Edgar Filing: AMERICAN INTERNATIONAL GROUP INC

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q


(Mark One)
þ		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the quarterly period ended March 31, 2005
or

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

		For the transition period from to

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 or organization)		(I.R.S. Employer Identification No.)

70 Pine Street, New York, New York (Address of principal executive offices)		10270 (Zip Code)

Registrant’s telephone number, including area code: (212) 770-7000

Former name, former address and former fiscal year, if changed since last report: None

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 ü No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ü No

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of March 31, 2005: 2,594,907,032.

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET

(in millions) (unaudited)


				March 31,		December 31,
				2005		2004


Assets:
	Investments, financial services assets and cash:
		Fixed maturities:
			Bonds available for sale, at market value (amortized cost: 2005 – $338,161; 2004 – $329,838)	$	350,400	$	344,399
			Bonds held to maturity, at amortized cost (market value: 2005 – $21,734; 2004 – $18,791)		21,477		18,294
			Bond trading securities, at market value (cost: 2005 – $3,562; 2004 – $2,973)		3,580		2,984
		Equity securities:
			Common stocks available for sale, at market value (cost: 2005 – $9,220; 2004 – $8,569)		10,896		9,917
			Common stocks trading, at market value (cost: 2005 – $5,947; 2004 – $5,651)		6,379		5,894
			Preferred stocks, at market value (cost: 2005 – $2,272; 2004 – $2,017)		2,280		2,040
		Mortgage loans on real estate, net of allowance (2005 – $62; 2004 – $65)			14,065		13,146
		Policy loans			7,109		7,035
		Collateral and guaranteed loans, net of allowance (2005 – $16; 2004 – $18)			2,261		2,282
		Financial services assets:
			Flight equipment primarily under operating leases, net of accumulated depreciation (2005 – $6,718; 2004 – $6,390)		34,550		32,705
			Securities available for sale, at market value (cost: 2005 – $28,652; 2004 – $28,845)		29,332		30,448
			Trading securities, at market value		3,485		3,142
			Spot commodities, at market value		98		95
			Unrealized gain on swaps, options and forward transactions		20,149		22,670
			Trading assets		1,372		3,331
			Securities purchased under agreements to resell, at contract value		32,593		26,272
			Finance receivables, net of allowance (2005 – $573; 2004 – $571)		24,929		23,574
		Securities lending collateral, at cost (approximates market value)			52,693		49,972
		Other invested assets			24,532		22,527
		Short-term investments, at cost (approximates market value)			22,017		16,102
		Cash			2,361		2,009

			Total investments, financial services assets and cash		666,558		638,838
	Investment income due and accrued				5,653		5,588
	Premiums and insurance balances receivable, net of allowance (2005 – $220; 2004 – $225)				15,724		15,137
	Reinsurance assets, net				19,719		19,958
	Deferred policy acquisition costs				31,536		29,736
	Investments in partially owned companies				1,469		1,452
	Real estate and other fixed assets, net of accumulated depreciation (2005 – $4,688; 2004 – $4,650)				6,190		6,192
	Separate and variable accounts				57,417		57,741
	Goodwill				8,577		8,601
	Income taxes receivable – current				–		95
	Other assets				15,413		15,322

Total assets				$	828,256	$	798,660

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET (continued)

(in millions, except share amounts) (unaudited)


			March 31,			December 31,
			2005			2004


Liabilities:
	Reserve for losses and loss expenses		$	64,061		$	62,371
	Reserve for unearned premiums			23,764			23,094
	Future policy benefits for life and accident and health insurance contracts			108,182			104,737
	Policyholders’ contract deposits			225,860			216,655
	Other policyholders’ funds			10,212			10,280
	Reserve for commissions, expenses and taxes			4,783			4,583
	Insurance balances payable			4,307			3,703
	Funds held by companies under reinsurance treaties			3,137			3,404
	Income taxes payable:
		Current		667			–
		Deferred		6,622			7,042
	Financial services liabilities:
		Borrowings under obligations of guaranteed investment agreements		22,691			18,919
		Securities sold under agreements to repurchase, at contract value		19,463			21,264
		Trading liabilities		1,283			2,304
		Securities and spot commodities sold but not yet purchased, at market value		4,881			4,866
		Unrealized loss on swaps, options and forward transactions		14,751			18,132
		Trust deposits and deposits due to banks and other depositors		4,612			4,248
		Commercial paper		8,477			6,724
		Notes, bonds, loans and mortgages payable		63,082			59,663
	Commercial paper			3,479			2,969
	Notes, bonds, loans and mortgages payable			5,557			5,499
	Liabilities connected to trust preferred stock			1,489			1,489
	Separate and variable accounts			57,417			57,741
	Minority interest			4,960			4,584
	Securities lending payable			52,693			49,972
	Other liabilities			28,945			23,611

Total liabilities				745,375			717,854

Preferred shareholders’ equity in subsidiary companies				198			199

Shareholders’ equity:
	Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2005 – 2,751,327,476; 2004 – 2,751,327,476			6,878			6,878
	Additional paid-in capital			1,991			1,954
	Retained earnings			67,752			64,393
	Accumulated other comprehensive income (loss)			8,374			9,593
	Treasury stock, at cost; 2005 – 156,420,444; 2004 – 154,904,286 shares of common stock			(2,312	)		(2,211	)

Total shareholders’ equity				82,683			80,607

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity			$	828,256		$	798,660

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME



(in millions, except per share amounts) (unaudited)

Three Months Ended March 31,			2005			2004


Revenues:
	Premiums and other considerations		$	17,682		$	15,982
	Net investment income			5,292			4,575
	Realized capital gains (losses)			88			115
	Other revenues			4,050			2,703

	Total revenues			27,112			23,375

Benefits and expenses:
	Incurred policy losses and benefits			14,865			13,597
	Insurance acquisition and other operating expenses			6,804			5,839

	Total benefits and expenses			21,669			19,436

Income before income taxes, minority interest and cumulative effect of an accounting change				5,443			3,939

Income taxes (benefits):
	Current			987			1,322
	Deferred			626			(153	)

				1,613			1,169

Income before minority interest and cumulative effect of an accounting change				3,830			2,770

Minority interest				(146	)		(70	)

Income before cumulative effect of an accounting change				3,684			2,700

Cumulative effect of an accounting change, net of tax				–			(144	)

Net income			$	3,684		$	2,556

Earnings per common share:
	Basic
		Income before cumulative effect of an accounting change	$	1.42		$	1.04
		Cumulative effect of an accounting change, net of tax		–			(0.06	)
		Net income		1.42			0.98

	Diluted
		Income before cumulative effect of an accounting change	$	1.40		$	1.03
		Cumulative effect of an accounting change, net of tax		–			(0.06	)
		Net income		1.40			0.97

Cash dividends per common share			$	0.125		$	0.065

Average shares outstanding:
	Basic			2,597			2,610
	Diluted			2,624			2,642

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS



(in millions) (unaudited)

Three Months Ended March 31,				2005			2004


Summary:
	Net cash provided by operating activities			$	654		$	8,719
	Net cash used in investing activities				(18,801	)		(19,725	)
	Net cash provided by financing activities				18,620			11,802
	Change in cumulative translation adjustments				(121	)		202

	Change in cash				352			998
	Cash at beginning of period				2,009			922

	Cash at end of period			$	2,361		$	1,920

Cash flows from operating activities:
	Net income			$	3,684		$	2,556

	Adjustments to reconcile net income to net cash provided by operating activities:
		Noncash revenues, expenses, gains and losses included in income:
		Change in:
			General and life insurance reserves		5,584			6,700
			Premiums and insurance balances receivable and payable – net		17			(670	)
			Reinsurance assets		239			(411	)
			Deferred policy acquisition costs		(936	)		(1,081	)
			Investment income due and accrued		(65	)		(339	)
			Funds held under reinsurance treaties		(267	)		102
			Other policyholders’ funds		(68	)		473
			Current and deferred income taxes – net		1,385			1,204
			Reserve for commissions, expenses and taxes		200			443
			Other assets and liabilities – net		(683	)		(544	)
			Trading assets and liabilities – net		938			(672	)
			Trading securities, at market value		(343	)		(962	)
			Spot commodities, at market value		(3	)		67
			Net unrealized (gain) loss on swaps, options and forward transactions		(860	)		(309	)
			Securities purchased under agreements to resell		(6,321	)		1,819
			Securities sold under agreements to repurchase		(1,801	)		388
			Securities and spot commodities sold but not yet purchased, at market value		15			(231	)
		Realized capital (gains) losses			(88	)		(115	)
		Equity in income of partially owned companies and other invested assets			(390	)		(325	)
		Amortization of premium and discount on securities			113			74
		Depreciation expenses, principally flight equipment			526			486
		Provision for finance receivable losses			86			90
		Other – net			(308	)		(24	)

		Total adjustments			(3,030	)		6,163

Net cash provided by operating activities				$	654		$	8,719

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)



(in millions) (unaudited)

Three Months Ended March 31,	2005			2004


Cash flows from investing activities:
Cost of bonds, at market sold	$	29,895		$	30,088
Cost of bonds, at market matured or redeemed		2,980			4,122
Cost of equity securities sold		2,971			3,664
Realized capital gains (losses)		88			115
Purchases of fixed maturities		(45,165	)		(48,863	)
Purchases of equity securities		(4,130	)		(4,797	)
Mortgage, policy and collateral loans granted		(1,551	)		(537	)
Repayments of mortgage, policy and collateral loans		575			539
Sales of securities available for sale		804			620
Maturities of securities available for sale		2,164			324
Purchases of securities available for sale		(2,765	)		(2,853	)
Sales of flight equipment		41			1,080
Purchases of flight equipment		(2,220	)		(1,843	)
Net additions to real estate and other fixed assets		(188	)		(182	)
Sales or distributions of other invested assets		2,163			2,171
Investments in other invested assets		(3,327	)		(3,748	)
Change in short-term investments		301			1,356
Investments in partially owned companies		4			(6	)
Finance receivable originations and purchases		(10,605	)		(5,579	)
Finance receivable principal payments received		9,164			4,604

Net cash used in investing activities	$	(18,801	)	$	(19,725	)

Cash flows from financing activities:
Receipts from policyholders’ contract deposits	$	16,269		$	13,093
Withdrawals from policyholders’ contract deposits		(7,149	)		(4,507	)
Change in trust deposits and deposits due to banks and other depositors		364			50
Change in commercial paper		2,263			1,875
Proceeds from notes, bonds, loans and mortgages payable		16,575			6,732
Repayments on notes, bonds, loans and mortgages payable		(13,022	)		(5,297	)
Proceeds from guaranteed investment agreements		4,955			1,505
Maturities of guaranteed investment agreements		(1,183	)		(1,428	)
Proceeds from common stock issued		31			40
Cash dividends to shareholders		(325	)		(170	)
Acquisition of treasury stock		(166	)		(92	)
Other – net		8			1

Net cash provided by financing activities	$	18,620		$	11,802

Supplementary information:
Taxes paid	$	382		$	493

Interest paid	$	1,147		$	1,032

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME



*(in millions) (unaudited)*

Three Months Ended March 31,			2005			2004


Comprehensive income:
	Net income		$	3,684		$	2,556

Other comprehensive income:
	Unrealized (depreciation) appreciation of investments – net of reclassification adjustments			(2,416	)		4,669
		Deferred income tax benefit (expense) on above changes		1,147			(1,494	)
	Foreign currency translation adjustments			(117	)		202
		Applicable income tax benefit on above changes		18			2
	Net derivative gains (losses) arising from cash flow hedging activities			385			(57	)
		Deferred income tax (expense) benefit on above changes		(206	)		49
	Retirement plan liabilities adjustment, net of tax			(30	)		(27	)

Other comprehensive income (loss)				(1,219	)		3,344

Comprehensive income			$	2,465		$	5,900

See Accompanying Notes to Financial Statements.

American International Group, Inc. and Subsidiaries

NOTES TO FINANCIAL STATEMENTS


1.	Financial Statement Presentation

These statements are unaudited. In the opinion of management, all adjustments consisting only of normal recurring accruals have been made for a fair statement of the results presented herein. All material intercompany accounts and transactions have been eliminated. Certain accounts have been reclassified in the 2004 financial statements to conform to their 2005 presentation. For further information, refer to the Annual Report on Form 10-K of American International Group, Inc. (AIG) for the year ended December 31, 2004 (2004 Annual Report on Form 10-K). As more fully described in AIG’s 2004 Annual Report on Form 10-K, and AIG’s Form 10-Q/A for the quarterly period ended March 31, 2004, AIG restated the accounting for certain transactions and certain relationships for the quarter ended March 31, 2004.


2.	Segment Information

The following table summarizes the operations by major operating segment for the three months ended March 31, 2005 and 2004:


Operating Segments
(in millions)		2005			2004


Revenues^(a):
	General Insurance^(b)	$	11,263		$	10,075
	Life Insurance & Retirement Services^(c)		11,820			10,523
	Financial Services^(d)		2,449			1,788
	Asset Management^(e)		1,375			1,032
	Other		205			(43	)

Consolidated		$	27,112		$	23,375

Operating income^(a)(f):
	General Insurance	$	1,697		$	1,441
	Life Insurance & Retirement Services		2,223			1,785
	Financial Services		1,043			545
	Asset Management		526			353
	Other^(g)		(46	)		(185	)

Consolidated		$	5,443		$	3,939


(a)	Revenues and operating income reflect changes in market or estimated fair value associated with derivatives that do not qualify for hedge accounting pursuant to FAS 133.
(b)	Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).


(c)	Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).


(d)	Represents interest, lease and finance charges.


(e)	Represents management and advisory fees and net investment income with respect to GICs.


(f)	Represents income before income taxes, minority interest and cumulative effect of an accounting change.


(g)	Represents other income (deductions) – net and other realized capital gains (losses).

The following table summarizes AIG’s General Insurance operations by major internal reporting unit for the three months ended March 31, 2005 and 2004:


General Insurance
(in millions)		2005			2004

Revenues:
	Domestic Brokerage Group	$	6,289		$	5,514
	Transatlantic		982			972
	Personal Lines		1,172			1,089
	Mortgage Guaranty		168			162
	Foreign General		2,646			2,331
	Reclassifications and Eliminations		6			7

Total General Insurance		$	11,263		$	10,075

Operating Income:
	Domestic Brokerage Group	$	721	*	$	556
	Transatlantic		114			117
	Personal Lines		109			98
	Mortgage Guaranty		104			96
	Foreign General		643			568
	Reclassifications and Eliminations		6			6

Total General Insurance		$	1,697		$	1,441


*	Includes $118 million of additional losses incurred resulting from increased labor and material costs related to the 2004 Florida hurricanes.

The following table summarizes AIG’s Life Insurance & Retirement Services operations by major internal reporting unit for the three months ended March 31, 2005 and 2004:


Life Insurance & Retirement Services
(in millions)			2005		2004

Revenues^(a):
	Foreign:
		AIA, AIRCO and Nan Shan	$	4,167	$	3,741
		ALICO, AIG Star Life and AIG Edison Life		3,579		2,865
		Philamlife and Other		129		117
	Domestic:
		AGLA and AG Life^(b)		2,271		2,094
		VALIC, AIG Annuity and AIG SunAmerica^(c)		1,674		1,706

Total Life Insurance & Retirement Services			$	11,820	$	10,523

Operating Income:
	Foreign:
		AIA, AIRCO and Nan Shan	$	687	$	491
		ALICO, AIG Star Life and AIG Edison Life		660		377
		Philamlife and Other		16		28
	Domestic:
		AGLA and AG Life^(b)		344		257
		VALIC, AIG Annuity and AIG SunAmerica^(c)		516		632

Total Life Insurance & Retirement Services			$	2,223	$	1,785


(a)	Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).
(b)	Includes the life operations of AIG Life Insurance Company and American International Life Assurance Company of New York.


(c)	“AIG SunAmerica” represents the annuity operations of AIG SunAmerica Life Assurance Company, as well as those of First SunAmerica Life Insurance Company and SunAmerica Life Insurance Company.

American International Group, Inc. and Subsidiaries


2.	Segment Information (continued)

The following table summarizes AIG’s Financial Services operations by major internal reporting unit for the three months ended March 31, 2005 and 2004:


Financial Services
(in millions)		2005		2004


Revenues^(a):
	Aircraft Finance^(b)	$	858	$	752
	Capital Markets^(c)(d)		738		317
	Consumer Finance^(e)		833		693
	Other		20		26

Total Financial Services		$	2,449	$	1,788

Operating income^(a):
	Aircraft Finance	$	206	$	180
	Capital Markets^(d)		599		167
	Consumer Finance		231		183
	Other		7		15

Total Financial Services		$	1,043	$	545


(a)	Includes the unrealized gain (loss) attributable to economic hedges not qualifying for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the first three months of 2005 and 2004, the effect was $15 million and $20 million, respectively, in operating income for Aircraft Finance and $449 million and $37 million in both revenues and operating income for Capital Markets.
(b)	Revenues were primarily from ILFC aircraft lease rentals.


(c)	Revenues, shown net of interest expense, were primarily from hedged proprietary positions entered into in connection with counterparty transactions and the effect of not qualifying for hedge accounting treatment under FAS 133 described in (a) above.


(d)	Certain transactions entered into by AIGFP generate tax credits and benefits which are shown in the income tax line on the consolidated statement of income. The amount of tax credits and benefits for the first three months of March 31, 2005 and 2004 are $19 million, and $35 million, respectively.


(e)	Revenues were primarily finance charges.

The following table summarizes AIG’s Asset Management revenues and operating income for the three months ended March 31, 2005 and 2004:


(in millions)		2005		2004


Revenues:
	Guaranteed investment contracts	$	896	$	730
	Institutional Asset Management^(a)		317		183
	Brokerage Services and Mutual Funds		63		61
	Other		99		58

Total Asset Management		$	1,375	$	1,032

Operating income:
	Guaranteed investment contracts	$	257	$	223
	Institutional Asset Management^(a)(b)		159		55
	Brokerage Services and Mutual Funds		13		20
	Other		97		55

Total Asset Management		$	526	$	353


(a)	Includes AIG Global Investment Group and certain smaller asset management operations.
(b)	Includes the results of certain AIG managed private equity and real estate funds that are consolidated effective December 31, 2003 pursuant to FIN46R, “Consolidation of Variable Interest Entities”. For the first three months of 2005 and 2004, operating income includes $75 million and $4 million of third-party limited partner earnings offset in Minority interest expense.


