FORM 10-Q
 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-Q

     
(Mark One)
   
þ
  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the quarterly period ended March 31, 2006
or
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the transition period from           to

Commission File Number 1-8787


American International Group, Inc.

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

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

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


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

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

 
Large accelerated filer    þ Accelerated filer    o Non-accelerated filer    o

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes    o         No    þ

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of March 31, 2006: 2,597,469,137.




 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED BALANCE SHEET

(in millions) (unaudited)


                       
March 31, December 31,
2006 2005

Assets:
               
  Investments and financial services assets:                
    Fixed maturities:                
     
Bonds available for sale, at market value (amortized cost: 2006 – $358,275; 2005 – $349,612) (includes hybrid financial instruments: 2006 – $512)
  $ 364,510     $ 359,516  
     
Bonds held to maturity, at amortized cost (market value: 2006 – $21,841; 2005 – $22,047)
    21,520       21,528  
     
Bond trading securities, at market value (cost: 2006 – $5,230; 2005 – $4,623)
    5,229       4,636  
    Equity securities:                
     
Common stocks available for sale, at market value (cost: 2006 – $10,838; 2005 – $10,125)
    13,569       12,227  
     
Common stocks trading, at market value (cost: 2006 – $8,785; 2005 – $7,746)
    10,270       8,959  
     
Preferred stocks available for sale, at market value (cost: 2006 – $2,381; 2005 – $2,282)
    2,456       2,402  
   
Mortgage loans on real estate, net of allowance (2006 – $55; 2005 – $54)
    14,968       14,300  
   
Policy loans
    7,218       7,039  
   
Collateral and guaranteed loans, net of allowance (2006 – $10; 2005 – $10)
    4,114       3,570  
    Financial services assets:                
     
Flight equipment primarily under operating leases, net of accumulated depreciation (2006 – $7,728; 2005 – $7,419)
    37,580       36,245  
     
Securities available for sale, at market value (cost: 2006 – $38,446; 2005 – $37,572)
    38,225       37,511  
     
Trading securities, at market value
    6,350       6,499  
     
Spot commodities
    230       92  
     
Unrealized gain on swaps, options and forward transactions
    17,792       18,695  
     
Trading assets
    1,411       1,204  
     
Securities purchased under agreements to resell, at contract value
    12,297       14,547  
     
Finance receivables, net of allowance (2006 – $743; 2005 – $670)
    27,219       27,995  
    Securities lending collateral, at market value (which approximates cost)     62,967       59,471  
    Other invested assets     29,296       27,267  
    Short-term investments, at cost (approximates market value)     17,343       15,342  

      Total investments and financial services assets     694,564       679,045  
  Cash     1,248       1,897  
  Investment income due and accrued     5,733       5,727  
 
Premiums and insurance balances receivable, net of allowance (2006 – $1,025; 2005 – $1,011)
    18,001       15,333  
  Reinsurance assets, net of allowance (2006 – $979; 2005 – $992)     24,857       24,978  
  Deferred policy acquisition costs     35,988       33,248  
  Investments in partially owned companies     1,167       1,158  
 
Real estate and other fixed assets, net of accumulated depreciation (2006 – $5,135; 2005 – $4,990)
    8,059       7,446  
  Separate and variable accounts     67,597       63,797  
  Goodwill     8,208       8,093  
  Other assets     14,376       12,329  

Total assets
  $ 879,798     $ 853,051  

See Accompanying Notes to Consolidated Financial Statements.

1


 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED BALANCE SHEET (continued)

(in millions, except share data) (unaudited)


                     
March 31, December 31,
2006 2005

Liabilities:
               
 
Reserve for losses and loss expenses
  $ 78,100     $ 77,169  
 
Reserve for unearned premiums
    25,044       24,243  
 
Future policy benefits for life and accident and health insurance contracts
    114,606       108,807  
 
Policyholders’ contract deposits
    231,045       227,027  
 
Other policyholders’ funds
    10,684       10,870  
 
Reserve for commissions, expenses and taxes
    4,939       4,769  
 
Insurance balances payable
    3,987       3,564  
 
Funds held by companies under reinsurance treaties
    4,195       4,174  
 
Income taxes payable
    6,615       6,288  
 
Financial services liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    21,600       20,811  
   
Securities sold under agreements to repurchase, at contract value
    9,691       11,047  
   
Trading liabilities
    2,389       2,546  
   
Hybrid financial instrument liabilities, at fair value
    6,109        
   
Securities and spot commodities sold but not yet purchased, at market value
    6,429       5,975  
   
Unrealized loss on swaps, options and forward transactions
    11,267       12,740  
   
Trust deposits and deposits due to banks and other depositors
    4,384       4,877  
   
Commercial paper
    7,500       6,514  
   
Notes, bonds, loans and mortgages payable
    68,790       71,313  
 
Commercial paper
    5,965       2,694  
 
Notes, bonds, loans and mortgages payable
    7,427       7,126  
 
Liabilities connected to trust preferred stock
    1,390       1,391  
 
Separate and variable accounts
    67,597       63,797  
 
Securities lending payable
    63,959       60,409  
 
Minority interest
    5,872       5,124  
 
Other liabilities
    21,635       23,273  

Total liabilities
    791,219       766,548  

Preferred shareholders’ equity in subsidiary companies
    189       186  

 
Commitments and Contingent Liabilities (See Note 6)
               
Shareholders’ equity:
               
 
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2006 and 2005 – 2,751,327,476
    6,878       6,878  
 
Additional paid-in capital
    2,513       2,339  
 
Retained earnings
    75,433       72,330  
 
Accumulated other comprehensive income (loss)
    5,709       6,967  
 
Treasury stock, at cost; 2006 – 153,858,339; 2005 – 154,680,704 shares of common stock
    (2,143 )     (2,197 )

Total shareholders’ equity
    88,390       86,317  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 879,798     $ 853,051  

See Accompanying Notes to Consolidated Financial Statements.

2


 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED STATEMENT OF INCOME

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

Three Months Ended March 31, 2006 2005

Revenues:
               
 
Premiums and other considerations
  $ 18,242     $ 17,680  
 
Net investment income
    5,827       5,332  
 
Realized capital gains (losses)
    169       137  
 
Other revenues
    3,021       4,053  

 
Total revenues
    27,259       27,202  

Benefits and expenses:
               
 
Incurred policy losses and benefits
    15,000       14,873  
 
Insurance acquisition and other operating expenses
    7,466       6,680  

 
Total benefits and expenses
    22,466       21,553  

Income before income taxes, minority interest and cumulative effect of an accounting change
    4,793       5,649  

Income taxes
    1,435       1,706  

Income before minority interest and cumulative effect of an accounting change
    3,358       3,943  

Minority interest
    (197 )     (144 )

Income before cumulative effect of an accounting change
    3,161       3,799  

Cumulative effect of an accounting change, net of tax
    34        

Net income
  $ 3,195     $ 3,799  

Earnings per common share:
               
 
Basic
               
   
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.46  
   
Cumulative effect of an accounting change, net of tax
    0.01        
   
Net income
    1.22       1.46  

 
Diluted
               
   
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.45  
   
Cumulative effect of an accounting change, net of tax
    0.01        
   
Net income
    1.22       1.45  

Dividends declared per common share
  $ 0.150     $ 0.175  

Average shares outstanding:
               
 
Basic
    2,605       2,597  
 
Diluted
    2,624       2,624  

See Accompanying Notes to Consolidated Financial Statements.

3


 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED STATEMENT OF CASH FLOWS

                       
(in millions) (unaudited)

Three Months Ended March 31, 2006 2005

Summary:
               
 
Net cash provided by (used in) operating activities
  $ 3,066     $ (434 )
 
Net cash used in investing activities
    (19,937 )     (20,118 )
 
Net cash provided by financing activities
    15,672       20,961  
 
Effect of exchange rate changes on cash
    550       (57 )

 
Change in cash
    (649 )     352  
 
Cash at beginning of period
    1,897       2,009  

 
Cash at end of period
  $ 1,248     $ 2,361  

Cash flows from operating activities:
               
 
Net income
  $ 3,195     $ 3,799  

 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
               
   
Noncash revenues, expenses, gains and losses included in income:
               
   
Change in:
               
     
General and life insurance reserves
    7,263       5,605  
     
Premiums and insurance balances receivable and payable – net
    (2,245 )     8  
     
Reinsurance assets
    121       241  
     
Deferred policy acquisition costs
    (1,715 )     (944 )
     
Investment income due and accrued
    (6 )     (53 )
     
Funds held under reinsurance treaties
    21       (267 )
     
Other policyholders’ funds
    (186 )     (68 )
     
Income taxes payable
    761       1,457  
     
Reserve for commissions, expenses and taxes
    170       143  
     
Other assets and liabilities – net
    (3,125 )     (962 )
     
Bonds and common stocks trading, at market value
    (1,904 )     (1,082 )
     
Trading assets and liabilities – net
    (364 )     905  
     
Trading securities, at market value
    149       (345 )
     
Spot commodities
    (138 )     (120 )
     
Net unrealized (gain) loss on swaps, options and forward transactions
    (570 )     (598 )
     
Securities purchased under agreements to resell
    2,250       (6,321 )
     
Securities sold under agreements to repurchase
    (1,356 )     (1,939 )
     
Securities and spot commodities sold but not yet purchased, at market value
    454       182  
   
Realized capital (gains) losses
    (169 )     (137 )
   
Equity in income of partially owned companies and other invested assets
    (480 )     (445 )
   
Amortization of premium and discount on securities
    105       113  
   
Depreciation expenses, principally flight equipment
    554       526  
   
Provision for finance receivable losses
    160       86  
   
Other – net
    121       (218 )

   
Total adjustments
    (129 )     (4,233 )

Net cash provided by (used in) operating activities
  $ 3,066     $ (434 )

See Accompanying Notes to Consolidated Financial Statements.

4


 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED STATEMENT OF CASH FLOWS (continued)

                 
(in millions) (unaudited)

Three Months Ended March 31, 2006 2005

Cash flows from investing activities:
               
    Cost of bonds, at market sold
  $ 22,598     $ 27,572  
    Cost of bonds, at market matured or redeemed
    3,628       2,823  
    Cost of equity securities sold
    3,425       2,724  
    Realized capital gains (losses)
    169       137  
    Purchases of fixed maturities
    (34,507 )     (42,094 )
    Purchases of equity securities
    (4,285 )     (3,608 )
    Mortgage, policy, collateral and guaranteed loans granted
    (1,449 )     (1,578 )
    Repayments of mortgage, policy, collateral and guaranteed loans
    58       575  
    Sales of securities available for sale
    1,166       804  
    Maturities of securities available for sale
    360       2,164  
    Purchases of securities available for sale
    (2,386 )     (2,316 )
    Sales of flight equipment
    195       41  
    Purchases of flight equipment
    (1,897 )     (2,141 )
    Change in securities lending collateral
    (3,496 )     (2,721 )
    Net additions to real estate and other fixed assets
    (322 )     (188 )
    Sales or distributions of other invested assets
    2,161       2,163  
    Other invested assets
    (3,290 )     (3,339 )
    Change in short-term investments
    (2,676 )     301  
    Investments in partially owned companies
    (5 )     4  
    Finance receivable originations and purchases
    (7,696 )     (10,605 )
    Finance receivable principal payments received
    8,312       9,164  

Net cash used in investing activities
  $ (19,937 )   $ (20,118 )

Cash flows from financing activities:
               
    Receipts from policyholders’ contract deposits
  $ 14,108     $ 16,279  
    Withdrawals from policyholders’ contract deposits
    (10,090 )     (7,149 )
    Change in trust deposits and deposits due to banks and other depositors
    (493 )     364  
    Change in commercial paper
    4,257       2,263  
    Proceeds from notes, bonds, loans and mortgages payable, and hybrid
    financial instrument liabilities
    9,527       16,244  
    Repayments on notes, bonds, loans and mortgages payable, and hybrid
    financial instrument liabilities
    (5,644 )     (13,081 )
    Proceeds from guaranteed investment agreements
    3,306       4,955  
    Maturities of guaranteed investment agreements
    (2,517 )     (1,183 )
    Change in securities lending payable
    3,550       2,721  
    Proceeds from common stock issued
    34       31  
    Cash dividends to shareholders
    (390 )     (325 )
    Acquisition of treasury stock
    (2 )     (166 )
    Other – net
    26       8  

Net cash provided by financing activities
  $ 15,672     $ 20,961  

Supplementary information:
               
Taxes paid
  $ 460     $ 382  

Interest paid
  $ 1,284     $ 1,147  

See Accompanying Notes to Consolidated Financial Statements.

5


 

American International Group, Inc. and Subsidiaries
                                             

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

                     
(in millions) (unaudited)

Three Months Ended March 31, 2006 2005

Comprehensive income (loss):
               
 
Net income
  $ 3,195     $ 3,799  

Other comprehensive income (loss):
               
 
Unrealized appreciation (depreciation) of investments – net of reclassification adjustments
    (2,599 )     (2,535 )
   
Deferred income tax benefit (expense) on above changes
    1,100       1,256  
 
Foreign currency translation adjustments
    550       (53 )
   
Applicable income tax benefit (expense) on above changes
    (290 )     4  
 
Net derivative gains arising from cash flow hedging activities
    4       150  
   
Deferred income tax (expense) benefit on above changes
    13       (111 )
 
Retirement plan liabilities adjustment, net of tax
    (36 )     (30 )

Other comprehensive income (loss)
    (1,258 )     (1,319 )

Comprehensive income (loss)
  $ 1,937     $ 2,480  

See Accompanying Notes to Consolidated Financial Statements.

6


 

American International Group, Inc. and Subsidiaries
                                             

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 

 
  1.  Financial Statement Presentation

These statements are unaudited. In the opinion of management, all material adjustments including normal recurring accruals have been made for a fair statement of the results presented herein. All material intercompany accounts and transactions have been eliminated. Certain accounts have been reclassified in the 2005 financial statements to conform to their 2006 presentation. For further information, refer to the Annual Report on Form 10-K of American International Group, Inc. (AIG) for the year ended December 31, 2005 (2005 Annual Report on Form 10-K).

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American International Group, Inc. and Subsidiaries
                                             

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 
  2.  Segment Information

AIG identifies its reportable segments by product line consistent with its management structure. AIG’s major product and service groupings are general insurance, life insurance & retirement services, financial services and asset management. The following table summarizes the operations by the major operating segments for the three months ended March 31, 2006 and 2005:

                   
Operating Segments
(in millions) (unaudited) 2006 2005

Revenues(a):
               
 
General Insurance(b)
  $ 11,656     $ 11,219  
 
Life Insurance & Retirement Services(c)
    12,639       11,775  
 
Financial Services(d)
    1,615       2,436  
 
Asset Management(e)
    1,239       1,377  
 
Other
    110       395  

Consolidated
  $ 27,259     $ 27,202  

Operating income (loss)(a)(f):
               
 
General Insurance
  $ 2,331     $ 1,642  
 
Life Insurance & Retirement Services(g)
    2,555       2,181  
 
Financial Services(g)
    (159 )     1,045  
 
Asset Management
    461       590  
 
Other(h)
    (395 )     191  

Consolidated
  $ 4,793     $ 5,649  

(a)  Includes the effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the first three months of 2006 and 2005, the effect was $0 and $15 million, respectively, in operating income for Aircraft Finance and $(678) million and $468 million in revenues and operating income, respectively, for Capital Markets. These amounts result primarily from interest rate and foreign currency derivatives hedging available for sale securities and borrowings.
(b)  Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(c)  Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses). Included in realized capital gains (losses) is the effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133 and the application of FAS 52 of $278 million and $(79) million in the first three months of 2006 and 2005, respectively.
(d)  Represents interest, lease and finance charges.
(e)  Represents management and advisory fees and net investment income with respect to GICs.
(f)  Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(g)  Results of operations of AIG Credit Card Company (Taiwan) are shared equally by the Life Insurance & Retirement Services segment and the Financial Services segment. In 2006, additional allowances of $44 million were recorded by each segment for losses in these credit card operations.
(h)  Represents unallocated corporate expenses, relating primarily to interest expense and certain compensation related expenses, and other realized capital gains (losses) of $(57) million and $155 million in the first three months of 2006 and 2005, respectively.

