignificant. The maximum length of
time over which future cash flows are hedged is approximately 9 years.
In addition to hedging activities, AIG also uses derivative instruments with
respect to investment operations, which include, among other things, writing
option contracts, and purchasing investments with embedded derivatives, such
as equity linked notes and convertible bonds. All changes in the market
value of these derivatives are recorded in earnings. AIG bifurcates an
embedded derivative where: (1) the economic characteristics of the embedded
instruments are not clearly and closely related to those of the remaining
components of the financial instrument; and (2) a separate instrument with
the same terms as the embedded instrument meets the definition of a
derivative under FASB 133.
In accordance with the transition provisions of FASB 133, AIG transferred
bonds in the held to maturity, at amortized cost category into the bonds
available for sale, at market value category. The amortized cost of the
bonds transferred was $11.53 billion. The unrealized appreciation, net of
deferred tax expense was approximately $339 million at the date of transfer
and was recorded as a cumulative effect of an accounting change within other
comprehensive income. Under the provisions of FASB 133, such a transfer does
not affect AIG's intent nor its ability to hold current or future bonds to
their maturity.
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12
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Quarterly Report on Form 10-Q and other publicly available documents
may include, and AIG's officers and representatives may from time to time make,
statements which may constitute "forward-looking statements" within the meaning
of the Private Securities Litigation Reform Act of 1995. These statements are
not historical facts but instead represent only AIG's belief regarding future
events, many of which, by their nature, are inherently uncertain and outside of
AIG's control. These statements may address, among other things, AIG's strategy
for growth, product development, regulatory approvals, market position,
financial results and reserves. It is possible that AIG's actual results and
financial condition may differ, possibly materially, from the anticipated
results and financial condition indicated in these forward-looking statements.
Important factors that could cause AIG's actual results to differ, possibly
materially, from those in the specific forward-looking statements are discussed
throughout this Management's Discussion and Analysis of Financial Condition and
Results of Operations. AIG is not under any obligation to (and expressly
disclaims any such obligations to) update or alter any forward-looking
statement, whether written or oral, that may be made from time to time, whether
as a result of new information, future events or otherwise.
OPERATIONAL REVIEW
GENERAL INSURANCE OPERATIONS
AIG's general insurance subsidiaries are multiple line companies writing
substantially all lines of property and casualty insurance.
Domestic general insurance operations are comprised of the Domestic
Brokerage Group (DBG), which includes The Hartford Steam Boiler Inspection and
Insurance Company (HSB) and the domestic operations of Transatlantic Holdings,
Inc. (Transatlantic), Personal Lines, including 21st Century Insurance Group
(21st Century), and Mortgage Guaranty.
Commencing with AIG's acquisition of HSB in November 2000, HSB was
consolidated into AIG's financial statements.
DBG is AIG's primary domestic division. DBG writes substantially all
classes of business insurance, accepting such business mainly from insurance
brokers. This provides DBG the opportunity to select specialized markets and
retain underwriting control. Any licensed broker is able to submit business to
DBG without the traditional agent-company contractual relationship, but such
broker usually has no authority to commit DBG to accept a risk.
Personal Lines engages in the mass marketing of personal lines insurance,
primarily private passenger auto and homeowners and personal umbrella coverages.
Mortgage Guaranty provides guaranty insurance on conventional first
mortgage loans on single family dwellings and condominiums.
AIG's Foreign General insurance group accepts risks primarily underwritten
through American International Underwriters (AIU), a marketing unit consisting
of wholly owned agencies and insurance entities. The Foreign General insurance
group also includes business written by AIG's foreign-based insurance
subsidiaries for their own accounts. The Foreign General insurance group uses
various marketing methods to write both business and personal lines insurance
with certain refinements for local laws, customs and needs. AIU operates in over
70 countries in Asia, the Pacific Rim, Europe, Africa, Middle East and Latin
America. Transatlantic's foreign operations are included in this group. (See
also Note (d) of Notes to Financial Statements.)
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13
General insurance operations for the six month periods ending June 30, 2001
and 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
-------------------------------------------------------
Net premiums written*:
Domestic $6,953 $5,741
Foreign 2,967 2,989
-------------------------------------------------------
Total $9,920 $8,730
-------------------------------------------------------
Net premiums earned*:
Domestic $6,694 $5,636
Foreign 2,770 2,873
-------------------------------------------------------
Total $9,464 $8,509
-------------------------------------------------------
Adjusted underwriting profit*:
Domestic $ 219 $ 229
Foreign 277 210
-------------------------------------------------------
Total $ 496 $ 439
-------------------------------------------------------
Net investment income:
Domestic $1,109 $1,031
Foreign 314 292
-------------------------------------------------------
Total $1,423 $1,323
-------------------------------------------------------
Operating income before realized
capital gains (losses)*:
Domestic $1,328 $1,260
Foreign 591 502
-------------------------------------------------------
Total 1,919 1,762
Realized capital gains (losses) (58) 9
-------------------------------------------------------
Operating income $1,861 $1,771
-------------------------------------------------------
* Reflects the realignment of certain internal divisions in 2000.
During the first six months of 2001, net premiums written and net premiums
earned increased 13.6 percent and 11.2 percent, respectively, from those of
2000. During the first six months of 2001, AIG cancelled or non-renewed
approximately $225 million of business worldwide that did not meet AIG's
underwriting standards.
General insurance domestic net premiums written and net premiums earned for
the six month periods ended June 30, 2001 and 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
-------------------------------------------------------
Net premiums written:
DBG* $5,468 $4,290
Personal Lines 1,246 1,233
Mortgage Guaranty 239 218
-------------------------------------------------------
Total* $6,953 $5,741
-------------------------------------------------------
Net premiums earned:
DBG* $5,181 $4,269
Personal Lines 1,273 1,147
Mortgage Guaranty 240 220
-------------------------------------------------------
Total* $6,694 $5,636
-------------------------------------------------------
* Reflects the realignment of certain internal divisions in 2000.
Commencing in the latter part of 1999 and continuing through 2001, the
commercial property-casualty market place has experienced rate increases.
Virtually all areas of DBG have experienced rate increases. Overall, DBG's net
premiums written increased $1.18 billion or 27.5 percent in the first six months
of 2001 over 2000.
Personal Lines' net premiums written increased 1.1 percent or $13 million
in the first six months of 2001 over 2000. The growth in 2001 primarily resulted
from an increase in the number of policies issued with respect to preferred,
standard and non-standard auto risks and increased rates.
Foreign general insurance net premiums written and net premiums earned
declined 0.7 percent and 3.6 percent, respectively, in the first six months of
2001 when compared to the same period of 2000. Foreign general insurance
operations produced 29.9 percent of the general insurance net premiums written
in the first six months of 2001 and 34.2 percent in 2000.
In comparing the foreign currency exchange rates used to translate the
results of AIG's foreign general operations during the first six months of 2001
to those foreign currency exchange rates used to translate AIG's foreign general
results during the same period of 2000, the U.S. dollar strengthened in value in
relation to most major foreign currencies in which AIG transacts business.
Accordingly, when foreign net premiums written were translated into U.S. dollars
for the purposes of the preparation of the consolidated financial statements,
total general insurance net premiums written were approximately 3.0 percentage
points less than they would have been if translated utilizing those foreign
currency exchange rates which prevailed during that same period of 2000.
Because of the nature and diversity of AIG's operations and the continuing
rapid changes in the insurance industry worldwide, together with the factors
discussed above, it is difficult to assess further or project future growth in
AIG's net premiums written and reserve for losses and loss expenses.
Net premiums written are initially deferred and earned based upon the terms
of the underlying policies. The net unearned premium reserve constitutes
deferred revenues which are generally earned ratably over the policy period.
Thus, the net
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14
unearned premium reserve is not fully recognized as net premiums earned until
the end of the policy period.
AIG, along with most general insurance entities, uses the loss ratio, the
expense ratio and the combined ratio as measures of performance. The loss ratio
is the sum of losses and loss expenses incurred divided by net premiums earned.
The expense ratio is statutory underwriting expenses divided by net premiums
written. The combined ratio is the sum of the loss ratio and the expense ratio.
These ratios are relative measurements that describe for every $100 of net
premiums earned or written, the cost of losses and statutory expenses,
respectively. The combined ratio presents the total cost per $100 of premium
production. A combined ratio below 100 demonstrates underwriting profit; a
combined ratio above 100 demonstrates underwriting loss. The statutory general
insurance ratios were as follows:
------------------------------------------------------
2001 2000
-------------------------------------------------------
Domestic:
Loss Ratio 80.64 80.84
Expense Ratio 16.49 16.41
-------------------------------------------------------
Combined Ratio 97.13 97.25
-------------------------------------------------------
Foreign:
Loss Ratio 61.12 63.96
Expense Ratio 30.86 28.95
-------------------------------------------------------
Combined Ratio 91.98 92.91
-------------------------------------------------------
Consolidated:
Loss Ratio 74.92 75.14
Expense Ratio 20.79 20.71
-------------------------------------------------------
Combined Ratio 95.71 95.85
-------------------------------------------------------
AIG believes that underwriting profit is the true measure of the
performance of the core business of a general insurance company.
Underwriting profit is measured in two ways: statutory underwriting profit
and Generally Accepted Accounting Principles (GAAP) underwriting profit.
Statutory underwriting profit is arrived at by reducing net premiums earned
by net losses and loss expenses incurred and net expenses incurred. Statutory
accounting differs from GAAP, as statutory accounting requires immediate expense
recognition and ignores the matching of revenues and expenses as required by
GAAP. That is, for statutory purposes, all expenses, most specifically
acquisition expenses, are recognized immediately, not consistent with the
revenues earned.
A basic premise of GAAP accounting is the recognition of expenses at the
same time revenues are earned, the principle of matching. Therefore, to convert
underwriting results to a GAAP basis, acquisition expenses are deferred and
recognized together with the related revenues. Accordingly, the statutory
underwriting profit has been adjusted as a result of acquisition expenses being
deferred as required by GAAP. Thus, "adjusted underwriting profit" is a GAAP
measurement which can be viewed as gross margin or an intermediate subtotal in
calculating operating income and net income.
A major part of the discipline of a successful general insurance company is
to produce an underwriting profit, exclusive of investment income. If
underwriting is not profitable, losses incurred are a major factor. The result
is that the premiums are inadequate to pay for losses and expenses and produce a
profit; therefore, investment income must be used to cover underwriting losses.
If assets and the income therefrom are insufficient to pay claims and expenses
over extended periods, an insurance company cannot survive. For these reasons,
AIG views and manages its underwriting operations separately from its investment
operations.
The adjusted underwriting profits were $496 million in the first six months
of 2001 and $439 million in the same period of 2000. Domestic adjusted
underwriting profit increased primarily as a result of the disciplined
underwriting of DBG. The regulatory, product type and competitive environment as
well as the degree of litigation activity in any one country varies
significantly. These factors have a direct impact on pricing and consequently
profitability as reflected by adjusted underwriting profit and statutory general
insurance ratios.
AIG's results reflect the net impact of incurred losses from catastrophes
approximating $48 million and $44 million in the first six months of 2001 and
2000, respectively. AIG's gross incurred losses from catastrophes approximated
$101 million and $112 million in 2001 and 2000, respectively. The impact of
losses caused by catastrophes can fluctuate widely from period to period, making
comparisons of recurring type business more difficult. The pro forma table below
excludes catastrophe losses in order to present comparable results of AIG's
recurring core underwriting operations. The pro forma
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15
consolidated statutory general insurance ratios would be as follows:
--------------------------------------------------------
2001 2000
--------------------------------------------------------
Loss Ratio 74.42 74.62
Expense Ratio 20.79 20.71
--------------------------------------------------------
Combined Ratio 95.21 95.33
--------------------------------------------------------
AIG's historic ability to maintain its combined ratio below 100 is
primarily attributable to the profitability of AIG's foreign general insurance
operations and AIG's emphasis on maintaining its disciplined underwriting,
especially in the domestic specialty markets. In addition, AIG does not seek net
premium growth where rates do not adequately reflect its assessment of
exposures.
General insurance net investment income in the first six months of 2001
increased 7.6 percent when compared to the same period of 2000. The growth in
net investment income in 2001 was primarily attributable to new cash flow for
investment. The new cash flow was generated from net general insurance operating
cash flow and included the compounding of previously earned and reinvested net
investment income. (See also the discussion under "Liquidity" herein.)
General insurance realized capital losses were $58 million in the first six
months of 2001 and realized capital gains were $9 million in 2000. These
realized capital gains and losses resulted from the ongoing management of the
general insurance investment portfolios within the overall objectives of the
general insurance operations and arose primarily from the disposition of equity
securities and available for sale fixed maturities as well as redemptions of
fixed maturities.
General insurance operating income in the first six months of 2001
increased 5.1 percent when compared to the same period of 2000. The contribution
of general insurance operating income to income before income taxes, minority
interest and cumulative effect of an accounting change was 40.0 percent during
the first six months of 2001 compared to 43.3 percent in the same period of
2000.