3.	Earnings Per Share

Earnings per share of AIG are based on the weighted average number of common shares outstanding during the period.

Computation of Earnings Per Share:


Three Months Ended March 31,
(in millions, except per share amounts)		2005			2004


Numerator for basic earnings per share:
Income before cumulative effect of an accounting change		$	3,684		$	2,700
Cumulative effect of an accounting change, net of tax			–			(144	)

Net income applicable to common stock		$	3,684		$	2,556

Denominator for basic earnings per share:
Average shares outstanding used in the computation of per share earnings:
	Common stock issued		2,752			2,752
	Common stock in treasury		(155	)		(142	)

Average shares outstanding – basic			2,597			2,610

Numerator for diluted earnings per share:
Income before cumulative effect of an accounting change		$	3,684		$	2,700
Cumulative effect of an accounting change, net of tax			–			(144	)

Net income applicable to common stock			3,684			2,556

Interest on contingently convertible bonds, net of tax ^(a)			3			3

Adjusted net income applicable to common stock^(a)		$	3,687		$	2,559

NOTES TO FINANCIAL STATEMENTS (continued)

American International Group, Inc. and Subsidiaries


3.	Earnings Per Share (continued)


Three Months Ended March 31,
(in millions, except per share amounts)		2005		2004


Denominator for diluted earnings per share:
Average shares outstanding		2,597		2,610
Incremental shares from potential common stock:
Average number of shares arising from outstanding employee stock plans (treasury stock method)^(b)		18		23
Contingently convertible bonds^(a)		9		9

Adjusted average shares outstanding – diluted^(a)		2,624		2,642

Earnings per share:
Basic:
Income before cumulative effect of an accounting change	$	1.42	$	1.04
Cumulative effect of an accounting change, net of tax		–		(0.06	)
Net income	$	1.42	$	0.98

Diluted:
Income before cumulative effect of an accounting change	$	1.40	$	1.03
Cumulative effect of an accounting change, net of tax		–		(0.06	)
Net income	$	1.40	$	0.97


(a)	Assumes conversion of contingently convertible bonds due to the adoption of EITF Issue No. 04-8 “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.”
(b)	Certain shares arising from employee stock plans were not included in the computation of diluted earnings per share where the exercise price of the options exceeded the average market price and would have been antidilutive. The number of shares excluded were 22 million and 8 million for the first three months of 2005 and 2004, respectively.

Pursuant to Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment to FASB Statement No. 123” (FAS 148), AIG adopted the “Prospective Method” of accounting for stock-based employee compensation effective January 1, 2003. FAS 148 also requires that AIG disclose the effect of stock-based compensation expense that would have been recognized if the fair value based method had been applied to all the awards vesting in the current period.

The effect with respect to stock-based compensation expense that would have been recognized if the fair value based method had been applied to all the awards vesting in both the first three months of 2005 and 2004 was less than $0.005 per share.

The quarterly dividend rate per common share, commencing with the dividend paid March 18, 2005 is $0.125.


4.	Benefits Provided by Starr International Company, Inc.

Starr International Company, Inc. (SICO) has provided a series of two-year Deferred Compensation Profit Participation Plans (SICO Plans) to certain AIG employees. The SICO Plans came into being in 1975 when the voting shareholders and Board of Directors of SICO, a private holding company whose principal asset is AIG common stock, decided that a portion of the capital value of SICO should be used to provide an incentive plan for the current and succeeding managements of all American International companies, including AIG.

Participation in the SICO Plans by any person, and the amount of such participation, has been at the sole discretion of SICO’s Board of Directors. None of the costs of the various benefits provided under the SICO Plans has been paid by AIG, although AIG has recorded a charge to reported earnings for the deferred compensation amounts paid to AIG employees by SICO, with an offsetting entry to additional paid-in capital reflecting amounts deemed contributed by SICO. The SICO Plans provide that shares currently owned by SICO may be set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment with AIG prior to normal retirement age. In addition, SICO’s Board of Directors currently may elect to pay a participant cash in lieu of shares of AIG common stock. See also Note 6(f) herein.

SICO has also provided certain personal benefits to AIG employees. The cost of such benefits, primarily attributable to personal use of corporate aircraft, has not been included in compensation expense.

Compensation expense with respect to the SICO Plans aggregated $34 million and $14 million for the first three months of 2005 and 2004, respectively.


5.	Ownership and Transactions With Related Parties

(a) Ownership: The directors and officers of AIG, together with C.V. Starr & Co., Inc. (Starr), a private holding company, The Starr Foundation, and SICO, a private holding company, owned or otherwise controlled approximately 19 percent of the voting stock of AIG at March 31, 2005. Five directors of AIG served as directors of Starr and SICO as of March 31, 2005 and December 31, 2004. As of April 30, 2005, no director of AIG serving as an executive officer of AIG served as a director of Starr or SICO.

American International Group, Inc. and Subsidiaries


5.	Ownership and Transactions With Related Parties (continued)

(b) Transactions with Related Parties: During the ordinary course of business, AIG and its subsidiaries pay commissions to Starr and its subsidiaries for the production and management of insurance business. There are no significant receivables from/payables to related parties at March 31, 2005.


6.	Commitments and Contingent Liabilities

In the normal course of business, various commitments and contingent liabilities are entered into by AIG and certain of its subsidiaries. In addition, AIG guarantees various obligations of certain subsidiaries.

(a) AIG and certain of its subsidiaries become parties to derivative financial instruments with market risk resulting from both dealer and end user activities and to reduce currency, interest rate, equity and commodity exposures. These instruments are carried at their estimated fair values in the consolidated balance sheet. The vast majority of AIG’s derivative activity is transacted by AIG Financial Products Corp. and its subsidiaries (AIGFP). (See also Note 20 in AIG’s 2004 Annual Report on Form 10-K.)

(b) Securities sold, but not yet purchased and spot commodities sold but not yet purchased represent obligations of Capital Markets operations to deliver specified securities and spot commodities at their contracted prices. Capital Markets records a liability to repurchase the securities and spot commodities in the market at prevailing prices.

AIG has issued unconditional guarantees with respect to the prompt payment, when due, of all present and future payment obligations and liabilities of AIGFP arising from transactions entered into by AIGFP. Net revenues for the three months ended March 31, 2005 and 2004 from Capital Markets operations were $738 million and $317 million, respectively.

(c) At March 31, 2005, International Lease Finance Corporation (ILFC) had committed to purchase 322 new aircraft deliverable from 2005 through 2010 at an estimated aggregate purchase price of $19.5 billion and had options to purchase 6 new aircraft deliverable through 2007 at an estimated aggregate purchase price of $361 million. ILFC will be required to find customers for any aircraft acquired, and it must arrange financing for portions of the purchase price of such equipment.

(d) AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. The recent trend of increasing jury awards and settlements makes it difficult to assess the ultimate outcome of such litigation.

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 collectively referred to as environmental claims) and indemnity claims asserting injuries from asbestos. Estimation of asbestos and environmental claims loss reserves is a difficult process, as these claims, which emanate from policies written in 1984 and prior years, cannot be estimated by conventional reserving techniques. Asbestos and environmental claims development is affected by factors such as inconsistent court resolutions, the broadening of the intent of policies and scope of coverage and increasing number of new claims. AIG, together with other industry members, has and will continue to litigate the broadening judicial interpretation of policy coverage and the liability issues. If the courts continue in the future to expand the intent of the policies and the scope of the coverage, as they have in the past, additional liabilities would emerge for amounts in excess of reserves held. This emergence cannot now be reasonably estimated, but could have a material effect on AIG’s future operating results. The reserves carried for these claims at March 31, 2005 ($3.48 billion gross; $1.49 billion net) are believed to be adequate as these reserves are based on known facts and current law.

(e) SAI Deferred Compensation Holdings, Inc., a wholly-owned subsidiary of AIG, has established a deferred compensation plan for registered representatives of certain AIG subsidiaries, pursuant to which participants have the opportunity to invest deferred commissions and fees on a notional basis. The value of the deferred compensation fluctuates with the value of the deferred investment alternatives chosen. AIG has provided a full and unconditional guarantee of the obligations of SAI Deferred Compensation Holdings, Inc. to pay the deferred compensation under the plan.

(f) On May 18, 2005, the AIG Board of Directors passed resolutions (Resolutions) pursuant to which AIG agrees, subject to certain conditions, to (i) make any payment that is not promptly paid with respect to the benefits accrued by current employees of AIG and its subsidiaries under the SICO Plans (as defined in Note 4) and (ii) make any payment to the extent not promptly paid by Starr with respect to amounts that become payable to current employees of AIG and its subsidiaries who are also stockholders of Starr after the giving of a notice of repurchase or redemption under Starr’s organizational documents. On June 27, 2005, AIG entered into definitive documentation of these agreements. AIG will accrue approximately $1 million for 2005 for these contingent liabilities.

NOTES TO FINANCIAL STATEMENTS (continued)

American International Group, Inc. and Subsidiaries


6.	Commitments and Contingent Liabilities (continued)

(g) AIG and certain of its subsidiaries have been named defendants in two putative class actions in state court in Alabama that arise out of the 1999 settlement of class and derivative litigation involving Caremark Rx, Inc. (Caremark). An excess policy issued by a subsidiary of AIG with respect to the 1999 litigation was expressly stated to be without limit of liability. In the current actions, plaintiffs allege that the judge approving the 1999 settlement was misled as to the extent of available insurance coverage and would not have approved the settlement had he known of the existence and/or unlimited nature of the excess policy. They further allege that AIG, its subsidiaries, and Caremark are liable for fraud and suppression for misrepresenting and/or concealing the nature and extent of coverage. In their complaint, plaintiffs request compensatory damages for the 1999 class in the amount of $3.2 billion, plus punitive damages. AIG and its subsidiaries deny the allegations of fraud and suppression and have asserted, inter alia, that information concerning the excess policy was publicly disclosed months prior to the approval of the settlement. AIG and its subsidiaries further assert that the current claims are barred by the statute of limitations and that plaintiffs’ assertions that the statute was tolled cannot stand against the public disclosure of the excess coverage. Plaintiffs, in turn, have asserted that the disclosure was insufficient to inform them of the nature of the coverage and did not start the running of the statute of limitations. On January 28, 2005, the Alabama trial court determined that one of the current actions may proceed as a class action on behalf of the 1999 classes that were allegedly defrauded by the settlement. AIG, its subsidiaries, and Caremark are seeking appellate relief from the Alabama Supreme Court. AIG cannot now estimate either the likelihood of its prevailing in these actions or the potential damages in the event liability is determined.

(h) On December 30, 2004, an arbitration panel issued its ruling in connection with a 1998 workers compensation quota share reinsurance agreement under which Superior National Insurance Company, among others, was reinsured by The United States Life Insurance Company in the City of New York (USLIFE), a subsidiary of American General Corporation. In its 2-1 ruling the arbitration panel refused to rescind the contract as requested by USLIFE. Instead, the panel reformed the contract to reduce USLIFE’s participation by ten percent. USLIFE disagrees with the ruling and is pursuing all appropriate legal remedies. USLIFE has certain reinsurance recoverables in connection with the contract and the arbitration ruling established a second phase or arbitration in which USLIFE will present its challenges to cessions to the contract.

AIG recorded approximately a $178 million pre-tax charge in the fourth quarter of 2004 related to this matter and holds a reserve of approximately $349 million as of March 31, 2005.

(i) On October 14, 2004, the Office of the Attorney General of the State of New York (NYAG) brought a lawsuit challenging certain insurance brokerage practices related to contingent commissions. Neither AIG nor any of its subsidiaries is a defendant in that action, although two employees of an AIG subsidiary pleaded guilty in connection with the NYAG’s investigation in October 2004 and two additional employees of the same subsidiary pleaded guilty in February 2005. AIG has cooperated, and will continue to cooperate, in the investigation. Regulators from several additional states have commenced investigations into the same matters, and AIG expects there will be additional investigations as well. Various parties, including insureds and shareholders, have also asserted putative class action and other claims against AIG or its subsidiaries alleging, among other things, violations of the antitrust and federal securities laws, and AIG expects that additional claims may be made.

Various federal and state regulatory agencies are reviewing certain other transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries.

In February 2005, AIG received subpoenas from the NYAG and the SEC relating to investigations into the use of non-traditional insurance products and certain assumed reinsurance transactions and AIG’s accounting for such transactions. The United States Department of Justice and various state regulators are also investigating related issues. AIG has cooperated, and will continue to cooperate, in producing documents and other information in response to the subpoenas.

A number of lawsuits have been filed regarding the subject matter of the investigations of insurance brokerage practices and non-traditional insurance products, including derivative actions in New York state courts and civil actions under the federal securities laws and the Employee Retirement Income Security Act (ERISA) in the U.S. district court for the Southern District of New York. These actions are in the early pleadings stage.

In addition, in late 2002, a shareholder derivative action was filed in Delaware Chancery Court alleging breaches of fiduciary duty of loyalty and care against AIG’s directors. AIG’s Board of Directors appointed a special committee of independent directors to review the complaint and respond to the lawsuit. The special committee has issued a report that concluded that it was not in the best interests of AIG or its shareholders to pursue the litigation and moved the Delaware Chancery Court to terminate the litigation. The Plaintiff filed

American International Group, Inc. and Subsidiaries


6.	Commitments and Contingent Liabilities (continued)

an amended complaint on May 17, 2005. The amendment includes additional claims of breach of fiduciary duty by current and former directors of AIG based on, among other things, AIG’s transactions with reinsurers (including reinsurers in which AIG has an ownership interest) and accounting for these transactions, AIG’s broker compensation practices, and AIG’s sale of finite insurance products.

On May 26, 2005, the NYAG and the New York Superintendent of Insurance filed a civil complaint against AIG as well as its former Chairman and Chief Executive Officer M.R. Greenberg, and former Vice Chairman and Chief Financial Officer Howard Smith, in the Supreme Court of the State of New York. The complaint asserts claims under New York’s Martin Act and Insurance Law, among others, and makes allegations concerning certain of the transactions discussed more fully in the 2004 Annual Report on Form 10-K. The complaint seeks disgorgement, injunctive relief, punitive damages and costs, among other things.

AIG cannot at this time predict the outcome of the matters described above or estimate the potential costs related to these matters and, accordingly, no reserve is being established in AIG’s financial statements at this time. In the opinion of AIG management, AIG’s ultimate liability for the matters referred to above is not likely to have a material adverse effect on AIG’s consolidated financial condition, although it is possible that the effect would be material to AIG’s consolidated results of operations for an individual reporting period.


7.	Employee Benefits

The following table presents the components of the net periodic benefit costs with respect to pensions and other benefits for the three months ended March 31, 2005 and 2004:



		Pensions									Postretirement

		Non-U.S.			U.S.						Non-U.S.		U.S.
*(In millions)*		Plans			Plans			Total			Plans		Plans			Total

2005
	Components of net period benefit cost:
	Service cost	$	19		$	26		$	45		$	1	$	2		$	3
	Interest cost		8			37			45			–		4			4
	Expected return on assets		(5	)		(41	)		(46	)		–		–			–
	Amortization of prior service cost		(3	)		(1	)		(4	)		–		(2	)		(2	)
	FAS 88 loss due to settlements		1			–			1			–		–			–
	Recognized actuarial loss		6			16			22			–		1			1

Net period benefit cost		$	26		$	37		$	63		$	1	$	5		$	6

2004
	Components of net period benefit cost:
	Service cost	$	15		$	23		$	38		$	–	$	1		$	1
	Interest cost		8			40			48			–		4			4
	Expected return on assets		(5	)		(43	)		(48	)		–		–			–
	Amortization of prior service cost		(1	)		1			–			–		(1	)		(1	)
	Amortization of transitional liability		1			–			1			–		–			–
	Recognized actuarial loss		5			14			19			–		–			–

Net period benefit cost		$	23		$	35		$	58		$	–	$	4		$	4


8.	Recent Accounting Standards

At the March 2004 meeting, the Emerging Issue Task Force (EITF) reached a consensus with respect to Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF No. 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” delaying the effective date of this guidance until the FASB has resolved certain implementation issues with respect to this guidance. The disclosure requirements of EITF 03-1 were previously adopted by AIG as of December 31, 2003 and reflected in the Annual Report on Form 10-K for that year for investments accounted for under FAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” For all other investments within the scope of this Issue, the disclosures are effective for the year ended December 31, 2004.

NOTES TO FINANCIAL STATEMENTS (continued)

American International Group, Inc. and Subsidiaries


8.	Recent Accounting Standards (continued)

At the September 2004 meeting, the EITF reached a consensus with respect to Issue No. 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.” This Issue addresses when the dilutive effect of contingently convertible debt (Co-Cos) with a market price trigger should be included in diluted earnings per share (EPS). The EITF concluded that these securities should be treated as convertible securities and included in a dilutive EPS calculation (if dilutive), regardless of whether the market price triggers (or other contingent features) have been met. Co-Cos are generally convertible into common shares of the issuer after the common stock has exceeded a predetermined threshold for a specific time period. The predetermined threshold is greater than the conversion price of the debt. The guidance is effective for the year ending December 31, 2004; AIG has applied the guidance retroactively and has restated previously reported EPS. The adoption of Issue No. 04-8 did not have a material effect on AIG’s diluted EPS.

In December 2004, the FASB issued Statement No. 123 (revised 2004) (FAS 123R), “Share-Based Payment.” FAS 123R replaces FASB Statement No. 123 (FAS 123), “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” FAS 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. On January 1, 2003, AIG adopted the recognition provisions of FAS 123. In April 2005, the Securities and Exchange Commission (SEC) delayed the effective date for FAS 123R until the first fiscal year beginning after June 15, 2005. As a result, AIG expects to adopt the provisions of the revised FAS 123R in the first quarter of 2006. AIG is currently assessing the effect of FAS 123R and believes the effect will not be material to AIG’s financial condition or results of operations.

