AMERICAN INTERNATIONAL GROUP / FORM 10-Q
Table of Contents



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 September 30, 2001 Commission File Number 1-8787


AMERICAN INTERNATIONAL GROUP, INC.

(Exact name of registrant as specified in its charter)
     
Delaware
(State or other jurisdiction of incorporation or organization)
  13-2592361
(I.R.S. Employer Identification Number)
 
70 Pine Street, New York, New York
(Address of principal executive offices)
  10270
(Zip Code)
Registrant’s telephone number, including area code (212) 770-7000
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 September 30, 2001: 2,612,478,763.




TABLE OF CONTENTS

CONSOLIDATED BALANCE SHEET
AMERICAN INTERNATIONAL GROUP, INC. CONSOLIDATED STATEMENT OF INCOME
CONSOLIDATED STATEMENT OF CASH FLOWS
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
NOTES TO FINANCIAL STATEMENTS
Management’s Discussion and Analysis of Financial Condition and Results of Operations
PART II -- OTHER INFORMATION
SIGNATURES
EXHIBIT INDEX
EX-4: INDENTURE DATED AS OF NOVEMBER 9, 2001
EX-12: STATEMENT RE. COMPUTATION OF RATIOS


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

 
CONSOLIDATED BALANCE SHEET
(in millions)
(unaudited)
                         
September 30, December 31,
2001 2000


ASSETS:
               
 
Investments and cash:
               
   
Fixed maturities:
               
     
Bonds available for sale, at market value (amortized cost: 2001 — $182,551; 2000 — $153,921)
  $ 187,506     $ 153,763  
     
Bonds held to maturity, at amortized cost (market  value: 2001 — $0; 2000 — $12,053)
          11,533  
     
Bonds trading securities, at market value (cost:  2001 — $911; 2000 — $838)
    915       846  
   
Equity securities:
               
     
Common stocks (cost: 2001 — $6,577; 2000 — $7,051)
    5,650       6,805  
     
Non-redeemable preferred stocks (cost: 2001 — $1,561; 2000 — $1,318)
    1,385       1,207  
   
Mortgage loans on real estate, net of allowance (2001 — $112; 2000 — $104)
    11,050       11,047  
   
Policy Loans
    5,389       5,465  
   
Collateral and guaranteed loans, net of allowance (2001 — $41; 2000 — $40)
    2,095       2,084  
   
Financial services and asset management assets:
               
     
Flight equipment primarily under operating leases, net  of accumulated depreciation (2001 — $3,277; 2000 — $2,723)
    22,027       19,325  
     
Securities available for sale, at market value (cost:  2001 — $17,091; 2000 — $14,636)
    17,123       14,669  
     
Trading securities, at market value
    6,631       7,347  
     
Spot commodities, at market value
    498       363  
     
Unrealized gain on interest rate and currency swaps, options and forward transactions
    12,863       10,235  
     
Trading assets
    7,921       7,045  
     
Securities purchased under agreements to resell, at  contract value
    19,571       14,991  
     
Finance receivables, net of allowance (2001 — $423; 2000 — $383)
    11,196       11,378  
   
Other invested assets
    22,566       13,486  
   
Short-term investments, at cost (approximates market  value)
    9,641       6,502  
   
Cash
    485       522  
     
     
 
       
Total investments and cash
    344,512       298,613  
 
Investment income due and accrued
    3,793       3,522  
 
Premiums and insurance balances receivable, net of allowance (2001 — $178; 2000 — $170)
    13,062       11,832  
 
Reinsurance assets
    25,810       23,964  
 
Deferred policy acquisition costs
    16,723       16,647  
 
Investments in partially-owned companies
    513       336  
 
Real estate and other fixed assets, net of accumulated depreciation (2001 — $3,092; 2000 — $2,264)
    4,353       4,126  
 
Separate and variable accounts
    46,528       54,562  
 
Other assets
    13,381       13,069  
     
     
 
       
Total assets
  $ 468,675     $ 426,671  
     
     
 

See Accompanying Notes to Financial Statements.

1


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

CONSOLIDATED BALANCE SHEET — (continued)

(in millions, except share amounts)
(unaudited)
                       
September 30, December 31,
2001 2000


LIABILITIES:
               
 
Reserve for losses and loss expenses
  $ 41,920     $ 40,613  
 
Reserve for unearned premiums
    13,161       12,510  
 
Future policy benefits for life and accident and health insurance contracts
    56,501       51,532  
 
Policyholders’ contract deposits
    109,426       99,327  
 
Other policyholders’ funds
    6,383       5,885  
 
Reserve for commissions, expenses and taxes
    3,477       2,807  
 
Insurance balances payable
    4,281       2,794  
 
Funds held by companies under reinsurance treaties
    2,360       1,435  
 
Income taxes payable:
               
   
Current
    (170 )     189  
   
Deferred
    4,338       3,032  
 
Financial services and asset management liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    16,308       13,595  
   
Securities sold under agreements to repurchase, at contract value
    11,317       11,308  
   
Trading liabilities
    5,036       4,352  
   
Securities and spot commodities sold but not yet purchased, at market value
    6,877       7,701  
   
Unrealized loss on interest rate and currency swaps, options and forward transactions
    10,548       8,581  
   
Trust deposits and deposits due to banks and other depositors
    2,380       1,895  
   
Commercial paper
    8,511       9,421  
   
Notes, bonds and loans payable
    31,353       23,594  
 
Commercial paper
    6,232       3,626  
 
Notes, bonds, loans and mortgages payable
    4,222       4,087  
 
Separate and variable accounts
    46,528       54,562  
 
Minority interest
    1,476       1,465  
 
Other liabilities
    22,660       11,507  
     
     
 
     
Total liabilities
    415,125       375,818  
     
     
 
 
Preferred shareholders’ equity in subsidiary companies
    2,764       3,414  
     
     
 
CAPITAL FUNDS:
               
 
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2001 — 2,747,947,809; 2000 — 2,787,511,574
    6,870       6,914  
 
Additional paid-in capital
    559       2,830  
 
Retained earnings
    45,463       42,598  
 
Accumulated other comprehensive income (loss)
    (1,194 )     (2,440 )
 
Treasury stock, at cost; 2001 — 135,469,046; 2000 — 164,905,649 shares of common stock
    (912 )     (2,463 )
     
     
 
     
Total capital funds
    50,786       47,439  
     
     
 
     
Total liabilities and capital funds
  $ 468,675     $ 426,671  
     
     
 

See Accompanying Notes to Financial Statements.

2


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

CONSOLIDATED STATEMENT OF INCOME

(in millions, except per share amounts)
(unaudited)
                                     
Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




General insurance operations:
                               
 
Net premiums written
  $ 14,903     $ 13,023     $ 4,983     $ 4,293  
 
Change in unearned premium reserve
    (594 )     (402 )     (138 )     (181 )
     
     
     
     
 
 
Net premiums earned
    14,309       12,621       4,845       4,112  
 
Net investment income
    2,147       1,999       724       676  
 
Realized capital gains (losses)
    (147 )     42       (89 )     33  
     
     
     
     
 
      16,309       14,662       5,480       4,821  
     
     
     
     
 
 
Losses and loss expenses incurred
    10,652       9,460       3,561       3,066  
 
Losses and loss expenses incurred: World Trade Center and related losses (WTC)
    769             769        
 
Underwriting expenses
    2,915       2,529       1,038       853  
     
     
     
     
 
      14,336       11,989       5,368       3,919  
     
     
     
     
 
 
Operating income
    1,973       2,673       112       902  
     
     
     
     
 
Life insurance operations:
                               
 
Premium income
    14,066       12,633       4,873       4,140  
 
Net investment income
    8,687       7,807       2,935       2,666  
 
Realized capital gains (losses)
    (4 )     (123 )     17       (65 )
     
     
     
     
 
      22,749       20,317       7,825       6,741  
     
     
     
     
 
 
Death and other benefits
    8,355       6,953       3,078       2,368  
 
Death and other benefits: WTC
    131             131        
 
Increase in future policy benefits
    6,007       6,128       1,798       1,977  
 
Acquisition and insurance expenses
    4,133       3,663       1,482       1,197  
     
     
     
     
 
      18,626       16,744       6,489       5,542  
     
     
     
     
 
 
Operating income
    4,123       3,573       1,336       1,199  
     
     
     
     
 
Financial services operating income
    1,411       1,180       490       406  
Asset management operating income
    817       832       248       282  
Other realized capital losses
    (398 )     (140 )     (42 )     (25 )
Other income (deductions) — net
    (487 )     (476 )     (164 )     (166 )
Acquisition, restructuring and related charges
    (2,017 )     (315 )     (1,363 )      
     
     
     
     
 
Income before income taxes, minority interest and cumulative
effect of accounting changes
    5,422       7,327       617       2,598  
     
     
     
     
 
Income taxes — Current
    932       1,349       157       451  
             — Deferred
    603       835       7       334  
     
     
     
     
 
      1,535       2,184       164       785  
     
     
     
     
 
Income before minority interest and cumulative effect of accounting changes
    3,887       5,143       453       1,813  
     
     
     
     
 
Minority interest
    (254 )     (306 )     (45 )     (108 )
     
     
     
     
 
Income before cumulative effect of accounting changes
    3,633       4,837       408       1,705  
     
     
     
     
 
Cumulative effect of accounting changes, net of tax
    (136 )           (81 )      
     
     
     
     
 
Net income
  $ 3,497     $ 4,837     $ 327     $ 1,705  
     
     
     
     
 
Earnings per common share:
                               
 
Basic
                               
   
Income before cumulative effect of accounting changes
  $ 1.38     $ 1.86     $ 0.15     $ 0.66  
   
Cumulative effect of accounting changes
    (0.05 )           (0.03 )      
     
     
     
     
 
   
Net income
  $ 1.33     $ 1.86     $ 0.12     $ 0.66  
     
     
     
     
 
 
Diluted
                               
   
Income before cumulative effect of accounting changes
  $ 1.37     $ 1.84     $ 0.15     $ 0.65  
   
Cumulative effect of accounting changes
    (0.05 )           (0.03 )      
     
     
     
     
 
   
Net income
  $ 1.32     $ 1.84     $ 0.12     $ 0.65  
     
     
     
     
 
Cash dividends per common share
  $ 0.116     $ 0.104     $ 0.042     $ 0.037  
     
     
     
     
 
Average shares outstanding:
                               
 
Basic
    2,622       2,605       2,620       2,606  
     
     
     
     
 
 
Diluted
    2,653       2,637       2,651       2,633  
     
     
     
     
 
See Accompanying Notes to Financial Statements.

3


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

 
CONSOLIDATED STATEMENT OF CASH FLOWS
(in millions)
(unaudited)
                     
Nine Months
Ended September 30,

2001 2000


Cash Flows From Operating Activities:
               
Net Income
  $ 3,497     $ 4,837  
     
     
 
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
    6,603       5,001  
   
Premiums and insurance balances receivable and payable — net
    555       (127 )
   
Reinsurance assets
    (2,624 )     (246 )
   
Deferred policy acquisition costs
    (76 )     (913 )
   
Investment income due and accrued
    (271 )     (348 )
   
Funds held under reinsurance treaties
    903       (40 )
   
Other policyholders’ funds
    581       311  
   
Current and deferred income taxes — net
    256       785  
   
Reserve for commissions, expenses and taxes
    462       401  
   
Other assets and liabilities — net
    4,274       (371 )
   
Trading assets and liabilities — net
    (193 )     (1,941 )
   
Trading securities, at market value
    716       (177 )
   
Spot commodities, at market value
    (134 )     112  
   
Net unrealized gain on interest rate and currency swaps, options and forward transactions
    (662 )     (1,697 )
   
Securities purchased under agreements to resell
    (4,580 )     (3,977 )
   
Securities sold under agreements to repurchase
    9       2,730  
   
Securities and spot commodities sold but not yet purchased, at market value
    (824 )     2,014  
 
Realized capital losses
    549       221  
 
Equity in income of partially-owned companies and other invested assets
    (344 )     (179 )
 
Depreciation expenses, principally flight equipment
    1,076       851  
 
Change in cumulative translation adjustments
    (407 )     (123 )
 
Provision for finance receivable losses
    194       147  
 
Other — net
    (1,789 )     (176 )
     
     
 
 
Total Adjustments
    4,274       2,258  
     
     
 
Net cash provided by operating activities
  $ 7,771     $ 7,095  
     
     
 

See Accompanying Notes to Financial Statements.

4


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

CONSOLIDATED STATEMENT OF CASH FLOWS — (Continued)

(in millions)
(unaudited)
                   
Nine Months Ended
September 30,

2001 2000


Cash Flows From Investing Activities:
               
 
Cost of fixed maturities, at amortized cost matured or redeemed
  $     $ 11,789  
 
Cost of bonds, at market sold
    59,526       16,524  
 
Cost of bonds, at market matured or redeemed
    6,563       5,620  
 
Cost of equity securities sold
    4,559       3,824  
 
Realized capital losses
    (549 )     (221 )
 
Purchases of fixed maturities
    (82,789 )     (44,262 )
 
Purchases of equity securities
    (4,706 )     (4,552 )
 
Mortgage, policy and collateral loans granted
    (2,705 )     (2,187 )
 
Repayments of mortgage, policy and collateral loans
    2,563       1,633  
 
Sales of securities available for sale
    2,901       4,245  
 
Maturities of securities available for sale
    1,372       1,264  
 
Purchases of securities available for sale
    (6,721 )     (5,232 )
 
Sales of flight equipment
    218       136  
 
Purchases of flight equipment
    (3,514 )     (2,646 )
 
Net additions to real estate and other fixed assets
    (566 )     (658 )
 
Sales or distributions of other invested assets
    2,753       3,127  
 
Investments in other invested assets
    (4,832 )     (4,640 )
 
Change in short-term investments
    (3,137 )     (457 )
 
Investments in partially-owned companies
    (162 )     (1 )
 
Finance receivable originations and purchases
    (5,436 )     (4,762 )
 
Finance receivable principal payments received
    5,425       3,966  
 
Other net
          (146 )
     
     
 
Net cash used in investing activities
    (29,237 )     (17,636 )
     
     
 
Cash Flows From Financing Activities:
               
 
Change in policyholders’ contract deposits
    10,744       4,048  
 
Change in trust deposits and deposits due to banks and other depositors
    486       (266 )
 
Change in commercial paper
    1,696       4,599  
 
Proceeds from notes, bonds, loans and mortgages payable
    18,719       8,725  
 
Repayments on notes, bonds, loans and mortgages payable
    (10,835 )     (7,731 )
 
Proceeds from guaranteed investment agreements
    8,043       6,712  
 
Maturities of guaranteed investment agreements
    (5,330 )     (4,446 )
 
Redemption of subsidiary company preferred stock
    (688 )      
 
Proceeds from common stock issued
    163       114  
 
Proceeds from subsidiary company preferred stock issued
          645  
 
Cash dividends to shareholders
    (632 )     (580 )
 
Acquisition of treasury stock
    (1,039 )     (1,244 )
 
Other — net
    102       129  
     
     
 
Net cash provided by financing activities
    21,429       10,705  
     
     
 
Change in cash
    (37 )     164  
Cash at beginning of period
    522       425  
     
     
 
Cash at end of period
  $ 485     $ 589  
     
     
 

See Accompanying Notes to Financial Statements.

5


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC.

 
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(in millions)
(unaudited)
                                     
Nine Months Three Months
Ended September 30, Ended September 30,


2001 2000 2001 2000




Net income
  $ 3,497     $ 4,837     $ 327     $ 1,705  
Other comprehensive income:
                               
 
Unrealized appreciation of investments — net of reclassification adjustments
    2,460       567       1,672       1,423  
   
Deferred income tax expense on changes
    (826 )     (246 )     (595 )     (543 )
 
Foreign currency translation adjustments(a)
    (418 )     (123 )     (105 )     (127 )
   
Applicable income tax benefit on changes
    72       46       4       22  
 
Cumulative effect of accounting change, net of tax(b)
    150                    
 
Net derivative losses arising from cash flow hedging activities
    (669 )           (534 )      
   
Deferred income tax benefit on changes
    138             152        
 
Cumulative effect of accounting change, net of tax(c)
    339                    
     
     
     
     
 
 
Total
    1,246       244       594       775  
     
     
     
     
 
Comprehensive income
  $ 4,743     $ 5,081     $ 921     $ 2,480  
     
     
     
     
 

(a)  Includes immaterial derivative gains and losses arising from hedges of net investments in foreign operations.
 
(b)  Consists of derivative gains and losses arising from the adoption of FASB  133.
 
(c)  Represents the unrealized appreciation arising from the transfer of the bonds held to maturity portfolio to the bonds available for sale portfolio in connection with the implementation of FASB 133.

See Accompanying Notes to Financial Statements.

6


Table of Contents

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

 
NOTES TO FINANCIAL STATEMENTS

September 30, 2001

(unaudited)

a) On August 29, 2001, American General Corporation (AGC) was acquired by AIG. In connection with the acquisition, AIG issued approximately 290 million shares of its common stock in an exchange for all the outstanding common stock of AGC based on an exchange ratio of 0.5790 of a share of AIG common stock for each share of AGC common stock. The acquisition was accounted for as a pooling of interests and all prior historical financial information presented herein has been restated to include AGC.

  All of the share information included herein reflects the application of the exchange ratio to the number of shares of AGC common stock outstanding at the relevant times rather than the number of shares of AIG common stock actually issued and outstanding at such times.
 
  The following is a reconciliation of the individual companies combined results for the nine months and third quarter of 2000:
                                                 
Nine Months Three Months
Ended September 30, 2000 Ended September 30, 2000


AIG AGC Total AIG AGC Total






(in millions)
Revenues
  $ 33,456     $ 8,284     $ 41,740     $ 11,140     $ $2,791     $ 13,931  
Net income
  $ 4,139     $ 698     $ 4,837     $ 1,386     $ 319     $ 1,705  

b) These statements are unaudited. In the opinion of management, all adjustments consisting of normal recurring accruals have been made for a fair statement of the results presented herein. All material intercompany accounts and transactions have been eliminated. For further information, refer to the Annual Report on Form 10-K of AIG for the year ended December  31, 2000 (as supplemented by the Current Report on Form  8-K dated October 9, 2001).
 
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 50 percent common stock dividend paid July 28, 2000. The quarterly dividend rate per common share, commencing with the dividend paid September 14, 2001 is $0.042.

d) Cash flow information for the nine month periods ended September 30, 2001 and 2000 is as follows:
                 
2001 2000


(in millions)
Income taxes paid
  $ 1,140     $ 1,283  
Interest paid
  $ 3,042     $ 2,650  

e) Segment Information:

  The following table summarizes the operations by major operating segment for the first nine months and third quarter of 2001 and 2000 (in millions):
                                   
Operating Segments

Nine Months Three Months
Ended September 30, Ended September 30,


2001 2000 2001 2000




Revenues(1):
                               
 
General Insurance
  $ 16,309     $ 14,662     $ 5,480     $ 4,821  
 
Life Insurance
    22,749       20,317       7,825       6,741  
 
Financial Services
    4,728       4,310       1,633       1,508  
 
Asset Management
    2,608       2,591       832       886  
 
Other
    (398 )     (140 )     (42 )     (25 )
     
     
     
     
 
Total
  $ 45,996     $ 41,740     $ 15,728     $ 13,931  
     
     
     
     
 

7


Table of Contents

                                   
Operating Segments

Nine Months Three Months
Ended September 30, Ended September 30,


2001 2000 2001 2000




Operating income:
                               
 
General Insurance
  $ 1,973     $ 2,673     $ 112     $ 902  
 
Life Insurance
    4,123       3,573       1,336       1,199  
 
Financial Services
    1,411       1,180       490       406  
 
Asset Management
    817       832       248       282  
 
Other
    (2,902 )(2)     (931 )     (1,569 )(2)     (191 )
     
     
     
     
 
Total
  $ 5,422     $ 7,327     $ 617     $ 2,598  
     
     
     
     
 
 

  (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).  

  (2)  Includes pre-tax charges of $654 million for a termination fee ($600 million) and other related costs in connection with AGC’s termination of its merger agreement with Prudential plc in the second quarter of 2001, and $1.36 billion in acquisition, restructuring and related charges in connection with the acquisition of AGC in the third quarter of 2001. See also Note (j) of Notes to Financial Statements.

  The following table summarizes AIG’s general insurance operations by major reporting group for the first nine months and third quarter of 2001 and 2000 (in millions):
                                   
General Insurance

Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




Revenues:
                               
 
Domestic Brokerage Group
  $ 9,238     $ 7,659     $ 3,111     $ 2,464  
 
Foreign General
    4,619       4,719       1,561       1,558  
 
Other
    2,452       2,284       808       799  
     
     
     
     
 
Total
  $ 16,309     $ 14,662     $ 5,480     $ 4,821  
     
     
     
     
 
Operating income (loss) before realized capital gains (losses)(1):
                               
 
Domestic Brokerage Group
  $ 1,014     $ 1,499     $ (70 )   $ 525  
 
Foreign General
    719       712       128       210  
 
Other
    387       420       143       134  
     
     
     
     
 
Total
  $ 2,120     $ 2,631     $ 201     $ 869  
     
     
     
     
 
 

  (1)  Realized capital gains (losses) are not deemed to be an integral part of AIG’s general insurance operations’ internal reporting groups.  

  The following table summarizes AIG’s life insurance operations by major reporting group for the first nine months and third quarter of 2001 and 2000 (in millions):
                                   
Life Insurance

Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




Revenues:
                               
 
American International Assurance Company Ltd. and Nan Shan Life Insurance Company, Ltd. 
  $ 7,668     $ 6,983     $ 2,583     $ 2,307  
 
American Life Insurance Company
    4,156       4,095       1,372       1,345  
 
Domestic Life
    9,741       8,896       3,161       2,974  
 
Other
    1,184       343       709       115  
     
     
     
     
 
Total
  $ 22,749     $ 20,317     $ 7,825     $ 6,741  
     
     
     
     
 

8


Table of Contents

                                   
Life Insurance

Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




Operating income before realized capital gains (losses)(1):
                               
 
American International Assurance Company Ltd. and Nan Shan Life Insurance Company, Ltd. 
  $ 1,162     $ 1,028     $ 383     $ 355  
 
American Life Insurance Company
    629       561       191       189  
 
Domestic Life
    2,143       2,051       631       701  
 
Other
    193       56       114       19  
     
     
     
     
 
Total
  $ 4,127     $ 3,696     $ 1,319     $ 1,264  
     
     
     
     
 
 

  (1)  Realized capital gains (losses) are not deemed to be an integral part of AIG’s life insurance operations’ internal reporting groups.  