The following table summarizes AIG’s General Insurance operations by major internal reporting unit for the three months ended March 31, 2006 and 2005:

                   
General Insurance
(in millions) (unaudited) 2006 2005

Revenues:
               
 
Domestic Brokerage Group
  $ 6,555     $ 6,289  
 
Transatlantic
    1,016       982  
 
Personal Lines
    1,215       1,171  
 
Mortgage Guaranty
    198       169  
 
Foreign General
    2,670       2,602  
 
Reclassifications and Eliminations
    2       6  

Total General Insurance
  $ 11,656     $ 11,219  

Operating Income*:
               
 
Domestic Brokerage Group
  $ 1,357     $ 713  
 
Transatlantic
    141       114  
 
Personal Lines
    101       109  
 
Mortgage Guaranty
    109       104  
 
Foreign General
    621       596  
 
Reclassifications and Eliminations
    2       6  

Total General Insurance
  $ 2,331     $ 1,642  

Includes $103 million and $171 million of additional losses incurred and net reinstatement premium costs in 2006 and 2005, respectively, related primarily to prior year catastrophes.

The following table summarizes AIG’s Life Insurance & Retirement Services operations by major internal reporting unit for the three months ended March 31, 2006 and 2005:

                     
Life Insurance & Retirement Services
(in millions) (unaudited) 2006 2005

Revenues(a):
               
 
Foreign:
               
   
AIA, AIRCO and Nan Shan(b)
  $ 4,352     $ 4,066  
   
ALICO, AIG Star Life and AIG Edison Life(c)
    4,095       3,519  
   
Philamlife and Other
    124       130  
 
Domestic:
               
   
AGLA and AG Life(d)
    2,367       2,388  
   
VALIC, AIG Annuity and AIG SunAmerica(e)
    1,701       1,672  

Total Life Insurance & Retirement Services
  $ 12,639     $ 11,775  

Operating Income:
               
 
Foreign:
               
   
AIA, AIRCO and Nan Shan(b)
  $ 700     $ 588  
   
ALICO, AIG Star Life and AIG Edison Life(c)
    958       596  
   
Philamlife and Other
    11       16  
 
Domestic:
               
   
AGLA and AG Life(d)
    366       466  
   
VALIC, AIG Annuity and AIG SunAmerica(e)
    520       515  

Total Life Insurance & Retirement Services
  $ 2,555     $ 2,181  

(a)  Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).
(b)  Represents the operations of American International Assurance Company, Limited together with American International Assurance Company (Bermuda) Limited (AIA), American International Reinsurance Company, Ltd. (AIRCO), and Nan Shan Life Insurance Company, Ltd. (Nan Shan). Revenues and operating income include realized capital gains (losses) of $213 million and $66 million for the first three months of 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $173 million and

8


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  2.  Segment Information (continued)

$10 million for the first three months of 2006 and 2005, respectively. Includes $44 million in additional allowances for losses in AIG Credit Card Company (Taiwan) in 2006.
(c)  Represents the operations of American Life Insurance Company (ALICO), AIG Star Life Insurance Co., Ltd. (AIG Star Life), and AIG Edison Life Insurance Company (AIG Edison Life). Revenues and operating income include realized capital gains of $149 million and losses of $(139) million for the first three months of 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $40 million and losses of $(213) million for the first three months of 2006 and 2005, respectively.
(d)  Includes the life operations of American General Life Insurance Company (AG Life), AIG Life Insurance Company and American International Life Assurance Company of New York. Also includes the operations of American General Life and Accident Insurance Company (AGLA). Revenues and operating income include realized capital gains of $8 million and $72 million for the first three months of 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $86 million and $104 million for the first three months of 2006 and 2005, respectively.
(e)  “AIG SunAmerica” represents the annuity operations of AIG SunAmerica Life Assurance Company, as well as those of First SunAmerica Life Insurance Company and SunAmerica Life Insurance Company. Also includes the operations of The Variable Annuity Life Insurance Company (VALIC) and AIG Annuity Insurance Company (AIG Annuity). Revenues and operating income include realized capital losses of $(202) million and $(79) million for the first three months of 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $3 million and $20 million for the first three months of 2006 and 2005, respectively.

The following table summarizes AIG’s Financial Services operations by major internal reporting unit for the three months ended March 31, 2006 and 2005:

                   
Financial Services
(in millions) (unaudited) 2006 2005

Revenues(a):
               
 
Aircraft Finance(b)
  $ 965     $ 827  
 
Capital Markets(c)(d)
    (300 )     756  
 
Consumer Finance(e)
    924       833  
 
Other
    26       20  

Total Financial Services
  $ 1,615     $ 2,436  

Operating income (loss)(a):
               
 
Aircraft Finance
  $ 129     $ 187  
 
Capital Markets(d)
    (470 )     620  
 
Consumer Finance(f)
    175       221  
 
Other
    7       17  

Total Financial Services
  $ (159 )   $ 1,045  

(a)  Includes the effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the first three months of 2006 and 2005, the effect was $0 and $15 million, respectively, in operating income for Aircraft Finance and $(678) million and $468 million in both revenues and operating income for Capital Markets. These amounts result primarily from interest rate and foreign currency derivatives hedging available for sale securities and borrowings.
(b)  Revenues are primarily from International Lease Finance Corporation (ILFC) aircraft lease rentals.
(c)  Revenues, shown net of interest expense, are primarily from hedged financial positions entered into in connection with counterparty transactions and the effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133 described in (a) above.
(d)  Certain transactions entered into by AIGFP generate tax credits and benefits which are included in income taxes in the consolidated statement of income. The amount of such tax credits and benefits for the first three months of 2006 and 2005 are $18 million, and $19 million, respectively.
(e)  Revenues are primarily finance charges.
(f)  Includes $44 million in additional allowances for losses in AIG Credit Card Company (Taiwan) in 2006.

9


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  2.  Segment Information (continued)

The following table summarizes AIG’s Asset Management revenues and operating income for the three months ended March 31, 2006 and 2005:

                   
Asset Management
(in millions) (unaudited) 2006 2005

Revenues:
               
 
Guaranteed Investment Contracts
  $ 822     $ 896  
 
Institutional Asset Management
    279       319  
 
Brokerage Services and Mutual Funds
    73       63  
 
Other
    65       99  

Total Asset Management
  $ 1,239     $ 1,377  

Operating income:
               
 
Guaranteed Investment Contracts(a)
  $ 218     $ 319  
 
Institutional Asset Management(b)(c)
    159       161  
 
Brokerage Services and Mutual Funds
    23       13  
 
Other
    61       97  

Total Asset Management
  $ 461     $ 590  

(a)  The effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133 was $0 and $62 million for the first three months of 2006 and 2005, respectively.
(b)  Includes the full results of certain AIG managed private equity and real estate funds that are consolidated effective December 31, 2003 pursuant to FIN46R, “Consolidation of Variable Interest Entities”. For the first three months of 2006 and 2005, operating income includes $27 million and $75 million, respectively, of third-party limited partner earnings offset in minority interest expense.
(c)  Includes the full results of certain AIG managed partnerships that are consolidated effective January 1, 2006 pursuant to EITF 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” For the first three months of 2006, operating income includes $69 million of third-party limited partner earnings offset in minority interest expense.
 
  3.  Earnings Per Share

Earnings per share of AIG are based on the weighted average number of common shares outstanding during the period. See also Note 10 herein.

Computation of Earnings Per Share:

                   
Three Months Ended March 31,
(in millions, except per share data) (unaudited) 2006 2005

Numerator for basic earnings per share:
               
Income before cumulative effect of an accounting change
  $ 3,161     $ 3,799  
Cumulative effect of an accounting change, net of tax
    34        

Net income applicable to common stock
  $ 3,195     $ 3,799  

Denominator for basic earnings per share:
               
Average shares outstanding used in the computation of per share earnings:
               
 
Common stock issued
    2,752       2,752  
 
Common stock in treasury
    (154 )     (155 )
 
Deferred shares
    7        

Average shares outstanding – basic
    2,605       2,597  

Numerator for diluted earnings per share:
               
Income before cumulative effect of an accounting change
  $ 3,161     $ 3,799  
Cumulative effect of an accounting change, net of tax
    34        

Net income applicable to common stock
    3,195       3,799  

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

Adjusted net income applicable to common stock(a)
  $ 3,198     $ 3,802  

Denominator for diluted earnings per share:
               
Average shares outstanding
    2,605       2,597  
Incremental shares from potential common stock:
               
Average number of shares arising from outstanding employee stock plans (treasury stock method)(b)
    10       18  
Contingently convertible bonds(a)
    9       9  

Adjusted average shares outstanding – diluted(b)
    2,624       2,624  

Earnings per share:
               
Basic:
               
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.46  
Cumulative effect of an accounting change, net of tax
    0.01        
Net income
  $ 1.22     $ 1.46  

Diluted:
               
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.45  
Cumulative effect of an accounting change, net of tax
    0.01        
Net income
  $ 1.22     $ 1.45  

(a)  Assumes conversion of contingently convertible bonds due to the adoption of EITF Issue No. 04-8 “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.”
(b)  Certain shares arising from employee stock plans were not included in the computation of diluted earnings per share where the exercise price of the options exceeded the average market price and would have been antidilutive. The number of shares excluded were 7 million and 22 million for the first three months of 2006 and 2005, respectively.

     During the three months ended March 31, 2005, AIG purchased in the open market 2,477,100 shares of its common stock. From time to time, AIG may buy shares of its common stock in the open market for general corporate purposes, including to satisfy its obligations under various employee benefit plans. At March 31, 2006 and December 31, 2005, an additional 36,542,700 shares could be purchased under the then current authorization by AIG’s Board of Directors. Although AIG has authorization to purchase additional shares, AIG has not repurchased shares in 2006.

     The quarterly dividend rate per common share, commencing with the dividend declared in May 2005 and paid on

10


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
 3. Earnings Per Share (continued)

September 16, 2005, is $0.15. The declared dividend amount of $0.175 for the first three months of 2005 includes a $0.05 increase to the amount previously declared in the fourth quarter of 2004 for payment in March 2005 as well as the $0.125 dividend declared in March 2005 for payment in June 2005. See also Note 10 herein.

 
  4.  Benefits Provided by Starr International Company, Inc. and C.V. Starr & Co., Inc.

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

     None of the costs of the various benefits provided under the SICO Plans has been paid by AIG, although AIG has recorded a charge to reported earnings for the deferred compensation amounts paid to AIG employees by SICO, with an offsetting amount credited to additional paid-in capital reflecting amounts deemed contributed by SICO. The SICO Plans provide that shares currently owned by SICO are set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment with AIG prior to normal retirement age. Under the SICO Plans, SICO’s Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. Following notification from SICO to participants in the SICO Plans that it will settle specific future awards under the SICO Plans with shares rather than cash, AIG modified its accounting for the SICO Plans from variable to fixed measurement accounting, although variable accounting will continue to be applied where SICO makes cash payments pursuant to elections made prior to March 2005. AIG gave effect to this change in settlement method beginning on December 9, 2005, the date of SICO’s notice to participants in the SICO Plans. See also Note 6(f) herein.

     Compensation expense with respect to the SICO Plans aggregated $76 million, including various adjustments totalling $61 million, primarily relating to stock-split adjustments and other miscellaneous items, and $7 million for the first three months of 2006 and 2005, respectively. See also Note 10 herein.

     In January 2006, C.V. Starr & Co., Inc. (Starr) completed its tender offer to purchase Starr interests from AIG employees. In conjunction with AIG’s adoption of FAS 123R, Starr is considered to be an “economic interest holder” in AIG. As a result, compensation expense of $54 million with respect to the Starr offer was included in the first three months of 2006.

     As a result of its changing relationship with Starr and SICO, AIG has established new executive compensation plans to replace the SICO plans and investment opportunities previously provided by Starr. The replacement plans include both share-based plans and cash-based plans (AIG Senior Partners Plan). In addition, these replacement plans generally include performance as well as service conditions. See also Note 10 herein.

 
  5.  Ownership and Transactions With Related Parties

(a) Ownership: According to the Schedule 13D filed on March 7, 2006 by Starr, SICO, Edward E. Matthews, Maurice R. Greenberg, the Maurice R. and Corinne P. Greenberg Family Foundation, Inc. and the Universal Foundation, Inc., these reporting persons may be deemed to beneficially own 396,124,637 shares of common stock. Based on the shares of common stock outstanding as of March 31, 2006, this ownership represents approximately 15 percent of the voting stock of AIG.

     (b) Transactions with Related Parties: During the ordinary course of business, AIG and its subsidiaries pay commissions to Starr and its subsidiaries for the production and management of insurance business. There were no significant receivables from/payables to related parties at March 31, 2006.

 
  6.  Commitments and Contingent Liabilities

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

     (a) AIG and certain of its subsidiaries become parties to derivative financial instruments with market risk resulting from both dealer and end user activities and to reduce currency, interest rate, equity and commodity exposures. These instruments are carried at their estimated fair values in the consolidated balance sheet. The vast majority of AIG’s derivative activity is transacted by AIGFP. (See also Note 20 of Notes to Consolidated Financial Statements in AIG’s 2005 Annual Report on Form 10-K.)

11


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  6.  Commitments and Contingent Liabilities (continued)

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

     AIG has issued unconditional guarantees with respect to the prompt payment, when due, of all present and future payment obligations and liabilities of AIGFP arising from transactions entered into by AIGFP.

     (c) At March 31, 2006, ILFC had committed to purchase 308 new and used aircraft deliverable from 2006 through 2015 at an estimated aggregate purchase price of $21.4 billion and had options to purchase 16 new aircraft at an estimated aggregate purchase price of $1.5 billion. ILFC will be required to find customers for any aircraft acquired, and it must arrange financing for portions of the purchase price of such equipment.

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

     Although AIG regularly reviews the adequacy of the established reserve for losses and loss expenses, there can be no assurance that AIG’s ultimate loss reserves will not develop adversely and materially exceed AIG’s current loss reserves. Estimation of ultimate net losses, loss expenses and loss reserves is a complex process for long-tail casualty lines of business, which include excess and umbrella liability, directors and officers liability (D&O), professional liability, medical malpractice, workers compensation, general liability, products liability and related classes, as well as for asbestos and environmental exposures. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Moreover, any deviation in loss cost trends or in loss development factors might not be discernible for an extended period of time subsequent to the recording of the initial loss reserve estimates for any accident year. Thus, there is the potential for reserves with respect to a number of years to be significantly affected by changes in loss cost trends or loss development factors that were relied upon in setting the reserves. These changes in loss trends or loss development factors could be attributable to changes in inflation in labor and material costs or in the judicial environment, or in other social or economic phenomena affecting claims.

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

     (f) On June 27, 2005, AIG entered into an agreement pursuant to which AIG agrees, subject to certain conditions, to make any payment that is not promptly paid with respect to the benefits accrued by certain employees of AIG and its subsidiaries under the SICO Plans (as defined in Note 4).

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

     (h) On December 30, 2004, an arbitration panel issued its ruling in connection with a 1998 workers compensation quota share reinsurance agreement under which Superior National Insurance Company, among others, was reinsured by

12


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  6.  Commitments and Contingent Liabilities (continued)

The United States Life Insurance Company in the City of New York (USLIFE), a subsidiary of American General Corporation. In its 2-1 ruling the arbitration panel refused to rescind the contract as requested by USLIFE. Instead, the panel reformed the contract to reduce USLIFE’s participation by ten percent. USLIFE is pursuing certain reinsurance recoverables in connection with the contract. Further, the arbitration ruling established a second phase of arbitration which is pending, in which USLIFE is presenting its challenges to certain cessions to the contract. AIG holds a reserve of approximately $369 million related to this matter as of March 31, 2006.

     (i) Regulators from several states have commenced investigations into insurance brokerage practices related to contingent commissions and other broker-related conduct, such as alleged bid rigging. Various parties, including insureds and shareholders, have also asserted putative class action and other claims against AIG or its subsidiaries alleging, among other things, violations of the antitrust and federal securities laws, and AIG expects that additional claims may be made.

     In February 2006, AIG reached a resolution of claims and matters under investigation with the United States Department of Justice (DOJ), the Securities and Exchange Commission (SEC), the Office of the New York Attorney General (NYAG) and the New York State Department of Insurance (DOI). The settlements resolved outstanding litigation filed by the SEC, NYAG and DOI against AIG and concluded negotiations with these authorities and the DOJ in connection with the accounting, financial reporting and insurance brokerage practices of AIG and its subsidiaries, as well as claims relating to the underpayment of certain workers compensation premium taxes and other assessments. In the fourth quarter of 2005 AIG recorded an after-tax charge of $1.15 billion for the settlements.

     As a result of these settlements, AIG made payments or placed amounts in escrow in the first three months of 2006 totaling approximately $1.64 billion, $225 million of which represented fines and penalties. Of these amounts, $676 million held in escrow is included in other assets and other liabilities at March 31, 2006. A substantial portion of the money will be available to resolve claims asserted in various regulatory and civil proceedings, including shareholder lawsuits.

