FORM 10-K
 



SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


Form 10-K

     
(Mark One)
   
þ
  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
    For the fiscal year ended December 31, 2003
 
OR
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
    For the Transition period from           to

Commission file number 1-8787


American International Group, Inc.

(Exact name of registrant as specified in its charter)
     
Delaware
  13-2592361
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
70 Pine Street, New York, New York
(Address of principal executive offices)
  10270
(Zip Code)

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


Securities registered pursuant to Section 12(b) of the Act:

     
Name of each exchange
Title of each class on which registered


Common Stock, Par Value $2.50 Per Share
  New York Stock Exchange, Inc.

Securities registered pursuant to Section 12(g) of the Act:

     
Title of each class

None
   


    Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ü                    No              

    Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

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

    The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant computed by reference to the price at which the common equity was last sold as of June 30, 2003 (the last business day of the registrant’s most recently completed second fiscal quarter), was approximately $115,958,906,000.

    As of January 31, 2004, there were outstanding 2,608,947,657 shares of Common Stock, $2.50 par value per share, of the registrant.

Documents Incorporated by Reference:

    The registrant’s definitive proxy statement filed or to be filed with the Securities and Exchange Commission pursuant to Regulation 14A involving the election of directors at the annual meeting of the shareholders of the registrant scheduled to be held on May 19, 2004 is incorporated by reference in Part III of this Form 10-K.




 

PART I

 
ITEM 1.  Business

American International Group, Inc. (AIG), a Delaware corporation, is a holding company, which through its subsidiaries, is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG’s primary activities include both General and Life Insurance operations. Other significant activities include Financial Services, and Retirement Services & Asset Management. The principal General Insurance company subsidiaries are American Home Assurance Company (American Home), National Union Fire Insurance Company of Pittsburgh, Pa. (National Union), New Hampshire Insurance Company (New Hampshire), Lexington Insurance Company (Lexington), The Hartford Steam Boiler Inspection and Insurance Company (HSB), Transatlantic Reinsurance Company, American International Underwriters Overseas, Ltd. (AIUO) and United Guaranty Residential Insurance Company. Significant Life Insurance operations include those conducted through American Life Insurance Company (ALICO), American International Reinsurance Company, Ltd. (AIRCO), American International Assurance Company, Limited together with American International Assurance Company (Bermuda) Limited (AIA), Nan Shan Life Insurance Company, Ltd. (Nan Shan), AIG Star Life Insurance Co., Ltd. (AIG Star Life), AIG Annuity Insurance Company (AIG Annuity), the AIG American General Life Companies (AIG American General), and SunAmerica Life Insurance Company (SunAmerica Life). AIG’s Financial Services operations are conducted primarily through International Lease Finance Corporation (ILFC), AIG Financial Products Corp. and its subsidiaries (AIGFP), and American General Finance, Inc. and its subsidiaries (AGF), while Retirement Services & Asset Management operations include The Variable Annuity Life Insurance Company (VALIC), AIG SunAmerica Asset Management Corp. (SAAMCo), AIG SunAmerica Life Assurance Company and AIG Global Asset Management Holdings Corp. (formerly known as AIG Global Investment Group, Inc.) and its subsidiaries and affiliated companies (AIG Global Investment Group).

     On August 29, 2001, AIG acquired American General Corporation (AGC). In connection with the acquisition, AIG issued approximately 290 million shares of common stock, $2.50 par value per share (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. For information on AIG’s business segments, see Note 2 of Notes to Financial Statements.

     All per share information herein gives retroactive effect to all stock dividends and stock splits. As of January 31, 2004, beneficial ownership of approximately 11.9 percent, 2.0 percent and 1.8 percent of AIG common stock, was held by Starr International Company, Inc. (SICO), The Starr Foundation and C.V. Starr & Co., Inc. (Starr), respectively.

     At December 31, 2003, AIG and its subsidiaries had approximately 86,000 employees.

     AIG’s Internet address for its corporate website is www.aigcorporate.com. AIG makes available free of charge, on or through the Investor Information section of AIG’s corporate website, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the Securities and Exchange Commission (SEC).

     Throughout this Annual Report on Form 10-K, AIG presents its operations in the way it believes will be most meaningful, as well as most transparent. Certain of the measurements used by AIG management are “non-GAAP financial measures” under SEC rules and regulations. Gross premiums written, statutory underwriting profit (loss) and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities. For an explanation of why AIG management considers these “non-GAAP measures” useful to investors, see Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 
FORM 10-K : 1


 


American International Group, Inc. and Subsidiaries


The following table shows the general development of the business of AIG on a consolidated basis, the contributions made to AIG’s consolidated revenues and operating income and the assets held, in the periods indicated, by its General Insurance, Life Insurance, Financial Services, and Retirement Services & Asset Management operations and other realized capital gains (losses). (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes 1 and 2 of Notes to Financial Statements.)

                                           
Years Ended December 31,
(in millions) 2003 2002 2001 2000 1999

General Insurance operations:
                                       
 
Gross premiums written
  $ 47,440     $ 37,537     $ 29,640     $ 25,050     $ 22,569  
 
Net premiums written
    35,212       27,414       20,101       17,526       16,224  
 
Net premiums earned
    31,734       24,269       19,365       17,407       15,544  
 
Underwriting profit (loss)(a)
    2,220       (1,235 ) (b)     88 (c)     785       669  
 
Net investment income
    3,022       2,760       2,893       2,701       2,517  
 
Realized capital gains (losses)
    (172 )     (858 )     (130 )     38       295  
 
Operating income
    5,070       667 (b)     2,851 (c)     3,524       3,481  
 
Identifiable assets
    121,791       109,068       91,544       85,270       76,725  

 
Loss ratio
    73.3       85.8       79.5       75.3       75.5  
 
Expense ratio
    19.1       20.2       21.2       21.4       20.8  

 
Combined ratio
    92.4       106.0 (b)     100.7 (c)     96.7       96.3  

Life Insurance operations:
                                       
 
GAAP premiums
    22,879       20,320       19,063       17,163       15,476  
 
Net investment income
    13,640       12,274       11,084       9,962       8,932  
 
Realized capital gains (losses)
    (826 )     (1,053 )     (254 )     (162 )     (148 )
 
Operating income
    6,002       4,929       4,675 (d)     4,058       3,610  
 
Identifiable assets
    432,633       339,847       296,648       248,982       231,843  
 
Insurance in-force at end of year
    1,596,626       1,324,451       1,228,501       971,892       950,933  
Financial Services operations:
                                       
 
Commissions, transaction and other fees
    7,565       6,815       6,485       5,954       5,069  
 
Operating income
    2,464       2,189       1,991       1,666       1,417  
 
Identifiable assets
    137,299       124,617       107,322       94,173       78,868  
Retirement Services & Asset Management operations:
                                       
 
Commissions and other fees
    3,896       3,485       3,712       3,465       3,093  
 
Operating income
    1,271       1,016       1,088       1,108       873  
 
Identifiable assets
    4,254       2,567       1,842       1,590       1,132  
Other realized capital gains (losses)
    (435 )     (530 )     (452 )     (190 )     (44 )
Revenues(e)
    81,303       67,482       61,766       56,338       50,734  
Total assets
    678,346       561,229       493,061       426,671       383,685  

(a) Underwriting profit, a GAAP measure, is statutory underwriting income adjusted primarily for changes in the deferral of acquisition costs. This adjustment is necessary to present the financial statements in accordance with GAAP.
(b)  In the fourth quarter of 2002, after completion of its annual review of General Insurance loss and loss adjustment expense reserves, AIG increased its net loss reserves pertaining to accident years 1997 through 2001 by $2.8 billion. Excluding the loss reserve charge, the General Insurance combined ratio would have been 94.4.
(c) Includes $769 million in World Trade Center and related losses (WTC losses). Excluding WTC losses, the General Insurance combined ratio would have been 96.7.
(d)  Includes $131 million in WTC losses in 2001.
(e) Represents the sum of General Insurance net premiums earned, GAAP Life premiums, net investment income, Financial Services commissions, transaction and other fees, Retirement Services & Asset Management commissions and other fees and realized capital gains (losses).
 
FORM 10-K : 2


 

The following table shows identifiable assets, revenues and income derived from operations in the United States and Canada and from operations in other countries for the year ended December 31, 2003. (See also Note 2 of Notes to Financial Statements.)

                                           
Percent of Total

United States Other United States Other
(dollars in millions) Total and Canada Countries and Canada Countries

General Insurance operations:
                                       
  Net premiums earned   $ 31,734     $ 23,269     $ 8,465       73.3 %     26.7 %
  Underwriting profit     2,220       1,385       835       62.4       37.6  
  Net investment income     3,022       2,259       763       74.8       25.2  
  Realized capital gains (losses)     (172 )     (40 )     (132 )            
  Operating income     5,070       3,605       1,465       71.1       28.9  
  Identifiable assets     121,791       87,206       34,585       71.6       28.4  
Life Insurance operations:
                                       
  GAAP premiums     22,879       5,041       17,838       22.0       78.0  
  Net investment income     13,640       9,027       4,613       66.2       33.8  
  Realized capital gains (losses)     (826 )     (544 )     (282 )            
  Operating income     6,002       2,420       3,582       40.3       59.7  
  Identifiable assets     432,633       280,823       151,810       64.9       35.1  
Financial Services operations:
                                       
  Commissions, transaction and other fees     7,565       3,525       4,040       46.6       53.4  
  Operating income     2,464       672       1,792       27.3       72.7  
  Identifiable assets     137,299       121,894       15,405       88.8       11.2  
Retirement Services & Asset Management operations:
                                       
  Commissions and other fees     3,896       3,209       687       82.4       17.6  
  Operating income     1,271       1,108       163       87.2       12.8  
  Identifiable assets     4,254       2,752       1,502       64.7       35.3  
Other realized capital gains (losses)
    (435 )     (431 )     (4 )            
Income before income taxes, minority interest and cumulative effect of an accounting change
    13,908       6,757       7,151       48.6       51.4  
Revenues
    81,303       45,315       35,988       55.7       44.3  
Total assets
    678,346       473,571       204,775       69.8       30.2  

 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 operations of HSB; Transatlantic Holdings, Inc. (Transatlantic); Personal Lines, including 21st Century Insurance Group (21st Century); and United Guaranty Corporation (UGC).

     AIG’s primary domestic division is DBG. DBG’s business is derived from brokers in the United States and Canada and is conducted through its General Insurance subsidiaries including American Home, National Union, Lexington and certain other General Insurance company subsidiaries of AIG. The AIG Risk Management operation provides insurance and risk management programs for large corporate customers. The AIG Risk Finance division designs and implements risk financing alternatives using the insurance and financial services capabilities of AIG. Also included in DBG are the operations of AIG Environmental, which focuses specifically on providing specialty products to clients with environmental exposures.

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

     In addition to writing substantially all classes of business insurance, including large commercial or industrial property insurance, excess liability, inland marine, environmental, workers’ compensation and excess and umbrella coverages, DBG offers many specialized forms of insurance such as equipment breakdown, directors and officers liability, difference-in-conditions, kidnap-ransom, export credit and political risk, and various types of professional errors and omissions coverages. Lexington writes surplus lines, those risks for which conventional insurance companies do not readily provide insurance coverage, either because of complexity or because the coverage does not lend itself to conventional contracts.

     Transatlantic offers reinsurance capacity on both treaty and facultative basis. Transatlantic structures programs for a full range of property and casualty products with an emphasis on specialty risk.

     AIG engages in mass marketing of personal lines coverages, primarily private passenger auto and personal umbrella coverages, principally through American International Insur-

 
FORM 10-K : 3


 


American International Group, Inc. and Subsidiaries


ance Company and 21st Century. In 2003, AIG acquired the U.S.-based auto and home insurance business of General Electric Company (GE).

     The business of UGC and its subsidiaries is also included in the domestic operations of AIG. The principal business of the UGC subsidiaries is the writing of residential mortgage loan insurance, which is guaranty insurance on conventional first mortgage loans on single-family dwellings and condominiums. Such insurance protects lenders against loss if borrowers default. UGC subsidiaries also write home equity and property improvement loan insurance on loans to finance residential property improvements, alterations and repairs and for other purposes not necessarily related to real estate. During 2003, UGC commenced providing guaranty insurance to providers of student loans. UGC had approximately $22 billion of guaranty risk in-force at December 31, 2003.

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

     During 2003, DBG and the Foreign General insurance group accounted for 57.0 percent and 21.5 percent, respectively, of AIG’s General Insurance net premiums written.

     AIG’s General Insurance company subsidiaries worldwide operate primarily by underwriting and accepting risks for their direct account and securing reinsurance on that portion of the risk in excess of the limit which they wish to retain. This operating policy differs from that of many insurance companies which will underwrite only up to their net retention limit, thereby requiring the broker or agent to secure commitments from other underwriters for the remainder of the gross risk amount.

     The utilization of reinsurance is closely monitored by an internal reinsurance security committee, consisting of members of AIG’s senior management. No single reinsurer is a material reinsurer to AIG nor is AIG’s business substantially dependent upon any reinsurance contract. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 5 of Notes to Financial Statements.)

     AIG is diversified both in terms of lines of business and geographic locations. Of the General Insurance lines of business, workers’ compensation was approximately 12 percent of AIG’s net premiums written. This line of business is also diversified geographically.

     The majority of AIG’s General Insurance business is in the casualty classes, which tend to involve longer periods of time for the reporting and settling of claims. This may increase the risk and uncertainty with respect to AIG’s loss reserve development. (See also the Discussion and Analysis of Consolidated Net Losses and Loss Expense Reserve Development and Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

Loss and expense ratios of AIG’s consolidated General Insurance operations are set forth in the following table. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

                                                         
Ratio of Ratio of
Losses and Underwriting
Net Premiums Loss Expenses Expenses
Incurred to Incurred to Industry
Years Ended December 31,
Net Premiums Net Premiums Combined Underwriting Combined
(dollars in millions) Written Earned Earned Written Ratio Margin Ratio(c)

2003
  $ 35,212     $ 31,734       73.3       19.1       92.4       7.6       102.1  
2002
    27,414       24,269       85.8       20.2       106.0 (a)     (6.0 )     106.5  
2001
    20,101       19,365       79.5       21.2       100.7 (b)     (0.7 )     115.2  
2000
    17,526       17,407       75.3       21.4       96.7       3.3       107.8  
1999
    16,224       15,544       75.5       20.8       96.3       3.7       106.4  

(a) Excluding the net loss reserve charge of $2.8 billion, the General Insurance combined ratio would have been 94.4.
(b) Excluding WTC losses of $769 million, the General Insurance combined ratio would have been 96.7.
(c)  Source: Best’s Aggregates & Averages (Stock insurance companies, after dividends to policyholders): the ratio for 2003 was obtained from Fox-Pitt, Kelton Inc. and reflects estimated results.

     During 2003, of the direct General Insurance premiums written (gross premiums less return premiums and cancellations, excluding reinsurance assumed and before deducting reinsurance ceded), 11.0 percent, 7.6 percent and 6.4 percent were written in California, Illinois and New York, respectively. No other state accounted for more than 5 percent of such premiums.

     There was no significant adverse effect on AIG’s General Insurance results of operations from the economic environments in any one state, country or geographic region for the year ended December 31, 2003. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

 
FORM 10-K : 4


 

 
  Discussion and Analysis of Consolidated Net Losses and Loss Expense Reserve Development

The reserve for net losses and loss expenses represents the accumulation of estimates for reported losses (“case basis reserves”) and provisions for losses incurred but not reported (IBNR), both reduced by applicable reinsurance recoverable. Losses and loss expenses are charged to income as incurred.

     Loss reserves established with respect to foreign business are set and monitored in terms of the respective local or functional currency. Therefore, no assumption is included for changes in currency rates. (See also Note 1(w) of Notes to Financial Statements.)

     Management reviews the adequacy of established loss reserves through the utilization of a number of analytical reserve development techniques. Through the use of these techniques, management is able to monitor the adequacy of its established reserves and determine appropriate assumptions for inflation. Also, analysis of emerging specific development patterns, such as case reserve redundancies or deficiencies and IBNR emergence, allows management to determine any required adjustments. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     The “Analysis of Consolidated Net Losses and Loss Expense Reserve Development Excluding Asbestos and Environmental Net Losses and Loss Expense Reserve Development” table, which follows, presents the development of net losses and loss expense reserves for calendar years 1993 through 2003. The upper half of the table shows the cumulative amounts paid during successive years related to the opening loss reserves. For example, with respect to the net losses and loss expense reserve of $19.66 billion as of December 31, 1996, by the end of 2003 (seven years later) $16.30 billion had actually been paid in settlement of these net loss reserves. In addition, as reflected in the lower section of the table, the original reserve of $19.66 billion was reestimated to be $19.11 billion at December 31, 2003. This decrease from the original estimate would generally be a combination of a number of factors, including reserves being settled for smaller amounts than originally estimated. The original estimates will also be increased or decreased as more information becomes known about the individual claims and overall claim frequency and severity patterns. The redundancy (deficiency) depicted in the table, for any particular calendar year, shows the aggregate change in estimates over the period of years subsequent to the calendar year reflected at the top of the respective column heading. For example, the deficiency of $1.54 billion at December 31, 2003 related to December 31, 2002 net losses and loss expense reserves of $29.65 billion represents the cumulative amount by which reserves for 2002 and prior years have developed deficiently during 2003. The deficiency that has emerged in the last year can be attributed primarily to claims from accident years 1999 and 2000. The accident year emergence can be seen by comparing the respective developments in 2003 for each column’s loss reserve in the table below. For example, the liability associated with the year end 2000 loss reserves increased to $30.12 billion at year end 2003 from $28.26 billion at year end 2002, an increase of $1.86 billion in 2003. Thus, loss estimates for accident years 2000 and prior, which comprise the year end 2000 loss reserve, increased by $1.86 billion during 2003. Similarly, the table shows that the loss estimates for accident years 1999 and prior, which comprise the year end 1999 loss reserve, increased to $28.10 billion at year end 2003 from $26.95 billion at year end 2002, an increase of approximately $1.15 billion. This increase of $1.15 billion, as compared to the $1.86 billion increase in the 2000 column, indicates that accident year 2000 loss estimates increased by approximately $710 million during 2003, i.e. the difference between the respective $1.86 billion and $1.15 billion amounts. Similar calculations from the table below reveal that the accident year 1999 loss estimates increased approximately $600 million during 2003. Thus, loss estimates for accident years 1999 and 2000 increased by approximately $1.3 billion during 2003. Loss estimates also increased for accident years 1998 and prior, but by amounts small in comparison to 1999 and 2000. The primary cause of these higher loss estimates is higher than expected loss emergence in 2003. Loss development patterns utilized to test the reserves generally rely on the actual historical loss development patterns of prior accident years for each class of business. Accident years 1999 and 2000 exhibited significantly higher than normal loss development in the latest calendar year, thus creating the adverse developments noted above. The classes accounting for the majority of this higher than expected loss emergence in 2003 were excess casualty, directors and officers’ liability, and healthcare liability. It should be noted that loss estimates for accident years 2001 and 2002 did not develop adversely in 2003. Additionally, as shown in the table below, loss emergence from year end 1993, 1994, 1995 and 1996 has been favorable on an inception to date basis through year end 2003.