  The following table summarizes AIG’s financial services operations by major reporting group for the first nine months and third quarter of 2001 and 2000 (in millions):
                                   
Financial Services

Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




Revenues:
                               
 
International Lease Finance Corporation 
  $ 1,937     $ 1,786     $ 659     $ 629  
 
AIG Financial Products Corp. 
    802       711       283       260  
 
Consumer Finance Group 
    1,903       1,718       653       596  
 
Other(1)
    86       95       38       23  
     
     
     
     
 
Total
  $ 4,728     $ 4,310     $ 1,633     $ 1,508  
     
     
     
     
 
Operating income:
                               
 
International Lease Finance Corporation 
  $ 531     $ 476     $ 187     $ 166  
 
AIG Financial Products Corp. 
    524       433       170       155  
 
Consumer Finance Group 
    386       294       149       101  
 
Other(1)
    (30 )     (23 )     (16 )     (16 )
     
     
     
     
 
Total
  $ 1,411     $ 1,180     $ 490     $ 406  
     
     
     
     
 
 

  (1)  Including AIG Trading Group Inc.  

f) Computation of Earnings Per Share:
                                   
Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




(in millions, except per share amounts)
Numerator:
                               
Income before cumulative effect of accounting changes
  $ 3,633     $ 4,837     $ 408     $ 1,705  
Cumulative effect of accounting changes, net of tax
    (136 )           (81 )      
Net income (applicable to common stock) — basic
  $ 3,497     $ 4,837     $ 327     $ 1,705  
Dividends on preferred securities
          5              
     
     
     
     
 
Net income (applicable to common stock) — diluted
  $ 3,497     $ 4,842     $ 327     $ 1,705  
     
     
     
     
 
Denominator:
                               
Basic:
                               
Average outstanding shares used in the computation of per share earnings:
                               
 
Common stock
    2,766       2,799       2,763       2,792  
 
Common stock in treasury
    (144 )     (194 )     (143 )     (186 )
     
     
     
     
 
Average outstanding shares — basic
    2,622       2,605       2,620       2,606  
     
     
     
     
 

9


Table of Contents

                                     
Nine Months Three Months
Ended Ended
September 30, September 30,


2001 2000 2001 2000




(in millions, except per share amounts)
Diluted:
                               
Average outstanding shares used in the computation of per share earnings:
                               
 
Common stock
    2,766       2,799       2,763       2,792  
 
Common stock in treasury
    (144 )     (194 )     (143 )     (186 )
Stock options and stock purchase plan (treasury stock method)
    31       27       31       27  
Convertible preferred securities
          5              
     
     
     
     
 
Average outstanding shares — diluted
    2,653       2,637       2,651       2,633  
     
     
     
     
 
Net income per share:
                               
 
Basic
                               
   
Income before cumulative effect of accounting changes
  $ 1.38     $ 1.86     $ 0.15     $ 0.66  
   
Cumulative effect of accounting changes
    (0.05 )           (0.03 )      
     
     
     
     
 
   
Net income
  $ 1.33     $ 1.86     $ 0.12     $ 0.66  
     
     
     
     
 
 
Diluted
                               
   
Income before cumulative effect of accounting changes
  $ 1.37     $ 1.84     $ 0.15     $ 0.65  
   
Cumulative effect of accounting changes
    (0.05 )           (0.03 )      
     
     
     
     
 
   
Net income
  $ 1.32     $ 1.84     $ 0.12     $ 0.65  
     
     
     
     
 

g) Statement of Accounting Standards No. 130 “Comprehensive Income” (FASB 130) establishes standards for reporting comprehensive income and its components as part of capital funds. The reclassification adjustments with respect to available for sale securities were $(549) million and $(221) million for the first nine months and $(114) million and $(57) million for the third quarter of 2001 and 2000, respectively.

h)  Accounting Standards:

  In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities”. In June 2000, FASB issued Statement of Financial Accounting Standards No. 138 “Accounting for Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (collectively, FASB 133).
 
  FASB 133 requires AIG to recognize all derivatives in the consolidated balance sheet at fair value. The financial statement recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative and the extent to which the derivative is effective as part of a hedge transaction. The changes in fair value of the derivative transactions of AIG Financial Products Corp. and subsidiaries (AIGFP) and AIG Trading Group Inc. and subsidiaries (AIGTG) are presented as a component of AIG’s operating income. The discussion below relates to the derivative activities of AIG other than those of AIGFP and AIGTG.
 
  On the date the derivative contract is entered into, AIG designates the derivative as: (1) a hedge of the subsequent changes in the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value” hedge); (2) a hedge of a forecasted transaction, or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge); or (3) a hedge of a net investment in a foreign operation. Fair value and cash flow hedges may involve foreign currencies (“foreign currency hedges”). The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a fair value hedge is recorded in current period earnings along with the loss or gain on the hedged item attributable to the hedged risk. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a cash flow hedge is recorded in other comprehensive income, until earnings are affected by the variability of cash flows. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a hedge of a net investment in a foreign operation is recorded in the foreign currency translation adjustments account within other comprehensive income. Changes in the fair value of derivatives used for other than the above hedging activities are reported in current period earnings.
 
  AIG documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet, or specific firm commitments or forecasted transactions. AIG also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.
 
  In accordance with the transition provisions of FASB 133, AIG recorded in its consolidated income statement for the first nine months of 2001 a cumulative effect of an accounting change adjustment loss of $6 million. This loss represents the net fair value of all previously unrecorded derivative instruments as of January 1, 2001, net of tax and

10


Table of Contents

  after the application of hedge accounting. AIG also recorded in its consolidated statement of comprehensive income for the first nine months of 2001 a cumulative effect of an accounting change adjustment gain of $150 million. This gain represents the increase in other comprehensive income, net of taxes, arising from recognizing the fair value of all derivative contracts designated as cash flow hedging instruments, and to a lesser extent, hedging instruments used to hedge net investments in foreign operations.
 
  AIG (excluding its two trading operations, AIGFP and AIGTG) uses derivative instruments (principally swap and forward contracts) to hedge risk exposures to interest rate and foreign currency risks. These risks arise primarily from available-for-sale fixed income securities, debt, policyholder account balance liabilities associated with guaranteed investment contracts and net investments in foreign operations. Other hedging activities, such as those involving forecasted transactions or equity securities, are not significant. During the first nine months of 2001, there were no hedges that were discontinued or otherwise no longer qualify as hedges under FASB 133. With respect to fair value hedges, net income for the first nine months reflected a net $3 million gain from hedge ineffectiveness. With respect to cash flow hedges, such ineffectiveness amounted to a net loss of $1 million. During the first nine months of 2001, there were minor reclassifications to earnings from other comprehensive income under cash flow hedge accounting. These reclassifications were connected to programs of synthetically converting certain investment securities, debt issuances or policyholder account balance liabilities associated with guaranteed investment contracts, from a floating interest rate to a fixed interest rate. As at September 30, 2001, the maximum amount of net derivative losses to be reclassified into net income within the next twelve months is insignificant. The maximum length of time over which future cash flows are hedged is approximately 9 years.
 
  In addition to hedging activities, AIG also uses derivative instruments with respect to investment operations, which include, among other things, writing option contracts, and purchasing investments with embedded derivatives, such as equity linked notes and convertible bonds. All changes in the market value of these derivatives are recorded in earnings. AIG bifurcates an embedded derivative where: (1) the economic characteristics of the embedded instruments are not clearly and closely related to those of the remaining components of the financial instrument; and (2) a separate instrument with the same terms as the embedded instrument meets the definition of a derivative under FASB 133.
 
  In accordance with the transition provisions of FASB 133, AIG transferred bonds in the held to maturity, at amortized cost category into the bonds available for sale, at market value category. The amortized cost of the bonds transferred was $11.53 billion. The unrealized appreciation, net of deferred tax expense was approximately $339 million at the date of transfer and was recorded as a cumulative effect of an accounting change within other comprehensive income. Under the provisions of FASB 133, such a transfer does not affect AIG’s intent nor its ability to hold current or future bonds to their maturity.
 
  In January 2001, the Emerging Issues Task Force (EITF) issued EITF 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.” EITF 99-20 provides guidance on the calculation of interest income and the recognition of impairments related to beneficial interests held in an investment portfolio. Beneficial interests are investments that represent rights to receive specified cash flows from a pool of underlying assets (i.e., collateralized debt obligations). In accordance with the transition provisions of EITF 99-20, AIG recorded in its consolidated income statement for the first nine months of 2001 a cumulative effect of an accounting change adjustment loss of $130 million ($200 million before tax).

i) On July 31, 2001 AGC redeemed all preferred securities with respect to AGC’s 8.45% Cumulative Monthly Income Preferred Securities and AGC’s 8  1/8% Cumulative Monthly Income Preferred Securities. These preferred securities had a total carrying value of $502 million. The redemption price of each class of preferred security was $25 per share, its liquidation value.
 
j) Acquisition, Restructuring & Related Charges

  During the third quarter of 2001, AGC was consolidated into AIG. One-time charges in connection with this acquisition totaled $1.36 billion for the third quarter of 2001. During the second quarter of 2001, AGC incurred $654 million in connection with the termination of its merger agreement with Prudential plc. With respect to the charges of $1.36 billion incurred in the third quarter of 2001, approximately $512 million were related to direct costs of the acquisition, including $85 million in investment banking, legal and accounting fees. Direct costs of $427 million were related to employee severance and other termination benefits, and other compensation costs related to change in control agreements with AGC executives. The costs were also based in part on a projected elimination of positions, in accordance with AIG’s post-business combination plans, which will enhance the effectiveness and efficiency of the combined operations. The balance of the $1.36 billion represented charges resulting from post-business combination plans, recognizing that certain assets will have no future economic benefit or ability to generate future revenues. Such charges include asset impairment charges related to software, leasehold improvements and certain goodwill. Also included were certain adjustments associated with conforming AGC’s balances to AIG’s existing accounting policies and methodologies.

11


Table of Contents

  Less significant, ongoing costs with respect to the integration of operations will be expensed in future periods as incurred. AIG expects that these ongoing costs will include costs for the integration of computer systems, the training and relocation of certain employees and the consolidation of facilities. AIG ultimately anticipates annual savings of approximately $400 million from the business combination, reflecting principally the benefits of reductions in redundant operations. In addition to cost savings, it is anticipated that the acquisition will result in significant revenue enhancements as a result of new products and cross marketing initiatives.

12


Table of Contents

Management’s Discussion and Analysis of

Financial Condition and Results of Operations

Cautionary Statement Regarding Forward-Looking

Information

      This Quarterly Report on Form 10-Q and other publicly available documents may include, and AIG’s officers and representatives may from time to time make, statements which may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts but instead represent only AIG’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside of AIG’s control. These statements may address, among other things, AIG’s strategy for growth, product development, regulatory approvals, market position, financial results and reserves. It is possible that AIG’s actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause AIG’s actual results to differ, possibly materially, from those in the specific forward-looking statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations. AIG is not under any obligation to (and expressly disclaims any such obligations to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.

Operational Review

Consolidated Results

      AIG’s net income declined 27.7 percent to $3.50 billion during the first nine months of 2001. AIG’s income before income taxes, minority interest, cumulative effect of accounting changes and realized capital gains (losses) declined 20.9 percent to $5.97 billion during the first nine months of 2001. These declines resulted from the impact of the following charges:

        (a)  $2.02 billion with respect to pre-tax acquisition, restructuring and related charges (see the discussions under “Other Operations” herein and Note (j) of Notes to Financial Statements); and
 
        (b)  $900 million before taxes and minority interest share in World Trade Center (WTC) and related losses incurred in 2001 (see the discussions under “General Insurance Operations” and “Life Insurance Operations” herein and Note (j) of Notes to Financial Statements).

      Excluding these charges and American General’s home services operating income, which is being managed as a “closed block”, from AIG’s income before income taxes, minority interest, cumulative effect of accounting changes and realized capital gains (losses), adjusted operating income increased 13.2 percent to $8.54 billion during the first nine months of 2001, due to increased growth and profitability in AIG’s major businesses, including General Insurance, Life Insurance and Financial Services Operations.

      The following table presents the reconciliation for the nine month periods ending September 30, 2001 and 2000 with respect to adjusted operating income:

                         
(in millions)

2001 2000 Change

Income before income taxes, minority interest, cumulative effect of accounting changes
  $ 5,422     $ 7,327       (26.0 )%
Realized capital losses
    (549 )     (221 )        
Income before income taxes, minority interest, cumulative effect, realized capital losses
    5,971       7,548       (20.9 )

Acquisition related charges
    2,017       315          
WTC and related losses (AIG’s share is $820 million)
    900 *              
Home Services operations
    345       317          

Adjusted operating income
  $ 8,543     $ 7,546       13.2 %

Includes 100% of Transatlantic WTC and related losses.

General Insurance Operations

      AIG’s general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance.

      Domestic general insurance operations are comprised of the Domestic Brokerage Group (DBG), which includes The Hartford Steam Boiler

13


Table of Contents

Inspection and Insurance Company (HSB) and the domestic operations of Transatlantic Holdings, Inc. (Transatlantic), Personal Lines, including 21st Century Insurance Group (21st Century), and Mortgage Guaranty.

      HSB was acquired on November 22, 2000, and was initially consolidated into AIG’s financial statements during the fourth quarter of 2000.

      DBG is AIG’s primary domestic division. DBG writes substantially all classes of business insurance, accepting such business mainly from insurance brokers. This provides DBG the opportunity to select specialized markets and retain underwriting control. Any licensed broker is able to submit business to DBG without the traditional agent-company contractual relationship, but such broker usually has no authority to commit DBG to accept a risk.

      Personal Lines engages in the mass marketing of personal lines insurance, primarily private passenger auto and homeowners and personal umbrella coverages.

      Mortgage Guaranty provides guaranty insurance on conventional first mortgage loans on single family dwellings and condominiums.

      AIG’s Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG’s foreign-based insurance subsidiaries for their own accounts. The Foreign General insurance group uses various marketing methods to write both business and personal lines insurance with certain refinements for local laws, customs and needs. AIU operates in over 70 countries in Asia, the Pacific Rim, Europe, Africa, Middle East and Latin America. Transatlantic’s foreign operations are included in this group. (See also Note (e) of Notes to Financial Statements.)

      General insurance operations for the nine month periods ending September 30, 2001 and 2000 were as follows:

(in millions)


                   
2001 2000

Net premiums written:
               
 
Domestic
  $ 10,434     $ 8,612  
 
Foreign
    4,469       4,411  

Total
  $ 14,903     $ 13,023  

Net premiums earned:
               
 
Domestic
  $ 10,079     $ 8,349  
 
Foreign
    4,230       4,272  

Total
  $ 14,309     $ 12,621  

Adjusted underwriting profit (loss):
               
 
Domestic
  $ (287 )   $ 361  
 
Foreign
    260       271  

Total
  $ (27 )   $ 632  

Net investment income:
               
 
Domestic
  $ 1,688     $ 1,558  
 
Foreign
    459       441  

Total
  $ 2,147     $ 1,999  

Operating income before realized capital gains (losses):
               
 
Domestic
  $ 1,401     $ 1,919  
 
Foreign
    719       712  

Total
    2,120       2,631  
Realized capital gains (losses)
    (147 )     42  

Operating income
  $ 1,973     $ 2,673  

      During the first nine months of 2001, net premiums written and net premiums earned increased 14.4 percent and 13.4 percent, respectively, from those of 2000. During the first nine months of 2001, AIG cancelled or non-renewed approximately $374 million of business worldwide that did not meet AIG’s underwriting standards.

      General insurance domestic net premiums written and net premiums earned for the nine month periods ended September 30, 2001 and 2000 were as follows:

(in millions)


                   
2001 2000

Net premiums written:
               
 
DBG
  $ 8,212     $ 6,409  
 
Personal Lines
    1,858       1,868  
 
Mortgage Guaranty
    364       335  

Total
  $ 10,434     $ 8,612  

Net premiums earned:
               
 
DBG
  $ 7,840     $ 6,257  
 
Personal Lines
    1,878       1,756  
 
Mortgage Guaranty
    361       336  

Total
  $ 10,079     $ 8,349  

      Commencing in the latter part of 1999 and continuing through 2001, the commercial property-casualty market place has experienced rate increases. Virtually all areas of DBG have experienced rate increases. Overall, DBG’s net premiums written increased $1.80 billion or 28.1 percent in the first nine months of 2001 over 2000.

14


Table of Contents

      Personal Lines’ net premiums written decreased 0.5 percent or $10 million in the first nine months of 2001 from 2000.

      Foreign general insurance net premiums written increased 1.3 percent and net premiums earned decreased 1.0 percent in the first nine months of 2001 when compared to the same period of 2000. Foreign general insurance operations produced 30.0 percent of the general insurance net premiums written in the first nine months of 2001 and 33.9 percent in 2000.

      In comparing the foreign currency exchange rates used to translate the results of AIG’s foreign general operations during the first nine months of 2001 to those foreign currency exchange rates used to translate AIG’s foreign general results during the same period of 2000, the U.S. dollar strengthened in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, when foreign net premiums written were translated into U.S. dollars for the purposes of the preparation of the consolidated financial statements, total general insurance net premiums written were approximately 3.1 percentage points less than they would have been if translated utilizing those foreign currency exchange rates which prevailed during that same period of 2000.

      Because of the nature and diversity of AIG’s operations and the continuing rapid changes in the insurance industry worldwide, together with the factors discussed above, it is difficult to assess further or project future growth in AIG’s net premiums written and reserve for losses and loss expenses.

      Net premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes deferred revenues which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period.

      AIG, along with most general insurance entities, uses the loss ratio, the expense ratio and the combined ratio as measures of performance. The loss ratio is the sum of losses and loss expenses incurred divided by net premiums earned. The expense ratio is statutory underwriting expenses divided by net premiums written. The combined ratio is the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe for every $100 of net premiums earned or written, the cost of losses and statutory expenses, respectively. The combined ratio presents the total cost per $100 of premium production. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting loss. The statutory general insurance ratios, including losses with respect to WTC and related losses, were as follows:

                   
2001 2000

Domestic:
               
 
Loss Ratio
    86.10       80.48  
 
Expense Ratio
    17.15       16.60  

Combined Ratio
    103.25       97.08  

Foreign:
               
 
Loss Ratio
    64.84       64.15  
 
Expense Ratio
    30.80       29.68  

Combined Ratio
    95.64       93.83  

Consolidated:
               
 
Loss Ratio
    79.82       74.95  
 
Expense Ratio
    21.24       21.03  

Combined Ratio
    101.06       95.98  

      AIG believes that underwriting profit is the true measure of the performance of the core business of a general insurance company.

      Underwriting profit is measured in two ways: statutory underwriting profit and Generally Accepted Accounting Principles (GAAP) underwriting profit.

      Statutory underwriting profit is arrived at by reducing net premiums earned by net losses and loss expenses incurred and net expenses incurred. Statutory accounting differs from GAAP, as statutory accounting requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, all expenses, most specifically acquisition expenses, are recognized immediately, not consistent with the revenues earned.

      A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred and recognized together with the related revenues. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. Thus, “adjusted underwriting profit” is a GAAP measurement which can be viewed as gross margin or an intermediate subtotal in calculating operating income and net income.

15


Table of Contents

      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 profit (loss) was $(27) million for the first nine months of 2001 and $632 million for the same period of 2000. When WTC and related losses in 2001 are excluded from losses incurred, the adjusted underwriting profit would be $742 million for the first nine months of 2001, a 17.4 percent increase over the prior period. This increase was primarily due to the domestic adjusted underwriting profit resulting from the disciplined underwriting of DBG. The underwriting environment varies from country to country, as does the degree of litigation activity. Regulation, product type and competition 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 impact of incurred losses from catastrophes approximating $817 million (which include $769 million with respect to WTC and related losses) and $44 million in the first nine months of 2001 and 2000, respectively. AIG’s gross incurred losses from catastrophes approximated $2.1 billion (which includes approximately $2.0 billion with respect to the WTC and related losses) and $112 million in 2001 and 2000, respectively. The impact of losses caused by catastrophes can fluctuate widely from period to period, making comparisons of recurring type business more difficult. The pro forma table below excludes catastrophe losses in order to present comparable results of AIG’s recurring core underwriting operations. The pro forma consolidated statutory general insurance ratios would be as follows:

                 
2001 2000

Loss Ratio
    74.11       74.60  
Expense Ratio
    21.24       21.03  

Combined Ratio
    95.35       95.63  

      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 nine months of 2001 increased 7.4 percent when compared to the same period of 2000. The growth in net investment income in 2001 was primarily attributable to new cash flow for investment. The new cash flow was generated from net general insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. (See also the discussion under “Liquidity” herein.)

      General insurance realized capital losses were $147 million in the first nine months of 2001 and realized capital gains were $42 million in 2000. These realized capital gains and losses resulted from the ongoing management of the general insurance investment portfolios within the overall objectives of the general insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities.

      General insurance operating income for the first nine months of 2001 decreased 26.2 percent to $1.97 billion due to the WTC and related losses. Estimated WTC and related losses recorded in the third quarter of 2001 amounted to $769 million, including $200 million from Transatlantic Holdings, Inc. Adjusted general insurance operating income, which excludes WTC and related losses, as well as realized capital gains (losses), increased 9.8 percent to $2.89 billion during the first nine months of 2001. The contribution of general insurance operating income to income before income taxes, minority interest and cumulative effect of accounting changes was 36.4 percent during the first nine months of 2001 compared to 36.5 percent in the same period of 2000.

      AIG is a major purchaser of reinsurance for its general insurance operations. AIG is cognizant of the need to exercise good judgment in the selection and approval of both domestic and foreign companies participating in its reinsurance programs. AIG insures risks in over 70 countries and its reinsurance programs must be coordinated in order to provide

16


Table of Contents

AIG the level of reinsurance protection that AIG desires. These reinsurance arrangements do not relieve AIG from its direct obligations to its insureds.

      AIG held general reinsurance assets of $24.81 billion at September 30, 2001 as a result of its reinsurance arrangements. Thus, a credit exposure existed at September 30, 2001 with respect to reinsurance recoverable to the extent that any reinsurer may not be able to reimburse AIG under the terms of these reinsurance arrangements. AIG manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound, and when necessary AIG holds substantial collateral in the form of funds, securities and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. At December 31, 2000, approximately 43 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, nearly all of these balances were collateralized. The remaining 57 percent of the general reinsurance assets were from authorized reinsurers and over 95 percent of such balances are from reinsurers rated A-(excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. Through September 30, 2001, these distribution percentages have not significantly changed. With respect to the WTC and related losses, approximately $1.2 billion of the $2.0 billion in gross losses is covered by reinsurance. Approximately 99 percent of this coverage was placed with companies that are rated A or better.

      AIG’s allowance for estimated unrecoverable reinsurance has not significantly changed from December 31, 2000 when AIG had allowances for unrecoverable reinsurance approximating $76 million. At that date AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction).

      AIG’s Reinsurance Security Department conducts ongoing detailed assessments of the reinsurance markets and current and potential reinsurers, both foreign and domestic. Such assessments include, but are not limited to, identifying if a reinsurer is appropriately licensed, and has sufficient financial capacity, and the local economic environment in which a foreign reinsurer operates. This department also reviews the nature of the risks ceded and the need for collateral. In addition, AIG’s Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer.