     Also, as part of the settlements, AIG has agreed to retain for a period of three years an independent consultant who will conduct a review that will include the adequacy of AIG’s internal control over financial reporting and the remediation plan that AIG has implemented as a result of its own internal review.

     Various federal and state regulatory agencies are reviewing certain transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries. AIG has cooperated, and will continue to cooperate, in producing documents and other information in response to the subpoenas.

     A number of lawsuits have been filed regarding the subject matter of the investigations of insurance brokerage practices, including derivative actions, individual actions and class actions under the federal securities laws, Racketeer Influenced and Corrupt Organizations Act (RICO), Employee Retirement Income Security Act (ERISA) and state common and corporate laws in both federal and state courts, including the United States District Court for the Southern District of New York (Southern District of New York), in the Commonwealth of Massachusetts Superior Court and in Delaware Chancery Court. All of these actions generally allege that AIG and its subsidiaries violated the law by allegedly concealing a scheme to “rig bids” and “steer” business between insurance companies and insurance brokers.

     Since October 19, 2004, AIG or its subsidiaries have been named as a defendant in sixteen complaints that were filed in federal court and two that were originally filed in state court (Massachusetts and Florida) and removed to federal court. These cases generally allege that AIG and its subsidiaries violated federal and various state antitrust laws, as well as federal RICO laws, various state deceptive and unfair practice laws and certain state laws governing fiduciary duties. The alleged basis of these claims is that there was a conspiracy between insurance companies and insurance brokers with regard to the use of contingent commission agreements, bidding practices, and other broker-related conduct concerning coverage in certain sectors of the insurance industry. The Judicial Panel on Multidistrict Litigation entered an order on February 17, 2005, consolidating most of these cases and transferring them to the United States District Court for the District of New Jersey (District of New Jersey). The remainder of these cases have been transferred to the District of New Jersey. On August 15, 2005, the plaintiffs in the multidistrict litigation filed a Corrected First Consolidated Amended Commercial Class Action Complaint, which, in addition to the previously named AIG defendants, names new AIG subsidiaries as defendants. Also on August 15, 2005, AIG and two subsidiaries were named as defendants in a Corrected First Consolidated Amended Employee Benefits Class Action Complaint filed in the District of New Jersey, which asserts similar claims with respect to employee benefits insurance and a claim under ERISA on behalf of putative classes of employers and employees. On November 29, 2005, the AIG defendants, along with other insurer defendants and the broker defendants filed motions to dismiss both the Commercial and Employee Benefits Complaints. Plaintiffs have filed a motion for class certification in

13


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  6.  Commitments and Contingent Liabilities (continued)

the consolidated action. Defendants have filed an opposition to the motion for class certification. On April 4, 2006, a complaint against AIG and several of its subsidiaries was filed in the United States District Court for the Northern District of Georgia alleging claims similar to what was alleged in the consolidated complaint. The defendants are seeking to transfer this case to the District of New Jersey for consolidation. In addition, complaints were filed against AIG and several of its subsidiaries in Massachusetts and Florida state courts, which have both been stayed. In the Florida action, the plaintiff has filed a petition for a writ of certiorari with the District Court of Appeals of the State of Florida, Fourth District with respect to the stay order. On February 9, 2006, a complaint against AIG and several of its subsidiaries was filed in Texas state court, making claims similar to those in the federal cases above.

     In April and May 2005, amended complaints were filed in the consolidated derivative and securities cases, as well as in one of the ERISA lawsuits, pending in the Southern District of New York adding allegations concerning AIG’s accounting treatment for non-traditional insurance products. In September 2005, a second amended complaint was filed in the consolidated securities cases adding allegations concerning AIG’s first restatement of its financial statements described in the 2005 Annual Report on Form 10-K (the “First Restatement”), and a new securities action complaint was filed in the Southern District of New York, asserting claims premised on the same allegations made in the consolidated cases. In April 2006, motions to dismiss were denied in the securities actions. Also in September 2005, a class action complaint was filed to consolidate the ERISA cases pending in the Southern District of New York. Motions to dismiss in the consolidated action were filed in January 2006. Also in April 2005, new derivative actions were filed in Delaware Chancery Court, and in July and August 2005, two new derivative actions were filed in the Southern District of New York asserting claims duplicative of the claims made in the consolidated derivative action.

     In July 2005, a second amended complaint was filed in the consolidated derivative case in the Southern District of New York, expanding upon accounting-related allegations, based upon the First Restatement. In June 2005, the derivative cases in Delaware were consolidated and, in August 2005, an amended consolidated complaint was filed. AIG’s Board of Directors has appointed a special committee of independent directors to review the matters asserted in the derivative complaints. The courts have approved agreements staying the derivative cases pending in the Southern District of New York and in Delaware Chancery Court while the special committee of independent directors performs its work. In September 2005, a shareholder filed suit in Delaware Chancery Court seeking documents relating to some of the allegations made in the derivative suits. AIG filed a motion to dismiss in October 2005.

     In late 2002, a derivative action was filed in Delaware Chancery Court in connection with AIG’s transactions with certain entities affiliated with Starr and Starr International Company, Inc. (SICO). In May 2005, the plaintiff filed an amended complaint which adds additional claims premised on allegations relating to insurance brokerage practices and AIG’s non-traditional insurance products. Plaintiffs in that case have agreed to dismiss newly added allegations unrelated to transactions with entities affiliated with Starr and SICO without prejudice to pursuit of these claims in the separate derivative actions described above. On February 16, 2006, the Delaware Chancery Court entered an order dismissing the litigation with prejudice with respect to AIG’s outside directors and dismissing the claims against the remaining AIG defendants without prejudice.

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

     (j) On July 8, 2005, SICO filed a complaint against AIG in the Southern District of New York. The complaint alleges that AIG is in the possession of items, including artwork, which SICO claims it owns, and seeks an order causing AIG to release those items as well as actual, consequential, punitive and exemplary damages. On September 27, 2005, AIG filed its answer to SICO’s complaint denying SICO’s allegations and asserting counter-claims for breach of contract, unjust enrichment, conversion and breach of fiduciary duty relating to SICO’s breach of its commitment to use its AIG shares for the benefit of AIG and its employees. On October 17, 2005, SICO replied to AIG’s counter-claims and additionally sought a judgment declaring that SICO is neither a control person nor an affiliate of AIG for purposes of Schedule 13D under the Securities Exchange Act of 1934, as amended (the Exchange Act), and Rule 144 under the Securities Act of 1933, as amended (the Securities Act), respectively. AIG responded to the SICO claims on November 7, 2005.

     (k) AIG understands that some of its employees have received Wells notices in connection with previously disclosed SEC investigations of certain of AIG’s transactions or accounting practices. Under SEC procedures, a Wells notice is an indication that the SEC staff has made a preliminary decision to recommend enforcement action that provides recipients with an opportunity to respond to the SEC staff before a

14


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  6.  Commitments and Contingent Liabilities (continued)

formal recommendation is finalized. AIG anticipates that additional current and former employees could receive similar notices in the future as the regulatory investigations proceed.

     (l) AIG generates income tax credits as a result of investing in synthetic fuel production. Tax credits generated from the production and sale of synthetic fuel under Section 29 of the Internal Revenue Code are subject to an annual phase-out provision that is based on the average wellhead price of domestic crude oil. The price range within which the tax credits are phased-out was originally established in 1980 and is adjusted annually for inflation. Depending on the price of domestic crude oil for a particular year, all or a portion of the tax credits generated in that year might be eliminated. Tax credits reflected in the income tax provision for the first three months of 2006 have been reduced to reflect the estimated annual average oil price for 2006. Should the actual average oil price for 2006 exceed this estimate, further reductions in the tax credits could be required. Regardless of oil prices, the tax credits expire after 2007.

  7.  Employee Benefits

The following table presents the components of the net periodic benefit costs with respect to pensions and other benefits for the three months ended March 31, 2006 and 2005:

                                                   
Pensions Postretirement


Non-U.S. U.S. Non-U.S. U.S.
(in millions) Plans Plans Total Plans Plans Total

2006
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 19     $ 31     $ 50     $ 1     $ 1     $ 2  
 
Interest cost
    9       40       49       1       3       4  
 
Expected return on assets
    (7 )     (48 )     (55 )                  
 
Amortization of prior service cost
    (2 )     (1 )     (3 )           (2 )     (2 )
 
Recognized actuarial loss
    4       19       23                    

Net period benefit cost
  $ 23     $ 41     $ 64     $ 2     $ 2     $ 4  

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

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

 
  8.  Recent Accounting Standards

In March 2005, FASB issued FSP FIN46R-5 “Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities” (FSP FIN46R-5) to address whether a reporting enterprise has an implicit variable interest in a variable interest entity (VIE) or potential VIE when specific conditions exist. The identification of an implicit variable interest is a matter of judgment that depends on the relevant facts and circumstances. AIG’s adoption of FSP FIN46R-5 on April 1, 2005 did not have a material effect on AIG’s financial condition or results of operations.

     At the March 2004 meeting, the Emerging Issue Task Force (EITF) reached a consensus with respect to Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF No. 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” delaying the effective date of this guidance until the FASB has resolved certain implementation issues with respect to this guidance, but the disclosures remain effective. This FSP, retitled FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, ” replaces the measurement and recognition guidance set forth in Issue No. 03-1 and codifies certain existing guidance on impairment. AIG’s adoption of FSP FAS 115-1 on January 1, 2006 did not have a material effect on AIG’s consolidated financial condition or results of operations.

     In December 2004, the FASB issued Statement No. 123 (revised 2004), “Share-Based Payment” (FAS 123R). FAS 123R and its related interpretive guidance replaces FAS No. 123, “Accounting for Stock-Based Compensation” (FAS 123), supersedes Accounting Principles Board Opinion

15


 

American International Group, Inc. and Subsidiaries
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                             
  8.  Recent Accounting Standards (continued)

No. 25, “Accounting for Stock Issued to Employees” (APB 25) and amends FAS 95 “Statement of Cash Flows”. FAS 123, as originally issued in 1995, established as preferable a fair-value-based method of accounting for share-based payment transactions with employees. On January 1, 2003, AIG adopted the recognition provisions of FAS 123. See also Note 10 herein. In April 2005, the SEC delayed the effective date for FAS 123R until the first fiscal year beginning after June 15, 2005. As a result, AIG adopted the provisions of the revised FAS 123R and its related interpretive guidance on January 1, 2006.

     For its service-based awards (e.g. 1999 Stock Option Plan, 2002 Stock Incentive Plan and 1996 Employee Stock Purchase Plan), AIG recognizes compensation on a straight-line basis over the scheduled vesting period. Unrecognized unvested compensation expense for stock option awards granted under APB 25 (i.e., before January 1, 2003) will be recognized from January 1, 2006 to the vesting date. However, for the SICO Plans and the AIG Deferred Compensation Profit Participant Plan, which contain both performance and service conditions, AIG recognizes compensation utilizing a graded vesting expense attribution method. The effect of this approach is to recognize compensation cost over the requisite service period for each separately vesting tranche of the award.

     AIG’s share-based plans generally provide for accelerated vesting at retirement or after the participant turns 65. For awards granted after January 1, 2006, compensation expense is recognized ratably from the date of grant through the shorter of age 65 or the vesting period. The effect of this change was not material to AIG’s consolidated financial position or results of operations. Awards granted prior to January 1, 2006 will continue to be recognized over the vesting period with accelerated expense recognition upon an actual retirement. SICO compensation expense for participants retiring after age 65 had been reflected in prior years’ results consistent with vested status under the SICO Plans.

     On June 1, 2005, FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (FAS 154). FAS 154 replaces APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” FAS 154 requires that a voluntary change in accounting principles be applied retrospectively with all prior period financial statements presented based on the new accounting principle, unless it is impracticable to do so. FAS 154 also provides that a correction of errors in previously issued financial statements should be termed a “restatement.” The new standard is effective for accounting changes and correction of errors beginning January 1, 2006.

     At the June 2005 meeting, the EITF reached a consensus with respect to Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights”. The Issue addresses what rights held by the limited partner(s) preclude consolidation in circumstances in which the sole general partner would consolidate the limited partnership in accordance with generally accepted accounting principles absent the existence of the rights held by the limited partner(s). Based on that consensus, the EITF also agreed to amend the consensus in Issue No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholders Have Certain Approval or Veto Rights.” The guidance in this Issue is effective after June 29, 2005 for general partners of all new limited partnerships formed and for existing limited partnerships for which the partnership agreements are modified. For general partners in all other limited partnerships, the guidance in this Issue is effective beginning January 1, 2006. The effect of the adoption of this EITF Issue was not material to AIG’s consolidated financial condition or results of operations.

     On June 29, 2005, FASB issued Statement 133 Implementation Issue No. B38, “Embedded Derivatives: Evaluation of Net Settlement with Respect to the Settlement of a Debt Instrument through Exercise of an Embedded Put Option or Call Option.” This implementation guidance relates to the potential settlement of the debtor’s obligation to the creditor that would occur upon exercise of the put option or call option, which meets the net settlement criterion in FAS 133. The effective date of the implementation guidance is January 1, 2006. The adoption of this guidance did not have a material effect on AIG’s consolidated financial condition or results of operations.

     On June 29, 2005, FASB issued Statement 133 Implementation Issue No. B39, “Application of Paragraph 13(b) to Call Options That Are Exercisable Only by the Debtor.” The conditions in FAS 133 paragraph 13(b) do not apply to an embedded call option in a hybrid instrument containing a debt host contract if the right to accelerate the settlement of the debt can be exercised only by the debtor (issuer/borrower). This guidance does not apply to other embedded derivative features that may be present in the same hybrid instrument. The effective date of the implementation guidance is January 1, 2006. The adoption of this guidance did not have a material effect on AIG’s consolidated financial condition or results of operations.

     On September 19, 2005, FASB issued Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts.” SOP 05-1 provides guidance on accounting for deferred acquisition costs on internal

16


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  8.  Recent Accounting Standards (continued)

replacements of insurance and investment contracts other than those specifically described in FASB Statement No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.” The SOP defines an internal replacement as a modification in product benefits, features, rights, or coverage that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The effective date of the implementation guidance is January 1, 2007. AIG is currently assessing the effect of implementing this guidance.

     On February 16, 2006, FASB issued FAS No. 155, “Accounting for Certain Hybrid Financial Instruments” (FAS 155), an amendment of FAS 140 and FAS 133. FAS 155 allows AIG to include changes in fair value in earnings on an instrument-by-instrument basis for any hybrid financial instrument that contains an embedded derivative that would otherwise be required to be bifurcated and accounted for separately under FAS 133. The election to measure the hybrid instrument at fair value is irrevocable at the acquisition or issuance date.

     AIG has elected to early adopt FAS 155 as of January 1, 2006, and apply FAS 155 fair value measurement to certain structured note liabilities and structured investments in AIG’s available for sale portfolio that existed at December 31, 2005. The effect of this adoption resulted in an $11 million after-tax ($18 million pre-tax) decrease to opening retained earnings as of January 1, 2006, representing the difference between the fair value of these hybrid financial instruments and the prior carrying value as of December 31, 2005. The effect of adoption on after-tax gross gains and losses was $218 million ($336 million pre-tax) and $229 million ($354 million pre-tax), respectively.

     Effective with AIG’s early adoption of FAS 155, structured note liabilities of $6.1 billion and hybrid financial instruments of $512 million at March 31, 2006 are now carried at fair value. The effect on earnings in the first three months of 2006 for changes in the fair value of hybrid financial instruments was a pre-tax gain of $30 million and is reflected in income.

     On March 27, 2006, FASB issued FSP FTB 85-4-1, “Accounting for Life Settlement Contracts by Third-Party Investors” (FSP 85-4-1), an amendment of FTB 85-4, “Accounting for Purchases of Life Insurance”. Life settlements are designed to assist life insurance policyholders in monetizing the existing value of life insurance policies. FSP 85-4-1 allows AIG to measure life settlement contracts using either the investment method or fair value method. The election is made on an instrument-by-instrument basis and is irrevocable. AIG elected to early adopt FSP 85-4-1 as of January 1, 2006 using the investment method for pre-existing investments held at December 31, 2005. The effect of this adoption resulted in a $319 million after tax ($487 million pre-tax) increase to opening retained earnings for its share of the life settlement contracts held in certain non-consolidated trusts.

     On April 13, 2006, FASB issued FSP FIN 46(R)-6, “Determining the Variability to be Considered in Applying FASB Interpretation No. 46(R)” (FIN 46(R)-6 or FSP). The FSP affects the identification of which entities are variable interest entities through a “by design” approach in identifying and measuring the variable interests of the variable interest entity and its primary beneficiary. Under FIN 46(R), “Consolidation of Variable Interest Entities”, the requirements are to be applied to all such variable interest entities after September 30, 2006. The new requirements need not be applied to entities that have previously been analyzed under FIN 46(R) unless a reconsideration event occurs. The adoption of this guidance is not expected to have a material effect on AIG’s consolidated financial condition or results of operations.