     The reserve for net losses and loss expenses with respect to Transatlantic and 21st Century are included only in the consolidated net losses and loss expenses commencing with the year ended December 31, 1998. Reserve development for these operations is included only for the 1998 and subsequent periods. Thus, the comparisons for 1997 and prior year ends are not fully comparable to those for 1998 and subsequent in the table below.

 
FORM 10-K : 5


 


American International Group, Inc. and Subsidiaries


 
  Analysis of Consolidated Net Losses and Loss Expense Reserve Development Excluding Asbestos and Environmental Net Losses and Loss Expense Reserve Development

The following table excludes for each calendar year the net loss and loss expense reserves and the development thereof with respect to asbestos and environmental claims. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

                                                                                           
(in millions) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Reserve for Net Losses and Loss Expenses, Excluding Asbestos and Environmental Losses and Loss Expenses, December 31,
  $ 17,249     $ 18,089     $ 19,186     $ 19,664     $ 20,384     $ 23,754     $ 23,709     $ 24,097     $ 25,177     $ 29,653     $ 35,978  
Paid (Cumulative) as of:
                                                                                       
 
One year later
    5,061       4,700       5,174       5,507       5,576       6,657       7,712       9,069       10,250       9,905          
 
Two years later
    8,082       7,891       8,515       8,832       9,305       11,373       13,426       15,804       16,634                  
 
Three years later
    10,137       10,048       10,673       11,094       12,122       15,031       18,130       20,127                          
 
Four years later
    11,726       11,683       12,128       12,948       14,172       18,284       20,881                                  
 
Five years later
    12,871       12,734       13,466       14,401       16,025       19,927                                          
 
Six years later
    13,560       13,689       14,601       15,653       16,916                                                  
 
Seven years later
    14,285       14,421       15,487       16,304                                                          
 
Eight years later
    14,866       15,114       15,881                                                                  
 
Nine years later
    15,405       15,339                                                                          
 
Ten years later
    15,543                                                                                  
Net Liability Reestimated as of:
                                                                                       
 
End of year
    17,249       18,089       19,186       19,664       20,384       23,754       23,709       24,097       25,177       29,653       35,978  
 
One year later
    17,019       17,556       18,568       19,118       19,903       23,229       23,345       24,563       29,131       31,189          
 
Two years later
    16,813       17,355       18,347       18,910       19,771       22,827       24,111       28,257       30,977                  
 
Three years later
    16,790       17,293       18,141       18,934       19,428       23,306       26,951       30,117                          
 
Four years later
    16,960       17,090       18,292       18,670       19,532       24,994       28,098                                  
 
Five years later
    16,969       17,155       18,161       18,568       20,213       25,547                                          
 
Six years later
    17,080       17,169       17,836       18,923       20,518                                                  
 
Seven years later
    17,146       16,838       18,101       19,111                                                          
 
Eight years later
    16,968       17,052       18,228                                                                  
 
Nine years later
    17,110       17,137                                                                          
 
Ten years later
    17,167                                                                                  
Redundancy/(Deficiency)
    82       952       958       553       (134 )     (1,793 )     (4,389 )     (6,020 )     (5,800 )     (1,536 )*        
Less effect of 21st Century homeowners and earthquake lines in runoff
                                            (155 )     (149 )     (148 )     (95 )     (40 )        
Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines
                                            (1,638 )     (4,240 )     (5,872 )     (5,705 )     (1,496 )*        

$323 million of the deficiency reflected relates to the reserve development of the general reinsurance operations of Transatlantic.
 
FORM 10-K : 6


 

 
  Analysis of Consolidated Net Losses and Loss Expense Reserve Development

The following table includes for each calendar year the net loss and loss expense reserves and the development thereof with respect to asbestos and environmental claims. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

                                                                                           
(in millions) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Reserve for Net Losses and Loss Expenses, December 31,
  $ 17,557     $ 18,419     $ 19,693     $ 20,407     $ 21,171     $ 24,619     $ 24,600     $ 24,952     $ 25,896     $ 30,350     $ 36,647  
Paid (Cumulative) as of:
                                                                                       
 
One year later
    5,146       4,775       5,281       5,616       5,716       6,779       7,783       9,263       10,396       10,048          
 
Two years later
    8,242       8,073       8,726       9,081       9,559       11,565       13,690       16,144       16,924                  
 
Three years later
    10,404       10,333       11,024       11,456       12,442       15,416       18,540       20,610                          
 
Four years later
    12,095       12,107       12,591       13,376       14,684       18,815       21,434                                  
 
Five years later
    13,378       13,270       13,994       15,018       16,679       20,600                                          
 
Six years later
    14,179       14,290       15,317       16,412       17,708                                                  
 
Seven years later
    14,968       15,209       16,344       17,200                                                          
 
Eight years later
    15,735       16,043       16,874                                                                  
 
Nine years later
    16,414       16,403                                                                          
 
Ten years later
    16,688                                                                                  
Net Liability Reestimated as of:
                                                                                       
 
End of year
    17,557       18,419       19,693       20,407       21,171       24,619       24,600       24,952       25,896       30,350       36,647  
 
One year later
    17,434       18,139       19,413       20,009       20,890       24,237       24,265       25,471       29,969       31,973          
 
Two years later
    17,479       18,269       19,330       19,999       20,886       23,864       25,082       29,284       31,902                  
 
Three years later
    17,782       18,344       19,327       20,151       20,572       24,392       28,043       31,230                          
 
Four years later
    18,090       18,344       19,604       19,916       20,715       26,202       29,277                                  
 
Five years later
    18,300       18,535       19,500       19,851       21,513       26,841                                          
 
Six years later
    18,537       18,575       19,212       20,323       21,902                                                  
 
Seven years later
    18,629       18,281       19,592       20,594                                                          
 
Eight years later
    18,485       18,608       19,802                                                                  
 
Nine years later
    18,742       18,777                                                                          
 
Ten years later
    18,881                                                                                  
 
Redundancy/(Deficiency)
    (1,324 )     (358 )     (109 )     (187 )     (731 )     (2,222 )     (4,677 )     (6,278 )     (6,006 )     (1,623 )*        
 
Less effect of 21st Century homeowners and earthquake lines in runoff
                                            (155 )     (149 )     (148 )     (95 )     (40 )        
 
Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines
                                            (2,067 )     (4,528 )     (6,130 )     (5,911 )     (1,583 )*        

$323 million of the deficiency reflected relates to the reserve development of the general reinsurance operations of Transatlantic.
 
  Reconciliation of Net Reserves for
Losses and Loss Expenses
                           
(in millions) 2003 2002 2001

Net reserve for losses and loss
expenses at beginning of year
  $ 30,350     $ 25,896     $ 24,952  
Acquisition(a)
    391              

Losses and loss expenses incurred:
                       
 
Current year
    21,647       16,741       14,870  
 
Prior years(b)
    1,623       4,073       536  

      23,270       20,814       15,406  

Losses and loss expenses paid:
                       
 
Current year
    7,316       5,964       5,199  
 
Prior years
    10,048       10,396       9,263  

      17,364       16,360       14,462  

Net reserve for losses and loss
expenses at end of year(c)
  $ 36,647     $ 30,350     $ 25,896  

(a) Includes the opening balances with respect to the GE U.S.-based auto and home insurance business acquired in 2003.
(b) Does not include the effects of foreign exchange adjustments which are reflected in the “Net Losses and Loss Expense Reserve Development” table.
(c)  See also Note 6(a) of Notes to Financial Statements.

     For further discussion regarding net reserves for losses and loss expenses, see Management’s Discussion and Analysis of Financial Condition and Results of Operations.

     The reserve for losses and loss expenses as reported in AIG’s Consolidated Balance Sheet at December 31, 2003, differs from the total reserve reported in the Annual Statements filed with state insurance departments and, where appropriate, with foreign regulatory authorities. The differences at December 31, 2003 relate primarily to reserves for certain foreign operations. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     The reserve for gross losses and loss expenses is prior to reinsurance and represents the accumulation for reported losses and IBNR. Management reviews the adequacy of established gross loss reserves in the manner previously described for net loss reserves.

 
FORM 10-K : 7


 


American International Group, Inc. and Subsidiaries


 
  Analysis of Consolidated Gross Losses and Loss Expense Reserve Development

The “Analysis of Consolidated Gross Losses and Loss Expense Reserve Development” table, which follows, presents the development of gross losses and loss expense reserves for calendar years 1993 through 2003.

                                                                                           
(in millions) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Gross Losses and Loss Expenses, December 31,
  $ 30,046     $ 31,435     $ 33,047     $ 33,430     $ 33,400     $ 38,310     $ 38,252     $ 40,613     $ 44,792     $ 51,539     $ 56,118  
Paid (Cumulative) as of:
                                                                                       
 
One year later
    8,807       7,640       8,392       9,199       9,185       10,344       12,543       12,905       14,934       17,819          
 
Two years later
    13,279       13,036       15,496       15,043       14,696       19,155       19,350       24,079       30,115                  
 
Three years later
    17,311       17,540       18,837       18,721       19,706       24,309       28,699       33,656                          
 
Four years later
    20,803       20,653       21,811       21,729       22,659       30,301       36,019                                  
 
Five years later
    22,895       22,634       23,463       23,498       27,554       35,897                                          
 
Six years later
    23,779       24,205       24,927       26,649       30,974                                                  
 
Seven years later
    25,239       24,882       28,234       30,004                                                          
 
Eight years later
    26,314       27,404       30,057                                                                  
 
Nine years later
    28,221       28,479                                                                          
 
Ten years later
    29,202                                                                                  
Gross Liability Reestimated as of:
                                                                                       
 
End of year
    30,046       31,435       33,047       33,430       33,400       38,310       38,252       40,613       44,792       51,539       56,118  
 
One year later
    29,866       30,759       32,372       32,777       32,337       37,161       37,998       41,443       49,565       53,512          
 
Two years later
    29,537       30,960       32,398       31,719       32,251       37,959       40,454       46,259       52,575                  
 
Three years later
    30,362       30,825       31,759       31,407       32,810       39,713       43,865       50,424                          
 
Four years later
    31,020       30,508       31,604       32,388       34,449       41,828       47,258                                  
 
Five years later
    30,881       30,417       32,425       32,979       35,316       44,453                                          
 
Six years later
    30,969       31,128       32,869       33,328       37,360                                                  
 
Seven years later
    31,546       31,524       33,227       35,120                                                          
 
Eight years later
    31,841       31,875       34,683                                                                  
 
Nine years later
    32,044       32,922                                                                          
 
Ten years later
    32,854                                                                                  
 
Redundancy/(Deficiency)
    (2,808 )     (1,487 )     (1,636 )     (1,690 )     (3,960 )     (6,143 )     (9,006 )     (9,811 )     (7,783 )     (1,973 )*        
 
Less effect of 21st Century homeowners and earthquake lines in runoff
                                            (155 )     (149 )     (148 )     (95 )     (40 )        
 
Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines
                                            (5,988 )     (8,857 )     (9,663 )     (7,688 )     (1,933 )*        

$433 million of the deficiency reflected relates to the reserve development of the general reinsurance operations of Transatlantic.
 
  Life Insurance Operations

AIG’s Life Insurance subsidiaries offer a wide range of traditional insurance and financial and investment products both domestically and abroad. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     Life Insurance operations in foreign countries comprised 78.0 percent of GAAP Life premiums and 59.7 percent of life operating income in 2003. AIG operates overseas principally through ALICO, AIA and 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 Europe, Africa, Latin America, the Caribbean, the Middle East, South Asia and the Far East, with Japan being the largest territory. AIG added significantly to its presence in Japan with the acquisition of GE Edison Life Insurance Company, (now known as AIG Edison Life Insurance Company) (AIG Edison Life), in 2003 and AIG Star Life in 2001, as a result of the reorganization of Chiyoda Mutual Life Insurance Company. AIA operates primarily in China (including Hong Kong), Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. (See also Note 2 of Notes to Financial Statements.)

 
FORM 10-K : 8


 

     AIG’s principal domestic Life Insurance operations include AIG American General Life, AIG Annuity and SunAmerica Life. These companies utilize multiple distribution channels including brokerage and career and general agents to offer traditional life products as well as financial and investment products. The domestic life operations comprised 22.0 percent of total GAAP Life premiums in 2003.

     There was no significant adverse effect on AIG’s Life Insurance results of operations from economic environments in any one state, country or geographic region for the year ended December 31, 2003. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     Traditional Life Insurance products such as whole life and endowment continue to be significant in the overseas companies, especially in Southeast Asia, while a mixture of traditional, accident and health and financial products are sold in Japan.

     In addition to the above, AIG also has subsidiary operations in the Philippines, Canada, Mexico, Poland, Switzerland and Puerto Rico, and conducts life insurance business through AIUO subsidiary companies in Russia, Israel and in certain countries in Central and South America.

     The foreign life companies have over 230,000 career agents and sell their products largely to indigenous persons in local currencies. In addition to the agency outlets, these companies also distribute their products through direct marketing channels, such as mass marketing, and through brokers and other distribution outlets such as financial institutions.

 
  Insurance Investment Operations

A significant portion of AIG’s general and life operating revenues are derived from AIG’s insurance investment operations.

(See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 2 and 8 of Notes to Financial Statements.)

The following table summarizes the investment results of the General Insurance operations. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 8 of Notes to Financial Statements.)

                                                         
Annual Average Cash and Invested
Assets

Cash Realized
(including Net Rate of Return on Capital
Years Ended December 31, short-term Invested Investment Cash and Gains
(in millions) investments) Assets(a) Total Income(b) Invested Assets (Losses)

2003
  $ 1,875     $ 60,122     $ 61,997     $ 3,022       4.9 % (c)     5.0 % (d)   $ (172 )
2002
    1,726       47,592       49,318       2,760       5.6   (c)     5.8   (d)     (858 )
2001
    1,533       41,492       43,025       2,893       6.7   (c)     7.0   (d)     (130 )
2000
    1,212       39,801       41,013       2,701       6.6   (c)     6.8   (d)     38  
1999
    925       38,084       39,009       2,517       6.5   (c)     6.6   (d)     295  

(a) Including investment income due and accrued, and real estate.
(b) Net investment income is after deduction of investment expenses and excludes realized capital gains (losses).
(c) Net investment income divided by the annual average sum of cash and invested assets.
(d) Net investment income divided by the annual average invested assets.

The following table summarizes the investment results of the Life Insurance operations. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 8 of Notes to Financial Statements.)

                                                         
Annual Average Cash and Invested Assets

Cash
(including Net Rate of Return on Realized
Years Ended December 31, short-term Invested Investment Cash and Capital
(in millions) investments) Assets(a) Total Income(b) Invested Assets Losses

2003
  $ 5,772     $ 286,978     $ 292,750     $ 13,640       4.7 % (c)     4.8 % (d)   $ (826 )
2002
    5,167       231,290       236,457       12,274       5.2   (c)     5.3   (d)     (1,053 )
2001
    5,054       186,103       191,157       11,084       5.8   (c)     6.0   (d)     (254 )
2000
    5,670       155,477       161,147       9,962       6.2   (c)     6.4   (d)     (162 )
1999
    6,590       141,771       148,361       8,932       6.0   (c)     6.3   (d)     (148 )

(a) Including investment income due and accrued, and real estate.
(b) Net investment income is after deduction of investment expenses and excludes realized capital gains (losses).
(c) Net investment income divided by the annual average sum of cash and invested assets.
(d) Net investment income divided by the annual average invested assets.
 
 
FORM 10-K : 9


 


American International Group, Inc. and Subsidiaries


     AIG’s worldwide insurance investment policy places primary emphasis on investments in high quality, fixed income securities in all of its portfolios and, to a lesser extent, investments in marketable common stocks, in order to preserve policyholders’ surplus and generate net investment income. The ability to implement this policy is somewhat limited in certain territories as there may be a lack of qualified long term investments or investment restrictions may be imposed by the local regulatory authorities. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

 
  Financial Services Operations

AIG’s Financial Services subsidiaries engage in diversified financial products and services including aircraft leasing, capital market transactions, and consumer and insurance premium financing.

     AIG’s Aircraft Finance Operations represent the operations of ILFC which engages primarily in the acquisition of 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 2 of Notes to Financial Statements.)

     During the third quarter, AIG integrated the operations of AIG Trading Group Inc. (AIGTG) into AIGFP thereby establishing the Capital Markets reporting unit. AIGFP engages as principal in standard and customized interest rate, currency, equity, and credit products with top tier corporations, financial institutions, governments, agencies, institutional investors, and high net worth individuals throughout the world. AIGFP also raises funds through municipal re-investment contracts and other private and public security offerings, investing the proceeds in a diversified portfolio of high grade securities and derivative transactions. AIGTG engages in various commodity and foreign exchange trading and market making activities. (See also Note 2 of Notes to Financial Statements.)

     AIG’s Consumer Finance operations include AGF as well as AIG Consumer Finance Group, Inc. (AIGCFG). (See also Note 2 of Notes to Financial Statements.)

     AGF provides a wide variety of consumer finance products, including real estate mortgages, consumer loans, retail sales finance and credit related insurance to customers in the United States.

     AIGCFG, through its subsidiaries, is engaged in developing a multi-product consumer finance business with an emphasis on emerging markets.

     Together Aircraft Finance, Capital Markets and AIG’s Consumer Finance operations comprise the vast majority of the commissions, transaction and other fees of AIG’s consolidated financial services operations.

