View:
1 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------------- FORM 10-Q [ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO FOR QUARTER ENDED MARCH 31, 2000 COMMISSION FILE NUMBER 1-8787 --------------------- AMERICAN INTERNATIONAL GROUP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 13-2592361 (STATE OR OTHER JURISDICTION OF INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NUMBER) OR ORGANIZATION) 70 PINE STREET, NEW YORK, NEW YORK 10270 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (212) 770-7000 NONE FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT. --------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [ X ] NO [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of March 31, 2000: 1,541,383,485. - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
2 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED BALANCE SHEET (IN MILLIONS) MARCH 31, DECEMBER 31, 2000 1999 ----------- ------------ (UNAUDITED) ASSETS: Investments and cash: Fixed maturities: Bonds available for sale, at market value (amortized cost: 2000 -- $80,882; 1999 -- $78,218)............. $ 79,534 $ 77,028 Bonds held to maturity, at amortized cost (market value: 2000 -- $12,177; 1999 -- $12,202)............ 11,952 12,076 Bonds trading securities, at market value (cost: 2000 -- $747; 1999 -- $1,057)....................... 744 1,038 Preferred stocks, at amortized cost (market value: 2000 -- $0; 1999 -- $0)............................. 2 2 Equity securities: Common stocks (cost: 2000 -- $5,462; 1999 -- $5,496)..................................... 6,032 6,002 Non-redeemable preferred stocks (cost: 2000 -- $791; 1999 -- $718)....................................... 772 712 Mortgage loans on real estate, net of allowance (2000 -- $80; 1999 -- $78)............................ 7,260 7,139 Policy Loans........................................... 2,875 2,822 Collateral and guaranteed loans, net of allowance (2000 -- $74; 1999 -- $74)............................ 2,193 2,173 Financial services and asset management assets: Flight equipment primarily under operating leases, net of accumulated depreciation (2000 -- $2,370; 1999 -- $2,200)..................................... 18,117 17,334 Securities available for sale, at market value (cost: 2000 -- $13,388; 1999 -- $12,920)................... 13,422 12,954 Trading securities, at market value.................. 4,466 4,391 Spot commodities, at market value.................... 764 683 Unrealized gain on interest rate and currency swaps, options and forward transactions.................... 8,339 7,931 Trading assets....................................... 7,528 5,793 Securities purchased under agreements to resell, at contract value...................................... 10,260 10,897 Other invested assets.................................. 10,994 9,900 Short-term investments, at cost (approximates market value)................................................ 6,917 7,007 Cash................................................... 211 132 -------- -------- Total investments and cash...................... 192,382 186,014 Investment income due and accrued......................... 2,100 2,054 Premiums and insurance balances receivable, net of allowance (2000 -- $146; 1999 -- $133)................. 13,617 12,737 Reinsurance assets........................................ 19,635 19,368 Deferred policy acquisition costs......................... 9,869 9,624 Investments in partially-owned companies.................. 341 346 Real estate and other fixed assets, net of accumulated depreciation (2000 -- $1,823; 1999 -- $1,892).......... 2,946 2,933 Separate and variable accounts............................ 32,343 29,666 Other assets.............................................. 6,026 5,496 -------- -------- Total assets.................................... $279,259 $268,238 ======== ======== See Accompanying Notes to Financial Statements. 1
3 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED BALANCE SHEET -- (CONTINUED) (IN MILLIONS, EXCEPT SHARE AMOUNTS) MARCH 31, DECEMBER 31, 2000 1999 ----------- ------------ (UNAUDITED) LIABILITIES: Reserve for losses and loss expenses...................... $ 38,286 $ 38,252 Reserve for unearned premiums............................. 11,545 11,450 Future policy benefits for life and accident and health insurance contracts.................................... 36,455 34,608 Policyholders' contract deposits.......................... 42,638 42,549 Other policyholders' funds................................ 3,378 3,236 Reserve for commissions, expenses and taxes............... 2,918 2,598 Insurance balances payable................................ 2,466 2,254 Funds held by companies under reinsurance treaties........ 853 861 Income taxes payable: Current................................................ 98 138 Deferred............................................... 1,037 751 Financial services and asset management liabilities: Borrowings under obligations of guaranteed investment agreements............................................ 9,143 9,430 Securities sold under agreements to repurchase, at contract value........................................ 6,233 6,116 Trading liabilities.................................... 3,933 3,821 Securities and spot commodities sold but not yet purchased, at market value............................ 7,761 6,413 Unrealized loss on interest rate and currency swaps, options and forward transactions...................... 8,636 8,624 Trust deposits and deposits due to banks and other depositors............................................ 2,274 2,175 Commercial paper....................................... 3,857 2,958 Notes, bonds and loans payable......................... 17,089 16,806 Commercial paper.......................................... 2,361 1,446 Notes, bonds, loans and mortgages payable................. 2,388 2,344 Separate and variable accounts............................ 32,343 29,666 Minority interests........................................ 1,382 1,350 Other liabilities......................................... 7,102 6,191 -------- -------- Total liabilities................................. 244,176 234,037 -------- -------- Preferred shareholders' equity in subsidiary companies.... 1,245 895 -------- -------- CAPITAL FUNDS: Common stock, $2.50 par value; 2,000,000,000 shares authorized; shares issued 2000 -- 1,660,706,366; 1999 -- 1,660,707,090.................................. 4,152 4,152 Additional paid-in capital................................ 2,054 2,080 Retained earnings......................................... 32,309 31,040 Accumulated other comprehensive income.................... (2,043) (2,103) Treasury stock, at cost; 2000 -- 119,322,881; 1999 -- 111,579,044 shares of common stock............. (2,634) (1,863) -------- -------- Total capital funds............................... 33,838 33,306 -------- -------- Total liabilities and capital funds............... $279,259 $268,238 ======== ======== See Accompanying Notes to Financial Statements. 2
4 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED STATEMENT OF INCOME (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED MARCH 31, ------------------ 2000 1999 ------- ------- (UNAUDITED) General insurance operations: Net premiums written...................................... $4,226 $4,054 Change in unearned premium reserve........................ (119) (279) ------ ------ Net premiums earned....................................... 4,107 3,775 Net investment income..................................... 663 620 Realized capital gains.................................... 12 78 ------ ------ 4,782 4,473 ------ ------ Losses and loss expenses incurred......................... 3,088 2,843 Underwriting expenses..................................... 807 739 ------ ------ 3,895 3,582 ------ ------ Operating income.......................................... 887 891 ------ ------ Life insurance operations: Premium income............................................ 3,278 2,873 Net investment income..................................... 1,671 1,502 Realized capital losses................................... (29) (21) ------ ------ 4,920 4,354 ------ ------ Death and other benefits.................................. 1,247 1,179 Increase in future policy benefits........................ 2,059 1,751 Acquisition and insurance expenses........................ 831 774 ------ ------ 4,137 3,704 ------ ------ Operating income.......................................... 783 650 ------ ------ Financial services operating income......................... 281 251 Asset management operating income........................... 104 58 Other realized capital losses............................... (4) (7) Other income (deductions) -- net............................ (60) (42) ------ ------ Income before income taxes and minority interest............ 1,991 1,801 ------ ------ Income taxes -- Current..................................... 308 378 -- Deferred.................................. 282 144 ------ ------ 590 522 ------ ------ Income before minority interest............................. 1,401 1,279 ------ ------ Minority interest........................................... (55) (80) ------ ------ Net income.................................................. $1,346 $1,199 ====== ====== Earnings per common share: Basic..................................................... $ 0.87 $ 0.77 ====== ====== Diluted................................................... $ 0.86 $ 0.77 ====== ====== Cash dividends per common share............................. $0.050 $0.045 ====== ====== Average shares outstanding: Basic..................................................... 1,546 1,548 ------ ------ Diluted................................................... 1,564 1,568 ------ ------ See Accompanying Notes to Financial Statements. 3
5 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (IN MILLIONS) THREE MONTHS ENDED MARCH 31, ------------------ 2000 1999 ------- ------- (UNAUDITED) Cash Flows From Operating Activities: Net Income.................................................. $ 1,346 $ 1,199 ======= ======= Adjustments to reconcile net income to net cash provided by operating activities: Non-cash revenues, expenses, gains and losses included in income: Change in: General and life insurance reserves.................... 2,029 829 Premiums and insurance balances receivable and payable -- net........................................ (668) (1,253) Reinsurance assets..................................... (267) (334) Deferred policy acquisition costs...................... (245) (346) Investment income due and accrued...................... (46) (31) Funds held under reinsurance treaties.................. (8) (19) Other policyholders' funds............................. 142 33 Current and deferred income taxes -- net............... 241 414 Reserve for commissions, expenses and taxes............ 320 391 Other assets and liabilities -- net.................... (538) (271) Trading assets and liabilities -- net.................. (1,623) 1,138 Trading securities, at market value.................... (75) (975) Spot commodities, at market value...................... (81) 213 Net unrealized gain on interest rate and currency swaps, options and forward transactions............... (396) 2,440 Securities purchased under agreements to resell........ 637 (3,085) Securities sold under agreements to repurchase......... 117 (712) Securities and spot commodities sold but not yet purchased, at market value............................ 1,348 1,503 Realized capital gains (losses)........................... 21 (50) Equity in income of partially-owned companies and other invested assets........................................ (39) (83) Depreciation expenses, principally flight equipment....... 275 249 Change in cumulative translation adjustments.............. 49 (244) Other -- net.............................................. (40) (57) ------- ------- Total Adjustments......................................... 1,153 (250) ------- ------- Net cash provided by operating activities................... $ 2,499 $ 949 ======= ======= See Accompanying Notes to Financial Statements. 4
6 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED) (IN MILLIONS) THREE MONTHS ENDED MARCH 31, -------------------- 2000 1999 -------- -------- (UNAUDITED) Cash Flows From Investing Activities: Cost of fixed maturities, at amortized cost matured or redeemed............................................... $ 333 $ 228 Cost of bonds, at market sold............................. 7,063 12,816 Cost of bonds, at market matured or redeemed.............. 1,652 2,783 Cost of equity securities sold............................ 1,704 1,093 Realized capital gains (losses)........................... (21) 50 Purchases of fixed maturities............................. (10,779) (22,242) Purchases of equity securities............................ (1,725) (901) Mortgage, policy and collateral loans granted............. (531) (1,334) Repayments of mortgage, policy and collateral loans....... 338 1,382 Sales of securities available for sale.................... 2,483 1,600 Maturities of securities available for sale............... 476 219 Purchases of securities available for sale................ (3,439) (1,893) Sales of flight equipment................................. 2 53 Purchases of flight equipment............................. (954) (1,079) Net additions to real estate and other fixed assets....... (120) (51) Sales or distributions of other invested assets........... 985 898 Investments in other invested assets...................... (1,443) (2,101) Change in short-term investments.......................... 76 118 Investments in partially-owned companies.................. -- 47 -------- -------- Net cash used in investing activities....................... (3,900) (8,314) -------- -------- Cash Flows From Financing Activities: Change in policyholders' contract deposits................ 89 6,273 Change in trust deposits and deposits due to banks and other depositors....................................... 99 383 Change in commercial paper................................ 1,814 (15) Proceeds from notes, bonds, loans and mortgages payable... 2,221 2,870 Repayments on notes, bonds, loans and mortgages payable... (1,898) (2,531) Proceeds from guaranteed investment agreements............ 1,253 290 Maturities of guaranteed investment agreements............ (1,540) (442) Proceeds from subsidiary company preferred stock issued... 350 -- Proceeds from common stock issued......................... 47 129 Cash dividends to shareholders............................ (78) (69) Acquisition of treasury stock............................. (911) (26) Proceeds from redemption of Premium Equity Redemption Cumulative Security Units.............................. -- 431 Other -- net.............................................. 34 15 -------- -------- Net cash provided by financing activities................... 1,480 7,308 -------- -------- Change in cash.............................................. 79 (57) Cash at beginning of period................................. 132 303 -------- -------- Cash at end of period....................................... $ 211 $ 246 ======== ======== See Accompanying Notes to Financial Statements. 5
7 AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (IN MILLIONS) THREE MONTHS ENDED MARCH 31, ---------------- 2000 1999 ------ ------ (UNAUDITED) Net income.................................................. $1,346 $1,199 Other comprehensive income: Unrealized appreciation (depreciation) of investments -- net of reclassification adjustments..... 15 (908) Deferred income tax (expense) benefit on changes....... (23) 325 Foreign currency translation adjustments.................. 49 (243) Applicable income tax (expense) benefit on changes..... 19 (3) ------ ------ Total..................................................... 60 (829) ------ ------ Comprehensive income........................................ $1,406 $ 370 ====== ====== See Accompanying Notes to Financial Statements. 6