      AIG enters into certain intercompany reinsurance transactions for its general and life operations. 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 September 30, 2001, the consolidated general reinsurance assets of $24.81 billion include reinsurance recoverables for paid losses and loss expenses of $3.83 billion and $16.17 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 September 30, 2001 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded.

      At September 30, 2001, general insurance reserves for losses and loss expenses (loss reserves) amounted to $41.92 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 September 30, 2001, general insurance net loss reserves increased $803 million from prior year end to $25.75 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

17


Table of Contents

net losses and loss expenses at September 30, 2001. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on future results of operations.

      In a very broad sense, the general loss reserves can be categorized into two distinct groups: one group being long tail casualty lines of business. Such lines include excess and umbrella liability, directors and officers’ liability, professional liability, medical malpractice, general liability, products’ liability, and related classes. These lines account for approximately one-half of net losses and loss expenses. The other group is short tail lines of business consisting principally of property lines, certain classes of casualty lines and includes personal lines.

      Estimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. In the more recent accident years of long tail casualty lines there is limited statistical credibility in reported net losses. That is, a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. A relatively high proportion of net losses would therefore be IBNR.

      A variety of actuarial methods and assumptions are normally employed to estimate net losses for long tail casualty lines. These methods ordinarily involve the use of loss trend factors intended to reflect the estimated annual growth in loss costs from one accident year to the next. For the majority of long tail casualty lines, net loss trend factors approximated four percent. Loss trend factors reflect many items including changes in claims handling, exposure and policy forms and current and future estimates of monetary inflation and social inflation. Thus, many factors are implicitly considered in estimating the year to year growth in loss costs. Therefore, AIG’s carried net long tail loss reserves are judgmentally set as well as tested for reasonableness using the most appropriate loss trend factors for each class of business. In the evaluation of AIG’s net loss reserves, loss trend factors vary slightly, depending on the particular class and nature of the business involved. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience.

      Estimation of net losses for short tail business is less complex than for long tail casualty lines. Loss cost trends for many property lines can generally be assumed to be similar to the growth in exposure of such lines. For example, if the fire insurance coverage remained proportional to the actual value of the property, the growth in the property’s exposure to fire loss can be approximated by the amount of insurance purchased.

      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

18


Table of Contents

and the government’s refusal to release parties. The cleanup cost exposure may significantly change if potential Congressional reauthorization of Superfund dramatically changes the current program.

      In the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. At the current time, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as is the case for other types of claims. Such development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by the changes in Superfund and waste dump site coverage issues. Although the estimated liabilities for these claims are subject to a significantly greater margin of error than for other claims, the reserves carried for these claims at September 30, 2001 are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG’s net exposure retained relative to the gross exposure written was lower in 1984 and prior years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. In the future, if the environmental claims develop deficiently, such deficiency would have an adverse impact on future results of operations. (See the previous discussion on reinsurance collectibility herein.)

      The majority of AIG’s exposures for asbestos and environmental claims are excess casualty coverages, not primary coverages. Thus, the litigation costs are treated in the same manner as indemnity reserves. That is, litigation expenses are included within the limits of the liability AIG incurs. Individual significant claim liabilities, where future litigation costs are reasonably determinable, are established on a case basis.

      A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined at September 30, 2001 and 2000 was as follows:

                                 
(in millions)

2001 2000


Gross Net Gross Net

Asbestos:
                               
Reserve for losses and loss expenses at beginning of year
  $ 1,100     $ 338     $ 1,093     $ 306  
Losses and loss expenses incurred
    242       56       145       34  
Losses and loss expenses paid
    (251 )     (90 )     (314 )     (51 )

Reserve for losses and loss expenses at end of period
  $ 1,091     $ 304     $ 924     $ 289  

Environmental:
                               
Reserve for losses and loss expenses at beginning of year
  $ 1,345     $ 517     $ 1,519     $ 585  
Losses and loss expenses incurred
    (38 )     (54 )     58       21  
Losses and loss expenses paid
    (153 )     (58 )     (95 )     (19 )

Reserve for losses and loss expenses at end of period
  $ 1,154     $ 405     $ 1,482     $ 587  

Combined:
                               
Reserve for losses and loss expenses at beginning of year
  $ 2,445     $ 855     $ 2,612     $ 891  
Losses and loss expenses incurred
    204       2       203       55  
Losses and loss expenses paid
    (404 )     (148 )     (409 )     (70 )

Reserve for losses and loss expenses at end of period
  $ 2,245     $ 709     $ 2,406     $ 876  

      The gross and net IBNR included in the aforementioned reserve for losses and loss expenses at September 30, 2001 and December 31, 2000 were estimated as follows:

(in millions)


                                 
2001 2000


Gross Net Gross Net

Combined
  $ 1,039     $ 273     $ 1,042     $ 314  

      A summary of asbestos and environmental claims count activity for the nine month periods ended September 30, 2001 and 2000 was as follows:

                                                   

2001 2000


Asbestos Environmental Combined Asbestos Environmental Combined

Claims at beginning of year
    6,796       11,323       18,119       6,746       13,432       20,178  
Claims during year:
                                               
 
Opened
    587       1,517       2,104       487       1,301       1,788  
 
Settled
    (95 )     (897 )     (992 )     (79 )     (449 )     (528 )
 
Dismissed or otherwise resolved
    (638 )     (2,354 )     (2,992 )     (351 )     (2,465 )     (2,816 )

Claims at end of period
    6,650       9,589       16,239       6,803       11,819       18,622  

19


Table of Contents

      The average cost per claim settled, dismissed or otherwise resolved for the nine month periods ended September 30, 2001 and 2000 was as follows:


                                 
2001 2000


Gross Net Gross Net

Asbestos
  $ 342,400     $ 122,800     $ 730,200     $ 118,600  
Environmental
    47,100       17,800       32,600       6,500  
Combined
    101,400       37,100       122,300       20,900  

      A.M. Best, an insurance rating agency, has developed a survival ratio to measure the number of years it would take a company to exhaust both its asbestos and environmental reserves for losses and loss expenses based on that company’s current level of asbestos and environmental claims payments. This is a ratio derived by taking the current ending losses and loss expense reserves and dividing by the average annual payments for the prior three years. Therefore, the ratio derived is a simplistic measure of an estimate of the number of years it would be before the current ending losses and loss expense reserves would be paid off using recent average payments. The higher the ratio, the more years the reserves for losses and loss expenses cover these claims payments. These ratios are computed based on the ending reserves for losses and loss expenses over the respective claims settlements during the fiscal year. Such payments include indemnity payments and legal and loss adjustment payments. It should be noted, however, that this is an extremely simplistic approach to measuring asbestos and environmental reserve levels. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments thereof and the resultant ratio.

      The developed survival ratios include both involuntary and voluntary indemnity payments. Involuntary payments are primarily attributable to court judgments, court orders, covered claims with no coverage defenses, state mandated cleanup costs, claims where AIG’s coverage defenses are minimal, and settlements made less than six months before the first trial setting. Also, AIG considers all legal and loss adjustment payments as involuntary.

      AIG believes voluntary indemnity payments should be excluded from the survival ratio. The special asbestos and environmental claims unit actively manages AIG’s asbestos and environmental claims and proactively pursues early settlement of environmental claims for all known and unknown sites. As a result, AIG reduces its exposure to future environmental loss contingencies.

      AIG’s survival ratios for involuntary asbestos and environmental claims, separately and combined, were based upon a three year average payment. These ratios at September 30, 2001 and 2000 were as follows:


                                   
2001 2000


Gross Net Gross Net

Involuntary survival ratios:
                               
 
Asbestos
    3.2       3.8       2.9       5.1  
 
Environmental
    17.5       16.0       20.7       19.4  
 
Combined
    6.6       8.0       7.8       12.2  

      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 2000 were $15 million. Based upon current information, AIG does not anticipate that its net assessment will be significantly different in 2001.

      AIG is also required to participate in various involuntary pools (principally workers’ compensation business) which provide insurance coverage for those not able to obtain such coverage in the voluntary markets. This participation is also recorded upon notification, as these amounts cannot reasonably be estimated.

Life Insurance Operations

      AIG’s life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of single premium annuity, variable annuities, guaranteed investment contracts, universal life and pensions.

20


Table of Contents

      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 three separate operations, the life insurance subsidiaries of AGC, 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. The domestic subsidiaries of AIG and SunAmerica sell primarily financial and investment type products, while AGC’s subsidiaries sell these as well as traditional life products. (See also Note (e) of Notes to Financial Statements.)

      Life insurance operations for the nine month periods ending September 30, 2001 and 2000 were as follows:

(in millions)


                   
2001 2000

Premium income:
               
 
Domestic
  $ 3,763     $ 3,572  
 
Foreign
    10,303       9,061  

Total
  $ 14,066     $ 12,633  

Net investment income:
               
 
Domestic
  $ 6,025     $ 5,477  
 
Foreign
    2,662       2,330  

Total
  $ 8,687     $ 7,807  

Operating income before realized capital losses:
               
 
Domestic
  $ 2,143     $ 2,051  
 
Foreign
    1,984       1,645  

Total
    4,127       3,696  
Realized capital losses
    (4 )     (123 )

Operating income
  $ 4,123     $ 3,573  

Life insurance in-force:*
               
 
Domestic
  $ 505,724     $ 477,576  
 
Foreign
    716,183       494,316  

Total
  $ 1,221,907     $ 971,892  

Amounts presented were as at September 30, 2001 and December 31, 2000, respectively. September 30, 2001, included AIG Star Life Insurance Co., Ltd., (formerly The Chiyoda Mutual Life Insurance Company).

     AIG’s life premium income during the first nine months of 2001 represented a 11.3 percent increase from the same period in 2000. Foreign life operations produced 73.2 percent and 71.7 percent of the life premium income in 2001 and 2000, respectively.

      The traditional life products, particularly individual life products, were major contributors to the growth in foreign premium income. These traditional life products, coupled with the increased distribution of financial and investment products contributed to the growth in foreign investment income. A mixture of traditional, accident and health and financial products are being sold in Japan through ALICO.

      As previously discussed, the U.S. dollar strengthened in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, for the first nine months of 2001, when foreign life premium income was translated into U.S. dollars for purposes of the preparation of the consolidated financial statements, total life premium income was approximately 6.8 percentage points less than it would have been if translated utilizing exchange rates prevailing in 2000.

      Life insurance net investment income increased 11.3 percent during the first nine months of 2001. The growth in net investment income was primarily attributable to both foreign and domestic new cash flow for investment. The new cash flow was generated from life insurance operations and included the compounding of previously earned and reinvested net investment income. (See also the discussion under “Liquidity” herein.)

      Life insurance realized capital gains (losses) for the first nine months were $4 million in 2001 and $123 million in 2000. These realized capital gains (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

21


Table of Contents

securities and available for sale fixed maturities as well as redemptions of fixed maturities.

      Life insurance operating income increased 15.4 percent to $4.12 billion during the first nine months of 2001 when compared to the same period last year. Estimated WTC and related losses recorded in the third quarter of 2001 amount to $131 million. Adjusted life operating income, which excludes such losses, AGC’s home services operating income which is being managed as a “closed block,” as well as realized capital gains (losses), increased 15.2 percent to $4.26 billion during the first nine months of 2001 when compared to the same period last year. The contribution of life insurance operating income to income before income taxes, minority interest and cumulative effect of accounting changes amounted to 76.1 percent during the first nine months of 2001 compared to 48.8 percent in the same period of 2000.

      The risks associated with the traditional life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is investment risk.

      Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG’s foreign life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately one million dollars of coverage and AIG’s domestic life companies, including those of AGC, limit their maximum underwriting exposure on traditional life insurance of a single life to $2.5 million of coverage by using yearly renewable term reinsurance.

      The investment risk represents the exposure to loss resulting from the cash flows from the invested assets, primarily long-term fixed rate investments, being less than the cash flows required to meet the obligations of the expected policy and contract liabilities and the necessary return on investments.

      To minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to assess whether there is a liquidity excess or deficit. If a rebalancing of the invested assets to the policy and contract claims became necessary and did not occur, a demand could be placed upon liquidity. (See also the discussion under “Liquidity” herein.)

      The asset-liability relationship is appropriately managed in AIG’s foreign operations, as it has been throughout AIG’s history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of the related policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the initial investments may be at a yield below that of the interest required for the accretion of the policy liabilities. At December 31, 2000, the average duration of the investment portfolio in Japan was 6.0 years.

      Additionally, there exists a future investment risk associated with certain policies currently in force which will have premium receipts in the future. That is, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities. The anticipated average period for the receipt and investment of these future premium receipts is 6.1 years. These durations compare with an estimated average duration of 10.4 years for the corresponding policy liabilities. These durations have not changed significantly during 2001. To maintain an adequate yield to match the interest necessary to support future policy liabilities, constant management focus is required to reinvest the proceeds of the maturing securities and to invest the future premium receipts without sacrificing investment quality. To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and to support any operational shortfall through its international financial network. (See also the discussion under “Liquidity” herein.)

      The asset-liability relationship is appropriately managed in AIG’s domestic operations, as there is ample supply of qualified long-term investments.

      AIG uses asset-liability matching as a management tool worldwide to determine the composition of the invested assets and marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in

22


Table of Contents

an unmatched position due to anticipated interest rate or other economic changes.

Financial Services Operations

      AIG’s financial services subsidiaries engage in diversified financial products and services including premium financing, banking services and consumer finance services.

      International Lease Finance Corporation (ILFC) engages primarily in the acquisition of new and used commercial jet aircraft and the leasing and remarketing of such aircraft to airlines around the world. Also, ILFC provides, for a fee, fleet management services to certain third-party operators. (See also Note (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’s Consumer Finance Group includes primarily American General Finance, Inc. and its subsidiaries (AGF) as well as AIG Consumer Finance Group, Inc.

      AGF provides a wide variety of consumer finance products, including mortgages, consumer loans, retail sales finance and credit related insurance to customers in the United States. (See also Note (e) of Notes to Financial Statements.)

      Financial services operations for the nine month periods ending September 30, 2001, and 2000 were as follows:

(in millions)


                 
2001 2000

Revenues:
               
International Lease Finance Corporation
  $ 1,937     $ 1,786  
AIG Financial Products Corp.*
    802       711  
Consumer Finance Group
    1,903       1,718  
Other
    86       95  

Total
  $ 4,728     $ 4,310  

Operating income:
               
International Lease Finance Corporation
  $ 531     $ 476  
AIG Financial Products Corp.
    524       433  
Consumer Finance Group
    386       294  
Other, including intercompany adjustments
    (30 )     (23 )

Total
  $ 1,411     $ 1,180  

Represents commissions, transaction and other fees.

     Financial services operating income increased 19.5 percent in the first nine months of 2001 over 2000.

      Financial services operating income represented 26.0 percent of AIG’s income before income taxes, minority interest and cumulative effect of accounting changes in the first nine months of 2001. This compares to 16.1 percent in the same period of 2000.

      ILFC generates its revenues primarily from leasing new and used commercial jet aircraft to domestic and foreign airlines. Revenues also result from the remarketing of commercial jets for its own account, for airlines and for financial institutions. Revenues in the first nine months of 2001 increased 8.4 percent from the same period of 2000. The revenue growth resulted primarily from the increase in flight equipment available for operating lease and the increase in the relative cost of the leased fleet. Approximately 20 percent of ILFC’s operating lease revenues are derived from U.S. and Canadian airlines. During the first nine months of 2001, operating income increased 11.4 percent from the same period of 2000. ILFC finances its purchases of aircraft primarily through the issuance of a variety of debt instruments. The composite borrowing rates at the end of the first nine months of 2001 and 2000 were 5.21 percent and 6.38 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 September 30, 2001, there were 437 aircraft subject to operating leases and there was one aircraft off lease. Approximately 80 percent of ILFC’s fleet is leased to non-U.S. and Canadian carriers and this fleet, the most efficient in the airline industry, continues to be in high demand from such carriers. (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

23


Table of Contents

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 nine months of 2001 increased 12.8 percent from the same period of 2000. During the first nine months of 2001, operating income increased 21.2 percent from the same period of 2000. As AIGFP is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance. (See also the discussions under “Capital Resources,” “Liquidity” and “Derivatives” herein and Note (e) of Notes to Financial Statements.)

      AGF derives a substantial portion of its revenues from finance charges assessed on outstanding mortgages and finance receivables. AIG Consumer Finance Group, Inc., through its subsidiaries, is engaged in developing a multi-product consumer finance business with an emphasis on emerging markets.

      Revenues in the first nine months of 2001 increased 10.8 percent from the same period of 2000. The growth in revenues was generally due to the growth in the average finance receivables and higher finance margins. During the first nine months of 2001, operating income increased 31.1 percent from the same period of 2000. The increase in operating income resulted from the growth as described above.

      AGF is exposed to loss when contractual payments are not received. AGF manages its collection exposure through the mix of types of loans and security thereon. (See also the discussions under “Capital Resources” and “Liquidity” herein and Note (e) of Notes to Financial Statements.)

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 four principal asset management operations are SunAmerica’s asset management operations (SAAMCo), AIG Global Investment Group, Inc. and its subsidiaries (Global Investment), AIG Capital Partners, Inc. (Cap Partners) and AGC’s asset management operations through The Variable Annuity Life Insurance Company (VALIC). SAAMCo develops and sells variable annuities and other investment products, sells and manages mutual funds and provides financial services. Global Investment manages third-party institutional, retail and private equity funds invested assets on a global basis, and provides custodial services. Cap Partners organizes, and manages the invested assets of institutional investment funds and may also invest in such funds. VALIC provides tax qualified annuities to the employees of educational, healthcare and governmental entities. Each of these subsidiary operations receives fees for investment products and services provided.

      Asset management operations for the nine month periods ending September 30, 2001 and 2000 were as follows:

(in millions)


                 
2001 2000

Revenues:
               
AGC
  $ 1,725     $ 1,684  
SunAmerica
    507       566  
Other
    376       341  

Total
  $ 2,608     $ 2,591  

Operating Income:
               
AGC
  $ 533     $ 511  
SunAmerica
    169       242  
Other
    115       79  

Total
  $ 817     $ 832  

      Asset management operating income in the first nine months of 2001 decreased 1.8 percent when compared to the same period of 2000.

      Asset management operating income represented 15.1 percent of AIG’s income before income taxes, minority interest and cumulative effect of accounting changes in the first nine months of 2001. This compares to 11.4 percent in the same period of 2000.

      At September 30, 2001, AIG’s third party assets under management, including both retail mutual funds and institutional accounts, approximated $37 billion.

Other Operations

Other realized capital losses amounted to $398 million, and $140 million in the first nine months of 2001 and 2000, respectively.

24


Table of Contents

      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 nine months of 2001, net deductions amounted to $487 million. In the same period of 2000, net deductions amounted to $476 million. Acquisition, restructuring and related charges of $2.02 billion were incurred in connection with the acquisition of AGC, including $654 million paid by AGC in connection with the termination of AGC’s merger with Prudential plc. Charges of $315 million in the first nine months of 2000 were incurred by AGC in connection with acquisitions by AGC prior to its acquisition by AIG. (See also Note (j) of Notes to Financial Statements.)

      Income before income taxes, minority interest and cumulative effect of accounting changes amounted to $5.42 billion in the first nine months of 2001. Income before income taxes and minority interest amounted to $7.33 billion in the same period of 2000.

      In the first nine months of 2001, AIG recorded a provision for income taxes of $1.54 billion compared to the provision of $2.18 billion in the same period of 2000. These provisions represent effective tax rates of 28.3 percent in the first nine months of 2001, and 29.8 percent in the same period of 2000.

      Minority interest represents minority shareholders’ equity in income of certain majority-owned consolidated subsidiaries. Minority interest amounted to $254 million and $306 million in the first nine months of 2001 and 2000, respectively.

      Income before the cumulative effect of accounting changes amounted to $3.63 billion in the first nine months of 2001 and $4.84 billion in the same period of 2000.

      Refer to “Accounting Standards” herein for details of the cumulative effect of accounting changes.

      Net income amounted to $3.50 billion in the first nine months of 2001 and $4.84 billion in the same period of 2000. The decreases in net income over the periods resulted from those factors described above.

Capital Resources

At September 30, 2001, AIG had total capital funds of $50.79 billion and total borrowings of $66.63 billion. At that date, $60.09 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable.

      Total borrowings and borrowings not guaranteed or matched at September 30, 2001 and December 31, 2000 were as follows:

                   
(in millions)

2001 2000

GIAs — AIGFP
  $ 16,308     $ 13,595  

Commercial Paper:
               
 
AGC(a)
    3,217       1,921  
 
AGF(a)
    4,187       5,162  
 
AIG Funding, Inc.
    2,849       968  
 
ILFC(a)
    4,324       4,259  
 
A.I. Credit Corp.
          597  
 
AIG Finance (Taiwan) Limited(a)
    110       104  
 
AIG Credit Card Company (Taiwan)(a)
    56       36  

 
Total
    14,743       13,047  

Medium Term Notes:
               
 
AGF(a)
    4,229       3,069  
 
ILFC(a)
    4,291       3,175  
 
AIG
    594       582  

 
Total
    9,114       6,826  

Notes and Bonds Payable:
               
 
ILFC(a)
    6,418       5,529  
 
AIGFP
    13,816       8,755  
 
AIG
    733       720  
 
AGC(a)
    1,339       1,338  
 
AGF(a)
    2,201       2,602  

 
Total
    24,507       18,944  

Loans and Mortgages Payable:
               
 
ILFC(a)(b)
    398       463  
 
AIG Finance (Hong Kong) Limited(a)
    297       346  
 
AIG Consumer Finance Group, Inc.(a)
    814       662  
 
AIG
    445       440  

 
Total
    1,954       1,911  

 
Total Borrowings
    66,626       54,323  

Borrowings not guaranteed by AIG
    31,881       28,666  
Matched GIA borrowings
    16,308       13,595  
Matched notes and bonds payable — AIGFP
    11,898       8,127  

      60,087       50,388  

Remaining borrowings of AIG
  $ 6,539     $ 3,935  

(a) These borrowings were not guaranteed or supported by AIG at September 30, 2001.
(b) Capital lease obligations.

25


Table of Contents

     The maturity distributions of total borrowings at September 30, 2001 and December 31, 2000 were as follows:

(in millions)


                 
2001 2000

Short-term borrowings
  $ 19,365     $ 16,254  
Long-term borrowings(a)
    47,261       38,069  

Total borrowings
  $ 66,626     $ 54,323  

(a) Including commercial paper and excluding that portion of long-term debt maturing in less than one year.

     During the first nine months of 2001, AIGFP increased the aggregate principal amount outstanding of its notes and bonds payable to $13.8 billion. AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities and derivative transactions. The funds may also be temporarily invested in securities purchased under agreements to resell. (See also the discussions under “Operational Review”, “Liquidity” and “Derivatives” herein.)