In March 2005, FASB issued FSP FIN46R-5 “Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities” (FSP FIN46R-5) to address whether a reporting enterprise has an implicit variable interest in a variable interest entity (VIE) or potential VIE when specific conditions exist. Although implicit variable interests are mentioned in FIN46(R), the term is not defined and only one example is provided. This FSP FIN46R-5 offers additional guidance, stating that implicit variable interests are implied financial interests in an entity that change with changes in the fair value of the entity’s net assets exclusive of variable interests. An implicit variable interest acts the same as an explicit variable interest except it involves the absorbing and/or receiving of variability indirectly from the entity (rather than directly). The identification of an implicit variable interest is a matter of judgment that depends on the relevant facts and circumstances. FSP FIN46R-5 is effective for the second quarter of 2005, and AIG is currently assessing the effect, if any, of FSP FIN46R-5. AIG believes the effect of FSP FIN 46R-5 will not be material to AIG’s financial condition or results of operations.

American International Group, Inc. and Subsidiaries


9.	Information Provided in Connection with Outstanding Debt

The following condensed consolidating financial statements are provided in compliance with Regulation S-X of the Securities and Exchange Commission.

(a) American General Corporation (AGC) is a holding company and a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all outstanding debt of AGC.

American General Corporation:

Condensed Consolidating Balance Sheet

American

International

March 31, 2005

Group, Inc.

AGC

Other

Consolidated

(in millions)

Guarantor

Issuer

Subsidiaries

Eliminations

AIG

Assets:

Invested assets

1,131

–

675,001

(11,935

)

664,197

Cash

150

–

2,211

–

2,361

Carrying value of subsidiaries and partially owned companies, at equity

83,614

25,881

15,043

(123,069

)

1,469

Other assets

2,803

2,691

159,807

(5,072

)

160,229

Total assets

87,698

28,572

852,062

(140,076

)

828,256

Liabilities:

Insurance liabilities

391

–

443,986

(71

)

444,306

Debt

3,650

2,483

110,912

(12,270

)

104,775

Other liabilities

974

4,264

195,867

(4,811

)

196,294

Total liabilities

5,015

6,747

750,765

(17,152

)

745,375

Preferred shareholders’ equity in subsidiary companies

–

198

–

198

Total shareholders’ equity

82,683

21,825

101,099

(122,924

)

82,683

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity

87,698

28,572

852,062

(140,076

)

828,256


		American
		International
December 31, 2004		Group, Inc.		AGC		Other					Consolidated
(in millions)		Guarantor		Issuer		Subsidiaries		Eliminations			AIG


Assets:
	Invested assets	$	1,394	$	–	$	647,610	$	(12,175	)	$	636,829
	Cash		17		–		1,992		–			2,009
	Carrying value of subsidiaries and partially owned companies, at equity		81,610		26,165		12,076		(118,399	)		1,452
	Other assets		2,753		2,546		154,269		(1,198	)		158,370

Total assets		$	85,774	$	28,711	$	815,947	$	(131,772	)	$	798,660

Liabilities:
	Insurance liabilities	$	405	$	–	$	428,491	$	(69	)	$	428,827
	Debt		3,647		2,482		101,391		(12,257	)		95,263
	Other liabilities		1,115		4,076		189,779		(1,206	)		193,764

Total liabilities			5,167		6,558		719,661		(13,532	)		717,854

Preferred shareholders’ equity in subsidiary companies			–		–		199		–			199
Total shareholders’ equity			80,607		22,153		96,087		(118,240	)		80,607

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity		$	85,774	$	28,711	$	815,947	$	(131,772	)	$	798,660

NOTES TO FINANCIAL STATEMENTS (continued)

American International Group, Inc. and Subsidiaries


9.	Information Provided in Connection with Outstanding Debt (continued)

Condensed Consolidating Statement of Income

American

International

Three Months Ended March 31, 2005

Group, Inc.

AGC

Other

Consolidated

(in millions)

Guarantor

Issuer

Subsidiaries

Eliminations

AIG

Operating income

(38

)^(a)

(37

) ^(b)

5,518

^(c)

–

5,443

^(d)

Equity in undistributed net income of consolidated subsidiaries

3,552

633

–

(4,185

)

–

Dividend income from consolidated subsidiaries

271

–

(271

)

–

Income taxes (benefits)

101

(13

)

1,525

–

1,613

Minority interest

–

(146

)

–

(146

)

Net income (loss)

3,684

609

3,847

(4,456

)

3,684


	American
	International
Three Months Ended March 31, 2004	Group, Inc.			AGC			Other						Consolidated
*(in millions)*	Guarantor			Issuer			Subsidiaries			Eliminations			AIG

Operating income	$	98	^(e)	$	(30	) ^(f)	$	3,871	^(g)	$	–		$	3,939	^(h)
Equity in undistributed net income of consolidated subsidiaries		2,297			566			–			(2,863	)		–
Dividend income from consolidated subsidiaries		322			24			–			(346	)		–
Income taxes (benefits)		161			(11	)		1,019			–			1,169
Minority interest		–			–			(70	)		–			(70	)
Cumulative effect of an accounting change, net of tax		–			–			(144	)		–			(144	)

Net income (loss)	$	2,556		$	571		$	2,638		$	(3,209	)	$	2,556


(a)	Includes other income (deductions) – net and other realized capital gains (losses) of $(127) million.
(b)	Includes other income (deductions) – net and other realized capital gains (losses) of $(37) million.
(c)	Includes other income (deductions) – net and other realized capital gains (losses) of $118 million.
(d)	Includes other income (deductions) – net and other realized capital gains (losses) of $(46) million.
(e)	Includes other income (deductions) – net and other realized capital gains (losses) of $17 million.
(f)	Includes other income (deductions) – net and other realized capital gains (losses) of $(30) million.
(g)	Includes other income (deductions) – net and other realized capital gains (losses) of $(172) million.
(h)	Includes other income (deductions) – net and other realized capital gains (losses) of $(185) million.

Condensed Consolidating Statements of Cash Flow

American

International

Three Months Ended March 31, 2005

Group, Inc.

AGC

Other

Consolidated

(in millions)

Guarantor

Issuer

Subsidiaries

AIG

Net cash provided by operating activities

346

155

153

654

Cash flows from investing:

Invested assets disposed

265

–

50,885

51,150

Invested assets acquired

–

(69,763

)

(69,763

)

Other

(72

)

(120

)

(188

)

Net cash used in investing activities

193

(120

)

(18,874

)

(18,801

)

Cash flows from financing activities:

Change in debts

(34

)

9,621

9,588

Other

(402

)

(36

)

9,470

9,032

Net cash provided by (used in) financing activities

(436

)

(35

)

19,091

18,620

Change in cumulative translation adjustments

–

(151

)

(121

)

Change in cash

133

–

219

352

Cash at beginning of period

–

1,992

2,009

Cash at end of period

150

–

2,211

2,361

American International Group, Inc. and Subsidiaries


9.	Information Provided in Connection with Outstanding Debt (continued)


		American
		International
Three Months Ended March 31, 2004		Group, Inc.			AGC			Other			Consolidated
(in millions)		Guarantor			Issuer			Subsidiaries			AIG


Net cash provided by operating activities		$	527		$	468		$	7,724		$	8,719

Cash flows from investing:
	Invested assets disposed		315			–			48,362			48,677
	Invested assets acquired		(176	)		–			(68,044	)		(68,220	)
	Other		(345	)		(302	)		465			(182	)

Net cash used in investing activities			(206	)		(302	)		(19,217	)		(19,725	)

Cash flows from financing activities:
	Change in debts		(24	)		(147	)		3,558			3,387
	Other		(192	)		(19	)		8,626			8,415

Net cash (used in) provided by financing activities			(216	)		(166	)		12,184			11,802

Change in cumulative translation adjustments			(120	)		–			322			202

Change in cash			(15	)		–			1,013			998
Cash at beginning of period			19			–			903			922

Cash at end of period		$	4		$	–		$	1,916		$	1,920

(b) AIG Liquidity Corp. is a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all obligations of AIG Liquidity Corp., which commenced operations in 2003.

AIG Liquidity Corp.:

Condensed Consolidating Balance Sheet

American

International

AIG

March 31, 2005

Group, Inc.

Liquidity

Other

Consolidated

(in millions)

Guarantor

Corp.

Subsidiaries

Eliminations

AIG

Assets:

Invested assets

1,131

675,001

(11,935

)

664,197

Cash

150

2,211

–

2,361

Carrying value of subsidiaries and partially owned companies, at equity

83,614

–

40,924

(123,069

)

1,469

Other assets

2,803

162,498

(5,072

)

160,229

Total assets

87,698

880,634

(140,076

)

828,256

Liabilities:

Insurance liabilities

391

–

443,986

(71

)

444,306

Debt

3,650

113,395

(12,270

)

104,775

Other liabilities

974

200,131

(4,811

)

196,294

Total liabilities

5,015

757,512

(17,152

)

745,375

Preferred shareholders’ equity in subsidiary companies

–

198

–

198

Total shareholders’ equity

82,683

122,924

(122,924

)

82,683

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity

87,698

880,634

(140,076

)

828,256


*	Amounts significantly less than $1 million.

NOTES TO FINANCIAL STATEMENTS (continued)

American International Group, Inc. and Subsidiaries


9.	Information Provided in Connection with Outstanding Debt (continued)


		American
		International		AIG
December 31, 2004		Group, Inc.		Liquidity		Other					Consolidated
*(in millions)*		Guarantor		Corp.		Subsidiaries		Eliminations			AIG


Assets:
	Invested assets	$	1,394	$	*	$	647,610	$	(12,175	)	$	636,829
	Cash		17		*		1,992		–			2,009
	Carrying value of subsidiaries and partially owned companies, at equity		81,610		–		38,241		(118,399	)		1,452
	Other assets		2,753		*		156,815		(1,198	)		158,370

Total assets		$	85,774	$	*	$	844,658	$	(131,772	)	$	798,660

Liabilities:
	Insurance liabilities	$	405	$	–	$	428,491	$	(69	)	$	428,827
	Debt		3,647		*		103,873		(12,257	)		95,263
	Other liabilities		1,115		*		193,855		(1,206	)		193,764

Total liabilities			5,167		*		726,219		(13,532	)		717,854

Preferred shareholders’ equity in subsidiary companies			–		–		199		–			199
Total shareholders’ equity			80,607		*		118,240		(118,240	)		80,607

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity		$	85,774	$	*	$	844,658	$	(131,772	)	$	798,660


*	Amounts significantly less than $1 million.

Condensed Consolidating Statement of Income

American

International

AIG

Three Months Ended March 31, 2005

Group, Inc.

Liquidity

Other

Consolidated

(in millions)

Guarantor

Corp.

Subsidiaries

Eliminations

AIG

Operating income

(38

)^(a)

5,481

^(b)

–

5,443

^(c)

Equity in undistributed net income of consolidated subsidiaries

3,552

–

633

(4,185

)

–

Dividend income from consolidated subsidiaries

271

–

(271

)

–

Income taxes

101

1,512

–

1,613

Minority interest

–

(146

)

–

(146

)

Net income (loss)

3,684

4,456

(4,456

)

3,684


*	Amounts significantly less than $1 million.


	American
	International			AIG
Three Months Ended March 31, 2004	Group, Inc.			Liquidity		Other						Consolidated
*(in millions)*	Guarantor			Corp.		Subsidiaries			Eliminations			AIG


Operating income	$	98	^(d)	$	*	$	3,841	^(e)	$	–		$	3,939	^(f)
Equity in undistributed net income of consolidated subsidiaries		2,297			–		566			(2,863	)		–
Dividend income from consolidated subsidiaries		322			–		24			(346	)		–
Income taxes		161			*		1,008			–			1,169
Minority interest		–			–		(70	)		–			(70	)
Cumulative effect of an accounting change, net of tax		–			–		(144	)		–			(144	)

Net income (loss)	$	2,556		$	*	$	3,209		$	(3,209	)	$	2,556


*	Amounts significantly less than $1 million.
(a)	Includes other income (deductions) — net and other realized capital gains (losses) of $(127) million.
(b)	Includes other income (deductions) — net and other realized capital gains (losses) of $81 million.
(c)	Includes other income (deductions) — net and other realized capital gains (losses) of $(46) million.
(d)	Includes other income (deductions) — net and other realized capital gains (losses) of $17 million.
(e)	Includes other income (deductions) — net and other realized capital gains (losses) of $(202) million.
(f)	Includes other income (deductions) — net and other realized capital gains (losses) of $(185) million.

American International Group, Inc. and Subsidiaries


9.	Information Provided in Connection with Outstanding Debt (continued)

Condensed Consolidating Statements of Cash Flow

American

International

AIG

Three Months Ended March 31, 2005

Group, Inc.

Liquidity

Other

Consolidated

(in millions)

Guarantor

Corp.

Subsidiaries

AIG

Net cash provided by operating activities

346

308

654

Cash flows from investing:

Invested assets disposed

265

–

50,885

51,150

Invested assets acquired

–

(69,763

)

(69,763

)

Other

(72

)

(116

)

(188

)

Net cash used in investing activities

193

(18,994

)

(18,801

)

Cash flows from financing activities:

Change in debts

(34

)

–

9,622

9,588

Other

(402

)

9,434

9,032

Net cash provided by financing activities

(436

)

19,056

18,620

Change in cumulative translation adjustments

–

(151

)

(121

)

Change in cash

133

219

352

Cash at beginning of period

–

1,992

2,009

Cash at end of period

150

2,211

2,361


*	Amounts significantly less than $1 million.


		American
		International			AIG
Three Months Ended March 31, 2004		Group, Inc.			Liquidity		Other			Consolidated
*(in millions)*		Guarantor			Corp.		Subsidiaries			AIG


Net cash provided by operating activities		$	527		$	*	$	8,192		$	8,719

Cash flows from investing:
	Invested assets disposed		315			–		48,362			48,677
	Invested assets acquired		(176	)		–		(68,044	)		(68,220	)
	Other		(345	)		*		163			(182	)

Net cash used in investing activities			(206	)		*		(19,519	)		(19,725	)

Cash flows from financing activities:
	Change in debts		(24	)		–		3,411			3,387
	Other		(192	)		*		8,607			8,415

Net cash (used in) provided by financing activities			(216	)		*		12,018			11,802

Change in cumulative translation adjustments			(120	)		–		322			202

Change in cash			(15	)		*		1,013			998
Cash at beginning of period			19			–		903			922

Cash at end of period		$	4		$	*	$	1,916		$	1,920


*	Amounts significantly less than $1 million.

American International Group, Inc. and Subsidiaries

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide the reader a narrative with respect to AIG’s operations, financial condition and liquidity and certain other significant matters.

INDEX


			Page


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION				19
RESTATEMENT OF PREVIOUSLY ISSUED FINANCIAL STATEMENTS				20
OVERVIEW OF OPERATIONS AND BUSINESS RESULTS				20
	Consolidated Results			21
CRITICAL ACCOUNTING ESTIMATES				24
OPERATING REVIEW				25
	General Insurance Operations			25
		General Insurance Results		27
		Reinsurance		28
		Reserve for Losses and Loss Expenses		29
		Asbestos and Environmental Reserves		34
	Life Insurance & Retirement Services Operations			38
		Life Insurance & Retirement Services Results		39
		Underwriting and Investment Risk		40
	Insurance and Asset Management Invested Assets			41
		Credit Quality		42
		Valuation of Invested Assets		42
	Financial Services Operations			45
		Financial Services Results		46
		Financial Services Invested Assets		47
	Asset Management Operations			49
		Asset Management Results		49
	Other Operations			50
CAPITAL RESOURCES				50
		Borrowings		50
		Contractual Obligations and Other Commercial Commitments		53
		Shareholders’ Equity		54
		Stock Purchase		54
		Dividends from Insurance Subsidiaries		54
		Regulation and Supervision		54
LIQUIDITY				55
SPECIAL PURPOSE VEHICLES AND OFF BALANCE SHEET ARRANGEMENTS				56
DERIVATIVES				56
MANAGING MARKET RISK				57
		Insurance		57
		Financial Services		58
RECENT ACCOUNTING STANDARDS				59
CONTROLS AND PROCEDURES				60

Cautionary Statement Regarding
Forward-Looking Information

This Quarterly Report 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 AIG’s control. These statements may address, among other things, the status and potential future outcome of the current regulatory and civil proceedings against AIG and their potential effect on AIG’s businesses, financial position, results of operations, cash flows and liquidity, the effect of the credit rating downgrades on AIG’s businesses and competitive position, the unwinding and resolving of various relationships between AIG and Starr and SICO, AIG’s strategy for growth, product development, 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 (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.

American International Group, Inc. and Subsidiaries

Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, AIG presents its operations in the way it believes will be most meaningful. Statutory underwriting profit (loss) and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance used in the insurance industry and thus allow more meaningful comparisons with AIG’s insurance competitors. AIG has also incorporated into this discussion a number of cross-references to additional information included throughout this Form 10-Q to assist readers seeking related information on a particular subject.

Restatement of Previously Issued Financial Statements

AIG restated its financial statements for the years ended December 31, 2003, 2002, 2001 and 2000, the quarters ended March 31, June 30 and September 30, 2004 and 2003 and the quarter ended December 31, 2003 in conjunction with filing its 2004 Annual Report on Form 10-K. In connection with the preparation of AIG’s consolidated financial statements included in the 2004 Annual Report on Form 10-K, AIG’s current management initiated an internal review of AIG’s books and records, which was substantially expanded in mid-March 2005. Management believes that the scope and process of its internal review was sufficient to identify issues of a material nature that could affect AIG’s financial statements. For further discussion, see the 2004 Annual Report on Form 10-K.

Overview of Operations and Business Results

AIG’s operations in 2005 are conducted by its subsidiaries principally through four operating segments: General Insurance, Life Insurance and Retirement Services, Financial Services and Asset Management. Through these segments, AIG provides insurance and investment products and services to both businesses and individuals in more than 130 countries and jurisdictions. This geographic, product and service diversification is one of AIG’s major strengths and sets it apart from its competitors. The importance of this diversification was especially evident in 2004, when record catastrophe losses in certain insurance operations were more than offset by profitability in those operations as well as in other segments and product lines. Although regional economic downturns or political upheaval could negatively affect parts of AIG’s operations, AIG believes that its diversification makes it unlikely that regional difficulties would have a material effect on its operating results, financial condition or liquidity.