17


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  9.  Information Provided in Connection with Outstanding Debt

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

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

American General Corporation:

Condensed Consolidating Balance Sheet

                                           
American
International
March 31, 2006 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 112     $     $ 708,296     $ (13,844 )   $ 694,564  
 
Cash
    125             1,123             1,248  
 
Carrying value of subsidiaries and partially owned companies, at equity
    95,636       26,262       11,295       (132,026 )     1,167  
 
Other assets
    3,755       2,618       178,292       (1,846 )     182,819  

Total assets
  $ 99,628     $ 28,880     $ 899,006     $ (147,716 )   $ 879,798  

Liabilities:
                                       
 
Insurance liabilities
  $ 354     $     $ 472,310     $ (64 )   $ 472,600  
 
Debt
    4,587       2,086       125,655       (13,547 )     118,781  
 
Other liabilities
    6,297       3,915       191,799       (2,173 )     199,838  

Total liabilities
    11,238       6,001       789,764       (15,784 )     791,219  

Preferred shareholders’ equity in subsidiary companies
                189             189  
Total shareholders’ equity
    88,390       22,879       109,053       (131,932 )     88,390  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 99,628     $ 28,880     $ 899,006     $ (147,716 )   $ 879,798  

                                           
American
International
December 31, 2005 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,392     $     $ 691,349     $ (13,696 )   $ 679,045  
 
Cash
    190             1,707             1,897  
 
Carrying value of subsidiaries and partially owned companies, at equity
    90,723       27,027       15,577       (132,169 )     1,158  
 
Other assets
    2,768       2,577       166,933       (1,327 )     170,951  

Total assets
  $ 95,073     $ 29,604     $ 875,566     $ (147,192 )   $ 853,051  

Liabilities:
                                       
 
Insurance liabilities
  $ 408     $     $ 460,271     $ (56 )   $ 460,623  
 
Debt
    4,607       2,087       115,212       (12,057 )     109,849  
 
Other liabilities
    3,741       4,110       191,279       (3,054 )     196,076  

Total liabilities
    8,756       6,197       766,762       (15,167 )     766,548  

Preferred shareholders’ equity in subsidiary companies
                186             186  
Total shareholders’ equity
    86,317       23,407       108,618       (132,025 )     86,317  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 95,073     $ 29,604     $ 875,566     $ (147,192 )   $ 853,051  

18


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  9.  Information Provided in Connection with Outstanding Debt (continued)

Condensed Consolidating Statement of Income

                                         
American
International
Three Months Ended March 31, 2006 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income (loss)
  $ (286 )   $ (38 )   $ 5,117     $     $ 4,793  
Equity in undistributed net income of consolidated subsidiaries
    3,260       359             (3,619 )      
Dividend income from consolidated subsidiaries
    187       304             (491 )      
Income taxes (benefits)
    *       (13 )     1,448             1,435  
Minority interest
                (197 )           (197 )
Cumulative effect of an accounting change, net of tax
    34                         34  

Net income (loss)
  $ 3,195     $ 638     $ 3,472     $ (4,110 )   $ 3,195  

Amounts significantly less than $1 million.
                                         
American
International
Three Months Ended March 31, 2005 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income (loss)
  $ (10 )   $ (36 )   $ 5,695     $     $ 5,649  
Equity in undistributed net income of consolidated subsidiaries
    3,646       701             (4,347 )      
Dividend income from consolidated subsidiaries
    271                   (271 )      
Income taxes (benefits)
    108       (12 )     1,610             1,706  
Minority interest
                (144 )           (144 )

Net income (loss)
  $ 3,799     $ 677     $ 3,941     $ (4,618 )   $ 3,799  

Condensed Consolidating Statements of Cash Flow

                                   
American
International
Three Months Ended March 31, 2006 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries AIG

Net cash provided by operating activities
  $ (1,139 )   $ 45     $ 4,160     $ 3,066  

Cash flows from investing:
                               
 
Invested assets disposed
    1,269             38,122       39,391  
 
Invested assets acquired
                (59,006 )     (59,006 )
 
Other
    (2,283 )           1,961       (322 )

Net cash used in investing activities
    (1,014 )           (18,923 )     (19,937 )

Cash flows from financing activities:
                               
 
Change in debts
    2,262       (1 )     6,668       8,929  
 
Other
    (174 )     (44 )     6,961       6,743  

Net cash (used in) provided by financing activities
    2,088       (45 )     13,629       15,672  

Effect of exchange rate changes on cash
                550       550  

Change in cash
    (65 )           (584 )     (649 )
Cash at beginning of period
    190             1,707       1,897  

Cash at end of period
  $ 125     $     $ 1,123     $ 1,248  

19


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  9.  Information Provided in Connection with Outstanding Debt (continued)
                                   
American
International
Three Months Ended March 31, 2005 Group, Inc. AGC Other Consolidated
(in millions) (unaudited) Guarantor Issuer Subsidiaries AIG

Net cash (used in) provided by operating activities
  $ 373     $ 155     $ (962 )   $ (434 )

Cash flows from investing:
                               
 
Invested assets disposed
    265             48,207       48,472  
 
Invested assets acquired
                (68,402 )     (68,402 )
 
Other
    (72 )     (120 )     4       (188 )

Net cash (used in) provided by investing activities
    193       (120 )     (20,191 )     (20,118 )

Cash flows from financing activities:
                               
 
Change in debts
    (34 )     1       9,231       9,198  
 
Other
    (429 )     (36 )     12,228       11,763  

Net cash provided by (used in) financing activities
    (463 )     (35 )     21,459       20,961  

Effect of exchange rate changes on cash
    30             (87 )     (57 )

Change in cash
    133             219       352  
Cash at beginning of period
    17             1,992       2,009  

Cash at end of period
  $ 150     $     $ 2,211     $ 2,361  

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

AIG Liquidity Corp.:

Condensed Consolidating Balance Sheet

                                           
American
International AIG
March 31, 2006 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 112     $ *     $ 708,296     $ (13,844 )   $ 694,564  
 
Cash
    125       *       1,123             1,248  
 
Carrying value of subsidiaries and partially owned companies, at equity
    95,636             37,557       (132,026 )     1,167  
 
Other assets
    3,755       *       180,910       (1,846 )     182,819  

Total assets
  $ 99,628     $ *     $ 927,886     $ (147,716 )   $ 879,798  

Liabilities:
                                       
 
Insurance liabilities
  $ 354     $     $ 472,310     $ (64 )   $ 472,600  
 
Debt
    4,587       *       127,741       (13,547 )     118,781  
 
Other liabilities
    6,297       *       195,714       (2,173 )     199,838  

Total liabilities
    11,238       *       795,765       (15,784 )     791,219  

Preferred shareholders’ equity in subsidiary companies
                189             189  
Total shareholders’ equity
    88,390       *       131,932       (131,932 )     88,390  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 99,628     $ *     $ 927,886     $ (147,716 )   $ 879,798  

Amounts significantly less than $1 million.

20


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  9.  Information Provided in Connection with Outstanding Debt (continued)
                                           
American
International AIG
December 31, 2005 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,392     $ *     $ 691,349     $ (13,696 )   $ 679,045  
 
Cash
    190       *       1,707             1,897  
 
Carrying value of subsidiaries and partially owned companies, at equity
    90,723             42,604       (132,169 )     1,158  
 
Other assets
    2,768       *       169,510       (1,327 )     170,951  

Total assets
  $ 95,073     $ *     $ 905,170     $ (147,192 )   $ 853,051  

Liabilities:
                                       
 
Insurance liabilities
  $ 408     $     $ 460,271     $ (56 )   $ 460,623  
 
Debt
    4,607       *       117,299       (12,057 )     109,849  
 
Other liabilities
    3,741       *       195,389       (3,054 )     196,076  

Total liabilities
    8,756       *       772,959       (15,167 )     766,548  

Preferred shareholders’ equity in subsidiary companies
                186             186  
Total shareholders’ equity
    86,317       *       132,025       (132,025 )     86,317  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 95,073     $ *     $ 905,170     $ (147,192 )   $ 853,051  

* Amounts significantly less than $1 million.

Condensed Consolidating Statement of Income

                                         
American
International AIG
Three Months Ended March 31, 2006 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries Eliminations AIG

Operating income (loss)
  $ (286 )   $ *     $ 5,079     $     $ 4,793  
Equity in undistributed net income of consolidated subsidiaries
    3,260             359       (3,619 )      
Dividend income from consolidated subsidiaries
    187             304       (491 )      
Income taxes
    *       *       1,435             1,435  
Minority interest
                (197 )           (197 )
Cumulative effect of an accounting change, net of tax
    34                         34  

Net income (loss)
  $ 3,195     $ *     $ 4,110     $ (4,110 )   $ 3,195  

* Amounts significantly less than $1 million.
                                         
American
International AIG
Three Months Ended March 31, 2005 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries Eliminations AIG

Operating income (loss)
  $ (10 )   $ *     $ 5,659     $     $ 5,649  
Equity in undistributed net income of consolidated subsidiaries
    3,646             701       (4,347 )      
Dividend income from consolidated subsidiaries
    271                   (271 )      
Income taxes
    108       *       1,598             1,706  
Minority interest
                (144 )           (144 )

Net income (loss)
  $ 3,799     $ *     $ 4,618     $ (4,618 )   $ 3,799  

* Amounts significantly less than $1 million.

21


 

American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
  9.  Information Provided in Connection with Outstanding Debt (continued)

Condensed Consolidating Statements of Cash Flow

                                   
American
International AIG
Three Months Ended March 31, 2006 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries AIG

Net cash provided by operating activities
  $ (1,139 )   $ *     $ 4,205     $ 3,066  

Cash flows from investing:
                               
 
Invested assets disposed
    1,269             38,122       39,391  
 
Invested assets acquired
                (59,006 )     (59,006 )
 
Other
    (2,283 )     *       1,961       (322 )

Net cash used in investing activities
    (1,014 )     *       (18,923 )     (19,937 )

Cash flows from financing activities:
                               
 
Change in debts
    2,262             6,667       8,929  
 
Other
    (174 )     *       6,917       6,743  

Net cash (used in) provided by financing activities
    2,088       *       13,584       15,672  

Effect of exchange rate changes on cash
                550       550  

Change in cash
    (65 )     *       (584 )     (649 )
Cash at beginning of period
    190             1,707       1,897  

Cash at end of period
  $ 125     $ *     $ 1,123     $ 1,248  

* Amounts significantly less than $1 million.
                                   
American
International AIG
Three Months Ended March 31, 2005 Group, Inc. Liquidity Other Consolidated
(in millions) (unaudited) Guarantor Corp. Subsidiaries AIG

Net cash (used in) provided by operating activities
  $ 373     $ *     $ (807 )   $ (434 )

Cash flows from investing:
                               
 
Invested assets disposed
    265             48,207       48,472  
 
Invested assets acquired
                (68,402 )     (68,402 )
 
Other
    (72 )     *       (116 )     (188 )

Net cash (used in) provided by investing activities
    193       *       (20,311 )     (20,118 )

Cash flows from financing activities:
                               
 
Change in debts
    (34 )           9,232       9,198  
 
Other
    (429 )     *       12,192       11,763  

Net cash (used in) provided by financing activities
    (463 )     *       21,424       20,961  

Effect of exchange rate changes on cash
    30             (87 )     (57 )

Change in cash
    133       *       219       352  
Cash at beginning of period
    17             1,992       2,009  

Cash at end of period
  $ 150     $ *     $ 2,211     $ 2,361  

* Amounts significantly less than $1 million.
 
  10.  Stock Compensation Plans

At March 31, 2006, AIG employees could receive compensation pursuant to six different stock-based compensation plan arrangements: (i) AIG 1999 Stock Option Plan, as amended (1999 Plan); (ii) AIG 1996 Employee Stock Purchase Plan, as amended (the 1996 Plan); (iii) AIG 2002 Stock Incentive Plan, as amended (2002 Plan) under which AIG has to date issued only restricted stock units (RSUs); (iv) SICO’s Deferred Compensation Profit Participation Plans (SICO Plans); (v) AIG’s 2005-2006 Deferred Compensation Profit Participation Plan (AIG DCPPP) and (vi) the AIG Partners Plan. The AIG DCPPP was adopted as a replacement for the SICO Plans for the 2005-2006 period, and the AIG Partners Plan will replace the AIG DCPPP for future years, although no awards have been made under this plan as of March 31, 2006. Stock-based compensation earned under the AIG DCPPP and the AIG Partners Plan will be issued as awards under the 2002 Plan. AIG currently settles share option exercises and other share awards to participants through the issuance of shares it has previously acquired and holds in its treasury account, except for share awards made by SICO, which are settled by SICO.

     At March 31, 2006, AIG’s non-employee directors received stock-based compensation in two forms, options granted pursuant to the 1999 Plan and grants of AIG common stock with delivery deferred until retirement from the Board, pursuant to the AIG Director Stock Plan, which was approved by the shareholders at the 2004 Annual Meeting of Shareholders.

22


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)

     Effective January 1, 2003, AIG adopted FAS 123 utilizing the prospective method to account for awards granted after January 1, 2003. Prior to adoption of FAS 123, AIG followed the provisions of Accounting Principles Board Opinion No. 25. See Note 8 herein. Under the recognition provisions of FAS 123, costs with respect to stock compensation were measured using the fair value of the shares subscribed or granted at the date of grant recognized ratably over the vesting period. Such fair value was derived through an option pricing model or the fair value of AIG’s common stock, as applicable.

     Effective January 1, 2006, AIG adopted FAS 123R utilizing the modified prospective application method which provides that previously issued financial statements need not be restated. Awards granted or modified after January 1, 2006 and outstanding awards not yet vested as of January 1, 2006 will be accounted for under FAS 123R.

     FAS 123R requires AIG to estimate forfeitures in calculating the expense relating to stock-based compensation, rather than recognizing these forfeitures and corresponding reductions in expense as they occur. The pre-tax cumulative effect of adoption, recognized as a reduction in stock-based compensation expense of $46 million ($34 million after-tax), was recorded as the cumulative effect of an accounting change, net of tax in the consolidated statement of income during the first three months of 2006.

The effect of the adoption of FAS 123R on the consolidated statements of income and cash flows was as follows:

                         
Including Effect of
Three Months Ended March 31, 2006 Pre-adoption of Effect of Adoption of Adoption of
(in millions, except per share data) FAS 123R FAS 123R FAS 123R

Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 4,801     $ (8 )   $ 4,793  

Provision for income taxes
  $ 1,438     $ (3 )   $ 1,435  

Income before minority interest and cumulative effect of an accounting change
  $ 3,363     $ (5 )     3,358  

Cumulative effect of an accounting change, net of tax
  $     $ 34     $ 34  

Net income
  $ 3,166     $ 29     $ 3,195  

Net cash provided by operating activities
  $ 3,068     $ (2 )   $ 3,066  

Net cash provided by financing activities
  $ 15,670     $ 2     $ 15,672  

Basic earnings per share
  $ 1.22     $     $ 1.22  

Diluted earnings per share
  $ 1.22     $     $ 1.22  

     The following table presents share-based compensation expenses, including the cumulative effect of adoption of FAS 123R, included in AIG’s consolidated statement of income:

         
Three Months Ended March 31, 2006
(in millions)

Share-based compensation expense before tax
  $ 154  
Income tax benefit
  $ 12  
After-tax compensation expense
  $ 142  

     Included in share-based compensation expense of $154 million was approximately $54 million related to the Starr tender offer and various adjustments totalling $61 million, primarily relating to stock-split adjustments and other miscellaneous items for the SICO plans, offset by a $46 million pre-tax adjustment for the cumulative effect of the adoption of FAS 123R. See Note 4 herein for a discussion of the Starr tender offer and Note 8 herein for discussion of prospective change to the accounting for retiree eligibility provisions and forfeiture treatment.

23


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)

     If AIG had adopted the FAS 123 provisions for recognizing compensation expense commencing at the date of grant of the awards, the effect would not have been material to net income or basic or diluted earnings per share for the three months ended March 31, 2005.

1999 Stock Option Plan

The 1999 Plan provides that options to purchase a maximum of 45,000,000 shares of common stock can be granted to certain key employees and members of the Board of Directors at prices not less than fair market value at the date of grant.