      AIG Funding, Inc. (Funding), through the issuance of commercial paper, fulfills the short-term cash requirements of AIG and its non-insurance subsidiaries. Funding intends to continue to meet AIG’s funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of Funding’s commercial paper is subject to the approval of AIG’s Board of Directors. ILFC and A.I. Credit Corp. (AICCO) as well as AIG Credit Card Company (Taiwan) — (AIGCCC-Taiwan) and AIG Finance (Taiwan) Limited — (AIGF-Taiwan), both consumer finance subsidiaries in Taiwan, AGC and AGF have issued commercial paper for the funding of their own operations. At September 30, 2001, AIG did not guarantee or support the commercial paper of any of its subsidiaries other than Funding but as of November 2001, AIG guarantees the commercial paper of AGC. In early 2001, AICCO ceased issuing commercial paper under its program and the agreement which AIG had provided supporting the commercial paper was terminated; AICCO’s funding requirements are now met through Funding’s program. (See also the discussion under “Derivatives” herein.)

      AIG and Funding have entered into syndicated revolving credit facilities (collectively, the Facility) aggregating $1.5 billion. The Facility consists of $1.0 billion in a short-term revolving credit facility and a $500 million five year revolving credit facility. The Facility can be used for general corporate purposes and also to provide backup for AIG’s commercial paper programs administered by Funding. There are currently no borrowings outstanding under the Facility, nor were any borrowings outstanding as of September 30, 2001.

      AGC and AGF have entered into a $5.2 billion unsecured bank credit facility to support their commercial paper borrowings. There were no borrowings under this facility as of September 30, 2001. AGC had $400 million in aggregate principal amount of debt securities registered and available for issuance as of September 30, 2001. AGF had $3.5 billion in aggregate principal amount of debt securities registered and available for issuance at September 30, 2001. AGC uses the proceeds from the issuance of notes and bonds for general corporate purposes. AGF uses the proceeds from the issuance of notes and bonds for the funding of its finance receivables. As of November 2001, AIG guarantees the notes and bonds of AGC.

      At September 30, 2001, ILFC had increased the aggregate principal amount outstanding of its medium term and term notes to $10.71 billion, a net increase of $2.0 billion, and recorded a net decline in its capital lease obligations of $65 million and a net increase in its commercial paper of $65 million. At September 30, 2001, ILFC had $2.50 billion in aggregate principal amount of debt securities registered for issuance from time to time. In addition, ILFC has a Euro Medium Term Note Program for $2.0 billion, under which $771 million in notes were sold through September 30, 2001.

      ILFC has a $4.3 billion Export Credit Facility for use in connection with the purchase of approximately 75 aircraft to be delivered through 2001. ILFC has the right, but is not required, to use the facility to fund 85 percent of each aircraft’s purchase price. This facility is guaranteed by various European Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90 percent on these aircraft depending on the delivery date of the aircraft. Through September 30, 2001, ILFC borrowed $2.8 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

26


Table of Contents

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 nine months of 2001, AIG issued $129 million principal amount of medium term notes and $117 million of previously issued notes matured. At September 30, 2001, AIG had $652 million in aggregate principal amount of debt securities registered for issuance from time to time.

      On November 9, 2001, AIG received proceeds of approximately $1 billion from the issuance of Zero Coupon Convertible Senior Debentures Due 2031 with an aggregate principal amount at maturity of approximately $1.52 billion.

      AIG’s capital funds increased $3.35 billion during the first nine months of 2001. Unrealized appreciation of investments, net of taxes increased $1.63 billion. During the first nine months of 2001, the cumulative translation adjustment loss, net of taxes, increased $346 million. The change from period to period with respect to the unrealized appreciation of investments, net of taxes was primarily impacted by the decline in domestic interest rates. The transfer of bonds in the held to maturity, at amortized cost category to the bonds available for sale, at market value category in accordance with the transition provisions of FASB 133 resulted in a gain of $339 million recorded in the statement of comprehensive income as a cumulative effect of an accounting change adjustment. (See also the discussion under “Operational Review” and “Liquidity” herein.) At September 30, 2001, capital funds included a cumulative effect of an accounting change adjustment gain of $150 million. During the first nine months of 2001, there was a loss of $531 million, net of taxes relating to derivative contracts designated as cash flow hedging instruments. (See also the discussion under Notes to Financial Statements and the Consolidated Statement of Comprehensive Income.) During the first nine months of 2001, retained earnings increased $2.87 billion, resulting from net income less dividends.

      During the period from January 2001 through September 30, 2001, AIG repurchased in the open market 13,619,900 shares of its common stock. Included in these repurchases were approximately 10 million shares which were exempt from pooling of interests accounting restrictions under orders issued by the SEC following the WTC disaster. 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 September 30, 2001, there were no significant statutory or regulatory issues which would impair AIG’s financial condition, results of operations or liquidity. To AIG’s knowledge, no AIG company is on any regulatory or similar “watch list”. (See also the discussion under “Liquidity” herein.)

      AIG’s insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and jurisdictions in which they do business. The National Association of Insurance Commissioners (NAIC) has developed Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company’s statutory surplus to the risk inherent in its overall operations. At September 30, 2001, the adjusted capital of each of AIG’s domestic general companies and of each of AIG’s domestic life companies exceeded each of their RBC standards by considerable margins.

      A substantial portion of AIG’s general insurance business and a majority of its life insurance business are conducted in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to AIG subsidiaries are subject to modification and revocation. Thus, AIG’s insurance subsidiaries could be prevented from conducting future business in certain of the jurisdictions where they currently operate. AIG’s international operations include operations in various developing nations. Both current and future foreign operations could be adversely affected by unfavorable political developments up to and including nationalization of AIG’s operations without compensation. Adverse effects resulting from any one country may impact AIG’s results of operations, liquidity and financial condition depending on the

27


Table of Contents

magnitude of the event and AIG’s net financial exposure at that time in that country.

Liquidity

AIG’s liquidity is primarily derived from the operating cash flows of its general and life insurance operations.

      At September 30, 2001, AIG’s consolidated invested assets included $10.13 billion of cash and short-term investments. Consolidated net cash provided from operating activities in the first nine months of 2001 amounted to $7.77 billion.

      Sources of funds considered in meeting the objectives of AIG’s financial services operations include guaranteed investment agreements, issuance of long and short-term debt, maturities and sales of securities available for sale, securities sold under repurchase agreements, trading liabilities, securities and spot commodities sold but not yet purchased, issuance of equity, and cash provided from such operations. AIG’s strong capital position is integral to managing this liquidity, as it enables AIG to raise funds in diverse markets worldwide. (See also the discussions under “Capital Resources” herein.)

      Management believes that AIG’s liquid assets, its net cash provided by operations, and access to the capital markets will enable it to meet any foreseeable cash requirements.

      The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG’s insurance operations generated approximately $23.3 billion in pre-tax cash flow during the first nine months of 2001. 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 $10.3 billion in investment income cash flow during the first nine months of 2001. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains net of realized capital losses.

      In addition to the combined insurance pre-tax operating cash flow, AIG’s insurance operations held $8.87 billion in cash and short-term investments at September 30, 2001. The aforementioned operating cash flow and the cash and short-term balances held provided AIG’s insurance operations with a significant amount of liquidity.

      This liquidity is available, among other things, to purchase high quality and diversified fixed income securities and to a lesser extent marketable equity securities and to provide mortgage loans on real estate, policy loans and collateral loans. This cash flow coupled with proceeds of approximately $71 billion from the maturities, sales and redemptions of fixed income securities and from the sale of equity securities was used to purchase approximately $87 billion of fixed income securities and marketable equity securities during the first nine months of 2001.

      The following table is a summary of AIG’s invested assets by significant segment, including investment income due and accrued of $3.79 billion and $3.52 billion and real estate of $2.16 billion and $2.08 billion, at September 30, 2001 and December 31, 2000, respectively:

(dollars in millions)


                                 
September 30, 2001 December 31, 2000


Invested Percent Invested Percent
Assets of Total Assets of Total

General insurance
  $ 44,153       12.6 %   $ 42,892       14.1 %
Life insurance
    202,016       57.6       171,019       56.2  
Financial services and asset management
    103,389       29.5       89,479       29.4  
Other
    911       0.3       831       0.3  

Total
  $ 350,469       100.0 %   $ 304,221       100.0 %

28


Table of Contents

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 September 30, 2001 and December 31, 2000:

(dollars in millions)


                                                   
Percent Distribution
General Life Percent
September 30, 2001 Insurance Insurance Total of Total Domestic Foreign

Fixed maturities:
                                               
 
Available for sale, at market value(a)
  $ 30,318     $ 157,946     $ 188,264       76.5 %     73.3 %     26.7 %
Equity securities, at market value(b)
    4,347       2,479       6,826       2.8       55.7       44.3  
Mortgage loans on real estate, policy and collateral loans
    65       16,609       16,674       6.8       73.2       26.8  
Short-term investments, including time deposits, and cash
    1,759       7,106       8,865       3.6       63.8       36.2  
Real estate
    414       1,614       2,028       0.8       25.3       74.7  
Investment income due and accrued
    589       3,079       3,668       1.5       64.0       36.0  
Other invested assets
    6,661       13,183       19,844       8.0       80.8       19.2  

Total
  $ 44,153     $ 202,016     $ 246,169       100.0 %     72.5 %     27.5 %

(a) Includes $915 million of bonds trading securities, at market value.
(b) Includes $1.37 billion of non-redeemable preferred stocks, at market value.

(dollars in millions)


                                                   
Percent Distribution
General Life Percent
December 31, 2000 Insurance Insurance Total of Total Domestic Foreign

Fixed maturities:
                                               
 
Available for sale, at market value(a)
  $ 18,168     $ 135,212     $ 153,380       71.7 %     71.6 %     28.4 %
 
Held to maturity, at amortized cost
    11,533             11,533       5.4       100.0        
Equity securities, at market value(b)
    4,666       3,112       7,778       3.6       60.0       40.0  
Mortgage loans on real estate, policy and collateral loans
    65       16,860       16,925       7.9       74.0       26.0  
Short-term investments, including time deposits, and cash
    1,448       4,839       6,287       2.9       51.6       48.4  
Real estate
    408       1,565       1,973       0.9       25.3       74.7  
Investment income due and accrued
    584       2,773       3,357       1.6       64.0       36.0  
Other invested assets
    6,020       6,658       12,678       6.0       88.4       11.6  

Total
  $ 42,892     $ 171,019     $ 213,911       100.0 %     72.8 %     27.2 %

(a) Includes $846 million of bonds trading securities, at market value.
(b) Includes $1.19 billion of non-redeemable preferred stocks, at market value.

     Generally, insurance regulations restrict the types of assets in which an insurance company may invest.

      With respect to fixed maturities, AIG’s general strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations. With respect to general insurance, AIG’s strategy is to invest in longer duration fixed maturities to maximize the yields at the date of purchase. With respect to life insurance, AIG’s strategy is to produce cash flows required to meet maturing insurance liabilities. (See also the discussion under “Operational Review: Life Insurance Operations” herein.)

      The fixed maturity available for sale portfolio is subject to decline in fair value as interest rates rise. Such declines in fair value are presented as a component of comprehensive income in unrealized appreciation of investments, net of taxes.

      At September 30, 2001, approximately 73 percent of the fixed maturities investments were domestic securities. Approximately 31 percent of such domestic securities were rated AAA. Approximately 9 percent were below investment grade or not rated.

      A significant portion of the foreign insurance fixed income portfolio is rated by Moody’s, Standard & Poor’s (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At September 30, 2001, approximately 10 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

29


Table of Contents

securities so rated. Approximately 15 percent were below investment grade or not rated at that date. A large portion of the foreign insurance fixed income portfolio are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance.

      At September 30, 2001, approximately 19 percent of the fixed maturities portfolio was collateralized mortgage obligations (CMOs), including commercial mortgage backed securities. Substantially all of the CMOs were investment grade and approximately 28 percent of the CMOs were backed by various U.S. government agencies. CMOs are exposed to interest rate risk as the duration and ultimate realized yield would be affected by the accelerated prepayments of the underlying mortgages.

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

      AIG invests in equities for various reasons, including diversifying its overall exposure to interest rate risk. Equity securities are subject to declines in fair value. Such declines in fair value are presented in unrealized appreciation of investments, net of taxes as a component of comprehensive income.

      Mortgage loans on real estate, policy and collateral loans comprised 6.8 percent of AIG’s insurance invested assets at September 30, 2001. AIG’s insurance operations’ holdings of real estate mortgages amounted to $10.59 billion of which 86.0 percent was domestic. At September 30, 2001, only a nominal amount were in default. It is AIG’s practice to maintain a maximum loan to value ratio of 75 percent at loan origination. At September 30, 2001, AIG’s insurance holdings of collateral loans amounted to $692 million, all of which were foreign. It is AIG’s strategy to enter into mortgage and collateral loans as an adjunct primarily to life insurance fixed maturity investments. AIG’s policy loans decreased from $5.47 billion at December 31, 2000 to $5.39 billion at September 30, 2001.

      Short-term investments represent amounts invested in various internal and external money market funds, time deposits and cash held.

      AIG’s real estate investment properties are primarily occupied by AIG’s various operations. The current market value of these properties considerably exceeds their carrying value.

      Other invested assets were primarily comprised of both foreign and domestic private placements, limited partnerships and outside managed funds.

      When permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from adverse movements in foreign currency exchange rates, interest rates and equity prices, AIG and its insurance subsidiaries may enter into derivative transactions as end users. To date, such activities have not been significant. (See also the discussion under “Derivatives” herein.)

      In certain jurisdictions, significant regulatory and/or foreign governmental barriers exist which may not permit the immediate free flow of funds between insurance subsidiaries or from the insurance subsidiaries to AIG parent. These barriers generally cause only minor delays in the outward remittance of the funds.

      AIG’s insurance operations are exposed to market risk. Market risk is the risk of loss of fair value resulting from adverse fluctuations in interest and foreign currency exchange rates and equity prices.

      Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (VaR). VaR is a summary statistical measure that uses historical interest and foreign currency exchange rates and equity prices and estimates the volatility and correlation of each of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability.

      AIG believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management.

      AIG has performed a VaR analysis to estimate the maximum potential loss of fair value for each of AIG’s insurance segments and for each market risk within each insurance segment. In this analysis, financial instrument assets include the domestic and

30


Table of Contents

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 September 30, 2001 and December 31, 2000. AIG’s methodology for calculating VaR and the results of the calculations presented herein were performed using historical simulation. Using historical simulation over the delta-normal approach does not significantly change the results of this disclosure. The historical simulation methodology entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical market information for interest rates, foreign exchange rates, and equity index prices were used to construct the historical scenarios. For each scenario, each transaction was re-priced. Portfolio, business unit and finally AIG-wide scenario values were then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum potential loss incurred by these scenarios with 95% confidence (i.e., only 5% of historical scenarios show losses greater than the VaR figure). A one month holding period was assumed in computing the VaR figure.

      The following table presents the VaR on a combined basis and of each component of market risk for each of AIG’s insurance segments as of September 30, 2001 and December 31, 2000. VaR with respect to combined operations cannot be derived by aggregating the individual risk or segment amounts presented herein.

(in millions)


                                 
General Insurance Life Insurance


Market Risk 2001 2000 2001 2000

Combined
  $ 810     $ 744     $ 1,675     $ 1,456  
Interest rate
    441       454       1,631       1,422  
Currency
    42       59       175       373  
Equity
    778       603       332       384  

      The following table presents the average, high and low VaRs on a combined basis and of each component of market risk for each of AIG’s insurance segments as of September 30, 2001 and December 31, 2000.

(in millions)


                                                   
2001 2000


Average High Low Average High Low

General Insurance
                                               
Market Risk
                                               
 
Combined
  $ 802     $ 837     $ 744     $ 811     $ 954     $ 737  
 
Interest rate
    455       464       441       419       454       338  
 
Currency
    49       59       42       49       65       29  
 
Equity
    749       812       603       694       828       603  
Life Insurance
                                               
Market Risk
                                               
 
Combined
  $ 1,495     $ 1,675     $ 1,354     $ 1,355     $ 1,456     $ 1,254  
 
Interest rate
    1,472       1,631       1,364       1,296       1,422       1,169  
 
Currency
    244       373       175       430       566       372  
 
Equity
    364       384       332       423       384       462  

31


Table of Contents

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 September 30, 2001 and December 31, 2000. (See also the discussions under “Operational Review: Financial Services Operations”, “Operational Review: Asset Management Operations”, “Capital Resources” and “Derivatives” herein.)

(dollars in millions)


                                 
2001 2000


Invested Percent Invested Percent
Assets of Total Assets of Total

Flight equipment primarily under operating leases, net of accumulated depreciation
  $ 22,027       21.3 %   $ 19,325       21.6 %
Finance receivables, net of allowance
    11,196       10.8       11,378       12.7  
Unrealized gain on interest rate and currency swaps, options and forward transactions
    12,863       12.4       10,235       11.5  
Securities available for sale, at market value
    17,123       16.6       14,669       16.4  
Trading securities, at market value
    6,631       6.4       7,347       8.2  
Securities purchased under agreements to resell, at contract value
    19,546       18.9       14,979       16.7  
Trading assets
    7,921       7.7       7,045       7.9  
Spot commodities, at market value
    498       0.5       363       0.4  
Other, including short-term investments
    5,584       5.4       4,138       4.6  

Total
  $ 103,389       100.0 %   $ 89,479       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 nine months of 2001, ILFC acquired flight equipment costing $3.51 billion.

      ILFC is exposed to market risk and the risk of loss of fair value resulting from adverse fluctuations in interest rates. As of September 30, 2001 and December 31, 2000, AIG statistically measured the aforementioned loss of fair value through the application of a VaR model. In this analysis, the net fair value of ILFC was determined using the financial instrument assets which included the tax adjusted future flight equipment lease revenue and the financial instrument liabilities which included the future servicing of the current debt. The estimated impact of the current derivative positions was also taken into account.

      AIG calculated the VaR with respect to the net fair value of ILFC using the historical simulation methodology, as previously described. As of September 30, 2001 and December 31, 2000, the VaR with respect to the aforementioned net fair value of ILFC was approximately $7 million and $11 million, respectively.

      AIGFP’s derivative transactions are carried at market value or at estimated fair value when market prices are not readily available. AIGFP reduces its economic risk exposure through similarly valued offsetting transactions including swaps, trading securities, options, forwards and futures. The estimated fair values of these transactions represent assessments of the present value of expected future cash flows. These transactions are exposed to liquidity risk if AIGFP were to sell or close out the transactions prior to maturity. AIG believes that the impact of any such limited liquidity would not be significant to AIG’s financial condition or its overall liquidity. (See also the discussion under “Operational Review: Financial Services Operations” and “Derivatives” herein.)

      AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities, including securities available for sale, at market, and derivative transactions. The funds may also be temporarily 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 September 30, 2001, the average credit rating of this portfolio was AA or the equivalent thereto as deter-

32


Table of Contents

mined through rating agencies or internal review. AIGFP has also entered into credit derivative transactions to hedge its credit risk associated with $182 million of these securities. There were no securities deemed below investment grade at September 30, 2001. There have been no significant downgrades through November 1, 2001. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP takes possession of or obtains a security interest in securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring counterparty credit exposure and, when AIGFP deems necessary, it requires additional collateral to be deposited. Trading securities, at market value are marked to market daily and are held to meet the short-term risk management objectives of AIGFP.

      AIG Trading Group Inc. and its subsidiaries (AIGTG) conduct, 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 September 30, 2001 were as follows:

(in millions)


                 
Gross Gross
Unrealized Unrealized
Gains Losses

Securities available for sale, at market value
  $ 1,112     $ 1,080  
Unrealized gain/loss on interest rate and currency swaps, options and forward transactions(a)(b)
    12,863       10,548  
Trading assets
    7,226       5,696  
Spot commodities, at market value
          36  
Trading liabilities
          1,757  
Securities and spot commodities sold but not yet purchased, at market value
    274        

(a)These amounts are also presented as the respective balance sheet amounts.

(b)At September 30, 2001, AIGTG’s replacement values with respect to interest rate and currency swaps were $503 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 September 30, 2001, the unrealized gains and losses remaining after the benefit of the offsets were $70 million and $38 million, respectively.

      Trading securities, at market value, and securities and spot commodities sold but not yet purchased, at market value are marked to market daily with the unrealized gain or loss being recognized in income at that time. These securities and positions are held to meet the short-term risk management objectives of AIGFP and AIGTG.

      The senior management of AIG defines the policies and establishes general operating parameters for AIGFP and AIGTG. AIG’s senior management has established various oversight committees to review the various financial market, operational and credit issues of AIGFP and AIGTG. The senior managements of AIGFP and AIGTG report the results of their respective operations to and review future strategies with AIG’s senior management.

      AIG actively manages the exposures to limit potential losses, while maximizing the rewards afforded by these business opportunities. In doing so, AIG must continually manage a variety of exposures including credit, market, liquidity, operational and legal risks.

      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

33


Table of Contents

separately managed. (See the discussion on the management of credit risk below.)

      AIG’s Market Risk Management Department provides detailed independent review of AIG’s market exposures, particularly those market exposures of AIGFP and AIGTG. This department determines whether AIG’s market risks, as well as those market risks of individual subsidiaries, are within the parameters established by AIG’s senior management. Well established market risk management techniques such as sensitivity analysis are used. Additionally, this department verifies that specific market risks of each of certain subsidiaries are managed and hedged by that subsidiary.

      AIGFP is exposed to market risk due to changes in the level and volatility of interest rates and the shape and slope of the yield curve. AIGFP hedges its exposure to interest rate risk by entering into transactions such as interest rate swaps and options and purchasing U.S. and foreign government obligations.

      AIGFP is exposed to market risk due to changes in and volatility of foreign currency exchange rates. AIGFP hedges its foreign currency exchange risk primarily through the use of currency swaps, options, forwards and futures.

      AIGFP is exposed to market risk due to changes in the level and volatility of equity prices which affect the value of securities or instruments that derive their value from a particular stock, a basket of stocks or a stock index. AIGFP reduces the risk of loss inherent in its inventory in equity securities by entering into hedging transactions, including equity swaps and options and purchasing U.S. and foreign government obligations.

      AIGFP does not seek to manage the market risk of each of its transactions through an individual offsetting transaction. Rather, AIGFP takes a portfolio approach to the management of its market risk exposure. AIGFP values its portfolio at market value or estimated fair value when market values are not readily available. These valuations represent an assessment of the present values of expected future cash flows of AIGFP’s transactions and may include reserves for such risks as are deemed appropriate by AIGFP’s and AIG’s management. AIGFP evaluates the portfolio’s discounted cash flows with reference to current market conditions, maturities within the portfolio and other relevant factors. Based upon this evaluation, AIGFP determines what, if any, offsetting transactions are necessary to reduce the market risk exposure of the portfolio.