AIG’s subsidiaries serve commercial, institutional and individual customers through an extensive property-casualty and life insurance and retirement services network. In the United States, AIG companies are the largest underwriters of commercial and industrial insurance and one of the largest life insurance and retirement services operations as well. AIG’s Financial Services businesses include commercial aircraft and equipment leasing, capital markets operations and consumer finance, both in the United States and abroad. AIG also provides asset management services and offers guaranteed investment contracts, also known as funding agreements, (GICs) to institutions and individuals.

AIG’s operating performance reflects implementation of various long-term strategies and defined goals in its various operating segments.

A primary goal of AIG in managing its General Insurance operations is to achieve an underwriting profit. To achieve this goal, AIG must be disciplined in its risk selection and premiums must be adequate and terms and conditions appropriate to cover the risk accepted. AIG believes in strict control of expenses.

Another central focus of AIG operations in current years is the development and expansion of new distribution channels. In 2004, AIG expanded its distribution channels in many Asian countries, which now include banks, credit card companies and television-media home shopping. In late 2003, AIG entered into an agreement with PICC Property and Casualty Company, Limited (PICC), which will enable the marketing of accident and health products throughout China through PICC’s branch networks and agency system. AIG participates in the underwriting results through a reinsurance agreement and also holds a 9.9 percent ownership interest in PICC. Other examples of new distribution channels used both domestically and overseas include banks, affinity groups, direct response and e-commerce.

AIG patiently builds relationships in markets around the world where it sees long-term growth opportunities. For example, the fact that AIG has the only wholly-owned foreign life insurance operations in eight cities in China is the result of relationships developed over nearly 30 years. AIG’s more recent extensions of operations into India, Vietnam, Russia and other emerging markets reflect the same growth strategy. Moreover, AIG believes in investing in the economies and infrastructures of these countries and growing with them. When AIG companies enter a new jurisdiction, they typically offer both basic protection and savings products. As the economies evolve, AIG’s products evolve with them, to more complex and investment-oriented models.

Growth for AIG may be generated both internally and through acquisitions which both fulfill strategic goals and offer adequate return on investment. In recent years, the acquisitions of AIG Star Life and AIG Edison Life have broadened AIG’s penetration of the Japanese market through new distribution channels and will result in operating efficiencies as they are integrated into AIG’s previously existing companies operating in Japan.

American International Group, Inc. and Subsidiaries

AIG provides leadership on issues of concern to the global and local economies as well as the insurance and financial services industries. In recent years, efforts to reform the tort system and class action litigation procedures, legislation to deal with the asbestos problem and the renewal of the Terrorism Risk Insurance Act have been key issues, while in prior years trade legislation and Superfund had been issues of concern.

The following table summarizes AIG’s revenues, income before income taxes, minority interest and cumulative effect of an accounting change and net income for the three months ended March 31, 2005 and 2004:


(in millions)	2005		2004


Total revenues	$	27,112	$	23,375

Income before income taxes, minority interest and cumulative effect of an accounting change		5,443		3,939

Net income	$	3,684	$	2,556

Consolidated Results

The 16.0 percent growth in revenues in the first three months of 2005 was primarily attributable to the growth in net premiums earned from global General Insurance operations as well as growth in both General Insurance and Life Insurance & Retirement Services net investment income and Life Insurance & Retirement Services GAAP premiums.

AIG’s income before income taxes, minority interest and cumulative effect of an accounting change increased 38.2 percent in the first three months of 2005 when compared to the same period of 2004. General Insurance, Life Insurance & Retirement Services, Financial Services, and Asset Management operating income gains were the primary factors for the increase over 2004 in both pretax income and net income.

The following table summarizes the operations of each principal segment for the three months ended March 31, 2005 and 2004. (See also Note 2 of Notes to Financial Statements.)


(in millions)		2005			2004

Revenues^(a):
	General Insurance^(b)	$	11,263		$	10,075
	Life Insurance & Retirement Services^(c)		11,820			10,523
	Financial Services^(d)		2,449			1,788
	Asset Management^(e)		1,375			1,032
	Other		205			(43	)

Consolidated		$	27,112		$	23,375

Operating Income^(a)(f):
	General Insurance	$	1,697		$	1,441
	Life Insurance & Retirement Services		2,223			1,785
	Financial Services		1,043			545
	Asset Management		526			353
	Other^(g)		(46	)		(185	)

Consolidated		$	5,443		$	3,939


(a)	Revenues and operating income reflect changes in market or estimated fair value associated with derivatives that do not qualify for hedge accounting pursuant to FAS 133.
(b)	Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).


(c)	Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).


(d)	Represents interest, lease and finance charges.


(e)	Represents management and advisory fees and net investment income with respect to GICs.
(f)	Represents income before income taxes, minority interest and cumulative effect of an accounting change.


(g)	Represents other income (deductions) – net and other realized capital gains (losses).

General Insurance

AIG’s General Insurance operations provide property and casualty products and services throughout the world. The increase in General Insurance operating income in the first three months of 2005 compared to the same period of 2004 was primarily attributable to strong growth in operating income with respect to Domestic Brokerage Group’s and Foreign General’s operations, offset by a decrease in realized capital gains for the segment in the first three months of 2005 compared to the same period of 2004. DBG’s operating income included additional losses in the first three months of 2005 resulting from increased labor and material costs related to the 2004 Florida hurricanes.

Life Insurance & Retirement Services

AIG’s Life Insurance & Retirement Services operations provide insurance, financial and investment products throughout the world. Foreign operations provided approximately 60 percent of AIG’s Life Insurance & Retirement Services operating income for the first quarter of 2005.

Life Insurance & Retirement Services operating income increased by 24.5 percent in the first three months of 2005 when compared to the same period of 2004. This increase

American International Group, Inc. and Subsidiaries

resulted from growth in AIG’s principal Life Insurance & Retirement Services businesses, and capital gains realized in 2005 rather than the capital losses realized in 2004.

Financial Services

AIG’s Financial Services subsidiaries engage in diversified activities including aircraft and equipment leasing, capital market transactions, consumer finance and insurance premium financing.

Financial Services operating income increased by 91.4 percent in the first three months of 2005 compared to the same period of 2004, primarily due to the fluctuation in earnings resulting from the accounting effect of FAS 133. Fluctuations in revenues and operating income from quarter to quarter are not unusual because of the transaction-oriented nature of Capital Markets operations and the effect of not qualifying for hedge accounting treatment under FAS 133 for hedges on securities available for sale and borrowings. Consumer Finance operations increased revenues and operating income, both domestically and internationally.

Asset Management

AIG’s Asset Management operations include institutional and retail asset management and broker dealer services and spread-based investment business from the sale of GICs. These products and services are offered to individuals and institutions, both domestically and overseas.

Asset Management operating income increased 49.0 percent in the first three months of 2005 when compared to the same period of 2004 as a result of the upturn in worldwide financial markets and a strong global product portfolio.

Capital Resources

At March 31, 2005, AIG had total consolidated shareholders’ equity of $82.68 billion and total consolidated borrowings of $104.78 billion. At that date, $95.26 billion of such borrowings were either not guaranteed by AIG or were AIGFP’s matched borrowings under obligations of guaranteed investment agreements (GIAs), liabilities connected to trust preferred stock, or matched notes and bonds payable.

During the period from January 1, 2005 through March 31, 2005, AIG purchased in the open market 2,477,100 shares of its common stock.

Liquidity

At March 31, 2005, AIG’s consolidated invested assets included $24.38 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first three months of 2005 amounted to $654 million. The $654 million in consolidated net cash provided by operating activities is net of approximately $8 billion used by AIGFP to purchase securities purchased under agreements to resell and to repurchase securities sold under agreements to repurchase in the ordinary course of AIGFP’s business. This operating activity was funded in part by proceeds from security sales under similar repurchase and reverse repurchase agreements, but primarily by AIGFP’s financing activities, specifically proceeds from guaranteed investment agreements and notes, bonds, loans and mortgages payable. To date, approximately half of the $8 billion was subsequently invested in securities available for sale. AIG believes that its liquid assets, cash provided by operations and access to short term funding through commercial paper and bank credit facilities will enable it to meet any anticipated cash requirements.

Outlook

From March through June of 2005, the major rating agencies downgraded AIG’s ratings in a series of actions. Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (S&P), lowered the long-term senior debt and counterparty ratings of AIG from ‘AAA’ to ‘AA’ and changed the rating outlook to negative. Moody’s Investors Service (Moody’s) lowered AIG’s long-term senior debt rating from ‘Aaa’ to ‘Aa2’ and changed the outlook to stable. Fitch Ratings (Fitch) downgraded the long-term senior debt ratings of AIG from ‘AAA’ to ‘AA’ and placed the ratings on Rating Watch Negative.

The agencies also took rating actions on AIG’s insurance subsidiaries. S&P and Fitch lowered to ‘AA+’ the insurance financial strength ratings of most of AIG’s insurance companies. Moody’s lowered the insurance financial strength ratings generally to either ‘Aa1’ or ‘Aa2’. A.M. Best downgraded the financial strength ratings for most of AIG’s insurance subsidiaries from ‘A++’ to ‘A+’ and the issuer credit ratings from ‘aa+’ to ‘aa-’. Many of these companies’ ratings remain on a negative watch.

In addition, S&P changed the outlook on ILFC’s ‘AA-’ long-term senior debt rating to negative. Moody’s affirmed ILFC’s long-term and short-term senior debt ratings (‘A1’/‘P-1’). Fitch downgraded ILFC’s long-term senior debt rating from ‘AA-’ to ‘A+’ and placed the rating on Rating Watch Negative and downgraded ILFC’s short-term debt rating from ‘F1+’ to ‘F1’. Fitch also placed the ‘A+’ long-term senior debt ratings of American General Finance Corporation and American General Finance, Inc. on Rating Watch Negative. S&P and Moody’s affirmed the long-term and short-term senior debt ratings of American General Finance Corporation at ‘A+’/‘A-1’ and ‘A1’/‘P-1’, respectively.

These debt and financial strength ratings are current opinions of the rating agencies. As such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of changes in, or unavailability of, information or based on other circumstances. Ratings may also be withdrawn at AIG management’s request. This discussion of ratings is not a complete list of ratings of AIG and its subsidiaries.

These ratings actions have affected and will continue to affect AIG’s business and results of operations in a number of ways.

American International Group, Inc. and Subsidiaries


•	Downgrades in AIG’s debt ratings will adversely affect AIG’s results of operations. AIG relies on external sources of financing to fund several of its operations. The cost and availability of unsecured financing are generally dependent on the issuer’s long-term and short-term debt ratings. The recent downgrades and any future downgrades in AIG’s debt ratings will increase AIG’s borrowing costs and therefore adversely affect AIG’s results of operations.

•	The downgrade in AIG’s long-term senior debt ratings will adversely affect AIGFP’s ability to compete for certain businesses. Credit ratings are very important to the ability of financial institutions to compete in the derivative and structured transaction marketplaces. Historically, AIG’s triple-A ratings provided AIGFP a competitive advantage. The downgrades will reduce this advantage and, for specialized financial transactions that generally are conducted only by triple-A rated financial institutions, counterparties may be unwilling to transact business with AIGFP except on a secured basis. This could require AIGFP to post more collateral to counterparties in the future. See below for a further discussion of the effect that posting collateral may have on AIG’s liquidity.

•	Although the financial strength ratings of AIG’s insurance company subsidiaries remain high compared to many of their competitors, the downgrades have reduced the previous ratings differential. The competitive advantage of the ratings to AIG’s insurance company subsidiaries may be lessened accordingly. The recent regulatory inquiries, internal investigations, and delay in the filing of the 2004 Annual Report on Form 10-K, as well as negative publicity, had caused independent producers and distributors of AIG’s domestic life and retirement services products to be more cautious in placing business with AIG subsidiaries. AIG is unable to predict the effect of these issues on AIG’s business, including any increase in associated surrender or replacement activity.

•	As a result of the downgrades of AIG’s long-term senior debt ratings, AIG has been required to post approximately $1.16 billion of collateral with counterparties to municipal guaranteed investment agreements and financial derivatives transactions. In the event of a further downgrade, AIG will be required to post additional collateral. It is estimated that, as of the close of business on June 23, 2005, based on AIG’s outstanding municipal guaranteed investment agreements and financial derivatives transactions as of such date, a further downgrade of AIG’s long-term senior debt ratings to ‘Aa3’ by Moody’s or ‘AA-’ by S&P would permit counterparties to call for approximately $2.10 billion of additional collateral. Further, additional downgrades could result in requirements for substantial additional collateral, which could have a material effect on how AIG manages its liquidity. The actual amount of additional collateral that AIG would be required to post to counterparties in the event of such downgrades depends on market conditions, the market value of the outstanding affected transactions and other factors prevailing at the time of the downgrade. The requirement to post additional collateral may increase if additional counterparties begin to require credit support from AIG through collateralization agreements. Additional obligations to post collateral will increase the demand on AIG’s liquidity.

Despite industry price erosion in some classes of general insurance, AIG expects to continue to identify profitable opportunities and build attractive new General Insurance businesses as a result of AIG’s broad product line and extensive distribution networks. AIG expects total General Insurance premiums to increase for 2005 and expects cash flow for investments to remain strong. Thus, General Insurance net investment income is expected to rise in future quarters even in a continued low interest rate environment.

In China, AIG has wholly-owned life insurance operations in eight cities. These operations should benefit from China’s rapid rate of economic growth and growing middle class, a segment that is a prime market for life insurance. AIG believes that it may also have opportunities in the future to grow by entering the group insurance business. However, in March 2005 it withdrew its application to serve the group insurance market until certain regulatory issues are resolved. Among the regulatory issues to be addressed is the response to AIG’s acknowledgment that certain of its Hong Kong based agents sold life insurance to customers on the Chinese mainland in contravention of applicable regulations.

AIG Edison Life, acquired in August 2003, adds to the current agency force in Japan, and provides alternative distribution channels including banks, financial advisers, and corporate and government employee relationships. AIG Edison Life’s integration into AIG’s existing Japanese operations will provide future operating efficiencies. In January 2005, AIG Star Life entered into an agreement with the Bank of Tokyo Mitsubishi, one of Japan’s largest banks, to market a multi-currency fixed annuity. Through ALICO, AIG Star Life and AIG Edison, AIG has developed a leadership position in the distribution of annuities through banks. AIG is also a leader in the direct marketing of insurance products through sponsors and in the broad market. AIG also expects continued growth in India, Korea and Vietnam.

Domestically, AIG anticipates continued operating growth in 2005 as distribution channels are expanded and new products are introduced. The home service operation has not met business objectives, although its cash flow has been strong, and domestic group life/health was also weak in 2004. AIG expects restructuring efforts in these businesses to show positive results by early 2006. AIG American General’s current ratings remain equal to or higher than many of its principal competitors. Nevertheless, recent events have caused independent producers and distributors of AIG Amer-

American International Group, Inc. and Subsidiaries

ican General’s products to be more cautious in placing business with AIG. Therefore, AIG is unable to predict the effect of these issues on AIG’s business, including any increase in associated surrender or replacement activity.

In the airline industry, changes in market conditions are not immediately apparent in operating results. Lease rates have firmed considerably, as a result of strong demand spurred by the recovering global commercial aviation market, especially in Asia. Sales have begun to increase, and AIG expects an increasing level of interest from a variety of purchasers. Therefore, AIG believes that the improvements in that market which commenced in 2003 will be gradually reflected in ILFC’s results in 2005. In the Capital Markets operations, the integration of AIG Trading Group Inc. and its subsidiaries into the operations of AIGFP created operating efficiencies that will continue to be realized and product synergies that should enhance 2005 results, although quarter to quarter variations are to be expected in this transaction-oriented business. AIG also expects increased contributions to Financial Services revenues and income from its consumer finance operations both domestically and overseas. However, the downgrades of AIG’s credit ratings may adversely affect funding costs for AIG and its subsidiaries and AIGFP’s ability to engage in derivative transactions and certain structured products. See “Certain Factors Affecting AIG’s Business — AIG’s Credit Ratings” in Item 1 of Part I of AIG’s 2004 Annual Report on Form 10-K.

GICs, which are sold domestically and abroad to both institutions and individuals, are written on an opportunistic basis when market conditions are favorable. AIG expects to launch a matched investment program utilizing issuances of AIG debt securities, which will become AIG’s principal spread-based investment activity. However, in light of recent developments, the timing of the launch of this program is uncertain. Because AIG’s credit spreads in the capital markets have widened following the ratings declines, there may be a reduction in the earnings on new business in AIG’s spread based funding businesses.

AIG has many promising growth initiatives underway around the world in its insurance and other operations. Cooperative agreements such as those with PICC and various banks in the U.S., Japan and Korea are expected to expand distribution networks for AIG’s products and provide models for future growth.

Critical Accounting Estimates

AIG considers its most critical accounting estimates those with respect to reserves for losses and loss expenses, future policy benefits for life and accident and health contracts, deferred policy acquisition costs, estimated gross profits for investment-oriented products, fair value determinations for certain Capital Markets assets and liabilities and other than temporary declines in value-investments. These accounting estimates require the use of assumptions about matters, some of which are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, AIG’s results of operations would be directly affected.

Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, AIG’s critical accounting estimates are discussed in detail. The major categories for which assumptions are developed and used to establish each critical accounting estimate are highlighted below.

Reserves for Losses and Loss Expenses (General Insurance):


•	Loss trend factors: used to establish expected loss ratios for subsequent accident years based on premium rate adequacy and the projected loss ratio with respect to prior accident years.
•	Expected loss ratios for the latest accident year: for example, accident year 2004 for the year end 2004 loss reserve analysis. For low frequency, high severity classes such as excess casualty and directors and officers liability (D&O), expected loss ratios generally are utilized for at least the three most recent accident years.
•	Loss development factors: used to project the reported losses for each accident year to an ultimate amount.

Future Policy Benefits for Life and Accident and Health Contracts (Life Insurance & Retirement Services):


•	Interest rates: which vary by geographical region, year of issuance and products.
•	Mortality, morbidity and surrender rates: based upon actual experience by geographical region modified to allow for variation in policy form.

Estimated Gross Profits (Life Insurance & Retirement Services):


•	Estimated gross profits to be realized over the estimated duration of the contracts (investment-oriented products) affects the carrying value of deferred policy acquisition costs under FAS 97. Estimated gross profits include investment income and gains and losses on investments less required interest, actual mortality and other expenses.