AIG is a major purchaser of reinsurance for its general insurance
operations. AIG is cognizant of the need to exercise good judgment in the
selection and approval of both domestic and foreign companies participating in
its reinsurance programs. AIG insures risks in over 70 countries and its
reinsurance programs must be coordinated in order to provide AIG the level of
reinsurance protection that AIG desires. These reinsurance arrangements do not
relieve AIG from its direct obligations to its insureds.
AIG's general reinsurance assets amounted to $23.88 billion and resulted
from AIG's reinsurance arrangements. Thus, a credit exposure existed at June 30,
2001 with respect to reinsurance recoverable to the extent that any reinsurer
may not be able to reimburse AIG under the terms of these reinsurance
arrangements. AIG manages its credit risk in its reinsurance relationships by
transacting with reinsurers that it considers financially sound, and when
necessary AIG holds substantial collateral in the form of funds, securities
and/or irrevocable letters of credit. This collateral can be drawn on for
amounts that remain unpaid beyond specified time periods on an individual
reinsurer basis. At December 31, 2000, approximately 43 percent of the general
reinsurance assets were from unauthorized reinsurers. In order to obtain
statutory recognition, nearly all of these balances were collateralized. The
remaining 57 percent of the general reinsurance assets were from authorized
reinsurers and over 95 percent of such balances are from reinsurers rated
A-(excellent) or better, as rated by A.M. Best. This rating is a measure of
financial strength. The terms authorized and unauthorized pertain to regulatory
categories, not creditworthiness. Through June 30, 2001, these distribution
percentages have not significantly changed.
AIG's allowance for estimated unrecoverable reinsurance has not
significantly changed from December 31, 2000 when AIG had allowances for
unrecoverable reinsurance approximating $76 million. At that date AIG had no
significant reinsurance recoverables from any individual reinsurer which is
financially troubled (e.g., liquidated, insolvent, in receivership or otherwise
subject to formal or informal regulatory restriction).
AIG's Reinsurance Security Department conducts ongoing detailed assessments
of the reinsurance markets and current and potential reinsurers, both foreign
and domestic. Such assessments include, but are not limited to, identifying if a
reinsurer is appropriately licensed, and has sufficient financial capacity, and
the local economic environment in which a foreign reinsurer operates. This
department also reviews the nature of the risks ceded and the need for
collateral. In addition, AIG's Credit Risk Committee reviews the credit limits
for and concentrations with any one reinsurer.
AIG enters into certain intercompany reinsurance transactions for its
general and life operations.
14
16
AIG enters these transactions as a sound and prudent business practice in order
to maintain underwriting control and spread insurance risk among various legal
entities. These reinsurance agreements have been approved by the appropriate
regulatory authorities. All material intercompany transactions have been
eliminated in consolidation.
At June 30, 2001, the consolidated general reinsurance assets of $23.88
billion include reinsurance recoverables for paid losses and loss expenses of
$3.69 billion and $15.78 billion with respect to the ceded reserve for losses
and loss expenses, including ceded losses incurred but not reported (IBNR)
(ceded reserves). The ceded reserves represent the accumulation of estimates of
ultimate ceded losses including provisions for ceded IBNR and loss expenses. The
methods used to determine such estimates and to establish the resulting ceded
reserves are continually reviewed and updated. Any adjustments therefrom are
reflected in income currently. It is AIG's belief that the ceded reserves at
June 30, 2001 were representative of the ultimate losses recoverable. In the
future, as the ceded reserves continue to develop to ultimate amounts, the
ultimate loss recoverable may be greater or less than the reserves currently
ceded.
At June 30, 2001, general insurance reserves for losses and loss expenses
(loss reserves) amounted to $40.84 billion. These loss reserves represent the
accumulation of estimates of ultimate losses, including IBNR, and loss expenses
and amounts of discounting related to certain workers' compensation claims. At
June 30, 2001, general insurance net loss reserves increased $112 million from
prior year end to $25.06 billion. The net loss reserves represent loss reserves
reduced by reinsurance recoverables, net of an allowance for unrecoverable
reinsurance. The methods used to determine such estimates and to establish the
resulting reserves are continually reviewed and updated. Any adjustments
resulting therefrom are reflected in operating income currently. It is
management's belief that the general insurance net loss reserves are adequate to
cover all general insurance net losses and loss expenses as at June 30, 2001. In
the future, if the general insurance net loss reserves develop deficiently, such
deficiency would have an adverse impact on future results of operations.
In a very broad sense, the general loss reserves can be categorized into
two distinct groups: one group being long tail casualty lines of business. Such
lines include excess and umbrella liability, directors and officers' liability,
professional liability, medical malpractice, general liability, products'
liability, and related classes. These lines account for approximately one-half
of net losses and loss expenses. The other group is short tail lines of business
consisting principally of property lines, certain classes of casualty lines and
includes personal lines.
Estimation of ultimate net losses and loss expenses (net losses) for long
tail casualty lines of business is a complex process and depends on a number of
factors, including the line and volume of the business involved. In the more
recent accident years of long tail casualty lines there is limited statistical
credibility in reported net losses. That is, a relatively low proportion of net
losses would be reported claims and expenses and an even smaller proportion
would be net losses paid. A relatively high proportion of net losses would
therefore be IBNR.
A variety of actuarial methods and assumptions are normally employed to
estimate net losses for long tail casualty lines. These methods ordinarily
involve the use of loss trend factors intended to reflect the estimated annual
growth in loss costs from one accident year to the next. For the majority of
long tail casualty lines, net loss trend factors approximated four percent. Loss
trend factors reflect many items including changes in claims handling, exposure
and policy forms and current and future estimates of monetary inflation and
social inflation. Thus, many factors are implicitly considered in estimating the
year to year growth in loss costs. Therefore, AIG's carried net long tail loss
reserves are judgmentally set as well as tested for reasonableness using the
most appropriate loss trend factors for each class of business. In the
evaluation of AIG's net loss reserves, loss trend factors vary slightly,
depending on the particular class and nature of the business involved. These
factors are periodically reviewed and subsequently adjusted, as appropriate, to
reflect emerging trends which are based upon past loss experience.
Estimation of net losses for short tail business is less complex than for
long tail casualty lines. Loss cost trends for many property lines can generally
be assumed to be similar to the growth in exposure of such lines. For example,
if the fire insurance coverage remained proportional to the actual value of the
property, the growth in the property's exposure to fire loss can be approximated
by the amount of insurance purchased.
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17
For other property and short tail casualty lines, the loss trend is
implicitly assumed to grow at the rate that reported net losses grow from one
year to the next. The concerns noted above for longer tail casualty lines with
respect to the limited statistical credibility of reported net losses generally
do not apply to shorter tail lines.
AIG continues to receive claims asserting injuries from toxic waste,
hazardous substances, and other environmental pollutants and alleged damages to
cover the cleanup costs of hazardous waste dump sites (hereinafter referred to
collectively as environmental claims) and indemnity claims asserting injuries
from asbestos. The vast majority of these asbestos and environmental claims
emanate from policies written in 1984 and prior years. AIG has established a
specialized claims unit which investigates and adjusts all such asbestos and
environmental claims. Commencing in 1985, standard policies contained an
absolute exclusion for pollution related damage. However, AIG currently
underwrites environmental impairment liability insurance on a claims made basis
and excluded such claims from the analyses included herein.
Estimation of asbestos and environmental claims loss reserves is a
difficult process. These asbestos and environmental claims cannot be estimated
by conventional reserving techniques as previously described. Quantitative
techniques frequently have to be supplemented by subjective considerations
including managerial judgment. Significant factors which affect the trends which
influence the development of asbestos and environmental claims are the
inconsistent court resolutions and judicial interpretations which broaden the
intent of the policies and scope of coverage. The current case law can be
characterized as still evolving and there is little likelihood that any firm
direction will develop in the near future. Additionally, the exposure for
cleanup costs of hazardous waste dump sites involves issues such as allocation
of responsibility among potentially responsible parties and the government's
refusal to release parties. The cleanup cost exposure may significantly change
if potential Congressional reauthorization of Superfund dramatically changes the
current program.
In the interim, AIG and other industry members have and will continue to
litigate the broadening judicial interpretation of the policy coverage and the
liability issues. At the current time, it is not possible to determine the
future development of asbestos and environmental claims with the same degree of
reliability as is the case for other types of claims. Such development will be
affected by the extent to which courts continue to expand the intent of the
policies and the scope of the coverage, as they have in the past, as well as by
the changes in Superfund and waste dump site coverage issues. Although the
estimated liabilities for these claims are subject to a significantly greater
margin of error than for other claims, the reserves carried for these claims at
June 30, 2001 are believed to be adequate as these reserves are based on the
known facts and current law. Furthermore, as AIG's net exposure retained
relative to the gross exposure written was lower in 1984 and prior years, the
potential impact of these claims is much smaller on the net loss reserves than
on the gross loss reserves. In the future, if the environmental claims develop
deficiently, such deficiency would have an adverse impact on future results of
operations. (See the previous discussion on reinsurance collectibility herein.)
The majority of AIG's exposures for asbestos and environmental claims are
excess casualty coverages, not primary coverages. Thus, the litigation costs are
treated in the same manner as indemnity reserves. That is, litigation expenses
are included within the limits of the liability AIG incurs. Individual
significant claim liabilities, where future litigation costs are reasonably
determinable, are established on a case basis.
A summary of reserve activity, including estimates for applicable IBNR,
relating to asbestos and environmental claims separately and combined at June
30, 2001 and 2000 was as follows:
(in millions)
------------------------------------------------------------
2001 2000
-------------- -------------
GROSS NET GROSS NET
------------------------------------------------------------
Asbestos:
Reserve for losses and loss
expenses at beginning of
year $1,100 $ 338 $1,093 $306
Losses and loss expenses
incurred 191 38 29 14
Losses and loss expenses
paid (174) (60) (206) (51)
------------------------------------------------------------
Reserve for losses and loss
expenses at end of period $1,117 $ 316 $ 916 $269
------------------------------------------------------------
Environmental:
Reserve for losses and loss
expenses at beginning of
year $1,345 $ 517 $1,519 $585
Losses and loss expenses
incurred (30) (40) 3 2
Losses and loss expenses
paid (128) (46) (47) (25)
------------------------------------------------------------
Reserve for losses and loss
expenses at end of period $1,187 $ 431 $1,475 $562
------------------------------------------------------------
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18
(in millions)
------------------------------------------------------------
2001 2000
-------------- -------------
GROSS NET GROSS NET
------------------------------------------------------------
Combined:
Reserve for losses and loss
expenses at beginning of
year $2,445 $ 855 $2,612 $891
Losses and loss expenses
incurred 161 (2) 32 16
Losses and loss expenses
paid (302) (106) (253) (76)
------------------------------------------------------------
Reserve for losses and loss
expenses at end of period $2,304 $ 747 $2,391 $831
------------------------------------------------------------
The gross and net IBNR included in the aforementioned reserve for losses
and loss expenses at June 30, 2001 and December 31, 2000 were estimated as
follows:
(in millions)
------------------------------------------------------
2001 2000
------------- -------------
GROSS NET GROSS NET
------------------------------------------------------------
Combined $1,040 $287 $1,042 $314
------------------------------------------------------------
A summary of asbestos and environmental claims count activity for the six
month periods ended June 30, 2001 and 2000 was as follows:
--------------------------------------------------------------------------------------------------------------------
2001 2000
----------------------------------- -----------------------------------
ASBESTOS ENVIRONMENTAL COMBINED ASBESTOS ENVIRONMENTAL COMBINED
--------------------------------------------------------------------------------------------------------------------
Claims at beginning of year 6,796 11,323 18,119 6,746 13,432 20,178
Claims during year:
Opened 481 1,087 1,568 395 909 1,304
Settled (77) (776) (853) (61) (348) (409)
Dismissed or otherwise resolved (426) (1,708) (2,134) (287) (1,766) (2,053)
--------------------------------------------------------------------------------------------------------------------
Claims at end of period 6,774 9,926 16,700 6,793 12,227 19,020
--------------------------------------------------------------------------------------------------------------------
The average cost per claim settled, dismissed or otherwise resolved for the
six month periods ended June 30, 2001 and 2000 was as follows:
------------------------------------------------------
2001 2000
------------------- ---------------------
GROSS NET GROSS NET
------------------------------------------------------------------
Asbestos $345,900 $119,300 $ 592,000 $146,600
Environmental 51,500 18,500 22,200 11,800
Combined 101,100 35,500 102,800 30,900
------------------------------------------------------------------
A.M. Best, an insurance rating agency, has developed a survival ratio to
measure the number of years it would take a company to exhaust both its asbestos
and environmental reserves for losses and loss expenses based on that company's
current level of asbestos and environmental claims payments. This is a ratio
derived by taking the current ending losses and loss expense reserves and
dividing by the average annual payments for the prior three years. Therefore,
the ratio derived is a simplistic measure of an estimate of the number of years
it would be before the current ending losses and loss expense reserves would be
paid off using recent average payments. The higher the ratio, the more years the
reserves for losses and loss expenses cover these claims payments. These ratios
are computed based on the ending reserves for losses and loss expenses over the
respective claims settlements during the fiscal year. Such payments include
indemnity payments and legal and loss adjustment payments. It should be noted,
however, that this is an extremely simplistic approach to measuring asbestos and
environmental reserve levels. Many factors, such as aggressive settlement
procedures, mix of business and level of coverage provided, have significant
impact on the amount of asbestos and environmental losses and loss expense
reserves, ultimate payments thereof and the resultant ratio.