      The aforementioned estimated fair values are based upon the use of valuation models. These models utilize, among other things, current interest, foreign exchange and volatility rates. These valuation models are integrated into the evaluation of the portfolio, as described above, in order to provide timely information for the market risk management of the portfolio.

      Additionally, depending upon the changes in interest rates and other market movements during the day, the system will produce reports for management’s consideration for intra-day offsetting positions. Overnight, the system generates reports which recommend the types of offsets management should consider for the following day. Additionally, AIGFP operates in major business centers overseas and is essentially open for business 24 hours a day. Thus, the market exposure and offset strategies are monitored, reviewed and coordinated around the clock. Therefore, offsetting adjustments can be made as and when necessary from any AIGFP office in the world.

      As part of its monitoring and controlling of its exposure to market risk, AIGFP applies various testing techniques which reflect potential market movements. These techniques vary by currency and are regularly changed to reflect factors affecting the derivatives portfolio. In addition to the daily monitoring, AIGFP’s senior management and local risk managers conduct a weekly review of the derivatives portfolio and existing hedges. This review includes an examination of the portfolio’s risk measures, such as aggregate option sensitivity to movements in market variables. AIGFP’s management may change these measures to reflect their judgment and evaluation of the dynamics of the markets. This management group will also determine whether additional or alternative action is required in order to manage the portfolio.

      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

34


Table of Contents

particular transaction or group of transactions depending upon the extent of market risk AIGTG expects to reduce.

      AIGTG’s senior management has established positions and stop-loss limits for each line of business. AIGTG’s traders are required to maintain positions within these limits. These positions are monitored during the day either manually and/or through on-line computer systems. In addition, these positions are reviewed by AIGTG’s management. Reports which present each trading books position and the prior day’s profit and loss are reviewed by traders, head traders and AIGTG’s senior management. Based upon these and other reports, AIGTG’s senior management may determine to adjust AIGTG’s risk profile.

      AIGTG attempts to secure reliable current market prices, such as published prices or third party quotes, to value its derivatives. Where such prices are not available, AIGTG uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. The methodology may reflect interest and exchange rates, commodity prices, volatility rates and other relevant factors.

      A significant portion of AIGTG’s business is transacted in liquid markets. Certain of AIGTG’s derivative product exposures are evaluated using simulation techniques which consider such factors as changes in currency and commodity prices, interest rates, volatility levels and the effect of time.

      AIGFP and AIGTG are both exposed to the risk of loss of fair value from adverse fluctuations in interest rate and foreign currency exchange rates and equity and commodity prices. AIG statistically measured the losses of fair value through the application of a VaR model. AIG separately calculated the VaR with respect to AIGFP and AIGTG, as AIG manages these operations separately.

      AIGFP’s and AIGTG’s asset and liability portfolios for which the VaR analyses were performed included over the counter and exchange traded investments, derivative instruments and commodities. Because 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 September 30, 2001 and December 31, 2000. AIG’s methodology for calculating VaR and the results of the calculations presented herein were performed using historical simulation. Using historical simulation over the delta-normal approach does not significantly change the results of this disclosure. The historical simulation methodology entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical market information for interest rates, foreign exchange rates, and equity index prices were used to construct the historical scenarios. For each scenario, each transaction was re-priced. Portfolio, business unit and finally AIG-wide scenario values were then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum potential loss incurred by these scenarios with 95% confidence (i.e., only 5% of historical scenarios show losses greater than the VaR figure).

      The following table presents the VaR on a combined basis and of each component of AIGFP’s and AIGTG’s market risk as of September 30, 2001 and December 31, 2000. VaR with respect to combined operations cannot be derived by aggregating the individual risk presented herein.

(in millions)


                                 
AIGFP(a) AIGTG(b)


Market Risk 2001 2000 2001 2000

Combined
  $ 9     $ 15     $ 2     $ 6  
Interest rate
    8       15       2       4  
Currency
                2       3  
Equity
    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.

     The following table presents the average, high and low VaRs on a combined basis and of each component of AIGFP’s and AIGTG’s market risk as of September 30, 2001 and December 31, 2000.

35


Table of Contents

(in millions)


                                                   
2001 2000


Average High Low Average High Low

AIGFP Market Risk:
                                               
 
Combined
  $ 11     $ 15     $ 9     $ 15     $ 24     $ 8  
 
Interest rate
    11       15       8       15       23       7  
 
Currency
          1                          
 
Equity
    1       2             1       2        
AIGTG Market Risk:
                                               
 
Combined
  $ 3     $ 6     $ 2     $ 5     $ 6     $ 4  
 
Interest Rate
    3       4       2       3       4       3  
 
Currency
    2       3       1       3       4       2  

Derivatives

      Derivatives are financial arrangements among two or more parties whose returns are linked to or “derived” from some underlying equity, debt, commodity or other asset, liability, or index. Derivatives payments may be based on interest rates and exchange rates and/or prices of certain securities, certain commodities, or financial or commodity indices. The more significant types of derivative arrangements in which AIG transacts are swaps, forwards, futures, options and related instruments.

      The most commonly used swaps are interest rate swaps, currency swaps, equity swaps and swaptions. Such derivatives are traded over the counter. An interest rate swap is a contract between two parties to exchange interest rate payments (typically a fixed interest rate versus a variable interest rate) calculated on a notional principal amount for a specified period of time. The notional amount is not exchanged. Currency and equity swaps are similar to interest rate swaps but may involve the exchange of principal amounts at the commencement and termination of the swap. Swaptions are options where the holder has the right but not the obligation to enter into a swap transaction or cancel an existing swap transaction.

      A futures or forward contract is a legal contract between two parties to purchase or sell at a specified future date a specified quantity of a commodity, security, currency, financial index or other instrument, at a specified price. A futures contract is traded on an exchange, while a forward contract is executed over the counter.

      Over the counter derivatives are not transacted in an exchange traded environment. The futures exchanges maintain considerable financial requirements and surveillance to ensure the integrity of exchange traded futures and options.

      An option contract generally provides the option purchaser with the right but not the obligation to buy or sell during a period of time or at a specified date the underlying instrument at a set price. The option writer is obligated to sell or buy the underlying item if the option purchaser chooses to exercise his right. The option writer receives a nonrefundable fee or premium paid by the option purchaser. Options may be traded over the counter or on an exchange.

      Derivatives are generally either negotiated over the counter contracts or standardized contracts executed on an exchange. Standardized exchange traded derivatives include futures and options which can be readily bought or sold over recognized security or commodity exchanges and settled daily through such clearing houses. Negotiated over the counter derivatives include forwards, swaps and options. Over the counter derivatives are generally not traded like exchange traded securities and the terms of over the counter derivatives are non-standard and unique to each contract. However, in the normal course of business, with the agreement of the original counterparty, these contracts may be terminated early or assigned to another counterparty.

      All significant derivatives activities are conducted through AIGFP and AIGTG permitting AIG to participate in the derivatives dealer market acting primarily as principal. In these derivative operations, AIG structures agreements which generally allow its counterparties to enter into transactions with respect to changes in interest and exchange rates, securities’ prices and certain commodities and financial or commodity indices. Generally, derivatives are used by AIG’s customers such as corporations, financial institutions, multinational organizations, sovereign entities, government agencies and municipalities. For example, a futures, forward or option contract can be used to protect

36


Table of Contents

the customers’ assets or liabilities against price fluctuations.

      A counterparty may default on any obligation to AIG, including a derivative contract. Credit risk is a consequence of extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative contract when that contract has an estimated positive fair value. To help manage this risk, the credit departments of AIGFP and AIGTG operate within the guidelines of the AIG Credit Risk Committee, which sets credit policy and limits for counterparties and provides limits for derivative transactions with counterparties having different credit ratings. In addition to credit ratings, this committee takes into account other factors, including the industry and country of the counterparty. Transactions which fall outside these pre-established guidelines require the approval of the AIG Credit Risk Committee. It is also AIG’s policy to establish reserves for potential credit impairment when necessary.

      AIGFP and AIGTG determine the credit quality of each of their counterparties taking into account credit ratings assigned by recognized statistical rating organizations. If it is determined that a counterparty requires credit enhancement, then one or more enhancement techniques will be used. Examples of such enhancement techniques include letters of credit, guarantees, collateral credit triggers and credit derivatives and margin agreements.

      A significant majority of AIGFP’s transactions are contracted and documented under ISDA Master Agreements. Management believes that such agreements provide for legally enforceable set-off in the event of default. Also, under such agreements, in connection with a counterparty desiring to terminate a contract prior to maturity, AIGFP may be permitted to set-off its receivables from that counterparty against AIGFP’s payables to that same counterparty arising out of all included transactions. Excluding regulated exchange transactions, AIGTG, whenever possible, enters into netting agreements with its counterparties which are similar in effect to those discussed above.

      The following tables provide the notional and contractual amounts of AIGFP’s and AIGTG’s derivatives transactions at September 30, 2001 and December 31, 2000.

      The notional amounts used to express the extent of AIGFP’s and AIGTG’s involvement in swap transactions represent a standard of measurement of the volume of AIGFP’s and AIGTG’s swaps business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps.

      The timing and the amount of cash flows relating to AIGFP’s and AIGTG’s foreign exchange forwards and exchange traded futures and options contracts are determined by each of the respective contractual agreements.

      The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss after the application of the aforementioned strategies, netting under ISDA Master Agreements and applying collateral held. Prior to the application of these credit enhancements, the gross credit risk with respect to these derivative instruments was $58.5 billion at September 30, 2001 and $33.4 billion at December 31, 2000. Subsequent to the application of such credit enhancements, the net exposure to credit risk or the net replacement value of all interest rate, currency and equity swaps, swaptions and forward commitments approximated $12.30 billion at September 30, 2001 and $9.51 billion at December 31, 2000. The net replacement value for futures and forward contracts approximated $44 million at September 30, 2001 and $204 million at December 31, 2000. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss.

37


Table of Contents

      The following table presents AIGFP’s derivatives portfolio by maturity and type of derivative at September 30, 2001 and December 31, 2000:

(in millions)


                                                   
Remaining Life

One Two Through Six Through After Ten Total Total
Year Five Years Ten Years Years 2001 2000

Interest rate, currency and equity swaps and swaptions:
                                               
Notional amount:
                                               
 
Interest rate swaps
  $ 96,449     $ 209,722     $ 97,294     $ 12,428     $ 415,893     $ 344,203  
 
Currency swaps
    34,313       57,397       38,035       4,970       134,715       117,792  
 
Swaptions and equity swaps
    17,078       26,314       11,692       4,444       59,528       59,026  

Total
  $ 147,840     $ 293,433     $ 147,021     $ 21,842     $ 610,136     $ 521,021  

Futures and forward contracts:
                                               
Exchange traded futures contracts contractual amount
  $ 5,889                       $ 5,889     $ 11,082  

Over the counter forward contracts contractual amount
  $ 54,074     $ 452     $ 193           $ 54,719     $ 22,809  

      AIGFP determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At September 30, 2001 and December 31, 2000, the counterparty credit quality by derivative product with respect to the net replacement value of AIGFP’s derivatives portfolio was as follows:

(in millions)


                                   
Net Replacement Value

Swaps and Futures and Total Total
Swaptions Forward Contracts 2001 2000

Counterparty credit quality:
                               
 
AAA
  $ 5,715     $     $ 5,715     $ 3,778  
 
AA
    3,157       19       3,176       2,825  
 
A
    2,482       22       2,504       1,801  
 
BBB
    912       3       915       1,059  
 
Below investment grade
    29             29       252  

Total
  $ 12,295     $ 44     $ 12,339     $ 9,715  

38


Table of Contents

      At September 30, 2001 and December 31, 2000, the counterparty breakdown by industry with respect to the net replacement value of AIGFP’s derivatives portfolio was as follows:

(in millions)


                                 
Net Replacement Value

Swaps and Futures and Total Total
Swaptions Forward Contracts 2001 2000

Non-U.S. banks
  $ 2,483     $ 37     $ 2,520     $ 2,517  
Insured municipalities
    762             762       595  
U.S. industrials
    3,409       2       3,411       1,945  
Governmental
    469             469       463  
Non-U.S. financial service companies
    413             413       309  
Non-U.S. industrials
    1,189       3       1,192       1,372  
Special purpose
    2,029             2,029       1,204  
U.S. banks
    71             71       220  
U.S. financial service companies
    1,231       2       1,233       894  
Supranationals
    239             239       196  

Total
  $ 12,295     $ 44     $ 12,339     $ 9,715  

      The gross replacement values presented in the following table represent the sum of the estimated positive fair values of all of AIGTG’s derivatives contracts at September 30, 2001 and December 31, 2000. These values do not represent the credit risk to AIGTG.

      The net replacement values presented represent the net sum of estimated positive fair values after the application of legally enforceable master netting agreements and collateral held. The net replacement values most closely represent the net credit risk to AIGTG or the maximum amount exposed to potential loss.

      The following table provides the contractual and notional amounts and credit exposure, if applicable, by maturity and type of derivative of AIGTG’s derivatives portfolio at September 30, 2001 and December 31, 2000. In addition, the
estimated positive fair values associated with the derivatives portfolio are also provided and include a maturity profile for the September 30, 2001 balances based upon the expected timing of the future cash flows.

(in millions)


                                                   
Remaining Life

Two Six After
One Through Through Ten Total Total
Year Five Years Ten Years Years 2001 2000

Contractual amount of futures, forwards and options:
                                               
 
Exchange traded futures and options
  $ 10,786     $ 3,416     $ 18     $     $ 14,220     $ 18,064  

 
Forwards
  $ 195,121     $ 13,730     $ 645     $     $ 209,496     $ 234,316  

 
Over the counter purchased options
  $ 83,404     $ 17,534     $ 39,003     $ 116     $ 140,057     $ 104,919  

 
Over the counter sold options(a)
  $ 79,516     $ 18,823     $ 38,743     $ 121     $ 137,203     $ 103,742  

39


Table of Contents

                                                     
Remaining Life

Two Six After
One Through Through Ten Total Total
Year Five Years Ten Years Years 2001 2000

Notional amount:
                                               
 
Interest rate swaps and forward rate agreements
  $ 15,030     $ 36,998     $ 7,640     $ 89     $ 59,757     $ 63,264  
 
Currency swaps
    4,040       5,564       1,022             10,626       8,573  
 
Swaptions
    1,733       12,999       1,415             16,147       15,419  

Total
  $ 20,803     $ 55,561     $ 10,077     $ 89     $ 86,530     $ 87,256  

Credit exposure:
                                               
 
Futures, forwards, swaptions and purchased options contracts and interest rate and currency swaps:
                                               
   
Gross replacement value
  $ 5,818     $ 2,412     $ 981     $ 1     $ 9,212     $ 10,319  
   
Master netting arrangements
    (3,312 )     (1,527 )     (650 )     (1 )     (5,490 )     (6,136 )
   
Collateral
    (6 )     (16 )     (42 )           (64 )     (107 )

Net replacement value(b)
  $ 2,500     $ 869     $ 289     $     $ 3,658     $ 4,076  

(a) Sold options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposure.
(b) The net replacement values with respect to exchange traded futures and options, forward contracts, and purchased over the counter options are presented as a component of trading assets in the accompanying balance sheet. The net replacement values with respect to interest rate and currency swaps are presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions in the accompanying balance sheet.

     AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At September 30, 2001 and December 31, 2000, the counterparty credit quality and counterparty breakdown by industry with respect to the net replacement value of AIGTG’s derivatives portfolio were as follows:

(in millions)


                   
Net Replacement Value

2001 2000

Counterparty credit quality:
               
 
AAA
  $ 443     $ 442  
 
AA
    1,283       1,807  
 
A
    1,145       1,139  
 
BBB
    471       460  
 
Below investment grade
    88       48  
 
Not externally rated, including exchange traded futures and options*
    228       180  

Total
  $ 3,658     $ 4,076  

Counterparty breakdown by industry:
               
 
Non-U.S. banks
  $ 1,106     $ 2,076  
 
U.S. industrials
    301       67  
 
Governmental
    86       70  
 
Non-U.S. financial service companies
    411       282  
 
Non-U.S. industrials
    357       243  
 
U.S. banks
    796       468  
 
U.S. financial service companies
    373       690  
 
Exchanges*
    228       180  

Total
  $ 3,658     $ 4,076  

Exchange traded futures and options are not deemed to have significant credit exposure as the exchanges guarantee that every contract will be properly settled on a daily basis.

     Generally, AIG manages and operates its businesses in the currencies of the local operating environment. Thus, exchange gains or losses occur when AIG’s foreign currency net investment is affected by changes in the foreign exchange rates relative to the U.S. dollar from one reporting period to the next.

      AIG, through its Foreign Exchange Operating Committee, evaluates each of its worldwide consolidated foreign currency net asset or liability positions and manages AIG’s translation exposure to adverse movement in currency exchange rates. AIG may use forward exchange contracts and purchase options where the cost of such is reasonable and

40


Table of Contents

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, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 133 “Accounting for Derivative Instruments and Hedging Activities”. In June 2000, FASB issued Statement of Financial Accounting Standards No. 138 “Accounting for Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133” (collectively, FASB 133).

      FASB 133 requires AIG to recognize all derivatives in the consolidated balance sheet at fair value. The financial statement recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative and the extent to which the derivative is effective as part of a hedge transaction. The changes in fair value of the derivative transactions of AIGFP and AIGTG are currently presented, in all material respects, as a component of AIG’s operating income. The discussion below relates to the derivative activities of AIG other than those of AIGFP and AIGTG.

      On the date the derivative contract is entered into, AIG designates the derivative as: (1) a hedge of the subsequent changes in the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value” hedge); (2) a hedge of a forecasted transaction, or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow” hedge); or (3) a hedge of a net investment in a foreign operation. Fair value and cash flow hedges may involve foreign currencies (“foreign currency hedges”). The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a fair value hedge is recorded in current period earnings, along with the loss or gain on the hedged item attributable to the hedged risk. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a cash flow hedge is recorded in other comprehensive income, until earnings are affected by the variability of cash flows. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a hedge of a net investment in a foreign operation is recorded in the foreign currency translation adjustments account within other comprehensive income. Changes in the fair value of derivatives used for other than the above hedging activities are reported in current period earnings.

      AIG documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet, or specific firm commitments or forecasted transactions. AIG also assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.

      In accordance with the transition provisions of FASB 133, AIG recorded in its consolidated in-

41


Table of Contents

come statement for the first nine months of 2001 a cumulative effect of an accounting change adjustment loss of $6 million. This amount is presented as a component of Other income (deductions)-net. This loss represents the net fair value of all previously unrecorded derivative instruments as of January 1, 2001, net of tax and after the application of hedge accounting. AIG also recorded in its consolidated statement of comprehensive income for the first nine months of 2001 a cumulative effect of an accounting change adjustment gain of $150 million. This gain represents the increase in other comprehensive income, net of taxes, arising from recognizing the fair value of all derivative contracts designated as cash flow hedging instruments, and to a lesser extent, hedging instruments used to hedge net investments in foreign operations.

      In January 2001, the Emerging Issues Task Force (EITF) issued EITF 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.” EITF 99-20 provides guidance on the calculation of interest income and the recognition of impairments related to beneficial interests held in an investment portfolio. Beneficial interests are investments that represent rights to receive specified cash flows from a pool of underlying assets (i.e., collateralized debt obligations). In accordance with the transition provisions of EITF 99-20, AIG recorded in its consolidated income statement for the first nine months of 2001 a cumulative effect of an accounting change adjustment loss of $130 million ($200 million before tax).

      In June 2001, FASB issued Statement of Financial Accounting Standard No. 141 “Business Combinations” (FASB 141). FASB 141 requires AIG to apply the purchase method of accounting for all acquisitions initiated after June 30, 2001.

      In June 2001, FASB issued Statement of Financial Accounting Standard No. 142 “Goodwill and Other Intangible Assets” (FASB 142). FASB 142 requires AIG to discontinue the amortization of goodwill on its consolidated income statement.

      However, FASB 142 requires goodwill to be subject to an assessment of impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. AIG is currently evaluating the impact of the impairment provisions of FASB 142, and believes that the impact on its results of operations and financial condition will not be significant. FASB 142 is effective for AIG for the year commencing January 1, 2002.

Recent Developments

      On November 9, 2001, AIG issued Zero Coupon Convertible Senior Debentures Due 2031 in an aggregate principal amount at maturity of approximately $1.52 billion (excluding an over-allotment option of approximately $228 million principal amount at maturity). The Convertible Debentures are convertible into shares of AIG common stock under certain specified conditions.

      The Convertible Debentures are not callable for five years after issuance, and mature in 30 years. However, holders can require AIG to repurchase the Convertible Debentures once every five years. The Convertible Debentures were offered through Morgan Stanley & Co. Incorporated with original issue discount and generated gross proceeds of approximately $1.0 billion. AIG will use the proceeds of the offering for general corporate purposes.

      The Zero Coupon Convertible Senior Debentures were offered at an initial offering price of $658.01 per $1,000 of principal amount at maturity. The issue price represents a yield to maturity of 1.4 percent per annum, with a conversion rate of 6.0627 shares of common stock per $1,000 principal amount at maturity of Convertible Debentures.

42


Table of Contents

PART II — OTHER INFORMATION

ITEM 6 — EXHIBITS AND REPORTS ON FORM 8-K

  (a) Exhibits
See accompanying Exhibit Index.
 
  (b) Reports on Form 8-K

  During the three months ended September 30, 2001, Current Reports on Form 8-K were filed as follows:
 
  On August 29, 2001 AIG filed a Current Report on Form 8-K to report closing of the acquisition of AGC.
 
  On September 13, 2001, AIG filed a Current Report on Form 8-K to file the AIG press release announcing its initial estimate of losses resulting from the September 11 terrorist attacks.
 
  On September 18, 2001, AIG filed a Current Report on Form 8-K for the purpose of incorporating the most recent AGC annual, quarterly and current reports.

43


Table of Contents

SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

  AMERICAN INTERNATIONAL GROUP, INC.
 
  (Registrant)
 
  /s/ HOWARD I. SMITH
 
  Howard I. Smith
  Executive Vice President and
  Chief Financial Officer

Dated: November 13, 2001

44


Table of Contents

EXHIBIT INDEX

             
Exhibit
Number Description Location



   2     Plan of acquisition, reorganization, arrangement, liquidation or succession   None
   4     Indenture dated as of November 9, 2001 between American International Group, Inc. and The Bank of New York, as Trustee   Filed herewith.
  10     Material contracts   None
  11     Statement re computation of per share earnings   Included in Note  (f) of Notes to Financial Statements.
  12     Statement re computation of ratios   Filed herewith.
  15     Letter re unaudited interim financial information   None
  18     Letter re change in accounting principles   None
  19     Report furnished to security holders   None
  22     Published report regarding matters submitted to vote of security holders   None
  23     Consents of experts and counsel   None
  24     Power of attorney   None
  99     Additional exhibits   None

45

EX-4: INDENTURE DATED AS OF NOVEMBER 9, 2001
 

EXHIBIT 4

AMERICAN INTERNATIONAL GROUP, INC.