8 AMERICAN INTERNATIONAL GROUP, INC. NOTES TO FINANCIAL STATEMENTS MARCH 31, 2000 (UNAUDITED) a) On January 1, 1999 (the merger date), American International Group, Inc. (AIG) issued 187.5 million shares of its common stock in exchange for all the outstanding common stock and Class B stock of SunAmerica Inc. (SunAmerica) based on an exchange ratio of 0.855 shares of AIG common stock for each share of SunAmerica stock. b) These statements are unaudited. In the opinion of management, all adjustments consisting of normal recurring accruals have been made for a fair presentation of the results shown. All material intercompany accounts and transactions have been eliminated. For further information, refer to the Annual Report on Form 10-K of AIG for the year ended December 31, 1999. c) Earnings per share of AIG are based on the weighted average number of common shares outstanding during the period, retroactively adjusted to reflect all stock splits. Cash dividends per common share reflect the adjustment for a common stock split in the form of a 25 percent common stock dividend paid July 30, 1999. The quarterly dividend rate per common share, commencing with the dividend paid September 17, 1999 is $0.05. d) Cash flow information for the three month periods ended March 31, 2000 and 1999 is as follows: 2000 1999 ----- ----- (IN MILLIONS) Income taxes paid........................................... $311 $242 Interest paid............................................... $592 $474 e) Segment Information: The following table summarizes the operations by major operating segment for the three month periods ended March 31, 2000 and 1999: OPERATING SEGMENTS ------------------- 2000 1999 ------- ------ (IN MILLIONS) Revenues(1): General Insurance......................................... $ 4,782 $4,473 Life Insurance............................................ 4,920 4,354 Financial Services........................................ 895 789 Asset Management.......................................... 297 216 Other..................................................... (4) (7) ------- ------ Total................................................... $10,890 $9,825 ======= ====== Operating income: General Insurance......................................... $ 887 $ 891 Life Insurance............................................ 783 650 Financial Services........................................ 281 251 Asset Management.......................................... 104 58 Other..................................................... (64) (49) ------- ------ Total................................................... $ 1,991 $1,801 ======= ====== ------------------- (1) Represents the sum of general net premiums earned, life premium income, net investment income, financial services commissions, transaction and other fees, asset management commissions and other fees, and realized capital gains (losses). 7
9 The following table summarizes AIG's general insurance operations by major reporting group for the three month periods ended March 31, 2000 and 1999: GENERAL INSURANCE ------------------ 2000 1999 ------- ------- (IN MILLIONS) Revenues: Domestic Brokerage Group.................................. $2,459 $2,426 Foreign General........................................... 1,593 1,430 Other..................................................... 730 617 ------ ------ Total................................................... $4,782 $4,473 ====== ====== Operating income before realized capital gains(1): Domestic Brokerage Group.................................. $ 457 $ 430 Foreign General........................................... 263 252 Other..................................................... 155 131 ------ ------ Total................................................... $ 875 $ 813 ====== ====== ------------------- (1) Realized capital gains are not deemed to be an integral part of AIG's general insurance operations' internal reporting groups. The following table summarizes AIG's life insurance operations by major reporting group for the three month periods ended March 31, 2000 and 1999: LIFE INSURANCE ---------------- 2000 1999 ------ ------ (IN MILLIONS) Revenues: American International Assurance Company Ltd. and Nan Shan Life Insurance Company, Ltd. ........................... $2,268 $1,925 American Life Insurance Company........................... 1,372 1,275 Domestic Life............................................. 1,166 1,052 Other..................................................... 114 102 ------ ------ Total................................................... $4,920 $4,354 ====== ====== Operating income before realized capital gains(1): American International Assurance Company Ltd. and Nan Shan Life Insurance Company, Ltd. ........................... $ 313 $ 263 American Life Insurance Company........................... 182 165 Domestic Life............................................. 299 229 Other..................................................... 18 14 ------ ------ Total................................................... $ 812 $ 671 ====== ====== ------------------- (1) Realized capital gains are not deemed to be an integral part of AIG's life insurance operations' internal reporting groups. 8
10 The following table summarizes AIG's financial services operations by major reporting group for the three month periods ended March 31, 2000 and 1999: FINANCIAL SERVICES -------------- 2000 1999 ----- ----- (IN MILLIONS) Revenues: International Lease Finance Corporation .................. $550 $512 AIG Financial Products Corp. ............................. 212 168 AIG Trading Group Inc. ................................... 73 64 Other..................................................... 60 45 ---- ---- Total................................................... $895 $789 ==== ==== Operating income: International Lease Finance Corporation .................. $139 $133 AIG Financial Products Corp. ............................. 139 101 AIG Trading Group Inc. ................................... 22 39 Other..................................................... (19) (22) ---- ---- Total................................................... $281 $251 ==== ==== f) Statement of Accounting Standards No. 130 "Comprehensive Income" (FASB 130) establishes standards for reporting comprehensive income and its components as part of capital funds. The reclassification adjustment with respect to available for sale securities was $(21) million. g) Derivatives Accounting Policy: AIG Financial Products Corp. and its subsidiaries (AIGFP) and AIG Trading Group Inc. and its subsidiaries (AIGTG) enter into future, forward, swap and option derivative transactions. These transactions are marked to market. With the exception of the derivatives used in market hedging activities with respect to securities available for sale, at market, the marks to market on all such other derivative transactions are recognized in income currently. The mark to market with respect to derivatives which hedge the market movements of securities available for sale, at market is recognized as a component of unrealized appreciation of investments, net of taxes. When the underlying security is sold, the loss or gain resulting from the hedging derivative transaction is recognized as income in that same period. h) In June 1998, FASB issued Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FASB 133). This statement requires AIG to recognize all derivatives in the consolidated balance sheet measuring these derivatives at fair value. The recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative. Currently, AIGTG and AIGFP present, in all material respects, the changes in fair value of their derivative transactions as a component of AIG's operating income. AIG is evaluating the impact of FASB 133 with respect to derivative transactions entered into by other AIG operations. AIG believes that the impact of FASB 133 on its results of operations, financial condition or liquidity will not be significant. FASB 133 is effective for the year commencing January 1, 2001. 9
11 AMERICAN INTERNATIONAL GROUP, INC. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OPERATIONAL REVIEW General Insurance Operations AIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. Domestic general insurance operations are comprised of the Domestic Brokerage Group (DBG), which includes the domestic operations of Transatlantic Holdings, Inc. (Transatlantic), Personal Lines, including 21st Century Insurance Group (21st Century) and Mortgage Guaranty. DBG is AIG's primary domestic division. DBG writes substantially all classes of business insurance accepting such business mainly from insurance brokers. This provides DBG the opportunity to select specialized markets and retain underwriting control. Any licensed broker is able to submit business to DBG without the traditional agent-company contractual relationship, but such broker usually has no authority to commit DBG to accept a risk. Personal Lines engages in the mass marketing of personal lines insurance, primarily private passenger auto, and includes homeowners and personal umbrella coverages. Mortgage Guaranty provides guaranty insurance on conventional first mortgage loans on single family dwellings and condominiums. AIG's Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG's foreign-based insurance subsidiaries for their own accounts. The Foreign General group uses various marketing methods to write both business and personal lines insurance with certain refinements for local laws, customs and needs. AIU operates in over 70 countries in Asia, the Pacific Rim, Europe, Africa, Middle East and Latin America. Transatlantic's foreign operations are included in this group. (See also Note (e) of Notes to Financial Statements.) General insurance operations for the three month periods ending March 31, 2000 and 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - ------------------------------------------------------- Net premiums written: Domestic $2,740 $2,672 Foreign 1,486 1,382 - ------------------------------------------------------- Total $4,226 $4,054 - ------------------------------------------------------- Net premiums earned: Domestic $2,678 $2,474 Foreign 1,429 1,301 - ------------------------------------------------------- Total $4,107 $3,775 - ------------------------------------------------------- Adjusted underwriting profit: Domestic $ 104 $ 55 Foreign 108 138 - ------------------------------------------------------- Total $ 212 $ 193 - ------------------------------------------------------- Net investment income: Domestic $ 508 $ 506 Foreign 155 114 - ------------------------------------------------------- Total $ 663 $ 620 - ------------------------------------------------------- Operating income before realized capital gains: Domestic $ 612 $ 561 Foreign 263 252 - ------------------------------------------------------- Total 875 813 Realized capital gains 12 78 - ------------------------------------------------------- Operating income $ 887 $ 891 - ------------------------------------------------------- During the first three months of 2000, the net premiums written and net premiums earned in AIG's general insurance operations increased 4.3 percent and 8.8 percent, respectively, from those of 1999. General insurance domestic net premiums written and net premiums earned for the three month periods ending March 31, 2000 and 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - ------------------------------------------------------- Net premiums written: DBG $2,030 $2,099 Personal Lines 601 479 Mortgage Guaranty 109 94 - ------------------------------------------------------- Total $2,740 $2,672 - ------------------------------------------------------- Net premiums earned: DBG $2,000 $1,928 Personal Lines 568 450 Mortgage Guaranty 110 96 - ------------------------------------------------------- Total $2,678 $2,474 - ------------------------------------------------------- During the latter part of 1999, the commercial insurance market continued to experience some rate 10
12 increases. However, this market remains competitive and excessively capitalized. DBG continued to monitor its operations, canceling, non-renewing or losing business where underwriting and pricing standards could not be achieved. During the first three months of 2000, DBG declined to renew $110 million of business. DBG has been able to sustain some growth in various specialty markets, such as pollution, excess liability and risk management, where AIG provides cost effective coverages for large complex risks, underwriting flexibility, and creative risk financing solutions. Excluding non-renewed business as well as risk finance operations, DBG's net premiums written increased approximately 10 percent. As reflected in the preceding table showing the distribution of net premiums written and net premiums earned, domestic growth was primarily achieved through the growth in the personal auto insurance segment of Personal Lines. Personal Lines net premiums written increased $122 million in the first three months of 2000 over the same period of 1999. The increase was related to the significant growth in the number of policies issued with respect to the preferred, standard and non-standard auto risks. Growth of 7.6 percent and 9.8 percent for foreign general insurance net premiums written and net premiums earned, respectively, in the first three months of 2000 over 1999 reflects growth of operations in the United Kingdom and the Far East. Foreign general insurance operations produced 35.2 percent of the general insurance net premiums written in the first three months of 2000 and 34.1 percent in 1999. Differences in foreign exchange rates during 2000 relative to 1999 had a negligible effect on foreign general insurance net premiums written when translated from original currencies into U.S. dollars. (See also the discussion under "Capital Resources" herein.) Because of the nature and diversity of AIG's operations and the continuing rapid changes in the insurance industry worldwide, together with the factors discussed above, it is difficult to assess further or project future growth in AIG's net premiums written and reserve for losses and loss expenses. Net premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes deferred revenues which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period. AIG, along with most general insurance entities, uses the loss ratio, the expense ratio and the combined ratio as measures of performance. The loss ratio is derived as the sum of losses and loss expenses incurred divided by net premiums earned. The expense ratio is derived as statutory underwriting expenses divided by net premiums written. The combined ratio is the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe for every $100 of net premiums earned or written, the cost of losses and statutory expenses, respectively. The combined ratio presents the total cost per $100 of premium production. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting loss. The statutory general insurance ratios were as follows: - ------------------------------------------------------ 2000 1999 - ------------------------------------------------------- Domestic: Loss Ratio 81.21 81.58 Expense Ratio 16.17 16.13 - ------------------------------------------------------- Combined Ratio 97.38 97.71 - ------------------------------------------------------- Foreign: Loss Ratio 63.94 63.36 Expense Ratio 28.68 27.42 - ------------------------------------------------------- Combined Ratio 92.62 90.78 - ------------------------------------------------------- Consolidated: Loss Ratio 75.21 75.30 Expense Ratio 20.57 19.98 - ------------------------------------------------------- Combined Ratio 95.78 95.28 - ------------------------------------------------------- AIG believes that underwriting profit is the true measure of the performance of the core business of a general insurance company. Underwriting profit is measured two ways: statutory underwriting profit and Generally Accepted Accounting Principles (GAAP) underwriting profit. Statutory underwriting profit is arrived at by reducing net premiums earned by net losses incurred and net expenses incurred. Statutory accounting differs from GAAP, as statutory accounting requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, all expenses, most specifically acquisition 11
13 expenses, are recognized immediately which is not consistent with the revenues earned. A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred and recognized together with the related revenues. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. Thus, "adjusted underwriting profit" is a GAAP measurement which can be viewed as gross margin or an intermediate subtotal in calculating operating income and net income. A major part of the discipline of a successful general insurance company is to produce an underwriting profit, exclusive of investment income. If underwriting is not profitable, losses incurred are a major factor. The result is that the premiums are inadequate to pay for losses and expenses and produce a profit; therefore, investment income must be used to cover underwriting losses. If assets and the income therefrom are insufficient to pay claims and expenses over extended periods, an insurance company cannot survive. For these reasons, AIG views and manages its underwriting operations separately from its investment operations. The adjusted underwriting profits were $212 million in the first three months of 2000 and $193 million in the same period of 1999. The regulatory, product type and competitive environment as well as the degree of litigation activity in any one country varies significantly. These factors have a direct impact on pricing and consequently profitability as reflected by adjusted underwriting profit and statutory general insurance ratios. AIG's results reflect the net impact of incurred losses from catastrophes approximating $25 million in the first three months of 2000. AIG's gross incurred losses from catastrophes approximated $89 million in 2000. There were no catastrophe losses in the first three months of 1999. If catastrophes were excluded from the losses incurred, the pro forma consolidated statutory general insurance ratios would be as follows: - -------------------------------------------------------- 2000 1999 - -------------------------------------------------------- Loss Ratio 74.60 75.30 Expense Ratio 20.57 19.98 - -------------------------------------------------------- Combined Ratio 95.17 95.28 - -------------------------------------------------------- AIG presents calculations of general insurance ratios which exclude catastrophe losses because the impact of catastrophes can fluctuate widely from period to period making comparisons of recurring type business more difficult. Thus, the pro forma results are comparable and allow the reader to focus on the results of AIG's core business, underwriting. AIG's historic ability to maintain its combined ratio below 100 is primarily attributable to the profitability of AIG's foreign general insurance operations and AIG's emphasis on maintaining its disciplined underwriting, especially in the domestic specialty markets. In addition, AIG does not seek net premium growth where rates do not adequately reflect its assessment of exposures. General insurance net investment income in the first three months of 2000 increased 7.0 percent when compared to the same period of 1999. The growth in net investment income in 2000 was primarily attributable to new cash flow for investment. The new cash flow was generated from net general insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein.) General insurance realized capital gains were $12 million in the first three months of 2000 and $78 million in 1999. These realized gains resulted from the ongoing management of the general insurance investment portfolios within the overall objectives of the general insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities. General insurance operating income in the first three months of 2000 decreased 0.5 percent when compared to the same period of 1999. The contribution of general insurance operating income to income before income taxes and minority interest was 44.5 percent in 2000 compared to 49.5 percent in 1999. AIG is a major purchaser of reinsurance for its general insurance operations. AIG is cognizant of the need to exercise good judgment in the selection and approval of both domestic and foreign companies participating in its reinsurance programs. AIG insures risks in over 70 countries and its reinsurance programs must be coordinated in order to provide AIG the level of reinsurance protection that AIG 12