     The 1999 Plan was approved by the shareholders at the 2000 Annual Meeting of Shareholders, with certain amendments approved at the 2003 Annual Meeting of Shareholders. The 1999 Plan superseded the 1991 employee stock option plan (the 1991 Plan), although outstanding options granted under the 1991 Plan continue in force until exercise or expiration. The maximum number of shares that may be granted to any employee in any one year under the 1999 Plan is 900,000. Options granted under the 1999 Plan generally vest over four years (25 percent vesting per year) and expire 10 years from the date of grant.

24


 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)

     At March 31, 2006, there were 20,431,101 shares reserved for future grants under the 1999 Plan and 28,935,898 shares reserved for issuance under the 1999 and 1991 Plans.

     In 2004, AIG developed a binomial lattice model to calculate the fair value of stock option grants. In prior years, a Black-Scholes model was used. A more detailed description of the valuation methodology is provided below.

The following weighted average assumptions were used for stock options granted in the first three months of 2006:

         

Expected annual dividend yield(1)
    0.71%  
Expected volatility(2)
    27.3%  
Risk-free interest rate(3)
    4.17%  
Expected term(4)
    7  years  

(1)  The dividend yield is based on the dividend yield over the twelve month period prior to the grant date.
(2)  Expected volatility is the average of historical volatility (based on seven years of daily stock price changes) and the implied volatility of actively traded options on AIG shares.
(3)  The interest rate curves used in the valuation model were the US Treasury STRIP rates with terms from 3 months to 10 years.
(4)  The contractual term of the option is generally 10 years with an expected term of 7 years calculated based on an analysis of historical employee exercise behavior and employee turnover (post-vesting terminations). The early exercise rate is a function of time elapsed since the grant. Fifteen years of historical data was used to estimate the early exercise rate.

Additional information with respect to AIG’s stock option plans at March 31, 2006, and changes for the three months then ended, were as follows:

                 
Weighted Average
Options: Shares Exercise Price

Outstanding at beginning of year
    52,545,425     $ 54.84  
Granted
    41,000     $ 68.65  
Exercised
    (538,784 )   $ 40.80  
Forfeited or expired
    (374,181 )   $ 69.57  
Outstanding at end of period
    51,673,460     $ 54.89  
Options exercisable at end of period
    40,389,118     $ 52.59  
Weighted average fair value per share of options granted
          $ 22.38  

25


 

American International Group, Inc. and Subsidiaries
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                             
  10.  Stock Compensation Plans (continued)

Information about stock options outstanding at March 31, 2006, is summarized as follows:

                                                                     
Options Outstanding Options Exercisable


Weighted Weighted
Average Weighted Average Weighted
Remaining Average Aggregate Intrinsic Number Remaining Average Aggregate
Range of Number Contractual Exercise Values Exercisable Contractual Exercise Intrinsic Values
Exercise Prices Outstanding Life Price (in millions) (vested) Life Price (in millions)

  $11.28-$27.14       6,755,947       1.06     $ 21.32     $ 302       6,755,947       1.06     $ 21.32     $ 302  
  $30.44-$41.51       5,402,644       2.29     $ 36.87       158       5,402,644       2.29     $ 36.87       158  
  $43.31-$53.40       7,056,736       4.61     $ 48.56       124       6,234,130       4.31     $ 48.77       108  
  $54.11-$59.99       8,440,050       4.86     $ 57.84       70       6,324,940       3.32     $ 57.34       55  
  $60.13-$63.95       9,241,271       6.67     $ 62.33       35       6,099,845       6.27     $ 61.92       26  
  $64.01-$69.63       8,302,783       7.56     $ 65.45       6       3,837,847       5.61     $ 65.66       2  
  $70.35-$98.00       6,474,029       5.16     $ 83.88             5,733,765       5.07     $ 84.48        

  Total       51,673,460       4.86     $ 54.89     $ 695       40,389,118       3.87     $ 52.59     $ 651  

     Vested or expected-to-vest options as of March 31, 2006 were 46,168,298 shares, of which 40,389,118 were vested, with a weighted average exercise price of $53.70, a weighted average contractual life of 4.32 years and an aggregate intrinsic value of $678 million, of which $651 million is attributable to the vested options.

     As of March 31, 2006, total unrecognized compensation cost (net of expected forfeitures) totalled $204 million and $4 million related to nonvested share-based compensation awards granted under the 1999 Plan and the 1996 Plan, respectively, with a blended weighted-average period of 1.40 years and 0.5 years, respectively. The costs of awards outstanding under these plans at March 31, 2006 is expected to be recognized over approximately three years and one year for the 1999 Plan and the 1996 Plan, respectively.

     The intrinsic value of options exercised during the three months ending March 31, 2006 was approximately $15 million. The fair value of options vesting during the period was approximately $26 million. AIG received $27 million and $19 million in cash from the exercise of stock options during the three months ended March 31, 2006 and 2005, respectively. AIG did not cash-settle any share-based payment awards during the three months ended March 31, 2006 and 2005. The tax benefits realized as a result of stock option exercises were $4 million and $6 million for the first three months of 2006 and 2005, respectively.

2002 Stock Incentive Plan

AIG’s 2002 Plan was adopted at the 2002 shareholders meeting and amended and restated by the AIG Board of Directors on September 18, 2002 (the 2002 Plan). The 2002 Plan provides that equity-based or equity-related awards with respect to shares of common stock can be issued to employees in any year up to a maximum of that number of shares equal to (a) 1,000,000 shares plus (b) the number of shares available but not issued in the prior calendar year. The maximum award that a grantee may receive under the 2002 Plan per year is rights with respect to 250,000 shares. For the three months ended March 31, 2006 and 2005, respectively, 66,715 and 13,940 RSUs were granted by AIG. There were 14,665,260 shares reserved for issuance in connection with future awards as of March 31, 2006. Substantially all RSUs granted to date under the 2002 Plan vest on the fourth anniversary of the date of grant.

Director Stock Awards

The methodology used for valuing employee stock options is also used to value director stock options. Director stock options vest one year after the grant date, but are otherwise the same as employee stock options. Options with respect to 5,000 shares and no shares were granted during the first three months of 2006 and 2005, respectively.

     AIG also granted 3,750 shares and 1,250 shares, with delivery deferred, to directors during the first three months of 2006 and 2005, respectively, under the Director Stock Plan. At March 31, 2006, there were 81,250 shares reserved for future grants under the Director Stock Plan.

Employee Stock Purchase Plan

AIG’s 1996 Plan provides that eligible employees (those employed at least one year) may receive privileges to purchase

26


 

American International Group, Inc. and Subsidiaries
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                             
  10.  Stock Compensation Plans (continued)

up to an aggregate of 10,000,000 shares of AIG common stock, at a price equal to 85 percent of the fair market value on the date of the grant of the purchase privilege. Purchase privileges are granted quarterly and are limited to the number of whole shares that can be purchased on an annual basis by an amount equal to the lesser of 10 percent of an employee’s annual salary or $10,000.

SICO Plans

The SICO Plans provide that shares of AIG common stock currently held by SICO are set aside for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s termination of employment with AIG prior to normal retirement age.

     Historically, SICO’s Board of Directors could elect to pay a participant cash in lieu of shares of AIG common stock. On December 9, 2005, SICO notified participants that essentially all subsequent distributions would be made only in shares, and not cash. As of that date, AIG modified its accounting for the SICO Plans from variable to fixed measurement accounting. Variable measurement accounting will still be used for those few awards for which cash elections had been made prior to March 2005. The SICO Plans are also described in Note 4 herein.

     Although none of the costs of the various benefits provided under the SICO Plans has been paid by AIG, AIG has recorded a charge to reported earnings for the deferred compensation amounts paid to AIG employees by SICO, with an offsetting amount credited to additional paid-in capital reflecting amounts deemed contributed by SICO.

     As of December 9, 2005, there were 12,650,292 non-vested AIG shares under the SICO Plans with a weighted-average fair value per share of $61.92. As of March 31, 2006, there were 12,307,967 non-vested AIG shares under the SICO Plans with a weighted-average fair value per share of $61.92.

     A significant portion of the awards under the SICO Plans vest upon retirement if the participant reaches age 65. The portion of the awards for which early payout is available vest on the applicable payout date.

AIG DCPPP

Effective September 21, 2005, AIG adopted the AIG DCPPP, which provides equity-based compensation to key AIG employees, including senior executive officers. The AIG DCPPP was modeled on the SICO Plans.

     The AIG DCPPP will contingently allocate a fixed number of shares to each participant if AIG’s cumulative adjusted earnings per share for 2005 and 2006 exceed that for 2003 and 2004. The performance period is September 21, 2005 to December 31, 2006. At the end of the performance period, common shares are contingently allocated. The service period and related vesting consists of three pre-retirement tranches and a final retirement tranche at age 65.

     At March 31, 2006, there were units representing 4,898,880 shares granted to participants.

AIG Partners Plan

The AIG Partners Plan was approved on March 16, 2006 by AIG’s Compensation Committee. No awards have been made under the Plan as of March 31, 2006.

VALUATION

     The fair value of each award granted under the 2002 Plan, the SICO Plans, the AIG DCPPP, and the AIG Partners Plan is based on the closing price of AIG stock on the date of grant.

A summary of shares relating to outstanding awards not yet vested under the foregoing plans as of March 31, 2006, and changes during the three months ended March 31, 2006 is presented below:

                                             
Number of Shares Weighted Average Grant-Date Fair Value


SICO AIG SICO AIG
2002 Plan Plan DCPPP 2002 Plan Plan DCPPP

Not yet vested at January 1, 2006
    4,322,265       12,650,292       4,898,880       $63.63     $ 61.92     $52.55
Granted
    66,715                   $69.13          
Vested
    (3,620 )     (132,511 )           $65.13     $ 61.92    
Forfeited
    (56,340 )     (209,814 )     (165,450 )     $60.66     $ 61.92     $59.40

Not yet vested at March 31, 2006
    4,329,020       12,307,967       4,733,430       $63.75     $ 61.92     $52.31

27


 

American International Group, Inc. and Subsidiaries
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
                                             
  10.  Stock Compensation Plans (continued)

     At March 31, 2006, the total unrecognized compensation cost (net of expected forfeitures) related to nonvested share-based compensation awards granted under the 2002 Plan, the SICO Plans, and the AIG DCPPP and the blended weighted-average period over which that cost is expected to be recognized is as follows:

                 
Unrecognized Blended
Compensation Weighted-
Cost Average
(in millions) Period

2002 Plan
  $ 196       1.83 years  
SICO Plans
  $ 357       6.08 years  
AIG DCPPP
  $ 248       11.62  years  

     The total cost for awards outstanding as of March 31, 2006 under the 2002 Plan, the SICO Plans and the AIG DCPPP is expected to be recognized over approximately four years, 12 years and 23 years, respectively.

     The AIG Board of Directors has construed the AIG stock option plans to allow, at the request of an optionee, the deferral of delivery of AIG shares otherwise deliverable upon the exercise of an option to a date or dates specified by the optionee. During 2005, options with respect to 1,731,471 shares were exercised with delivery deferred. At December 31, 2005, optionees had made valid elections to defer delivery of 2,067,643 shares of AIG common stock upon exercise of options expiring during 2006. In addition, nonemployee directors of AIG had made valid elections to defer delivery of 21,093 shares of AIG common stock upon exercise of options expiring during 2006.

28


 

American International Group, Inc. and Subsidiaries
                                             

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

INDEX

             
Page

CAUTIONARY STATEMENT REGARDING PROJECTIONS AND OTHER INFORMATION ABOUT FUTURE EVENTS
    29  
OVERVIEW OF OPERATIONS AND BUSINESS RESULTS
    30  
 
Consolidated Results
    30  
CRITICAL ACCOUNTING ESTIMATES
    33  
OPERATING REVIEW
    34  
 
General Insurance Operations
    34  
   
General Insurance Results
    36  
   
Reinsurance
    37  
   
Reserve for Losses and Loss Expenses
    39  
   
Discounting of Reserves
    40  
   
Quarterly Reserving Process
    40  
   
Loss Reserving Process
    41  
   
Asbestos and Environmental Reserves
    41  
 
Life Insurance & Retirement Services Operations
    43  
   
Life Insurance & Retirement Services Results
    44  
   
Underwriting and Investment Risk
    48  
 
Invested Assets
    51  
 
Insurance and Asset Management Invested Assets
    52  
   
Credit Quality
    54  
   
Valuation of Invested Assets
    54  
 
Financial Services Operations
    57  
   
Aircraft Finance
    57  
   
Capital Markets
    57  
   
Consumer Finance
    58  
   
Financial Services Results
    59  
   
Financial Services Invested Assets
    61  
 
Asset Management Operations
    62  
   
Asset Management Results
    63  
 
Other Operations
    63  
CAPITAL RESOURCES     64  
   
Borrowings
    64  
   
Contractual Obligations and Other Commercial Commitments
    67  
   
Shareholders’ Equity
    68  
   
Stock Purchase
    69  
   
Dividends from Insurance Subsidiaries
    69  
   
Regulation and Supervision
    69  
LIQUIDITY     70  
SPECIAL PURPOSE VEHICLES AND OFF BALANCE SHEET ARRANGEMENTS
    71  
DERIVATIVES     72  
MANAGING MARKET RISK     72  
 
Insurance
    72  
 
Financial Services
    73  
RECENT ACCOUNTING STANDARDS     74  
CONTROLS AND PROCEDURES     77  

Cautionary Statement Regarding Projections and Other Information About Future Events

This Quarterly Report and other publicly available documents may include, and AIG’s officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are not historical facts but instead represent only AIG’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside AIG’s control. These projections and statements may address, among other things, the status and potential future outcome of the current regulatory and civil proceedings against AIG and their potential effect on AIG’s businesses, financial position, results of operations, cash flows and liquidity, the effect of the credit rating downgrades on AIG’s businesses and competitive position, the unwinding and resolving of various relationships between AIG and Starr and SICO, and AIG’s strategy for growth, product development, market position, financial results and reserves. It is possible that AIG’s actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these projections and statements. Factors that could cause AIG’s actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in “Risk Factors” in Item 1A. of Part I of AIG’s 2005 Annual Report on Form 10-K and Item 1A. of Part II of this Quarterly Report. AIG is not under any obligation (and expressly disclaims any such obligations) to update or alter any projections or other statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.

29


 

American International Group, Inc. and Subsidiaries
                                             

Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, AIG presents its operations in the way it believes will be most meaningful. Statutory loss ratios and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance filed with insurance regulatory authorities and used for analysis in the insurance industry and thus allow more meaningful comparisons with AIG’s insurance competitors. AIG has also incorporated into this discussion a number of cross-references to additional information included throughout this Form 10-Q and its 2005 Annual Report on Form 10-K to assist readers seeking related information on a particular subject.

Overview of Operations and Business Results

AIG identifies its reportable segments by product line, consistent with its management structure. AIG’s major product and service groupings are General Insurance, Life Insurance & Retirement Services, Financial Services and Asset Management. AIG’s operations in 2006 are conducted by its subsidiaries principally through these segments. Through these segments, AIG provides insurance and investment products and services to both businesses and individuals in more than 130 countries and jurisdictions. This geographic, product and service diversification is one of AIG’s major strengths and sets it apart from its competitors.

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

     AIG’s operating performance reflects implementation of various long-term strategies and defined goals in its various operating segments. A primary goal of AIG in managing its General Insurance operations is to achieve an underwriting profit. To achieve this goal, AIG must be disciplined in its risk selection and premiums must be adequate and terms and conditions appropriate to cover the risk accepted. AIG also believes in strict control of expenses.

     A central focus of AIG operations in recent years is the development and expansion of new distribution channels. In 2005 and the first three months of 2006, AIG expanded its distribution channels, which now include banks, credit card companies and television-media home shopping in many Asian countries. Examples of new distribution channels used both domestically and overseas include banks, affinity groups, direct response and e-commerce.

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

     Growth for AIG may be generated both internally and through acquisitions which both fulfill strategic goals and offer adequate return on capital. Recently AIG announced its acquisition of Travel Guard International, one of the nation’s leading providers of travel insurance programs and emergency travel assistance, and its plans to acquire Central Insurance Co., Ltd., a leading general insurance company in Taiwan.

The following table summarizes AIG’s revenues, income before income taxes, minority interest and cumulative effect of an accounting change and net income for the three months ended March 31, 2006 and 2005:

                 
(in millions) 2006 2005

Total revenues
  $ 27,259     $ 27,202  

Income before income taxes, minority interest and cumulative effect of an accounting change
    4,793       5,649  

Net income
  $ 3,195     $ 3,799  

Consolidated Results

The small increase in revenues in the first three months of 2006 was primarily attributable to the growth in net premiums earned from global General Insurance operations as well as growth in both General Insurance and Life Insurance & Retirement Services net investment income and Life Insurance & Retirement Services GAAP premiums, offset, in part, by decreases in revenue in the Financial Services and Asset Management segments.