Zero Coupon Convertible Senior Debentures Due 2031

INDENTURE

Dated as of November 9, 2001

THE BANK OF NEW YORK,

AS TRUSTEE

 


 

Certain Sections of this Indenture relating to
Sections 310 through 318 of the
Trust Indenture Act of 1939:

           
Trust Indenture        
Act Section   Indenture Section

 
Section 310 (a) (1)
    7.9  
 
(a) (2)
    7.9  
 
(a) (3)
  Not Applicable
 
(a) (4)
  Not Applicable
 
(b)
    7.9  
Section 311(a)
    7.10  
 
(b)
    7.10  
Section 312(a)
    2.5  
 
(b)
    12.3  
 
(c)
    12.3  
Section 313(a)
    7.5  
 
(b)
    7.5  
 
(c)
    7.5  
 
(d)
    7.5  
Section 314(a)
    4.2  
 
(a) (4)
    4.3  
 
(b)
  Not Applicable
 
(c) (1)
    12.4 (1)
 
(c) (2)
    12.4 (2)
 
(c) (3)
  Not Applicable
 
(d)
  Not Applicable
 
(e)
    12.5  
Section 315(a)
    7.1 (b)
 
(b)
    6.1  
 
(c)
    7.1 (a)
 
(d)
    7.1 (c)
 
(e)
    6.11  


    Note: This reconciliation and tie shall not, for any purpose, be deemed to be a part of the Indenture.

i


 

           
Trust Indenture        
Act Section   Indenture Section

 
Section 316(a)
    2.8  
 
(a)(1)(A)
    6.5  
 
(a)(1)(B)
    6.4  
 
(a)(2)
  Not Applicable
 
(b)
    6.7  
 
(c)
    1.5 (e)
Section 317(a)(1)
    6.8  
 
(a)(2)
    6.9  
 
(b)
    2.4  
Section 318(a)
    12.1  


    Note: This reconciliation and tie shall not, for any purpose, be deemed to be a part of the Indenture.

ii


 

TABLE OF CONTENTS

Page

ARTICLE ONE
DEFINITIONS AND INCORPORATION BY REFERENCE

             
Section 1.1   Definitions     1  
Section 1.2   Other Definitions     5  
Section 1.3   Incorporation by Reference of Trust Indenture Act     6  
Section 1.4   Rules of Construction     6  
Section 1.5   Acts of Holders     7  

ARTICLE TWO
THE SECURITIES

             
Section 2.1   Form and Dating     8  
Section 2.2   Execution and Authentication     9  
Section 2.3   Registrar, Paying Agent and Conversion Agent     9  
Section 2.4   Paying Agent to Hold Money and Securities in Trust     10  
Section 2.5   Securityholder Lists     10  
Section 2.6   Transfer and Exchange     10  
Section 2.7   Replacement Securities     11  
Section 2.8   Outstanding Securities; Determinations of Holders’ Action     13  
Section 2.9   Temporary Securities     13  
Section 2.10   Cancellation     14  
Section 2.11   Persons Deemed Owners     14  
Section 2.12   Global Securities     14  
Section 2.13   Calculations in Respect of Securities     17  
Section 2.14   CUSIP Numbers     17  

ARTICLE THREE
REDEMPTION AND PURCHASES

             
Section 3.1   Company’s Right to Redeem; Notices to Trustee     17  
Section 3.2   Selection of Securities to Be Redeemed     17  
Section 3.3   Notice of Redemption     18  
Section 3.4   Effect of Notice of Redemption     19  
Section 3.5   Deposit of Redemption Price     19  
Section 3.6   Securities Redeemed in Part     19  
Section 3.7   Purchase of Securities by the Company at Option of the Holder     19  
Section 3.8   Company’s Right to Elect Manner of Payment of Purchase Price for Payment     21  
Section 3.9   Effect of Purchase Notice     25  
Section 3.10   Deposit of Purchase Price     26  
Section 3.11   Securities Purchased in Part     27  
Section 3.12   Repayment to the Company     27  

i


 

ARTICLE
FOUR COVENANTS

             
Section 4.1   Payment of Securities     27  
Section 4.2   SEC and Other Reports     28  
Section 4.3   Compliance Certificate     28  
Section 4.4   Maintenance of Office or Agency     28  
Section 4.5   Tax Treatment of Securities     28  
Section 4.6   Calculation of accrued Original Issue Discount and Tax Original Issue Discount     28  

ARTICLE FIVE
SUCCESSOR CORPORATION

             
Section 5.1   When Company May Merge or Transfer Assets     29  

ARTICLE SIX
DEFAULTS AND REMEDIES

             
Section 6.1   Events of Default     30  
Section 6.2   Acceleration     31  
Section 6.3   Other Remedies     31  
Section 6.4   Waiver of Past Defaults     31  
Section 6.5   Control by Majority     32  
Section 6.6   Limitation on Suits     32  
Section 6.7   Rights of Holders to Receive Payment     32  
Section 6.8   Collection Suit by Trustee     33  
Section 6.9   Trustee May File Proofs of Claim     33  
Section 6.10   Priorities     33  
Section 6.11   Undertaking for Costs     34  
Section 6.12   Waiver of Stay, Extension or Usury Laws     34  

ARTICLE SEVEN
TRUSTEE

             
Section 7.1   Duties of Trustee     34  
Section 7.2   Rights of Trustee     35  
Section 7.3   Individual Rights of Trustee     37  
Section 7.4   Trustee’s Disclaimer     37  
Section 7.5   Reports by Trustee to Holders     37  
Section 7.6   Compensation and Indemnity     37  
Section 7.7   Replacement of Trustee     38  
Section 7.8   Successor Trustee by Merger     38  
Section 7.9   Eligibility; Disqualification     38  
Section 7.10   Preferential Collection of Claims Against Company     39  

ARTICLE EIGHT
DISCHARGE OF INDENTURE

             
Section 8.1   Satisfaction and Discharge of Indenture     39  
Section 8.2   Application of Trust Money     40  

ii


 

ARTICLE NINE
AMENDMENTS

             
Section 9.1   Without Consent of Holders     40  
Section 9.2   With Consent of Holders     41  
Section 9.3   Compliance with Trust Indenture Act     42  
Section 9.4   Revocation and Effect of Consents, Waivers and Actions     42  
Section 9.5   Notation on or Exchange of Securities     42  
Section 9.6   Trustee to Sign Supplemental Indentures     42  
Section 9.7   Effect of Supplemental Indentures     43  

ARTICLE TEN
CONVERSIONS

             
Section 10.1   Conversion Privilege     43  
Section 10.2   Conversion Procedure; Conversion Price; Fractional Shares     44  
Section 10.3   Adjustment of Conversion Price for Common Stock     46  
Section 10.4   Consolidation or Merger of the Company     52  
Section 10.5   Notice of Adjustment     53  
Section 10.6   Notice in Certain Events     53  
Section 10.7   Company To Reserve Stock: Registration; Listing     54  
Section 10.8   Taxes on Conversion     54  
Section 10.9   Company Determination Final     55  
Section 10.10   Responsibility of Trustee for Conversion Provisions     55  
Section 10.11   Unconditional Right of Holders to Convert     55  

ARTICLE ELEVEN
CONTINGENT INTEREST

             
Section 11.1   Contingent Interest     55  
Section 11.2   Payment of Contingent Interest; Contingent Interest Rights Preserved     58  
Section 11.3   Contingent Interest: Conversion, Redemption or Purchase     58  
Section 11.4   Defaulted Interest     59  
Section 11.5   Contingent Interest Notification     60  

ARTICLE TWELVE
MISCELLANEOUS

             
Section 12.1   Trust Indenture Act Controls     60  
Section 12.2   Notices     60  
Section 12.3   Communication by Holders with Other Holders     61  
Section 12.4   Certificate and Opinion as to Conditions Precedent     61  
Section 12.5   Statements Required in Certificate or Opinion     61  
Section 12.6   Separability Clause     62  
Section 12.7   Legal Holidays     62  
Section 12.8   GOVERNING LAW     62  
Section 12.9   No Recourse Against Others     62  
Section 12.10   Successors     62  
Section 12.11   Effect of Headings and Table of Contents     62  
Section 12.12   Multiple Originals     62  

iii


 

     
EXHIBIT A   Form of Global Security
EXHIBIT B   Form of Certificated Security

iv


 

                  INDENTURE, dated as of November 9, 2001, between AMERICAN INTERNATIONAL GROUP, INC., a Delaware corporation (“Company”), and THE BANK OF NEW YORK, a New York banking corporation, as Trustee.

                  Each party agrees as follows for the benefit of the other party and for the equal and ratable benefit of the Holders of the Company’s Zero Coupon Convertible Senior Debentures Due 2031:

ARTICLE ONE

DEFINITIONS AND INCORPORATION BY REFERENCE

                  Section 1.1 Definitions.

                  “accrued” when used with respect to Original Issue Discount shall mean the amount of Original Issue Discount that has accrued on a Security from its Issue Price based on a 1.40% per annum interest rate compounded semi-annually using a 360-day year composed of twelve 30-day months. The determination of the amount of accrued Original Issue Discount shall be made without reference to the payment of any contingent interest payable pursuant to Article Eleven.

                  “Affiliate” of any specified Person means any other Person directly or indirectly controlling or controlled by or under direct or indirect common control with such specified Person. For the purposes of this definition, “control” when used with respect to any specified Person means the power to direct or cause the direction of the management and policies of such Person, directly or indirectly, whether through the ownership of voting securities, by contract or otherwise; and the terms “controlling” and “controlled” have meanings correlative to the foregoing.

                  “Applicable Procedures” means, with respect to any transfer or transaction involving a Global Security or beneficial interest therein, the rules and procedures of the Depositary for such Security, in each case to the extent applicable to such transaction and as in effect from time to time.

                  “Board of Directors” means either the board of directors of the Company or any duly authorized committee of such board.

                  “Board Resolution” means a resolution of the Board of Directors.

                  “Business Day” means each day of the year, other than a Saturday or Sunday, on which banking institutions in The City of New York are not authorized or obligated by law or regulation to close.

                  “Capital Stock” for any corporation means any and all shares, interests, rights to purchase, warrants, options, participations or other equivalents of or interests in (however designated) stock issued by that corporation.


 

                  “Certificated Securities” means Securities that are in the form of the Securities attached hereto as Exhibit B.

                  “Common Stock” includes any stock of any class of the Company that has no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Company and that is not subject to redemption by the Company. However, subject to the provisions of Section 10.4, shares issuable on conversion of Securities shall include only shares of the class designated as Common Stock of the Company at the date of this instrument or shares of any class or classes resulting from any reclassification or reclassifications thereof and that have no preference in respect of dividends or of amounts payable in the event of any voluntary or involuntary liquidation, dissolution or winding-up of the Company and that are not subject to redemption by the Company; provided that if at any time there shall be more than one such resulting class, the shares of each such class then so issuable shall be substantially in the proportion that the total number of shares of such class resulting from all such reclassifications bears to the total number of shares of all such classes resulting from all such reclassifications.

                  “Company” means the party named as the “Company” in the preamble to this Indenture until a successor replaces it pursuant to the applicable provisions of this Indenture and, thereafter, shall mean such successor. The foregoing sentence shall likewise apply to any subsequent such successor or successors.

                  “Company Request” or “Company Order” means a written request or order signed in the name of the Company by any two Officers.

                  “contingent interest” means interest that accrues and is payable as provided in Article Eleven.

                  “Conversion Price” means, as of any day, the sum of the Issue Price and the accrued Original Issue Discount divided by the number of shares of Common Stock then issuable upon conversion of a Security. Each $1,000 Principal Amount of Security is initially convertible into 6.0627 shares of Common Stock.

                  “Corporate Trust Office” means the principal office of the Trustee at which at any time its corporate trust business shall be administered, which office at the date hereof is located at 101 Barclay Street, New York, NY 10286, Attention: Corporate Trust Department, or such other address as the Trustee may designate from time to time by notice to the Holders and the Company, or the principal corporate trust office of any successor Trustee (or such other address as a successor Trustee may designate from time to time by notice to the Holders and the Company).

                  “Default” means any event which is, or after notice or passage of time or both would be, an Event of Default.

                  “Exchange Act” means the Securities Exchange Act of 1934, as amended from time to time.

                  “Global Securities” means Securities that are in the form of the Securities attached hereto as Exhibit A, and that are registered in the register of Securities in the name of a Depositary or a nominee thereof.

                  

-2-


 

                  “Holder” or “Securityholder” means a Person in whose name a Security is registered on the Registrar’s books.

                  “Indenture” means this Indenture, as amended or supplemented from time to time in accordance with the terms hereof, including the provisions of the TIA that are deemed to be a part hereof.

                  “Issue Date” of any Security means the date on which the Security was originally issued or deemed issued as set forth on the face of the Security.

                  “Issue Price” of any Security means, in connection with the original issuance of such Security, the initial issue price at which the Security is sold as set forth on the face of the Security.

                  “London Business Day” means each day on which dealings in United States dollars are transacted in the London interbank market.

                  “NYSE” means The New York Stock Exchange, Inc.

                  “Officer” means the Chairman of the Board, any Vice Chairman, the Chief Executive Officer, the President, any Executive Vice President, any Senior Vice President, the Treasurer, the Controller, or the Secretary or any Assistant Treasurer or Assistant Secretary of the Company.

                  “Officers’ Certificate” means a written certificate containing the information specified in Sections 12.4 and 12.5, signed in the name of the Company by any two Officers, and delivered to the Trustee. An Officers’ Certificate given pursuant to Section 4.3 shall be signed by the principal executive, financial or accounting Officer of the Company but need not contain the information specified in Sections 12.4 and 12.5.

                  “Opinion of Counsel” means a written opinion containing the information specified in Sections 12.4 and 12.5, from legal counsel who is reasonably acceptable to the Trustee. The counsel may be an employee of, or counsel to, the Company or the Trustee.

                  “Original Issue Discount” of any Security means the difference between the Issue Price and the Principal Amount of the Security as set forth on the face of the Security.

                  “Person” means any individual, corporation, company, limited liability company, association, partnership, joint venture, association, joint-stock company, trust, business trust, unincorporated organization, or government or any agency or political subdivision thereof.

                  “Predecessor Security” of any particular Security means every previous Security evidencing all or a portion of the same debt as that evidenced by such particular Security; and, for the purposes of this definition, any Security authenticated and delivered under Section 2.7 in exchange for or in lieu of a mutilated, destroyed, lost or stolen Security shall be deemed to evidence the same debt as the mutilated, destroyed, lost or stolen Security.

-3-


 

                  “Principal,” “Principal Amount” or “principal amount” of a Security means the principal amount due at the final Stated Maturity of the Security as set forth on the face of the Security.

                  “Redemption Date” or “redemption date” shall mean the date specified in a notice of redemption on which the Securities may be redeemed in accordance with the terms of the Securities and this Indenture.

                  “Redemption Price” or “redemption price” shall have the meaning set forth in Section 6 of the Securities.

                  “Responsible Officer” shall mean, when used with respect to the Trustee, any officer within the corporate trust department of the Trustee, including any vice president, assistant vice president, assistant secretary, assistant treasurer, trust officer or any other officer of the Trustee who customarily performs functions similar to those performed by the persons who at the time shall be such officers, respectively, or to whom any corporate trust matter is referred because of such person’s knowledge of and familiarity with the particular subject and who shall have direct responsibility for the administration of this Indenture.

                  “SEC” means the Securities and Exchange Commission, as from time to time constituted, created under the Exchange Act, or, if at any time after the execution of this instrument such Commission is not existing and performing the duties now assigned to it under the TIA, then the body performing such duties at such time.

                  “Securities” means any of the Company’s Zero Coupon Convertible Senior Debentures Due 2031 issued under this Indenture.

                  “Securities Act” means the Securities Act of 1933, as amended from time to time.

                  “Securityholder” or “Holder” means a person in whose name a Security is registered on the Registrar’s books.

                  “Stated Maturity”, when used with respect to any Security or any installment of contingent interest thereon, means the date specified in such Security as the fixed date on which the Principal Amount, Redemption Price or Purchase Price of such Security or such installment of interest is due and payable.

                  “Subsidiary” means any corporation, partnership, limited liability company or business trust of which at least a majority of the Outstanding Voting Stock shall at the time directly or indirectly be owned or controlled by the Company or by one or more Subsidiaries or by the Company and one or more Subsidiaries.

                  “Tax Original Issue Discount” means the amount of ordinary interest income on a Security that must be accrued as original issue discount for United States federal income tax purposes pursuant to Treasury Regulation Section 1.1275-4.

-4-


 

                  “TIA” means the Trust Indenture Act of 1939 as in effect on the date of this Indenture, provided, however, that in the event the TIA is amended after such date, TIA means, to the extent required by any such amendment, the TIA as so amended.

                  “Trading Day” means a day during which trading in the shares of Common Stock occurs regular way on the NYSE or, if the shares of Common Stock are not listed on the NYSE, on the principal other national or regional securities exchange on which the shares of Common Stock are then listed or, if the shares of Common Stock are not listed on a national or regional securities exchange, as reported on the Nasdaq or, if the shares of Common Stock are not so quoted, on the principal other market on which the shares of Common Stock are then traded.

                  “Trustee” means the party named as the “Trustee” in the first paragraph of this Indenture until a successor replaces it pursuant to the applicable provisions of this Indenture and, thereafter, shall mean such successor. The foregoing sentence shall likewise apply to any subsequent such successor or successors.

                  “Voting Stock” of a Person means Capital Stock of such Person of the class or classes pursuant to which the holders thereof have the general voting power under ordinary circumstances to elect at least a majority of the board of directors, managers or trustees of such Person (irrespective of whether or not at the time Capital Stock of any other class or classes shall have or might have voting power by reason of the happening of any contingency).

                  Section 1.2 Other Definitions.

         
Term Section:   Defined in:
“Act”
    1.5  
“Agent”
    11.1 (2)
“Agent Members”
    2.12 (b)
“cash”
    3.8 (a)
“Common Stock Record Date”
    11.1  
“Company Notice”
    3.8 (d)
“Company Notice Date”
    3.8 (b)
“Contingent Interest Payment Date”
    11.2  
“Contingent Interest Record Date”
    11.2  
“Conversion Agent”
    2.3  
“Current Market Price”
    10.3 (f)
“Defaulted Interest”
    11.4  
“Depositary”
    2.1 (a)
“distributed assets”
    10.3 (d)
“Downside Contingent Interest”
    11.1  
“DTC”
    2.1 (a)
“Event of Default”
    6.1  
“Ex-Dividend Time”
    10.1  
“Fair Market Value”
    10.3 (f)
“Legal Holiday”
    12.7  
“LIBOR”
    11.1  
“Market Price”
    3.8 (c)
“Non-Electing Share”
    10.4  
“Notice of Default”
    6.1  

-5-


 

         
Term Section:   Defined in:
“Outstanding”
    2.8  
“Paying Agent”
    2.3  
“Per Share Distribution Amount”
    10.3 (e)
“Protected Purchaser”
    3.7  
“Purchase Date”
    3.7  
“Purchase Notice”
    3.7  
“Purchase Price”
    3.7  
“Reference Banks”
    11.1 (2)
“Reference Debt Security”
    11.1  
“Registrar”
    2.3  
“Regular Cash Dividend”
    11.1  
“Relevant Value”
    11.1  
“Representative Amount”
    11.1  
“Sale Price”
    3.8 (c)
“Spread Determination Date”
    11.1  
“Special Record Date”
    11.4 (a)
“Spread”
    11.1 (2)
“Telerate LIBOR Page”
    11.1  
“Telerate Page”
    11.1  
“Trigger Event”
    10.3 (d)

                  Section 1.3 Incorporation by Reference of Trust Indenture Act. Whenever this Indenture refers to a provision of the TIA, the provision is incorporated by reference in and made a part of this Indenture. The following TIA terms used in this Indenture have the following meanings:

                  “indenture securities” means the Securities.

                  “indenture to be qualified” means this Indenture.

                  “indenture trustee” or “institutional trustee” means the Trustee.

                  “obligor” on the indenture securities means the Company.

                  All other TIA terms used in this Indenture that are defined by the TIA, defined by TIA reference to another statute or defined by SEC rule have the meanings assigned to them by such definitions.

                  Section 1.4 Rules of Construction. Unless the context otherwise requires:

  (1)   a term has the meaning assigned to it;
 
  (2)   an accounting term not otherwise defined has the meaning assigned to it in accordance with generally accepted accounting principles;
 
  (3)   “or” is not exclusive;
 
  (4)   “including” means including, without limitation; and
 
  (5)   words in the singular include the plural, and words in the plural include the singular.

                  Section 1.5 Acts of Holders. (a) Any request, demand, authorization, direction, notice, consent, waiver or other action provided by this Indenture to be given or taken

-6-


 

by Holders may be embodied in and evidenced by one or more instruments of substantially similar tenor signed by such Holders in person or by an agent duly appointed in writing; and, except as herein otherwise expressly provided, such action shall become effective when such instrument or instruments are delivered to the Trustee and, where it is hereby expressly required, to the Company, as described in Section 12.2. Such instrument or instruments (and the action embodied therein and evidenced thereby) are herein sometimes referred to as the “Act” of Holders signing such instrument or instruments. Proof of execution of any such instrument or of a writing appointing any such agent shall be sufficient for any purpose of this Indenture and conclusive in favor of the Trustee and the Company, if made in the manner provided in this Section.

                  (b) The fact and date of the execution by any person of any such instrument or writing may be proved by the affidavit of a witness of such execution or by a certificate of a notary public or other officer authorized by law to take acknowledgments of deeds, certifying that the individual signing such instrument or writing acknowledged to such officer the execution thereof. Where such execution is by a signer acting in a capacity other than such signer’s individual capacity, such certificate or affidavit shall also constitute sufficient proof of such signer’s authority. The fact and date of the execution of any such instrument or writing, or the authority of the person executing the same, may also be proved in any other manner which the Trustee deems sufficient.

                  (c) The principal amount and serial number of any Security and the ownership of Securities shall be proved by the register for the Securities.

                  (d) Any request, demand, authorization, direction, notice, consent, waiver or other Act of the Holder of any Security shall bind every future Holder of the same Security and the Holder of every Security issued upon the registration of transfer thereof or in exchange therefor or in lieu thereof in respect of anything done, omitted or suffered to be done by the Trustee or the Company in reliance thereon, whether or not notation of such action is made upon such Security.