14 desires. These reinsurance arrangements do not relieve AIG from its direct obligations to its insureds. AIG's general reinsurance assets amounted to $19.39 billion and resulted from AIG's reinsurance arrangements. Thus, a credit exposure existed at March 31, 2000 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, 1999, approximately 50 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, nearly all of these balances were collateralized. The remaining 50 percent of the general reinsurance assets were from authorized reinsurers and over 95 percent of such balances are from reinsurers rated A-(excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. Through March 31, 2000, these distribution percentages have not significantly changed. AIG's allowance for estimated unrecoverable reinsurance has not changed significantly from December 31, 1999 when AIG had allowances for unrecoverable reinsurance approximating $78 million. At that date, and prior to this allowance, AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction). AIG's Reinsurance Security Department conducts ongoing detailed assessments of the reinsurance markets and current and potential reinsurers, both foreign and domestic. Such assessments include, but are not limited to, identifying if a reinsurer is appropriately licensed, and has sufficient financial capacity, and the local economic environment in which a foreign reinsurer operates. This department also reviews the nature of the risks ceded and the need for collateral. In addition, AIG's Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer. AIG enters into certain intercompany reinsurance transactions for its general and life operations. AIG enters these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among various legal entities. These reinsurance agreements have been approved by the appropriate regulatory authorities. All material intercompany transactions have been eliminated in consolidation. At March 31, 2000, the consolidated general reinsurance assets of $19.39 billion include reinsurance recoverables for paid losses and loss expenses of $2.66 billion and $13.66 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported (IBNR) (ceded reserves). The ceded reserves represent the accumulation of estimates of ultimate ceded losses including provisions for ceded IBNR and loss expenses. The methods used to determine such estimates and to establish the resulting ceded reserves are continually reviewed and updated. Any adjustments therefrom are reflected in income currently. It is AIG's belief that the ceded reserves at March 31, 2000 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded. At March 31, 2000, general insurance reserves for losses and loss expenses (loss reserves) amounted to $38.29 billion. These loss reserves represent the accumulation of estimates of ultimate losses, including IBNR, and loss expenses and amounts of discounting related to certain workers' compensation claims. At March 31, 2000, general insurance net loss reserves increased $22 million to $24.62 billion. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments resulting therefrom are reflected in operating income currently. It is management's belief that the general insurance net loss reserves are adequate to cover all general insurance net losses and loss expenses as at March 31, 2000. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on such future results of operations. 13
15 In a very broad sense, the general loss reserves can be categorized into two distinct groups: one group being long tail casualty lines of business. Such lines include excess and umbrella liability, directors and officers' liability, professional liability, medical malpractice, general liability, products' liability, and related classes. These lines account for approximately one-half of net losses and loss expenses. The other group is short tail lines of business consisting principally of property lines, certain classes of casualty lines and includes personal lines. Estimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. In the more recent accident years of long tail casualty lines there is limited statistical credibility in reported net losses. That is, a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. A relatively high proportion of net losses would therefore be IBNR. A variety of actuarial methods and assumptions are normally employed to estimate net losses for long tail casualty lines. These methods ordinarily involve the use of loss trend factors intended to reflect the estimated annual growth in loss costs from one accident year to the next. For the majority of long tail casualty lines, net loss trend factors approximated five percent. Loss trend factors reflect many items including changes in claims handling, exposure and policy forms and current and future estimates of monetary inflation and social inflation. Thus, many factors are implicitly considered in estimating the year to year growth in loss costs. Therefore, AIG's carried net long tail loss reserves are judgmentally set as well as tested for reasonableness using the most appropriate loss trend factors for each class of business. In the evaluation of AIG's net loss reserves, loss trend factors vary slightly, depending on the particular class and nature of the business involved. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience. Estimation of net losses for short tail business is less complex than for long tail casualty lines. Loss cost trends for many property lines can generally be assumed to be similar to the growth in exposure of such lines. For example, if the fire insurance coverage remained proportional to the actual value of the property, the growth in property's exposure to fire loss can be approximated by the amount of insurance purchased. For other property and short tail casualty lines, the loss trend is implicitly assumed to grow at the rate that reported net losses grow from one year to the next. The concerns noted above for longer tail casualty lines with respect to the limited statistical credibility of reported net losses generally do not apply to shorter tail lines. AIG continues to receive claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites (hereinafter referred to collectively as environmental claims) and indemnity claims asserting injuries from asbestos. The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. AIG has established a specialized claims unit which investigates and adjusts all such asbestos and environmental claims. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage. However, AIG currently underwrites environmental impairment liability insurance on a claims made basis and excluded such claims from the analyses included herein. Estimation of asbestos and environmental claims loss reserves is a difficult process. These asbestos and environmental claims cannot be estimated by conventional reserving techniques as previously described. Quantitative techniques frequently have to be supplemented by subjective considerations including managerial judgment. Significant factors which affect the trends which influence the development of asbestos and environmental claims are the inconsistent court resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving and there is little likelihood that any firm direction will develop in the near future. Additionally, the exposure for cleanup costs of hazardous waste dump sites involves issues such as allocation of responsibility among potentially responsible parties and the government's refusal to release parties. The cleanup cost exposure may significantly change if the Congressional reauthorization of Superfund dramatically changes, thereby reducing or increasing litigation and cleanup costs. Additionally, proposed legislation, if passed in cur- 14
16 rent form, would be expected to reduce ultimate asbestos exposure. In the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. At the current time, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as is the case for other types of claims. Such development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by the changes in Superfund and waste dump site coverage issues. Although the estimated liabilities for these claims are subject to a significantly greater margin of error than for other claims, the reserves carried for these claims at March 31, 2000 are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG's net exposure retained relative to the gross exposure written was lower in 1984 and prior years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. (See the previous discussion on reinsurance collectibility herein.) The majority of AIG's exposures for asbestos and environmental claims are excess casualty coverages, not primary coverages. Thus, the litigation costs are treated in the same manner as indemnity reserves. That is, litigation expenses are included within the limits of the liability AIG incurs. Individual significant claim liabilities, where future litigation costs are reasonably determinable, are established on a case basis. A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined at March 31, 2000 and 1999 was as follows: (in millions) - ------------------------------------------------------------ 2000 1999 ------------- ------------- GROSS NET GROSS NET - ------------------------------------------------------------ Asbestos: Reserve for losses and loss expenses at beginning of year $1,093 $306 $ 964 $259 Losses and loss expenses incurred 16 7 170 22 Losses and loss expenses paid (127) (25) (62) (12) - ------------------------------------------------------------ Reserve for losses and loss expenses at end of period $ 982 $288 $1,072 $269 - ------------------------------------------------------------ Environmental: Reserve for losses and loss expenses at beginning of year $1,519 $585 $1,536 $604 Losses and loss expenses incurred 9 6 10 7 Losses and loss expenses paid (42) (21) (43) (17) - ------------------------------------------------------------ Reserve for losses and loss expenses at end of period $1,486 $570 $1,503 $594 - ------------------------------------------------------------ Combined: Reserve for losses and loss expenses at beginning of year $2,612 $891 $2,500 $863 Losses and loss expenses incurred 25 13 180 29 Losses and loss expenses paid (169) (46) (105) (29) - ------------------------------------------------------------ Reserve for losses and loss expenses at end of period $2,468 $858 $2,575 $863 - ------------------------------------------------------------ The gross and net IBNR included in the aforementioned reserve for losses and loss expenses at March 31, 2000 and December 31, 1999 were estimated as follows: (in millions) - ------------------------------------------------------ 2000 1999 ------------- ------------- GROSS NET GROSS NET - ------------------------------------------------------------ Combined $ 919 $341 $ 930 $352 - ------------------------------------------------------------ A summary of asbestos and environmental claims count activity for the three month periods ended March 31, 2000 and 1999 was as follows: - --------------------------------------------------------------------------------------------------------------------- 2000 1999 ----------------------------------- ----------------------------------- ASBESTOS ENVIRONMENTAL COMBINED ASBESTOS ENVIRONMENTAL COMBINED - --------------------------------------------------------------------------------------------------------------------- Claims at beginning of year 6,746 13,432 20,178 6,388 16,560 22,948 Claims during period: Opened 182 497 679 426 778 1,204 Settled (33) (164) (197) (27) (135) (162) Dismissed or otherwise resolved (81) (618) (699) (290) (1,447) (1,737) - --------------------------------------------------------------------------------------------------------------------- Claims at end of period 6,814 13,147 19,961 6,497 15,756 22,253 - --------------------------------------------------------------------------------------------------------------------- 15
17 The average cost per claim settled, dismissed or otherwise resolved for the three month periods ended March 31, 2000 and 1999 was as follows: - ------------------------------------------------------ 2000 1999 --------------------- ------------------ GROSS NET GROSS NET - ----------------------------------------------------------------- Asbestos $1,114,000 $219,300 $195,000 $39,400 Environmental 53,700 26,900 27,100 10,600 Combined 188,600 51,300 55,100 15,400 - ----------------------------------------------------------------- A.M. Best, an insurance rating agency, has developed a survival ratio to measure the number of years it would take a company to exhaust both its asbestos and environmental reserves for losses and loss expenses based on that company's current level of asbestos and environmental claims payments. This is a ratio derived by taking the current ending losses and loss expense reserves and dividing by the average annual payments for the prior three years. Therefore, the ratio derived is a simplistic measure of an estimate of the number of years it would be before the current ending losses and loss expense reserves would be paid off using recent average payments. The higher the ratio, the more years the reserves for losses and loss expenses cover these claims payments. These ratios are computed based on the ending reserves for losses and loss expenses over the respective claims settlements during the fiscal year. Such payments include indemnity payments and legal and loss adjustment payments. It should be noted, however, that this is an extremely simplistic approach to measuring asbestos and environmental reserve levels. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments thereof and the resultant ratio. The developed survival ratios include both involuntary and voluntary indemnity payments. Involuntary payments are primarily attributable to court judgments, court orders, covered claims with no coverage defenses, state mandated cleanup costs, claims where AIG's coverage defenses are minimal, and settlements made less than six months before the first trial setting. Also, AIG considers all legal and loss adjustment payments as involuntary. AIG believes voluntary indemnity payments should be excluded from the survival ratio. The special asbestos and environmental claims unit actively manages AIG's asbestos and environmental claims and proactively pursues early settlement of environmental claims for all known and unknown sites. As a result, AIG reduces its exposure to future environmental loss contingencies. AIG's survival ratios for involuntary asbestos and environmental claims, separately and combined, were based upon a three year average payment. These ratios at March 31, 2000 and 1999 were as follows: - ------------------------------------------------------ 2000 1999 -------------- -------------- GROSS NET GROSS NET - --------------------------------------------------------- Involuntary survival ratios: Asbestos 1.8 3.5 2.3 3.9 Environmental 13.7 13.3 13.0 13.1 Combined 4.4 7.7 4.9 8.2 - --------------------------------------------------------- AIG's operations are negatively impacted under guarantee fund assessment laws which exist in most states. As a result of operating in a state which has guarantee fund assessment laws, a solvent insurance company may be assessed for certain obligations arising from the insolvencies of other insurance companies which operated in that state. AIG generally records these assessments upon notice. Additionally, certain states permit at least a portion of the assessed amount to be used as a credit against a company's future premium tax liabilities. Therefore, the ultimate net assessment cannot reasonably be estimated. The guarantee fund assessments net of credits for 1999 were $15 million. Based upon current information, AIG does not anticipate that its net assessment will be significantly different in 2000. AIG is also required to participate in various involuntary pools (principally workers' compensation business) which provide insurance coverage for those not able to obtain such coverage in the voluntary markets. This participation is also recorded upon notification, as these amounts cannot reasonably be estimated. Life Insurance Operations AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of single premium annuity, variable annuities, guaranteed investment contracts, universal life and pensions. 16