     AIG’s income before income taxes, minority interest and cumulative effect of an accounting change decreased 15 percent in the first three months of 2006 when compared to the same period of 2005. Increases in General Insurance and Life Insurance & Retirement Services operating income were offset by an operating loss in Financial Services driven by the effects of hedging activities that do not qualify for hedge accounting treatment under FAS 133 and a decrease in Asset

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Management operating income. Results for the first three months of 2006 were negatively affected by the compensation expense relating to the Starr tender offer ($54 million before tax and after tax) and an additional allowance for losses in AIG Credit Card Company (Taiwan) ($88 million before tax and $57 million after tax). Results were also negatively affected by certain adjustments, primarily relating to deferred advertising costs in General Insurance under SOP 93-7 ($59 million before tax and $38 million after tax) and various adjustments relating to the SICO Plans ($61 million before tax and after tax).

The following table summarizes the operations of each principal segment for the three months ended March 31, 2006 and 2005. (See also Note 2 of Notes to Consolidated Financial Statements).

                   
(in millions) 2006 2005

Revenues(a):
               
 
General Insurance(b)
  $ 11,656     $ 11,219  
 
Life Insurance & Retirement Services(c)
    12,639       11,775  
 
Financial Services(d)
    1,615       2,436  
 
Asset Management(e)
    1,239       1,377  
 
Other
    110       395  

Consolidated
  $ 27,259     $ 27,202  

Operating Income (loss)(a)(f):
               
 
General Insurance
  $ 2,331     $ 1,642  
 
Life Insurance & Retirement Services(g)
    2,555       2,181  
 
Financial Services(g)
    (159 )     1,045  
 
Asset Management
    461       590  
 
Other(h)
    (395 )     191  

Consolidated
  $ 4,793     $ 5,649  

(a) Includes the effect of hedging activities that do not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the first three months of 2006 and 2005, the effect was $0 and $15 million, respectively, in operating income for Aircraft Finance and $(678) million and $468 million in revenues and operating income, respectively, for Capital Markets. These amounts result primarily from interest rate and foreign currency derivatives hedging available for sale securities and borrowings.
(b) Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(c) Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).
(d) Represents interest, lease and finance charges.
(e) Represents management and advisory fees and net investment income with respect to GICs.
(f) Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(g) Results of operations of AIG Credit Card Company (Taiwan) are shared equally by the Life Insurance & Retirement Services segment and the Financial Services segment. In 2006, additional allowances of $44 million were recorded by each segment for losses in these credit card operations.
(h) Represents unallocated corporate expenses, relating primarily to interest expense and certain compensation related expenses, and other realized capital gains (losses) of $(57) million and $155 million in the first three months of 2006 and 2005, respectively.

General Insurance

AIG’s General Insurance operations provide property and casualty products and services throughout the world. The increase in General Insurance operating income in the first three months of 2006 compared to the same period of 2005 was primarily attributable to improvement in underwriting results with respect to the Domestic Brokerage Group (DBG). General Insurance operating income included adverse development in the first three months of 2006 and 2005 from catastrophes in prior years.

Life Insurance & Retirement Services

AIG’s Life Insurance & Retirement Services operations provide insurance, financial and investment products throughout the world. Foreign operations provided approximately 65 percent and 55 percent of AIG’s Life Insurance & Retirement Services operating income for the first three months of 2006 and 2005, respectively.

     Life Insurance & Retirement Services operating income increased by 17 percent in the first three months of 2006 when compared to the same period of 2005 driven by a 39 percent increase in Foreign Life Insurance & Retirement Services operating income, offset, in part, by an approximately 10 percent decrease in the Domestic Life Insurance & Retirement Services operating income, primarily due to lower partnership income. Realized capital gains included in revenues and operating income were $158 million in the first three months of 2006 compared to realized capital losses of $82 million in the same period of 2005. The increase in realized capital gains in the first three months of 2006 compared to the same period of 2005 was due to the effect of hedging activities that do not qualify for hedge accounting under FAS 133 and the foreign exchange gains and losses related to the application of FAS 52, offset by other-than-temporary declines in the value of investments.

Financial Services

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

     Financial Services operating income decreased in the first three months of 2006 compared to the same period of 2005, primarily due to the fluctuation in earnings resulting from the accounting effect of FAS 133. Fluctuations in revenues and operating income from quarter to quarter are not unusual because of the transaction-oriented nature of Capital Markets operations and the effect of not qualifying for hedge accounting treatment under FAS 133 for hedges on securities available for sale and borrowings. Consumer Finance revenues increased but operating income decreased, primarily as a result of increasing the allowance for losses in connection with the industry-wide credit deterioration in the Taiwan credit card market.

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Asset Management

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

     Asset Management operating income decreased 22 percent in the first three months of 2006 when compared to the same period of 2005 as a result of continued run off in AIG’s GIC portfolio combined with spread compression. In addition, there was a decline in realized gains on sales of real estate investments and performance fees earned on various private equity investments.

Capital Resources

At March 31, 2006, AIG had total consolidated shareholders’ equity of $88.39 billion and total consolidated borrowings of $118.8 billion. At that date, $104.1 billion of such borrowings were either not guaranteed by AIG or were AIGFP’s matched borrowings under obligations of guaranteed investment agreements (GIAs), liabilities connected to trust preferred stock, or matched notes and bonds payable.

     During the period from January 1, 2006 through March 31, 2006, AIG did not purchase any shares of its common stock under its existing common stock repurchase authorization.

Liquidity

At March 31, 2006, AIG’s consolidated invested assets included $18.59 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first three months of 2006 amounted to $3.07 billion. AIG believes that its liquid assets, cash provided by operations and access to short term funding through commercial paper and bank credit facilities will enable it to meet any anticipated cash requirements.

Outlook

Despite industry price erosion in some classes of general insurance, AIG expects to continue to identify profitable opportunities and build attractive new General Insurance businesses as a result of AIG’s broad product line and extensive distribution networks. In December 2005, American International Underwriters Overseas, Ltd. (AIUO) received a license from the government of Vietnam to operate a wholly owned general insurance company in Vietnam. This license, the first general insurance license granted by Vietnam to a U.S.-based insurance organization, permits AIG to operate a general insurance company throughout Vietnam.

     In China, AIG has wholly-owned life insurance operations in eight cities. These operations should benefit from China’s rapid rate of economic growth and growing middle class, a segment that is a prime market for life insurance. Chinese insurance regulators have indicated satisfaction with the implementation of corrective measures to stop AIG’s Hong Kong based agents from selling life insurance to mainland Chinese. In April 2006, applications for provincial expansion of AIG’s life insurance operations in Guangdong and Jiangsu and of general insurance operations in Guangdong were approved, and AIG resubmitted its application to serve the group insurance market, a business where AIG expects future growth.

     In Japan, AIG Star Life Insurance Co., Ltd. (AIG Star Life) and AIG Edison Life Insurance Company (AIG Edison Life) continue to grow new business by expanding distribution and new product offerings. AIG has developed a leadership position in the distribution of annuities through banks in both Japan and Korea. Also, American Life Insurance Company (ALICO) has launched new life products to the Japan bank market after further deregulation of banks in December 2005. AIG is a leader in direct marketing through sponsors and in the broad market in Japan and Korea. AIG also is investing in expanding distribution channels with emphasis in India, Korea and Vietnam.

     Domestically, AIG anticipates its life insurance and retirement services businesses to continue growing in 2006 through distribution channel expansion and new and enhanced products. The home service operation, which is expected to be a slow growth business, has not met business objectives, although its cash flow has been strong. Domestic group life/health results continue to be weak reflecting the ongoing restructuring activities including the consideration of exiting certain product lines. AIG Retirement Services individual fixed annuities business will continue to be challenged due to the interest rate environment and increased competition from bank products.

     In the airline industry, changes in market conditions are not immediately apparent in operating results. Lease rates have firmed as a result of strong demand spurred by the recovering global commercial aviation market, especially in Asia. Sales have begun to increase, and AIG expects an increasing level of interest from a variety of purchasers. However, higher interest rates are expected to continue to compress lease margins. AIG’s Consumer Finance operations overseas have been negatively affected in 2006 by industry-wide credit deterioration in the Taiwan credit card market.

     GICs, which are sold domestically and abroad to both institutions and individuals, are written on an opportunistic basis when market conditions are favorable. In September 2005, AIG launched a $10 billion medium term note program in the Euromarkets under which AIG debt securities are issued primarily for a matched investment program. In April 2006, AIG issued its first debt securities under the matched investment program, selling Euro 500 million principal amount of notes. AIG also expects to launch a matched investment program in the domestic market which, along with

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the Euro program, will become AIG’s principal spread-based investment activity. However, the timing of the launch of the domestic program remains uncertain. Because AIG’s credit spreads in the capital markets have widened following the ratings declines described in Item 1A. Risk Factors, there may be a reduction in the earnings on new business in AIG’s spread based funding businesses.

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

Critical Accounting Estimates

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

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

Reserves for Losses and Loss Expenses (General Insurance):

Loss trend factors: used to establish expected loss ratios for subsequent accident years based on premium rate adequacy and the projected loss ratio with respect to prior accident years.
Expected loss ratios for the latest accident year: for example, accident year 2005 for the year end 2005 loss reserve analysis. For low frequency, high severity classes such as excess casualty and directors and officers liability (D&O), expected loss ratios generally are utilized for at least the three most recent accident years.
Loss development factors: used to project the reported losses for each accident year to an ultimate amount.

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

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

Estimated Gross Profits (Life Insurance & Retirement Services):

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

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

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

Deferred Policy Acquisition Costs (General Insurance):

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

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

Valuation models: utilizing factors, such as market liquidity and current interest, foreign exchange and volatility rates.
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 its model. When such prices are not available, AIG uses an internal methodology, which includes interpolation and extrapolation from verifiable prices from trades occurring on dates nearest to the dates of the transactions.

Other-Than-Temporary Declines in the Value of Investments:

A security is considered a candidate for other-than-temporary impairment based upon the following criteria:
Trading at a significant (25 percent or more) discount to par or amortized cost (if lower) for an extended period of time (nine months or longer).
The occurrence of a discrete credit event resulting in the debtor defaulting or seeking bankruptcy or insolvency protection or voluntary reorganization.
The probability of non-realization of a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

     At each balance sheet date, AIG evaluates its securities holdings in an unrealized loss position. Where AIG does not intend to hold such securities until they have fully recovered their carrying value, based on the circumstances present at the date of evaluation, AIG records the unrealized loss in income. If events or circumstances change, such as unexpected changes in creditworthiness of the obligor, general interest rate environment, tax circumstances, liquidity events,

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American International Group, Inc. and Subsidiaries
                                             
and statutory capital management considerations among others, AIG revisits its intent to determine if a loss should be recorded in income. Further, if a loss is recognized from a sale subsequent to a balance sheet date pursuant to these changes in circumstances, the loss is recognized in the period in which the intent to hold the securities to recovery no longer exists.

Flight Equipment — Recoverability (Financial Services):

Expected undiscounted future net cash flows: based upon current lease rates, projected future lease rates and estimated terminal values of each aircraft based on third party information.

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 the operations of The Hartford Steam Boiler Inspection and Insurance Company (HSB); Transatlantic Holdings, Inc. (Transatlantic); Personal Lines, including 21st Century Insurance Group (21st Century); and United Guaranty Corporation (UGC).

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

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

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

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

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

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

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

     The main business of the UGC subsidiaries is the issuance of residential mortgage guaranty insurance on conventional first lien mortgages for the purchase or refinance of one to four family residences. UGC subsidiaries also write second lien and private student loan guaranty insurance.

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

     As previously noted, AIG believes it should present and discuss its financial information in a manner most meaningful to its investors. Accordingly, in its General Insurance business, AIG uses certain regulatory 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 profit from underwriting activities exclusive of investment-related income. When underwriting is not profitable, premiums are inadequate to pay for insured losses and underwriting related expenses. In these situations, the addition of general insurance related investment income and realized capital gains may, however, enable a general insurance business to produce operating income. For these reasons, AIG views underwriting results to be criti-

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cal in the overall evaluation of performance. (See also the discussion under “Liquidity” herein.)

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

     GAAP provides for the recognition of expenses at the same time revenues are earned, the accounting principle of matching. Therefore, acquisition expenses are deferred and amortized over the period the related net premiums written are earned. DAC is reviewed for recoverability, and such review requires management judgment. (See also “Critical Accounting Estimates” herein.)

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

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

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

General Insurance operating income is comprised of statutory underwriting results, changes in DAC, net investment income and realized capital gains and losses. Operating income, as well as net premiums written, net premiums earned, net investment income and realized capital gains (losses) and statutory ratios for the three months ended March 31, 2006 and 2005 were as follows:

                     
(in millions, except ratios) 2006 2005

Net premiums written:
               
 
Domestic General
               
   
DBG
  $ 5,900     $ 5,720  
   
Transatlantic
    914       885  
   
Personal Lines
    1,198       1,186  
   
Mortgage Guaranty
    197       165  
 
Foreign General
    3,046       2,834  

Total
  $ 11,255     $ 10,790  

Net premiums earned:
               
 
Domestic General
               
   
DBG
  $ 5,763     $ 5,573  
   
Transatlantic
    908       888  
   
Personal Lines
    1,159       1,120  
   
Mortgage Guaranty
    166       140  
 
Foreign General(a)
    2,474       2,419  

Total
  $ 10,470     $ 10,140  

Net investment income:
               
 
Domestic General
               
   
DBG
  $ 745     $ 659  
   
Transatlantic
    102       85  
   
Personal Lines
    57       52  
   
Mortgage Guaranty
    32       28  
   
Intercompany adjustments and eliminations – net
          1  
 
Foreign General
    182       190  

Total
  $ 1,118     $ 1,015  

Realized capital gains (losses)
    68       64  

Operating Income(b):
               
 
Domestic General
               
   
DBG
  $ 1,357     $ 713  
   
Transatlantic
    141       114  
   
Personal Lines
    101       109  
   
Mortgage Guaranty
    109       104  
 
Foreign General
    621       596  
Reclassifications and Eliminations
    2       6  

Total
  $ 2,331     $ 1,642  

Domestic General:
               
 
Loss Ratio
    70.94       77.23  
 
Expense Ratio
    20.18       19.76  

Combined Ratio
    91.12       96.99  

Foreign General:
               
 
Loss Ratio
    52.74       54.43  
 
Expense Ratio(c)(d)
    28.85       27.25  

Combined ratio(a)
    81.59       81.68  

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(in millions, except ratios) 2006 2005

Consolidated:
               
 
Loss Ratio(b)
    66.64       71.79  
 
Expense Ratio
    22.53       21.73  

Combined Ratio
    89.17       93.52  

(a)  Income statement accounts expressed in non-functional currencies are translated into U.S. dollars using average exchange rates.
(b)  Includes $103 million and $171 million of additional losses incurred and net reinstatement premium costs in the first three months of 2006 and 2005, respectively, related primarily to prior year catastrophes, resulting in increases of 0.97 points and 1.66 points, respectively, in the consolidated General Insurance loss ratio.
(c)  Includes the results of wholly owned AIU agencies.
(d)  Includes amortization of advertising costs.

General Insurance Results

General Insurance operating income in the first three months of 2006 showed significant improvement from the prior year results. The increase in General Insurance operating income in the first three months of 2006 was primarily attributable to improvement in DBG’s underwriting results and growth in overall General Insurance net investment income. Underwriting results in the first three months of 2006 and 2005 included $103 million and $171 million, respectively, of additional losses incurred and net reinstatement premium costs resulting primarily from increased costs related to the 2005 and 2004 catastrophes. The $103 million of losses and net reinstatement premium costs incurred in the first three months of 2006 includes $78 million attributable to 2005 hurricanes and $25 million attributable to 2004 hurricanes. The losses and net reinstatement premium costs attributable to the 2004 hurricanes are primarily related to multi-event and multi-location claims that required extensive investigation to determine the full extent and value of the insured damage. The $171 million of losses and net reinstatement premium costs incurred in the first three months of 2005 is primarily attributable to 2004 hurricanes as well as $44 million from a January 2005 European storm. At March 31, 2006, the inception to date incurred losses and net reinstatement premium costs for 2005 hurricanes were approximately $2.7 billion. At March 31, 2006, the inception to date incurred losses and net reinstatement premium costs for 2004 hurricanes were approximately $1.2 billion.