The developed survival ratios include both involuntary and voluntary
indemnity payments. Involuntary payments are primarily attributable to court
judgments, court orders, covered claims with no coverage defenses, state
mandated cleanup costs, claims where AIG's coverage defenses are minimal, and
settlements made less than six months before the first trial setting. Also, AIG
considers all legal and loss adjustment payments as involuntary.
AIG believes voluntary indemnity payments should be excluded from the
survival ratio. The special asbestos and environmental claims unit actively
manages AIG's asbestos and environmental claims and proactively pursues early
settlement of environmental claims for all known and unknown sites. As a result,
AIG reduces its exposure to future environmental loss contingencies.
AIG's survival ratios for involuntary asbestos and environmental claims,
separately and combined, were based upon a three year average pay-
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19
ment. These ratios at June 30, 2001 and 2000 were as follows:
------------------------------------------------------
2001 2000
------------- -------------
GROSS NET GROSS NET
-----------------------------------------------------------
Involuntary survival
ratios:
Asbestos 3.2 3.4 2.8 3.9
Environmental 17.4 16.3 19.1 18.3
Combined 6.6 7.5 6.9 9.4
-----------------------------------------------------------
AIG's operations are negatively impacted under guarantee fund assessment
laws which exist in most states. As a result of operating in a state which has
guarantee fund assessment laws, a solvent insurance company may be assessed for
certain obligations arising from the insolvencies of other insurance companies
which operated in that state. AIG generally records these assessments upon
notice. Additionally, certain states permit at least a portion of the assessed
amount to be used as a credit against a company's future premium tax
liabilities. Therefore, the ultimate net assessment cannot reasonably be
estimated. The guarantee fund assessments net of credits for 2000 were $15
million. Based upon current information, AIG does not anticipate that its net
assessment will be significantly different in 2001.
AIG is also required to participate in various involuntary pools
(principally workers' compensation business) which provide insurance coverage
for those not able to obtain such coverage in the voluntary markets. This
participation is also recorded upon notification, as these amounts cannot
reasonably be estimated.
LIFE INSURANCE OPERATIONS
AIG's life insurance subsidiaries offer a wide range of traditional
insurance and financial and investment products. Traditional products consist of
individual and group life, annuity, endowment and accident and health policies.
Financial and investment products consist of single premium annuity, variable
annuities, guaranteed investment contracts, universal life and pensions.
AIG's three principal overseas life operations are American Life Insurance
Company (ALICO), American International Assurance Company, Limited together with
American International Assurance Company (Bermuda) Limited (AIA) and Nan Shan
Life Insurance Company, Ltd. (Nan Shan). ALICO is incorporated in Delaware and
all of its business is written outside of the United States. ALICO has
operations either directly or through subsidiaries in approximately 50 countries
located in Europe, Africa, Latin America, the Caribbean, the Middle East, and
the Far East, with Japan being the largest territory. AIA operates primarily in
Hong Kong, Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. AIG's
domestic life operations are comprised of two separate operations, AIG's
domestic life companies and the life insurance subsidiaries of SunAmerica Inc.
(SunAmerica), a Delaware corporation which owns substantially all of the
subsidiaries which were owned by SunAmerica Inc., the Maryland corporation which
was merged into AIG in January 1999. Both of these operations sell primarily
financial and investment type products. (See also Note (d) of Notes to Financial
Statements.)
Life insurance operations for the six month periods ending June 30, 2001
and 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
--------------------------------------------------------
Premium income:
Domestic $ 752 $ 570
Foreign 6,603 6,095
--------------------------------------------------------
Total $ 7,355 $ 6,665
--------------------------------------------------------
Net investment income:
Domestic $ 2,137 $ 1,879
Foreign 1,735 1,532
--------------------------------------------------------
Total $ 3,872 $ 3,411
--------------------------------------------------------
Operating income before realized
capital losses:
Domestic $ 731 $ 625
Foreign 1,296 1,082
--------------------------------------------------------
Total 2,027 1,707
Realized capital losses (21) (58)
--------------------------------------------------------
Operating income $ 2,006 $ 1,649
--------------------------------------------------------
Life insurance in-force:*
Domestic $ 93,632 $ 88,743
Foreign 657,396 494,316
--------------------------------------------------------
Total $751,028 $583,059
--------------------------------------------------------
* Amounts presented were as at June 30, 2001 and December 31, 2000,
respectively. June 30, 2001, included AIG Star Life Insurance Co., Ltd.,
(formerly The Chiyoda Mutual Life Insurance Company).
AIG's life premium income during the first six months of 2001 represented a
10.4 percent increase from the same period in 2000. Foreign life operations
produced 89.8 percent and 91.5 percent of the life premium income in 2001 and
2000, respectively.
The traditional life products, particularly individual life products, were
major contributors to the
18
20
growth in foreign premium income. These traditional life products, coupled with
the increased distribution of financial and investment products contributed to
the growth in foreign investment income. A mixture of traditional, accident and
health and financial products are being sold in Japan through ALICO.
As previously discussed, the U.S. dollar strengthened in value in relation
to most major foreign currencies in which AIG transacts business. Accordingly,
for the first six months of 2001, when foreign life premium income was
translated into U.S. dollars for purposes of the preparation of the consolidated
financial statements, total life premium income was approximately 7.5 percentage
points less than it would have been if translated utilizing exchange rates
prevailing in 2000.
Life insurance net investment income increased 13.5 percent during the
first six months of 2001. The growth in net investment income was primarily
attributable to both foreign and domestic new cash flow for investment. The new
cash flow was generated from life insurance operations and included the
compounding of previously earned and reinvested net investment income. (See also
the discussion under "Liquidity" herein.)
Life insurance realized capital losses for the first six months were $21
million in 2001 and $58 million in 2000. These realized capital losses resulted
from the ongoing management of the life insurance investment portfolios within
the overall objectives of the life insurance operations and arose primarily from
the disposition of equity securities and available for sale fixed maturities as
well as redemptions of fixed maturities.
Life insurance operating income during the first six months of 2001
increased 21.7 percent to $2.01 billion. Excluding realized capital losses from
life insurance operating income, the percent increase would be 18.8 percent. The
contribution of life insurance operating income to income before income taxes,
minority interest and cumulative effect of an accounting change amounted to 43.1
percent during the first six months of 2001 compared to 40.3 percent in the same
period of 2000.
The risks associated with the traditional life and accident and health
products are underwriting risk and investment risk. The risk associated with the
financial and investment contract products is investment risk.
Underwriting risk represents the exposure to loss resulting from the actual
policy experience adversely emerging in comparison to the assumptions made in
the product pricing associated with mortality, morbidity, termination and
expenses. AIG's life companies limit their maximum underwriting exposure on
traditional life insurance of a single life to approximately one million dollars
of coverage by using yearly renewable term reinsurance.
The investment risk represents the exposure to loss resulting from the cash
flows from the invested assets, primarily long-term fixed rate investments,
being less than the cash flows required to meet the obligations of the expected
policy and contract liabilities and the necessary return on investments.
To minimize its exposure to investment risk, AIG tests the cash flows from
the invested assets and the policy and contract liabilities using various
interest rate scenarios to assess whether there is a liquidity excess or
deficit. If a rebalancing of the invested assets to the policy and contract
claims became necessary and did not occur, a demand could be placed upon
liquidity. (See also the discussion under "Liquidity" herein.)
The asset-liability relationship is appropriately managed in AIG's foreign
operations, as it has been throughout AIG's history, even though certain
territories lack qualified long-term investments or there are investment
restrictions imposed by the local regulatory authorities. For example, in Japan
and several Southeast Asia territories, the duration of the investments is often
for a shorter period than the effective maturity of the related policy
liabilities. Therefore, there is a risk that the reinvestment of the proceeds at
the maturity of the initial investments may be at a yield below that of the
interest required for the accretion of the policy liabilities. At December 31,
2000, the average duration of the investment portfolio in Japan was 6.0 years.
Additionally, there exists a future investment risk associated with certain
policies currently in force which will have premium receipts in the future. That
is, the investment of these future premium receipts may be at a yield below that
required to meet future policy liabilities. The anticipated average period for
the receipt and investment of these future premium receipts is 6.1 years. These
durations compare with an estimated average duration of 10.4 years for the
corresponding policy liabilities. These durations have not changed significantly
19
21
during 2001. To maintain an adequate yield to match the interest necessary to
support future policy liabilities, constant management focus is required to
reinvest the proceeds of the maturing securities and to invest the future
premium receipts without sacrificing investment quality. To the extent permitted
under local regulation, AIG may invest in qualified longer-term securities
outside Japan to achieve a closer matching in both duration and the required
yield. AIG is able to manage any asset-liability duration difference through
maintenance of sufficient global liquidity and to support any operational
shortfall through its international financial network. (See also the discussion
under "Liquidity" herein.)
AIG uses asset-liability matching as a management tool to determine the
composition of the invested assets and marketing strategies. As a part of these
strategies, AIG may determine that it is economically advantageous to be
temporarily in an unmatched position due to anticipated interest rate or other
economic changes.
FINANCIAL SERVICES OPERATIONS
AIG's financial services subsidiaries engage in diversified financial
products and services including premium financing, banking services and consumer
finance services.
International Lease Finance Corporation (ILFC) engages primarily in the
acquisition of new and used commercial jet aircraft and the leasing and
remarketing of such aircraft to airlines around the world. Also, ILFC provides,
for a fee, fleet management services to certain third-party operators. (See also
Note (d) of Notes to Financial Statements.)
AIG Financial Products Corp. and its subsidiaries (AIGFP) structure
financial transactions, including long-dated interest rate and currency swaps
and structured borrowings through notes, bonds and guaranteed investment
agreements. (See also Note (d) of Notes to Financial Statements.)
AIG Trading Group Inc. and its subsidiaries (AIGTG) engage in various
commodities trading, foreign exchange trading, interest rate swaps and market
making activities. (See also Note (d) of Notes to Financial Statements.)
Financial services operations for the six month periods ending June 30,
2001, and 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
--------------------------------------------------------
Revenues:
International Lease Finance
Corporation $1,278 $1,157
AIG Financial Products Corp.* 519 451
AIG Trading Group Inc.* 59 135
Other 244 127
--------------------------------------------------------
Total $2,100 $1,870
--------------------------------------------------------
Operating income:
International Lease Finance
Corporation $ 344 $ 310
AIG Financial Products Corp. 354 278
AIG Trading Group Inc. 14 35
Other, including intercompany
adjustments (11) (38)
--------------------------------------------------------
Total $ 701 $ 585
--------------------------------------------------------
* Represents commissions, transaction and other fees.
Financial services operating income increased 19.7 percent in the first six
months of 2001 over 2000.
Financial services operating income represented 15.1 percent of AIG's
income before income taxes, minority interest and cumulative effect of an
accounting change in the first six months of 2001. This compares to 14.3 percent
in the same period of 2000.
ILFC generates its revenues primarily from leasing new and used commercial
jet aircraft to domestic and foreign airlines. Revenues also result from the
remarketing of commercial jets for its own account, for airlines and for
financial institutions. Revenues in the first six months of 2001 increased 10.5
percent from the same period of 2000. The revenue growth resulted primarily from
the increase in flight equipment available for operating lease and the increase
in the relative cost of the leased fleet. Approximately 20 percent of ILFC's
operating lease revenues are derived from U.S. and Canadian airlines. During the
first six months of 2001, operating income increased 11.0 percent from the same
period of 2000. ILFC finances its purchases of aircraft primarily through the
issuance of a variety of debt instruments. The composite borrowing rates at the
end of the first six months of 2001 and 2000 were 5.49 percent and 6.33 percent,
respectively. (See also the discussions under "Capital Resources" and
"Liquidity" herein and Note (d) of Notes to Financial Statements.)
20
22
ILFC is exposed to loss through non-performance of aircraft lessees,
through owning aircraft which it would be unable to sell or re-lease at
acceptable rates at lease expiration and through committing to purchase aircraft
which it would be unable to lease. ILFC manages its lessee non-performance
exposure through credit reviews and security deposit requirements. At June 30,
2001, there were 429 aircraft subject to operating leases and there was one
aircraft off lease. (See also the discussions under "Capital Resources" and
"Liquidity" herein.)
AIGFP participates in the derivatives dealer market conducting, primarily
as principal, an interest rate, currency, equity and credit derivative products
business. AIGFP also enters into structured transactions including long-dated
forward foreign exchange contracts, option transactions, liquidity facilities
and investment agreements and invests in a diversified portfolio of securities.
AIGFP derives substantially all its revenues from proprietary positions entered
in connection with counterparty transactions rather than from speculative
transactions. Revenues in the first six months of 2001 increased 15.2 percent
from the same period of 2000. During the first six months of 2001, operating
income increased 27.1 percent from the same period of 2000. As AIGFP is a
transaction-oriented operation, current and past revenues and operating results
may not provide a basis for predicting future performance. (See also the
discussions under "Capital Resources," "Liquidity" and "Derivatives" herein and
Note (d) of Notes to Financial Statements.)