18 AIG's three principal overseas life operations are American Life Insurance Company (ALICO), American International Assurance Company, Limited together with American International Assurance Company (Bermuda) Limited (AIA) and Nan Shan Life Insurance Company, Ltd. (Nan Shan). ALICO is incorporated in Delaware and all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in approximately 50 countries located in Europe, Africa, Latin America, the Caribbean, the Middle East, and the Far East, with Japan being the largest territory. AIA operates primarily in Hong Kong, Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. AIG's domestic life operations are comprised of two separate operations, AIG's domestic life companies and the life insurance subsidiaries of SunAmerica Inc. (SunAmerica), a Delaware corporation which owns substantially all of the subsidiaries which were owned by SunAmerica Inc., the Maryland corporation which was merged into AIG in January 1999. Both of these operations sell primarily financial and investment type products. (See also Note (e) of Notes to Financial Statements.) Life insurance operations for the three month periods ending March 31, 2000 and 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - -------------------------------------------------------- Premium income: Domestic $ 286 $ 223 Foreign 2,992 2,650 - -------------------------------------------------------- Total $ 3,278 $ 2,873 - -------------------------------------------------------- Net investment income: Domestic $ 924 $ 843 Foreign 747 659 - -------------------------------------------------------- Total $ 1,671 $ 1,502 - -------------------------------------------------------- Operating income before realized capital losses: Domestic $ 299 $ 229 Foreign 513 442 - -------------------------------------------------------- Total 812 671 Realized capital losses (29) (21) - -------------------------------------------------------- Operating income $ 783 $ 650 - -------------------------------------------------------- Life insurance in-force:* Domestic $ 84,349 $103,049 Foreign 492,623 481,910 - -------------------------------------------------------- Total $576,972 $584,959 - -------------------------------------------------------- * Amounts presented were as at March 31, 2000 and December 31, 1999, respectively. AIG's life premium income during the first three months of 2000 represented a 14.1 percent increase from the same period in 1999. Foreign life operations produced 91.3 percent and 92.2 percent of the life premium income in 2000 and 1999, respectively. The traditional life products, particularly individual life products, were major contributors to the growth in foreign premium income and resulting investment income, particularly in those countries in which AIA and Nan Shan operate. A mixture of traditional, accident and health and financial products are being sold in Japan through ALICO. Differences in foreign exchange rates during 2000 relative to 1999 had a negligible effect on foreign life premium income when translated from original currencies into U.S. dollars. Life insurance net investment income increased 11.3 percent during the first three months of 2000. The growth in net investment income was primarily attributable to both foreign and domestic operations new cash flow for investment. The new cash flow was generated from life insurance operations and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein.) Life insurance realized capital losses were $29 million in 2000 and $21 million in 1999. These realized capital losses resulted from the ongoing management of the life insurance investment portfolios within the overall objectives of the life insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities. Life insurance operating income during the first three months of 2000 increased 20.5 percent to $783 million. Excluding realized capital losses from life insurance operating income, the percent increase would be 20.9. The contribution of life insurance operating income to income before income taxes and minority interest amounted to 39.3 percent during the first three months of 2000 compared to 36.1 percent in the same period of 1999. The risks associated with the traditional life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is investment risk. 17
19 Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately one million dollars of coverage by using yearly renewable term reinsurance. The investment risk represents the exposure to loss resulting from the cash flows from the invested assets, primarily long-term fixed rate investments, being less than the cash flows required to meet the obligations of the expected policy and contract liabilities and the necessary return on investments. To minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to assess whether there is a liquidity excess or deficit. If a rebalancing of the invested assets to the policy and contract claims became necessary and did not occur, a demand could be placed upon liquidity. (See also the discussion under "Liquidity" herein.) The asset-liability relationship is appropriately managed in AIG's foreign operations, as it has been throughout AIG's history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of the related policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the investments may be at a yield below that of the interest required for the accretion of the policy liabilities. At December 31, 1999, the average duration of the investment portfolio in Japan was 5.6 years. Additionally, there exists a future investment risk that is 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. With respect to the investment of these future premium receipts, the average maturity is estimated to be 6.0 years. These durations compare with an estimated average duration of 9.4 years for the corresponding policy liabilities. These durations have not changed significantly during 2000. To maintain an adequate yield to match the interest necessary to support future policy liabilities, constant management focus is required to reinvest the proceeds of the maturing securities and to invest the future premium receipts without sacrificing investment quality. To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and to support any operational shortfall through its international financial network. Domestically, active monitoring assures appropriate asset-liability matching as there are investments available to match the duration and the required yield. (See also the discussion under "Liquidity" herein.) AIG uses asset-liability matching as a management tool to determine the composition of the invested assets and marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in an unmatched position due to anticipated interest rate or other economic changes. Financial Services Operations AIG's financial services subsidiaries engage in diversified financial products and services including premium financing, banking services and consumer finance services. International Lease Finance Corporation (ILFC) engages primarily in the acquisition of new and used commercial jet aircraft and the leasing and remarketing of such aircraft to airlines around the world. (See also Note (e) of Notes to Financial Statements.) AIG Financial Products Corp. and its subsidiaries (AIGFP) structure financial transactions, including long-dated interest rate and currency swaps and structured borrowings through notes, bonds and guaranteed investment agreements. (See also Note (e) of Notes to Financial Statements.) AIG Trading Group Inc. and its subsidiaries (AIGTG) engage in various commodities trading, foreign exchange trading, interest rate swaps and market making activities. (See also Note (e) of Notes to Financial Statements.) 18
20 Financial services operations for the three month periods ending March 31, 2000 and 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - -------------------------------------------------------- Revenues: International Lease Finance Corporation $ 550 $ 512 AIG Financial Products Corp.* 212 168 AIG Trading Group Inc.* 73 64 Other 60 45 - -------------------------------------------------------- Total $ 895 $ 789 - -------------------------------------------------------- Operating income: International Lease Finance Corporation $ 139 $ 133 AIG Financial Products Corp. 139 101 AIG Trading Group Inc. 22 39 Other, including intercompany adjustments (19) (22) - -------------------------------------------------------- Total $ 281 $ 251 - -------------------------------------------------------- * Represents commissions, transaction and other fees. Financial services operating income increased 12.1 percent in the first three months of 2000 over 1999. Financial services operating income represented 14.1 percent of AIG's income before income taxes and minority interest in the first three months of 2000. This compares to 13.9 percent in the same period of 1999. ILFC generates its revenues primarily from leasing new and used commercial jet aircraft to domestic and foreign airlines. Revenues also result from the remarketing of commercial jets for its own account, for airlines and for financial institutions. Revenues in the first three months of 2000 increased 7.3 percent from 1999. The revenue growth resulted primarily from the increase in flight equipment available for operating lease and the increase in the relative cost of the leased fleet. Approximately 20 percent of ILFC's operating lease revenues are derived from U.S. and Canadian airlines. During the first three months of 2000, operating income increased 4.2 percent from 1999. The composite borrowing rates at the end of the first three months of 2000 and 1999 were 6.12 percent and 5.90 percent, respectively. (See also the discussions under "Capital Resources" and "Liquidity" herein and Note (e) of Notes to Financial Statements.) ILFC is exposed to loss through non-performance of aircraft lessees, through owning aircraft which it would be unable to sell or re-lease at acceptable rates at lease expiration and through committing to purchase aircraft which it would be unable to lease. ILFC manages its lessee non-performance exposure through credit reviews and security deposit requirements. At March 31, 2000, there were 361 aircraft subject to operating leases and there were no aircraft off lease. (See also the discussions under "Capital Resources" and "Liquidity" herein.) AIGFP participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity and credit derivative products business. AIGFP also enters into structured transactions including long-dated forward foreign exchange contracts, option transactions, liquidity facilities and investment agreements and invests in a diversified portfolio of securities. AIGFP derives substantially all its revenues from proprietary positions entered in connection with counterparty transactions rather than from speculative transactions. Revenues in the first three months of 2000 increased 26.6 percent from the same period of 1999. During the first three months of 2000, operating income increased 38.7 percent from the same period of 1999. As AIGFP is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein and Note (e) of Notes to Financial Statements.) AIGTG derives a substantial portion of its revenues from market making and trading activities, as principal, in foreign exchange, interest rates and precious and base metals. Revenues in the first three months of 2000 increased 14.6 percent from the same period of 1999. During the first three months of 2000, operating income decreased 43.7 percent from the same period of 1999. The decline of AIGTG operating income resulted primarily from the decline in volatility in foreign exchange rates. As AIGTG is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance or for comparing revenues to operating income. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein and Note (e) of Notes to Financial Statements.) AIG Consumer Finance Group, Inc., through its subsidiaries, is engaged in developing a multi-product consumer finance business with an emphasis on emerging markets. 19
21 Asset Management Operations AIG's asset management operations offer a wide variety of investment vehicles and services, including variable annuities, mutual funds, and investment asset management. Such products and services are offered to individuals and institutions both domestically and internationally. AIG's three principal asset management operations are SunAmerica's asset management operations (SAAMCo), AIG Global Investment Group, Inc. (Global Investment) and AIG Capital Partners, Inc. (Cap Partners). SAAMCo develops and sells variable annuities and other investment products, sells and manages mutual funds and provides financial services. Global Investment manages invested assets of institutions, including insurance companies and pension funds, and provides custodial services. Cap Partners organizes, and manages the invested assets of institutional investment funds and may also invest in such funds. Each of these subsidiary operations receives fees for investment products and services provided. Asset management operations for the three month periods ending March 31, 2000 and 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - ------------------------------------------------------- Revenues $297 $216 Operating income $104 $ 58 - ------------------------------------------------------- These increases were primarily attributable to increased fees from the management of the variable annuity business and mutual fund assets by SAAMCo. Asset management operating income in the first three months of 2000 increased 79.0 percent when compared to the same period of 1999. Asset management operating income represented 5.2 percent of AIG's income before income taxes and minority interest in the first three months of 2000. This compares to 3.2 percent in the same period of 1999. At March 31, 2000, AIG's third party assets under management, including both retail mutual funds and institutional accounts approximated $35 billion. Other Operations Other realized capital losses amounted to $4 million and $7 million in the first three months of 2000 and 1999, respectively. Other income (deductions) -- net includes AIG's equity in certain minor majority-owned subsidiaries and certain partially owned companies, realized foreign exchange transaction gains and losses in substantially all currencies and unrealized gains and losses in hyperinflationary currencies, as well as the income and expenses of the parent holding company and other miscellaneous income and expenses. In the first three months of 2000, net deductions amounted to $60 million. In the same period of 1999, net deductions amounted to $42 million. Income before income taxes and minority interest amounted to $1.99 billion in the first three months of 2000 and $1.80 billion in the same period of 1999. In the first three months of 2000, AIG recorded a provision for income taxes of $590 million compared to the provision of $522 million in the same period of 1999. These provisions represent effective tax rates of 29.6 percent in the first three months of 2000 and 29.0 percent in the same period of 1999. Minority interest represents minority shareholders' equity in income of certain majority-owned consolidated subsidiaries. Minority interest amounted to $55 million and $80 million in the first three months of 2000 and 1999, respectively. Net income amounted to $1.35 billion in the first three months of 2000 and $1.20 billion in the same period of 1999. The increases in net income over the periods resulted from those factors described above. CAPITAL RESOURCES At March 31, 2000, AIG had total capital funds of $33.84 billion and total borrowings of $34.84 billion. At that date, $30.54 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable. 20