     DBG’s net premiums written increased modestly in the first three months of 2006 when compared to the same period of 2005, reflecting generally improving renewal retention, a modest change in the mix of business towards smaller accounts and a reduction in the amount of reinsurance purchased. DBG also continued to expand its relationships with a larger number and broader range of brokers. Recently, DBG has seen improvement in domestic property rates as well as increases in submission activity in the aftermath of the 2005 hurricanes. DBG attributes the increase in submissions to its overall financial strength in comparison to many insurers that experienced significant losses and reductions of surplus as a result of the hurricanes.

     The improvement in DBG’s underwriting results for the first three months of 2006 compared to the same period of 2005 was due to a reduction in the loss ratio of 8.1 points, primarily due to lower accident year loss ratios for 2006 compared to the loss ratios recorded in the first three months of 2005 for accident year 2005. The improvement in 2006 loss ratios is based on a comprehensive actuarial study conducted at the end of 2005 and updated as of March 31, 2006 as described below under “Quarterly Reserving Process”. In addition, the first three months of 2006 includes $28 million for losses related to prior year hurricanes compared to the first three months of 2005 which included $118 million for losses related to prior year hurricanes.

     The DBG expense ratio was approximately the same for the first three months of 2006 and 2005.

     Transatlantic’s net premiums written and net premiums earned for the first three months of 2006 increased compared to the same period of 2005 due largely to increased domestic specialty casualty and property premiums offset, in part, by the adverse effect of changes in foreign currency exchange rates on international premiums. Operating income in the first three months of 2006 increased due to improved underwriting profit, resulting largely from reduced significant net catastrophe losses and lower net adverse development on loss reserves, offset, in part, by higher commission costs, and increased net investment income.

     Personal Lines net premiums written for the first three months of 2006 increased slightly when compared to the same period of 2005 as strong growth in the Private Client Group and Agency Auto divisions offset the runoff of the involuntary auto business and a small decline in the AIG Direct and 21st Century divisions. The reduction in the involuntary business is a result of terminating an MGA relationship. The Private Client Group and Agency Auto divisions continue to grow as they expand their agency/broker relationships with multiple product offerings. The AIG Direct and 21st Century decline is due largely to a reduction in response rates. The loss ratio improved in 2006 due to favorable loss development trends in the AIG Direct and 21st Century businesses. The expense ratio increased in 2006 over 2005 driven by an investment in people and technology in the Agency Auto Division, higher compensation expenses in 21st Century due to implementing FAS 123R, and accelerated amortization of direct response advertising costs in AIG Direct resulting from a change in estimated future premiums.

     Mortgage Guaranty’s net premiums written were up for the first three months of 2006 when compared to the same period of 2005. Strong growth was reported in all business segments as domestic first lien, domestic second lien and international operations grew 9 percent, 22 percent and 84 percent, respectively. Underwriting results for the first three

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months of 2006 improved slightly from the same period of 2005 as strong earned premium growth was partially offset by loss development in the domestic second lien business.

     Foreign General Insurance had strong results in the first three months of 2006 even after additional losses incurred related to the 2005 catastrophes and a pre-tax adjustment of $53 million to expenses for a write-off of deferred advertising costs. Growth in net premiums written for this period was achieved in consumer lines due to new business as well as new distribution channels. Commercial lines had modest growth in net premiums written. Commercial lines in Europe exhibited strong growth and had positive results for the first three months of 2006, partially offset by rate decreases in Australia and the United Kingdom. The Ascot Lloyd’s syndicate reported growth for this period due to rate increases on its U.S. book of business along with contractual terms on renewals that reflect better conditions and higher deductibles. In the Far East, personal accident business exhibited strong growth. Europe, Southeast Asia and Latin America also had strong growth in personal accident business. Personal lines operations in Latin America and Brazil continue to exhibit strong growth. For the first three months of 2006, 55 percent of Foreign General Insurance net premiums written was derived from commercial insurance and the remainder from consumer lines. The Foreign General Insurance loss ratio decreased in the first three months of 2006 from the same period of 2005 primarily due to the lower accident year loss ratio for 2006 compared to the loss ratio recorded in the first three months of 2005 for accident year 2005. The Foreign General Insurance expense ratio increased in the first three months of 2006 from the same period in 2005 principally due to the $53 million write-off of advertising costs.

AIG transacts business in most major foreign currencies. The following table summarizes the effect of changes in foreign currency exchange rates on the growth of General Insurance net premiums written for the first three months of 2006:

         
2006

Growth in original currency
    6.0 %
Foreign exchange effect
    (1.7 )
Growth as reported in U.S. dollars
    4.3 %

     As previously noted, General Insurance results include $103 million and $171 million of additional losses incurred and net reinstatement premium costs in the first three months of 2006 and 2005, respectively, related primarily to the 2005 and 2004 catastrophes. The losses attributable to the 2004 hurricanes are primarily related to multi-event and multi-location claims that required extensive investigation to determine the full extent and value of the insured damage. Losses caused by catastrophes can fluctuate widely from year to year, making comparisons of recurring type business more difficult. With respect to catastrophe losses, AIG believes that it has taken appropriate steps, such as careful exposure selection and obtaining reinsurance coverage, to reduce the effect of the magnitude of possible future losses. The occurrence of one or more catastrophic events of unanticipated frequency or severity, such 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 the first three months of 2006 when compared to the same period of 2005. AIG is benefiting from strong cash flow and higher interest rates. Additionally, net investment income was positively affected by the compounding of previously earned and reinvested net investment income. Foreign General Insurance net investment income declined in the first three months of 2006 when compared to the same period of 2005 due to lower partnership income. Market valuations by partnerships in the private equity sector did not match the increases in 2005, the results of which benefited from initial public offering activity of partnership investments.

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

     The contribution of General Insurance operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change was 49 percent in the first three months of 2006 compared to 29 percent in the same period of 2005.

Reinsurance

AIG is a major purchaser of reinsurance for its General Insurance operations. AIG insures risks globally, and its reinsurance programs must be coordinated in order to provide AIG the level of reinsurance protection that AIG desires. Reinsurance is an important risk management tool to manage transaction and insurance line risk retention at prudent levels set by management. AIG also purchases reinsurance to mitigate its catastrophic exposure. AIG is cognizant of the need to exercise good judgment in the selection and approval of both domestic and foreign companies participating in its reinsurance programs because one or more catastrophe losses could negatively affect AIG’s reinsurers and result in an inability of AIG to collect reinsurance recoverables. AIG’s reinsurance department evaluates catastrophic events and assesses the probability of occurrence and magnitude of catastrophic events through the use of state-of-the-art industry recognized program models, among other techniques. AIG supplements these models through continually monitoring the risk exposure of AIG’s worldwide General Insurance operations and adjusting such models accordingly. Although reinsurance ar-

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American International Group, Inc. and Subsidiaries
                                             
rangements do not relieve AIG from its direct obligations to its insureds, an efficient and effective reinsurance program substantially limits AIG’s exposure to potentially significant losses. With respect to its property business, AIG has either renewed existing coverage or purchased new coverage that, in the opinion of management, is adequate to limit AIG’s exposures.

     AIG’s consolidated general reinsurance assets amounted to $23.44 billion at March 31, 2006 and resulted from AIG’s reinsurance arrangements. Thus, a credit exposure existed at March 31, 2006 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, 2005, approximately 48 percent of the general reinsurance assets were from unauthorized reinsurers. Many of these balances were collateralized, permitting statutory recognition. Additionally, with the approval of its domiciliary insurance regulators, AIG posted approximately $1.5 billion of letters of credit issued by several commercial banks in favor of certain Domestic General Insurance companies to permit statutory recognition of balances otherwise uncollateralized at December 31, 2005. The remaining 52 percent of the general reinsurance assets were from authorized reinsurers. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. At December 31, 2005, approximately 88 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, a division of The McGraw-Hill Companies, Inc. (S&P). Through March 31, 2006, there has been no significant deterioration in the rating profile of AIG’s reinsurers representing more than five percent of AIG’s reinsurance assets as of December 31, 2005. These ratings are measures of financial strength.

     AIG maintains an allowance for estimated unrecoverable reinsurance. Although AIG has been largely successful in its previous recovery efforts, at March 31, 2006 AIG had an allowance for unrecoverable reinsurance approximating $979 million. At that date, AIG had no significant reinsurance recoverables due from any individual reinsurer that was financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction).

     AIG’s Reinsurance Security Department conducts ongoing detailed assessments of the reinsurance markets and current and potential reinsurers, both foreign and domestic. Such assessments include, but are not limited to, identifying if a reinsurer is appropriately licensed and has sufficient financial capacity, and evaluating the local economic environment in which a foreign reinsurer operates. This department also reviews the nature of the risks ceded and the requirements for credit risk mitigants. For example, in AIG’s treaty reinsurance contracts, AIG includes provisions that frequently require a reinsurer to post collateral when a referenced event occurs. Furthermore, AIG limits its unsecured exposure to reinsurers through the use of credit triggers, which include, but are not limited to, insurer financial strength rating downgrades, policyholder surplus declines at or below a certain predetermined level or a certain predetermined level of a reinsurance recoverable being reached. In addition, AIG’s Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer.

     AIG enters into intercompany reinsurance transactions, primarily through American International Reinsurance Company, Ltd. (AIRCO), for its General Insurance and Life Insurance operations. AIG enters into these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among AIG’s various legal entities. All material intercompany transactions have been eliminated in consolidation. AIG generally obtains letters of credit in order to obtain statutory recognition of these intercompany reinsurance transactions. At March 31, 2006, approximately $3.5 billion of letters of credit were outstanding to cover intercompany reinsurance transactions with AIRCO or other General Insurance subsidiaries.

     At March 31, 2006, consolidated general reinsurance assets of $23.44 billion include reinsurance recoverables for paid losses and loss expenses of $1.17 billion and $19.21 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported (IBNR) (ceded reserves) and $3.07 billion of ceded reserve for unearned premiums. The ceded reserve for losses and loss expenses represent the accumulation of estimates of ultimate ceded losses including provisions for ceded IBNR and loss expenses. The methods used to determine such estimates and to establish the resulting ceded reserves are continually reviewed and updated by management. Any adjustments thereto are reflected in income currently. It is AIG’s belief that the ceded reserves for losses and loss expenses at March 31, 2006 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.

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American International Group, Inc. and Subsidiaries
                                             

Reserve for Losses and Loss Expenses

The table below classifies as of March 31, 2006 the components of the General Insurance gross reserve for losses and loss expenses (loss reserves) by major lines of business on a statutory Annual Statement basis*:

         
(in millions)

Other liability occurrence
  $ 18,437  
Other liability claims made
    12,137  
Workers compensation
    11,909  
Auto liability
    6,274  
Property
    7,541  
International
    5,494  
Reinsurance
    3,039  
Medical malpractice
    2,173  
Aircraft
    1,589  
Products liability
    1,988  
Commercial multiple peril
    1,449  
Accident and health
    1,641  
Fidelity/ surety
    988  
Other
    3,441  

Total
  $ 78,100  

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

     AIG’s reserve for losses and loss expenses represents the accumulation of estimates of ultimate losses, including IBNR and loss expenses. The methods used to determine loss reserve estimates and to establish the resulting reserves are continually reviewed and updated by management. Any adjustments resulting therefrom are reflected in operating income currently. Because loss reserve estimates are subject to the outcome of future events, changes in estimates are unavoidable given that loss trends vary and time is often required for changes in trends to be recognized and confirmed. Reserve changes that increase previous estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development.

     At March 31, 2006, General Insurance net loss reserves increased $1.42 billion from the prior year end to $58.89 billion. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance and applicable discount for future investment income. The table below classifies the components of the General Insurance net loss reserves by business unit as of March 31, 2006.

         
(in millions)

DBG(a)
  $ 41,807  
Personal Lines(b)
    2,556  
Transatlantic
    5,737  
Mortgage Guaranty
    349  
Foreign General(c)
    8,443  

Total Net Loss Reserve
  $ 58,892  

(a) DBG loss reserves include approximately $3.59 billion ($4.04 billion before discount) related to business written by DBG but ceded to AIRCO and reported in AIRCO’s statutory filings. DBG loss reserves also include approximately $462 million related to business included in AIUO’s statutory filings.
(b) Personal Lines loss reserves include $885 million related to business ceded to DBG and reported in DBG’s statutory filings.
(c) Foreign General loss reserves include approximately $2.57 billion related to business reported in DBG’s statutory filings.

     The DBG net loss reserve of $41.81 billion is comprised principally of the business of AIG subsidiaries participating in the American Home/National Union pool (11 companies) and the surplus lines pool (Lexington, Starr Excess Liability Insurance Company and Landmark Insurance Company).

     Beginning in 1998, DBG ceded a quota share percentage of its other liability occurrence and products liability occurrence business to AIRCO. The quota share percentage ceded was 40 percent in 1998, 65 percent in 1999, 75 percent in 2000 and 2001, 50 percent in 2002 and 2003, 40 percent in 2004, 35 percent in 2005 and 20 percent in 2006 and covered all business written in these years for these lines by participants in the American Home/National Union pool. In 1998 the cession reflected only the other liability occurrence business, but in 1999 and subsequent years included products liability occurrence. AIRCO’s loss reserves relating to these quota share cessions from DBG are recorded on a discounted basis. As of March 31, 2006, AIRCO carried a discount of approximately $450 million applicable to the $4.04 billion in undiscounted reserves it assumed from the American Home/National Union pool via this quota share cession. AIRCO also carries approximately $465 million in net loss reserves relating to Foreign General insurance business. These reserves are carried on an undiscounted basis.

     Beginning in 1997, the Personal Lines division ceded a percentage of all business written by the companies participating in the personal lines pool to the American Home/National Union pool. As noted above, the total reserves carried by participants in the American Home/National Union pool relating to this cession amounted to $885 million as of March 31, 2006.

     The companies participating in the American Home/National Union pool have maintained a participation in the business written by AIU for decades. As of March 31, 2006, these AIU reserves carried by participants in the American Home/National Union pool amounted to approximately $2.57 billion. The remaining Foreign General reserves are carried by AIUO, AIRCO, and other smaller AIG subsidiaries domiciled outside the United States. Statutory filings in the U.S. by AIG companies reflect all the business written by U.S. domiciled entities only, and therefore exclude business written by AIUO, AIRCO, and all other internationally domiciled subsidiaries. The total reserves carried at March 31, 2006 by AIUO and AIRCO were approximately $3.92 billion and $4.06 billion, respectively. AIRCO’s $4.06 billion in total general insurance reserves consist of approximately $3.59 billion from business assumed from the American Home/National Union pool and an additional $465 million relating to Foreign General Insurance business.

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American International Group, Inc. and Subsidiaries
                                             

Discounting of Reserves

At March 31, 2006, AIG’s overall General Insurance net loss reserves reflects a loss reserve discount of $2.11 billion, including tabular and non-tabular calculations. The tabular workers compensation discount is calculated using a 3.5 percent interest rate and the 1979-81 Decennial Mortality Table. The non-tabular workers compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations for each state. For New York companies, the discount is based on a five percent interest rate and the companies’ own payout patterns. For Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a six percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the yield of U.S. Treasury securities ranging from one to twenty years and the company’s own payout pattern, with the future expected payment for each year using the interest rate associated with the corresponding Treasury security yield for that time period. The discount is comprised of the following: $512 million – tabular discount for workers compensation in DBG; $1.15 billion – non-tabular discount for workers compensation in DBG; and, $450 million – non-tabular discount for other liability occurrence and products liability occurrence in AIRCO. The total undiscounted workers compensation loss reserve carried by DBG is approximately $9.9 billion as of March 31, 2006. The other liability occurrence and products liability occurrence business in AIRCO that is assumed from DBG is discounted based on the yield of U.S. Treasury securities ranging from one to twenty years and the DBG payout pattern for this business. The undiscounted reserves assumed by AIRCO from DBG totaled approximately $4.04 billion at March 31, 2006.

Quarterly Reserving Process

It is management’s belief that the General Insurance net loss reserves are adequate to cover General Insurance net losses and loss expenses as of March 31, 2006. While AIG regularly reviews the adequacy of established loss reserves, there can be no assurance that AIG’s ultimate loss reserves will not develop adversely and materially exceed AIG’s loss reserves as of March 31, 2006. In the opinion of management, such adverse development and resulting increase in reserves is not likely to have a material adverse effect on AIG’s consolidated financial position, although it could have a material adverse effect on AIG’s consolidated results of operations for an individual reporting period.