AIGTG derives a substantial portion of their revenues from market making
and trading activities, as principals, in foreign exchange, interest rates and
precious and base metals. Revenues in the first six months of 2001 decreased
56.4 percent from the same period of 2000. During the first six months of 2001,
operating income decreased 60.5 percent from the same period of 2000. As AIGTG
is a transaction-oriented operation, current and past revenues and operating
results may not provide a basis for predicting future performance or for
comparing revenues to operating income. (See also the discussions under "Capital
Resources," "Liquidity" and "Derivatives" herein and Note (d) of Notes to
Financial Statements.)
AIG Consumer Finance Group, Inc., through its subsidiaries, is engaged in
developing a multi-product consumer finance business with an emphasis on
emerging markets.
ASSET MANAGEMENT OPERATIONS
AIG's asset management operations offer a wide variety of investment
vehicles and services, including variable annuities, mutual funds, and
investment asset management. Such products and services are offered to
individuals and institutions both domestically and internationally.
AIG's three principal asset management operations are SunAmerica's asset
management operations (SAAMCo), AIG Global Investment Group, Inc. and its
subsidiaries (Global Investment) and AIG Capital Partners, Inc. (Cap Partners).
SAAMCo develops and sells variable annuities and other investment products,
sells and manages mutual funds and provides financial services. Global
Investment manages third-party institutional, retail and private equity funds
invested assets on a global basis, and provides custodial services. Cap Partners
organizes, and manages the invested assets of institutional investment funds and
may also invest in such funds. Each of these subsidiary operations receives fees
for investment products and services provided.
Asset management operations for the six month periods ending June 30, 2001
and 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
-------------------------------------------------------
Revenues $611 $593
Operating income 211 210
-------------------------------------------------------
Asset management operating income in the first six months of 2001 increased
0.4 percent when compared to the same period of 2000.
Asset management operating income represented 4.5 percent of AIG's income
before income taxes, minority interest and cumulative effect of an accounting
change in the first six months of 2001. This compares to 5.1 percent in the same
period of 2000.
At June 30, 2001, AIG's third party assets under management, including both
retail mutual funds and institutional accounts, approximated $34 billion.
OTHER OPERATIONS
Other realized capital losses amounted to $17 million, and $6 million in
the first six months of 2001 and 2000, respectively.
21
23
Other income (deductions)-net includes AIG's equity in certain minor
majority-owned subsidiaries and certain partially-owned companies, realized
foreign exchange transaction gains and losses in substantially all currencies
and unrealized gains and losses in hyperinflationary currencies, as well as the
income and expenses of the parent holding company and other miscellaneous income
and expenses. In the first six months of 2001, net deductions amounted to $105
million. In the same period of 2000, net deductions amounted to $122 million.
Income before income taxes, minority interest and cumulative effect of an
accounting change amounted to $4.66 billion in the first six months of 2001.
Income before income taxes and minority interest amounted to $4.09 billion in
the same period of 2000.
In the first six months of 2001, AIG recorded a provision for income taxes
of $1.37 billion compared to the provision of $1.21 billion in the same period
of 2000. These provisions represent effective tax rates of 29.4 percent in the
first six months of 2001, and 29.7 percent in the same period of 2000.
Minority interest represents minority shareholders' equity in income of
certain majority-owned consolidated subsidiaries. Minority interest amounted to
$123 million and $121 million in the first six months of 2001 and 2000,
respectively.
Income before the cumulative effect of an accounting change amounted to
$3.17 billion in the first six months of 2001 and $2.75 billion in the same
period of 2000.
The cumulative effect of an accounting change resulted from the adoption of
Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities" and Statement of Financial Accounting
Standards No. 138 "Accounting for Derivative Instruments and Hedging
Activities -- an amendment of FASB Statement No. 133" (collectively, FASB 133).
Net income amounted to $3.16 billion in the first six months of 2001 and
$2.75 billion in the same period of 2000. The increases in net income over the
periods resulted from those factors described above.
CAPITAL RESOURCES
At June 30, 2001, AIG had total capital funds of $42.66 billion and total
borrowings of $49.36 billion. At that date, $43.84 billion of such borrowings
were either not guaranteed by AIG or were matched borrowings under obligations
of guaranteed investment agreements (GIAs) or matched notes and bonds payable.
Total borrowings and borrowings not guaranteed or matched at June 30, 2001
and December 31, 2000 were as follows:
(in millions)
--------------------------------------------------------
2001 2000
--------------------------------------------------------
GIAs -- AIGFP $14,977 $13,595
--------------------------------------------------------
Commercial Paper:
AIG Funding, Inc. 2,024 968
ILFC(a) 4,139 4,259
A.I. Credit Corp. -- 597
AIG Finance (Taiwan) Limited(a) 108 104
AIG Credit Card Company
(Taiwan)(a) 47 36
--------------------------------------------------------
Total 6,318 5,964
--------------------------------------------------------
Medium Term Notes:
ILFC(a) 4,274 3,175
AIG 656 582
--------------------------------------------------------
Total 4,930 3,757
--------------------------------------------------------
Notes and Bonds Payable:
ILFC(a) 6,429 5,529
AIGFP 14,098 8,755
AIG 726 720
--------------------------------------------------------
Total 21,253 15,004
--------------------------------------------------------
Loans and Mortgages Payable:
ILFC(a)(b) 415 463
AIG Finance (Hong Kong) Limited(a) 256 346
AIG Consumer Finance Group,
Inc.(a) 765 662
AIG 442 440
--------------------------------------------------------
Total 1,878 1,911
--------------------------------------------------------
Total Borrowings 49,356 40,231
--------------------------------------------------------
Borrowings not guaranteed by AIG 16,433 14,574
Matched GIA borrowings 14,977 13,595
Matched notes and bonds payable --
AIGFP 12,426 8,127
--------------------------------------------------------
43,836 36,296
--------------------------------------------------------
Remaining borrowings of AIG $ 5,520 $ 3,935
--------------------------------------------------------
(a)AIG does not guarantee or support these borrowings.
(b)Capital lease obligations.
The maturity distributions of total borrowings at June 30, 2001 and
December 31, 2000 were as follows:
(in millions)
------------------------------------------------------
2001 2000
--------------------------------------------------------
Short-term borrowings $16,664 $14,989
Long-term borrowings(a) 32,692 25,242
--------------------------------------------------------
Total borrowings $49,356 $40,231
--------------------------------------------------------
(a)Including commercial paper and excluding that portion of long-term debt
maturing in less than one year.
22
24
During the first six months of 2001, AIGFP increased the aggregate
principal amount outstanding of its notes and bonds payable to $14.10 billion.
AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings
to invest in a diversified portfolio of securities and derivative transactions.
The funds may also be temporarily invested in securities purchased under
agreements to resell. (See also the discussions under "Operational Review",
"Liquidity" and "Derivatives" herein.)
AIG Funding, Inc. (Funding), through the issuance of commercial paper,
fulfills the short-term cash requirements of AIG and its non-insurance
subsidiaries. Funding intends to continue to meet AIG's funding requirements
through the issuance of commercial paper guaranteed by AIG. This issuance of
Funding's commercial paper is subject to the approval of AIG's Board of
Directors. ILFC and A.I. Credit Corp. (AICCO) as well as AIG Credit Card Company
(Taiwan) -- (AIGCCC-Taiwan) and AIG Finance (Taiwan) Limited -- (AIGF-Taiwan),
both consumer finance subsidiaries in Taiwan, have issued commercial paper for
the funding of their own operations. At June 30, 2001, AIG did not guarantee or
support the commercial paper of any of its subsidiaries other than Funding. In
early 2001, AICCO ceased issuing commercial paper under its program and the
agreement which AIG had provided supporting the commercial paper was terminated;
AICCO's funding requirements are now met through Funding's program. (See also
the discussion under "Derivatives" herein.)
AIG and Funding have entered into syndicated revolving credit facilities
(collectively, the Facility) aggregating $1.5 billion. The Facility consists of
$1.0 billion in a short-term revolving credit facility and a $500 million five
year revolving credit facility. The Facility can be used for general corporate
purposes and also to provide backup for AIG's commercial paper programs
administered by Funding. There are currently no borrowings outstanding under the
Facility, nor were any borrowings outstanding as of June 30, 2001.
At June 30, 2001, ILFC had increased the aggregate principal amount
outstanding of its medium term and term notes to $10.70 billion, a net increase
of $2.0 billion, and recorded a net decline in its capital lease obligations of
$48 million and a net decrease in its commercial paper of $120 million. At June
30, 2001, ILFC had $3.08 billion in aggregate principal amount of debt
securities registered for issuance from time to time. In addition, ILFC has a
Euro Medium Term Note Program for $2.0 billion, under which $771 million in
notes were sold through June 30, 2001.
ILFC has a $4.3 billion Export Credit Facility for use in connection with
the purchase of approximately 75 aircraft to be delivered through 2001. ILFC has
the right, but is not required, to use the facility to fund 85 percent of each
aircraft's purchase price. This facility is guaranteed by various European
Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90
percent on these aircraft depending on the delivery date of the aircraft.
Through June 30, 2001, ILFC borrowed $2.5 billion under this facility.
Borrowings with respect to this facility are included in Notes and Bonds Payable
in the accompanying table of borrowings.
The proceeds of ILFC's debt financing are primarily used to purchase flight
equipment, including progress payments during the construction phase. The
primary sources for the repayment of this debt and the interest expense thereon
are the cash flow from operations, proceeds from the sale of flight equipment
and the rollover and refinancing of the prior debt. (See also the discussions
under "Operational Review" and "Liquidity" herein.)
During the first six months of 2001, AIG issued $129 million principal
amount of Medium Term Notes and $55 million of previously issued notes matured.
At June 30, 2001, AIG had $652 million in aggregate principal amount of debt
securities registered for issuance from time to time.
AIG's capital funds increased $3.04 billion during the first six months of
2001. Unrealized appreciation of investments, net of taxes increased $149
million. During the first six months of 2001, the cumulative translation
adjustment loss, net of taxes, increased $245 million. The change from period to
period with respect to the unrealized appreciation of investments, net of taxes
was primarily impacted by the decline in domestic interest rates. The transfer
of bonds in the held to maturity, at amortized cost category to the bonds
available for sale, at market value category in accordance with the transition
provisions of FASB 133 resulted in a gain of $339 million recorded in the
statement of comprehensive income as a cumulative effect of an accounting change
adjustment. (See also the discussion under "Operational Review" and "Liquidity"
herein.) At June 30, 2001, capital funds included a cumulative effect of an
accounting
23
25
change adjustment gain of $179 million. During the first six months of 2001,
there was a loss of $142 million, net of taxes relating to derivative contracts
designated as cash flow hedging instruments. (See also the discussion under
Notes to Financial Statements and the Consolidated Statement of Comprehensive
Income.) During the first six months of 2001, retained earnings increased $2.99
billion, resulting from net income less dividends.
During the period from January 2001 through June 30, 2001, AIG repurchased
in the open market 2,795,000 shares of its common stock. AIG intends to continue
to buy its common shares in the open market for general corporate purposes,
including to satisfy its obligations under various employee benefit plans.
Payments of dividends to AIG by its insurance subsidiaries are subject to
certain restrictions imposed by statutory authorities. AIG has in the past
reinvested most of its unrestricted earnings in its operations and believes such
continued reinvestment in the future will be adequate to meet any foreseeable
capital needs. However, AIG may choose from time to time to raise additional
funds through the issuance of additional securities. At June 30, 2001, there
were no significant statutory or regulatory issues which would impair AIG's
financial condition, results of operations or liquidity. To AIG's knowledge, no
AIG company is on any regulatory or similar "watch list". (See also the
discussion under "Liquidity" herein.)
AIG's insurance subsidiaries, in common with other insurers, are subject to
regulation and supervision by the states and jurisdictions in which they do
business. The National Association of Insurance Commissioners (NAIC) has
developed Risk-Based Capital (RBC) requirements. RBC relates an individual
insurance company's statutory surplus to the risk inherent in its overall
operations. At June 30, 2001, the adjusted capital of each of AIG's domestic
general companies and of each of AIG's domestic life companies exceeded each of
their RBC standards by considerable margins.
A substantial portion of AIG's general insurance business and a majority of
its life insurance business are conducted in foreign countries. The degree of
regulation and supervision in foreign jurisdictions varies from minimal in some
to stringent in others. Generally, AIG, as well as the underwriting companies
operating in such jurisdictions, must satisfy local regulatory requirements.
Licenses issued by foreign authorities to AIG subsidiaries are subject to
modification and revocation. Thus, AIG's insurance subsidiaries could be
prevented from conducting future business in certain of the jurisdictions where
they currently operate. AIG's international operations include operations in
various developing nations. Both current and future foreign operations could be
adversely affected by unfavorable political developments up to and including
nationalization of AIG's operations without compensation. Adverse effects
resulting from any one country may impact AIG's results of operations, liquidity
and financial condition depending on the magnitude of the event and AIG's net
financial exposure at that time in that country.
LIQUIDITY
AIG's liquidity is primarily derived from the operating cash flows of its
general and life insurance operations.
At June 30, 2001, AIG's consolidated invested assets included $6.54 billion
of cash and short-term investments. Consolidated net cash provided from
operating activities in the first six months of 2001 amounted to $1.48 billion.