22 Total borrowings and borrowings not guaranteed or matched at March 31, 2000 and December 31, 1999 were as follows: (in millions) - -------------------------------------------------------- 2000 1999 - -------------------------------------------------------- GIAs -- AIGFP $ 9,143 $ 9,430 - -------------------------------------------------------- Commercial Paper: AIG Funding, Inc. 1,703 888 ILFC(a) 3,857 2,958 A.I. Credit Corp. 568 475 AIG Finance (Taiwan) Limited 90 83 - -------------------------------------------------------- Total 6,218 4,404 - -------------------------------------------------------- Medium Term Notes: ILFC(a) 2,829 3,226 AIG 493 481 - -------------------------------------------------------- Total 3,322 3,707 - -------------------------------------------------------- Notes and Bonds Payable: ILFC(a) 5,002 5,016 AIGFP 8,603 7,895 AIG 708 705 - -------------------------------------------------------- Total 14,313 13,616 - -------------------------------------------------------- Loans and Mortgages Payable: ILFC(a)(b) 655 670 AIG Finance (Hong Kong) Limited(a) 482 566 AIG Consumer Finance Group, Inc.(a) 451 334 AIG 254 257 - -------------------------------------------------------- Total 1,842 1,827 - -------------------------------------------------------- Total Borrowings 34,838 32,984 - -------------------------------------------------------- Borrowings not guaranteed by AIG 13,366 12,853 Matched GIA borrowings 9,143 9,430 Matched notes and bonds payable -- AIGFP 8,033 7,370 - -------------------------------------------------------- 30,542 29,653 - -------------------------------------------------------- Remaining borrowings of AIG $ 4,296 $ 3,331 - -------------------------------------------------------- (a)AIG does not guarantee or support these borrowings. (b)Capital lease obligations. The maturity distributions of total borrowings at March 31, 2000 and December 31, 1999 were as follows: (in millions) - ------------------------------------------------------ 2000 1999 - -------------------------------------------------------- Short-term borrowings $ 9,416 $10,088 Long-term borrowings(a) 25,422 22,896 - -------------------------------------------------------- Total borrowings $34,838 $32,984 - -------------------------------------------------------- (a)Including commercial paper and excluding that portion of long-term debt maturing in less than one year. During the first three months of 2000, AIGFP increased the aggregate principal amount outstanding of its notes and bonds payable to $8.60 billion. AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities and derivative transactions. The funds may also be temporarily invested in securities purchased under agreements to resell. (See also the discussions under "Operational Review", "Liquidity" and "Derivatives" herein.) AIG Funding, Inc. (Funding), through the issuance of commercial paper, fulfills the short-term cash requirements of AIG and its non-insurance subsidiaries. Funding intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of Funding's commercial paper is subject to the approval of AIG's Board of Directors. ILFC, A.I. Credit Corp. (AICCO) and AIG Finance (Taiwan) Limited -- (AIGF-Taiwan), a consumer finance subsidiary in Taiwan, issue commercial paper for the funding of their own operations. AIG does not guarantee AICCO's, ILFC's or AIGF-Taiwan's commercial paper. However, AIG has entered into an agreement in support of AICCO's commercial paper. From time to time, AIGFP may issue commercial paper, which AIG guarantees, to fund its operations. At March 31, 2000, AIGFP had no commercial paper outstanding. (See also the discussion under "Derivatives" herein.) AIG and Funding have entered into two syndicated revolving credit facilities (the Facilities) aggregating $1 billion. The Facilities consist of a $500 million 364 day revolving credit facility and a $500 million five year revolving credit facility. The Facilities can be used for general corporate purposes and also provide backup for AIG's commercial paper programs administered by Funding. There are currently no borrowings outstanding under either of the Facilities, nor were any borrowings outstanding as of March 31, 2000. At March 31, 2000, ILFC had decreased the aggregate principal amount outstanding of its medium term and term notes to $7.83 billion, a net decrease of $411 million, and recorded a net decline in its capital lease obligations of $15 million and a net increase in its commercial paper of $899 million. At March 31, 2000, ILFC had $1.62 billion in aggregate principal amount of debt securities registered for issuance from time to time. In addition, ILFC established a Euro Medium Term Note Program for $2.0 billion, under which $771 million in notes were sold through March 31, 2000. ILFC has an Export Credit Facility, up to a maximum of $4.3 billion, for approximately 75 aircraft to be delivered from 1999 through 2001. ILFC has the right, but is not required, to use the facility to fund 85 percent of each aircraft's 21
23 purchase price. This facility is guaranteed by various European Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90 percent on the first 75 aircraft depending on the delivery date of the aircraft. Through March 31, 2000, ILFC borrowed $1.48 billion under this facility. Borrowings with respect to this facility are included in Notes and Bonds Payable in the accompanying table of borrowings. The proceeds of ILFC's debt financing are primarily used to purchase flight equipment, including progress payments during the construction phase. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover and refinancing of the prior debt. (See also the discussions under "Operational Review" and "Liquidity" herein.) During the first three months of 2000, AIG issued $24 million principal amount of Medium Term Notes and $12 million of previously issued notes matured. At March 31, 2000, AIG had $991 million in aggregate principal amount of debt securities registered for issuance from time to time. On May 11, 2000, AIG issued $210 million of 0.5% Cash Exchangeable Equity-Linked Senior Notes due May 15, 2007. AIG's capital funds increased $532 million during the first three months of 2000. Unrealized appreciation of investments, net of taxes decreased $8 million. During the first three months of 2000, the cumulative translation adjustment loss, net of taxes decreased $68 million. (See also the discussion under "Operational Review" and "Liquidity" herein.) Retained earnings increased $1.27 billion, resulting from net income less dividends. During the period from January 1, 2000 through March 31, 2000, AIG repurchased in the open market 10,351,600 shares of its common stock. AIG intends to continue to buy its common shares in the open market for general corporate purposes, including to satisfy its obligations under various employee benefit plans. Payments of dividends to AIG by its insurance subsidiaries are subject to certain restrictions imposed by statutory authorities. AIG has in the past reinvested most of its unrestricted earnings in its operations and believes such continued reinvestment in the future will be adequate to meet any foreseeable capital needs. However, AIG may choose from time to time to raise additional funds through the issuance of additional securities. At March 31, 2000, there were no significant statutory or regulatory issues which would impair AIG's financial condition, results of operations or liquidity. To AIG's knowledge, no AIG company is on any regulatory or similar "watch list". (See also the discussion under "Liquidity" herein.) The National Association of Insurance Commissioners (NAIC) has developed Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company's statutory surplus to the risk inherent in its overall operations. At March 31, 2000, the adjusted capital of each of AIG's domestic general companies and of each of AIG's domestic life companies exceeded each of their RBC standards by considerable margins. A substantial portion of AIG's general insurance business and a majority of its life insurance business are conducted in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must satisfy local regulatory requirements. LIQUIDITY AIG's liquidity is primarily derived from the operating cash flows of its general and life insurance operations. At March 31, 2000, AIG's consolidated invested assets included $7.13 billion of cash and short-term investments. Consolidated net cash provided from operating activities in the first three months of 2000 amounted to $2.50 billion. Sources of funds considered in meeting the objectives of AIG's financial services operations include guaranteed investment agreements, issuance of long and short-term debt, maturities and sales of securities available for sale, securities sold under repurchase agreements, trading liabilities, securities and spot commodities sold but not yet purchased, issuance of equity, and cash provided from such operations. AIG's strong capital position is integral to managing this liquidity, as it enables AIG to raise funds in diverse markets worldwide. (See also the discussions under "Capital Resources" herein.) Management believes that AIG's liquid assets, its net cash provided by operations, and access to 22
24 the capital markets will enable it to meet any foreseeable cash requirements. The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $2.9 billion in pre-tax cash flow during the first three months of 2000. Cash flow includes periodic premium collections, including policyholders' contract deposits, paid loss recoveries less reinsurance premiums, losses, benefits, acquisition and operating expenses. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance investment operations generated approximately $2.3 billion in investment income cash flow during the first three months of 2000. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains net of realized capital losses. In addition to the combined insurance pre-tax operating cash flow, AIG's insurance operations held $6.7 billion in cash and short-term investments at March 31, 2000. The aforementioned operating cash flow and the cash and short-term balances held provided AIG's insurance operations with a significant amount of liquidity. This liquidity is available, among other things, to purchase high quality and diversified fixed income securities and to a lesser extent marketable equity securities and to provide mortgage loans on real estate, policy loans and collateral loans. This cash flow coupled with proceeds of approximately $11 billion from the maturities, sales and redemptions of fixed income securities and from the sale of equity securities was used to purchase approximately $12.5 billion of fixed income securities and marketable equity securities during the first three months of 2000. The following table is a summary of AIG's invested assets by significant segment, including investment income due and accrued of $2.10 billion and $2.05 billion, and real estate of $1.62 billion for each period at March 31, 2000 and December 31, 1999, respectively: (dollars in millions) - -------------------------------------------------------------------------------- MARCH 31, 2000 December 31, 1999 ----------------------- ----------------------- INVESTED PERCENT INVESTED PERCENT ASSETS OF TOTAL ASSETS OF TOTAL - ------------------------------------------------------------------------------------------------------------------------- General insurance $ 40,265 20.5% $ 39,135 20.6% Life insurance 89,746 45.8 87,355 46.1 Financial services and asset management 65,441 33.4 62,548 33.0 Other 651 0.3 651 0.3 - ------------------------------------------------------------------------------------------------------------------------- Total $196,103 100% $189,689 100.0% - ------------------------------------------------------------------------------------------------------------------------- 23
25 INSURANCE INVESTED ASSETS The following tables summarize the composition of AIG's insurance invested assets by insurance segment, including investment income due and accrued and real estate, at March 31, 2000 and December 31, 1999: (dollars in millions) - ----------------------------------------------------------------------------------------------------------------------- PERCENT DISTRIBUTION GENERAL LIFE PERCENT --------------------- MARCH 31, 2000 INSURANCE INSURANCE TOTAL OF TOTAL DOMESTIC FOREIGN - ----------------------------------------------------------------------------------------------------------------------- Fixed maturities: Available for sale, at market value(a) $16,609 $63,525 $ 80,134 61.6% 52.7% 47.3% Held to maturity, at amortized cost 11,954 -- 11,954 9.2 100.0 -- Equity securities, at market value(b) 4,031 2,565 6,596 5.1 50.8 49.2 Mortgage loans on real estate, policy and collateral loans 62 10,661 10,723 8.2 56.4 43.6 Short-term investments, including time deposits, and cash 1,382 5,344 6,726 5.2 43.5 56.5 Real estate 383 1,134 1,517 1.2 17.3 82.7 Investment income due and accrued 561 1,465 2,026 1.6 49.9 50.1 Other invested assets 5,283 5,052 10,335 7.9 85.6 14.4 - ----------------------------------------------------------------------------------------------------------------------- Total $40,265 $89,746 $130,011 100.0% 58.9% 41.1% - ----------------------------------------------------------------------------------------------------------------------- (a)Includes $744 million of bonds trading securities, at market value. (b)Includes $758 million of non-redeemable preferred stocks, at market value. (dollars in millions) - -------------------------------------------------------------------------------- Percent Distribution General Life Percent --------------------- December 31, 1999 Insurance Insurance Total of Total Domestic Foreign - ------------------------------------------------------------------------------------------------------------------------ Fixed maturities: Available for sale, at market value(a) $16,903 $61,022 $ 77,925 61.6% 53.5% 46.5% Held to maturity, at amortized cost 12,078 -- 12,078 9.5 100.0 -- Equity securities, at market value(b) 4,000 2,503 6,503 5.1 50.2 49.8 Mortgage loans on real estate, policy and collateral loans 70 10,420 10,490 8.3 57.0 43.0 Short-term investments, including time deposits, and cash 977 5,710 6,687 5.3 45.1 54.9 Real estate 381 1,141 1,522 1.2 18.5 81.5 Investment income due and accrued 576 1,421 1,997 1.6 48.0 52.0 Other invested assets 4,150 5,138 9,288 7.4 85.1 14.9 - ------------------------------------------------------------------------------------------------------------------------ Total $39,135 $87,355 $126,490 100.0% 59.5% 40.5% - ------------------------------------------------------------------------------------------------------------------------ (a)Includes $1.04 billion of bonds trading securities, at market value. (b)Includes $697 million of non-redeemable preferred stocks, at market value. Generally, insurance regulations restrict the types of assets in which an insurance company may invest. With respect to fixed maturities, AIG's general strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations. With respect to general insurance, AIG's strategy is to invest in longer duration fixed maturities to maximize the yields at the date of purchase. With respect to life insurance, AIG's strategy is to produce cash flows required to meet maturing insurance liabilities. (See also the discussion under "Operational Review: Life Insurance Operations" herein.) The fixed maturities available for sale portfolio is subject to decline in fair value as interest rates rise. Such declines in fair value are presented as a component of comprehensive income in unrealized appreciation of investments, net of taxes. The fixed maturities held to maturity portfolio is exposed to adverse interest rate fluctuations. However, AIG has the ability and intent to hold such securities to maturity. Therefore, there would be no detrimental impact to AIG's results of operations or financial condition as a result of such fluctuations. At March 31, 2000, approximately 58.8 percent of the fixed maturities investments were domestic securities. Approximately 38 percent of such domestic securities were rated AAA. Approximately 14 percent were below investment grade or not rated. A significant portion of the foreign insurance fixed income portfolio is rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews 24