     Imperial A.I. Credit Companies also contribute to financial services income. This operation engages principally in insurance premium financing. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 9 and 12 of Notes to Financial Statements.)

 
  Retirement Services & Asset Management Operations

AIG’s Retirement Services & Asset Management operations offer a wide variety of investment products, including variable annuities and mutual funds, as well as investment services, such as investment asset management. Such products and services are offered to individuals and institutions both domestically and overseas.

     AIG’s principal Retirement Services & Asset Management operations are conducted through AIG Retirement Services, Inc. and its subsidiaries (AIG SunAmerica), VALIC and its related marketing entities (AIG VALIC) and AIG Global Investment Group. AIG SunAmerica develops and sells variable annuities and other investment products, sells and manages mutual funds and provides financial services. AIG VALIC provides tax qualified annuities to the employees of educational, healthcare and governmental entities. AIG Global Investment Group manages third-party institutional, retail and private equity funds invested assets on a global basis, provides securities lending and custodial services and organizes and manages the invested assets of institutional private equity investment funds. Each of these subsidiary operations receives fees for investment products and services provided. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 1 of Notes to Financial Statements.)

 
  Other Operations

Certain other AIG subsidiaries provide insurance-related services such as adjusting claims and marketing specialized products. AIG also has several other subsidiaries which engage in various businesses. For example, American International Technology Enterprises, Inc. provides information technology and processing services to businesses worldwide. Mt. Mansfield Company, Inc. owns and operates the ski slopes, lifts, school and an inn located at Stowe, Vermont.

 
FORM 10-K : 10


 

 
  Additional Investments

AIG holds a 24.3 percent interest in IPC Holdings, Ltd., a reinsurance holding company, a 23.4 percent interest in Allied World Assurance Holdings, Ltd., a property-casualty insurance holding company, and a 22.1 percent interest in The Fuji Fire and Marine Insurance Co., Ltd., a general insurance company. (See also Note 1(q) of Notes to Financial Statements.)

 
  Locations of Certain Assets

As of December 31, 2003, approximately 30 percent of the consolidated assets of AIG were located in foreign countries (other than Canada), including $3.05 billion of cash and securities on deposit with foreign regulatory authorities. Foreign operations and assets held abroad may be adversely affected by political developments in foreign countries, including such possibilities as tax changes, nationalization and changes in regulatory policy, as well as by consequence of hostilities and unrest. The risks of such occurrences and their overall effect upon AIG vary from country to country and cannot easily be predicted. If expropriation or nationalization does occur, AIG’s policy is to take all appropriate measures to seek recovery of such assets. Certain of the countries in which AIG’s business is conducted have currency restrictions which generally cause a delay in a company’s ability to repatriate assets and profits. (See also Notes 1 and 2 of Notes to Financial Statements.)

 
  Regulation and Competition

Certain states require registration and periodic reporting by insurance companies that are licensed in such states and are controlled by other corporations. Applicable legislation typically requires periodic disclosure concerning the corporation that controls the registered insurer and the other companies in the holding company system and prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system. AIG’s subsidiaries are registered under such legislation in those states that have such requirements. (See also Note 11 of Notes to Financial Statements.)

     AIG’s insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk-based capital measurements, the licensing of insurers and their agents, the nature of and limitations on investments, restrictions on the size of risks that may be insured under a single policy, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than security holders. (See also Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     Risk-Based Capital (RBC) is designed to measure the adequacy of an insurer’s statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized General and Life Insurance companies may be identified.

     The RBC formula develops a risk adjusted target level of statutory surplus by applying certain factors to various asset, premium and reserve items. Higher factors are applied to more risky items and lower factors are applied to less risky items. Thus, the target level of statutory surplus varies not only as a result of the insurer’s size, but also on the risk profile of the insurer’s operations.

     The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control.

     The risk-based adjusted surplus of each of AIG’s Domestic General and Life Insurance subsidiaries exceeded their RBC standards as of December 31, 2003.

     To the extent that any of AIG’s insurance entities would fall below prescribed levels of surplus, it would be AIG’s intention to infuse necessary capital to support that entity.

     Privacy provisions of the Gramm-Leach-Bliley Act became fully effective in 2001. These provisions established consumer protections regarding the security and confidentiality of nonpublic personal information and require full disclosure of the privacy policies of financial institutions to their consumer customers. There is also legislation pending in the United States Congress and various states designed to provide additional privacy protections to consumer customers of financial institutions. These statutes and similar legislation and regulations in the United States or other jurisdictions could impact AIG’s ability to market its products or otherwise limit the nature or scope of AIG’s Insurance and Financial Services operations.

 
FORM 10-K : 11


 


American International Group, Inc. and Subsidiaries


     A substantial portion of AIG’s General Insurance business and a majority of its Life Insurance business is carried on 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 or revocation by such authorities, and AIU or other AIG subsidiaries could be prevented from conducting business in certain of the jurisdictions where they currently operate. In the past, AIU has been allowed to modify its operations to conform with new licensing requirements in most jurisdictions.

     In addition to licensing requirements, AIG’s foreign operations are also regulated in various jurisdictions with respect to currency, policy language and terms, amount and type of security deposits, amount and type of reserves, amount and type of local investment and the share of profits to be returned to policyholders on participating policies. Some foreign countries regulate rates on various types of policies. Certain countries have established reinsurance institutions, wholly or partially owned by the state, to which admitted insurers are obligated to cede a portion of their business on terms which do not always allow foreign insurers, including AIG, full compensation. In some countries, regulations governing constitution of technical reserves and remittance balances may hinder remittance of profits and repatriation of assets.

     The insurance industry is highly competitive. Within the United States, AIG’s General Insurance subsidiaries compete with approximately 3,000 other stock companies, specialty insurance organizations, mutual companies and other underwriting organizations. AIG’s subsidiaries offering Life Insurance and Retirement Services compete in the United States with approximately 1,800 life insurance companies and other participants in related financial service fields. Overseas, AIG subsidiaries compete for business with foreign insurance operations of the larger U.S. insurers and local companies in particular areas in which they are active.

     AIG’s Insurance, Financial Services and Asset Management operations operate in a highly competitive and increasingly regulated environment, both domestically and overseas. Principal sources of competition are banks, investment banks and other non-bank financial institutions. The focus of AIG’s operations has also become more consumer-oriented, thereby increasing the risks of regulatory supervision and intervention.

 
ITEM 2.  Properties

AIG and its subsidiaries operate from approximately 2,200 offices in the United States, 9 offices in Canada and numerous offices in approximately 100 foreign countries. The offices in Springfield, Illinois; Amarillo, Ft. Worth and Houston, Texas; Wilmington, Delaware; Hato Rey and Isabella, Puerto Rico; Tampa, Florida; Livingston, New Jersey; Evansville, Indiana; Nashville, Tennessee; 70 Pine Street, 72 Wall Street and 175 Water Street in New York City; and offices in approximately 30 foreign countries including Bermuda, Chile, Hong Kong, the Philippines, Japan, United Kingdom, Singapore, Switzerland, Taiwan and Thailand are located in buildings owned by AIG and its subsidiaries. The remainder of the office space utilized by AIG subsidiaries is leased.

 
ITEM 3.  Legal Proceedings

AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material adverse effect on its financial condition, future operating results or liquidity. (See also the Discussion and Analysis of Consolidated Net Losses and Loss Expense Reserve Development and Management’s Discussion and Analysis of Financial Condition and Results of Operations.)

     In late 2002, a shareholder derivative action was filed in Delaware Chancery Court alleging breaches of fiduciary duty of loyalty and care against AIG’s directors. AIG’s management believes the allegations of the complaint are without merit. AIG’s Board of Directors appointed a special committee of independent directors to review the complaint and respond to the lawsuit. The special committee has issued a report that concluded that it was not in the best interests of AIG or its shareholders to pursue the litigation and moved the Delaware Chancery Court to terminate the litigation. Discovery is ongoing relating to that motion.

 
ITEM 4.  Submission of Matters to a Vote of Security Holders

There were no matters submitted to a vote of security holders during the fourth quarter of 2003.

 
 
FORM 10-K : 12


 

 
  Directors and Executive Officers
of the Registrant

Set forth below is certain information concerning the directors and executive officers of AIG. All directors are elected for one year terms at the annual meeting of shareholders. All officers serve at the pleasure of the Board of Directors, but subject to the foregoing, are elected to one year terms expiring in May of each year.

     Except as hereinafter noted, each of the directors who is also an executive officer of AIG and each of the other executive officers has, for more than five years, occupied an executive position with AIG or companies that are now its subsidiaries. There are no other arrangements or understandings between any director or officer and any other person pursuant to which the director or officer was elected to such position. Prior to joining AIG in 2001, Mr. Rautenberg was Vice President and General Manager, Corporate Communications at Canon, U.S.A. from September 2000 to June 2001 and for five years prior to that he was the senior corporate communications executive at Reliance Group Holdings. Prior to joining AIG in September 2002, Mr. Bensinger was Executive Vice President and Chief Financial Officer of Combined Specialty Group, Inc. (a division of Aon Corporation) commencing in March 2002, and served as Executive Vice President of Trenwick Group, Ltd. from October 1999 through December 2001 and as President of Chartwell Re Corp. from March 1993 until October 1999.

                 
Served as Director
Name Title Age or Officer Since

M. Bernard Aidinoff*
  Director     75     1984
Pei-yuan Chia
  Director     65     1996
Marshall A. Cohen
  Director     69     1992
William S. Cohen
  Director     63     2004
Martin S. Feldstein
  Director     64     1987
Ellen V. Futter
  Director     54     1999
M. R. Greenberg*
  Director, Chairman and Chief Executive Officer     78     1967
Carla A. Hills*
  Director     70     1993
Frank J. Hoenemeyer*
  Director     84     1985
Richard C. Holbrooke
  Director     62     2001
Howard I. Smith
  Director, Vice Chairman, Chief Financial Officer and Chief Administrative Officer     59     1984
Martin J. Sullivan
  Director, Vice Chairman and Co-Chief Operating Officer     49     1997
Edmund S. W. Tse
  Director and Senior Vice Chairman – Life Insurance     66     1991
Jay S. Wintrob
  Director and Executive Vice President – Retirement Services     46     1999
Frank G. Wisner
  Director and Vice Chairman – External Affairs     65     1997
Frank G. Zarb*
  Director     68     2001
Thomas R. Tizzio
  Senior Vice Chairman – General Insurance     66     1982
Donald P. Kanak
  Vice Chairman and Co-Chief Operating Officer     51     1998
John A. Graf
  Executive Vice President – Retirement Services     44     2002
Rodney O. Martin, Jr.
  Executive Vice President – Life Insurance     51     2002
Kristian P. Moor
  Executive Vice President – Domestic General Insurance     44     1998
Win J. Neuger
  Executive Vice President and Chief Investment Officer     54     1995
R. Kendall Nottingham
  Executive Vice President – Life Insurance     65     1998
Robert M. Sandler
  Executive Vice President, Senior Casualty Actuary and Senior Claims Officer     61     1980
William N. Dooley
  Senior Vice President – Financial Services     51     1992
Lawrence W. English
  Senior Vice President – Administration     62     1985
Axel I. Freudmann
  Senior Vice President – Human Resources     57     1986
Robert E. Lewis
  Senior Vice President and Chief Credit Officer     53     1993
Ernest T. Patrikis
  Senior Vice President and General Counsel     60     1998
Brian T. Schreiber
  Senior Vice President – Strategic Planning     38     2002
Richard W. Scott
  Senior Vice President – Investments     50     2002
Kathleen E. Shannon
  Senior Vice President, Secretary and Deputy General Counsel     54     1986
Steven J. Bensinger
  Vice President and Treasurer     49     2002
Michael J. Castelli
  Vice President and Comptroller     48     1998
Keith L. Duckett
  Vice President and Director of Internal Audit     43     2001
Peter K. Lathrop
  Vice President and Director of Taxes     61     2001
Charles M. Lucas
  Vice President and Director of Market Risk Management     65     1996
Steven A. Rautenberg
  Vice President – Communications     54     2001

Member of Executive Committee.
 
FORM 10-K : 13


 


American International Group, Inc. and Subsidiaries


PART II

 
ITEM 5.  Market for the Registrant’s Common Equity and Related Stockholder Matters

(a) The table below shows the high and low closing sales prices per share of AIG’s common stock on the New York Stock Exchange Composite Tape, for each quarter of 2003 and 2002.

                                 
2003 2002


High Low High Low

First quarter
    63.50       44.47       79.61       70.15  
Second quarter
    60.20       50.60       75.26       62.84  
Third quarter
    64.70       55.54       67.91       51.10  
Fourth quarter
    66.28       56.59       67.89       52.45  

     (b) In 2003, AIG paid a quarterly dividend of 4.7 cents in March and June and 6.5 cents in September and December for a total cash payment of 22.4 cents per share of common stock. In 2002, AIG paid a quarterly dividend of 4.2 cents in March and June and 4.7 cents in September and December for a total cash payment of 17.8 cents per share of common stock. Subject to the dividend preference of any of AIG’s serial preferred stock which may be outstanding, the holders of shares of common stock are entitled to receive such dividends as may be declared by the Board of Directors from funds legally available therefor.

     See Note 11(a) of Notes to Financial Statements for a discussion of certain restrictions on the payment of dividends to AIG by some of its insurance subsidiaries.

     (c) The approximate number of holders of common stock as of January 31, 2004, based upon the number of record holders, was 60,000.

 
FORM 10-K : 14


 

 
ITEM 6.  Selected Financial Data

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES

SELECTED CONSOLIDATED FINANCIAL DATA

The following Selected Consolidated Financial Data, which has been restated to give retroactive effect to the acquisitions of AGC and SunAmerica Inc. on a pooling of interests basis, is presented in accordance with generally accepted accounting principles. This data should be read in conjunction with the supplemental financial statements and accompanying notes included elsewhere herein.

                                             
Years Ended December 31,
(in millions, except per share amounts) 2003 2002 2001 2000 1999

Revenues(a):
                                       
 
Premiums and other considerations
  $ 54,613     $ 44,589     $ 38,428     $ 34,570     $ 31,020  
 
Net investment income
    16,662       15,034       13,977       12,663       11,449  
 
Realized capital gains (losses)
    (1,433 )     (2,441 )     (836 )     (314 )     103  
 
Other revenues
    11,461       10,300       10,197       9,419       8,162  
Total revenues
    81,303       67,482       61,766       56,338       50,734  
Benefits and expenses:
                                       
 
Incurred policy losses and benefits
    46,886       41,927       35,054       30,864       27,495  
 
Insurance acquisition and other operating expenses
    20,509       17,413       16,556       15,136       13,840  
 
Acquisition, restructuring and related charges
                2,017       315        
Total benefits and expenses
    67,395       59,340       53,627       46,315       41,335  
Income before income taxes, minority interest and cumulative effect of accounting changes(b)
    13,908       8,142       8,139       10,023       9,399  
Income taxes
    4,264       2,328       2,339       2,971       2,833  
Income before minority interest and cumulative effect of accounting changes
    9,644       5,814       5,800       7,052       6,566  
Minority interest
    (379 )     (295 )     (301 )     (413 )     (380 )
Income before cumulative effect of accounting changes
    9,265       5,519       5,499       6,639       6,186  
Cumulative effect of accounting changes, net of tax
    9             (136 )            
Net income
    9,274       5,519       5,363       6,639       6,186  
Earnings per common share(c):
                                       
 
Basic
                                       
   
Income before cumulative effect of accounting changes
    3.55       2.11       2.10       2.55       2.37  
   
Cumulative effect of accounting changes, net of tax
                (0.05 )            
   
Net income
    3.55       2.11       2.05       2.55       2.37  
 
Diluted
                                       
   
Income before cumulative effect of accounting changes
    3.53       2.10       2.07       2.52       2.34  
   
Cumulative effect of accounting changes, net of tax
                (0.05 )            
   
Net income
    3.53       2.10       2.02       2.52       2.34  
Cash dividends per common share(d)
    .22       .18       .16       .14       .13  
Total assets
    678,346       561,229       493,061       426,671       383,685  
Long-term debt(e)
                                       
   
Guaranteed by AIG
    6,427       5,259       5,539       2,370       1,968  
   
Matched/not guaranteed by AIG
    64,913       57,514       48,300       38,906       34,261  
Commercial paper
                                       
   
Guaranteed by AIG
    1,223       1,645       3,370       1,565       1,363  
   
Not guaranteed by AIG
    4,715       7,467       8,522       11,482       8,718  
Shareholders’ equity
    71,253       59,103       52,150       47,439       39,641  

(a) Represents the sum of General Insurance net premiums earned, GAAP Life premiums, net investment income, Financial Services commissions, transaction and other fees, Retirement Services & Asset Management commissions and other fees and realized capital gains (losses).
(b) Includes net loss reserve charge of $2.8 billion in 2002 and World Trade Center losses of $900 million in 2001.
(c) Per share amounts for all periods presented have been retroactively adjusted to reflect all stock dividends and splits and reflect the adoption of the Statement of Financial Accounting Standards No. 128, “Earnings per Share.”
(d)  Cash dividends have not been restated to reflect dividends paid by AGC which was acquired by AIG on August 29, 2001.
(e) Including that portion of long-term debt maturing in less than one year. (See also Note 9 of Notes to Financial Statements.)
 
FORM 10-K : 15


 


American International Group, Inc. and Subsidiaries


INDEX TO FINANCIAL INFORMATION

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

INDEX

             
Page

INTRODUCTION AND EXECUTIVE SUMMARY
    17  
 
Consolidated Results
    18  
CRITICAL ACCOUNTING ESTIMATES
    19  
OPERATING REVIEW
    20  
 
General Insurance Operations
    20  
   
General Insurance Results
    21  
   
Reinsurance
    23  
   
Reserve for Losses and Loss Expenses
    24  
   
Asbestos and Environmental Reserves
    27  
 
Life Insurance Operations
    30  
   
Life Insurance Results
    31  
   
Underwriting and Investment Risk
    31  
 
Insurance Invested Assets
    32  
   
Credit Quality
    33  
   
Valuation of Invested Assets
    33  
 
Financial Services Operations
    36  
   
Financial Services Results
    37  
   
Financial Services Invested Assets
    38  
 
Retirement Services & Asset Management Operations
    40  
   
Retirement Services & Asset Management Results
    40  
 
Other Operations
    40  
CAPITAL RESOURCES     41  
   
Borrowings
    41  
   
Shareholders’ Equity
    43  
   
Stock Repurchase
    43  
   
Dividends from Insurance Subsidiaries
    43  
   
Regulation and Supervision
    43  
   
Contractual Obligations and Other Commercial Commitments
    44  
SPECIAL PURPOSE VEHICLES AND OFF BALANCE SHEET ARRANGEMENTS
    45  
LIQUIDITY     45  
MANAGING MARKET RISK     46  
   
Insurance
    46  
   
Financial Services
    47  
DERIVATIVES     48  
ACCOUNTING STANDARDS     49  
 
  Cautionary Statement Regarding
Forward-Looking Information

This Annual Report and other publicly available documents may include, and AIG’s officers and representatives may from time to time make, statements which may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts but instead represent only AIG’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside 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.