Sources of funds considered in meeting the objectives of AIG's financial
services operations include guaranteed investment agreements, issuance of long
and short-term debt, maturities and sales of securities available for sale,
securities sold under repurchase agreements, trading liabilities, securities and
spot commodities sold but not yet purchased, issuance of equity, and cash
provided from such operations. AIG's strong capital position is integral to
managing this liquidity, as it enables AIG to raise funds in diverse markets
worldwide. (See also the discussions under "Capital Resources" herein.)
Management believes that AIG's liquid assets, its net cash provided by
operations, and access to the capital markets will enable it to meet any
foreseeable cash requirements.
The liquidity of the combined insurance operations is derived both
domestically and abroad. The combined insurance operating cash flow is derived
from two sources, underwriting operations and investment operations. In the
aggregate, AIG's insurance operations generated approximately $10.2 billion in
pre-tax cash flow during the first six months of 2001. Cash flow includes
periodic pre-
24
26
mium collections, including policyholders' contract deposits, paid loss
recoveries less reinsurance premiums, losses, benefits, acquisition and
operating expenses. Generally, there is a time lag from when premiums are
collected and, when as a result of the occurrence of events specified in the
policy, the losses and benefits are paid. AIG's insurance investment operations
generated approximately $5.2 billion in investment income cash flow during the
first six months of 2001. Investment income cash flow is primarily derived from
interest and dividends received and includes realized capital gains net of
realized capital losses.
In addition to the combined insurance pre-tax operating cash flow, AIG's
insurance operations held $5.91 billion in cash and short-term investments at
June 30, 2001. The aforementioned operating cash flow and the cash and
short-term balances held provided AIG's insurance operations with a significant
amount of liquidity.
This liquidity is available, among other things, to purchase high quality
and diversified fixed income securities and to a lesser extent marketable equity
securities and to provide mortgage loans on real estate, policy loans and
collateral loans. This cash flow coupled with proceeds of approximately $22
billion from the maturities, sales and redemptions of fixed income securities
and from the sale of equity securities was used to purchase approximately $30
billion of fixed income securities and marketable equity securities during the
first six months of 2001.
The following table is a summary of AIG's invested assets by significant
segment, including investment income due and accrued of $2.42 billion at both
June 30, 2001 and December 31, 2000 and real estate of $1.85 billion and $1.87
billion, at June 30, 2001 and December 31, 2000, respectively:
(dollars in millions)
--------------------------------------------------------------------------------
JUNE 30, 2001 December 31, 2000
----------------------- -----------------------
INVESTED PERCENT INVESTED PERCENT
ASSETS OF TOTAL ASSETS OF TOTAL
-------------------------------------------------------------------------------------------------------------------------
General insurance $ 43,401 18.0% $ 42,892 19.6%
Life insurance 112,791 46.7 98,711 45.0
Financial services and asset management 84,388 34.9 76,748 35.0
Other 891 0.4 831 0.4
-------------------------------------------------------------------------------------------------------------------------
Total $241,471 100.0% $219,182 100.0%
-------------------------------------------------------------------------------------------------------------------------
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27
INSURANCE INVESTED ASSETS
The following tables summarize the composition of AIG's insurance invested
assets by insurance segment, including investment income due and accrued and
real estate, at June 30, 2001 and December 31, 2000:
(dollars in millions)
------------------------------------------------------------------------------------------------------------------------
PERCENT DISTRIBUTION
GENERAL LIFE PERCENT ---------------------
JUNE 30, 2001 INSURANCE INSURANCE TOTAL OF TOTAL DOMESTIC FOREIGN
------------------------------------------------------------------------------------------------------------------------
Fixed maturities:
Available for sale, at market value(a) $29,763 $ 82,005 $111,768 71.6% 57.7% 42.3%
Equity securities, at market value(b) 4,531 2,210 6,741 4.3 54.7 45.3
Mortgage loans on real estate, policy and
collateral loans 66 10,582 10,648 6.8 57.9 42.1
Short-term investments, including time
deposits, and cash 1,809 4,102 5,911 3.8 45.3 54.7
Real estate 410 1,349 1,759 1.1 15.2 84.8
Investment income due and accrued 563 1,746 2,309 1.5 49.5 50.5
Other invested assets 6,259 10,797 17,056 10.9 76.3 23.7
------------------------------------------------------------------------------------------------------------------------
Total $43,401 $112,791 $156,192 100.0% 58.5% 41.5%
------------------------------------------------------------------------------------------------------------------------
(a)Includes $822 million of bonds trading securities, at market value.
(b)Includes $1.20 billion of non-redeemable preferred stocks, at market value.
(dollars in millions)
--------------------------------------------------------------------------------
Percent Distribution
General Life Percent ---------------------
December 31, 2000 Insurance Insurance Total of Total Domestic Foreign
------------------------------------------------------------------------------------------------------------------------
Fixed maturities:
Available for sale, at market value(a) $18,168 $72,159 $ 90,327 63.8% 51.8% 48.2%
Held to maturity, at amortized cost 11,533 -- 11,533 8.1 100.0 --
Equity securities, at market value(b) 4,666 2,309 6,975 4.9 55.4 44.6
Mortgage loans on real estate, policy and
collateral loans 65 10,563 10,628 7.5 58.6 41.4
Short-term investments, including time
deposits, and cash 1,448 4,066 5,514 3.9 44.8 55.2
Real estate 408 1,359 1,767 1.3 16.6 83.4
Investment income due and accrued 584 1,689 2,273 1.6 46.8 53.2
Other invested assets 6,020 6,566 12,586 8.9 88.3 11.7
------------------------------------------------------------------------------------------------------------------------
Total $42,892 $98,711 $141,603 100.0% 58.9% 41.1%
------------------------------------------------------------------------------------------------------------------------
(a)Includes $846 million of bonds trading securities, at market value.
(b)Includes $1.04 billion of non-redeemable preferred stocks, at market value.
Generally, insurance regulations restrict the types of assets in which an
insurance company may invest.
With respect to fixed maturities, AIG's general strategy is to invest in
high quality securities while maintaining diversification to avoid significant
exposure to issuer, industry and/or country concentrations. With respect to
general insurance, AIG's strategy is to invest in longer duration fixed
maturities to maximize the yields at the date of purchase. With respect to life
insurance, AIG's strategy is to produce cash flows required to meet maturing
insurance liabilities. (See also the discussion under "Operational Review: Life
Insurance Operations" herein.)
The fixed maturity available for sale portfolio is subject to decline in
fair value as interest rates rise. Such declines in fair value are presented as
a component of comprehensive income in unrealized appreciation of investments,
net of taxes.
At June 30, 2001, approximately 58 percent of the fixed maturities
investments were domestic securities. Approximately 35 percent of such domestic
securities were rated AAA. Approximately 12 percent were below investment grade
or not rated.
A significant portion of the foreign insurance fixed income portfolio is
rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar
credit quality rating services are not available in all overseas locations. AIG
annually reviews the credit quality of the foreign portfolio nonrated fixed
income investments, including mortgages. At June 30, 2001, approximately 11
percent of the foreign fixed income investments were either rated AAA or, on the
basis of AIG's internal analysis, were equivalent from a credit standpoint to
securi-
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ties so rated. Approximately 16 percent were below investment grade or not rated
at that date. A large portion of the foreign insurance fixed income portfolio
are sovereign fixed maturity securities supporting the policy liabilities in the
country of issuance.
At June 30, 2001, approximately 18 percent of the fixed maturities
portfolio was collateralized mortgage obligations (CMOs), including commercial
mortgage backed securities. Substantially all of the CMOs were investment grade
and approximately 12 percent of the CMOs were backed by various U.S. government
agencies. CMOs are exposed to interest rate risk as the duration and ultimate
realized yield would be affected by the accelerated prepayments of the
underlying mortgages.
Any fixed income security may be subject to downgrade for a variety of
reasons subsequent to any balance sheet date.
AIG invests in equities for various reasons, including diversifying its
overall exposure to interest rate risk. Equity securities are subject to
declines in fair value. Such declines in fair value are presented in unrealized
appreciation of investments, net of taxes as a component of comprehensive
income.
Mortgage loans on real estate, policy and collateral loans comprised 6.8
percent of AIG's insurance invested assets at June 30, 2001. AIG's insurance
operations' holdings of real estate mortgages amounted to $6.97 billion of which
78.8 percent was domestic. At June 30, 2001, only a nominal amount were in
default. It is AIG's practice to maintain a maximum loan to value ratio of 75
percent at loan origination. At June 30, 2001, AIG's insurance holdings of
collateral loans amounted to $815 million, all of which were foreign. It is
AIG's strategy to enter into mortgage and collateral loans as an adjunct
primarily to life insurance fixed maturity investments. AIG's policy loans
decreased from $3.03 billion at December 31, 2000 to $2.86 billion at June 30,
2001.
Short-term investments represent amounts invested in various internal and
external money market funds, time deposits and cash held.
AIG's real estate investment properties are primarily occupied by AIG's
various operations. The current market value of these properties considerably
exceeds their carrying value.
Other invested assets were primarily comprised of both foreign and domestic
private placements, limited partnerships and outside managed funds.
When permitted by regulatory authorities and when deemed necessary to
protect insurance assets, including invested assets, from adverse movements in
foreign currency exchange rates, interest rates and equity prices, AIG and its
insurance subsidiaries may enter into derivative transactions as end users. To
date, such activities have not been significant. (See also the discussion under
"Derivatives" herein.)
In certain jurisdictions, significant regulatory and/or foreign
governmental barriers exist which may not permit the immediate free flow of
funds between insurance subsidiaries or from the insurance subsidiaries to AIG
parent. These barriers generally cause only minor delays in the outward
remittance of the funds.
AIG's insurance operations are exposed to market risk. Market risk is the
risk of loss of fair value resulting from adverse fluctuations in interest and
foreign currency exchange rates and equity prices.
Measuring potential losses in fair values has recently become the focus of
risk management efforts by many companies. Such measurements are performed
through the application of various statistical techniques. One such technique is
Value at Risk (VaR). VaR is a summary statistical measure that uses historical
interest and foreign currency exchange rates and equity prices and estimates the
volatility and correlation of each of these rates and prices to calculate the
maximum loss that could occur over a defined period of time given a certain
probability.
AIG believes that statistical models alone do not provide a reliable method
of monitoring and controlling market risk. While VaR models are relatively
sophisticated, the quantitative market risk information generated is limited by
the assumptions and parameters established in creating the related models.
Therefore, such models are tools and do not substitute for the experience or
judgment of senior management.
AIG has performed a VaR analysis to estimate the maximum potential loss of
fair value for each of AIG's insurance segments and for each market risk within
each insurance segment. In this analysis, financial instrument assets include
the domestic and
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29
foreign invested assets excluding real estate and investment income due and
accrued. Financial instrument liabilities include reserve for losses and loss
expenses, reserve for unearned premiums, future policy benefits for life and
accident and health insurance contracts and policyholders' funds.
Due to the nature of each insurance segment, AIG manages the general and
life insurance operations separately. As a result, AIG manages separately the
invested assets of each. Accordingly, the VaR analysis was separately performed
for the general and the life insurance operations.
AIG calculated the VaR with respect to the net fair value of each of AIG's
insurance segments as of June 30, 2001 and December 31, 2000. AIG's methodology
for calculating VaR and the results of the calculations presented herein were
performed using historical simulation. Using historical simulation over the
delta-normal approach does not significantly change the results of this
disclosure. The historical simulation methodology entails re-pricing all assets
and liabilities under explicit changes in market rates within a specific
historical time period. In this case, the most recent three years of historical
market information for interest rates, foreign exchange rates, and equity index
prices were used to construct the historical scenarios. For each scenario, each
transaction was re-priced. Portfolio, business unit and finally AIG-wide
scenario values were then calculated by netting the values of all the underlying
assets and liabilities. The final VaR number represents the maximum potential
loss incurred by these scenarios with 95% confidence (i.e., only 5% of
historical scenarios show losses greater than the VaR figure). A one month
holding period was assumed in computing the VaR figure.
The following table presents the VaR on a combined basis and of each
component of market risk for each of AIG's insurance segments as of June 30,
2001 and December 31, 2000. VaR with respect to combined operations cannot be
derived by aggregating the individual risk or segment amounts presented herein.
(in millions)
--------------------------------------------------------------------------------
GENERAL INSURANCE LIFE INSURANCE
----------------- ---------------------
MARKET RISK 2001 2000 2001 2000
--------------------------------------------------------------------------------------------------------------------
Combined $837 $744 $1,230 $1,162
Interest rate 460 454 1,188 1,119
Currency 44 59 183 373
Equity 812 603 266 293
--------------------------------------------------------------------------------------------------------------------
The following table presents the average, high and low VaRs on a combined
basis and of each component of market risk for each of AIG's insurance segments
as of June 30, 2001 and December 31, 2000.