                  (e) If the Company shall solicit from the Holders any request, demand, authorization, direction, notice, consent, waiver or other Act, the Company may, at its option, by or pursuant to a Board Resolution, fix in advance a record date for the determination of Holders entitled to give such request, demand, authorization, direction, notice, consent, waiver or other Act, but the Company shall have no obligation to do so. If such a record date is fixed, such request, demand, authorization, direction, notice, consent, waiver or other Act may be given before or after such record date, but only the Holders of record at the close of business on such record date shall be deemed to be Holders for the purposes of determining whether Holders of the requisite proportion of Outstanding Securities have authorized or agreed or consented to such request, demand, authorization, direction, notice, consent, waiver or other Act, and for that purpose the Outstanding Securities shall be computed as of such record date; provided that no such authorization, agreement or consent by the Holders on such record date shall be deemed effective unless it shall become effective pursuant to the provisions of this Indenture not later than six months after the record date.

-7-


 

ARTICLE TWO

THE SECURITIES

                  Section 2.1 Form and Dating. The Securities and the Trustee’s certificate of authentication shall be substantially in the form of Exhibits A and B, which are a part of this Indenture. The Securities may have notations, legends or endorsements required by law, stock exchange rule or usage (provided that any such notation, legend or endorsement required by usage is in a form acceptable to the Company). The Company shall provide any such notations, legends or endorsements to the Trustee in writing. Each Security shall be dated the date of its authentication.

                  (a) Global Securities. The Securities shall be issued, initially in the form of one or more Global Securities, which shall be deposited with the Trustee at its Corporate Trust Office, as custodian for the Depositary (as defined below) and registered in the name of The Depository Trust Company (“DTC”) or the nominee thereof (DTC, or any successor thereto, and any such nominee being hereinafter referred to as the “Depositary”), duly executed by the Company and authenticated by the Trustee as hereinafter provided. The aggregate principal amount of the Global Securities may from time to time be increased or decreased by adjustments made on the records of the Trustee and the Depositary as hereinafter provided but in no event more than the aggregate principal amount permitted by Section 2.2.

                  Each Global Security shall represent such of the Outstanding Securities as shall be specified therein and each shall provide that it shall represent the aggregate amount of Outstanding Securities from time to time endorsed thereon and that the aggregate amount of Outstanding Securities represented thereby may from time to time be reduced or increased, as appropriate, to reflect exchanges, redemptions, repurchases and conversions.

                  (b) Book-Entry Provisions. This Section 2.1(b) shall apply only to Global Securities deposited with or on behalf of the Depositary.

                  The Company shall execute and the Trustee shall, in accordance with this Section 2.1(b), authenticate and deliver initially one or more Global Securities that (a) shall be registered in the name of the Depositary, (b) shall be held by the Trustee as custodian for the Depositary and (c) shall be substantially in the form of Exhibit A attached hereto.

                  (c) Certificated Securities. Securities not issued as interests in the Global Securities will be issued in certificated form substantially in the form of Exhibit B attached hereto.

                  Section 2.2 Execution and Authentication. The Securities shall be executed on behalf of the Company by any Officer. The signature of the Officer on the Securities may be manual or facsimile.

                  Securities bearing the manual or facsimile signatures of individuals who were at the time of the execution of the Securities Officers shall bind the Company, notwithstanding that such individuals or any of them have ceased to hold such offices prior to the authentication and

-8-


 

delivery of such Securities or did not hold such offices at the date of authentication of such Securities.

                  No Security shall be entitled to any benefit under this Indenture or be valid or obligatory for any purpose unless there appears on such Security a certificate of authentication substantially in the form provided for herein duly executed by the Trustee by manual signature of an authorized signatory, and such certificate upon any Security shall be conclusive evidence, and the only evidence, that such Security has been duly authenticated and delivered hereunder.

                  The Trustee shall authenticate and deliver the Securities for original issue in an aggregate principal amount of $1,519,734,000 (or up to $1,747,694,000 aggregate principal amount to the extent Morgan Stanley & Co. Incorporated exercises its option to purchase additional Securities pursuant to the Underwriting Agreement, dated November 7, 2001, between the Company and Morgan Stanley & Co. Incorporated) upon one or more Company Orders without any further action by the Company. The aggregate principal amount of the Securities due at the final Stated Maturity thereof Outstanding at any time may not exceed the amount set forth in the foregoing sentence.

                  The Securities shall be issued only in registered form without coupons and only in denominations of $1,000 of principal amount and any whole multiple of $1,000.

                  Section 2.3 Registrar, Paying Agent and Conversion Agent. The Company shall maintain an office or agency where Securities may be presented for registration of transfer or for exchange (“Registrar”), an office or agency where Securities may be presented for purchase or payment (“Paying Agent”) and an office or agency where Securities may be presented for conversion (“Conversion Agent”). The Registrar shall keep a register of the Securities and of their transfer and exchange. The Company may have one or more co-registrars, one or more additional paying agents and one or more additional conversion agents. The term Paying Agent includes any additional paying agent, including any named pursuant to Section 4.4. The term Conversion Agent includes any additional conversion agent, including any named pursuant to Section 4.4.

                  If the Company appoints a Registrar, Paying Agent or Conversion Agent other than the Trustee, the Company shall notify the Trustee of the name and address of any such Agent. If the Company fails to maintain a Registrar, Paying Agent or Conversion Agent, the Trustee shall act as such and shall be entitled to appropriate compensation therefor pursuant to Section 7.6. The Company or any Subsidiary or an Affiliate of either of them may act as Paying Agent, Registrar, Conversion Agent or co-registrar.

                  The Company initially appoints the Trustee as Registrar, Conversion Agent, Calculation Agent and Paying Agent in connection with the Securities.

                  Section 2.4 Paying Agent to Hold Money and Securities in Trust. Except as otherwise provided herein, on or prior to each due date of payments in respect of any Security, the Company shall deposit with the Paying Agent a sum of money (in immediately available funds if deposited on the due date) or shares of Common Stock sufficient to make such payments when so becoming due. The Company shall require each Paying Agent (other than the Trustee) to agree in writing that the Paying Agent shall hold in trust for the benefit of Securityholders or

-9-


 

the Trustee all money and shares of Common Stock held by the Paying Agent for the making of payments in respect of the Securities and shall notify the Trustee of any default by the Company in making any such payment. At any time during the continuance of any such default, the Paying Agent shall, upon the written request of the Trustee, forthwith pay to the Trustee all money and shares of Common Stock so held in trust. If the Company, a Subsidiary or an Affiliate of either acts as Paying Agent, it shall segregate the money and shares of Common Stock held by it as Paying Agent and hold it as a separate trust fund. The Company at any time may require a Paying Agent to pay all money and shares of Common Stock held by it to the Trustee and to account for any funds and Common Stock disbursed by it. Upon doing so, the Paying Agent shall have no further liability for the money or shares of Common Stock.

                  Any money deposited with the Trustee or any Paying Agent, or then held by the Company, in trust for the payment of the Principal Amount, Redemption Price, Purchase Price or contingent interest on any Security and remaining unclaimed for two years after such amount has become due and payable shall be paid to the Company on Company Request, or (if then held by the Company) shall be discharged from such trust; and the Holder of such Security shall thereafter, as an unsecured general creditor, look only to the Company for payment thereof, and all liability of the Trustee or such Paying Agent with respect to such trust money, and all liability of the Company as trustee thereof, shall thereupon cease; provided, however, that the Trustee or such Paying Agent, before being required to make any such repayment, may at the expense of the Company cause to be published once, in a newspaper published in the English language, customarily published on each Business Day and of general circulation in the Borough of Manhattan, The City of New York, notice that such money remains unclaimed and that, after a date specified therein, which shall not be less than 30 days from the date of such publication. Any unclaimed balance of such money then remaining will be repaid to the Company.

                  Section 2.5 Securityholder Lists. The Trustee shall preserve in as current a form as is reasonably practicable the most recent list available to it of the names and addresses of Securityholders. If the Trustee is not the Registrar, the Company shall cause to be furnished to the Trustee at least semiannually on March 31 and September 30 a listing of Securityholders dated within 15 days of the date on which the list is furnished and at such other times as the Trustee may request in writing a list in such form and as of such date as the Trustee may reasonably require of the names and addresses of Securityholders. The Company may exclude from such list any names and addresses received by the Trustee in its capacity as Registrar.

                  Section 2.6 Transfer and Exchange. (a) Subject to Section 2.12 hereof, upon surrender for registration of transfer of any Security, together with a written instrument of transfer satisfactory to the Registrar duly executed by the Securityholder or such Securityholder’s attorney duly authorized in writing, at the office or agency of the Company designated as Registrar or co-registrar pursuant to Section 2.3, the Company shall execute, and the Trustee shall authenticate and deliver, in the name of the designated transferee or transferees, one or more new Securities of any authorized denomination or denominations, of a like aggregate Principal Amount. The Company shall not charge a service charge for any registration of transfer or exchange, but the Company may require payment of a sum sufficient to pay all taxes, assessments or other governmental charges that may be imposed in connection with the transfer or exchange of the Securities from the Securityholder requesting such transfer or exchange.

                  

-10-


 

                  At the option of the Holder, Securities may be exchanged for other Securities of any authorized denomination or denominations, of a like aggregate Principal Amount upon surrender of the Securities to be exchanged, together with a written instrument of transfer satisfactory to the Registrar duly executed by the Securityholder or such Securityholder’s attorney duly authorized in writing, at such office or agency. Whenever any Securities are so surrendered for exchange, the Company shall execute, and the Trustee shall authenticate and deliver, the Securities which the Holder making the exchange is entitled to receive.

                  The Company shall not be required to make, and the Registrar need not register, transfers or exchanges of Securities selected for redemption (except, in the case of Securities to be redeemed in part, the portion thereof not to be redeemed) or any Securities in respect of which a Purchase Notice has been given and not withdrawn by the Holder thereof in accordance with the terms of this Indenture (except, in the case of Securities to be purchased in part, the portion thereof not to be purchased) or any Securities for a period of 15 days before the mailing of a notice of redemption of Securities to be redeemed.

                  (b) Notwithstanding any provision to the contrary herein, so long as a Global Security remains Outstanding and is held by or on behalf of the Depositary, transfers of a Global Security, in whole or in part, shall be made only in accordance with Section 2.12 and this Section 2.6(b). Transfers of a Global Security shall be limited to transfers of such Global Security, in whole or in part, to the Depositary, to nominees of the Depositary or to a successor of the Depositary or such successor’s nominee.

                  (c) Successive registrations and registrations of transfers and exchanges as aforesaid may be made from time to time as desired, and each such registration shall be noted on the register for the Securities.

                  (d) Any Registrar appointed pursuant to Section 2.3 hereof shall provide to the Trustee such information as the Trustee may reasonably require in connection with the delivery by such Registrar of Securities upon transfer or exchange of Securities.

                  (e) All Securities issued upon any registration of transfer or exchange of Securities shall be the valid obligations of the Company, evidencing the same debt, and entitled to the same benefits under this Indenture, as the Securities surrendered upon such registration of transfer or exchange.

                  Section 2.7 Replacement Securities. If (a) any mutilated Security is surrendered to the Trustee, or (b) the Company and the Trustee receive evidence to their satisfaction of the destruction, loss or theft of any Security, and there is delivered to the Company and the Trustee such security or indemnity as may be required by them to save each of them harmless, then, in the absence of notice to the Company or the Trustee that such Security has been acquired by a protected purchaser within the meaning of Article 8 of the Uniform Commercial Code as in effect from time to time in the State of New York (a “Protected Purchaser”), the Company shall execute and upon its written request the Trustee shall authenticate and deliver, in exchange for any such mutilated Security or in lieu of any such destroyed, lost or stolen Security, a new Security of like tenor and principal amount, bearing a certificate number not contemporaneously Outstanding.

-11-


 

                  In case any such mutilated, destroyed, lost or stolen Security has become or is about to become due and payable, or is about to be purchased by the Company pursuant to Article Three hereof, or such Security has been surrendered for conversion pursuant to Article Ten, the Company in its discretion may, instead of issuing a new Security, pay, purchase or convert such Security, as the case may be.

                  Upon the issuance of any new Securities under this Section 2.7, the Company may require the payment of a sum sufficient to cover any tax or other governmental charge that may be imposed in relation thereto and any other expenses (including the fees and expenses of the Trustee) connected therewith.

                  Every new Security issued pursuant to this Section 2.7 in lieu of any mutilated, destroyed, lost or stolen Security shall constitute an original additional contractual obligation of the Company, whether or not the mutilated, destroyed, lost or stolen Security shall be at any time enforceable by anyone, and shall be entitled to all benefits of this Indenture equally and proportionately with any and all other Securities duly issued hereunder.

                  The provisions of this Section 2.7 are exclusive and shall preclude (to the extent lawful) all other rights and remedies with respect to the replacement or payment of mutilated, destroyed, lost or stolen Securities.

                  Section 2.8 Outstanding Securities; Determinations of Holders’ Action. Securities Outstanding at any time are all the Securities authenticated by the Trustee except for those cancelled by it, those paid pursuant to Section 2.7, those delivered to it for cancellation and those described in this Section 2.8 as not Outstanding. The Securities shall cease to be Outstanding upon the satisfaction and discharge of the Indenture pursuant to Article Eight. A Security does not cease to be Outstanding because the Company or an Affiliate thereof holds the Security; provided, however, that in determining whether the Holders of the requisite principal amount of Securities have given or concurred in any request, demand, authorization, direction, notice, consent, waiver, or other Act hereunder, Securities owned by the Company or any other obligor upon the Securities or any Affiliate of the Company or such other obligor shall be disregarded and deemed not to be Outstanding, except that, in determining whether the Trustee shall be protected in relying upon any such request, demand, authorization, direction, notice, consent, waiver or other Act, only Securities which a Responsible Officer of the Trustee actually knows to be so owned shall be so disregarded. Subject to the foregoing, only Securities Outstanding at the time of such determination shall be considered in any such determination (including, without limitation, determinations pursuant to Articles Six and Nine).

                  If a Security is replaced pursuant to Section 2.7, it ceases to be Outstanding unless the Trustee receives proof satisfactory to it that the replaced Security is held by a Protected Purchaser.

                  If the Paying Agent holds, in accordance with this Indenture, on a Redemption Date, or on the Business Day following a Purchase Date, or on Stated Maturity, money or securities, if permitted hereunder, sufficient to pay Securities payable on that date, then immediately after such Redemption Date, Purchase Date or Stated Maturity, as the case may be,

-12-


 

such Securities shall cease to be Outstanding and Original Issue Discount and contingent interest, if any, shall cease to accrue.

                  Securities for whose payment or redemption money, Common Stock or other securities in the necessary amount has been theretofore deposited with the Trustee or any Paying Agent (other than the Company) in trust or set aside and segregated in trust by the Company (if the Company shall act as its own Paying Agent) for the Holders of such Securities shall be deemed to be no longer Outstanding; provided that, if such Securities are to be redeemed, notice of such redemption has been duly given pursuant to this Indenture or provision therefore satisfactory to the Trustee has been made or, if the Securities are to be purchased, a Purchase Notice shall have been duly given and not be subject to withdrawal.

                  If a Security is converted in accordance with Article Ten, then from and after the time of conversion on the date of conversion, such Security shall cease to be Outstanding and Original Issue Discount and contingent interest, if any, shall cease to accrue on such Security.

                  Section 2.9 Temporary Securities. Pending the preparation of definitive Securities, the Company may execute, and upon Company Order the Trustee shall authenticate and deliver, temporary Securities which are printed, lithographed, typewritten, mimeographed or otherwise produced, in any authorized denomination, substantially of the tenor of the definitive Securities in lieu of which they are issued and with such appropriate insertions, omissions, substitutions and other variations as the officers executing such Securities may determine, as conclusively evidenced by their execution of such Securities.

                  If temporary Securities are issued, the Company will cause definitive Securities to be prepared without unreasonable delay. After the preparation of definitive Securities, the temporary Securities shall be exchangeable for definitive Securities upon surrender of the temporary Securities at the office or agency of the Company designated for such purpose pursuant to Section 2.3, without charge to the Holder. Upon surrender for cancellation of any one or more temporary Securities the Company shall execute and the Trustee shall authenticate and deliver in exchange therefor a like principal amount of definitive Securities of authorized denominations. Until so exchanged the temporary Securities shall in all respects be entitled to the same benefits under this Indenture as definitive Securities.

                  Section 2.10 Cancellation. All Securities surrendered for payment, purchase by the Company pursuant to Article Three, conversion, redemption or registration of transfer or exchange shall, if surrendered to any person other than the Trustee, be delivered to the Trustee and shall be promptly cancelled by it. The Company may at any time deliver to the Trustee for cancellation any Securities previously authenticated and delivered hereunder, which the Company may have acquired in any manner whatsoever, and all Securities so delivered shall be promptly cancelled by the Trustee. The Company may not issue new Securities to replace Securities it has paid or delivered to the Trustee for cancellation or that any Holder has converted pursuant to Article Ten. No Securities shall be authenticated in lieu of or in exchange for any Securities cancelled as provided in this Section, except as expressly permitted by this Indenture. All cancelled Securities held by the Trustee shall be disposed of by the Trustee in accordance with the Trustee’s customary procedure.

-13-


 

                  Section 2.11 Persons Deemed Owners. Prior to due presentment of a Security for registration of transfer, the Company, the Trustee and any agent of the Company or the Trustee may treat the Person in whose name such Security is registered as the owner of such Security for the purpose of receiving payment of principal of the Security or the payment of any Redemption Price or Purchase Price in respect thereof, and (subject to Section 11.4) contingent interest thereon, for the purpose of conversion and for all other purposes whatsoever, whether or not such Security be overdue, and neither the Company, the Trustee nor any agent of the Company or the Trustee shall be affected by notice to the contrary.

                  Section 2.12 Global Securities. (a) Notwithstanding any other provisions of this Indenture or the Securities, (A) transfers of a Global Security, in whole or in part, shall be made only in accordance with Section 2.6 and Section 2.12(a)(i), (B) transfers of a beneficial interest in a Global Security for a Certificated Security shall comply with Section 2.6, Section 2.12(a)(ii) below and Section 2.12(b)(1) below, and (C) transfers of a Certificated Security shall comply with Section 2.6 and Sections 2.12(a)(iii) and (iv) below.

       (i) Transfer of Global Security. A Global Security may not be transferred, in whole or in part, to any Person other than the Depositary or a nominee of the Depositary or any successor to either of them, and no such transfer to any such other Person may be registered. No transfer of a Security to any person shall be effective under this Indenture or the Securities unless and until such Security has been registered in the name of such Person. Nothing in this Section 2.12(a)(i) shall prohibit or render ineffective any transfer of a beneficial interest in a Global Security effected in accordance with the other provisions of this Section 2.12(a).
 
       (ii) Restrictions on Transfer of a Beneficial Interest in a Global Security for a Certificated Security. A beneficial interest in a Global Security may not be exchanged for a Certificated Security except upon satisfaction of the requirements set forth below and in Section 2.12(b)(1) below. Upon receipt by the Trustee of a transfer of a beneficial interest in a Global Security in accordance with Applicable Procedures for a Certificated Security, together with written instructions to the Trustee to make, or direct the Registrar to make, an adjustment on its books and records with respect to such Global Security to reflect a decrease in the aggregate principal amount of the Securities represented by the Global Security, then the Trustee shall cause, or direct the Registrar to cause, in accordance with the standing instructions and procedures existing between the Depositary and the Registrar, the aggregate principal amount of the Securities represented by the Global Security to be decreased by the aggregate principal amount of the Certificated Security to be issued, shall issue such Certificated Security and shall debit or cause to be debited to the account of the Person specified in such instructions a beneficial interest in the Global Security equal to the principal amount of the Certificated Security so issued.
 
       (iii) Transfer and Exchange of Certificated Securities. When Certificated Securities are presented to the Registrar with a request:
 
       (y) to register the transfer of such Certificated Securities; or

-14-


 

       (z) to exchange such Certificated Securities for an equal principal amount of Certificated Securities of other authorized denominations,
 
       the Registrar shall register the transfer or make the exchange as provided in Section 2.6; provided, however, that the Certificated Securities surrendered for transfer or exchange shall be duly endorsed or accompanied by a written instrument of transfer in form reasonably satisfactory to the Company, duly executed by the Holder thereof or his attorney duly authorized in writing.
 
       (iv) Restrictions on Transfer of a Certificated Security for a Beneficial Interest in a Global Security. A Certificated Security may not be exchanged for a beneficial interest in a Global Security.

                  (b) The provisions of clauses (1), (2), (3), (4) and (5) below shall apply only to Global Securities:

  (1)   Notwithstanding any other provisions of this Indenture or the Securities, a Global Security shall not be exchanged, in whole or in part, for a Security registered in the name of any Person other than the Depositary or one or more nominees of the Depositary or the successor to either of them, provided that a Global Security may be exchanged for Securities registered in the names of any person designated by the Depositary in the event that (i) the Depositary has notified the Company that it is unwilling or unable to continue as Depositary for such Global Security or such Depositary has ceased to be a “clearing agency” registered under the Exchange Act, and a successor Depositary is not appointed by the Company within 90 days, (ii) an Event of Default has occurred and is continuing with respect to the Securities or (iii) the Company delivers to the Trustee a Company Order to that effect. Any Global Security exchanged pursuant to clause (i) or (iii) above shall be so exchanged in whole and not in part, and any Global Security exchanged pursuant to clause (ii) above may be exchanged in whole or from time to time in part as directed by the Depositary.
 
  (2)   Certificated Securities issued in exchange for a Global Security or any portion thereof shall be issued in definitive, fully registered form, without interest coupons, shall have an aggregate principal amount equal to that of such Global Security or portion thereof to be so exchanged, shall be registered in such names and be in such authorized denominations as the Depositary shall designate. Any Global Security to be exchanged in whole shall be surrendered by the Depositary to the Trustee, as Registrar. With regard to any Global Security to be exchanged in part, either such Global Security shall be so surrendered for exchange or, if the Trustee is acting as custodian for the Depositary or its nominee with respect to such Global Security, the principal amount thereof shall be reduced, by an amount equal to the portion thereof to be so exchanged, by means of an appropriate adjustment made on the records of the Trustee.

-15-


 

  (3)   Subject to the provisions of clause (5) below, the registered Holder may grant proxies and otherwise authorize any person, including Agent Members (as defined below) and persons that may hold interests through Agent Members, to take any Act of a Holder that a Holder is entitled to take under this Indenture or the Securities.
 
  (4)   In the event of the occurrence of any of the events specified in clause (1) above, the Company will promptly make available to the Trustee a reasonable supply of Certificated Securities in definitive, fully registered form, without interest coupons.
 
  (5)   Neither any members of, or participants in, the Depositary (collectively, the “Agent Members”) nor any other persons on whose behalf Agent Members may act shall have any rights under this Indenture with respect to any Global Security registered in the name of the Depositary or any nominee thereof, or under any such Global Security, and the Depositary or such nominee, as the case may be, may be treated by the Company, the Trustee and any agent of the Company or the Trustee as the absolute owner and holder of such Global Security for all purposes whatsoever.