 
FORM 10-K : 16


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 
ITEM 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, AIG presents its operations in the way it believes will be most meaningful. Gross premiums written, statutory underwriting profit (loss) and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance used in the insurance industry and thus allow more meaningful comparisons with AIG’s insurance competitors. AIG has also incorporated into this discussion a number of parenthetical cross-references to additional information included throughout this Form 10-K to assist readers seeking related information on a particular subject.
 
  Introduction and Executive Summary

AIG’s operations in 2003 were conducted by its subsidiaries principally through four operating segments: General Insurance, Life Insurance, Financial Services and Retirement Services & Asset Management. Through these segments, AIG provided insurance and investment products and services to both businesses and individuals in over 130 countries and jurisdictions. This geographic product and service diversification is one of AIG’s major strengths and sets it apart from its competitors. Although regional economic downturns or political upheaval could negatively impact parts of AIG’s operations, AIG believes that this diversification makes it unlikely that regional difficulties would have a material impact on its operating results, financial condition or liquidity.

     AIG’s subsidiaries serve commercial, institutional and individual customers through an extensive property-casualty and life insurance network. In the United States, AIG companies are the largest underwriter of commercial and industrial insurance and one of the largest life insurance operations as well. AIG’s Financial Services businesses include commercial aircraft leasing, capital markets and consumer finance, both in the United States and abroad. AIG also has one of the largest retirement services business in the United States and provides asset management services to institutions and individuals.

     AIG’s 2003 performance reflects implementation of various long-term strategies and defined goals in its various operating segments.

     A primary goal of AIG in managing its General Insurance operations is to achieve an underwriting profit – maintaining a combined loss and expense ratio under 100. To achieve this end, AIG is disciplined in its risk selection and premiums must be adequate to cover the risk accepted. AIG believes in strict control of expenses, so it historically has one of the lowest expense ratios in the industry.

     AIG patiently builds relationships in markets around the world where it sees long-term growth opportunities. For example, AIG’s ability to expand its Chinese operations more quickly and extensively than its competitors is the result of relationships developed over nearly 30 years. AIG’s more recent extensions of operations into India, Brazil, Russia and other emerging markets follow the same pattern. Moreover, AIG believes in investing in the economies and infrastructures of these countries and growing with them. When AIG companies enter a new jurisdiction, they typically offer both basic protection and savings products. As the economies evolve, AIG’s products evolve with them, to more complex and investment-oriented models.

     Another central focus of AIG operations in current years is the development and expansion of new distribution channels. In late 2003, AIG entered into an agreement with the Peoples Insurance Company of China (PICC) which will enable AIG companies to market accident and health products throughout China through PICC’s agency system. Other examples of new distribution channels used both domestically and overseas include banks, affinity groups and e-commerce.

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

     AIG provides leadership on issues of concern to the global and local economies as well as the insurance and financial services industries. In recent years, tort reform and legislation to deal with the asbestos problem have been key issues, while in prior years trade legislation and superfund have been issues of concern.

The following table summarizes AIG’s revenues, income before income taxes, minority interest and cumulative effect of accounting changes and net income for the twelve months ended December 31, 2003, 2002 and 2001:

                         
Years Ended December 31,
(in millions) 2003 2002 2001

Total revenues
  $ 81,303     $ 67,482     $ 61,766  

Income before income taxes, minority interest and cumulative effect of accounting changes
    13,908       8,142       8,139  

Net income
  $ 9,274     $ 5,519     $ 5,363  

 
FORM 10-K : 17


 

 


American International Group, Inc. and Subsidiaries


Consolidated Results

The 20.5 percent growth in revenues in 2003 was primarily attributable to the growth in net premiums earned from global General Insurance operations as well as growth in both General Insurance and Life Insurance net investment income and GAAP Life premiums. Additionally, net realized capital losses declined $1.0 billion in 2003 over 2002.

     AIG’s income before income taxes, minority interest and cumulative effect of an accounting change increased 70.8 percent in 2003 when compared to 2002. General Insurance and Life Insurance operating income gains, together with the reduction of realized capital losses as well as the impact of the loss reserve charge in 2002, were the primary factors for the increase over 2002 in both pretax income and net income.

The following table summarizes the operations of each principal segment for the twelve months ended December 31, 2003, 2002 and 2001. (See also Note 2 of Notes to Financial Statements.)

                           
(in millions) 2003 2002 2001

Revenues:
                       
 
General Insurance(a)
  $ 34,584     $ 26,171     $ 22,128  
 
Life Insurance(b)
    35,693       31,541       29,893  
 
Financial Services(c)
    7,565       6,815       6,485  
 
Retirement Services & Asset Management(d)
    3,896       3,485       3,712  
 
Other
    (435 )     (530 )     (452 )

Total
  $ 81,303     $ 67,482     $ 61,766  

Operating Income(e):
                       
 
General Insurance
  $ 5,070     $ 667     $ 2,851  
 
Life Insurance
    6,002       4,929       4,675  
 
Financial Services
    2,464       2,189       1,991  
 
Retirement Services & Asset Management
    1,271       1,016       1,088  
 
Other(f)
    (899 )     (659 )     (2,466 )

Total
  $ 13,908     $ 8,142     $ 8,139  

(a) Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(b) Represents the sum of GAAP Life premiums, net investment income and realized capital gains (losses).
(c)  Represents Financial Services commissions, transactions and other fees.
(d)  Represents Retirement Services & Asset Management commissions and other fees.
(e) Represents income before income taxes, minority interest, and cumulative effect of accounting changes.
(f) Represents other income (deductions)-net, and for 2001, acquisition, restructuring and related charges connected to the acquisition of American General Corporation.

General Insurance

AIG’s General Insurance operations provide property and casualty products and services throughout the world. The increase in General Insurance operating income in 2003 compared to 2002 was primarily attributable to strong growth in operating income with respect to Domestic Brokerage Group’s and Foreign General’s operations in 2003 and the impact of the loss reserve charge of $2.8 billion in 2002. In addition, the level of realized capital losses with respect to General Insurance operations declined to $172 million in 2003 from $858 million in 2002. General Insurance operating income in 2002 was substantially lower than 2001 due to the $2.8 billion reserve charge in 2002.

Life Insurance

AIG’s Life Insurance operations provide traditional, financial and investment products throughout the world. AIG’s foreign operations provide over 50 percent of AIG’s Life Insurance operating income.

     Life Insurance operating income increased by 21.8 percent in 2003. This increase resulted from growth in each of AIG’s principal life insurance businesses, and the decline in realized capital losses to $826 million in 2003 from $1.05 billion in 2002. Life Insurance operating income grew in 2002 relative to 2001. This growth rate was negatively impacted by substantial increase in realized capital losses in 2002, compared to the $254 million realized capital losses in 2001.

Financial Services

AIG’s Financial Services subsidiaries engage in diversified financial products and services including aircraft leasing, capital market transactions and consumer and insurance premium financing.

     Financial Services operating income increased in 2003 compared to 2002 and in 2002 compared to 2001, reflecting operating income growth derived from a broadened range of businesses and products in each year.

Retirement Services & Asset Management

AIG’s Retirement Services & Asset Management operations provide a wide variety of investment products, including variable annuities and mutual funds, as well as investment services, such as asset management. These products and services are offered to individuals, government agencies and institutions both domestically and overseas.

     Retirement Services & Asset Management operating income increased 25.1 percent in 2003 when compared to 2002 as a result of the upturn in worldwide financial markets and the improved U.S. economic conditions; operating income declined 6.6 percent in 2002 when compared to 2001 due to the depressed markets and economic environment.

 
FORM 10-K : 18


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Realized Capital Losses

AIG incurred net realized capital losses of $1.43 billion in 2003, $2.44 billion in 2002 and $836 million in 2001. The realized capital losses in each year reflect primarily impairment loss provisions. Upon the ultimate disposition of these holdings, a portion of these losses may be recovered depending on future market conditions.

Capital Resources

At December 31, 2003, AIG had total shareholders’ equity of $71.25 billion and total borrowings of $77.28 billion. At that date, $69.63 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.

     During 2003, AIG repurchased in the open market 3,822,500 shares of its common stock.

Liquidity

At December 31, 2003, consolidated invested assets were $525.23 billion including $9.84 billion in cash and short-term investments. Consolidated net cash provided from operating activities in 2003 amounted to $36.16 billion. AIG believes that its liquid assets, cash provided by operations and access to the capital markets will enable it to meet any forseeable cash requirements.

Outlook

Overall, premium rates in the General Insurance business have continued to be strong both domestically and in key international markets, although the rates of increase have moderated in most lines and begun to fall in certain classes. AIG also continues to be able to modify and limit its contractual obligations by adding appropriate exclusions and policy restrictions. AIG expects total premiums to increase for 2004 resulting in positive growth in cash flow for investments. Thus, General Insurance net investment income is expected to rise in future quarters even in the current low interest rate environment.

     In October 2003, AIG entered into an agreement with PICC that will enable AIG to market its accident and health products through PICC’s 4,300 branch offices throughout the country. PICC has over 70 percent of the non-life market in China and AIG expects substantial opportunity for growth through this new distribution channel.

     In the Life Insurance segment, AIG expects overall continued growth through expansion in China, where AIG was the first foreign insurance organization to have wholly owned Life Insurance operations in eight major cities, as well as in India, Korea and Vietnam.

     AIG Edison Life was acquired in August of 2003. AIG Edison Life adds to the current agency force in Japan, and provides alternative distribution channels including banks, financial advisers, and corporate and government employee relationships. AIG Edison Life’s integration into AIG’s existing Japanese operations will provide future operating efficiencies.

     Domestically, AIG expects continued strong operating growth in 2004 as distribution channels are expanded and new products are introduced.

     In the airline industry, changes in market conditions are not immediately apparent in operating results. Therefore, AIG believes that improvements in that market commencing in 2003 will be gradually reflected in ILFC’s results in 2004. In the Capital Markets operations, the integration of AIG Trading Group Inc. (AIGTG) into the AIGFP operations created operating efficiencies that will continue to be realized and product synergies that should enhance 2004 results. AIG also expects increased contributions to Financial Services revenues and income from its consumer finance operations both domestically, as a result of the improving economy, and overseas, as expansion of credit card operations continues and economic conditions improve.

     AIG expects both its Retirement Services operations and its Asset Management operations to continue to benefit from the recovery in the equity markets and global economy.

     AIG has many promising growth initiatives underway around the world in its insurance and other operations. Cooperative agreements such as those in Russia and with the PICC are expected to expand distribution networks for AIG’s products and investment opportunities and provide models for future growth.

 Critical Accounting Estimates

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

 
FORM 10-K : 19


 

 


American International Group, Inc. and Subsidiaries


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

Reserves for Losses and Loss Expenses (General Insurance):

Loss trend factors: used to establish expected loss ratios for subsequent accident years based on the projected loss ratio with respect to prior accident years.
Expected loss ratios for the latest accident year: in this case, accident year 2003 for the year end 2003 loss reserve analysis. For low frequency, high severity classes such as Excess Casualty and Directors and Officers’ Liability, expected loss ratios generally are utilized for at least the three most recent accident years.
Loss development factors: used to project the reported losses for each accident year to an ultimate amount.

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

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

Deferred Policy Acquisition Costs (General Insurance):

Recoverability based upon the current profitability of the underlying insurance contracts.

Life Insurance and Retirement Services & Asset Management:

Estimated gross profits: to be realized over the estimated duration of the contracts (nontraditional life). Estimated gross profits include investment income and gains and losses on investments less required interest, actual mortality and other expenses.

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

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

 Operating Review

General Insurance Operations

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

     Domestic General Insurance operations are comprised of DBG, which includes HSB; Transatlantic; Personal Lines, including 21st Century; and UGC (Mortgage Guaranty).

     DBG is AIG’s primary domestic general 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.

     Transatlantic offers, through its reinsurance company subsidiaries, reinsurance capacity, both domestically and overseas, on a treaty and facultative basis for a full range of property and casualty products.

     Personal Lines engages in the mass marketing of personal lines insurance, primarily private passenger auto and personal umbrella coverages, as well as providing comprehensive insurance coverage to high net-worth households through its Private Client Group.

     UGC provides guaranty insurance to mortgage providers primarily with respect to conventional first mortgage loans on single family dwellings and condominiums. During 2003, UGC commenced providing guaranty insurance to providers of student loans.

     AIG’s Foreign General insurance group accepts risks primarily underwritten through 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. (See also Note 2 of Notes to Financial Statements.)

     As previously noted, AIG believes it should present and discuss its financial information in a manner most meaningful to its investors. Accordingly, in its General Insurance business, AIG uses certain non-GAAP measures, where AIG has determined these measurements to be useful and meaningful.

     A critical discipline of a successful general insurance business is the objective to produce operating income from underwriting exclusive of investment related income. When underwriting is not profitable, premiums are inadequate to pay for insured losses and underwriting related expenses. In these situations, the addition of general insurance related in-

 
FORM 10-K : 20


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

vestment income and realized capital gains may, however, enable a general insurance business to produce operating income. If underwriting losses persist over extended periods, an insurance company will likely not continue to exist as a going concern. For these reasons, AIG views underwriting profit to be critical in the overall evaluation of performance. Although in and of itself not a GAAP measurement, AIG believes this measurement is a useful and meaningful disclosure. (See also the discussion under “Liquidity” herein.)

General Insurance operating income is comprised of underwriting profit (loss), net investment income and realized capital gains and losses. These components, as well as net premiums written, net premiums earned and statutory ratios for 2003, 2002 and 2001 were as follows:

                             
(in millions, except ratios) 2003 2002 2001

Net premiums written:
                       
 
Domestic General
                       
   
DBG
  $ 20,061     $ 15,214     $ 10,197  
   
Transatlantic
    3,341       2,500       1,906  
   
Personal Lines
    3,706       3,182       2,454  
   
Mortgage Guaranty
    532       508       494  
 
Foreign General
    7,572       6,010       5,050  

Total
  $ 35,212     $ 27,414     $ 20,101  

Net premiums earned:
                       
 
Domestic General
                       
   
DBG
  $ 17,309     $ 13,053     $ 9,776  
   
Transatlantic
    3,171       2,369       1,790  
   
Personal Lines
    3,652       2,913       2,478  
   
Mortgage Guaranty
    496       502       489  
 
Foreign General
    7,106       5,432       4,832  

Total
  $ 31,734     $ 24,269     $ 19,365  

Underwriting profit (loss):
                       
 
Domestic General
                       
   
DBG
  $ 955     $ (2,049 ) (a)   $ (338 ) (b)
   
Transatlantic
    109       (58 ) (a)     (274 ) (b)
   
Personal Lines
    111       29   (c)     (92 )
   
Mortgage Guaranty
    264       278       311  
 
Foreign General
    781       565       481   (b)

Total
  $ 2,220     $ (1,235 )   $ 88  

Net investment income:
                       
 
Domestic General
                       
   
DBG
  $ 1,772     $ 1,609     $ 1,827  
   
Transatlantic
    271       252       240  
   
Personal Lines
    142       122       114  
   
Mortgage Guaranty
    142       139       106  
   
Intercompany adjustments and eliminations – net
    7       23       23  
 
Foreign General
    688       615       583  

Total
  $ 3,022     $ 2,760     $ 2,893  

Realized capital gains (losses)
    (172 )     (858 )     (130 )

Operating income
  $ 5,070     $ 667   (a)   $ 2,851   (b)

(continued)
Domestic General:
                       
 
Loss ratio
    77.16       92.86       85.89  
 
Expense ratio
    16.81       17.72       17.64  

Combined ratio
    93.97       110.58       103.53  

Foreign General:
                       
 
Loss ratio
    60.02       61.13       60.51  
 
Expense ratio
    27.47       28.99       31.67  

Combined ratio
    87.49       90.12       92.18  

Consolidated:
                       
 
Loss ratio(d)
    73.33       85.76       79.55  
 
Expense ratio
    19.10       20.19       21.16  

Combined ratio
    92.43       105.95       100.71  

(a) Includes loss reserve charge of $2.8 billion in the aggregate.
(b) Includes WTC losses of $769 million in the aggregate.
(c) Includes 21st Century’s loss adjustment expense pretax provision of $43 million for SB1899 Northridge earthquake claims.
(d) The impact of the loss reserve charge and the WTC losses on the loss ratio was an increase of 11.54 in 2002 and 3.97 in 2001.

General Insurance Results

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.

     Commencing in the latter part of 1999 and continuing through 2003, the commercial property-casualty market place has experienced premium rate increases. Virtually all areas of DBG have experienced premium rate increases as well as maintaining an excellent retention rate for desired renewal business. The vast majority of the net premiums written increase in 2003 resulted from rate increases with respect to renewed business. Overall, DBG’s net premiums written increased in 2003 and 2002. Adjusting this growth for cancelled or nonrenewed business, such growth would have approximated 38 percent in 2003 and 56 percent in 2002. AIG believes that these premium rate increases will continue into 2004 particularly with respect to long tail lines of business where the insurer’s stability is critical to the insured. Based on historical patterns, AIG believes that overall growth in net premiums written will slow as competition for premiums increases in certain lines of business.

 
FORM 10-K : 21


 

 


American International Group, Inc. and Subsidiaries


     Personal Lines’ net premiums written for 2003 includes $159 million from the domestic insurance operations of GE that were acquired in August. The increase in net premiums written apart from this acquisition resulted from increased marketing efforts as well as rate increases in several states. The increase in underwriting profits in 2003 and 2002 result from premium rate increases and growth in net premiums written. Underwriting profits are expected to continue to increase through 2004 as a result of continued marketing efforts, loss cost stabilization and the full year impact of the acquisition.