26 the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At March 31, 2000, approximately 15 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 12 percent were below investment grade or not rated at that date. A large portion of these fixed maturity securities are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance. At March 31, 2000, approximately 16 percent of the fixed maturities portfolio was collateralized mortgage obligations (CMOs), including minor amounts with respect to commercial mortgage backed securities. Substantially all of the CMOs were investment grade and approximately 17 percent of the CMOs were backed by various U.S. government agencies. CMOs are exposed to interest rate risk as the duration and ultimate realized yield would be affected by the accelerated prepayments of the underlying mortgages. Any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date. AIG invests in equities for reasons including diversifying its overall exposure to interest rate risk. Equity securities are subject to declines in fair value. Such declines in fair value are presented in unrealized appreciation of investments, net of taxes as a component of comprehensive income. Mortgage loans on real estate, policy and collateral loans comprised 8.2 percent of AIG's insurance invested assets at March 31, 2000. AIG's insurance operations' holdings of real estate mortgages amounted to $6.79 billion of which 74.8 percent was domestic. At March 31, 2000, only a nominal amount were in default. It is AIG's practice to maintain a maximum loan to value ratio of 75 percent at loan origination. At March 31, 2000, AIG's insurance holdings of collateral loans amounted to $1.06 billion, all of which were foreign. It is AIG's strategy to enter into mortgage and collateral loans as an adjunct primarily to life insurance fixed maturity investments. AIG's policy loans increased from $2.82 billion at December 31, 1999 to $2.88 billion at March 31, 2000. Short-term investments represent amounts invested in various internal and external money market funds, time deposits and cash held. AIG's real estate investment properties are primarily occupied by AIG's various operations. The current market value of these properties considerably exceeds their carrying value. Other invested assets were primarily comprised of both foreign and domestic private placements, limited partnerships and outside managed funds. When permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from adverse movements in foreign currency exchange rates, interest rates and equity prices, AIG and its insurance subsidiaries may enter into derivative transactions as end users. To date, such activities have not been significant. (See also the discussion under "Derivatives" herein.) In certain jurisdictions, significant regulatory and/or foreign governmental barriers exist which may not permit the immediate free flow of funds between insurance subsidiaries or from the insurance subsidiaries to AIG parent. These barriers generally cause only minor delays in the outward remittance of the funds. AIG's insurance operations are exposed to market risk. Market risk is the risk of loss of fair value resulting from adverse fluctuations in interest and foreign currency exchange rates and equity prices. Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (VaR). VaR is a summary statistical measure that uses historical interest and foreign currency exchange rates and equity prices and estimates the volatility and correlation of each of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability. AIG believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management. 25
27 AIG has performed a VaR analysis to estimate the maximum potential loss of fair value for each of AIG's insurance segments and for each market risk within each insurance segment. In this analysis, financial instrument assets include the domestic and foreign invested assets excluding real estate and investment income due and accrued. Financial instrument liabilities include reserve for losses and loss expenses, reserve for unearned premiums, future policy benefits for life and accident and health insurance contracts and policyholders' funds. Due to the nature of each insurance segment, AIG manages the general and life insurance operations separately. As a result, AIG manages separately the invested assets of each. Accordingly, the VaR analysis was separately performed for the general and the life insurance operations. AIG calculated the VaR with respect to the net fair value of each of AIG's insurance segments as of December 31, 1999 and December 31, 1998. Through March 31, 2000, the economic facts and circumstances have not significantly changed. Therefore, the VaR at December 31, 1999 was representative of a VaR at March 31, 2000. These calculations used the variance-covariance (delta-normal) methodology. These calculations also used daily historical interest and foreign currency exchange rates and equity prices in the two years ending December 31, 1999 and December 31, 1998, as applicable. The VaR model estimated the volatility of each of these rates, equity prices and the correlations among them. For interest rates, each country's yield curve was constructed using eleven separate points on this curve to model possible curve movements. Inter-country correlations were also used. The redemption experience of municipal and corporate fixed maturities and mortgage securities was taken into account as well as the use of financial modeling. Thus, the VaR measured the sensitivity of the asset and the liability portfolios of each of the aforementioned market exposures. Each sensitivity was estimated separately to capture the market exposures within each insurance segment. These sensitivities were then applied to a database, which contained both historical ranges of movements in all market factors and the correlations among them. The results were aggregated to provide a single amount that depicts the maximum potential loss in fair value at a confidence level of 95 percent for a time period of one month. At December 31, 1999 and December 31, 1998 the VaR of AIG's insurance segments was approximately $863 million and $760 million for general insurance, respectively, and $1.19 billion and $981 million for life insurance, respectively. The following table presents the VaR of each component of market risk for each of AIG's insurance segments as of December 31, 1999 and December 31, 1998. VaR with respect to combined operations cannot be derived by aggregating the individual risk or segment amounts presented herein. (in millions) - -------------------------------------------------------------------------------- GENERAL INSURANCE LIFE INSURANCE ----------------- ----------------- MARKET RISK 1999 1998 1999 1998 - ---------------------------------------------------------------------------------------------------------------- Interest rate $338 $232 $950 $809 Currency 29 26 566 457 Equity 798 716 396 254 - ---------------------------------------------------------------------------------------------------------------- 26
28 FINANCIAL SERVICES AND ASSET MANAGEMENT INVESTED ASSETS The following table is a summary of the composition of AIG's financial services and asset management invested assets at March 31, 2000 and December 31, 1999. (See also the discussions under "Operational Review: Financial Services Operations", "Operational Review: Asset Management Operations", "Capital Resources" and "Derivatives" herein.) (dollars in millions) - -------------------------------------------------------------------------------- 2000 1999 ---------------------- ---------------------- INVESTED PERCENT INVESTED PERCENT ASSETS OF TOTAL ASSETS OF TOTAL - ----------------------------------------------------------------------------------------------------------------- Flight equipment primarily under operating leases, net of accumulated depreciation $18,117 27.7% $17,334 27.7% Unrealized gain on interest rate and currency swaps, options and forward transactions 8,339 12.7 7,931 12.7 Securities available for sale, at market value 13,422 20.5 12,954 20.7 Trading securities, at market value 4,466 6.8 4,391 7.0 Securities purchased under agreements to resell, at contract value 10,260 15.7 10,897 17.4 Trading assets 7,528 11.5 5,793 9.3 Spot commodities, at market value 764 1.2 683 1.1 Other, including short-term investments 2,545 3.9 2,565 4.1 - ----------------------------------------------------------------------------------------------------------------- Total $65,441 100.0% $62,548 100.0% - ----------------------------------------------------------------------------------------------------------------- As previously discussed, the cash used for the purchase of flight equipment is derived primarily from the proceeds of ILFC's debt financings. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover and refinancing of the prior debt. During the first three months of 2000, ILFC acquired flight equipment costing $954 million. ILFC is exposed to market risk and the risk of loss of fair value resulting from adverse fluctuations in interest rates. As of December 31, 1999 and December 31, 1998, AIG statistically measured the aforementioned loss of fair value through the application of a VaR model. In this analysis, the net fair value of ILFC was determined using the financial instrument assets which included the tax adjusted future flight equipment lease revenue and the financial instrument liabilities which included the future servicing of the current debt. The estimated impact of the current derivative positions was also taken into account. AIG calculated the VaR with respect to the net fair value of ILFC using the variance-covariance (delta-normal) methodology. This calculation also used daily historical interest rates for the two years ending December 31, 1999 and December 31, 1998. The VaR model estimated the volatility of each of these interest rates and the correlation among them. The yield curve was constructed using eleven key points on the curve to model possible curve movements. Thus, the VaR measured the sensitivity of the assets and liabilities to the calculated interest rate exposures. These sensitivities were then applied to a database, which contained the historical ranges of movements in interest rates and the correlation among them. The results were aggregated to provide a single amount that depicts the maximum potential loss in fair value of a confidence level of 95 percent for a time period of one month. As of December 31, 1999 and December 31, 1998, the VaR with respect to the aforementioned net fair value of ILFC was approximately $50 million and $9 million, respectively. Through March 31, 2000, the economic facts and circumstances have not significantly changed. Therefore, the VaR at December 31, 1999 was representative of a VaR at March 31, 2000. AIGFP's derivative transactions are carried at market value or at estimated fair value when market prices are not readily available. AIGFP reduces its economic risk exposure through similarly valued offsetting transactions including swaps, trading securities, options, forwards and futures. The estimated fair values of these transactions represent assessments of the present value of expected future cash flows. These transactions are exposed to liquidity risk if AIGFP were to sell or close out the transactions prior to maturity. AIG believes that the impact of any such limited liquidity would not be significant to AIG's financial condition or its overall liquidity. (See also the discussion under "Operational Review: Financial Services Operations" and "Derivatives" herein.) 27
29 AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities, including securities available for sale, at market, and derivative transactions. The funds may also be temporarily invested in securities purchased under agreements to resell. The proceeds from the disposal of the aforementioned securities available for sale and securities purchased under agreements to resell have been used to fund the maturing GIAs or other AIGFP financings. (See also the discussion under "Capital Resources" herein.) Securities available for sale is mainly a portfolio of debt securities, where the individual securities have varying degrees of credit risk. At March 31, 2000, the average credit rating of this portfolio was AA or the equivalent thereto as determined through rating agencies or internal review. AIGFP has also entered into credit derivative transactions to hedge its credit risk associated with $229 million of these securities. There were no securities deemed below investment grade at March 31, 2000. There have been no significant downgrades through May 1, 2000. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP takes possession of or obtains a security interest in securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring counterparty credit exposure and, when AIGFP deems necessary, it requires additional collateral to be deposited. Trading securities, at market value are marked to market daily and are held to meet the short-term risk management objectives of AIGFP. AIGTG conducts, as principal, market making and trading activities in foreign exchange, interest rates and precious and base metals. AIGTG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts. AIGTG uses derivatives to manage the economic exposure of its various trading positions and transactions from adverse movements of interest rates, foreign currency exchange rates and commodity prices. AIGTG supports its trading activities largely through trading liabilities, unrealized losses on swaps, short-term borrowings, securities sold under agreements to repurchase and securities and commodities sold, but not yet purchased. (See also the discussions under "Capital Resources" and "Derivatives" herein.) The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG included in the financial services assets and liabilities at March 31, 2000 were as follows: (in millions) - -------------------------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES - -------------------------------------------------------------------------------------- Securities available for sale, at market value $ 802 $ 768 Unrealized gain/loss on interest rate and currency swaps, options and forward transactions(a)(b) 8,339 8,636 Trading assets 5,953 4,127 Spot commodities, at market value 33 -- Trading liabilities -- 2,415 Securities and spot commodities sold but not yet purchased, at market value 401 -- - -------------------------------------------------------------------------------------- (a)These amounts are also presented as the respective balance sheet amounts. (b)At March 31, 2000, AIGTG's replacement values with respect to interest rate and currency swaps were $373 million. AIGFP's interest rate and currency risks on securities available for sale, at market, are managed by taking offsetting positions on a security by security basis, thereby offsetting a significant portion of the unrealized appreciation or depreciation. At March 31, 2000, the unrealized gains and losses remaining after the benefit of the offsets were $40 million and $6 million, respectively. Trading securities, at market value, and securities and spot commodities sold but not yet purchased, at market value are marked to market daily with the unrealized gain or loss being recognized in income at that time. These securities are held to meet the short-term risk management objectives of AIGFP and AIGTG. The senior management of AIG defines the policies and establishes general operating parameters for AIGFP and AIGTG. AIG's senior management has established various oversight committees to review the various financial market, operational and credit issues of AIGFP and AIGTG. The senior managements of AIGFP and AIGTG report the results of their respective operations to and review future strategies with AIG's senior management. 28
30 AIG actively manages the exposures to limit potential losses, while maximizing the rewards afforded by these business opportunities. In doing so, AIG must manage a variety of exposures including credit, market, liquidity, operational and legal risks. Market risk arises principally from the uncertainty that future earnings are exposed to potential changes in volatility, interest rates, foreign currency exchange rates, and equity and commodity prices. AIG generally controls its exposure to market risk by taking offsetting positions. AIG's philosophy with respect to its financial services operations is to minimize or set limits for open or uncovered positions that are to be carried. Credit risk exposure is separately managed. (See the discussion on the management of credit risk below.) AIG's Market Risk Management Department provides detailed independent review of AIG's market exposures, particularly those market exposures of AIGFP and AIGTG. This department determines whether AIG's market risks, as well as those market risks of individual subsidiaries, are within the parameters established by AIG's senior management. Well established market risk management techniques such as sensitivity analysis are used. Additionally, this department verifies that specific market risks of each of certain subsidiaries are managed and hedged by that subsidiary. AIGFP is exposed to market risk due to changes in the level and volatility of interest rates and the shape and slope of the yield curve. AIGFP hedges its exposure to interest rate risk by entering into transactions such as interest rate swaps and options and purchasing U.S. and foreign government obligations. AIGFP is exposed to market risk due to changes in and volatility of foreign currency exchange rates. AIGFP hedges its foreign currency exchange risk primarily through the use of currency swaps, options, forwards and futures. AIGFP is exposed to market risk due to changes in the level and volatility of equity prices which affect the value of securities or instruments that derive their value from a particular stock, a basket of stocks or a stock index. AIGFP reduces the risk of loss inherent in its inventory in equity securities by entering into hedging transactions, including equity swaps and options and purchasing U.S. and foreign government obligations. AIGFP does not seek to manage the market risk of each of its transactions through an individual offsetting transaction. Rather, AIGFP takes a portfolio approach to the management of its market risk exposure. AIGFP values its portfolio at market value or estimated fair value when market values are not readily available. These valuations represent an assessment of the present values of expected future cash flows of AIGFP's transactions and may include reserves for such risks as are deemed appropriate by AIGFP's and AIG's management. AIGFP evaluates the portfolio's discounted cash flows with reference to current market conditions, maturities within the portfolio and other relevant factors. Based upon this evaluation, AIGFP determines what, if any, offsetting transactions are necessary to reduce the market risk exposure of the portfolio. The aforementioned estimated fair values are based upon the use of valuation models. These models utilize, among other things, current interest, foreign exchange and volatility rates. These valuation models are integrated into the evaluation of the portfolio, as described above, in order to provide timely information for the market risk management of the portfolio. Additionally, depending upon the changes in interest rates and other market movements during the day, the system will produce reports for management's consideration for intra-day offsetting positions. Overnight, the system generates reports which recommend the types of offsets management should consider for the following day. Additionally, AIGFP operates in major business centers overseas and is essentially open for business 24 hours a day. Thus, the market exposure and offset strategies are monitored, reviewed and coordinated around the clock. Therefore, offsetting adjustments can be made as and when necessary from any AIGFP office in the world. As part of its monitoring and controlling of its exposure to market risk, AIGFP applies various testing techniques which reflect potential market movements. These techniques vary by currency and are regularly changed to reflect factors affecting the derivatives portfolio. In addition to the daily monitoring, AIGFP's senior management and local risk managers conduct a weekly review of the derivatives portfolio and existing hedges. This review includes an examination of the portfolio's risk measures, such as aggregate option sensitivity to movements in market variables. AIGFP's management may 29