(in millions)
--------------------------------------------------------------------------------
2001 2000
--------------------------- ---------------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
---------------------------------------------------------------------------------------------------------------------
GENERAL INSURANCE
Market Risk
Combined $ 799 $ 837 $ 744 $ 811 $ 954 $ 737
Interest rate 459 464 454 419 454 338
Currency 51 59 44 49 65 29
Equity 740 812 603 694 828 603
LIFE INSURANCE
Market Risk
Combined $1,144 $1,230 $1,041 $1,157 $1,211 $1,105
Interest rate 1,129 1,188 1,081 1,094 1,206 950
Currency 273 373 183 430 566 372
Equity 283 293 266 315 396 293
---------------------------------------------------------------------------------------------------------------------
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30
FINANCIAL SERVICES AND ASSET MANAGEMENT INVESTED ASSETS
The following table is a summary of the composition of AIG's financial
services and asset management invested assets at June 30, 2001 and December 31,
2000. (See also the discussions under "Operational Review: Financial Services
Operations", "Operational Review: Asset Management Operations", "Capital
Resources" and "Derivatives" herein.)
(dollars in millions)
--------------------------------------------------------------------------------
2001 2000
------------------------- -------------------------
INVESTED PERCENT INVESTED PERCENT
ASSETS OF TOTAL ASSETS OF TOTAL
-----------------------------------------------------------------------------------------------------------------------------
Flight equipment primarily under operating leases, net of
accumulated depreciation $21,674 25.7% $19,325 25.2%
Unrealized gain on interest rate and currency swaps,
options and forward transactions 10,746 12.7 10,235 13.3
Securities available for sale, at market value 17,027 20.2 14,669 19.1
Trading securities, at market value 6,523 7.7 7,347 9.6
Securities purchased under agreements to resell, at
contract value 17,692 21.0 14,979 19.5
Trading assets 7,503 8.9 7,045 9.2
Spot commodities, at market value 316 0.4 363 0.5
Other, including short-term investments 2,907 3.4 2,785 3.6
-----------------------------------------------------------------------------------------------------------------------------
Total $84,388 100.0% $76,748 100.0%
-----------------------------------------------------------------------------------------------------------------------------
As previously discussed, the cash used for the purchase of flight equipment
is derived primarily from the proceeds of ILFC's debt financings. The primary
sources for the repayment of this debt and the interest expense thereon are the
cash flow from operations, proceeds from the sale of flight equipment and the
rollover and refinancing of the prior debt. During the first six months of 2001,
ILFC acquired flight equipment costing $2.80 billion.
ILFC is exposed to market risk and the risk of loss of fair value resulting
from adverse fluctuations in interest rates. As of June 30, 2001 and December
31, 2000, AIG statistically measured the aforementioned loss of fair value
through the application of a VaR model. In this analysis, the net fair value of
ILFC was determined using the financial instrument assets which included the tax
adjusted future flight equipment lease revenue and the financial instrument
liabilities which included the future servicing of the current debt. The
estimated impact of the current derivative positions was also taken into
account.
AIG calculated the VaR with respect to the net fair value of ILFC using the
variance-covariance (delta-normal) methodology. This calculation also used daily
historical interest rates for the two years ending June 30, 2001 and December
31, 2000. The VaR model estimated the volatility of each of these interest rates
and the correlation among them. The yield curve was constructed using eleven key
points on the curve to model possible curve movements. Thus, the VaR measured
the sensitivity of the assets and liabilities to the calculated interest rate
exposures. These sensitivities were then applied to a database, which contained
the historical ranges of movements in interest rates and the correlation among
them. The results were aggregated to provide a single amount that depicts the
maximum potential loss in fair value of a confidence level of 95 percent for a
time period of one month. As of June 30, 2001 and December 31, 2000, the VaR
with respect to the aforementioned net fair value of ILFC was approximately $8
million and $11 million, respectively.
AIGFP's derivative transactions are carried at market value or at estimated
fair value when market prices are not readily available. AIGFP reduces its
economic risk exposure through similarly valued offsetting transactions
including swaps, trading securities, options, forwards and futures. The
estimated fair values of these transactions represent assessments of the present
value of expected future cash flows. These transactions are exposed to liquidity
risk if AIGFP were to sell or close out the transactions prior to maturity. AIG
believes that the impact of any such limited liquidity would not be significant
to AIG's financial condition or its overall liquidity. (See also the discussion
under "Operational Review: Financial Services Operations" and "Derivatives"
herein.)
AIGFP uses the proceeds from the issuance of notes and bonds and GIA
borrowings to invest in a diversified portfolio of securities, including
securities available for sale, at market, and derivative transactions. The funds
may also be temporarily
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31
invested in securities purchased under agreements to resell. The proceeds from
the disposal of the aforementioned securities available for sale and securities
purchased under agreements to resell have been used to fund the maturing GIAs or
other AIGFP financings. (See also the discussion under "Capital Resources"
herein.)
Securities available for sale is mainly a portfolio of debt securities,
where the individual securities have varying degrees of credit risk. At June 30,
2001, the average credit rating of this portfolio was AA or the equivalent
thereto as determined through rating agencies or internal review. AIGFP has also
entered into credit derivative transactions to hedge its credit risk associated
with $182 million of these securities. There were no securities deemed below
investment grade at June 30, 2001. There have been no significant downgrades
through August 1, 2001. Securities purchased under agreements to resell are
treated as collateralized transactions. AIGFP takes possession of or obtains a
security interest in securities purchased under agreements to resell. AIGFP
further minimizes its credit risk by monitoring counterparty credit exposure
and, when AIGFP deems necessary, it requires additional collateral to be
deposited. Trading securities, at market value are marked to market daily and
are held to meet the short-term risk management objectives of AIGFP.
AIGTG conducts, as principal, market making and trading activities in
foreign exchange, interest rates and precious and base metals. AIGTG owns
inventories in the commodities in which it trades and may reduce the exposure to
market risk through the use of swaps, forwards, futures and option contracts.
AIGTG uses derivatives to manage the economic exposure of its various trading
positions and transactions from adverse movements of interest rates, foreign
currency exchange rates and commodity prices. AIGTG supports its trading
activities largely through trading liabilities, unrealized losses on swaps,
short-term borrowings, securities sold under agreements to repurchase and
securities and commodities sold but not yet purchased. (See also the discussions
under "Capital Resources" and "Derivatives" herein.)
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG
included in the financial services assets and liabilities at June 30, 2001 were
as follows:
(in millions)
--------------------------------------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED
GAINS LOSSES
--------------------------------------------------------------------------------------
Securities available for sale, at market value $ 846 $ 814
Unrealized gain/loss on interest rate and currency swaps,
options and forward transactions(a)(b) 10,746 7,948
Trading assets 8,010 6,178
Spot commodities, at market value 28 --
Trading liabilities -- 2,303
Securities and spot commodities sold but not yet purchased, 505 --
at market value
--------------------------------------------------------------------------------------
(a)These amounts are also presented as the respective balance sheet amounts.
(b)At June 30, 2001, AIGTG's replacement values with respect to interest rate
and currency swaps were $410 million.
AIGFP's interest rate and currency risks on securities available for sale,
at market, are managed by taking offsetting positions on a security by security
basis, thereby offsetting a significant portion of the unrealized appreciation
or depreciation. At June 30, 2001, the unrealized gains and losses remaining
after the benefit of the offsets were $51 million and $19 million, respectively.
Trading securities, at market value, and securities and spot commodities
sold but not yet purchased, at market value are marked to market daily with the
unrealized gain or loss being recognized in income at that time. These
securities and positions are held to meet the short-term risk management
objectives of AIGFP and AIGTG.
The senior management of AIG defines the policies and establishes general
operating parameters for AIGFP and AIGTG. AIG's senior management has
established various oversight committees to review the various financial market,
operational and credit issues of AIGFP and AIGTG. The senior managements of
AIGFP and AIGTG report the results of their respective operations to and review
future strategies with AIG's senior management.
AIG actively manages the exposures to limit potential losses, while
maximizing the rewards afforded by these business opportunities. In doing so,
AIG must continually manage a variety of exposures including credit, market,
liquidity, operational and legal risks.
30
32
Market risk arises principally from the uncertainty that future earnings
are exposed to potential changes in volatility, interest rates, foreign currency
exchange rates, and equity and commodity prices. AIG generally controls its
exposure to market risk by taking offsetting positions. AIG's philosophy with
respect to its financial services operations is to minimize or set limits for
open or uncovered positions that are to be carried. Credit risk exposure is
separately managed. (See the discussion on the management of credit risk below.)
AIG's Market Risk Management Department provides detailed independent
review of AIG's market exposures, particularly those market exposures of AIGFP
and AIGTG. This department determines whether AIG's market risks, as well as
those market risks of individual subsidiaries, are within the parameters
established by AIG's senior management. Well established market risk management
techniques such as sensitivity analysis are used. Additionally, this department
verifies that specific market risks of each of certain subsidiaries are managed
and hedged by that subsidiary.
AIGFP is exposed to market risk due to changes in the level and volatility
of interest rates and the shape and slope of the yield curve. AIGFP hedges its
exposure to interest rate risk by entering into transactions such as interest
rate swaps and options and purchasing U.S. and foreign government obligations.
AIGFP is exposed to market risk due to changes in and volatility of foreign
currency exchange rates. AIGFP hedges its foreign currency exchange risk
primarily through the use of currency swaps, options, forwards and futures.
AIGFP is exposed to market risk due to changes in the level and volatility
of equity prices which affect the value of securities or instruments that derive
their value from a particular stock, a basket of stocks or a stock index. AIGFP
reduces the risk of loss inherent in its inventory in equity securities by
entering into hedging transactions, including equity swaps and options and
purchasing U.S. and foreign government obligations.
AIGFP does not seek to manage the market risk of each of its transactions
through an individual offsetting transaction. Rather, AIGFP takes a portfolio
approach to the management of its market risk exposure. AIGFP values its
portfolio at market value or estimated fair value when market values are not
readily available. These valuations represent an assessment of the present
values of expected future cash flows of AIGFP's transactions and may include
reserves for such risks as are deemed appropriate by AIGFP's and AIG's
management. AIGFP evaluates the portfolio's discounted cash flows with reference
to current market conditions, maturities within the portfolio and other relevant
factors. Based upon this evaluation, AIGFP determines what, if any, offsetting
transactions are necessary to reduce the market risk exposure of the portfolio.
The aforementioned estimated fair values are based upon the use of
valuation models. These models utilize, among other things, current interest,
foreign exchange and volatility rates. These valuation models are integrated
into the evaluation of the portfolio, as described above, in order to provide
timely information for the market risk management of the portfolio.
Additionally, depending upon the changes in interest rates and other market
movements during the day, the system will produce reports for management's
consideration for intra-day offsetting positions. Overnight, the system
generates reports which recommend the types of offsets management should
consider for the following day. Additionally, AIGFP operates in major business
centers overseas and is essentially open for business 24 hours a day. Thus, the
market exposure and offset strategies are monitored, reviewed and coordinated
around the clock. Therefore, offsetting adjustments can be made as and when
necessary from any AIGFP office in the world.
As part of its monitoring and controlling of its exposure to market risk,
AIGFP applies various testing techniques which reflect potential market
movements. These techniques vary by currency and are regularly changed to
reflect factors affecting the derivatives portfolio. In addition to the daily
monitoring, AIGFP's senior management and local risk managers conduct a weekly
review of the derivatives portfolio and existing hedges. This review includes an
examination of the portfolio's risk measures, such as aggregate option
sensitivity to movements in market variables. AIGFP's management may change
these measures to reflect their judgment and evaluation of the dynamics of the
markets. This management group will also determine whether additional or
alternative action is required in order to manage the portfolio.
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33
All of AIGTG's market risk sensitive instruments are entered into for
trading purposes. The fair values of AIGTG's financial instruments are exposed
to market risk as a result of adverse market changes in interest rates, foreign
currency exchange rates, commodity prices and adverse changes in the liquidity
of the markets in which AIGTG trades.
AIGTG's approach to managing market risk is to establish an appropriate
offsetting position to a particular transaction or group of transactions
depending upon the extent of market risk AIGTG expects to reduce.
AIGTG's senior management has established positions and stop-loss limits
for each line of business. AIGTG's traders are required to maintain positions
within these limits. These positions are monitored during the day either
manually and/or through on-line computer systems. In addition, these positions
are reviewed by AIGTG's management. Reports which present each trading books
position and the prior day's profit and loss are reviewed by traders, head
traders and AIGTG's senior management. Based upon these and other reports,
AIGTG's senior management may determine to adjust AIGTG's risk profile.
AIGTG attempts to secure reliable current market prices, such as published
prices or third party quotes, to value its derivatives. Where such prices are
not available, AIGTG uses an internal methodology which includes interpolation
or extrapolation from verifiable prices nearest to the dates of the
transactions. The methodology may reflect interest and exchange rates, commodity
prices, volatility rates and other relevant factors.
A significant portion of AIGTG's business is transacted in liquid markets.
Certain of AIGTG's derivative product exposures are evaluated using simulation
techniques which consider such factors as changes in currency and commodity
prices, interest rates, volatility levels and the effect of time.
AIGFP and AIGTG are both exposed to the risk of loss of fair value from
adverse fluctuations in interest rate and foreign currency exchange rates and
equity and commodity prices. AIG statistically measured the losses of fair value
through the application of a VaR model. AIG separately calculated the VaR with
respect to AIGFP and AIGTG, as AIG manages these operations separately.