     Mortgage Guaranty’s net premiums written increased 4.7 percent in 2003 over 2002 primarily due to its entry into student loan insurance market beginning in early 2003. The residential first mortgage operation was negatively impacted by refinancing fueled by low interest rates. AIG anticipates continued growth in Mortgage Guaranty in 2004 resulting from a full year of student loan insurance operations. Also, as the number of refinancings decreases, persistency should improve on the first mortgage book and renewal premiums are expected to increase. Underwriting profit should recover from the decrease shown in 2003 which resulted from the adverse impact on net premiums earned from the refinancing activities.

     Foreign General insurance net premiums written growth was due to premium rate increases as well as flight to quality. The regions that had the strongest premium growth were Western Europe and UK/Ireland. Although AIG expects growth in Foreign General commercial lines rates to decelerate in 2004, Foreign General has commenced various initiatives with respect to target markets, products, and distribution to offset this decline.

     In comparing the foreign currency exchange rates used to translate the results of AIG’s Foreign General operations during 2003 to those foreign currency exchange rates used to translate AIG’s Foreign General results during 2002, the U.S. dollar weakened slightly 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 1.9 percentage points more than they would have been if translated utilizing those foreign currency exchange rates which prevailed during 2002.

     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 2003 domestic and foreign combined ratios improved over last year’s ratios primarily because the growth in net premiums exceeded the growth in expenses, continued expense control in 2003 and the impact of the $2.8 billion loss reserve charge in 2002.

     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 generally requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, expenses are recognized immediately, not over the same period that the revenues are earned.

     A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the accounting principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred (deferred policy acquisition costs (DAC)) and amortized over the period the related net premiums written are earned. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. DAC is reviewed for recoverability and such review requires management judgment. (See also Critical Accounting Estimates herein and Notes 1 and 4 of Notes to Financial Statements.)

     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 on profitability as reflected in underwriting profit and statutory general insurance ratios.

 
FORM 10-K : 22


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     In 2002, AIG’s General Insurance results reflect the net impact of the loss reserve charge of $2.8 billion with respect to accident years 1997 through 2001. Such charge was the result of AIG’s annual year-end review of General Insurance loss reserves. (See also the discussion under “2002 Loss Reserve Charge” herein.) In addition, these results reflect the net impact of catastrophe losses approximating $57 million in 2002, and $867 million in 2001 (which include $769 million in WTC losses and $50 million with respect to the Northridge earthquake, following the unprecedented decision by the State of California to require all insurers to reopen claims nearly eight years after the occurrence). On a gross basis, incurred losses included $3.5 billion attributable to the loss reserve charge and approximately $245 million from catastrophes in 2002, and catastrophe losses of $2.15 billion in 2001 (which include $2.0 billion in WTC losses).

     The effects of catastrophes incurred in 2003 were insignificant. The impact of losses caused by catastrophes can fluctuate widely from year to year, making comparisons of recurring type business more difficult. With respect to catastrophe losses, AIG believes that it has taken appropriate steps, such as careful exposure selection and obtaining reinsurance coverage, to reduce the impact of the magnitude of possible future losses. The occurrence of one or more catastrophic events of unanticipated frequency or severity, such as a terrorist attack, earthquake or hurricane, that causes insured losses, however, could have a material adverse effect on AIG’s results of operations, liquidity or financial condition.

     General Insurance net investment income grew in 2003 when compared to 2002. The invested cash flow resulting from the growth in net premiums written in this and prior periods had a positive impact on net investment income. In 2002, net investment income decreased when compared to 2001. The decrease in net investment income in 2002 was primarily a result of lower earnings with respect to the general insurance private equity portfolio. Also, interest income earned from the General Insurance bond portfolio was impacted by lower yields as the proceeds from maturing fixed income securities were reinvested. As AIG believes that net premiums written will continue to increase in 2004, it is expected that cash flow for investment will continue to grow as well. As a result, net investment income is expected to grow in 2004. (See also the discussion under “Liquidity” herein and Note 8 of Notes to Financial Statements.)

     Realized gains and losses resulted from the ongoing investment management of the General Insurance portfolios within the overall objectives of the General Insurance operations and were reflective of weakness in the equity markets in early 2003 and prior periods and impairment loss provisions for both equity and fixed income holdings in all three years. (See the discussion on “Valuation of Invested Assets” herein.)

     The increase in General Insurance operating income in 2003 was primarily attributable to strong profitable growth in DBG’s and Foreign General’s operations, the decrease in realized capital losses relative to prior periods and the impact of the loss reserve charge in 2002. The decline in the growth rate in 2002 was caused by the $2.8 billion loss reserve charge as well as the $728 million increase in realized capital losses in 2002.

     The contribution of General Insurance operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of accounting changes was 36.5 percent in 2003 compared to 8.2 percent in 2002 and 35.0 percent in 2001. The increase over 2002 and the decrease of 2002 compared to 2001 was a result of the $2.8 billion loss reserve charge in 2002.

Reinsurance

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 globally and its reinsurance programs must be coordinated in order to provide AIG the level of reinsurance protection that AIG desires. AIG purchases reinsurance to mitigate its catastrophic exposure. However, one or more catastrophe losses could negatively impact AIG’s reinsurers and result in an inability of AIG to collect reinsurance recoverables. AIG’s reinsurance department evaluates catastrophic events and assesses the probability of occurrence and magnitude of catastrophic events through the use of state of the art industry recognized program models among other techniques. AIG supplements these models through continually monitoring the risk exposure of AIG’s worldwide general insurance operations and adjusting such models accordingly. While reinsurance arrangements do not relieve AIG from its direct obligations to its insureds, an efficient and effective reinsurance program substantially limits AIG’s probable losses.

 
FORM 10-K : 23


 

 


American International Group, Inc. and Subsidiaries


     AIG’s general reinsurance assets amounted to $26.76 billion and resulted from AIG’s reinsurance arrangements. Thus, a credit exposure existed at December 31, 2003 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, 2003, approximately 47 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, the majority of these balances were collateralized. The remaining 53 percent of the general reinsurance assets were from authorized reinsurers. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. Approximately 90 percent of the balances with respect to authorized reinsurers are from reinsurers rated A (excellent) or better, as rated by A.M. Best, or A (strong) or better, as rated by Standard & Poor’s. This rating is a measure of financial strength.

     AIG maintains an allowance for estimated unrecoverable reinsurance and has been largely successful in its previous recovery efforts. At December 31, 2003, AIG had allowances for unrecoverable reinsurance approximating $140 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. For example, in AIG’s treaty reinsurance contracts, AIG includes credit triggers that require a reinsurer to post collateral when a referenced event occurs. Such credit triggers include, but are not limited to, insurer financial strength rating downgrades, policyholder surplus declines at or below a certain predetermined level or a certain predetermined level of a reinsurance recoverable being reached. In addition, AIG’s Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer.

     AIG enters into certain intercompany reinsurance transactions for its general and life operations. AIG enters these transactions as a sound and prudent business practice in or-der 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 December 31, 2003, the consolidated general reinsurance assets of $26.76 billion include reinsurance recoverables for paid losses and loss expenses of $3.59 billion and $19.47 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 thereto are reflected in income currently. It is AIG’s belief that the ceded reserves at December 31, 2003 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded.

Reserve for Losses and Loss Expenses

The table below classifies as of December 31, 2003 the components of the General Insurance reserve for losses and loss expenses (loss reserves) with respect to major lines of business on a statutory basis*:

         
(in millions)

Other liability occurrence
  $ 13,515  
Other liability claims made
    9,991  
Workers compensation
    7,258  
Auto liability
    5,301  
International
    3,254  
Property
    3,254  
Reinsurance
    2,010  
Medical malpractice
    2,013  
Aircraft
    1,432  
Products liability
    1,352  
Accident and health
    1,335  
Fidelity/ surety
    975  
Other
    4,428  

Total
  $ 56,118  

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

     These loss reserves represent the accumulation of estimates of ultimate losses, including IBNR and loss expenses.

     At December 31, 2003, General Insurance net loss reserves increased $5.91 billion from the prior year end to $36.65 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

 
FORM 10-K : 24


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

therefrom are reflected in operating income currently. It is management’s belief that the General Insurance net loss reserves are adequate to cover all General Insurance net losses and loss expenses as at December 31, 2003. While AIG annually reviews the adequacy of established loss reserves, there can be no assurance that AIG’s ultimate loss reserves will not adversely develop and materially exceed AIG’s loss reserves as of December 31, 2003. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on future results of operations. See “2002 Loss Reserve Charge” herein.

     In a very broad sense, the General Insurance 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. The other group is short tail lines of business consisting principally of property lines, personal lines and certain classes of casualty lines.

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

     Estimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. Experience in the more recent accident years of long tail casualty lines shows limited statistical credibility in reported net losses. 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.

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

     A number of actuarial assumptions are made in the review of reserves for each line of business.

     For longer tail lines of business, actuarial assumptions generally are made with respect to the following:

Loss trend factors which are used to establish expected loss ratios for subsequent accident years based on the projected loss ratio for prior accident years.
 
Expected loss ratios for the latest accident year (i.e., accident year 2003 for the year end 2003 loss reserve analysis) and in some cases, for accident years prior to the latest accident year. The expected loss ratio generally reflects the projected loss ratio from prior accident years, adjusted for the loss trend (See 1 above) and the impact of rate changes and other quantifiable factors. For low-frequency, high-severity classes such as Excess Casualty and Directors and Officers Liability (D & O), expected loss ratios generally are utilized for at least the three most recent accident years.
 
Loss development factors which are used to project the reported losses for each accident year to an ultimate basis.

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

 
FORM 10-K : 25


 

 


American International Group, Inc. and Subsidiaries


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

     A comprehensive annual loss reserve review is conducted in the fourth quarter of each year for each AIG General Insurance subsidiary. These reviews are conducted in full detail for each class or line of business for each subsidiary, and thus consist of literally hundreds of individual analyses. The purpose of these reviews is to confirm the reasonableness of the reserves carried by each of the individual subsidiaries, and thereby of AIG’s overall carried reserves. The reserve analysis for each business class is performed by the actuarial personnel who are most familiar with that class of business. In completing these detailed actuarial reserve analyses, the actuaries are required to make numerous assumptions, including for example the selection of loss development factors and loss cost trend factors. They are also required to determine and select the most appropriate actuarial method(s) to employ for each business class. Additionally, they must determine the appropriate segmentation of data or segments from which the adequacy of the reserves can be most accurately tested. In the course of these detailed reserve reviews for each business segment, a point estimate of the loss reserve is generally determined. The sum of these point estimates for each of the individual business classes for each subsidiary provides an overall actuarial point estimate of the loss reserve for that subsidiary. The overall actuarial point estimate is compared to the subsidiary’s carried loss reserve. If the carried reserve can be supported by actuarial methods and assumptions which are also believed to be reasonable, then the carried reserve wouldgenerally be considered reasonable and no adjustment would be considered. The ultimate process by which the actual carried reserves are determined considers not only the actuarial point estimate but a myriad of other factors. Other crucial internal and external factors considered include a qualitative assessment of inflation and other economic conditions in the United States and abroad, changes in the legal, regulatory, judicial and social environments, underlying policy pricing, terms and conditions, and claims handling.

     In the 2002 year-end actuarial loss reserve analysis for DBG, the more recent accident years showed significant increases in loss development for the excess casualty and directors and officers’ liability classes, as well as lesser amounts in certain other classes including healthcare liability. As a result, the actuaries performing the loss reserve analyses for these classes modified their historical assumptions in producing the point estimate of required reserves. A key modification was to give additional weight to the actual loss development in the immature years. For example, for the excess casualty lead umbrella class, the actual loss developments for accident year 1999 were used, even though that development normally would have been considered too immature to produce reliable results (and therefore, not used under historical assumptions). Another key change for the most recent accident years (generally accident years 2000, 2001 and 2002) was, although the actuaries continued to use actuarial assumptions that rely on expected loss ratios based on the results of prior accident years, the expected loss ratio assumptions used gave far greater weight to more recent accident year experience than was the case in the historical assumptions. Thus for the excess casualty lead umbrella class described above, the actuaries gave 100 percent weight to the results of the 1997 through 1999 accident years only, giving no weight to the more favorable development of all prior years, in setting expected loss ratio assumptions for accident years 2000 to 2002. Again, using the lead umbrella class as an example, rather than using the historical loss trend factor of 2.5 percent per year as actually experienced, the actuaries used 7.5 percent as the annual loss cost trend factor, reflecting the more current experience. As a result of the modified assumptions, the actuaries developed a second point estimate of the net loss reserve for DBG. (See “2002 Loss Reserve Charge” herein.)

     With respect to the 2003 year-end actuarial loss reserve analysis for DBG, the actuaries continued to utilize the modified assumptions as described above, with appropriate adjustments to account for the additional year of loss experience which emerged in 2003. For example, in setting the expected loss ratios for accident years 2001, 2002 and 2003 for the

 
FORM 10-K : 26


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

excess casualty lead umbrella class, the actuaries gave 100 percent weight to the results of the 1997 through 2000 accident years only, giving no weight to the more favorable development of accident years prior to 1997. In addition, they continued to utilize the 7.5 percent annual loss cost trend factor.

     Loss development trends for long tail lines such as Excess Casualty and D&O, however, have not followed any consistent trend. This has at times led to overstated loss ratio projections and is a key reason why the actuaries have customarily utilized the historical projection method, which gave more weight to the experience of older, more mature accident years. For long tail lines, judgment is required in analyzing the appropriate weighting of current trends to avoid overreacting to data anomalies that may distort such current trends. Given the accuracy of the historical approach and the uncertainty of the more recent trends, AIG management decided to give approximately equal weight to the point estimate of the required reserve resulting from the historical assumptions and the point estimate of the required reserve from the modified assumptions described above in determining the actual loss reserve carried at year-end 2003.

     AIG’s annual loss reserve does not calculate a range of loss reserve estimates. Because AIG’s General Insurance business is primarily in long tail casualty lines driven almost entirely by severity rather than frequency of claims, developing a range around loss reserve estimates would not be meaningful. An estimate is calculated which AIG’s actuaries believe provides a reasonable estimate of the required reserve. This amount is evaluated against actual carried reserves. It must be understood that there is the potential for significant variation in the actual results versus the assumptions used to test the reserves, particularly for the long tail casualty classes of business such as excess casualty. As an example, for the lead umbrella segment of the excess casualty class of business, a 5 percent change in the assumed loss cost trend from each accident year to the next would cause approximately a $300 million impact (either positively or negatively) in the net loss and loss expense reserve position for that segment. In the early 1990’s actual loss cost trends were negative for the excess casualty class, whereas in the late 1990’s they spiked significantly and ran well into the double digits. Thus, while the 7.5 percent assumption used in the modified assumptions for both year-end 2002 and 2003 is believed to be reasonable, there can be no assurance that actual loss trends will not deviate significantly from this assumption. Another key assumption for long tail classes such as excess casualty is the loss development factors which are utilized to project thereported losses for each year to an ultimate basis. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Again using the excess casualty class as an example, if future loss development factors differed by 5 percent from those utilized in the year-end 2003 loss reserve review, there would be approximately a $300 million impact to the overall AIG loss reserve position.

In 2002, following completion of its annual year-end net loss reserve study, AIG increased General Insurance loss and loss adjustment reserves, incurring a net, after-tax charge of $1.8 billion in the fourth quarter of 2002. The $1.8 billion was largely attributable to the “Other Liability Occurrence” and “Other Liability Claims Made” lines of business, and accident years 1997 through 2001.

Asbestos and Environmental Reserves

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, 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. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage and an absolute asbestos exclusion was also implemented. However, AIG currently underwrites environmental impairment liability insurance on a claims made basis and has excluded such claims from this analyses.

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

     Estimation of asbestos and environmental claims loss reserves is a complex process. These asbestos and environmental claims cannot be estimated by AIG using conventional reserving techniques as previously described. Significant factors which affect the trends that influence the asbestos and environmental claims estimation process are the inconsistent court resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving and there is little likelihood that any firm direction will develop in the

 
FORM 10-K : 27


 

 


American International Group, Inc. and Subsidiaries


near future. Additionally, the exposure for cleanup costs of hazardous waste dump sites involve issues such as allocation of responsibility among potentially responsible parties and the government’s refusal to release parties.

     Due to this uncertainty it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as is with other types of claims. Such future development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by the changes in Superfund and waste dump site coverage issues. AIG and other industry members will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues.

     Although the estimated liabilities with respect to asbestos and environmental reserves are subject to a significantly greater margin of error than for other loss reserves, the asbestos and environmental reserves carried at December 31, 2003 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. However, if the asbestos and environmental reserves develop deficiently, such deficiency would have an adverse impact on future results of operations. (See the previous discussion on reinsurance collectibility herein.) AIG does not discount its asbestos and environmental reserves.

     With respect to known asbestos and environmental claims, AIG established over a decade ago specialized toxic tort and environmental claims units, which investigate and adjust all such asbestos and environmental claims. These units evaluate these asbestos and environmental claims utilizing a comprehensive ground up approach on a claim-by-claim basis. The asbestos and environmental claims are reserved to ultimate probable loss based upon known facts, current law, jurisdiction, policy language and other factors. Each claim is reviewed at least semi-annually utilizing the aforementioned approach and adjusted as necessary to reflect the current information.

     In both the specialized and dedicated asbestos and environmental claims units, AIG actively manages and pursues early settlement with respect to these claims thereby reducing its exposure to the unpredictable development of these claims.

     With respect to asbestos claims reserves, AIG has resolved all claims with respect to miners and major manufacturers (Tier 1), and payments have been completed or reserves are established to cover future payment obligations.Asbestos claims with respect to products containing asbestos (Tier 2), are generally very mature losses, and have been appropriately recognized and reserved by AIG’s asbestos claims operation. AIG believes that the vast majority of the incoming claims with respect to products containing small amounts of asbestos, companies in the distribution chain and parties with remote, ill-defined involvement with asbestos (Tier 3 and 4), should not impact its coverage. This is due to a combination of factors, including the increasingly peripheral companies being named in asbestos litigation, smaller limits issued to peripheral defendants, tenuous liability cases against peripheral defendants, attachment points of the excess policies, and the manner in which resolution of these weaker cases would be allocated among all insurers, including non-AIG companies, over a long period of time.