31 change these measures to reflect their judgment and evaluation of the dynamics of the markets. This management group will also determine whether additional or alternative action is required in order to manage the portfolio. All of AIGTG's market risk sensitive instruments are entered into for trading purposes. The fair values of AIGTG's financial instruments are exposed to market risk as a result of adverse market changes in interest rates, foreign currency exchange rates, commodity prices and adverse changes in the liquidity of the markets in which AIGTG trades. AIGTG's approach to managing market risk is to establish an appropriate offsetting position to a particular transaction or group of transactions depending upon the extent of market risk AIGTG expects to reduce. AIGTG's senior management has established positions and stop-loss limits for each line of business. AIGTG's traders are required to maintain positions within these limits. These positions are monitored during the day either manually and/or through on-line computer systems. In addition, these positions are reviewed by AIGTG's management. Reports which present each trading books position and the prior day's profit and loss are reviewed by traders, head traders and AIGTG's senior management. Based upon these and other reports, AIGTG's senior management may determine to adjust AIGTG's risk profile. AIGTG attempts to secure reliable current market prices, such as published prices or third party quotes, to value its derivatives. Where such prices are not available, AIGTG uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. The methodology may reflect interest and exchange rates, commodity prices, volatility rates and other relevant factors. A significant portion of AIGTG's business is transacted in liquid markets. Certain of AIGTG's derivative product exposures are evaluated using simulation techniques which consider such factors as changes in currency and commodity prices, interest rates, volatility levels and the effect of time. Though not indicative of the future, past volatile market scenarios have represented profit opportunities for AIGTG. AIGFP and AIGTG are both exposed to the risk of loss of fair value from adverse fluctuations in interest rate and foreign currency exchange rates and equity and commodity prices. AIG statistically measured the losses of fair value through the application of a VaR model. AIG separately calculated the VaR with respect to AIGFP and AIGTG, as AIG manages these operations separately. AIGFP's and AIGTG's asset and liability portfolios for which the VaR analyses were performed included over the counter and exchange traded investments, derivative instruments and commodities. Since the market risk with respect to securities available for sale, at market is substantially hedged, segregation of market sensitive instruments into trading and other than trading was not deemed necessary. AIG calculated the VaR with respect to AIGFP and AIGTG as of December 31, 1999 and December 31, 1998. Through March 31, 2000, the trading activities and exposures have not significantly changed. Therefore, the VaR at December 31, 1999 was representative of a VaR at March 31, 2000. These calculations used the variance-covariance (delta-normal) methodology. These calculations also used, where appropriate for each entity, daily historical interest and foreign currency exchange rates and equity/commodity prices in the two years ending December 31, 1999 and December 31, 1998, as applicable. The VaR model estimated the volatility of each of these rates, prices and the correlations among them. For interest rates, the yield curves of the United States and certain foreign countries were constructed using eleven separate points on each country's yield curve to model possible curve movements. Inter-country correlations were also used. The redemption experience of corporate fixed maturities was taken into account. Thus, the VaR measured the sensitivity of the asset and the liability portfolios of each of the market exposures. Each sensitivity was estimated separately to capture the market exposures within each entity. These sensitivities were then applied to a database, which contained both historical ranges of movements in all market factors and the correlations among them. The results depict the maximum potential loss in fair value at a confidence level of 95 percent. Given the distinct business strategies at AIGFP and AIGTG, the VaR calculations used different time periods to measure market exposures. Many of AIGFP's customized, longer-term contracts may require several days to transact and 30
32 hedge. AIG therefore used a one month holding period to measure market exposures for AIGFP. The large majority of AIGTG's contracts can be arranged and hedged within one day. AIG therefore used a one day holding period to measure market exposures at AIGTG. The following table presents the VaR on a combined basis and of each component of AIGFP's and AIGTG's market risk as of December 31, 1999 and December 31, 1998. VaR with respect to combined operations cannot be derived by aggregating the individual risk presented herein. (in millions) - -------------------------------------------------------------------------------- AIGFP(A) AIGTG(B) ----------- ----------- MARKET RISKS 1999 1998 1999 1998 - --------------------------------------------------------------------------------------- Combined $24 $42 $ 5 $ 3 Interest rate 23 42 3 3 Currency -- -- 4 2 Equity/Commodity 1 2 -- -- - --------------------------------------------------------------------------------------- (a)A one month holding period was used to measure the market exposures of AIGFP. (b)A one day holding period was used to measure the market exposures of AIGTG. DERIVATIVES Derivatives are financial arrangements among two or more parties whose returns are linked to or "derived" from some underlying equity, debt, commodity or other asset, liability, or index. Derivatives payments may be based on interest rates and exchange rates and/or prices of certain securities, certain commodities, or financial or commodity indices. The more significant types of derivative arrangements in which AIG transacts are swaps, forwards, futures, options and related instruments. The most commonly used swaps are interest rate swaps, currency swaps, equity swaps and swaptions. Such derivatives are traded over the counter. An interest rate swap is a contract between two parties to exchange interest rate payments (typically a fixed interest rate versus a variable interest rate) calculated on a notional principal amount for a specified period of time. The notional amount is not exchanged. Currency and equity swaps are similar to interest rate swaps but may involve the exchange of principal amounts at the commencement and termination of the swap. Swaptions are options where the holder has the right but not the obligation to enter into a swap transaction or cancel an existing swap transaction. A futures or forward contract is a legal contract between two parties to purchase or sell at a specified future date a specified quantity of a commodity, security, currency, financial index or other instrument, at a specified price. A futures contract is traded on an exchange, while a forward contract is executed over the counter. Over the counter derivatives are not transacted in an exchange traded environment. The futures exchanges maintain considerable financial requirements and surveillance to ensure the integrity of exchange traded futures and options. An option contract generally provides the option purchaser with the right but not the obligation to buy or sell during a period of time or at a specified date the underlying instrument at a set price. The option writer is obligated to sell or buy the underlying item if the option purchaser chooses to exercise his right. The option writer receives a nonrefundable fee or premium paid by the option purchaser. Options may be traded over the counter or on an exchange. Derivatives are generally either negotiated over the counter contracts or standardized contracts executed on an exchange. Standardized exchange traded derivatives include futures and options which can be readily bought or sold over recognized security or commodity exchanges and settled daily through such clearing houses. Negotiated over the counter derivatives include forwards, swaps and options. Over the counter derivatives are generally not traded like exchange traded securities and the terms of over the counter derivatives are non-standard and unique to each contract. However, in the normal course of business, with the agreement of the original counterparty, these contracts may be terminated early or assigned to another counterparty. All significant derivatives activities are conducted through AIGFP and AIGTG permitting AIG to participate in the derivatives dealer market acting primarily as principal. In these derivative operations, AIG structures agreements which gen- 31
33 erally allow its counterparties to enter into transactions with respect to changes in interest and exchange rates, securities' prices and certain commodities and financial or commodity indices. Generally, derivatives are used by AIG's customers such as corporations, financial institutions, multinational organizations, sovereign entities, government agencies and municipalities. For example, a futures, forward or option contract can be used to protect the customers' assets or liabilities against price fluctuations. A counterparty may default on any obligation to AIG, including a derivative contract. Credit risk is a consequence of extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative contract when that contract has an estimated positive fair value. To help manage this risk, the credit departments of AIGFP and AIGTG operate within the guidelines of the AIG Credit Risk Committee, which sets credit policy and limits for counterparties and provides limits for derivative transactions with counterparties having different credit ratings. In addition to credit ratings, this committee takes into account other factors, including the industry and country of the counterparty. Transactions which fall outside these pre-established guidelines require the approval of the AIG Credit Risk Committee. It is also AIG's policy to establish reserves for potential credit impairment when necessary. AIGFP and AIGTG determine the credit quality of each of their counterparties taking into account credit ratings assigned by recognized statistical rating organizations. If it is determined that a counterparty requires credit enhancement, then one or more enhancement techniques will be used. Examples of such enhancement techniques include letters of credit, guarantees, collateral credit triggers and credit derivatives and margin agreements. A significant majority of AIGFP's transactions are contracted and documented under ISDA Master Agreements that provide for legally enforceable set-offs in the event of a default. Also, under such agreements, in connection with a counterparty desiring to terminate a contract prior to maturity, AIGFP may be permitted to set-off its receivables from that counterparty against AIGFP's payables to that same counterparty arising out of all included transactions. Excluding regulated exchange transactions, AIGTG, whenever possible, enters into netting agreements with its counterparties which are similar in effect to those discussed above. The following tables provide the notional and contractual amounts of AIGFP's and AIGTG's derivative transactions at March 31, 2000 and December 31, 1999. The notional amounts used to express the extent of AIGFP's and AIGTG's involvement in swap transactions represent a standard of measurement of the volume of AIGFP's and AIGTG's swaps business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps. The timing and the amount of cash flows relating to AIGFP's and AIGTG's foreign exchange forwards and exchange traded futures and options contracts are determined by each of the respective contractual agreements. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss after the application of the aforementioned strategies, netting under ISDA Master Agreements and applying collateral held. Prior to the application of these credit enhancements, the gross credit risk with respect to these derivative instruments was $17.90 billion at March 31, 2000. Subsequent to the application of such credit enhancements, the net exposure to credit risk or the net replacement value of all interest rate, currency and equity swaps, swaptions and forward commitments at March 31, 2000, approximated $7.85 billion. The net replacement value for futures and forward contracts at March 31, 2000, approximated $41 million. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss. 32
34 The following table presents AIGFP's derivatives portfolio by maturity and type of derivative at March 31, 2000 and December 31, 1999: (in millions) - -------------------------------------------------------------------------------- REMAINING LIFE ------------------------------------------------------------------------- ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL YEAR FIVE YEARS TEN YEARS YEARS 2000 1999 - -------------------------------------------------------------------------------------------------------------------- Interest rate, currency and equity/commodity swaps and swaptions: Notional amount: Interest rate swaps $ 90,760 $130,912 $ 77,337 $ 7,555 $306,564 $281,682 Currency swaps 29,148 28,956 25,700 4,207 88,011 83,673 Swaptions and equity swaps 11,214 23,915 9,889 2,802 47,820 48,002 - -------------------------------------------------------------------------------------------------------------------- Total $131,122 $183,783 $112,926 $14,564 $442,395 $413,357 - -------------------------------------------------------------------------------------------------------------------- Futures and forward contracts: Exchange traded futures contracts contractual amount $ 9,217 -- -- -- $ 9,217 $ 6,587 - -------------------------------------------------------------------------------------------------------------------- Over the counter forward contracts contractual amount $ 21,943 $ 316 $ 48 -- $ 22,307 $ 21,873 - -------------------------------------------------------------------------------------------------------------------- AIGFP determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At March 31, 2000 and December 31, 1999, the counterparty credit quality by derivative product with respect to the net replacement value of AIGFP's derivatives portfolio was as follows: (in millions) - -------------------------------------------------------------------------------- NET REPLACEMENT VALUE ------------------------------ SWAPS AND FUTURES AND TOTAL TOTAL SWAPTIONS FORWARD CONTRACTS 2000 1999 - ---------------------------------------------------------------------------------------------------------------- Counterparty credit quality: AAA $2,556 $ -- $2,556 $2,067 AA 2,684 41 2,725 2,839 A 1,609 -- 1,609 1,576 BBB 947 -- 947 997 Below investment grade 49 -- 49 55 - ---------------------------------------------------------------------------------------------------------------- Total $7,845 $ 41 $7,886 $7,534 - ---------------------------------------------------------------------------------------------------------------- At March 31, 2000 and December 31, 1999, the counterparty breakdown by industry with respect to the net replacement value of AIGFP's derivatives portfolio was as follows: (in millions) - -------------------------------------------------------------------------------- NET REPLACEMENT VALUE ------------------------------ SWAPS AND FUTURES AND TOTAL TOTAL SWAPTIONS FORWARD CONTRACTS 2000 1999 - ---------------------------------------------------------------------------------------------------------------- Non-U.S. banks $2,500 $ 41 $2,541 $2,515 Insured municipalities 357 -- 357 352 U.S. industrials 908 -- 908 780 Governmental 248 -- 248 180 Non-U.S. financial service companies 207 -- 207 158 Non-U.S. industrials 1,112 -- 1,112 1,117 Special purpose 955 -- 955 716 U.S. banks 217 -- 217 510 U.S. financial service companies 1,208 -- 1,208 1,112 Supranationals 133 -- 133 94 - ---------------------------------------------------------------------------------------------------------------- Total $7,845 $ 41 $7,886 $7,534 - ---------------------------------------------------------------------------------------------------------------- 33