                  Notwithstanding the foregoing, nothing herein shall prevent the Company, the Trustee or any agent of the Company or the Trustee from giving effect to any written certification, proxy or other authorization furnished by the Depositary or such nominee, as the case may be, or impair, as between the Depositary, its Agent Members and any other person on whose behalf an Agent Member may act, the operation of customary practices of such Persons governing the exercise of the rights of any Person having a beneficial interest in a Security.

                  Section 2.13 Calculations in Respect of Securities. The Company or its agents will be responsible for making all calculations and determinations called for under the Securities including, but not limited to, the determination of the market prices for the Securities and of the Common Stock, the Sale Price and the amounts of contingent interest payments, if any, on the Securities. Any calculations made in good faith and without manifest error will be final and binding on Holders of the Securities.

                  Section 2.14 CUSIP Numbers. The Company may issue the Securities with one or more “CUSIP” numbers (if then generally in use), and, if so, the Trustee shall use CUSIP numbers in notices of redemption and Purchase Notices as a convenience to Holders; provided that any such redemption notice or Purchase Notice may state that no representation is made as to the correctness of such numbers either as printed on the Securities or as contained in any notice of a redemption or Purchase Notice and that reliance may be placed only on the other identification numbers printed on the Securities, and any such redemption or repurchase shall not be affected by any defect in or omission of such numbers.

-16-


 

ARTICLE THREE

REDEMPTION AND PURCHASES

                  Section 3.1 Company’s Right to Redeem; Notices to Trustee. Prior to November 9, 2006, the Securities will not be redeemable at the Company’s option. Beginning on and including November 9, 2006, the Company, at its option, may redeem the Securities in accordance with the provisions of Sections 6 and 8 of the Securities for cash at any time as a whole, or from time to time in part, at the Redemption Price. If the Company elects to redeem Securities pursuant to Section 6 of the Securities, it shall notify the Trustee in writing of the Redemption Date, the principal amount of Securities to be redeemed and the Redemption Price.

                  The Company shall give the notice to the Trustee provided for in this Section 3.1 by a Company Order, at least 25 days (unless a shorter notice shall be satisfactory to the Trustee) but not more than 70 days before the Redemption Date.

                  Section 3.2 Selection of Securities to Be Redeemed. If less than all the Outstanding Securities are to be redeemed, unless the procedures of the Depositary provide otherwise, the Trustee shall select the Securities to be redeemed by lot, on a pro rata basis or by another method the Trustee considers fair and appropriate (so long as such method is not prohibited by the rules of any stock exchange on which the Securities are then listed). The Trustee shall, within five Business Days after it receives the notice provided for in Section 3.1, make the selection from Outstanding Securities not previously called for redemption.

                  Securities and portions of Securities that the Trustee selects shall be in principal amounts of $1,000 or whole multiples of $1,000. Provisions of this Indenture that apply to Securities called for redemption also apply to portions of Securities called for redemption. The Trustee shall notify the Company promptly of the Securities or portions of the Securities to be redeemed.

                  Securities and portions of Securities that are to be redeemed are convertible by the Holder up to, but not including, the third Business Day prior to the Redemption Date. If any Security selected for partial redemption is converted in part before termination of the conversion right with respect to the portion of the Security so selected, the converted portion of such Security shall be deemed (so far as may be) to be the portion selected for redemption. Securities that have been converted during a selection of Securities to be redeemed may be treated by the Trustee as Outstanding for the purpose of such selection.

                  Section 3.3 Notice of Redemption. At least 15 days but not more than 60 days before a Redemption Date, the Company shall mail a notice of redemption by first-class mail, postage prepaid, to each Holder of Securities to be redeemed.

                  The notice shall identify the Securities to be redeemed and shall state:

  (1)   the Redemption Date;
 
  (2)   the Redemption Price;

-17-


 

  (3)   the Conversion Price;
 
  (4)   the name and address of the Paying Agent and Conversion Agent;
 
  (5)   that Securities called for redemption may be converted at any time up to, but not including, the third Business Day prior to the Redemption Date;
 
  (6)   that Holders who want to convert their Securities must satisfy the requirements set forth in Section 9 of the Securities;
 
  (7)   that Securities called for redemption must be surrendered to the Paying Agent to collect the Redemption Price;
 
  (8)   if fewer than all of the Outstanding Securities are to be redeemed, the certificate numbers, if any, and principal amounts of the particular Securities to be redeemed;
 
  (9)   that, unless the Company defaults in making payment of such Redemption Price, Original Issue Discount and contingent interest, if any, on Securities called for redemption, Original Issue Discount and contingent interest will cease to accrue on and after the Redemption Date; and
 
  (10)   the CUSIP number(s) of the Securities.

                  Notices of redemption may be given by the Company or, at the Company’s request, the Trustee shall give the notice of redemption in the Company’s name and at the Company’s expense.

                  Section 3.4 Effect of Notice of Redemption. Once notice of redemption is given, Securities called for redemption become due and payable on the Redemption Date and at the Redemption Price stated in the notice except for Securities that are converted in accordance with the terms of this Indenture. Upon surrender to the Paying Agent, such Securities shall be paid at the Redemption Price stated in the notice; provided, however, that any contingent interest that is due and payable on or prior to the Redemption Date shall be payable to the Holders of such Securities, or one or more Predecessor Securities, as provided in Article Eleven.

                  Section 3.5 Deposit of Redemption Price. Prior to 10:00 a.m. (New York City time) on the Redemption Date, the Company shall deposit with the Paying Agent (or if the Company or a Subsidiary or an Affiliate of either of them is the Paying Agent, shall segregate and hold in trust) money sufficient to pay the Redemption Price of all Securities to be redeemed on that date other than Securities or portions of Securities called for redemption that on or prior thereto have been delivered by the Company to the Trustee for cancellation or have been converted. The Paying Agent shall as promptly as practicable return to the Company any money not required for payment of the Redemption Price because of conversion of Securities pursuant to Article Ten. If such money is then held by the Company in trust and is not required for payment of the Redemption Price it shall be discharged from such trust.

                  

-18-


 

                  Section 3.6 Securities Redeemed in Part. Upon surrender of a Security that is redeemed in part, the Company shall execute and the Trustee shall authenticate and deliver to the Holder a new Security in an authorized denomination equal in principal amount to the unredeemed portion of the Security surrendered.

                  Section 3.7 Purchase of Securities by the Company at Option of the Holder. Securities shall be purchased by the Company pursuant to Section 7 of the Securities at the option of the Holder on November 9, 2006, November 9, 2011, November 9, 2016, November 9, 2021 and November 9, 2026 (each, a “Purchase Date”), at a purchase price of $705.55, $756.53, $811.18, $869.79 and $932.63, respectively, plus any accrued Original Issue Discount and any accrued and unpaid contingent interest, in each case, up to but excluding such Purchase Date (the “Purchase Price”), subject to the provisions of Section 3.8; provided, however, that any contingent interest that is due and payable on or prior to the Purchase Date shall be paid to the Holders of the Securities, or one or more Predecessor Securities, as provided in Article Eleven. Purchases of Securities hereunder shall be made, at the option of the Holder thereof, upon:

  (1)   delivery to the Paying Agent by the Holder of a written notice of purchase (a “Purchase Notice”) during the period beginning at any time from the opening of business on the date that is 24 Business Days prior to the relevant Purchase Date until the close of business on the fourth Business Day prior to such Purchase Date stating:
 
     
  (A)   the certificate number of the Security which the Holder will deliver to be purchased or the appropriate Depositary procedures if Certificated Securities have not been issued,
 
  (B)   the portion of the principal amount of the Security that the Holder will deliver to be purchased, which portion must be in principal amounts of $1,000 or a whole multiple of $1,000,
 
  (C)   that such Security shall be purchased by the Company as of the Purchase Date pursuant to the terms and conditions specified in Section 7 of the Securities and in this Indenture, and
 
  (D)   in the event the Company elects, pursuant to Section 3.8, to pay the Purchase Price, in whole or in part, in shares of Common Stock but such portion of the Purchase Price shall ultimately be paid to such Holder entirely in cash because any of the conditions to payment of the Purchase Price in shares of Common Stock is not satisfied prior to the close of business on the relevant Purchase Date, as set forth in Section 3.8, whether such Holder elects (i) to withdraw such Purchase Notice as to some or all of the Securities to which such Purchase Notice relates (stating the principal amount and certificate numbers, if any, of the Securities as to which such withdrawal shall relate), or (ii) to receive cash in respect of the entire Purchase Price for all Securities (or portions thereof) to which such Purchase Notice relates; and

-19-


 

  (2)   book-entry transfer or delivery of such Security to the Paying Agent at any time after delivery of the Purchase Notice (together with all necessary endorsements) at the offices of the Paying Agent, such delivery being a condition to receipt by the Holder of the Purchase Price therefor; provided, however, that such Purchase Price shall be so paid pursuant to this Section 3.7 only if the Security so delivered to the Paying Agent shall conform in all respects to the description thereof in the related Purchase Notice.

                  If a Holder, in such Holder’s Purchase Notice and in any written notice of withdrawal delivered by such Holder pursuant to the terms of Section 3.8, fails to indicate such Holder’s choice with respect to the election set forth in clause (D) of Section 3.7 (1), such Holder shall be deemed to have elected to receive cash in respect of the entire Purchase Price for all Securities subject to such Purchase Notice in the circumstances set forth in such clause (D).

                  The Company shall purchase from the Holder thereof, pursuant to this Section 3.7, a portion of a Security, if the principal amount of such portion is $1,000 or a whole multiple of $1,000. Provisions of this Indenture that apply to the purchase of all of a Security also apply to the purchase of such portion of such Security.

                  Any purchase by the Company contemplated pursuant to the provisions of this Section 3.7 shall be consummated by the delivery of the consideration to be received by the Holder promptly following the later of the Purchase Date and the time of the book-entry transfer or delivery of the Security.

                  Notwithstanding anything herein to the contrary, any Holder delivering to the Paying Agent the Purchase Notice contemplated by this Section 3.7 shall have the right to withdraw such Purchase Notice at any time up to, but excluding, the third Business Day prior to the Purchase Date by delivery of a written notice of withdrawal to the Paying Agent in accordance with Section 3.9.

                  The Paying Agent shall promptly notify the Company of the receipt by it of any Purchase Notice or written notice of withdrawal thereof.

                  Section 3.8 Company’s Right to Elect Manner of Payment of Purchase Price for Payment. (a) The Securities to be purchased on any Purchase Date pursuant to Section 3.7(a) may be paid for, in whole or in part, at the election of the Company, in U.S. legal tender (“cash”) or shares of Common Stock, or in any combination of cash and shares of Common Stock, subject to the conditions set forth in Sections 3.8(c) and (d). The Company shall designate, in the Company Notice delivered pursuant to Section 3.8(d), whether the Company will purchase the Securities for cash or shares of Common Stock, or, if a combination thereof, the percentages of the Purchase Price of Securities in respect of which it will pay in cash or shares of Common Stock; provided that the Company will pay cash for fractional interests in shares of Common Stock. For purposes of determining the existence of potential fractional interests, all Securities subject to purchase by the Company held by a Holder shall be considered together (no matter how many separate certificates are to be presented). Each Holder whose Securities are purchased pursuant to Section 3.7 shall receive the same percentage of cash or

-20-


 

shares of Common Stock in payment of the Purchase Price for such Securities, except with regard to the payment of cash in lieu of fractional shares of Common Stock. The Company may not change its election with respect to the consideration (or components or percentages of components thereof) to be paid once the Company has given its Company Notice to Holders except pursuant to Section 3.8(c) in the event of a failure to satisfy, prior to the close of business on the Business Day immediately preceding the Purchase Date, any condition to the payment of the Purchase Price, in whole or in part, in shares of Common Stock.

                  At least three Business Days before each Company Notice Date, the Company shall deliver an Officers’ Certificate to the Trustee specifying:

       (i) the manner of payment selected by the Company,
 
       (ii) the information required by Section 3.8(d) in the Company Notice,
 
       (iii) if the Company elects to pay the Purchase Price, or a specified percentage thereof, in shares of Common Stock, that the conditions to such manner of payment set forth in Section 3.8(c) have been or will be complied with, and
 
       (iv) whether the Company desires the Trustee to give the Company Notice required by Section 3.8(d).

                  (b) At the option of the Company, the Purchase Price of Securities in respect of which a Purchase Notice pursuant to Section 3.7 has been given, or a specified percentage thereof, may be paid by the Company with cash equal to the aggregate Purchase Price of such Securities. The Company Notice, as provided in Section 3.8(d), shall be sent to Holders not less than 24 Business Days prior to such Purchase Date (the “Company Notice Date”).

                  (c) At the option of the Company, the Purchase Price of Securities in respect of which a Purchase Notice pursuant to Section 3.7 has been given, or a specified percentage thereof, may be paid by the Company by the issuance of a number of shares of Common Stock equal to the quotient obtained by dividing (i) the portion of the Purchase Price to be paid in shares of Common Stock by (ii) 100% of the Market Price determined by the Company in the Company Notice, subject to the next succeeding paragraph.

                  The Company will not issue fractional shares of Common Stock in payment of the Purchase Price. Instead, the Company will pay cash based on the current market price for all fractional shares. It is understood that if a Holder elects to have more than one Security purchased, the number of shares of Common Stock shall be based on the aggregate amount of Securities to be purchased.

                  If the Company elects to purchase the Securities by the issuance of shares of Common Stock or in any combination of cash and Common Stock, the Company Notice, as provided in Section 3.8(d), shall be sent to the Holders not later than the Company Notice Date.

-21-


 

                  The Company’s right to exercise its election to purchase Securities through the issuance of shares of Common Stock shall be conditioned upon:

       (i) the Company’s not having given its Company Notice of an election to pay entirely in cash and its giving of timely Company Notice of an election to purchase all or a specified percentage of the Securities with shares of Common Stock as provided herein;
 
       (ii) the registration of such shares of Common Stock under the Securities Act and the Exchange Act, in each case, if required;
 
       (iii) the listing of such shares of Common Stock on a United States national securities exchange or the quotation of such shares of Common Stock in an inter-dealer quotation system of any registered United States national securities association, in each case, if the Common Stock is then listed on a national securities exchange or quoted in an inter-dealer quotation system;
 
       (iv) any necessary qualification or registration of such shares of Common Stock under applicable state securities laws or the availability of an exemption from such qualification and registration; and
 
       (v) the receipt by the Trustee of (A) an Officers’ Certificate stating that the terms of the issuance of the shares of Common Stock are in conformity with this Indenture, (B) an Opinion of Counsel to the effect that the shares of Common Stock to be issued by the Company in payment of the Purchase Price in respect of the Securities have been duly authorized and, when issued and delivered pursuant to the terms of this Indenture in payment of the Purchase Price in respect of the Securities, will be validly issued, fully paid and non-assessable and (c) an Officers’ Certificate, stating that the conditions to the issuance of the shares of Common Stock have been satisfied.

                  Such Officers’ Certificate shall also set forth the number of shares of Common Stock to be issued for each $1,000 principal amount at Stated Maturity of Securities and the Sale Price of a share of Common Stock on each Trading Day during the period commencing on the first Trading Day of the period during which the Market Price is calculated and ending on but excluding the third Business Day prior to the applicable Purchase Date. If the foregoing conditions are not satisfied prior to the close of business on the last day prior to the Purchase Date and the Company has elected to purchase the Securities through the issuance of shares of Common Stock, the Company shall pay the entire Purchase Price of the Securities in cash.

                  The “Market Price” means the average of the Sale Prices of the shares of Common Stock for the five-Trading Day period immediately preceding but excluding the third Business Day prior to the applicable Purchase Date (if the fourth Business Day prior to the applicable Purchase Date is a Trading Day, or if not, then on the last Trading Day prior to the fourth Business Day), appropriately adjusted to take into account the occurrence, during the period commencing on the first of the Trading Days during the five-Trading Day period and ending on the Purchase Date, of any event described in Sections 10.3 or 10.4.

                  The “Sale Price” of the shares of Common Stock on any date means the closing per share sale price (or, if no closing sale price is reported, the average of the closing bid and ask prices

-22-


 

or, if more than one in either case, the average of the average closing bid and the average ask prices) on such date as reported on the NYSE or, if the shares of Common Stock are not listed on the NYSE, as reported on a national securities exchange, or if not reported on a national securities exchange, as reported by the Nasdaq. In the absence of such quotations, the Company shall be entitled to determine the closing sales price on the basis of such quotations as it considers appropriate. Sale Prices shall be determined without reference to extended or after hours trading.

                  Upon determination of the actual number of shares of Common Stock to be issued upon redemption or repurchase of Securities, the Company shall be required to disseminate a press release through Dow Jones & Company, Inc. or Bloomberg Business News containing this information or publish the information on the Company’s web site or through such other public medium as the Company may use at that time.

                  (d) In connection with any purchase of Securities pursuant to Section 7 of the Securities, the Company shall, no less than 24 Business Days prior to each Purchase Date, give notice to Holders setting forth information specified in this Section 3.8(d) (the “Company Notice”).

                  In the event the Company has elected to pay the Purchase Price (or a specified percentage thereof), with shares of Common Stock, the Company Notice shall:

  (1)   state that each Holder will receive a number of shares of Common Stock with a value equal to 100% of the Market Price equal to such specified percentage of the Purchase Price of the Securities to be paid in Common Stock (except any cash amount to be paid in lieu of fractional shares);
 
  (2)   set forth the method of calculating the Market Price of the shares of Common Stock; and
 
  (3)   state that because the Market Price of shares of Common Stock will be determined prior to the Purchase Date Holders of the Securities will bear the market risk with respect to the value of the shares of Common Stock to be received from the date such Market Price is determined to the Purchase Date.

                  In any case, each Company Notice shall include a form of Purchase Notice to be completed by a Holder and shall state:

       (i) the Purchase Price;
 
       (ii) the name and address of the Paying Agent and the Conversion Agent;
 
       (iii) if the Securities are then convertible, that Securities as to which a Purchase Notice has been given may be converted only if the Purchase Notice is withdrawn in accordance with the terms of this Indenture;
 
       (iv) that Securities must be surrendered to the Paying Agent to collect the Purchase Price;

-23-


 

       (v) that the Purchase Price for any security as to which a Purchase Notice has been given and not withdrawn will be paid promptly following the later of the Purchase Date and the time of surrender of such Security;
 
       (vi) that, unless the Company defaults in making payment on Securities for which a Purchase Notice has been submitted, Original Issue Discount and any contingent interest on such Securities will cease to accrue on and after the Purchase Date; provided, however, that any contingent interest that is due and payable prior to the Purchase Date will be payable to the Holders of Securities, or one or more Predecessor Securities, as provided in Article Eleven; and
 
       (vii) the CUSIP number of the Securities.

                  Company Notices may be given by the Company or, at the Company’s request, the Trustee shall give such Company Notice in the Company’s name and at the Company’s expense.

                  (e) All shares of Common Stock delivered upon purchase of the Securities shall be duly authorized, validly issued, fully paid and nonassessable.

                  (f) If a Holder of a purchased Security is paid in shares of Common Stock, the Company shall pay any documentary, stamp or similar issue or transfer tax due on such issue of Common Stock. However, the Holder shall pay any such tax which is due because the Holder requests the Common Stock to be issued in a name other than the Holder’s name. The Paying Agent may refuse to deliver the certificates representing the shares of Common Stock being issued in a name other than the Holder’s name until the Paying Agent receives a sum sufficient to pay any tax which will be due because the shares of Common Stock are to be issued in a name other than the Holder’s name. Nothing herein shall preclude any income tax withholding required by law or regulations.

                  Section 3.9 Effect of Purchase Notice. Upon receipt by the Paying Agent of the Purchase Notice specified in Section 3.7, the Holder of the Security in respect of which such Purchase Notice was given shall (unless such Purchase Notice is validly withdrawn) thereafter be entitled to receive solely the Purchase Price with respect to such Security. Such Purchase Price shall be paid to such Holder, subject to receipt of funds and/or securities by the Paying Agent, promptly following the later of (x) the Purchase Date with respect to such Security (provided the Holder has satisfied the conditions in Section 3.7) and (y) the time of delivery of such Security to the Paying Agent by the Holder thereof in the manner required by Section 3.7. Securities in respect of which a Purchase Notice has been given by the Holder thereof may not be converted pursuant to Article Ten hereof on or after the date of the delivery of such Purchase Notice unless such Purchase Notice has first been validly withdrawn.

                  A Purchase Notice may be withdrawn by means of a written notice of withdrawal delivered to the office of the Paying Agent in accordance with the Purchase Notice at any time prior to but excluding the third Business Day before the Purchase Date, specifying:

  (1)   the certificate number, if any, of the Security in respect of which such notice of withdrawal is being submitted, or the appropriate Depositary procedures if Certified Securities have not been issued,

-24-


 

  (2)   the principal amount of the Security with respect to which such notice of withdrawal is being submitted, and
 
  (3)   the principal amount, if any, of such Security which remains subject to the original Purchase Notice and which has been or will be delivered for purchase by the Company.

                  A written notice of withdrawal of a Purchase Notice may be in the form set forth in the preceding paragraph or may be in the form of a conditional withdrawal contained in a Purchase Notice pursuant to the terms of Section 3.7 (1)(D).

                  The Company may, in its sole and complete discretion, accept a written notice of withdrawal on or after the third Business Day prior to a Purchase Date. The decision of the Company to accept or reject such a withdrawal notice shall be conclusive and binding on the Holder proposing to make the withdrawal.

                  There shall be no purchase of any Securities pursuant to Section 3.7 if there has occurred and is continuing an Event of Default on the Purchase Date (other than a default in the payment of the Purchase Price with respect to such Securities or a default that is cured by the repurchase). The Paying Agent will promptly return to the respective Holders thereof any Securities (x) with respect to which a Purchase Notice has been withdrawn in compliance with this Indenture, or (y) held by it during the continuance of an Event of Default (other than a default in the payment of the Purchase Price with respect to such Securities or a default that is cured by the repurchase) in which case, upon such return, the Purchase Notice with respect thereto shall be deemed to have been withdrawn.

                  Section 3.10 Deposit of Purchase Price. Prior to 10:00 a.m. (New York City Time) on the Business Day following the Purchase Date, the Company shall deposit with the Trustee or with the Paying Agent (or, if the Company or a Subsidiary or an Affiliate of either of them is acting as the Paying Agent, shall segregate and hold in trust as provided in Section 2.4) an amount of cash (in immediately available funds if deposited on such Business Day) or Common Stock, if permitted hereunder, sufficient to pay the aggregate Purchase Price of all the Securities or portions thereof that are to be purchased as of the Purchase Date.

                  As soon as practicable after the Purchase Date the Company shall deliver to each Holder entitled to receive shares of Common Stock through the Paying Agent, a certificate for the number of full shares of Common Stock is