     AIG believes the majority of its known long-tail environmental exposures have been resolved utilizing a combination of pro-active claim-handling techniques including policy buybacks, complete environmental releases, compromise settlements, and, where indicated, litigation. Current and new claims are generally cases of declining severity. Strong coverage defenses (including late notice) and stronger liability defenses are among the factors contributing to declining severity.

     AIG uses primarily two methods to test the adequacy of its asbestos and environmental reserves, including the related IBNR, the Market Share method and the Frequency/ Severity method. The Market Share method produces indicated asbestos and environmental reserves needs by applying the appropriate AIG company market share to estimated potential industry ultimate loss and loss expenses based on the latest estimates from A.M. Best and Tillinghast.

     The second method, the frequency/ severity approach, utilizes current information as the basis of an analysis that predicts for each of the next ten years a number with respect to future expected environmental claims and the average severity of each. The estimated trend in frequency is based upon assumptions judged by AIG to be the most reasonable. The trend in severity starts with severities based on current actual average severity using the varying case adequacy assumptions and trending forward under assumptions deemed most reasonable by AIG. A similar frequency/ severity analysis is also performed for asbestos. However, future asbestos claims (IBNR) are projected for each of the next twenty years.

     Quantitative techniques frequently have to be supplemented by subjective consideration, including managerial judgment, to assure management satisfaction that the overall reserves are adequate to meet projected losses.

 
FORM 10-K : 28


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined at December 31, 2003, 2002 and 2001 follows:

                                                 
2003 2002 2001



(in millions) Gross Net Gross Net Gross Net

Asbestos:
                                               
Reserve for losses and loss expenses at beginning of year
  $ 1,304     $ 400     $ 1,114     $ 312     $ 1,100     $ 338  
Losses and loss expenses incurred*
    175       43       395       168       358       92  
Losses and loss expenses paid*
    (244 )     (57 )     (205 )     (80 )     (344 )     (118 )

Reserve for losses and loss expenses at end of year
  $ 1,235     $ 386     $ 1,304     $ 400     $ 1,114     $ 312  

Environmental:
                                               
Reserve for losses and loss expenses at beginning of year
  $ 832     $ 296     $ 1,115     $ 407     $ 1,345     $ 517  
Losses and loss expenses incurred*
    133       52       (140 )     (44 )     (41 )     (34 )
Losses and loss expenses paid*
    (176 )     (65 )     (143 )     (67 )     (189 )     (76 )

Reserve for losses and loss expenses at end of year
  $ 789     $ 283     $ 832     $ 296     $ 1,115     $ 407  

Combined:
                                               
Reserve for losses and loss expenses at beginning of year
  $ 2,136     $ 696     $ 2,229     $ 719     $ 2,445     $ 855  
Losses and loss expenses incurred*
    308       95       255       124       317       58  
Losses and loss expenses paid*
    (420 )     (122 )     (348 )     (147 )     (533 )     (194 )

Reserve for losses and loss expenses at end of year
  $ 2,024     $ 669     $ 2,136     $ 696     $ 2,229     $ 719  

* All amounts pertain to policies underwritten in prior years.

The gross and net IBNR included in the reserve for losses and loss expenses at December 31, 2003, 2002 and 2001 were estimated as follows:

                                                 
2003 2002 2001



(in millions) Gross Net Gross Net Gross Net

Combined
  $ 1,042     $ 280     $ 1,022     $ 283     $ 1,038     $ 278  

A summary of asbestos and environmental claims count activity for the years ended December 31, 2003, 2002 and 2001 was as follows:

                                                                           
2003 2002 2001



Asbestos Environmental Combined Asbestos Environmental Combined Asbestos Environmental Combined

Claims at beginning of year
    7,085       8,995       16,080       6,672       9,364       16,036       6,796       11,323       18,119  
Claims during year:
                                                                       
 
Opened
    669       2,106       2,775       959       1,657       2,616       739       1,892       2,631  
 
Settled
    (86 )     (244 )     (330 )     (154 )     (546 )     (700 )     (124 )     (988 )     (1,112 )
 
Dismissed or otherwise resolved
    (194 )     (2,005 )     (2,199 )     (392 )     (1,480 )     (1,872 )     (739 )     (2,863 )     (3,602 )

Claims at end of year
    7,474       8,852       16,326       7,085       8,995       16,080       6,672       9,364       16,036  

     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 lossexpenses over the respective claims settlement 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 a significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments made and the resultant ratio.

     AIG believes that voluntary payments with respect to environmental claims should be excluded from the calculation of the survival ratio for the environmental claims. That is, involuntary payments are primarily attributable to court

 
FORM 10-K : 29


 

 


American International Group, Inc. and Subsidiaries


judgments, court orders, covered claims with no coverage defenses, state mandated clean up costs, claims where AIG’s coverage defenses are minimal and settlements that are made less than six months before the first trial setting. Payments other than these are deemed voluntary because AIG can control the amount and timing of such payments, if any.

AIG’s survival ratios for asbestos and environmental claims, separately and combined, excluding voluntary environmental claim payments, were based upon a three year average payment. These ratios for the years ended December 31, 2003, 2002 and 2001 were as follows:

                   
Gross Net

2003
               
Survival ratios:
               
 
Asbestos
    4.7       4.6  
 
Environmental
    16.1       11.8  
 
Combined
    8.0       7.4  

2002
               
Survival ratios:
               
 
Asbestos
    4.1       4.9  
 
Environmental
    17.6       13.3  
 
Combined
    7.3       7.9  

2001
               
Survival ratios:
               
 
Asbestos
    3.3       4.3  
 
Environmental
    18.7       16.5  
 
Combined
    6.8       8.7  

Life Insurance Operations

AIG’s Life Insurance subsidiaries offer a wide range of traditional insurance and financial and investment products both domestically and abroad. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. (See also Note 2 of Notes to Financial Statements.)

     Domestically, AIG offers a broad range of protection and interest sensitive accumulation products, including life insurance and fixed annuities. Home service operations include an array of traditional and investment type products sold through agents. Group life and health products and pension and investment products include structured settlements and terminal pension funding.

     Overseas, AIG’s Life Insurance operations include traditional products such as whole and term life and endowments, personal accident products and group products including life and health.

     Guaranteed investment contracts, also known as funding agreements (GICs), are sold domestically and abroad to both institutions and individuals. These products are written on anopportunistic basis when market conditions are favorable. Thus, production, cash flow and net investment income attributable to GICs will vary from one reporting period to the next.

Life Insurance operations presented on a major product basis for 2003, 2002 and 2001 were as follows:

                             
(in millions) 2003 2002(a) 2001(a)

GAAP premiums:
                       
 
Domestic:
                       
   
Life insurance
  $ 1,748     $ 1,604     $ 1,497  
   
Individual fixed annuities(b)
    59       35       426  
   
Individual fixed annuities – runoff(c)
    4       7       11  
   
Home service
    834       854       876  
   
Group life/ health
    1,046       967       925  
   
Pension and investment products(b)
    1,328       1,105       1,144  
   
Other
    22       50       69  

 
Total Domestic
    5,041       4,622       4,948  

 
Foreign:
                       
   
Life insurance
    13,335       12,000       10,771  
   
Personal accident
    3,126       2,491       2,196  
   
Group products
    1,267       1,094       1,050  
   
Other
    110       113       98  

 
Total Foreign
    17,838       15,698       14,115  

Total GAAP premiums
  $ 22,879     $ 20,320     $ 19,063  

Net investment income:
                       
 
Domestic:
                       
   
Life insurance
  $ 1,358     $ 1,275     $ 1,181  
   
Individual fixed annuities
    2,982       2,516       2,174  
   
Individual fixed annuities – runoff(c)
    689       713       701  
   
Home service
    690       683       653  
   
Group life/ health
    122       108       105  
   
Pension and investment products
    982       836       702  
   
GICs
    2,204       2,194       1,988  

 
Total Domestic
    9,027       8,325       7,504  

 
Foreign:
                       
   
Life insurance
    3,753       3,206       2,848  
   
Personal accident
    163       141       128  
   
Group products
    338       255       227  
   
GICs
    374       359       387  
   
Intercompany adjustments
    (15 )     (12 )     (10 )

 
Total Foreign
    4,613       3,949       3,580  

Total net investment income
  $ 13,640     $ 12,274     $ 11,084  

Realized capital gains (losses)
    (826 )     (1,053 )     (254 )

Total operating income(d)
  $ 6,002     $ 4,929     $ 4,675  

Life insurance in-force:
                       
 
Domestic
  $ 645,606     $ 577,686     $ 517,067  
 
Foreign
    951,020 (e)     746,765       711,434  

Total
  $ 1,596,626     $ 1,324,451     $ 1,228,501  

(a) Restated to conform to the 2003 presentation.
(b) 2001 GAAP premiums included certain annuity products now reported in Pension & Investment Products.
(c) Represents runoff annuity business largely sold through discontinued distribution channels.
(d) 2001 included WTC losses of $131 million.
(e) Approximately $124 billion relates to the acquisition of AIG Edison Life in August 2003.
 
FORM 10-K : 30


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Life Insurance Results

The increase in operating income in 2003 was caused in part by strong growth, particularly overseas, and lower realized capital losses. The lower growth rate in 2002 was primarily a result of increased realized capital losses over 2001.

     The contribution of Life Insurance operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of accounting changes amounted to 43.2 percent in 2003 compared to 60.5 percent in 2002 and 57.4 percent in 2001. The decline in 2003 resulted from General Insurance operating income growing significantly. The contribution rate in 2002 and 2001 was influenced by the poor performance in General Insurance resulting in the reduced contribution of General Insurance to income before income taxes, minority interest and cumulative effect of accounting changes.

     Since AIG purchased AIG Star Life, a part of the income earned by AIG Star Life has resulted from surrender charges earned on policies that were either surrendered or lapsed. This favorable impact on operating income was anticipated when AIG acquired AIG Star Life. As these surrenders diminish in subsequent years, operating income from that source will also diminish. The majority of AIG Star Life’s future income will be related to continuing premiums paid on renewal business, and new business to be generated from a growing agency force and new product sales to current insureds.

     Domestically, the growth is predominantly attributable to Pension and Investment Products, Life Insurance and Group Life/Health. With respect to Foreign Life, the majority of the growth in GAAP life premiums was attributable to the Life Insurance and Personal Accident lines of business. This growth was most significant in Southeast Asia where AIG maintains significant market share established by its strong agency force, and in Japan, where AIG is benefiting from a flight to quality. Foreign Life operations produced 78.0 percent, 77.3 percent and 74.0 percent of the GAAP life premiums in 2003, 2002 and 2001, respectively.

     As previously discussed, the U.S. dollar weakened in relation to most major foreign currencies in which AIG transacts business. Accordingly, for 2003, when foreign life premiums were translated into U.S. dollars for purposes of the preparation of the consolidated financial statements, total life premiums were approximately 2.6 percentage points more than they would have been if translated utilizing exchange rates prevailing in 2002.

     The growth in net investment income in 2003 was attributable to both foreign and domestic invested new cash flow for investment as well as improved returns on nontraditional investments. Domestically, this cash flow was generated from Life Insurance and individual annuity operations. Overseas, cash flow was generated primarily from Life Insurance operations. Additionally, net investment income was positively impacted by the compounding of previously earned and reinvested net investment income. (See also the discussion under “Liquidity” herein.)

     Life Insurance investment portfolios are managed within the overall objectives of the Life Insurance operations. Life Insurance realized capital losses reflect weaknesses in the equity markets in the early months of 2003 and the prior years as well as impairment loss provisions for certain equity and fixed income holdings. (See also the discussion on “Valuation of Invested Assets” herein.)

Underwriting and Investment Risk

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 primarily investment risk.

     Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. The emergence of significant adverse experience would require an adjustment to the benefit reserves that could have a substantial impact with respect to AIG’s results of operations.

     AIG’s foreign life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately $1.5 million of coverage and AIG’s domestic life companies generally 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. (See also Note 5 of Notes to Financial Statements and the discussion under “Liquidity” herein.)

     The investment risk represents the exposure to loss resulting from the cash flows from the invested assets, primarily long-term fixed rate investments, being less than the cash flows required to meet the obligations of the expected policy and contract liabilities and the necessary return on investments. (See also the discussion under “Liquidity” herein.)

     To minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to assess whether there is a liquidity excess or deficit. If a 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.)

 
FORM 10-K : 31


 

 


American International Group, Inc. and Subsidiaries


     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. Additionally, there exists a future investment risk associated with certain policies currently in force which will have premium receipts in the future. That is, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities.

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

     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.)

     Certain foreign jurisdictions have limited long-dated bond markets and AIG may use alternative investments, including equities and foreign denominated fixed income instruments to extend the effective duration of the investment portfolio to more closely match that of the policyholder liabilities.

     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 appropriate marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in an unmatched position due to anticipated interest rate or other economic changes.

     A number of guaranteed benefits are offered on certain variable life products. (Included in the “Accounting Standards” section is a discussion of new accounting guidance for these benefits.)

     DAC for life insurance products arises from the deferral of those costs that vary with, and are directly related to, the acquisition of new or renewal business. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs which relate to universal life and investment-type products (nontraditional life products) are deferred and amortized, with interest, in relation to the historical and future incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits include investment income and gains and losses on investments less interest required as well as other charges in the contract less actual mortality and expenses. Current experience and changes in the expected future gross profits are analyzed to determine the impact on the amortization of DAC. The estimation of projected gross profits requires significant management judgment. The elements with respect to the current and projected gross profits are reviewed and analyzed quarterly and are appropriately adjusted.

     DAC for both traditional life and nontraditional life products are subject to review for recoverability, which involve estimating the future profitability of current business. This review also involves significant management judgment. If the actual emergence of future profitability were to be substantially different than that estimated, AIG’s results of operations could be significantly impacted. (See also Note 4 of Notes to Financial Statements.)

Insurance Invested Assets

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 “Operating Review: Life Insurance Operations” herein.) 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 or depreciation of investments, net of taxes as a component of comprehensive income. Generally, insurance regulations restrict the types of assets in which an insurance company may invest. When permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from adverse movements in foreign currency exchange rates, interest rates and equity prices, AIG and its insurance subsidiaries may enter into derivative transactions as end users. (See also the discussion under “Derivatives” herein.)

 
FORM 10-K : 32


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     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.

The following tables summarize the composition of AIG’s insurance invested assets by insurance segment, at December 31, 2003 and 2002:

                                                   
Percent
Distribution
2003 General Life Percent
(dollars in millions) Insurance Insurance Total of Total Domestic Foreign

Fixed Maturities:
                                               
 
Available for sale, at market value(a)
  $ 41,610     $ 258,139     $ 299,749       75.9 %     64.1 %     35.9%  
 
Held to maturity, at amortized cost
    8,037             8,037       2.0       100.0        
Equity securities, at market value(b)
    5,130       4,233       9,363       2.4       53.7       46.3  
Mortgage loans on real estate, policy and collateral loans
    25       20,260       20,285       5.1       67.7       32.3  
Short-term investments, including time deposits, and cash
    1,918       6,497       8,415       2.1       50.3       49.7  
Real estate
    569       2,903       3,472       0.9       22.7       77.3  
Investment income due and accrued
    881       4,003       4,884       1.2       62.8       37.2  
Securities lending collateral
    5,225       24,970       30,195       7.7       76.0       24.0  
Other invested assets
    5,121       5,357       10,478       2.7       81.9       18.1  

Total
  $ 68,516     $ 326,362     $ 394,878       100.0 %     65.4 %     34.6%  

(a) Includes $282 million of bond trading securities, at market value.
(b) Includes $1.90 billion of nonredeemable preferred stocks, at market value.
                                                 
Percent
Distribution
2002 General Life Percent
(dollars in millions) Insurance Insurance Total of Total Domestic Foreign

Fixed maturities available for sale, at market value(a)
  $ 35,990     $ 206,003     $ 241,993       76.9 %     69.1%       30.9%  
Equity securities, at market value(b)
    3,928       2,931       6,859       2.2       53.4       46.6  
Mortgage loans on real estate, policy and collateral loans
    35       18,901       18,936       6.0       68.8       31.2  
Short-term investments, including time deposits, and cash
    1,833       5,048       6,881       2.2       42.5       57.5  
Real estate
    488       2,367       2,855       0.9       24.8       75.2  
Investment income due and accrued
    729       3,489       4,218       1.4       64.2       35.8  
Securities lending collateral
    7,249       16,445       23,694       7.5       75.8       24.2  
Other invested assets
    5,226       3,954       9,180       2.9       82.1       17.9  

Total
  $ 55,478     $ 259,138     $ 314,616       100.0 %     68.6%       31.4%  

(a) Includes $981 million of bond trading securities, at market value.
(b) Includes $1.58 billion of nonredeemable preferred stocks, at market value.

Credit Quality

At December 31, 2003, approximately 65 percent of the fixed maturities investments were domestic securities. Approximately 33 percent of such domestic securities were rated AAA by one or more of the principal rating agencies. Approximately 7 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 December 31, 2003, approximately 17 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG’s internal analysis, were equivalent from a credit standpoint to securities so rated. Approximately 7 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.

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

Valuation of Invested Assets

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

     Another aspect of valuation is an assessment of impairment. As a matter of policy, the determination that a security has incurred an other-than-temporary decline in value and the amount of any loss recognition requires the judgment of AIG’s management and a continual review of its investments.

 
FORM 10-K : 33


 

 


American International Group, Inc. and Subsidiaries


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

  •  Trading at a significant discount to par, amortized cost (if lower) or cost for an extended period of time;
  •  The occurrence of a discrete credit event resulting in (i) the issuer defaulting on a material outstanding obligation; or (ii) the issuer seeking protection from creditors under the bankruptcy laws or any similar laws intended for the court supervised reorganization of insolvent enterprises; or (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or
  •  In the opinion of AIG’s management, it is possible that AIG may not realize a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

     Once a security has been identified as impaired, the amount of such impairment is determined by reference to that security’s contemporaneous market price.

     AIG has the ability to hold any security to its stated maturity. Therefore, the decision to sell reflects the judgment of AIG’s management that the security sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management’s judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale.