AIGFP's and AIGTG's asset and liability portfolios for which the VaR
analyses were performed included over the counter and exchange traded
investments, derivative instruments and commodities. Since the market risk with
respect to securities available for sale, at market is substantially hedged,
segregation of market sensitive instruments into trading and other than trading
was not deemed necessary.
AIG calculated the VaR with respect to AIGFP and AIGTG as of June 30, 2001
and December 31, 2000. AIG's methodology for calculating VaR and the results of
the calculations presented herein were performed using historical simulation.
Using historical simulation over the delta-normal approach does not
significantly change the results of this disclosure. The historical simulation
methodology entails re-pricing all assets and liabilities under explicit changes
in market rates within a specific historical time period. In this case, the most
recent three years of historical market information for interest rates, foreign
exchange rates, and equity index prices were used to construct the historical
scenarios. For each scenario, each transaction was re-priced. Portfolio,
business unit and finally AIG-wide scenario values were then calculated by
netting the values of all the underlying assets and liabilities. The final VaR
number represents the maximum potential loss incurred by these scenarios with
95% confidence (i.e., only 5% of historical scenarios show losses greater than
the VaR figure).
The following table presents the VaR on a combined basis and of each
component of AIGFP's and AIGTG's market risk as of June 30, 2001 and December
31, 2000. VaR with respect to combined operations cannot be derived by
aggregating the individual risk presented herein.
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(in millions)
--------------------------------------------------------------------------------
AIGFP(A) AIGTG(B)
------------ ------------
MARKET RISK 2001 2000 2001 2000
------------------------------------------------------------------------------------------
Combined $12 $15 $2 $6
Interest rate 11 15 2 4
Currency -- -- 2 3
Equity/Commodity 1 -- -- --
------------------------------------------------------------------------------------------
(a)A one month holding period was used to measure the market exposures of AIGFP.
(b)A one day holding period was used to measure the market exposures of AIGTG.
The following table presents the average, high and low VaRs on a combined
basis and of each component of AIGFP's and AIGTG's market risk as of June 30,
2001 and December 31, 2000.
(in millions)
--------------------------------------------------------------------------------
2001 2000
---------------------- ----------------------
AVERAGE HIGH LOW AVERAGE HIGH LOW
--------------------------------------------------------------------------------------------------------------
AIGFP MARKET RISK:
Combined $12 $15 $10 $15 $24 $8
Interest rate 12 15 10 15 23 7
Currency -- 1 -- -- -- --
Equity/Commodity 1 1 -- 1 2 --
AIGTG MARKET RISK:
Combined $ 4 $ 6 $2 $ 5 $ 6 $4
Interest Rate 3 4 2 3 4 3
Currency 2 3 1 3 4 2
--------------------------------------------------------------------------------------------------------------
DERIVATIVES
Derivatives are financial arrangements among two or more parties whose
returns are linked to or "derived" from some underlying equity, debt, commodity
or other asset, liability, or index. Derivatives payments may be based on
interest rates and exchange rates and/or prices of certain securities, certain
commodities, or financial or commodity indices. The more significant types of
derivative arrangements in which AIG transacts are swaps, forwards, futures,
options and related instruments.
The most commonly used swaps are interest rate swaps, currency swaps,
equity swaps and swaptions. Such derivatives are traded over the counter. An
interest rate swap is a contract between two parties to exchange interest rate
payments (typically a fixed interest rate versus a variable interest rate)
calculated on a notional principal amount for a specified period of time. The
notional amount is not exchanged. Currency and equity swaps are similar to
interest rate swaps but may involve the exchange of principal amounts at the
commencement and termination of the swap. Swaptions are options where the holder
has the right but not the obligation to enter into a swap transaction or cancel
an existing swap transaction.
A futures or forward contract is a legal contract between two parties to
purchase or sell at a specified future date a specified quantity of a commodity,
security, currency, financial index or other instrument, at a specified price. A
futures contract is traded on an exchange, while a forward contract is executed
over the counter.
Over the counter derivatives are not transacted in an exchange traded
environment. The futures exchanges maintain considerable financial requirements
and surveillance to ensure the integrity of exchange traded futures and options.
An option contract generally provides the option purchaser with the right
but not the obligation to buy or sell during a period of time or at a specified
date the underlying instrument at a set price. The option writer is obligated to
sell or buy the underlying item if the option purchaser chooses to exercise his
right. The option writer receives a nonrefundable fee or premium paid by the
option purchaser. Options may be traded over the counter or on an exchange.
Derivatives are generally either negotiated over the counter contracts or
standardized contracts executed on an exchange. Standardized exchange traded
derivatives include futures and options which can be readily bought or sold over
recognized security or commodity exchanges and settled daily through such
clearing houses. Negotiated over the counter derivatives include forwards, swaps
and options. Over the counter derivatives are generally not traded like exchange
traded securities and the terms
33
35
of over the counter derivatives are non-standard and unique to each contract.
However, in the normal course of business, with the agreement of the original
counterparty, these contracts may be terminated early or assigned to another
counterparty.
All significant derivatives activities are conducted through AIGFP and
AIGTG permitting AIG to participate in the derivatives dealer market acting
primarily as principal. In these derivative operations, AIG structures
agreements which generally allow its counterparties to enter into transactions
with respect to changes in interest and exchange rates, securities' prices and
certain commodities and financial or commodity indices. Generally, derivatives
are used by AIG's customers such as corporations, financial institutions,
multinational organizations, sovereign entities, government agencies and
municipalities. For example, a futures, forward or option contract can be used
to protect the customers' assets or liabilities against price fluctuations.
A counterparty may default on any obligation to AIG, including a derivative
contract. Credit risk is a consequence of extending credit and/or carrying
trading and investment positions. Credit risk exists for a derivative contract
when that contract has an estimated positive fair value. To help manage this
risk, the credit departments of AIGFP and AIGTG operate within the guidelines of
the AIG Credit Risk Committee, which sets credit policy and limits for
counterparties and provides limits for derivative transactions with
counterparties having different credit ratings. In addition to credit ratings,
this committee takes into account other factors, including the industry and
country of the counterparty. Transactions which fall outside these
pre-established guidelines require the approval of the AIG Credit Risk
Committee. It is also AIG's policy to establish reserves for potential credit
impairment when necessary.
AIGFP and AIGTG determine the credit quality of each of their
counterparties taking into account credit ratings assigned by recognized
statistical rating organizations. If it is determined that a counterparty
requires credit enhancement, then one or more enhancement techniques will be
used. Examples of such enhancement techniques include letters of credit,
guarantees, collateral credit triggers and credit derivatives and margin
agreements.
A significant majority of AIGFP's transactions are contracted and
documented under ISDA Master Agreements. Management believes that such
agreements provide for legally enforceable set-off in the event of default.
Also, under such agreements, in connection with a counterparty desiring to
terminate a contract prior to maturity, AIGFP may be permitted to set-off its
receivables from that counterparty against AIGFP's payables to that same
counterparty arising out of all included transactions. Excluding regulated
exchange transactions, AIGTG, whenever possible, enters into netting agreements
with its counterparties which are similar in effect to those discussed above.
The following tables provide the notional and contractual amounts of
AIGFP's and AIGTG's derivatives transactions at June 30, 2001 and December 31,
2000.
The notional amounts used to express the extent of AIGFP's and AIGTG's
involvement in swap transactions represent a standard of measurement of the
volume of AIGFP's and AIGTG's swaps business. Notional amount is not a
quantification of market risk or credit risk and it may not necessarily be
recorded on the balance sheet. Notional amounts represent those amounts used to
calculate contractual cash flows to be exchanged and are not paid or received,
except for certain contracts such as currency swaps.
The timing and the amount of cash flows relating to AIGFP's and AIGTG's
foreign exchange forwards and exchange traded futures and options contracts are
determined by each of the respective contractual agreements.
The net replacement value most closely represents the net credit risk to
AIGFP or the maximum amount exposed to potential loss after the application of
the aforementioned strategies, netting under ISDA Master Agreements and applying
collateral held. Prior to the application of these credit enhancements, the
gross credit risk with respect to these derivative instruments was $51.1 billion
at June 30, 2001 and $33.4 billion at December 31, 2000. Subsequent to the
application of such credit enhancements, the net exposure to credit risk or the
net replacement value of all interest rate, currency and equity swaps, swaptions
and forward commitments approximated $10.07 billion at June 30, 2001 and $9.51
billion at December 31, 2000. The net replacement value for futures and forward
contracts approximated $185 million at June 30, 2001 and $204 million at
December 31, 2000. The net replacement value most closely represents the net
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credit risk to AIGFP or the maximum amount exposed to potential loss.
The following table presents AIGFP's derivatives portfolio by maturity and
type of derivative at June 30, 2001 and December 31, 2000:
(in millions)
--------------------------------------------------------------------------------
REMAINING LIFE
----------------------------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 2001 2000
--------------------------------------------------------------------------------------------------------------------------
Interest rate, currency and equity/commodity swaps
and swaptions:
Notional amount:
Interest rate swaps $ 75,278 $195,884 $ 89,281 $ 9,518 $369,961 $344,203
Currency swaps 29,711 51,959 34,220 4,970 120,860 117,792
Swaptions and equity swaps 15,103 26,040 10,900 3,770 55,813 59,026
--------------------------------------------------------------------------------------------------------------------------
Total $120,092 $273,883 $134,401 $18,258 $546,634 $521,021
--------------------------------------------------------------------------------------------------------------------------
Futures and forward contracts:
Exchange traded futures contracts contractual
amount $ 8,624 -- -- -- $ 8,624 $ 11,082
--------------------------------------------------------------------------------------------------------------------------
Over the counter forward contracts contractual
amount $ 47,337 $ 471 $ 189 -- $ 47,997 $ 22,809
--------------------------------------------------------------------------------------------------------------------------
AIGFP determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At June 30, 2001 and December
31, 2000, the counterparty credit quality by derivative product with respect to
the net replacement value of AIGFP's derivatives portfolio was as follows:
(in millions)
--------------------------------------------------------------------------------
NET REPLACEMENT VALUE
-----------------------------
SWAPS AND FUTURES AND TOTAL TOTAL
SWAPTIONS FORWARD CONTRACTS 2001 2000
--------------------------------------------------------------------------------------------------------------
Counterparty credit quality:
AAA $ 3,742 $ 15 $ 3,757 $3,778
AA 3,198 139 3,337 2,825
A 2,097 29 2,126 1,801
BBB 926 2 928 1,059
Below investment grade 110 -- 110 252
--------------------------------------------------------------------------------------------------------------
Total $10,073 $185 $10,258 $9,715
--------------------------------------------------------------------------------------------------------------
At June 30, 2001 and December 31, 2000, the counterparty breakdown by
industry with respect to the net replacement value of AIGFP's derivatives
portfolio was as follows:
(in millions)
--------------------------------------------------------------------------------
NET REPLACEMENT VALUE
-----------------------------
SWAPS AND FUTURES AND TOTAL TOTAL
SWAPTIONS FORWARD CONTRACTS 2001 2000
--------------------------------------------------------------------------------------------------------------
Non-U.S. banks $ 2,543 $ 68 $ 2,611 $2,517
Insured municipalities 555 -- 555 595
U.S. industrials 2,004 -- 2,004 1,945
Governmental 481 -- 481 463
Non-U.S. financial service companies 426 1 427 309
Non-U.S. industrials 961 15 976 1,372
Special purpose 1,476 -- 1,476 1,204
U.S. banks 204 99 303 220
U.S. financial service companies 1,132 2 1,134 894
Supranationals 291 -- 291 196
--------------------------------------------------------------------------------------------------------------
Total $10,073 $185 $10,258 $9,715
--------------------------------------------------------------------------------------------------------------
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The gross replacement values presented in the following table represent the
sum of the estimated positive fair values of all of AIGTG's derivatives
contracts at June 30, 2001 and December 31, 2000. These values do not represent
the credit risk to AIGTG.
The net replacement values presented represent the net sum of estimated
positive fair values after the application of legally enforceable master netting
agreements and collateral held. The net replacement values most closely
represent the net credit risk to AIGTG or the maximum amount exposed to
potential loss.
The following table provides the contractual and notional amounts and
credit exposure, if applicable, by maturity and type of derivative of AIGTG's
derivatives portfolio at June 30, 2001 and December 31, 2000. In addition, the
estimated positive fair values associated with the derivatives portfolio are
also provided and include a maturity profile for the June 30, 2001 balances
based upon the expected timing of the future cash flows.