Deferred Policy Acquisition Costs (Life Insurance & Retirement Services):


•	Recoverability based on current and future expected profitability, which is affected by interest rates, foreign exchange rates, mortality experience, and policy persistency.

Deferred Policy Acquisition Costs (General Insurance):


•	Recoverability and eligibility based upon the current terms and profitability of the underlying insurance contracts.

Fair Value Determinations of Certain Assets and Liabilities (Financial Services – Capital Markets):


•	Valuation models: utilizing factors, such as market liquidity and current interest, foreign exchange and volatility rates.

American International Group, Inc. and Subsidiaries

•

AIG attempts to secure reliable and independent current market price data, such as published exchange rates from external subscription services such as Bloomberg or Reuters or third-party broker quotes for use in this model. When such prices are not available, AIG uses an internal methodology, which includes interpolation from verifiable prices from trades occurring on dates nearest to the dates of the transactions.

Other Than Temporary Declines in Value – Investments:

Securities are considered a candidate for impairment based upon the following criteria:


•	Trading at a significant (25 percent or more) discount to par, amortized cost (if lower) or cost for an extended period of time (nine months or longer).
•	The occurrence of a discrete credit event resulting in the debtor default, seeking bankruptcy or insolvency protection or voluntary reorganization.
•	The possibility of non-realization of a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

Operating Review

General Insurance Operations

AIG’s General Insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance both domestically and abroad.

Domestic General Insurance operations are comprised of the Domestic Brokerage Group (DBG), which includes the operations of The Hartford Steam Boiler Inspection and Insurance Company (HSB), Transatlantic Holdings, Inc. (Transatlantic); Personal Lines, including 21st Century Insurance Group (21st Century); and United Guaranty Corporation (UGC).

AIG’s primary domestic division is DBG. DBG’s business in the United States and Canada is conducted through its General Insurance subsidiaries including American Home, National Union, Lexington and certain other General Insurance company subsidiaries of AIG.

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.

In addition to writing substantially all classes of business insurance, including large commercial or industrial property insurance, excess liability, inland marine, environmental, workers compensation and excess and umbrella coverages, DBG offers many specialized forms of insurance such as aviation, accident and health, equipment breakdown, directors and officers liability (D&O), difference-in-conditions, kidnap-ransom, export credit and political risk, and various types of professional errors and omissions coverages. The AIG Risk Management operation provides insurance and risk management programs for large corporate customers. The AIG Risk Finance operation is a leading provider of customized structured insurance products. Also included in DBG are the operations of AIG Environmental, which focuses specifically on providing specialty products to clients with environmental exposures. Lexington writes surplus lines, those risks for which conventional insurance companies do not readily provide insurance coverage, either because of complexity or because the coverage does not lend itself to conventional contracts.

Certain of the products of the DBG companies include funding components or have been structured in a manner such that little or no insurance risk is actually transferred. Funds received in connection with these products are recorded as deposits, included in other liabilities, rather than premiums and incurred losses.

The AIG Worldsource Division introduces and coordinates AIG’s products and services to U.S.-based multinational clients and foreign corporations doing business in the U.S.

Transatlantic subsidiaries offer reinsurance capacity on both a treaty and facultative basis both in the U.S. and abroad. Transatlantic structures programs for a full range of property and casualty products with an emphasis on specialty risks.

AIG’s Personal Lines operations provide automobile insurance through AIG Direct, the mass marketing operation of AIG, Agency Auto Division and 21^st Century Insurance Group, as well as a broad range of coverages for high-net-worth individuals through the AIG Private Client Group.

The principal business of the UGC subsidiaries is the writing of residential mortgage loan insurance, which is guaranty insurance on conventional first mortgage loans on single-family dwellings and condominiums. This type of insurance protects lenders against loss if borrowers default. UGC subsidiaries also write home equity and property improvement loan insurance on loans to finance residential property improvements, alterations and repairs and for other purposes not necessarily related to real estate.

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 companies. The Foreign General Insurance group also includes business written by AIG’s foreign-based insurance subsidiaries. The Foreign General group uses various marketing methods and multiple distribution channels to write both business and personal lines insurance with certain refinements for local laws, customs and needs. AIU operates in Asia, the Pacific Rim, the United Kingdom, Europe, Africa, the Middle East and Latin America.

As previously noted, AIG believes it should present and discuss its financial information in a manner most meaningful

American International Group, Inc. and Subsidiaries

to its investors. Accordingly, in its General Insurance business, AIG uses certain non-GAAP measures, where AIG has determined these measurements to be useful and meaningful.

A critical discipline of a successful general insurance business is the objective to produce operating income from underwriting exclusive of investment-related income. When underwriting is not profitable, premiums are inadequate to pay for insured losses and underwriting related expenses. In these situations, the addition of general insurance related investment income and realized capital gains may, however, enable a general insurance business to produce operating income. For these reasons, AIG views underwriting profit to be critical in the overall evaluation of performance. Although in and of itself not a Generally Accepted Accounting Principles (GAAP) measurement, AIG believes that underwriting profit is a useful and meaningful disclosure. (See also the discussion under “Liquidity” herein.)

Underwriting profit is measured in two ways: statutory underwriting profit and GAAP underwriting profit.

Statutory underwriting profit is derived by reducing net premiums earned by net losses and loss expenses incurred and net expenses incurred. Statutory accounting generally requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, expenses are recognized immediately, not over the same period that the revenues are earned.

A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the accounting principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred (deferred policy acquisition costs (DAC)) and amortized over the period the related net premiums written are earned. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. DAC is reviewed for recoverability, and such review requires management judgment. (See also “Critical Accounting Estimates” herein.)

AIG, along with most General Insurance companies, uses the loss ratio, the expense ratio and the combined ratio as measures of underwriting 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.

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 unearned premium reserve is not fully recognized in income as net premiums earned until the end of the policy period.

The underwriting environment varies from country to country, as does the degree of litigation activity. Regulation, product type and competition have a direct effect on pricing and consequently on profitability as reflected in underwriting profit and statutory general insurance ratios.

General Insurance operating income is comprised of underwriting profit (loss), net investment income and realized capital gains and losses. These components, as well as net premiums written, net premiums earned and statutory ratios for the three months ended March 31, 2005 and 2004 were as follows:


*(in millions, except ratios)*			2005			2004


Net premiums written:
	Domestic General
		DBG	$	5,727		$	5,355
		Transatlantic		885			907
		Personal Lines		1,186			1,119
		Mortgage Guaranty		165			154
	Foreign General			2,830			2,500

Total			$	10,793		$	10,035

Net premiums earned:
	Domestic General
		DBG	$	5,574		$	4,938
		Transatlantic		888			893
		Personal Lines		1,120			1,042
		Mortgage Guaranty		140			134
	Foreign General			2,416			2,086

Total			$	10,138		$	9,093

Underwriting profit (loss):
	Domestic General
		DBG	$	6	^(a)	$	(19	)
		Transatlantic		20			37
		Personal Lines		58			50
		Mortgage Guaranty		75			68
	Foreign General			413			323

Total			$	572		$	459

Net investment income:
	Domestic General
		DBG	$	658		$	475
		Transatlantic		85			72
		Personal Lines		52			45
		Mortgage Guaranty		28			29
		Intercompany adjustments and eliminations – net		1			–
	Foreign General			209			176

Total			$	1,033		$	797

Realized capital gains (losses)				92			185

Operating income			$	1,697		$	1,441

American International Group, Inc. and Subsidiaries


*(in millions, except ratios)*		2005			2004


Domestic General:
	Loss Ratio		77.12	^(a)		78.54
	Expense Ratio		19.73			19.65

Combined Ratio			96.85			98.19

Foreign General:
	Loss Ratio		54.50			57.75
	Expense Ratio^(b)		27.16			25.35

Combined ratio^(b)			81.66			83.10

Consolidated:
	Loss Ratio		71.73	^(a)		73.77
	Expense Ratio		21.68			21.07

Combined Ratio			93.41			94.84


(a)	Includes $118 million of additional losses incurred resulting from increased labor and material costs related to the 2004 Florida Hurricanes (1.53 points increase on the domestic general loss ratio and 1.16 points increase on the consolidated general loss ratio).


(b)	Includes the results of wholly owned AIU agencies.

General Insurance Results

General Insurance operating income in the first three months of 2005 showed excellent results. The increase in General Insurance operating income in the first three months of 2005 was primarily attributable to strong profitable growth in Foreign General’s underwriting results and DBG’s and Foreign General’s net investment income partially offset by a decrease in realized capital gains relative to the same period of 2004. DBG’s underwriting results included additional losses incurred resulting from increased labor and material costs related to the 2004 Florida hurricanes.

Like most AIG units, DBG benefited in the first three months of 2005 from a strong profit center focus and growing distribution channels. Overall, DBG’s net premiums written increased in the first three months of 2005 and 2004, as new business, generally higher renewal retention rates and a modest change in the mix of business towards classes (i.e. smaller accounts) that purchase less reinsurance more than offset modest rate decreases in some classes (i.e. property, D&O, healthcare, aviation). Domestic property-casualty premium rates are generally satisfactory at this time, although AIG has begun to see evidence in some classes of business, including property, D&O, energy and healthcare, where rates quoted by other carriers on selected accounts or segments do not meet AIG’s view of satisfactory. The loss ratio decreased from same period of 2004 principally as a result of the impact of prior year rate increases on premiums earned in the quarter, lower losses in the quarter in short tail classes of business, such as property and accident & health, offset by $118 million of additional losses incurred resulting from increased labor and material costs related to the 2004 Florida hurricanes.

Transatlantic’s net premiums written and net premiums earned for the first quarter of 2005 decreased compared with the same period in 2004, principally as a result of decreased domestic business, partially offset by increased international business.

Personal Lines net premiums written in the first three months of 2005 increased when compared to the same period of 2004 due to good growth in its core business units through expanded marketing efforts, increased agent/broker appointments, and enhanced product offerings. These gains were partially offset by reductions in its involuntary auto business due to aggressive re-underwriting of the previously acquired GE business. Underwriting income increased as a result of earned premium growth and favorable development of prior accident years.

Mortgage Guaranty’s net premiums written increased in the first three months of 2005 when compared to the same period of 2004. Strong growth in junior liens, student loans and international business were offset by continued low persistency in the residential first lien business, caused by high refinance activity fueled by low mortgage interest rates.

Foreign General Insurance had strong results in the first three months of 2005. Growth in net premiums written was achieved due to new business as well as new distribution channels partially offset by rate decreases in Australia and the United Kingdom commercial lines. The Far East region had excellent results. Personal accident business exhibited strong growth. In Japan, the purchase of the Royal & SunAlliance branch operations opened new distribution channels. Commercial lines in Europe and the Ascot syndicate continue to exhibit strong growth, as did Personal Lines operations in Brazil and Latin America. This growth translated to improved underwriting results.

AIG transacts business in most major foreign currencies. The following table summarizes the effect of changes in foreign currency exchange rates on the growth of General Insurance net premiums written for the first three months of 2005:


	2005


Growth in original currency		6.3%
Foreign exchange effect		1.3
Growth as reported in U.S. dollars		7.6%

As previously noted, DBG’s results include $118 million of additional losses incurred in the first three months of 2005 resulting from increased labor and material costs related to the 2004 Florida hurricanes. Other effects of catastrophes incurred in the first three months of 2005 and 2004 were insignificant. The effect on losses caused by catastrophes can fluctuate widely from year to year, making comparisons of recurring type business more difficult. With respect to catastrophe losses, AIG believes that it has taken appropriate steps, such as careful exposure selection and obtaining reinsurance coverage, to reduce the effect of the magnitude of possible future losses. The occurrence of one or more catastrophic events of unanticipated frequency or severity, such

American International Group, Inc. and Subsidiaries

as terrorist attack, earthquake or hurricane, that causes insured losses, however, could have a material adverse effect on AIG’s results of operations, liquidity or financial condition.

General Insurance net investment income grew in the first three months of 2005 when compared to the same period of 2004. AIG is benefiting from strong cash flow, higher interest rates as well as increased partnership income. Additionally, net investment income was positively affected by the compounding of previously earned and reinvested net investment income. As AIG believes that net premiums written will continue to increase in 2005, AIG expects that cash flow for investment will continue to be strong, resulting in growth in net investment income in 2005.

Realized capital gains and losses resulted from the ongoing investment management of the General Insurance portfolios within the overall objectives of the General Insurance operations. (See the discussion on “Valuation of Invested Assets” herein.)

The contribution of General Insurance operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change was 31.2 percent in the first three months of 2005 compared to 36.6 percent in the same period of 2004.

Reinsurance

AIG is a major purchaser of reinsurance for its General Insurance operations. AIG insures risks globally, and its reinsurance programs must be coordinated in order to provide AIG the level of reinsurance protection that AIG desires. Reinsurance is an important risk management tool to manage transaction and insurance line risk retention at prudent levels set by management. AIG also purchases reinsurance to mitigate its catastrophic exposure. 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 because one or more catastrophe losses could negatively affect AIG’s reinsurers and result in an inability of AIG to collect reinsurance recoverables. AIG’s reinsurance department evaluates catastrophic events and assesses the probability of occurrence and magnitude of catastrophic events through the use of state-of-the-art industry recognized program models among other techniques. AIG supplements these models through continually monitoring the risk exposure of AIG’s worldwide General Insurance operations and adjusting such models accordingly. While reinsurance arrangements do not relieve AIG from its direct obligations to its insureds, an efficient and effective reinsurance program substantially limits AIG’s exposure to potentially significant losses.

AIG’s consolidated general reinsurance assets amounted to $18.30 billion at March 31, 2005 and resulted from AIG’s reinsurance arrangements. Thus, a credit exposure existed at March 31, 2005 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, 2004, approximately 43 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, the majority of these balances were collateralized. The remaining 57 percent of the general reinsurance assets were from authorized reinsurers. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. Approximately 90 percent of the balances with respect to authorized reinsurers are from reinsurers rated A (excellent) or better, as rated by A.M. Best, or A (strong) or better, as rated by Standard & Poor’s. Through March 31, 2005, these distribution percentages have not changed significantly. These ratings are measures of financial strength.

AIG maintains a reserve for estimated unrecoverable reinsurance, but it has been largely successful in its previous recovery efforts. At December 31, 2004 AIG had allowances for unrecoverable reinsurance approximating $400 million. At that date, AIG had no significant reinsurance recoverables due from any individual reinsurer that was 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 evaluating the local economic environment in which a foreign reinsurer operates. This department also reviews the nature of the risks ceded and the requirements for credit risk mitigants. For example, in AIG’s treaty reinsurance contracts, AIG includes provisions that frequently require a reinsurer to post collateral when a referenced event occurs. Furthermore, AIG limits its unsecured exposure to reinsurers through the use of credit triggers, which include, but are not limited to, insurer financial strength rating downgrades, policyholder surplus declines at or below a certain predetermined level or a certain predetermined level of a reinsurance recoverable being reached. In addition, AIG’s Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer.

AIG enters into intercompany reinsurance transactions, primarily through AIRCO, for its General Insurance and Life Insurance operations. AIG enters into these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among AIG’s various legal entities. These reinsurance agreements have

American International Group, Inc. and Subsidiaries

been approved by the appropriate regulatory authorities. All material intercompany transactions have been eliminated in consolidation. AIG generally obtains letters of credit in order to obtain statutory recognition of these intercompany reinsurance transactions. At March 31, 2005, approximately $3.3 billion of letters of credit were outstanding to cover intercompany reinsurance transactions with AIRCO or other General Insurance subsidiaries.

At March 31, 2005, the consolidated general reinsurance assets of $18.30 billion include reinsurance recoverables for paid losses and loss expenses of $944 million, $14.24 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported (IBNR) (ceded reserves) and ceded reserve for unearned premiums of $3.12 billion. 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 by management. Any adjustments thereto are reflected in income currently. It is AIG’s belief that the ceded reserves at March 31, 2005 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.

Reserve for Losses and Loss Expenses

The table below classifies as of March 31, 2005 the components of the General Insurance reserve for losses and loss expenses (loss reserves) with respect to major lines of business on a statutory basis^*:


*(in millions)*

Other liability occurrence			$16,835
Other liability claims made			10,654
Workers compensation			9,612
Auto liability			5,512
Property			4,223
International			3,608
Reinsurance			2,480
Medical malpractice			2,236
Aircraft			1,697
Products liability			1,384
Commercial multiple peril			1,154
Accident and health			1,097
Fidelity/ surety			960
Other			2,609

Total			$64,061


*	Presented pursuant to statutory reporting requirements as prescribed by the National Association of Insurance Commissioners.

These loss reserves represent the accumulation of estimates of ultimate losses, including IBNR and loss expenses on a statutory accounting basis.

At March 31, 2005, General Insurance net loss reserves increased $2.08 billion from the prior year end to $49.83 billion. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance and the discount for future investment income. The table below classifies the components of the General Insurance net loss reserves by business unit as of March 31, 2005.


*(in millions)*

DBG^(a)			$34,383
Personal Lines^(b)			2,314
Transatlantic			5,062
Mortgage Guaranty			353
Foreign General^(c)			7,714

Total Net Loss Reserve			$49,826


(a)	DBG loss reserves include approximately $3.37 billion ($3.98 billion before discount) related to business written by DBG but ceded to AIRCO and reported in AIRCO’s statutory filings.
(b)	Personal Lines loss reserves include $700 million related to business ceded to DBG and reported in DBG’s statutory filings.
(c)	Foreign General loss reserves include approximately $1.95 billion related to business reported in DBG’s statutory filings.

The DBG net loss reserve of $34.38 billion is comprised principally of the business of AIG subsidiaries participating in the American Home/National Union pool (11 companies) and the surplus lines pool (Lexington, Starr Excess Liability Insurance Company and Landmark Insurance Company).

Beginning in 1998, DBG ceded a quota share percentage of its other liability occurrence and products liability occurrence business to AIRCO. The quota share percentage ceded was 40 percent in 1998, 65 percent in 1999, 75 percent in 2000 and 2001, 50 percent in 2002 and 2003, 40 percent in 2004 and 35 percent in 2005 and covered all business written in these years for these lines by participants in the American Home/National Union pool. In 1998 the cession reflected only the other liability occurrence business, but in 1999 and subsequent years included products liability occurrence. AIRCO’s loss reserves relating to these quota share cessions from DBG are recorded on a discounted basis. As of March 31, 2005, AIRCO carried a discount of approximately $610 million applicable to the $3.98 billion in undiscounted reserves it assumed from the American Home/National Union pool via this quota share cession. AIRCO also carries approximately $375 million in net loss reserves relating to Foreign General insurance business. These reserves are carried on an undiscounted basis.