     As a result of these policies, AIG recorded in 2003 impairment losses net of taxes of approximately $1.3 billion.

     No impairment charge with respect to any one single credit was significant to AIG’s consolidated financial condition or results of operations, and no individual impairment loss exceeded 1.3 percent of consolidated net income for 2003.

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

     At December 31, 2003, the unrealized losses after taxes of the fixed maturity securities were approximately $1.4 billion. At December 31, 2003, the unrealized losses after taxes of the equity securities portfolio were approximately $44 million.

     At December 31, 2003, aggregate unrealized gains after taxes were $10.4 billion and aggregate unrealized losses after taxes were $1.5 billion. No single issuer accounted for more than three percent of the unrealized losses.

     At December 31, 2003, the fair value of AIG’s fixed maturities and equity securities aggregated to $319.0 billion. Of this aggregate fair value, 0.35 percent represented securities trading at or below 75 percent of amortized cost or cost.

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

At December 31, 2003, the unrealized losses after taxes for fixed maturity securities and equity securities included the following industry concentrations:

         
Unrealized Losses
(in millions) After Taxes

Investment grade:
       
Transportation
  $ 47  
Utilities
    27  
Energy
    12  
Telecommunications
    11  

Not rated and below investment grade:
       
Transportation
  $ 91  
Utilities
    52  
Energy
    4  
Telecommunications
    25  

The amortized cost of fixed maturities available for sale in an unrealized loss position at December 31, 2003, by contractual maturity, is shown below:

         
Amortized
(in millions) Cost

Due in one year or less
  $ 1,130  
Due after one year through five years
    8,520  
Due after five years through ten years
    20,745  
Due after ten years
    36,537  

Total
  $ 66,932  

     In the twelve months ended December 31, 2003, the pretax realized losses incurred with respect to the sale of fixed maturities and equity securities were $3.2 billion. The aggregate fair value of securities sold was $32.2 billion, which was approximately 91 percent of amortized cost. The average period of time that securities sold at a loss during the twelve months ended December 31, 2003 were trading continuously at a price below book value was approximately seven months.

 
FORM 10-K : 34


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

At December 31, 2003, aggregate pretax unrealized gains were $16.0 billion, while the pretax unrealized losses with respect to investment grade bonds, below investment grade bonds and equity securities were $1.6 billion, $599 million and $67 million, respectively. Aging of the pretax unrealized losses with respect to these securities, distributed as a percentage of cost relative to unrealized loss (the extent by which the market value is less than amortized cost or cost), including the number of respective items, was as follows:

                                                                                                   

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




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

Investment grade bonds
                                                                                               
 
0-6 months
  $ 53,522     $ 1,111       2,428     $ 24     $ 6       3     $     $           $ 53,546     $ 1,117       2,431  
 
7-12 months
    5,547       264       393       21       6       3                         5,568       270       396  
 
>12 months
    2,628       142       241       312       90       21                         2,940       232       262  

Total
    61,697       1,517       3,062       357       102       27                         62,054       1,619       3,089  

Below investment grade bonds
                                                                                               
 
0-6 months
    1,288       38       168       217       58       28       35       24       13       1,540       120       209  
 
7-12 months
    523       34       82       107       31       23       18       14       6       648       79       111  
 
>12 months
    2,114       202       196       526       167       81       50       31       6       2,690       400       283  

Total
    3,925       274       446       850       256       132       103       69       25       4,878       599       603  

Total bonds
                                                                                               
 
0-6 months
    54,810       1,149       2,596       241       64       31       35       24       13       55,086       1,237       2,640  
 
7-12 months
    6,070       298       475       128       37       26       18       14       6       6,216       349       507  
 
>12 months
    4,742       344       437       838       257       102       50       31       6       5,630       632       545  

Total
    65,622       1,791       3,508       1,207       358       159       103       69       25       66,932       2,218       3,692  

Equity securities
                                                                                               
 
0-6 months
    491       26       253       164       19       92       4       3       27       659       48       372  
 
7-12 months
    73       5       41       56       14       8                         129       19       49  
 
>12 months
                                                                       

Total
  $ 564     $ 31       294     $ 220     $ 33       100     $ 4     $ 3       27     $ 788     $ 67       421  

(a) For bonds, represents amortized cost.
(b) As more fully described above, upon realization, certain realized losses will be charged to participating policyholder accounts, or realization will result in a current decrease in the amortization of certain deferred acquisition costs.

     As stated previously, the valuation for AIG’s investment portfolio comes from market exchanges or dealer quotations, with the exception of nontraded securities. AIG considers nontraded securities to mean certain fixed income investments, certain structured securities, direct private equities, limited partnerships and hedge funds. The aggregate carrying value of these securities at December 31, 2003 was approximately $59.9 billion.

     The methodology used to estimate fair value of nontraded fixed income investments is by reference to traded securities with similar attributes and using a matrix pricing methodology. This technique takes into account such factors as the industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer, and other relevant factors. The change in fair value is recognized as a component of unrealized appreciation.

     For certain structured securities, the carrying value is based on an estimate of the security’s future cash flows pursuant to the requirements of Emerging Issues Task Force Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets.” The change in carrying value is recognized in income.

     Direct private equities, hedge funds and limited partnerships in which AIG holds in the aggregate less than a five percent interest, are carried at fair value. The change in fair value is recognized as a component of Other comprehensive income.

     With respect to hedge funds and limited partnerships in which AIG holds in the aggregate a five percent or greater interest, AIG’s carrying value is the net asset value. The changes in such net asset values are recorded in income.

     AIG obtains the fair value of its investments in limited partnerships and hedge funds from information provided by the sponsors of each of these investments, the accounts of which are generally audited on an annual basis.

 
FORM 10-K : 35


 

 


American International Group, Inc. and Subsidiaries


     Each of these investment categories is regularly tested to determine if impairment in value exists. Various valuation techniques are used with respect to each category in this determination.

Financial Services Operations

AIG’s Financial Services subsidiaries engage in diversified financial products and services including aircraft leasing, capital market transactions, and consumer and insurance premium financing. (See also Note 2 of Notes to Financial Statements.)

     AIG’s Aircraft Finance operations represent the operations of ILFC, which 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.

     ILFC finances its purchases of aircraft primarily through the issuance of a variety of debt instruments. The composite borrowing rates at December 31, 2003, 2002 and 2001 were 4.53 percent, 4.73 percent and 5.07 percent, respectively. (See also the discussions under “Capital Resources” and “Liquidity” herein and Notes 2 and 9 of Notes to Financial Statements.)

     ILFC is exposed to operating loss and liquidity strain through nonperformance of aircraft lessees, through owning aircraft which it would be unable to sell or re-lease at acceptable rates at lease expiration and, in part, through committing to purchase aircraft which it would be unable to lease.

     ILFC manages its lessee nonperformance exposure through credit reviews and security deposit requirements. As a result of these measures and its own contingency planning, ILFC did not suffer any material losses from airline shutdowns in the aftermath of the September 11 terrorist attacks, but there can be no assurance that ILFC will successfully manage the risks relating to the impact of possible future deterioration in the airline industry. Over 80 percent of ILFC’s fleet is leased to non-U.S. carriers, and this fleet, comprised of the most efficient aircraft in the airline industry, continues to be in high demand from such carriers.

     ILFC typically contracts to re-lease aircraft before the end of the existing lease term. For aircraft returned before the end of the lease term, ILFC has generally been able to re-lease such aircraft within two to six months of its return. While some of the lease rates for aircraft that have been redeployed are lower, this is partially offset by low interest rates, which reduce ILFC’s financing costs. As a lessor, ILFC considers an aircraft “idle” or “off lease” when the aircraft is not subject to a signed lease agreement or signed letter of intent. ILFC had five aircraft off lease at December 31, 2003 which had been off lease for less than three months. As of March 8, 2004, all five of the five unleased aircraft were placed. All new aircraft deliveries in 2004 have been placed, and 67 percent of 2005 new aircraft deliveries have been leased. (See also the discussions under “Capital Resources” and “Liquidity” herein.)

     During 2003, ILFC entered into a securitization of a portfolio of 37 aircraft. Certain of AIG’s Life Insurance and Retirement Services businesses purchased a large share of this securitization. A second securitization was executed in January, 2004.

     ILFC management is very active in the airline industry. Management formally reviews regularly, and no less frequently than quarterly, issues affecting ILFC’s fleet, including events and circumstances that may cause impairment of aircraft values. Management evaluates aircraft in the fleet as necessary, based on these events and circumstances in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144). ILFC has not recognized any impairment related to its fleet, as the existing service potential of the aircraft in ILFC’s portfolio has not been diminished. Further, ILFC has been able to re-lease the aircraft without diminution in lease rates to an extent that would require an impairment write-down. (See also the discussions under “Liquidity” herein.)

     AIG has integrated the operations of AIGTG into AIGFP thereby establishing the Capital Markets reporting unit. AIG believes that this will result in greater efficiencies and product synergies as well as growth opportunities. Capital Markets revenues and operating income increases were attributable primarily to its interest rate linked products. As Capital Markets is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance.

     AIG’s Capital Markets operations derive substantially all their revenues from proprietary positions entered in connection with counterparty transactions rather than from speculative transactions. These subsidiaries participate in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity, commodity and credit derivative products business.

 
FORM 10-K : 36


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     As dealers, AIGFP and AIGTG mark transactions to fair value daily. Thus, a gain or loss on each transaction is recognized daily. AIGFP and AIGTG hedge the market risks arising from their transactions. Therefore, revenues and operating income are not significantly exposed to or affected by market fluctuations and volatility. Revenues of the Capital Markets operations and the percentage change in revenues for any given period are significantly affected by the number and size of transactions entered into by these subsidiaries during that period relative to those entered into during the prior period. Operating income and the percentage change in operating income for any period are determined by the number, size and profitability of the transactions attributable to that period relative to those attributable to the prior period. Generally, the realization of trading revenues as measured by the receipt of funds is not a significant reporting event as the gain or loss on Capital Markets trading transactions are currently reflected in operating income as the fair values change from period to period.

     Derivative transactions are entered into in the ordinary course of Capital Markets operations. Therefore, income on interest rate, equity, commodity and credit derivatives along with their related hedges are recorded on a mark to market value or at estimated fair value where market prices are not readily available with the resulting unrealized gains or losses reflected in the income statement in the current year. In 2003, less than five percent of revenues resulted from transactions valued at estimated fair value. The mark to fair value of derivative transactions is reflected in the balance sheet in the captions “Unrealized gain on interest rate and currency swaps, options and forward transactions” and “Unrealized loss on interest rate and currency swaps, options and forward transactions”. The unrealized gain represents the present value of the aggregate of each net receivable by counterparty, and the unrealized loss represents the present value of the aggregate of each net payable by counterparty as of December 31, 2003. These amounts will change from one period to the next due to changes in interest rates, currency rates, equity prices and other market variables, as well as cash movements, execution of new transactions and the maturing of existing transactions. (See also the discussion under “Derivatives” herein and Note 21 of Notes to Financial Statements.) Spread income on investments and borrowings are recorded on an accrual basis over the life of the transaction. Investments are classified as available for sale securities and are marked to market with the resulting unrealized gains or losses reflected in shareholders’ equity.

     Domestically, AIG’s consumer finance operations derive a substantial portion of their revenues from finance charges assessed on outstanding mortgages, home equity loans, secured and unsecured consumer loans and retail merchant financing. Overseas operations provide credit cards, personal and auto loans, term deposits, savings accounts, sales finance and mortgages with an emphasis on emerging markets.

     Consumer finance operations are exposed to loss when contractual payments are not received. Collection exposure is managed through the mix of tight underwriting controls, mix of loans and collateral thereon.

Financial Services operations for 2003, 2002 and 2001 were as follows:

                         
(in millions) 2003 2002 2001

Revenues:
                       
Aircraft Finance(a)
  $ 3,042     $ 2,845     $ 2,613  
Capital Markets(b)
    1,845       1,544       1,348  
Consumer Finance(c)
    2,642       2,473       2,560  
Other
    36       (47 )     (36 )

Total
  $ 7,565     $ 6,815     $ 6,485  

Operating income:
                       
Aircraft Finance
  $ 728     $ 801     $ 749  
Capital Markets
    1,086       870       806  
Consumer Finance
    649       549       505  
Other, including intercompany adjustments
    1       (31 )     (69 )

Total
  $ 2,464     $ 2,189     $ 1,991  

(a) Revenues were primarily from ILFC aircraft lease rentals.
(b)  Revenues were primarily fees from AIGFP and AIGTG proprietary positions entered into in connection with counterparty transactions.
(c) Revenues were primarily finance charges.

Financial Services Results

Capital Market activities were the primary reason for the growth in operating income in 2003 and to a lesser extent in 2002.

     Financial Services operating income represented 17.7 percent of AIG’s consolidated income before income taxes, minority interest and cumulative effect of accounting changes in 2003. This compares to 26.9 percent and 24.5 percent in 2002 and 2001, respectively. The decrease in contribution percentage was influenced by the impact that the General Insurance loss reserve charge in 2002 and the WTC losses in 2001 had on General Insurance operating income and the reduced contribution of General Insurance operations to income before income taxes, minority interest and cumulative effect of accounting changes in those years.

     With respect to ILFC, the revenue growth in each year resulted primarily from the increase in flight equipment under operating lease and the increase in the relative cost of the leased fleet. The decline in ILFC’s operating income for 2003 was largely a result of the decline in aircraft remarketing due to the poor market conditions for secondhand aircraft. Going forward, AIG believes that ILFC’s performance will improve as the improvements in the airline industry are not yet being reflected in ILFC’s results.

 
FORM 10-K : 37


 

 


American International Group, Inc. and Subsidiaries


The composition by percentage contribution of revenues and operating income for Capital Markets in 2003, 2002 and 2001 is set forth below. The percentages for operating income are the same as those for revenues because expenses are allocated across all products in proportion to the revenues generated by that product. Material changes in the distribution of revenues and operating income from period to period are not unusual due to the transactional nature of Capital Markets’ business.

                         
2003 2002 2001

Spread income on investments and borrowings
    37 %     47 %     40 %
Interest rate and currency products
    29       18       28  
Equity linked products
    4       3       17  
Credit linked products
    28       29       11  
Commodity and commodity linked
products and other revenue
    2       3       4  

     Financial market conditions in 2003 compared with 2002 were characterized by lower interest rates across fixed income markets globally, a tightening of credit spreads, and higher equity valuations. Capital Markets’ results in 2003 compared with 2002 reflected a shift in product segment activity to respond to these conditions. In particular, Capital Markets experienced increases in demand for interest and currency linked products that addressed the risk management needs of its counterparties. (See also Note 21 of Notes to Financial Statements.)

     The most significant component of Capital Markets’ operating expenses is compensation, which approximated 33 percent, 36 percent and 33 percent of revenues in 2003, 2002 and 2001, respectively.

     Consumer Finance revenues in 2003 increased. The increase in revenues in 2003 was the result of growth in average finance receivables and credit quality continues to be strong. Further, reductions of the cost to borrow led to an improvement in the operating income over the previous year. The decline in revenues in 2002 was the result of lower yields on the finance receivables, but borrowing costs also declined significantly so that spreads, and therefore operating income, increased as a result.

Financial Services Invested Assets

The following table is a summary of the composition of AIG’s Financial Services invested assets at December 31, 2003 and 2002. (See also the discussions under “Operating Review: Financial Services Operations”, “Capital Resources” and “Derivatives” herein.)

                                 
2003 2002


Invested Percent of Invested Percent of
(dollars in millions) Assets Total Assets Total

Flight equipment primarily under operating leases, net of accumulated depreciation
  $ 30,343       23.9 %   $ 26,867       23.4 %
Finance receivables, net of allowance
    17,609       13.9       15,857       13.8  
Unrealized gain on interest rate and currency swaps, options and forward transactions
    21,599       17.0       15,376       13.4  
Securities available for sale, at market value
    15,714       12.4       16,687       14.5  
Trading securities, at market value
    3,300       2.6       4,146       3.6  
Securities purchased under agreements to resell, at contract value
    28,144       22.2       25,560       22.2  
Trading assets
    2,548       2.0       4,786       4.2  
Spot commodities, at market value
    250       0.2       489       0.4  
Other, including short-term investments
    7,392       5.8       5,110       4.5  

Total
  $ 126,899       100.0 %   $ 114,878       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 2003, ILFC acquired flight equipment costing $5.51 billion. (See also the discussion under “Operating Review: Financial Services Operations” and “Capital Resources” herein.)

     At December 31, 2003, ILFC had committed to purchase 463 new and used aircraft deliverable from 2004 through 2010 at an estimated aggregate purchase price of $26.2 billion and had options to purchase 11 new aircraft deliverable from 2004 through 2008 at an estimated aggregate purchase price of $705 million. As of March 8, 2004, ILFC has entered into leases for all of the new aircraft to be delivered in 2004 and 61 of 91 of the new aircraft to be delivered in 2005 and 30 of 263 of the new aircraft to be delivered subsequent to 2005. ILFC will be required to find customers for any aircraft presently on order and any aircraft to be ordered, and it must arrange financing for portions of the purchase price of such equipment. In a rising interest rate environment, ILFC negotiates higher lease rates on any new contracts. ILFC has been successful to date both in placing its new aircraft on lease or under sales contract and obtaining adequate financing, but there can be no assurance that such success will continue in future environments.

 
FORM 10-K : 38


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     AIG’s Consumer Finance operations provide a wide variety of consumer finance products both domestically and overseas. Such products include real estate mortgages, consumer loans, and retail sales finance. These products are funded through various borrowings including commercial paper and medium term notes. AIG’s Consumer Finance operations are exposed to credit risk and risk of loss resulting from adverse fluctuations in interest rates. Over half of the loan balance is related to real estate loans which are substantially collateralized by the related properties.

     With respect to credit losses, the allowance for finance receivable losses is maintained at a level considered adequate to absorb anticipated credit losses existing in that portfolio.

     Capital Markets 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 required 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 “Operating 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 December 31, 2003, the average credit rating of this portfolio was AA or the equivalent thereto as determined through rating agencies or internal review. AIGFP has also entered into credit derivative transactions to hedge its credit risk associated with $218 million of these securities. Securities deemed below investment grade at December 31, 2003 amounted to approximately $98 million in fair value representing 0.6 of one percent of the total AIGFP securities available for sale. $30 million of this amount is hedged with a credit derivative. There have been no significant downgrades through March 1, 2004. 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.