(in millions)
--------------------------------------------------------------------------------
REMAINING LIFE
------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 2001 2000
-------------------------------------------------------------------------------------------------------------------------
Contractual amount of futures, forwards and
options:
Exchange traded futures and options $ 9,329 $ 3,560 $ 20 $-- $ 12,909 $ 18,064
-------------------------------------------------------------------------------------------------------------------------
Forwards $224,936 $17,021 $ 1,675 $-- $243,632 $234,316
-------------------------------------------------------------------------------------------------------------------------
Over the counter purchased options $ 87,242 $20,433 $34,761 $-- $142,436 $104,919
-------------------------------------------------------------------------------------------------------------------------
Over the counter sold options(a) $ 83,757 $21,606 $33,983 $87 $139,433 $103,742
-------------------------------------------------------------------------------------------------------------------------
Notional amount:
Interest rate swaps and forward rate agreements $ 16,754 $34,628 $ 6,978 $85 $ 58,445 $ 63,264
Currency swaps 3,876 5,412 648 -- 9,936 8,573
Swaptions 1,390 13,333 1,311 -- 16,034 15,419
-------------------------------------------------------------------------------------------------------------------------
Total $ 22,020 $53,373 $ 8,937 $85 $ 84,415 $ 87,256
-------------------------------------------------------------------------------------------------------------------------
Credit exposure:
Futures, forwards, swaptions and purchased
options contracts and interest rate and
currency swaps:
Gross replacement value $ 6,277 $ 2,412 $ 981 $ 1 $ 9,671 $ 10,319
Master netting arrangements (3,714) (1,574) (725) (1) (6,014) (6,136)
Collateral (60) (49) (24) -- (133) (107)
-------------------------------------------------------------------------------------------------------------------------
Net replacement value(b) $ 2,503 $ 789 $ 232 $-- $ 3,524 $ 4,076
-------------------------------------------------------------------------------------------------------------------------
(a)Sold options obligate AIGTG to buy or sell the underlying item if the option
purchaser chooses to exercise. The amounts do not represent credit exposure.
(b)The net replacement values with respect to exchange traded futures and
options, forward contracts, and purchased over the counter options are
presented as a component of trading assets in the accompanying balance sheet.
The net replacement values with respect to interest rate and currency swaps
are presented as a component of unrealized gain on interest rate and currency
swaps, options and forward transactions in the accompanying balance sheet.
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AIGTG determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At June 30, 2001 and December
31, 2000, the counterparty credit quality and counterparty breakdown by industry
with respect to the net replacement value of AIGTG's derivatives portfolio were
as follows:
(in millions)
--------------------------------------------------------------------------------
NET REPLACEMENT VALUE
--------------------------
2001 2000
------------------------------------------------------------------------------------------
Counterparty credit quality:
AAA $ 435 $ 442
AA 1,348 1,807
A 1,217 1,139
BBB 238 460
Below investment grade 76 48
Not externally rated, including exchange traded futures
and options* 210 180
------------------------------------------------------------------------------------------
Total $3,524 $4,076
------------------------------------------------------------------------------------------
Counterparty breakdown by industry:
Non-U.S. banks $1,288 $2,076
U.S. industrials 262 67
Governmental 78 70
Non-U.S. financial service companies 308 282
Non-U.S. industrials 404 243
U.S. banks 651 468
U.S. financial service companies 323 690
Exchanges* 210 180
------------------------------------------------------------------------------------------
Total $3,524 $4,076
------------------------------------------------------------------------------------------
* Exchange traded futures and options are not deemed to have significant credit
exposure as the exchanges guarantee that every contract will be properly
settled on a daily basis.
Generally, AIG manages and operates its businesses in the currencies of the
local operating environment. Thus, exchange gains or losses occur when AIG's
foreign currency net investment is affected by changes in the foreign exchange
rates relative to the U.S. dollar from one reporting period to the next.
AIG, through its Foreign Exchange Operating Committee, evaluates each of
its worldwide consolidated foreign currency net asset or liability positions and
manages AIG's translation exposure to adverse movement in currency exchange
rates. AIG may use forward exchange contracts and purchase options where the
cost of such is reasonable and markets are liquid to reduce these exchange
translation exposures. The exchange gain or loss with respect to these hedging
instruments is recorded on an accrual basis as a component of comprehensive
income in capital funds.
As an end user, AIG and its subsidiaries, including its insurance
subsidiaries, use derivatives to aid in managing AIG's foreign exchange
translation exposure. Derivatives may also be used to minimize certain exposures
with respect to AIG's debt financing and its insurance operations; to date, such
activities have not been significant.
AIG has formed a Derivatives Review Committee. This committee, with certain
exceptions, provides an independent review of any proposed derivative
transaction. The committee examines, among other things, the nature and purpose
of the derivative transaction, its potential credit exposure, if any, and the
estimated benefits. This committee does not review those derivative transactions
entered into by AIGFP and AIGTG for their own accounts.
Legal risk arises from the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of AIG's clients and counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the netting of mutual obligations. (See also the discussion on master
netting agreements above.) AIG seeks to eliminate or minimize such uncertainty
through continuous consultation with internal and external legal advisors, both
domestically and abroad, in order to understand the nature of legal risk, to
improve documentation and to strengthen transaction structure.
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ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 133 "Accounting for Derivative
Instruments and Hedging Activities". In June 2000, FASB issued Statement of
Financial Accounting Standards No. 138 "Accounting for Derivative Instruments
and Hedging Activities-an amendment of FASB Statement No. 133" (collectively,
FASB 133).
FASB 133 requires AIG to recognize all derivatives in the consolidated
balance sheet at fair value. The financial statement recognition of the change
in the fair value of a derivative depends on a number of factors, including the
intended use of the derivative and the extent to which the derivative is
effective as part of a hedge transaction. The changes in fair value of the
derivative transactions of AIGFP and AIGTG are currently presented, in all
material respects, as a component of AIG's operating income. The discussion
below relates to the derivative activities of AIG other than those of AIGFP and
AIGTG.
On the date the derivative contract is entered into, AIG designates the
derivative as: (1) a hedge of the subsequent changes in the fair value of a
recognized asset or liability or of an unrecognized firm commitment ("fair
value" hedge); (2) a hedge of a forecasted transaction, or the variability of
cash flows to be received or paid related to a recognized asset or liability
("cash flow" hedge); or (3) a hedge of a net investment in a foreign operation.
Fair value and cash flow hedges may involve foreign currencies ("foreign
currency hedges"). The gain or loss in the fair value of a derivative that is
designated, qualifies and is highly effective as a fair value hedge is recorded
in current period earnings, along with the loss or gain on the hedged item
attributable to the hedged risk. The gain or loss in the fair value of a
derivative that is designated, qualifies and is highly effective as a cash flow
hedge is recorded in other comprehensive income, until earnings are affected by
the variability of cash flows. The gain or loss in the fair value of a
derivative that is designated, qualifies and is highly effective as a hedge of a
net investment in a foreign operation is recorded in the foreign currency
translation adjustments account within other comprehensive income. Changes in
the fair value of derivatives used for other than the above hedging activities
are reported in current period earnings.
AIG documents all relationships between hedging instruments and hedged
items, as well as its risk-management objectives and strategy for undertaking
various hedge transactions. This process includes linking all derivatives that
are designated as hedges to specific assets or liabilities on the balance sheet,
or specific firm commitments or forecasted transactions. AIG also assesses, both
at the hedge's inception and on an ongoing basis, whether the derivatives used
in hedging transactions are highly effective in offsetting changes in fair
values or cash flows of hedged items.
AIG adopted FASB 133 on January 1, 2001. In accordance with the transition
provisions of FASB 133, AIG recorded in its consolidated income statement for
the first six months of 2001 a cumulative effect of an accounting change
adjustment loss of $6 million. This loss represents the net fair value of all
previously unrecorded derivative instruments as of January 1, 2001, net of tax
and after the application of hedge accounting. AIG also recorded in its
consolidated statement of comprehensive income for the first six months of 2001
a cumulative effect of an accounting change adjustment gain of $179 million.
This gain represents the increase in other comprehensive income, net of taxes,
arising from recognizing the fair value of all derivative contracts designated
as cash flow hedging instruments, and to a lesser extent, hedging instruments
used to hedge net investments in foreign operations.
In June 2001, FASB issued Statement of Financial Accounting Standard No.
141 "Business Combinations" (FASB 141). FASB 141 requires AIG to apply the
purchase method of accounting for all acquisitions initiated after June 30,
2001.
In June 2001, FASB issued Statement of Financial Accounting Standard No.
142 "Goodwill and Other Intangible Assets" (FASB 142). FASB 142 requires AIG to
discontinue the amortization of goodwill on its consolidated income statement.
FASB 142 is effective for AIG for the year commencing January 1, 2002.
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In addition, FASB 142 requires goodwill to be subject to an assessment of
impairment on an annual basis, or more frequently if circumstances indicate that
a possible impairment has occurred. As of June 30, 2001, AIG recorded $3.4
billion of goodwill on its consolidated balance sheet. AIG is currently
evaluating the impact of the impairment provisions of FASB 142, and believes
that the impact on its results of operations and financial condition will not be
significant.
RECENT DEVELOPMENTS
On April 20, 2001, AIG announced that the reorganization plan for The
Chiyoda Mutual Life Insurance Company (Chiyoda) had been approved by Japanese
regulatory authorities, and that Chiyoda had become a joint-stock company and
commenced operations as AIG Star Life Insurance Co., Ltd., a wholly owned
subsidiary of AIG.
On May 11, 2001, AIG announced that it has entered into a definitive
agreement to acquire American General Corporation (American General). American
General shareholders will receive $46 per American General share in AIG common
stock, subject to a collar mechanism. The transaction, which has been approved
by the boards of directors of both companies, will be a tax-free reorganization
and will be accounted for using the pooling of interests method. The transaction
values American General at approximately $23 billion. AIG expects to receive the
remaining regulatory approvals for the acquisition in August and plans to close
the transaction as soon as possible thereafter.
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PART II -- OTHER INFORMATION
ITEM 4 -- SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
At the Annual Meeting of Shareholders held on May 16, 2001, the
Shareholders:
(a) elected eighteen directors as follows:
NOMINEE SHARES FOR SHARES WITHHELD
------- ---------- ---------------
M. Bernard Aidinoff................................... 1,980,067,763 81,449,239
Eli Broad............................................. 1,868,919,428 192,597,574
Pei-yuan Chia......................................... 2,037,896,599 23,620,403
Marshall A. Cohen..................................... 2,037,644,738 23,872,264
Barber B. Conable, Jr. ............................... 2,036,370,185 25,146,817
Martin S. Feldstein................................... 2,037,772,118 23,744,884
Ellen V. Futter....................................... 2,037,236,477 24,280,525
Maurice R. Greenberg.................................. 1,865,952,867 195,564,135
Carla A. Hills........................................ 1,983,644,882 77,872,120
Frank J. Hoenemeyer................................... 2,036,078,717 25,438,285
Richard C. Holbrooke.................................. 2,037,357,907 24,159,095
Edward E. Matthews.................................... 1,866,336,703 195,180,299
Howard I. Smith....................................... 1,866,111,986 195,405,016
Thomas R. Tizzio...................................... 1,866,895,588 194,621,414
Edmund S.W. Tse....................................... 1,867,338,373 194,178,629
Jay S. Wintrob........................................ 1,871,185,617 190,331,385
Frank G. Wisner....................................... 1,881,521,965 179,995,037
Frank G. Zarb......................................... 2,037,486,744 24,030,258
(b) approved, by a vote of 2,047,827,223 shares to 6,823,261 shares, with
6,866,518 abstentions, a proposal to select PricewaterhouseCoopers LLP
as independent accountants for 2001;
(c) rejected, by a vote of 542,198,656 shares for and 1,314,478,719 shares
against, with 17,622,728 shares abstaining and 187,216,899 shares not
voting, a shareholder proposal requesting AIG to change the Board
nomination process;
(d) rejected, by a vote of 141,983,177 shares for and 1,709,262,772 shares
against, with 23,054,154 shares abstaining and 187,216,899 shares not
voting, a shareholder proposal requesting AIG to provide a report on
executive compensation; and
(e) rejected, by a vote of 204,422,134 shares for and 1,595,849,105 shares
against, with 74,028,864 shares abstaining and 187,216,899 shares not
voting, a shareholder proposal requesting AIG to distribute certain
statistical data on employees.
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See accompanying Exhibit Index.
(b) Reports on Form 8-K
During the three months ended June 30, 2001, there were two current
reports filed on Form 8-K:
On April 4, 2001, AIG filed a Current Report on Form 8-K (the "April
Form 8-K") which included a copy of the April 3, 2001 press release
announcing that it had offered to acquire American General
Corporation. Also included in the April Form 8-K was a slide prepared
for use by AIG executives in connection with the conference call
announced in the press release.
On May 11, 2001, AIG filed a Current Report on Form 8-K which included
a copy of the May 11, 2001 press release announcing the definitive
agreement to acquire American General Corporation.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERICAN INTERNATIONAL GROUP, INC.
--------------------------------------
(Registrant)
/s/ HOWARD I. SMITH
--------------------------------------
Howard I. Smith
Executive Vice President and
Chief Financial Officer
Dated: August 13, 2001
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EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION LOCATION
------- ----------- --------
2 Plan of acquisition, reorganization, arrangement,
liquidation or succession................................... None
4 Instruments defining the rights of security holders,
including indentures........................................ Not required to be
filed.
10 Material contracts.......................................... None
11 Statement re computation of per share earnings.............. Filed herewith.
12 Statement re computation of ratios.......................... Filed herewith.
15 Letter re unaudited interim financial information........... None
18 Letter re change in accounting principles................... None
19 Report furnished to security holders........................ None
22 Published report regarding matters submitted to vote of
security holders............................................ None
23 Consents of experts and counsel............................. None
24 Power of attorney........................................... None
99 Additional exhibits......................................... None
42