Beginning in 1997, the Personal Lines division ceded a percentage of all business written by the companies participating in the personal lines pool to the American Home/National Union pool. As noted above, the total reserves carried by participants in the American Home/National Union pool relating to this cession amounted to $700 million as of March 31, 2005.

The companies participating in the American Home/National Union pool have maintained a participation in the business written by AIU for decades. As of March 31, 2005, these AIU reserves carried by participants in the American Home/National Union pool amounted to approximately

American International Group, Inc. and Subsidiaries

$1.95 billion. The remaining Foreign General reserves are carried by AIUO, AIRCO, and other smaller AIG subsidiaries domiciled outside the United States. Statutory filings in the U.S. by AIG companies reflect all the business written by U.S. domiciled entities only, and therefore exclude business written by AIUO, AIRCO, and all other internationally domiciled subsidiaries. The total reserves carried at March 31, 2005 by AIUO and AIRCO were approximately $3.41 billion and $3.74 billion, respectively. AIRCO’s $3.74 billion in total general insurance reserves consist of approximately $3.37 billion from business assumed from the American Home/National Union pool and an additional $375 million relating to Foreign General Insurance business.

At March 31, 2005, AIG’s overall General Insurance net loss reserves reflects a loss reserve discount of $1.56 billion, including tabular and non-tabular calculations. The tabular workers compensation discount is calculated using a 3.5 percent interest rate and the 1979-81 Decennial Mortality Table. The non-tabular workers compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations for each state. For New York companies, the discount is based on a five percent interest rate and the companies’ own payout patterns. For Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a six percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the yield of U.S. Treasury securities ranging from one to twenty years and the company’s own payout pattern, with the future expected payment for each year using the interest rate associated with the corresponding Treasury security yield for that time period. The discount is comprised of the following: $401 million – tabular discount for workers compensation in DBG; $544 million – non-tabular discount for workers compensation in DBG; and, $610 million – non-tabular discount for other liability occurrence and products liability occurrence in AIRCO. The total undiscounted workers compensation loss reserve carried by DBG is approximately $6.9 billion as of March 31, 2005. The other liability occurrence and products liability occurrence business in AIRCO that is assumed from DBG is discounted using a 5.5 percent interest rate and the DBG payout pattern for this business. The undiscounted reserves assumed by AIRCO from DBG totaled approximately $3.98 billion at March 31, 2005.

The methods used to determine loss reserve estimates and to establish the resulting reserves are continually reviewed and updated by management. 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 March 31, 2005. While AIG annually reviews the adequacy of established loss reserves, there can be no assurance that AIG’s ultimate loss reserves will not adversely develop and materially exceed AIG’s loss reserves as of March 31, 2005. In the opinion of management, such adverse development and resulting increase in reserves is not likely to have a material adverse effect on AIG’s consolidated financial position, although it could have a material adverse effect on AIG’s consolidated results of operations for an individual reporting period.

AIG has announced that it will commission a comprehensive independent actuarial review of the loss reserves of its principal property-casualty insurance operations. The review is expected to be completed before AIG reports its full year 2005 financial results.

The table below presents the reconciliation of net loss reserves for the first three months ended March 31, 2005 and 2004 as follows:


*(in millions)*		2005		2004


Net reserve for losses and loss expenses at beginning of year		$	47,747	$	36,738
Foreign exchange effect			28		222

Losses and loss expenses incurred:
	Current year		7,032		6,340
	Prior years^*		240		368

Losses and loss expenses incurred			7,272		6,708

Losses and loss expenses paid			5,221		4,645

Net reserve for losses and loss expenses at end of period		$	49,826	$	39,023

Includes accretion of discount of $97 million in the first three months of 2005 and $94 million in the first three months of 2004. Additionally, includes $55 million in the first three months of 2005 and $45 million in the first three months of 2004 for the general reinsurance operations of Transatlantic, and $118 million of additional losses incurred in the first three months of 2005 resulting from increased labor and material costs related to the 2004 Florida hurricanes.

In a very broad sense, the General Insurance loss reserves can be categorized into two distinct groups. One group is long-tail casualty lines of business which include excess and umbrella liability, D&O, professional liability, medical malpractice, workers compensation, general liability, products liability, and related classes. The other group is short-tail lines of business consisting principally of property lines, personal lines and certain classes of casualty lines.

For operations writing short-tail coverages, such as property coverages, the process of recording quarterly loss reserve changes is geared toward maintaining an appropriate reserve level for the outstanding exposure, rather than determining an expected loss ratio for current business. For example, the IBNR reserve required for a class of property business might be expected to approximate 20 percent of the latest year’s earned premiums, and this level of reserve would be maintained regardless of the loss ratio emerging in the current quarter. The 20 percent factor is adjusted to reflect changes in rate levels, loss reporting patterns, known exposures to large unreported losses, or other factors affecting the particular class of business.

American International Group, Inc. and Subsidiaries

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. Experience in the more recent accident years of long-tail casualty lines shows limited statistical credibility in reported net losses because a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. Therefore, IBNR would constitute a relatively high proportion of net losses.

AIG’s carried net long-tail loss reserves are tested using loss trend factors that AIG considers most appropriate for each class of business. A variety of actuarial methods and assumptions is 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 five percent. Loss trend factors reflect many items including changes in claims handling, exposure and policy forms; current and future estimates of monetary inflation and social inflation and increases in litigation and awards. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience. Thus, many factors are implicitly considered in estimating the year to year growth in loss costs recognized.

A number of actuarial assumptions are made in the review of reserves for each line of business. For longer tail lines of business, actuarial assumptions generally are made with respect to the following:


•	Loss trend factors which are used to establish expected loss ratios for subsequent accident years based on the projected loss ratio for prior accident years.

•	Expected loss ratios for the latest accident year (i.e., accident year 2004 for the year end 2004 loss reserve analysis) and, in some cases, for accident years prior to the latest accident year. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend (see above) and the effect of rate changes and other quantifiable factors. For low-frequency, high-severity classes such as excess casualty and D&O, expected loss ratios generally are utilized for at least the three most recent accident years.

•	Loss development factors which are used to project the reported losses for each accident year to an ultimate basis.

AIG records quarterly changes in loss reserves for each of its many General Insurance profit centers. The overall change in AIG’s loss reserves is based on the sum of these profit center level changes. For most profit centers which write longer tail classes of casualty coverage, the process of recording quarterly loss reserve changes involves determining the estimated current loss ratio for each class of coverage. This loss ratio is multiplied by the current quarter’s net earned premium for that class of coverage to determine the quarter’s total estimated net incurred loss and loss expense. The change in loss reserves for the quarter for each class is thus the difference between the net incurred loss and loss expense, estimated as described above, and the net paid losses and loss expenses in the quarter.

The process of determining the current loss ratio for each class or business segment begins in the profit centers in the latter part of the previous year. The loss ratios determined for each profit center are based on a variety of factors. These include, but are not limited to, the following considerations: prior accident year and policy year loss ratios; actual and anticipated rate changes; actual and anticipated changes in coverage, reinsurance, or mix of business; actual and anticipated changes in external factors affecting results, such as trends in loss costs or in the legal and claims environment. Each profit center’s loss ratio for the following year is subject to review by the profit center’s management, by actuarial and accounting staffs, and ultimately by senior management. At the close of each quarter, the assumptions underlying the loss ratios are reviewed to determine if the loss ratios based thereon remain appropriate. This process includes a review of the actual claims experience in the quarter, actual rate changes achieved, actual changes in coverage, reinsurance or mix of business, and changes in certain other factors that may affect the loss ratio. When this review suggests that the initially determined loss ratio is no longer appropriate, the loss ratio for current business would be changed to reflect the revised assumptions.

A comprehensive annual loss reserve review is conducted in the fourth quarter of each year for each AIG General Insurance subsidiary. These reviews are conducted in full detail for each class or line of business for each subsidiary, and thus consist of literally hundreds of individual analyses. The purpose of these reviews is to confirm the reasonableness of the reserves carried by each of the individual subsidiaries, and thereby of AIG’s overall carried reserves. The reserve analysis for each business class is performed by the actuarial personnel who are most familiar with that class of business. In completing these detailed actuarial reserve analyses, the actuaries are required to make numerous assumptions, including for example the selection of loss development factors and loss cost trend factors. They are also required to determine and select the most appropriate actuarial method(s) to employ for each business class. Additionally, they must determine the appropriate segmentation of data or segments from which the adequacy of the reserves can be most accurately tested. In the course of these detailed reserve reviews for each business segment, a point estimate of the loss reserve is generally determined. The sum of these point estimates for each of the individual business classes for each subsidiary provides an overall actuarial point estimate of the loss reserve for that subsidiary. The overall actuarial point estimate is compared to the sub-

American International Group, Inc. and Subsidiaries

sidiary’s carried loss reserve. If the carried reserve can be supported by actuarial methods and assumptions which are also believed to be reasonable, then the carried reserve would generally be considered reasonable and no adjustment would be considered. The ultimate process by which the actual carried reserves are determined considers not only the actuarial point estimate but a myriad of other factors. Other crucial internal and external factors considered include a qualitative assessment of inflation and other economic conditions in the United States and abroad, changes in the legal, regulatory, judicial and social environments, underlying policy pricing, terms and conditions, and claims handling. Loss reserve development can also be affected by commutations of assumed and ceded reinsurance agreements.

With respect to the 2004 year-end actuarial loss reserve analysis for DBG, the actuaries continued to utilize the modified assumptions which gave additional weight to actual loss development from the more recent years, as identified during the 2002 and 2003 analysis, with appropriate adjustments to account for the additional year of loss experience which emerged in 2004. Although the actuaries continued to use actuarial assumptions that rely on expected loss ratios based on the results of prior accident years, the expected loss ratio assumptions used continue to give far greater weight to the more recent accident year experience than was the case in the prior year-end assumptions. For example, for the excess casualty lead umbrella class of business, 100 percent weight was given to the experience of accident years 1998-2001, with no weight given to the more favorable experience of accident years prior to 1998.

AIG’s annual loss reserve review does not calculate a range of loss reserve estimates. Because a large portion of the loss reserves from AIG’s General Insurance business relates to long-tail casualty lines driven by severity rather than frequency of claims, such as excess casualty and D&O, developing a range around loss reserve estimates would not be meaningful. An estimate is calculated which AIG’s actuaries believe provides a reasonable estimate of the required reserve. This amount is then evaluated against actual carried reserves.

There is potential for significant variation in the development of loss reserves, particularly for long-tail casualty classes of business such as excess casualty, when actual costs differ from the assumptions used to test the reserves. Such assumptions include those made for loss trend factors and loss development factors, as described earlier. Set forth below is a sensitivity analysis demonstrating the estimated effect on the loss reserve position of alternative loss trend or loss development factor assumptions as compared to those actually used to test the carried reserves.

For the excess casualty class of business the assumed loss cost trend was five percent. Thus, in establishing the expected loss ratios for accident years 2002 through 2004, the loss costs from accident years 1998 through 2001 were trended by this five percent factor per annum. A five percent change in the assumed loss cost trend from each accident year to the next would cause approximately a $600 million change (either positively or negatively) to the net loss and loss expense reserve for this business. For the D&O and related management liability classes of business the assumed loss cost trend was four percent. Thus, in establishing the expected loss ratios for accident years 2002 through 2004, the loss costs from accident years 1997 through 2001 were trended by this four percent factor per annum. A five percent change in this assumed loss cost trend would cause approximately a $500 million change (either positively or negatively) to the net loss and loss expense reserve for such business. For healthcare liability business, including hospitals and other healthcare exposures, a five percent change in the assumed loss cost trend would cause approximately a $150 million change (either positively or negatively) to the loss and loss expense reserve for this business. Actual loss cost trends in the early 1990’s were negative for these classes, whereas in the late 1990’s loss costs trends ran well into the double digits for each of these three classes. The sharp increase in loss costs in the late 1990’s was thus much greater than the five percent changes cited above, and caused significant increases in the overall loss reserve needs for these classes. While changes in the loss cost trend assumptions can have a significant effect on the reserve needs for other smaller classes of liability business, the potential effect of these changes on AIG’s overall carried reserves would be much less than for the classes noted above.

For the excess casualty class, if future loss development factors differed by five percent from those utilized in the year-end 2004 loss reserve review, there would be approximately a $450 million change (either positively or negatively) to the overall AIG loss reserve position. The comparable effect on the D&O and related management liability classes would be approximately $200 million (either positively or negatively) if future loss development factors differed by five percent from those utilized in the year-end 2004 loss reserve review. For healthcare liability classes, the effect would be approximately $125 million (either positively or negatively). For workers compensation reserves, the effect of a five percent deviation from the loss development factors utilized in the year-end 2004 reserve reviews would be approximately $750 million (either positively or negatively). Because loss development factors for this class have shown less volatility than higher severity classes such as excess casualty, however, actual changes in loss development factors are expected to be less than five percent. There is some degree of volatility in loss development patterns for other longer tail liability classes as well. However, the potential effect on AIG’s reserves would be much less than for the classes cited above.

The calculations of the effect of the five percent change in loss development factors are made by selecting the stage of accident year development where it is believed reasonable for such a deviation to occur. For example, for workers compen-

American International Group, Inc. and Subsidiaries

sation, the $750 million amount is calculated by assuming that each of the most recent eight accident years develop five percent higher than estimated by the current loss development factors utilized in the reserve study, i.e. the factor 1.05 is multiplied by the incurred losses (including IBNR and loss expenses) for these accident years.

AIG management believes that using a five percent change in the assumptions for loss cost trends and loss development factors provides a reasonable benchmark for a sensitivity analysis of the reserves of AIG’s most significant lines of general insurance business. For excess casualty business, both the loss cost trend and the loss development factor assumptions are critical. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Moreover, as excess casualty is a long-tail class of business, any deviation in loss cost trends or in loss development factors might not be discernible for an extended period of time subsequent to the recording of the initial loss reserve estimates for any accident year. Thus, there is the potential for the reserves with respect to a number of accident years to be significantly affected by changes in the loss cost trends or loss development factors that were initially relied upon in setting the reserves. These changes in loss trends or loss development factors could be attributable to changes in inflation or in the judicial environment, or in other social or economic phenomena affecting claims. For example, during the lengthy periods during which losses develop for excess casualty, actual changes in loss costs from one accident year to the next have ranged from negative values to double-digit amounts. Thus, there is the potential for significant volatility in loss costs for excess casualty and, although five percent is considered a reasonable benchmark for sensitivity analysis for this business, there is the potential for variations far greater than this amount (either positively or negatively). Likewise, in the judgment of AIG’s actuaries, five percent is considered an appropriate benchmark for sensitivity analysis with respect to the loss development factor assumptions used to test the reserves. It should be noted that the loss cost trend factor for excess casualty was reduced to five percent in the year-end 2004 loss reserve review compared to the 7.5 percent loss trend factor used in the 2003 review for excess casualty. This reduction was made by AIG’s actuaries in response to a significant favorable loss trend that had emerged from accident year 2000 to 2001. This favorable trend appears to be continuing in accident years 2002 and 2003, although these accident years are still immature.

For D&O and related management liability classes of business, the loss cost trend assumption is critical. The loss development factor assumption is important but less critical than for excess casualty. As this coverage is written on a claims-made basis, claims for a given accident year are all reported within that year. Actual changes in loss costs from one accident year to the next in the 1990s ranged from double digit negative values for several accident years in the early 1990s to nearly 50 percent per year for the period from accident year 1996 to accident year 1999. Thus, there is the potential for extreme volatility in loss costs for this business and, although five percent is considered a reasonable benchmark for sensitivity analysis, there is the potential for variations far greater than this amount (either positively or negatively). Five percent is also considered an appropriate benchmark for sensitivity analysis with respect to the loss development factor assumptions used to test the reserves for these classes. However, as noted above, the effect of such a deviation is less than that of a similar deviation in loss cost trends. It should be noted that the loss cost trend factor for D&O and related management liability classes was reduced to four percent in the year end 2004 loss reserve reviews compared to six percent in the 2003 review. This reduction was made by AIG’s actuaries in response to a relative stabilization in loss costs from accident year 1999 to 2001 following the period of sharp increases in loss costs through 1999. The stabilization in loss costs appears to be continuing in accident years 2002 and 2003, although these accident years are still immature.

For healthcare liability classes, both the loss cost trend and the loss development factor assumptions are critical. The nature of the potential volatility would be analogous to that described above for the excess casualty business. However, AIG’s volume of business in the healthcare classes is much smaller than for excess casualty, hence the potential effect on AIG’s overall reserves is smaller for these classes than for excess casualty. AIG’s healthcare liability business includes both primary and excess exposures.

For workers compensation, the loss development factor assumptions are important. Generally, AIG’s actual historical workers compensation loss development would be expected to provide a reasonably accurate predictor of future loss development. A five percent sensitivity indicator for workers compensation would thus be considered to be toward the high end of potential deviations for this class of business. AIG’s workers compensation reserves include a small portion relating to excess workers compensation coverage. The analysis applicable to excess casualty would apply to these reserves. However, the volume of such business is de minimis compared to the volume of excess casualty. The loss cost trend assumption for workers compensation is not believed to be material with respect to AIG’s loss reserves other than for that portion representing excess workers compensation. This is primarily because AIG’s actuaries are generally able to use loss development projections for all but the most recent accident year’s reserves, so there is limited need to rely on loss cost trend assumptions for workers compensation business.

For casualty business other than the classes noted above, there is generally some potential for deviation in both the loss cost trend and loss development factor selections. However,

American International Group, Inc. and Subsidiaries

the effect of such deviations would not be material when compared to the effect cited above for excess casualty and D&O.

The comprehensive annual loss reserve review process results in an accumulation of point estimates for AIG’s General Insurance business. The loss reserve carried at year-end 2004 for AIG’s General Insurance business was approximately equal to the aggregate reserve indicated by the actuarial point estimates. This represents a relative improvement of approximately two percent from AIG’s position as of December 31, 2003. This comparison excludes the reserves relating to asbestos and environmental exposures, which are determined using different methodologies, as described below.