     AIGFP is exposed to credit risk. If its securities available for sale portfolio were to suffer significant default and the collateral held declined significantly in value with no replacement or the credit default swap counterparty failed to perform, AIGFP could have a liquidity strain. AIG guarantees AIGFP’s debt and, as a result, is responsible for all of AIGFP’s obligations.

     AIGTG conducts, as principal, market making and trading activities in foreign exchange, and commodities, primarily 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 Note 21 of Notes to Financial Statements.)

The gross unrealized gains and gross unrealized losses of Capital Markets included in the financial services assets and liabilities at December 31, 2003 were as follows:

                 
Gross Gross
Unrealized Unrealized
(in millions) Gains Losses

Securities available for sale, at market value(a)
  $ 2,329     $ 2,347  
Unrealized gain/ loss on interest rate and currency swaps, options and forward transactions(b)
    21,599       15,268  
Trading assets
    10,431       8,067  
Spot commodities, at market value
    8        
Trading liabilities
          1,459  
Securities and spot commodities sold but not yet purchased, at market value
          754  

(a) See also Note 8(i) of Notes to Financial Statements.
(b) These amounts are also presented as the respective balance sheet amounts.

     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 December 31, 2003, the unrealized gains and losses

 
FORM 10-K : 39


 

 


American International Group, Inc. and Subsidiaries


remaining after the benefit of the offsets were $49 million and $67 million, respectively.

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

     The senior management of AIG defines the policies and establishes general operating parameters for Capital Markets operations. AIG’s senior management has established various oversight committees to review the various financial market, operational and credit issues of the Capital Markets operations. The senior management of AIGFP reports the results of its operations to and reviews 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.

Retirement Services & Asset Management Operations

AIG’s Retirement Services & Asset Management operations offer a wide variety of investment products, including variable annuities and mutual funds, as well as investment services, including investment asset management. Such products and services are offered to individuals and institutions both domestically and overseas.

Retirement Services & Asset Management revenues and operating income for 2003, 2002 and 2001 were as follows:

                         
(in millions) 2003 2002 2001

Revenues:
                       
AIG VALIC
  $ 2,305     $ 2,133     $ 2,110  
AIG SunAmerica
    537       563       652  
Other*
    1,054       789       950  

Total
  $ 3,896     $ 3,485     $ 3,712  

Operating income:
                       
AIG VALIC
  $ 902     $ 730     $ 630  
AIG SunAmerica
    38       32       185  
Other*
    331       254       273  

Total
  $ 1,271     $ 1,016     $ 1,088  

* Includes AIG Global Investment Group and certain foreign fixed and variable annuity operations.

Retirement Services & Asset Management Results

Retirement Services & Asset Management operating income increased in 2003 as a result of the upturn in worldwide financial markets and the improved U.S. economic conditions. The operating income growth with respect to Retirement Services & Asset Management is partly contingent upon the growth in the equity markets and customer interest in equity sensitive products. Thus, as markets expand and contract, the operating income with respect to this segment can be expected to be similarly affected.

     Retirement Services & Asset Management operating income represented 9.1 percent of AIG’s consolidated income before income taxes, minority interest and cumulative effect of accounting changes in 2003. This compares to 12.5 percent and 13.4 percent in 2002 and 2001, respectively.

     At December 31, 2003, AIG’s third party assets under management, including both retail mutual funds and institutional accounts, approximated $46 billion.

     With respect to variable annuities, AIG’s policy has been to adjust amortization assumptions for deferred acquisition costs (DAC) when estimates of current or future gross profits to be realized from these contracts are revised. With respect to variable annuities sold domestically (representing the vast majority of AIG’s variable annuity business), the assumption for the long-term annual net growth rate of the equity markets used in the determination of DAC amortization is approximately 10 percent. A methodology referred to as “reversion to the mean” is used to maintain this long-term net growth rate assumption, while giving consideration to short-term variations in equity markets.

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

     A number of guaranteed minimum death benefits (GMDB) and other similar benefits are offered on variable annuities. GMDB-related contract benefits incurred, net of reinsurance, were $72 million, $77 million and $20 million for 2003, 2002 and 2001, respectively. In accordance with GAAP, AIG expenses these benefits in the period paid. Included in the “Accounting Standards” section is a discussion of new accounting guidance for such benefits.

Other Operations

     Other income (deductions)-net includes income generated by the investment of capital held by AIG SunAmerica outside of its Life Insurance subsidiaries, 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

 
FORM 10-K : 40


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

other miscellaneous income and expenses. Other income (deductions)-net amounted to $(464) million, $(129) million and $3 million in 2003, 2002 and 2001, respectively. The decline in 2003 was primarily the result of increases in pension and interest expenses as well as the capital contribution of certain AIG SunAmerica partnership investments previously included herein to the Life Insurance and Retirement Services & Asset Management operations, and in 2002 weaker performance of AIG SunAmerica investments in partnerships and 21st Century’s third quarter 2002 pretax charge of $37 million to write off capitalized costs associated with a software development project. Acquisition, restructuring and related charges of $2.02 billion were incurred in 2001 in connection with the acquisition of AGC, including $654 million paid by AGC in connection with the termination of AGC’s merger agreement with Prudential plc. (See also Note 19 of Notes to Financial Statements.)

 
  Capital Resources

At December 31, 2003, AIG had total shareholders’ equity of $71.25 billion and total borrowings of $77.28 billion. At that date, $69.63 billion of such borrowings were either not guaranteed by AIG or were AIGFP’s matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable.

Borrowings

At December 31, 2003, AIG’s borrowings were $7.7 billion after reflecting amounts not guaranteed by AIG, amounts that were matched borrowings under AIGFP’s obligations of GIAs and matched notes and bonds payable. The following table summarizes borrowings outstanding at December 31, 2003 and 2002:

                   
(in millions)

December 31, 2003 2002

Remaining borrowings of AIG
  $ 7,650     $ 6,904  
Borrowings not guaranteed by AIG
    39,002       33,605  
AIGFP:
               
 
GIAs
    15,337       14,850  
 
Matched notes and bonds payable
    15,289       16,526  

    $ 77,278     $ 71,885  

Borrowings issued or guaranteed by AIG and those borrowings not guaranteed by AIG at December 31, 2003 and 2002 were as follows:

                   
(in millions)

December 31, 2003 2002

AIG borrowings:
               
 
Medium term notes
  $ 791     $ 998  
 
Notes and bonds payable
    3,141       1,608  
 
Loans and mortgages payable
    337       697  

 
Total
    4,269       3,303  

(continued)
Borrowings guaranteed by AIG:
               
AIGFP
               
 
GIAs
    15,337       14,850  
 
Notes and bonds payable
    16,203       16,940  

 
Total
    31,540       31,790  

AIG Funding, Inc. commercial paper
    1,223       1,645  

AGC Notes and bonds payable
    1,244       1,542  

 
Total borrowings issued or
guaranteed by AIG
    38,276       38,280  

Borrowings not guaranteed by AIG:
               
ILFC
               
 
Commercial paper
    1,575       4,213  
 
Medium term notes
    5,960       4,970  
 
Notes and bonds payable(a)
    14,431       9,825  
 
Loans and mortgages payable(b)
    143       261  

 
Total
    22,109       19,269  

AGF
               
 
Commercial paper
    2,877       2,956  
 
Medium term notes
    9,714       7,719  
 
Notes and bonds payable
    1,739       2,266  

 
Total
    14,330       12,941  

Commercial paper:
               
 
AIG Credit Card Company (Taiwan)
    250       234  
 
AIG Finance (Taiwan) Limited
    13       64  

 
Total
    263       298  

Loans and mortgages payable:
               
 
AIGCFG
    624       735  
 
AIG Finance (Hong Kong) Limited
    165       229  

 
Total
    789       964  

Other Subsidiaries
    727       133  

Variable Interest Entity debt:
               
 
ILFC
    464        
 
AIG Global Investment Group
    6        
 
AIG Capital Partners
    148        
 
AIG SunAmerica
    166        

 
Total
    784        

 
Total borrowings not guaranteed by AIG
    39,002       33,605  

 
Total Borrowings
  $ 77,278     $ 71,885  

(a) Includes borrowings under Export Credit Facility of $1.8 billion.
(b) Capital lease obligations.

See also Note 9 of Notes to Financial Statements.

     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 borrowings may also be temporarily invested in securities purchased under agreements to resell. (See also the discussions under “Operating Review”, “Liquidity” and “Derivatives” herein and Notes 1, 8, 9 and 21 of Notes to Financial Statements.)

     AIG Funding, Inc. (Funding), through the issuance of commercial paper, helps fulfill the short-term cash requirements of AIG and its subsidiaries. Funding intends to continue to meet AIG’s funding requirements through the issuance of commercial paper guaranteed by AIG. The issuance of Funding’s commercial paper is subject to the approval of AIG’s Board of Directors.

 
FORM 10-K : 41


 

 


American International Group, Inc. and Subsidiaries


     ILFC and AGF as well as AIG Credit Card Company (Taiwan) – (AIGCCC-Taiwan) and AIG Finance (Taiwan) Limited – (AIGF-Taiwan), both consumer finance subsidiaries in Taiwan, have issued commercial paper for the funding of their own operations. At December 31, 2003, AIG did not guarantee the commercial paper of any of its subsidiaries other than Funding. (See also the discussion under “Derivatives” herein and Note 9 of Notes to Financial Statements.)

     AIG and Funding are parties to unsecured syndicated revolving credit facilities (collectively, the Facility) aggregating $2.75 billion. The Facility consists of $1.375 billion in a short-term revolving credit facility and $1.375 billion in a five year revolving credit facility. The Facility can be used for general corporate purposes and also to provide backup for Funding’s commercial paper programs. There are currently no borrowings outstanding under the Facility, nor were any borrowings outstanding as of December 31, 2003.

     AGF is a party to unsecured syndicated revolving credit facilities aggregating $3.0 billion. The facilities consist of $1.5 billion in a short-term revolving credit facility and $1.5 billion in a five year revolving credit facility, which support AGF’s commercial paper borrowings. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2003. In 2003, AGF increased its shelf registration statement by $7.5 billion. AGF had $9.1 billion in aggregate principal amount of debt securities registered and available for issuance at December 31, 2003. AGF uses the proceeds from the issuance of notes and bonds for the funding of its finance receivables.

     Proceeds from the collection of finance receivables will be used to pay the principle and interest with respect to AGF’s debt.

     ILFC is a party to unsecured syndicated revolving credit facilities aggregating $4.2 billion at December 31, 2003. The facilities are used to support ILFC’s maturing debt and other obligations and consist of $3.15 billion in a short-term revolving credit facility and $1.05 billion in a three year revolving credit facility. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2003.

     At December 31, 2003, ILFC had increased the aggregate principal amount outstanding of its medium term and long-term notes to $20.39 billion, a net increase of $5.60 billion (of which $697 million results from foreign exchange translation), and a net decrease in its commercial paper of $2.64 billion. ILFC had $11.08 billion of debt securities registered for public sale at December 31, 2003. During 2003, $6.09 billion of debt securities were issued. During the second quarter of 2003, ILFC increased its Euro Medium Term Note Program from $4.0 billion to $5.0 billion, under which $3.39 billion in notes were sold through December 31, 2003. ILFC has substantially eliminated the currency exposure arising from foreign currency denominated notes by either hedging the notes through swaps or through the offset provided by operating lease payments. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings.

     ILFC had a $4.3 billion Export Credit Facility for use in connection with the purchase of approximately 75 aircraft delivered through 2001. This facility was guaranteed by various European Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90 percent on these borrowings depending on the delivery date of the aircraft. At December 31, 2003, ILFC had $1.8 billion outstanding under this facility. The debt is collateralized by a pledge of the shares of a subsidiary of ILFC, which holds title to the aircraft financed under the facility. During 2003, ILFC entered into various bank financings for a total funded amount of $1.3 billion. The financings mature through 2009. One tranche of one of the loans totaling $410 million was funded in Japanese yen and swapped to U.S. dollars. Borrowings with respect to this facility are included in Notes and Bonds Payable in the preceding table of borrowings.

     The proceeds of ILFC’s debt financing are primarily used to purchase flight equipment, including progress payments during the construction phase. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover and refinancing of the prior debt. (See also the discussions under “Operating Review” and “Liquidity” herein.)

     AIGFP has established a Euro Medium Term Note Program under which an aggregate principal amount of up to $4.0 billion of notes may be outstanding. As of December 31, 2003, $4.73 billion of notes had been issued under the program, $3.23 billion of which were outstanding. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings.

     During 2003, AIG did not issue any medium term notes, and $207 million of previously issued notes matured or were redeemed. At December 31, 2003, AIG had $140 million in aggregate principal amount of debt securities registered for issuance from time to time. AIG has filed a universal shelf registration statement to sell up to $5.1 billion of debt securities, preferred and common stock and other securities. AIG has no current plans to issue the equity, equity-linked or capital securities included in the registration statement, but intends to continue its customary practice of issuing securities from time to time for general corporate purposes.

 
FORM 10-K : 42


 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

     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. Commencing January 1, 2002, the debentures are convertible into shares of AIG common stock at a conversion rate of 6.0627 shares per $1,000 principal amount of debentures if AIG common stock trades at certain levels for certain time periods. The debentures are callable by AIG on or after November 9, 2006. Also, holders can require AIG to repurchase these debentures once every five years beginning on November 9, 2006.

     As of November 2001, AIG guaranteed the notes and bonds of AGC. During 2002, AGC issued $200 million in notes which matured in March 2003.

Shareholders’ Equity

AIG’s shareholders’ equity increased $12.15 billion during 2003. Unrealized appreciation of investments, net of taxes increased $2.99 billion and the cumulative translation adjustment loss, net of taxes, decreased $306 million. The change for 2003 with respect to the unrealized appreciation of investments, net of taxes, was primarily impacted by the decrease in domestic interest rates. During 2003, there was a gain of $325 million, net of taxes relating to derivative contracts designated as cash flow hedging instruments. (See also the discussion under “Operating Review” and “Liquidity” herein, Notes 1(z) and 8(d) of Notes to Financial Statements and the Consolidated Statement of Comprehensive Income.) During 2003, retained earnings increased $8.69 billion, resulting from net income less dividends.

Stock Repurchase

During 2003, AIG repurchased in the open market 3,822,500 shares of its common stock. AIG intends to continue to buy its common shares in the open market for general corporate purposes, including to satisfy its obligations under various employee benefit plans.

Dividends from Insurance Subsidiaries

Payments of dividends to AIG by its insurance subsidiaries are subject to certain restrictions imposed by statutory authorities. With respect to AIG’s domestic insurance subsidiaries, specifically the payment of any dividend requires formal notice to the insurance department in which the particular insurance subsidiary is domiciled. Under the laws of many states, an insurer may pay a dividend without prior approval of the insurance regulator when the amount of the dividend is below certain materiality thresholds. As a result of these regulations, approximately 71 percent of consolidated shareholders’ equity was restricted as to immediate payment by insurance subsidiaries to AIG parent at December 31, 2003.

     With respect to AIG’s foreign insurance subsidiaries, the most significant insurance regulatory jurisdictions include Bermuda, Japan, Hong Kong and the Republic of China. 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 December 31, 2003, there were no significant statutory or regulatory issues which would impair AIG’s financial condition, results of operations or liquidity, but there can be no assurance that such issues will not arise in the future. To AIG’s knowledge, no AIG company is on any regulatory or similar “watch list”. (See also the discussion under “Liquidity” herein and Note 11 of Notes to Financial Statements.)

Regulation and Supervision

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 December 31, 2003, the risk-based adjusted surplus of each of AIG’s domestic general companies and of each of AIG’s domestic life companies exceeded each of their RBC standards. Federal, state or local legislation may affect AIG’s ability to operate and expand its various financial services businesses and changes in the current laws, regulations or interpretations thereof may have a material adverse effect on these businesses.

     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 2003, 2002 and 2001 were $77 million, $76 million and $24 million, respectively.

 
FORM 10-K : 43


 

 


American International Group, Inc. and Subsidiaries


     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.

     A substantial portion of AIG’s General Insurance business and a majority of its Life Insurance business are conducted in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must

satisfy local regulatory requirements. Licenses issued by foreign authorities to AIG subsidiaries are subject to modification and revocation. Thus, AIG’s insurance subsidiaries could be prevented from conducting future business in certain of the jurisdictions where they currently operate. AIG’s international operations include operations in various developing nations. Both current and future foreign operations could be adversely affected by unfavorable political developments up to and including nationalization of AIG’s operations without compensation. Adverse effects resulting from any one country may impact AIG’s results of operations, liquidity and financial condition depending on the magnitude of the event and AIG’s net financial exposure at that time in that country.

Contractual Obligations and

Other Commercial Commitments

The maturity schedule of AIG’s contractual obligations at December 31, 2003 was as follows:

(in millions)

                                         
Payments due by Period

Less One Four
Than Through Through After
Total One Three Five Five
Payments Year Years Years Years

Borrowings*
  $ 70,556       $22,386     $ 15,626     $ 10,153       $22,391  
Operating leases
    2,409       483       633       384       909  
Aircraft purchase commitments
    26,153       4,957       9,972       8,810       2,414  

Total
  $ 99,118       $27,826     $ 26,231     $ 19,347       $25,714  

Excludes commercial paper and obligations included as debt pursuant to FIN46R and includes ILFC’s capital lease obligations.

The maturity schedule of AIG’s other commercial commitments by segment at December 31, 2003 was as follows:

(in millions)

                                           
Amount of Commitment Expiration

Less One Four
Total Than Through Through After
Amounts One Three Five Five
Committed Year Years Years Years

Letters of credit:
                                       
 
Retirement Services & Asset Management
  $ 139       $109     $     $       $30  
 
DBG
    217       119       98              
Standby letters of credit:
                                       
 
Capital Markets
    1,344       38       10       9       1,287  
Guarantees:
                                       
 
Retirement Services & Asset Management (a)
    3,150       146       2,130       367       507  
Other commercial commitments(b):
                                       
 
Capital Markets(c)
    14,379       148       1,175       2,439       10,617  
 
Aircraft Finance(d)
    1,383             528       411       444  
 
Retirement Services & Asset Management (a)
    5,242