35 The following tables provide the contractual and notional amounts of AIGTG's derivatives portfolio at March 31, 2000 and December 31, 1999. In addition, the estimated positive fair values associated with the derivatives portfolio are also provided and include a maturity profile for the March 31, 2000 balances based upon the expected timing of the future cash flows. The gross replacement values presented represent the sum of the estimated positive fair values of all of AIGTG's derivatives contracts at March 31, 2000 and December 31, 1999. These values do not represent the credit risk to AIGTG. Net replacement values presented represent the net sum of estimated positive fair values after the application of legally enforceable master netting agreements and collateral held. The net replacement values most closely represent the net credit risk to AIGTG or the maximum amount exposed to potential loss. The following tables present AIGTG's derivatives portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at March 31, 2000 and December 31, 1999: (in millions) - -------------------------------------------------------------------------------- REMAINING LIFE ------------------------------------------------ ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL YEAR FIVE YEARS TEN YEARS YEARS 2000 1999 - -------------------------------------------------------------------------------------------------------------------- Contractual amount of futures, forwards and options: Exchange traded futures and options $ 11,818 $ 5,753 $ 32 $ -- $ 17,603 $ 18,908 - -------------------------------------------------------------------------------------------------------------------- Forwards $217,120 $17,648 $ 2,687 $ -- $237,455 $220,428 - -------------------------------------------------------------------------------------------------------------------- Over the counter purchased options $ 75,056 $12,967 $14,519 $ 975 $103,517 $ 83,871 - -------------------------------------------------------------------------------------------------------------------- Over the counter sold options(a) $ 74,520 $13,105 $14,688 $1,029 $103,342 $ 86,726 - -------------------------------------------------------------------------------------------------------------------- Notional amount: Interest rate swaps and forward rate agreements $ 31,885 $36,291 $ 4,668 $ 60 $ 72,904 $ 80,436 Currency swaps 1,580 6,323 1,444 -- 9,347 8,359 Swaptions 1,025 6,715 2,092 145 9,977 9,996 - -------------------------------------------------------------------------------------------------------------------- Total $ 34,490 $49,329 $ 8,204 $ 205 $ 92,228 $ 98,791 - -------------------------------------------------------------------------------------------------------------------- Credit exposure: Futures, forwards, swaptions and purchased options contracts and interest rate and currency swaps: Gross replacement value $ 6,203 $ 1,387 $ 200 $ 19 $ 7,809 $ 7,889 Master netting arrangements (3,959) (394) (108) (2) (4,463) (4,580) Collateral (159) (41) (5) -- (205) (209) - -------------------------------------------------------------------------------------------------------------------- Net replacement value(b) $ 2,085 $ 952 $ 87 $ 17 $ 3,141 $ 3,100 - -------------------------------------------------------------------------------------------------------------------- (a)Sold options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposure. (b)The net replacement values with respect to exchange traded futures and options, forward contracts and purchased over the counter options are presented as a component of trading assets in the accompanying balance sheet. The net replacement values with respect to interest rate and currency swaps are presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions in the accompanying balance sheet. 34
36 AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At March 31, 2000 and December 31, 1999, the counterparty credit quality and counterparty breakdown by industry with respect to the net replacement value of AIGTG's derivatives portfolio was as follows: (in millions) - -------------------------------------------------------------------------------- NET REPLACEMENT VALUE ----------------------- 2000 1999 - --------------------------------------------------------------------------------------- Counterparty credit quality: AAA $ 281 $ 276 AA 1,201 1,241 A 1,046 1,010 BBB 250 256 Below investment grade 40 49 Not externally rated, including exchange traded futures and options* 323 268 - --------------------------------------------------------------------------------------- Total $3,141 $3,100 - --------------------------------------------------------------------------------------- Counterparty breakdown by industry: Non-U.S. banks $1,395 926 U.S. industrials 71 70 Governmental 148 178 Non-U.S. financial service companies 325 698 Non-U.S. industrials 193 176 U.S. banks 300 401 U.S. financial service companies 386 383 Exchanges* 323 268 - --------------------------------------------------------------------------------------- Total $3,141 $3,100 - --------------------------------------------------------------------------------------- * Exchange traded futures and options are not deemed to have significant credit exposure as the exchanges guarantee that every contract will be properly settled on a daily basis. Generally, AIG manages and operates its businesses in the currencies of the local operating environment. Thus, exchange gains or losses occur when AIG's foreign currency net investment is affected by changes in the foreign exchange rates relative to the U.S. dollar from one reporting period to the next. AIG, through its Foreign Exchange Operating Committee, evaluates each of its worldwide consolidated foreign currency net asset or liability positions and manages AIG's translation exposure to adverse movement in currency exchange rates. AIG may use forward exchange contracts and purchase options where the cost of such is reasonable and markets are liquid to reduce these exchange translation exposures. The exchange gain or loss with respect to these hedging instruments is recorded on an accrual basis as a component of comprehensive income in capital funds. As an end user, AIG and its subsidiaries, including its insurance subsidiaries, use derivatives to aid in managing AIG's foreign exchange translation exposure. Derivatives may also be used to minimize certain exposures with respect to AIG's debt financing and its insurance operations; to date, such activities have not been significant. AIG has formed a Derivatives Review Committee. This committee, with certain exceptions, provides an independent review of any proposed derivative transaction. The committee examines, among other things, the nature and purpose of the derivative transaction, its potential credit exposure, if any, and the estimated benefits. This committee does not review those derivative transactions entered into by AIGFP and AIGTG for their own accounts. Legal risk arises from the uncertainty of the enforceability, through legal or judicial processes, of the obligations of AIG's clients and counterparties, including contractual provisions intended to reduce credit exposure by providing for the netting of mutual obligations. (See also the discussion on master netting agreements above.) AIG seeks to eliminate or minimize such uncertainty through continuous consultation with internal and external legal advisors, both domestically and abroad, in order to understand the nature of legal risk, to improve documentation and to strengthen transaction structure. ACCOUNTING STANDARDS In June 1998, FASB issued Statement of Financial Accounting Standards No. 133 "Accounting 35
37 for Derivative Instruments and Hedging Activities" (FASB 133). This statement requires AIG to recognize all derivatives in the consolidated balance sheet measuring these derivatives at fair value. The recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative. Currently, AIGTG and AIGFP present, in all material respects, the changes in fair value of their derivative transactions as a component of AIG's operating income. AIG is evaluating the impact of FASB 133 with respect to derivative transactions entered into by other AIG operations. AIG believes that the impact of FASB 133 on its results of operations, financial condition or liquidity will not be significant. FASB 133 is effective for the year commencing January 1, 2001. In December 1997, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AcSEC) issued Statement of Position (SOP) 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments." This statement provides guidance for the recording of a liability for insurance-related assessments. The statement requires that a liability be recognized in certain defined circumstances. This statement was effective for the year commencing January 1, 1999 and has been adopted herein. SOP 97-3 did not have a material impact on AIG's results of operations, financial condition or liquidity. In October 1998, AcSEC issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." This statement identifies several methods of deposit accounting and provides guidance on the application of each method. This statement classifies insurance and reinsurance contracts for which the deposit method is appropriate as contracts that (i) transfer only significant timing risk, (ii) transfer only significant underwriting risk, (iii) transfer neither significant timing nor underwriting risk, and (iv) have an indeterminate risk. AIG believes that the impact of this statement on its results of operations, financial condition or liquidity will not be significant. This statement is effective for the year commencing January 1, 2000. Restatement of previously issued financial statements is not permitted. 36
38 PART II -- OTHER INFORMATION ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits See accompanying Exhibit Index. (b) There have been no reports on Form 8-K filed during the quarter ended March 31, 2000. 37
39 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. AMERICAN INTERNATIONAL GROUP, INC. -------------------------------------- (Registrant) /s/ HOWARD I. SMITH -------------------------------------- Howard I. Smith Executive Vice President, Chief Financial Officer and Comptroller Dated: May 12, 2000 38
40 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION LOCATION - ------- ----------- -------- 2 Plan of acquisition, reorganization, arrangement, liquidation or succession................................... None 4 Instruments defining the rights of security holders, including indentures........................................ Not required to be filed. 10 Material contracts.......................................... None 11 Statement re computation of per share earnings.............. Filed herewith. 12 Statement re computation of ratios.......................... Filed herewith. 15 Letter re unaudited interim financial information........... None 18 Letter re change in accounting principles................... None 19 Report furnished to security holders........................ None 22 Published report regarding matters submitted to vote of security holders............................................ None 23 Consents of experts and counsel............................. None 24 Power of attorney........................................... None 27 Financial Data Schedule..................................... Provided herewith. 99 Additional exhibits......................................... None 39
1 EXHIBIT 11 AMERICAN INTERNATIONAL GROUP, INC. COMPUTATION OF EARNINGS PER SHARE (IN MILLIONS, EXCEPT PER SHARE AMOUNTS) THREE MONTHS ENDED MARCH 31, ----------------- 2000(a) 1999 ------- ------ Share information reflects an adjustment on a pro forma basis for a common stock split in the form of a 25 percent common stock dividend paid July 30, 1999. Numerator: Net income (applicable to common stock)..................... $1,346 $1,199 ------ ------ Denominator: Basic: Average outstanding shares used in the computation of per share earnings: Common stock.............................................. 1,660 1,667 Common stock in treasury.................................. (114) (119) ------ ------ Average outstanding shares -- basic......................... 1,546 1,548 ------ ------ Diluted: Average outstanding shares used in the computation of per share earnings: Common stock.............................................. 1,660 1,667 Common stock in treasury.................................. (114) (119) Stock options and stock purchase plan (treasury stock method)................................................... 18 20 ------ ------ Average outstanding shares -- diluted....................... 1,564 1,568 ------ ------ Net income per share: Basic..................................................... $ 0.87 $ 0.77 ------ ------ Diluted................................................... $ 0.86 $ 0.77 ------ ------ - --------------- (a) The number of common shares outstanding as of March 31, 2000 was 1,541. The number of common shares that would have been outstanding as of March 31, 2000 assuming the exercise or issuance of all potentially dilutive common shares was 1,559.
1 EXHIBIT 12 AMERICAN INTERNATIONAL GROUP, INC. COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (IN MILLIONS, EXCEPT RATIOS) THREE MONTHS ENDED MARCH 31, ---------------- 2000 1999 ------ ------ Income before income taxes and minority interest............ $1,991 $1,801 Less -- Equity income (loss) of less than 50% owned persons................................................... (3) 9 Add -- Dividends from less than 50% owned persons........... -- 3 ------ ------ 1,994 1,795 Add -- Fixed charges............................................. 671 528 Less -- Capitalized interest...................................... 14 15 ------ ------ Income before income taxes, minority interest and fixed charges................................................... $2,651 $2,308 ====== ====== Fixed charges: Interest costs............................................ $ 640 $ 502 Rent expense*............................................. 31 26 ------ ------ Total fixed charges............................... $ 671 $ 528 ====== ====== Ratio of earnings to fixed charges.......................... 3.95 4.37 - --------------- * The proportion deemed representative of the interest factor. The ratio shown is significantly affected as a result of the inclusion of the fixed charges and operating results of AIG Financial Products Corp. and its subsidiaries (AIGFP). AIGFP structures borrowings through guaranteed investment agreements and engages in other complex financial transactions, including interest rate and currency swaps. In the course of its business, AIGFP enters into borrowings that are primarily used to purchase assets that yield rates greater than the rates on the borrowings with the intent of earning a profit on the spread and to finance the acquisition of securities utilized to hedge certain transactions. The pro forma ratios of earnings to fixed charges, which exclude the effects of the operating results of AIGFP, are 6.87 and 7.18 for 2000 and 1999, respectively. As AIGFP will continue to be a subsidiary, AIG expects that these ratios will continue to be lower than they would be if the fixed charges and operating results of AIGFP were not included therein.
7 1,000,000 U.S. DOLLARS 3-MOS DEC-31-2000 JAN-01-2000 MAR-31-2000 1 79,534 11,952 12,177 6,804 7,260 1,622 192,171 211 19,635 9,869 279,259 74,741 11,545 0 46,016 25,695 0 0 4,152 29,686 279,259 7,385 2,334 (21) (60) 6,394 622 1,016 1,991 590 1,346 0 0 0 1,346 .87 .86 24,600 3,089 0 1,299 1,768 24,622 0 Amount represents income before income taxes and minority interest. Earnings per share information reflects a common stock split in the form of a 25 percent common stock dividend paid July 30, 1999. Prior period financial data schedules have not been restated for this stock split.