Asbestos and Environmental Reserves

The estimation of loss reserves relating to asbestos and environmental claims on insurance policies written many years ago is subject to greater uncertainty than other types of claims due to inconsistent court decisions as well as judicial interpretations and legislative actions that in some cases have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability. The insurance industry as a whole is engaged in extensive litigation over these coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.

The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage and an absolute asbestos exclusion was also implemented. However, AIG currently underwrites environmental impairment liability insurance on a claims-made basis and has excluded such claims from the analysis 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.

Estimation of asbestos and environmental claims loss reserves is a subjective process and reserves for asbestos and environmental claims cannot be estimated using conventional reserving techniques such as those that rely on historical accident year loss development factors.

Significant factors which affect the trends that influence the asbestos and environmental claims estimation process 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 exposures for cleanup costs of hazardous waste dump sites involve issues such as allocation of responsibility among potentially responsible parties and the government’s refusal to release parties.

Due to this uncertainty, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as with other types of claims. Such future 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. If the asbestos and environmental reserves develop deficiently, such deficiency would have an adverse effect on AIG’s future results of operations. AIG does not discount asbestos and environmental reserves.

With respect to known asbestos and environmental claims, AIG established over a decade ago specialized toxic tort and environmental claims units, which investigate and adjust all such asbestos and environmental claims. These units evaluate these asbestos and environmental claims utilizing a claim-by-claim approach that involves a detailed review of individual policy terms and exposures. Because each policyholder presents different liability and coverage issues, AIG generally evaluates exposure on a policy-by-policy basis, considering a variety of factors such as known facts, current law, jurisdiction, policy language and other factors that are unique to each policy. Quantitative techniques have to be supplemented by subjective considerations including management judgment. Each claim is reviewed at least semi-annually utilizing the aforementioned approach and adjusted as necessary to reflect the current information.

In both the specialized and dedicated asbestos and environmental claims units, AIG actively manages and pursues early settlement with respect to these claims in an attempt to mitigate its exposure to the unpredictable development of these claims. AIG attempts to mitigate its known long-tail environmental exposures by utilizing a combination of proactive claim-handling techniques including policy buybacks, complete environmental releases, compromise settlements, and, where indicated, litigation.

With respect to asbestos claims handling, AIG’s specialized claims staff operates to mitigate losses through proactive handling, supervision and resolution of asbestos cases. Thus, while AIG has resolved all claims with respect to miners and major manufacturers (Tier One), its claims staff continues to operate under the same proactive philosophy to resolve claims involving accounts with products containing asbestos

American International Group, Inc. and Subsidiaries

(Tier Two), products containing small amounts of asbestos, companies in the distribution process, and parties with remote, ill defined involvement in asbestos (Tiers Three and Four). Through its commitment to appropriate staffing, training, and management oversight of asbestos cases, AIG mitigates to the extent possible its exposure to these claims.

In order to evaluate the overall reasonableness of the asbestos and environmental reserves established using the claim-by-claim approach as described above, AIG uses two methods, the market share method and the frequency/severity or report year method.

The market share method produces indicated asbestos and environmental reserve needs by applying the appropriate AIG market share to estimated potential industry ultimate loss and loss expenses based on the latest estimates from A.M. Best and Tillinghast. The market share method is a series of tests. Six estimates of potential industry ultimate losses for asbestos and environmental claims are tested. Additionally, a second series of tests are performed, using estimated industry unpaid losses, instead of industry ultimate losses. The market share tests are also performed using estimates of AIG’s market share. The reason AIG’s market share is an estimate is that there are assumptions as to which years and classes of business the asbestos and environmental exposure applies. For example, commercial multiple peril business is included in the market share calculation in some, but not all, of the scenarios.

AIG’s estimate of the carried net asbestos and environmental reserves were approximately $50 million greater than the mean indication of the outcomes of market share testing. However, the market share method does not give weight to AIG’s actual asbestos and environmental loss experience.

The frequency/severity or report year approach, is also a series of tests which are performed separately for asbestos and for environmental exposures. For asbestos, these tests project the expected losses to be reported over the next twenty years, i.e. from 2005 through 2024, based on the actual losses reported through 2004 and the expected future loss emergence for these claims. Three scenarios are tested, with a series of assumptions ranging from more optimistic to more conservative. In the first scenario, all carried asbestos case reserves, as determined above using the claim-by-claim approach, are assumed to be within ten percent of their ultimate settlement value.

The second scenario relies on an actuarial projection of report year developments for asbestos claims reported from 1993 to the present to estimate case reserve adequacy as of year-end 2004. The third scenario also relies on an actuarial projection of report year claims for asbestos, but reflects claims reported from 1989 to the present to estimate case reserve adequacy as of year-end 2004. As of year-end 2004, the results of the second and third scenarios varied significantly. In the second scenario, case reserves were indicated to be at slightly less than 60 percent of the ultimate settlement value at year-end 2004, whereas in the third scenario they were indicated to be at less than 25 percent of ultimate settlement value.

Based on the results of the prior report years for each of the three scenarios described above, the report year approach then projects forward to the year 2024 the expected future report year losses, based on AIG’s estimate of reasonable loss trend assumptions.

These calculations are performed on losses gross of reinsurance. The IBNR (including a provision for development of reported claims) on a net basis is based on applying a factor reflecting the expected ratio of net losses to gross losses for future loss emergence.

For environmental claims, an analogous series of frequency/severity tests are produced. In general, the case reserve adequacy assumptions are narrower, as case reserve adequacy is indicated within approximately 25 percent of adequacy in all scenarios tested. Environmental claims from future report years (i.e. IBNR) are projected out ten years, i.e. through the year 2014.

As of year-end 2004, the range of outcomes from the scenarios tested for environmental ranged from $20 million below AIG’s carried reserve to approximately $200 million greater than AIG’s carried reserve. The range of outcomes for asbestos was greater. The indication from the first scenario, as described above, was approximately $140 million below AIG’s carried reserve. The indication from the second scenario was approximately $10 million below AIG’s carried reserves. The indication from the third scenario was approximately $650 million greater than AIG’s carried reserve.

At year-end 2004, AIG considered a number of factors and recent experience to determine the appropriate reserve that should be carried for these claims, including the following:

1. Actual calendar experience for past ten years, five years, three years, and one year. AIG experienced consistent adverse development on its carried asbestos and environmental reserves over the years. The net carried reserves from ten years ago ran off $1.45 billion deficient; from five years ago $430 million deficient; from three years ago $350 million deficient; and from one year ago $150 million deficient. Thus the reserves consistently produced adverse development per year, with no evidence of recent improvement. These figures are prior to the year-end 2004 reserve increase.

On a gross of reinsurance basis, the adverse developments were analogous, with approximately $450 million in the latest year and $4.8 billion over the past ten years.

2. Input from claims officers on latest year events. DBG’s claims officers observed an increasing trend toward adverse claims experience in the layers underlying its excess

American International Group, Inc. and Subsidiaries

attachment points for a number of Tier Two claims, increasing the probability of further adverse loss developments going forward. They also noted the emergence of several asbestos non-products cases recently, raising a concern that asbestos non-products cases could become a more serious problem in the future.

3. Deterioration in Report Year claims experience. As noted above, the Scenario Two and Scenario Three indications for case reserve adequacy in AIG’s 2004 year-end actuarial report indicated an increasing deficiency in carried case reserves for asbestos. This was the result of continued adverse development on prior year case reserves and suggests future loss development will be at higher levels than previously indicated. As a result, the Scenario Three indicated reserve deficiency increased from approximately $480 million in the 2003 year-end reserve review to a deficiency of approximately $650 million in the year-end 2004 review. Furthermore, the year-end 2004 review utilized data evaluated as of June 30, 2004. An update to this data was produced (for all large claims) with claims evaluated as of March 31, 2005, i.e., an additional nine months of data beyond the year-end 2004 reserve study. This update showed that report year losses in the nine months from June 2004 to March 2005 produced additional adverse loss development. In fact, more loss development was observed during these nine months than for the twelve months from the June 2003 through June 2004 period. Thus, both the latest year’s data used in the year-end 2004 actuarial study and the nine months of additional data subsequent to that study indicated the experience was deteriorating beyond what was expected at year-end 2003.

4. Survival Ratios. AIG’s year-end 2004 survival ratio for asbestos was 5.7 and 5.2 on a gross and a net basis, respectively, prior to the year-end 2004 reserve increase. AIG’s year-end 2004 survival ratio for environmental was 4.8 and 3.8 on a gross and a net basis, respectively, prior to the year-end 2004 reserve increase. These survival ratios indicated AIG’s carried reserves were sufficient to fund four to five years of payments for these claims, assuming payment levels remain stable. Based on the latest two years of actual paid losses, AIG did not expect its losses to decline as quickly as these ratios imply.

5. Industry experience. The industry has experienced a significant wave of adverse development for asbestos since 2001, with little, if any, signs of recent improvement. Furthermore, the litigation environment has become increasingly adverse.

6. Reinsurance Recoverable. Although AIG has been successful in collecting the vast majority of its reinsurance on asbestos and environmental claims, the greater the future losses and the longer the exposure persists, the greater the likelihood of increased problems in collecting reinsurance. Thus, the continued adverse developments and lack of any signs that loss experience is beginning to diminish increases the risk of uncollectible reinsurance.

After considering all of these factors, particularly its recent experience, AIG determined that its carried reserve for asbestos and environmental claims would be best estimated by scenario three described above. This resulted in a $650 million increase in net asbestos reserves, and a $200 million increase in net environmental reserves. The corresponding increases in gross reserves were $1.2 billion for asbestos and $250 million for environmental reserves.

Significant uncertainty remains as to AIG’s ultimate liability relating to asbestos and environmental claims. This uncertainty is due to several factors including:


•	The long latency period between asbestos exposure and disease manifestation and the resulting potential for involvement of multiple policy periods for individual claims;

•	The increase in the volume of claims by currently unimpaired plaintiffs;

•	Claims filed under the non-aggregate premises or operations section of general liability policies;

•	The number of insureds seeking bankruptcy protection and the effect of prepackaged bankruptcies;

•	Diverging legal interpretations;

•	With respect to environmental claims, the difficulty in estimating the allocation of remediation cost among various parties; and

•	The possibility of federal legislation that would address the asbestos and environmental issue.

American International Group, Inc. and Subsidiaries

A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined for the three months ended March 31, 2005 and 2004 follows:



	2005						2004

(in millions)	Gross			Net			Gross			Net

Asbestos:
Reserve for losses and loss expenses at beginning of year	$	2,559		$	1,060		$	1,235		$	386
Losses and loss expenses incurred^*		78			24			49			20
Losses and loss expenses paid^*		(91	)		(29	)		(109	)		(38	)

Reserve for losses and loss expenses at end of period	$	2,546		$	1,055		$	1,175		$	368

Environmental:
Reserve for losses and loss expenses at beginning of year	$	974		$	451		$	789		$	283
Losses and loss expenses incurred^*		(13	)		(3	)		–			(10	)
Losses and loss expenses paid^*		(30	)		(16	)		(33	)		(13	)

Reserve for losses and loss expenses at end of period	$	931		$	432		$	756		$	260

Combined:
Reserve for losses and loss expenses at beginning of year	$	3,533		$	1,511		$	2,024		$	669
Losses and loss expenses incurred^*		65			21			49			10
Losses and loss expenses paid^*		(121	)		(45	)		(142	)		(51	)

Reserve for losses and loss expenses at end of period	$	3,477		$	1,487		$	1,931		$	628


*	All amounts pertain to policies underwritten in prior years.

The gross and net IBNR included in the reserve for losses and loss expenses, relating to asbestos and environmental claims separately and combined, at March 31, 2005 and 2004 were estimated as follows:



	2005				2004

(in millions)	Gross		Net		Gross		Net

Asbestos	$	1,864	$	786	$	686	$	196
Environmental		554		248		342		81

Combined	$	2,418	$	1,034	$	1,028	$	277

A summary of asbestos and environmental claims count activity for the three months ended March 31, 2005 and 2004 was as follows:



		2005									2004

		Asbestos			Environmental			Combined			Asbestos			Environmental			Combined

Claims at beginning of year			7,575			8,216			15,791			7,474			8,852			16,326
Claims during year:
	Opened		259			759			1,018			201			967			1,168
	Settled		(19	)		(52	)		(71	)		(60	)		(50	)		(110	)
	Dismissed or otherwise resolved		(130	)		(879	)		(1,009	)		(229	)		(856	)		(1,085	)

Claims at end of period			7,685			8,044			15,729			7,386			8,913			16,299

The table below presents AIG’s survival ratios for asbestos and environmental claims at March 31, 2005 and 2004. The survival ratio is derived by dividing the current carried loss reserve by the average payments for the three most recent calendar years for these claims. Therefore, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid off using recent year average payments. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have a significant effect on the amount of asbestos and environmental reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.

AIG’s survival ratios for asbestos and environmental claims, separately and combined were based upon a three-year average payment. These ratios at March 31, 2005 and 2004 were as follows:


		Gross		Net

2005
Survival ratios:
	Asbestos		9.8		12.7
	Environmental		6.3		6.7
	Combined		8.5		10.1

2004
Survival ratios:
	Asbestos		4.4		4.4
	Environmental		4.9		4.0
	Combined		4.6		4.3

American International Group, Inc. and Subsidiaries

Life Insurance & Retirement Services Operations

AIG’s Life Insurance & Retirement Services subsidiaries offer a wide range of insurance and retirement savings products both domestically and abroad. Insurance-oriented products consist of individual and group life, payout annuities, endowment and accident and health policies. Retirement savings products consist generally of fixed and variable annuities. (See also Note 2 of Notes to Financial Statements.)

Domestically, AIG’s Life Insurance & Retirement Services operations offer a broad range of protection products, including life insurance, group life and health products, including disability income products and payout annuities, which include single premium immediate annuities, structured settlements and terminal funding annuities. Home service operations include an array of life insurance, accident and health, and annuity products sold through career agents. In addition, home service includes a small block of run-off property and casualty coverage. Retirement services include group retirement products, individual fixed and variable annuities sold through banks, broker dealers and exclusive sales representatives, and annuity runoff operations which include previously-acquired “closed blocks” and other fixed and variable annuities largely sold through distribution relationships that have been discontinued.

Overseas, AIG’s Life Insurance & Retirement Services operations include insurance and investment-oriented products such as whole and term life investment linked, universal life and endowments, personal accident and health products, group products including pension, life and health, and fixed and variable annuities.

Life Insurance & Retirement Services operations presented on a major product basis for the three months ended March 31, 2005 and 2004 were as follows:


(in millions)		2005			2004


GAAP premiums:
Domestic Life:
	Life insurance	$	512		$	430
	Home service		204			206
	Group life/health		251			268
	Payout annuities^(a)		397			374

	Total		1,364			1,278

Domestic Retirement Services:
	Group retirement products		84			76
	Individual fixed annuities		20			13
	Individual variable annuities		112			100
	Individual annuities-runoff^(b)		23			20

	Total		239			209

Total Domestic			1,603			1,487

Foreign Life:
	Life insurance		4,093			3,860
	Personal accident & health		1,221			1,029
	Group products		517			415

	Total		5,831			5,304

Foreign Retirement Services:
	Individual fixed annuities		84			85
	Individual variable annuities		26			13

	Total		110			98

Total Foreign			5,941			5,402

Total GAAP premiums		$	7,544		$	6,889

Net investment income:
Domestic Life:
	Life insurance	$	333		$	341
	Home service		146			151
	Group life/health		32			31
	Payout annuities		210			199

	Total		721			722

Domestic Retirement Services:
	Group retirement products		549			542
	Individual fixed annuities		827			758
	Individual variable annuities		58			55
	Individual annuities-runoff^(b)		254			276

	Total		1,688			1,631

Total Domestic			2,409			2,353

Foreign Life:
	Life insurance		1,160			1,004
	Personal accident & health		54			42
	Group products		131			105
	Intercompany adjustments		(8	)		(4	)

	Total		1,337			1,147

Foreign Retirement Services:
	Individual fixed annuities		377			199
	Individual variable annuities		136			79

	Total		513			278

	Total Foreign		1,850			1,425

Total net investment income		$	4,259		$	3,778

Pricing net investment gains^(c)			81			78
Realized capital gains (losses)			(64	)		(222	)

Total realized gains (losses)^(c)			17			(144	)

Total operating income		$	2,223		$	1,785

Life insurance in-force^(d):
	Domestic	$	760,104		$	772,251
	Foreign		1,084,529			1,085,843

Total		$	1,844,633		$	1,858,094


(a)	Includes structured settlements, single premium immediate annuities and terminal funding annuities.


(b)	Represents runoff annuity business sold through discontinued distribution relationships.


(c)	For purposes of this presentation, pricing net investment gains are segregated as a component of total realized gains (losses). They represent certain amounts of realized capital gains where gains are an inherent element in pricing certain life products in some foreign countries.
(d)	Amounts presented were as at March 31, 2005 and December 31, 2004. The decline in Domestic in-force was due to the non-renewal of a single large group life case of $36 billion. Foreign in-force includes Tata AIG Life Insurance Company, Ltd.

AIG’s Life Insurance & Retirement Services subsidiaries report their operations through the following operating units: Domestic Life — AIG American General, including American

American International Group, Inc. and Subsidiaries

General Life Insurance Company (AG Life), USLIFE and AGLA; Domestic Retirement Services — VALIC, AIG Annuity and AIG SunAmerica; Foreign Life — ALICO, AIG Edison Life, AIG Star Life, AIA, Nan Shan and Philamlife.

Life Insurance & Retirement Services Results

The increase in operating income in the first three months of 2005 when compared to the same period of 2004 was caused in part by strong growth overseas, and realized capital gains in 2005 rather than the realized capital losses in 2004.

Life Insurance & Retirement Services GAAP premiums grew in the first three months of 2005 when compared with the same period in 2004. AIG’s Domestic Life operations had continued strong growth in term and universal life sales and good performance from the independent distribution channels. Payout annuities also had strong growth. The domestic group business is below AIG’s growth standards, largely because several accounts where pricing was unacceptable were not renewed and loss experience was higher than anticipated. Restructuring efforts in this business are focused on new product introductions, cross selling and other growth strategies. AGLA, the home service business, is diversifying product offerings, enhancing the capabilities and quality of the sales force and broadening the markets served beyond those historically serviced in an effort to accelerate growth.

Domestic Retirement Services businesses faced a challenging environment in the first three months of 2005, as deposits declined approximately nine percent compared to the same period in 2004 and operating income for the retirement services businesses remained relatively flat when compared with the first three months of 2004. The sales environment for the first three months of 2005 for individual variable annuities was unfavorably affected by the combination of weak equity market performance and the cumulative effect of more restrictive regulatory compliance procedures imposed by the broker-dealer and bank distributors in recent periods.

AIG’s domestic fixed annuity business has been affected by a significant flattening of the treasury yield curve over the past several quarters, which has affected sales as yields on competing products, such as bank CDs, approach those available on AIG’s fixed annuities. There are some indications that negative press coverage of AIG has adversely affected surrenders and withdrawals of fixed annuities. In addition, surrenders have increased from prior year levels as annuities sold in 2000 can now be surrendered without charges, and as a result of the competitive interest rate environment. The combination of reduced sales and increased surrenders and withdrawals resulted in net flows 21 percent lower than prior year net flows. AIG expects that net flows will remain lower than in prior years as long as an environment of poor equity market performance and the yield curve remains flat.

The majority of the growth in Life Insurance & Retirement Services GAAP premiums in Foreign Life operations was attributable to the life insurance, personal accident & health, and group products lines of business. Globally, AIG’s deep and diverse distribution, which includes bancassurance, worksite marketing, direct marketing and strong agency organizations, provides a powerful platform for growth. This growth was most significant in Southeast Asia where AIG maintains significant market share established by its strong agency force, and in Japan, where AIG has benefited from a flight to quality and development of multiple distribution channels. In light of AIG’s recent credit rating downgrades, it is unclear whether this flight to quality will continue to benefit AIG. Also in Japan, AIG Edison Life’s back office operations are being integrated successfully into AIG’s life operations. AIG Star Life is growing first year premiums as a result of new product introductions and an expanded agency force, and is benefiting from more successful conservation of in-force business. The Foreign Retirement Services business continues its strong growth based upon its success in Japan and Korea by expanding its extensive distribution network and leveraging AIG’s product expertise. AIG is introducing annuity products in new markets. In January 2005, AIG Star Life entered into an agreement with the Bank of Tokyo Mitsubishi, one of Japan’s largest banks, to market a multi-currency fixed annuity.

Foreign Life Insurance & Retirement Services operations produced 78.8 percent and 78.4 percent of Life Insurance & Retirement Services GAAP premiums in the first three months of 2005 and 2004, respectively.

AIG transacts business in most major foreign currencies. The following table summarizes the effect of changes in foreign currency exchange rates on the growth of Life Insurance & Retirement Services GAAP premiums.


	2005


Growth in original currency		6.1	%
Foreign exchange effect		3.4
Growth as reported in U.S. dollars		9.5	%

Under U.S. GAAP, deposits and certain other consideration received under deferred annuity (variable and fixed) and universal life contracts are not included as GAAP premiums.

The growth in net investment income in the first three months of 2005 was attributable to both foreign and domestic invested new cash flow for investment. Additionally, net investment income was positively affected by the compounding of previously earned and reinvested net investment income.

Life Insurance & Retirement Services investment portfolios are managed within the overall objectives of the Life Insurance & Retirement Services operations. AIG subsidiaries invest in certain limited liability companies that invest in synthetic fuel production facilities as a means of generating income tax credits. Net investment income includes operating

American International Group, Inc. and Subsidiaries

losses of approximately $37 million and $30 million, respectively, for the first three months of 2005 and 2004 and income taxes includes tax credits and benefits of approximately $54 million and $40 million, respectively, for the first three months of 2005 and 2004 from these investments.

The contribution of Life Insurance & Retirement Services operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change amounted to 40.8 percent in the first three months of 2005, compared to 45.3 percent in the same period of 2004.

Underwriting and Investment Risk

The risks associated with life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is primarily 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. The emergence of significant adverse experience would require an adjustment to DAC and benefit reserves that could have a substantial effect on AIG’s results of operations.

AIG’s Foreign Life companies generally limit their maximum underwriting exposure on life insurance of a single life to approximately $1.7 million of coverage and AIG’s Domestic Life companies generally limit their maximum underwriting exposure on life insurance of a single life to $5 million of coverage by using yearly renewable term reinsurance. (See also the discussion under “Liquidity” herein.)

AIRCO acts primarily as an internal reinsurance company for AIG’s foreign life operations. This facilitates insurance risk management (retention, volatility, concentrations) and capital planning locally (branch and subsidiary). It also allows AIG to pool its insurance risks and purchase reinsurance more efficiently at a consolidated level and manage global counterparty risk and relationships.

AIG’s domestic Life Insurance and Retirement Services operations utilize internal and third-party reinsurance relationships to manage insurance risks and to facilitate capital management strategies. Pools of highly-rated third-party reinsurers are utilized to manage net amounts at risk in excess of retention limits. AIG’s domestic life insurance companies also cede excess, non-economic reserves carried on a statutory-basis only on certain term and universal life insurance policies and certain fixed annuities to AIG Life of Bermuda Ltd., a wholly owned Bermuda reinsurer.

AIG generally obtains letters of credit in order to obtain statutory recognition of these intercompany reinsurance transactions. For this purpose, AIG entered into a $2.5 billion syndicated letter of credit facility in December 2004. Letters of credit totaling $2.17 billion was outstanding as of December 31, 2004, and all $2.5 billion was outstanding as of March 31, 2005. The letter of credit facility has a ten-year term, but the facility can be reduced or terminated by the lenders beginning after seven years.

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. (See also the discussion under “Liquidity” herein.)

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 necessary rebalancing of the invested assets to the policy and contract claims does not occur, a demand could be placed upon liquidity. (See also the discussion under “Liquidity” herein.)

AIG actively manages the asset-liability relationship in its foreign operations, as it has been doing throughout AIG’s history, even though certain territories lack qualified long-term investments or certain local regulatory authorities may impose investment restrictions. For example, in Japan and several Southeast Asian countries, 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. 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.

To maintain an adequate yield to match the interest necessary to support future policy liabilities, management focus is required to reinvest the proceeds of the maturing securities and to invest the future premium receipts while continuing to maintain satisfactory investment quality.

Certain foreign jurisdictions, including Japan, have limited long-dated bond markets and AIG may use alternative investments, including equities, real estate and foreign currency denominated fixed income instruments to extend the effective duration and increase the yield of the investment portfolio to more closely match the requirements of the policyholder liabilities and DAC recoverability, particularly in Taiwan, where Nan Shan has approximately 30 percent of invested assets in foreign currencies. Using foreign currency denominated investments to support policyholder liabilities could increase the risk to and volatility of cash flows and income. AIG actively manages this risk through regular monitoring and selected hedging strategies.

AIG actively manages the asset-liability relationship in its domestic operations. This relationship is more easily man-

American International Group, Inc. and Subsidiaries

aged through the ample supply of qualified long-term investments.

AIG uses asset-liability matching as a management tool worldwide to determine the composition of the invested assets and appropriate 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. In addition, the absence of long-dated fixed income instruments in certain markets may preclude a matched asset-liability position in those markets.

A number of guaranteed benefits are offered on certain variable life and variable annuity products.

DAC for life insurance and retirement services products arises from the deferral of those costs that vary with, and are directly related to, the acquisition of new or renewal business. Policy acquisition costs for life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs which relate to universal life and investment-type products, including variable and fixed annuities (investment-oriented products) are deferred and amortized, with interest, as appropriate, in relation to the historical and future incidence of estimated gross profits to be realized over the estimated lives of the contracts. With respect to universal life and investment-oriented products, AIG’s policy, as appropriate, has been to adjust amortization assumptions for DAC when estimates of current or future gross profits to be realized from these contracts are revised. With respect to variable annuities sold domestically (representing the vast majority of AIG’s variable annuity business), the assumption for the long-term annual net growth rate of the equity markets used in the determination of DAC amortization is approximately ten percent. A methodology referred to as “reversion to the mean” is used to maintain this long-term net growth rate assumption, while giving consideration to short-term variations in equity markets. Estimated gross profits include investment income and gains and losses on investments less interest required as well as other charges in the contract less actual mortality and expenses. Current experience and changes in the expected future gross profits are analyzed to determine the effect on the amortization of DAC. The estimation of projected gross profits requires significant management judgment. The elements with respect to the current and projected gross profits are reviewed and analyzed quarterly and are adjusted appropriately.

AIG’s variable annuity earnings will be affected by changes in market returns because separate account revenues, primarily composed of mortality and expense charges and asset management fees, are a function of asset values.

DAC for both insurance-oriented and investment-oriented products as well as retirement services products are subject to review for recoverability, which involve estimating the future profitability of current business. This review also involves significant management judgment. If the actual emergence of future profitability were to be substantially different than that estimated, AIG’s results of operations could be significantly affected in future periods.

Insurance and Asset Management Invested Assets

AIG’s investment strategy is to invest primarily 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 maturity investments to maximize the yields at the date of purchase. With respect to Life Insurance & Retirement Services, AIG’s strategy is to produce cash flows required to meet maturing insurance liabilities. (See also the discussion under “Operating Review: Life Insurance & Retirement Services Operations” herein.) AIG invests in equities for various reasons, including diversifying its overall exposure to interest rate risk. Available for sale bonds and equity securities are subject to declines in fair value. Such declines in fair value are presented in unrealized appreciation or depreciation of investments, net of taxes as a component of accumulated other comprehensive income. Generally, insurance regulations restrict the types of assets in which an insurance company may invest. 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. (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.

American International Group, Inc. and Subsidiaries

The following tables summarize the composition of AIG’s insurance and asset management invested assets by segment, at March 31, 2005 and December 31, 2004:

Life

Insurance &

Percent Distribution

March 31, 2005

General

Retirement

Asset

Percent

(dollars in millions)

Insurance

Services

Management

Total

of Total

Domestic

Foreign

Fixed maturities:

Available for sale, at market value

43,158

266,288

39,604

349,050

66.4

59.8

40.2

Held to maturity, at amortized cost

21,477

–

21,477

4.1

100.0

–

Trading securities, at market value

–

658

2,922

3,580

0.7

0.8

99.2

Equity securities:

Common stocks, at market value

4,211

12,599

266

17,076

3.2

20.3

79.7

Preferred stocks, at market value

1,541

729

–

2,270

0.5

87.9

12.1

Mortgage loans on real estate, policy and collateral loans

17,427

5,516

22,965

4.4

65.4

34.6

Short-term investments, including time deposits, and cash

2,431

10,749

10,563

23,743

4.5

48.2

51.8

Real estate

586

3,027

324

3,937

0.7

23.9

76.1

Investment income due and accrued

943

4,209

482

5,634

1.1

57.6

42.4

Securities lending collateral

5,519

37,074

10,100

52,693

10.0

85.1

14.9

Other invested assets

6,542

7,269

9,203

23,014

4.4

87.6

12.4

Total

86,430

360,029

78,980

525,439

100.0

63.0

37.0


				Life
				Insurance &									Percent Distribution
December 31, 2004		General		Retirement		Asset				Percent
(dollars in millions)		Insurance		Services		Management		Total		of Total			Domestic			Foreign

Fixed maturities:
	Available for sale, at market value	$	44,376	$	259,602	$	39,077	$	343,055		68.4	%		61.2	%		38.8%
	Held to maturity, at amortized cost		18,294		–		–		18,294		3.6			100.0			–
	Trading securities, at market value		–		600		2,384		2,984		0.6			1.2			98.8
Equity securities:
	Common stocks, at market value		4,165		11,280		177		15,622		3.1			21.9			78.1
	Preferred stocks, at market value		1,466		565		–		2,031		0.4			91.9			8.1
Mortgage loans on real estate, policy and collateral loans			22		16,858		5,093		21,973		4.4			65.6			34.4
Short-term investments, including time deposits, and cash			2,113		5,515		9,679		17,307		3.4			37.1			62.9
Real estate			592		3,007		326		3,925		0.8			22.8			77.2
Investment income due and accrued			1,023		4,041		461		5,525		1.1			57.5			42.5
Securities lending collateral			4,889		35,726		9,357		49,972		10.0			85.3			14.7
Other invested assets			5,604		7,154		8,316		21,074		4.2			86.8			13.2

Total		$	82,544	$	344,348	$	74,870	$	501,762		100.0	%		63.7	%		36.3%

Credit Quality

At March 31, 2005, approximately 62 percent of the fixed maturities investments were domestic securities. Approximately 33 percent of such domestic securities were rated AAA by one or more of the principal rating agencies. Approximately six percent were below investment grade or not rated.

A significant portion of the foreign fixed income portfolio is rated by Moody’s, S&P or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At March 31, 2005, approximately 20 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 securities so rated. Approximately four percent were below investment grade or not rated at that date. A large portion of the foreign fixed income portfolio are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance.

Any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date.

Valuation of Invested Assets

AIG has the ability to hold any fixed maturity security to its stated maturity, including those fixed maturity securities classified as available for sale. Therefore, the decision to sell any such fixed maturity security classified as available for sale reflects the judgment of AIG’s management that the security

American International Group, Inc. and Subsidiaries

sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale.

The valuation of invested assets involves obtaining a market value for each security. The source for the market value is generally from market exchanges or dealer quotations, with the exception of nontraded securities.

If AIG chooses to hold a security, it evaluates the security for an impairment in valuation. As a matter of policy, the determination that a security has incurred an other-than-temporary decline in value and the amount of any loss recognition requires the judgment of AIG’s management and a continual review of its investments.

In general, a security is considered a candidate for impairment if it meets any of the following criteria:


•	Trading at a significant (25 percent or more) discount to par, amortized cost (if lower) or cost for an extended period of time (nine months or longer);

•	The occurrence of a discrete credit event resulting in (i) the issuer defaulting on a material outstanding obligation; or (ii) the issuer seeking protection from creditors under the bankruptcy laws or any similar laws intended for the court supervised reorganization of insolvent enterprises; or (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or

•	In the opinion of AIG’s management, it is possible that AIG may not realize a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

Once a security has been identified as other-than-temporarily impaired, the amount of such impairment is determined by reference to that security’s contemporaneous market price and recorded as a charge to earnings.

As a result of these policies, AIG recorded impairment losses, net of taxes, of $92 million and $79 million in the first three months of 2005 and 2004, respectively.

No impairment charge with respect to any one single credit was significant to AIG’s consolidated financial condition or results of operations, and no individual impairment loss exceeded 1.0 percent of consolidated net income for the first three months of 2005.

Excluding the other-than-temporary impairments noted above, the changes in market value for AIG’s available for sale portfolio, which constitutes the vast majority of AIG’s investments, were recorded in accumulated other comprehensive income as unrealized gains or losses, net of tax.

At March 31, 2005, the fair value of AIG’s fixed maturities and equity securities aggregated to $395.3 billion. At March 31, 2005, aggregate unrealized gains after taxes for fixed maturity and equity securities were $10.9 billion. At March 31, 2005, the aggregate unrealized losses after taxes of fixed maturity and equity securities were approximately $1.8 billion.

The effect on net income of unrealized losses after taxes will be further mitigated upon realization, because certain realized losses will be charged to participating policyholder accounts, or realization will result in current decreases in the amortization of certain deferred policy acquisition costs.

At March 31, 2005, unrealized losses for fixed maturity securities and equity securities did not reflect any significant industry concentrations.

The amortized cost of fixed maturities available for sale in an unrealized loss position at March 31, 2005, by contractual maturity, is shown below:


	Amortized
(in millions)	Cost

Due in one year or less	$	3,075
Due after one year through five years		23,137
Due after five years through ten years		38,423
Due after ten years		43,305

Total	$	107,940

In the three months ended March 31, 2005, the pretax realized losses incurred with respect to the sale of fixed maturities and equity securities were $419 million. The aggregate fair value of securities sold was $13.4 billion, which was approximately 99 percent of amortized cost. The average period of time that securities sold at a loss during the three months ended March 31, 2005 were trading continuously at a price below book value was approximately four months.

American International Group, Inc. and Subsidiaries

At March 31, 2005, aggregate pretax unrealized gains were $16.7 billion, while the pretax unrealized losses with respect to investment grade bonds, below investment grade bonds and equity securities were $2.1 billion, $450 million and $248 million, respectively. Aging of the pretax unrealized losses with respect to these securities, distributed as a percentage of cost relative to unrealized loss (the extent by which the market value is less than amortized cost or cost), including the number of respective items, was as follows:






		Less than or equal to						Greater than 20% to						Greater than
		20% of Cost^(a)						50% of Cost^(a)						50% of Cost^(a)						Total

Aging				Unrealized						Unrealized						Unrealized						Unrealized
(dollars in millions)		Cost^(a)		Loss		Items		Cost^(a)		Loss		Items		Cost^(a)		Loss		Items		Cost^(a)		Loss^(b)		Items


Investment grade bonds
	0-6 months	$	71,953	$	1,012		7,008	$	19	$	7		3	$	2	$	2		8	$	71,974	$	1,021		7,019
	7-12 months		15,887		409		1,563		29		6		36		–		–		2		15,916		415		1,601
	>12 months		13,774		659		1,617		85		15		6		6		4		2		13,865		678		1,625

Total		$	101,614	$	2,080		10,188	$	133	$	28		45	$	8	$	6		12	$	101,755	$	2,114		10,245

Below investment grade bonds
	0-6 months	$	3,928	$	145		943	$	193	$	58		32	$	11	$	8		15	$	4,132	$	211		990
	7-12 months		731		48		141		38		10		27		3		2		14		772		60		182
	>12 months		961		85		251		310		87		97		10		7		13		1,281		179		361

Total		$	5,620	$	278		1,335	$	541	$	155		156	$	24	$	17		42	$	6,185	$	450		1,533

Total bonds
	0-6 months	$	75,881	$	1,157		7,951	$	212	$	65		35	$	13	$	10		23	$	76,106	$	1,232		8,009
	7-12 months		16,618		457		1,704		67		16		63		3		2		16		16,688		475		1,783
	>12 months		14,735		744		1,868		395		102		103		16		11