The table below presents the reconciliation of net loss reserves for the first three months ended March 31, 2006 and 2005 as follows:

                   
(in millions) 2006 2005

Net reserve for losses and loss expenses at beginning of year
  $ 57,476       $47,254  
Foreign exchange effect
    117       28  

Losses and loss expenses incurred:
               
 
Current year
    6,841       7,039  
 
Prior years, other than accretion of discount*
    35       143  
 
Prior years, accretion of discount
    101       97  

Losses and loss expenses incurred
    6,977       7,279  

Losses and loss expenses paid
    5,678       5,227  

Net reserve for losses and loss expenses at end of period
  $ 58,892       $49,334  

* Includes $35 million in the first three months of 2006 and $55 million in the first three months of 2005 for the general reinsurance operations of Transatlantic and $98 million and $118 million of additional losses incurred in the first three months of 2006 and 2005 resulting from increased costs related to the 2005 and 2004 catastrophes.

     The loss ratios recorded by AIG for the first three months of 2006 take into account the results of the comprehensive reserve reviews that were completed in the fourth quarter of 2005. As explained more fully in the 2005 Annual Report on Form 10-K, AIG’s year-end 2005 reserve review reflected careful consideration of the reserve analyses prepared by AIG’s internal actuarial staff with the assistance of third party actuaries. In determining the appropriate loss ratios for accident year 2006 for each class of business, AIG gave appropriate consideration to the loss ratios resulting from the reserve analyses as well as all other relevant information including rate changes, expected changes in loss costs, changes in coverage, reinsurance or mix of business, and other factors that may affect the loss ratios.

     In the first three months of 2006, AIG enhanced its process of determining the quarterly loss development from prior accident years. Beginning with the first three months of 2006, additional analyses are conducted to determine the change in estimated ultimate loss for each accident year for each profit center. For example, if loss emergence for a profit center is different than expected for certain accident years in the quarter, the actuaries now take additional steps to examine the indicated effect such emergence would have on the reserves of that profit center. In some cases, the higher or lower than expected emergence may result in no clear change in the ultimate loss estimate for the accident years in question, and no adjustment would be made to the profit center’s reserves for prior accident years. In other cases, the higher or lower than expected emergence may result in a larger change, either favorable or unfavorable, than the difference between the actual and expected loss emergence. Such additional analyses were conducted for each profit center, as appropriate, in the first three months of 2006 to determine the loss development from prior accident years for the first three months.

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American International Group, Inc. and Subsidiaries
                                             

     In the first three months of 2006, net loss development from prior accident years was approximately $35 million, including approximately $98 million pertaining to catastrophes in 2004 and 2005 and $35 million from the general reinsurance operations of Transatlantic, but excluding approximately $101 million pertaining to accretion of loss reserve discount applicable to accident years 2005 and prior. Excluding catastrophes and Transatlantic, as well as accretion of discount, net loss development from prior accident years in the first three months of 2006 was favorable by approximately $98 million. The majority of the $98 million in favorable development is attributable to shorter tail classes of business within Foreign General. Net loss development from prior accident years for DBG in the first three months of 2006 was nearly flat, excluding catastrophes and accretion of discount. Within the overall favorable development of $98 million, accident years 2003 through 2005 experienced favorable development of approximately $330 million, offset by approximately $230 million of adverse development from accident years 2002 and prior.

     Most classes of business throughout AIG experienced favorable loss emergence in the first three months of 2006 for accident years 2003 through 2005. The adverse development noted above from accident years 2002 and prior was primarily attributable to the excess casualty class of business, and to a lesser extent excess workers compensation. After conducting the more enhanced analyses described above, AIG determined that there was no overall adverse development in the first three months of 2006 for excess casualty, whereas there was determined to be $35 million of prior period adverse development for excess workers compensation from accident years 2002 and prior. For excess casualty, the adverse development for accident years 2002 and prior was offset by favorable development from accident years 2003 and 2004, and to a lesser extent 2005.

     In the first three months of 2005, net loss reserve development from prior accident years was approximately $143 million, including approximately $118 million pertaining to catastrophes in 2004 and $55 million from the general reinsurance operations of Transatlantic, but excluding approximately $97 million pertaining to the accretion of loss reserve discount pertaining to accident years 2004 and prior. Excluding catastrophes and Transatlantic, as well as accretion of discount, net loss development from prior accident years in the first three months of 2005 was favorable by approximately $30 million. In the first three months of 2005, the overall favorable emergence of $30 million was comprised of approximately $360 million of favorable emergence from accident years 2003 and 2004, offset by approximately $330 million of higher than expected loss emergence from accident years 2002 and prior. Most classes of business throughout AIG contributed to the favorable emergence from accident years 2003 and 2004 in the first three months of 2005. The majority of the higher than expected emergence from accident years 2002 and prior was attributable to the directors and officers and related management liability classes of business, as well as excess casualty.

Loss Reserving Process

The General Insurance loss reserves can generally be categorized into two distinct groups. One group is long-tail casualty lines of business which include excess and umbrella liability, D&O, professional liability, medical malpractice, workers compensation, general liability, products liability, and related classes. The other group is short-tail lines of business consisting principally of property lines, personal lines and certain classes of casualty lines. These lines of business and actuarial assumptions made in the review of these lines of business are described in the 2005 Annual Report on Form 10-K.

         The process of determining the current loss ratio for each class or business segment is based on a variety of factors and is described in detail in AIG’s 2005 Annual Report on Form 10-K. AIG uses the process described above to update AIG’s reserves on a quarterly basis. AIG’s 2005 Annual Report on Form 10-K also includes a discussion and analysis of the volatility of AIG’s 2005 reserve estimates and a sensitivity analysis.

Asbestos and Environmental Reserves

The estimation of loss reserves relating to asbestos and environmental claims on insurance policies written many years ago is subject to greater uncertainty than other types of claims due to inconsistent court decisions as well as judicial interpretations and legislative actions that in some cases have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability.

         As described more fully in the 2005 Annual Report on Form 10-K, AIG’s reserves relating to asbestos and environmental claims reflect the results of the comprehensive ground up analysis which was completed in the fourth quarter of 2005. AIG plans to update the ground up analysis on an annual basis. In the first three months of 2006, AIG maintained the ultimate loss estimates for asbestos and environmental claims resulting from the recently completed reserve analyses. A minor amount of incurred loss emergence pertaining to asbestos was reflected in the first three months of 2006, as depicted in the table that follows. This minor development is primarily attributable to the general reinsurance operations of Transatlantic.

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American International Group, Inc. and Subsidiaries
                                             

A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined for the three months ended March 31, 2006 and 2005 follows:

                                 
2006 2005


(in millions) Gross Net Gross Net

Asbestos:
                               
Reserve for losses and loss expenses at beginning of year
  $ 4,441     $ 1,840     $ 2,559     $ 1,060  
Losses and loss expenses incurred*
    5       2       78       24  
Losses and loss expenses paid*
    (149 )     (54 )     (91 )     (29 )

Reserve for losses and loss expenses at end of period
  $ 4,297     $ 1,788     $ 2,546     $ 1,055  

Environmental:
                               
Reserve for losses and loss expenses at beginning of year
  $ 926     $ 410     $ 974     $ 451  
Losses and loss expenses incurred*
                (13 )     (3 )
Losses and loss expenses paid*
    (21 )     (9 )     (30 )     (16 )

Reserve for losses and loss expenses at end of period
  $ 905     $ 401     $ 931     $ 432  

Combined:
                               
Reserve for losses and loss expenses at beginning of year
  $ 5,367     $ 2,250     $ 3,533     $ 1,511  
Losses and loss expenses incurred*
    5       2       65       21  
Losses and loss expenses paid*
    (170 )     (63 )     (121 )     (45 )

Reserve for losses and loss expenses at end of period
  $ 5,202     $ 2,189     $ 3,477     $ 1,487  

All amounts pertain to policies underwritten in prior years.

The gross and net IBNR included in the reserve for losses and loss expenses, relating to asbestos and environmental claims separately and combined, at March 31, 2006 and 2005 were estimated as follows:

                                 
2006 2005


(in millions) Gross Net Gross Net

Asbestos
  $ 3,314     $ 1,425     $ 1,864     $ 786  
Environmental
    572       256       554       248  

Combined
  $ 3,886     $ 1,681     $ 2,418     $ 1,034  

A summary of asbestos and environmental claims count activity for the three months ended March 31, 2006 and 2005 was as follows:

                                                   
2006 2005


Asbestos Environmental Combined Asbestos Environmental Combined

Claims at beginning of year
    7,293       9,873       17,166       7,575       8,216       15,791  
Claims during year:
                                               
 
Opened
    286       388       674       259       759       1,018  
 
Settled
    (37 )     (42 )     (79 )     (19 )     (52 )     (71 )
 
Dismissed or otherwise resolved
    (295 )     (296 )     (591 )     (130 )     (879 )     (1,009 )

Claims at end of period
    7,247       9,923       17,170       7,685       8,044       15,729  

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American International Group, Inc. and Subsidiaries
                                             

     The table below presents AIG’s survival ratios for asbestos and environmental claims at March 31, 2006 and 2005. The survival ratio is derived by dividing the current carried loss reserve by the average payments for the three most recent calendar years for these claims. Therefore, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid off using recent year average payments. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have a significant effect on the amount of asbestos and environmental reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.

AIG’s survival ratios for asbestos and environmental claims, separately and combined were based upon a three-year average payment. These ratios at March 31, 2006 and 2005 were as follows:

                   
(number of years) Gross Net

2006
               
Survival ratios:
               
 
Asbestos
    14.7       17.8  
 
Environmental
    7.1       6.4  
 
Combined
    12.4       13.5  

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

Life Insurance & Retirement Services Operations

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

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

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

Life Insurance & Retirement Services operations presented on a sub-product basis for the three months ended March 31, 2006 and 2005 were as follows:

                   
(in millions) 2006 2005

GAAP premiums:
               
Domestic Life:
               
 
Life insurance(a)
  $ 516     $ 497  
 
Home service
    200       203  
 
Group life/health
    246       268  
 
Payout annuities(b)
    450       397  

 
Total
    1,412       1,365  

Domestic Retirement Services:
               
 
Group retirement products
    94       84  
 
Individual fixed annuities
    29       20  
 
Individual variable annuities
    128       112  
 
Individual fixed annuities-runoff(c)
    20       23  

 
Total
    271       239  

Total Domestic
    1,683       1,604  

Foreign Life:
               
 
Life insurance
    4,081       4,089  
 
Personal accident & health
    1,306       1,221  
 
Group products
    573       517  

 
Total
    5,960       5,827  

Foreign Retirement Services:
               
 
Individual fixed annuities
    95       84  
 
Individual variable annuities
    34       25  

 
Total
    129       109  

Total Foreign
    6,089       5,936  

Total GAAP premiums
  $ 7,772     $ 7,540  

Net investment income:
               
Domestic Life:
               
 
Life insurance
  $ 338     $ 372  
 
Home service
    158       147  
 
Group life/health
    54       46  
 
Payout annuities
    237       210  

 
Total
    787       775  

Domestic Retirement Services:
               
 
Group retirement products
    572       549  
 
Individual fixed annuities
    932       827  
 
Individual variable annuities
    52       58  
 
Individual fixed annuities-runoff(c)
    236       254  

 
Total
    1,792       1,688  

Total Domestic
    2,579       2,463  

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American International Group, Inc. and Subsidiaries
                                             
                   
(in millions) 2006 2005

Foreign Life:
               
 
Life insurance
    1,210       1,164  
 
Personal accident & health
    64       54  
 
Group products
    177       131  
 
Intercompany adjustments
    (10 )     (8 )

 
Total
    1,441       1,341  

Foreign Retirement Services:
               
 
Individual fixed annuities
    496       377  
 
Individual variable annuities
    193       136  

 
Total
    689       513  

 
Total Foreign
    2,130       1,854  

Total net investment income
  $ 4,709     $ 4,317  

Realized capital gains (losses):
               
Domestic realized capital gains (losses)
  $ (194 )   $ (7 )

Foreign realized capital gains (losses)
    228       (156 )
Pricing net investment gains(d)
    124       81  

Total Foreign
    352       (75 )

Total realized capital gains (losses)(d)
  $ 158     $ (82 )

Operating Income:
               
 
Domestic
  $ 886     $ 981  
 
Foreign
    1,669       1,200  

Total operating income
  $ 2,555     $ 2,181  


Life insurance in-force(e):
               
 
Domestic
  $ 847,211     $ 825,151  
 
Foreign
    1,057,469       1,027,682  

Total
  $ 1,904,680     $ 1,852,833  

(a)   Effective January 1, 2006, the Broker/Dealer operations of the Domestic Life Insurance companies are being reported and managed within AIG Capital Advisors in Asset Management. Included in GAAP premiums were revenues of $24 million for the first three months of 2005.
(b)   Includes structured settlements, single premium immediate annuities and terminal funding annuities.
(c)   Primarily represents runoff annuity business sold through discontinued distribution relationships.
(d)   For purposes of this presentation, pricing net investment gains are segregated as a component of total realized gains (losses). They represent certain amounts of realized capital gains where gains are an inherent element in pricing certain life products in some foreign countries.
(e)   Amounts presented were as at March 31, 2006 and December 31, 2005.

     AIG’s Life Insurance & Retirement Services subsidiaries report their operations through the following operating units: Domestic Life — AIG American General, including American General Life Insurance Company (AG Life), United States Life Insurance in the City of New York (USLIFE) and American General Life and Accident Insurance Company (AGLA); Domestic Retirement Services — The Variable Annuity Life Insurance Company (VALIC), AIG Annuity Insurance Company (AIG Annuity) and AIG SunAmerica; Foreign Life — ALICO, AIRCO, AIG Edison Life, AIG Star Life, American International Assurance Company, Limited together with American International Assurance Company (Bermuda) Limited (AIA), Nan Shan Life Insurance Company, Ltd. (Nan Shan) and The Philippine American Life and General Insurance Company (Philamlife).

Life Insurance & Retirement Services Results

The increase in operating income in the first three months of 2006 when compared to the same period of 2005 is the net result of growth in domestic and foreign operations and increases in realized capital gains, somewhat offset by the negative effect of foreign exchange translation primarily related to a weaker Yen in 2006 as compared to the same period of 2005. The increase in realized capital gains in the first three months of 2006 compared to the first three months of 2005 were due to the effect of hedging activities that do not qualify for hedge accounting under FAS 133, foreign exchange gains and losses under FAS 52, offset by other-than-temporary declines in value of investments.

     Life Insurance & Retirement Services GAAP premiums grew in the first three months of 2006 when compared to the same period of 2005. AIG’s Domestic Life operations had continued growth of life insurance GAAP premiums. This growth reflects sustained strong periodic life sales from the independent distribution platform. Retail periodic life sales in the first three months of 2006 and 2005 were $207 million and $126 million, respectively. While not sustainable at this pace due to forthcoming product pricing changes, this result has positioned the Life segment to achieve another solid sales year. Strong growth of payout annuities GAAP premium emanated from sales of single premium immediate annuities. The group life/health business GAAP premium continued to decline reflecting lower growth in the credit business, and tightened pricing and underwriting in the group employer lines. Restructuring efforts in this business continue to focus on new product introductions, cross selling, other growth strategies, and exiting certain product lines. AGLA, the home service business, is diversifying product offerings, enhancing the capabilities and quality of the sales force and broadening the markets served beyond those historically serviced in an effort to accelerate growth, although it is expected to remain a slower growth business.

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American International Group, Inc. and Subsidiaries
                                             

     Domestic Retirement Services businesses faced a challenging environment in the first three months of 2006, as deposits declined approximately 7 percent compared to the same period last year. While individual variable annuity deposits grew 15 percent and group retirement deposits grew 19 percent, overall deposits declined from lower individual fixed annuity deposits. Individual fixed annuity deposits continued to decline due to the flat yield curve, which makes bank products such as certificates of deposit and other money market instruments with shorter duration more attractive than fixed annuities. Individual variable annuity deposit growth has improved since the introduction of new products in November 2005, primarily products with income and asset accumulation benefits. The following table reflects deposits for Domestic Retirement Services for the three months ended March 31, 2006 and 2005:

                   

(in millions) 2006 2005

Group retirement products*
  $ 1,941     $ 1,631  
Individual fixed annuities
    1,687       2,463  
Individual variable annuities
    1,027       891  
Individual fixed annuities - runoff
    43       49  

 
Total
  $ 4,698     $ 5,034  

* Includes mutual funds.

     In the first three months of 2006, surrender rates increased for individual fixed annuities, individual variable annuities and group retirement products compared to the first three months of 2005. Surrender rates for group retirement products improved modestly when compared to fourth quarter 2005. The increase in surrender rate for fixed annuities continues to be driven by the shape of the yield curve and general aging of the in-force block; however, less than 20 percent of the individual fixed annuity reserves are available to be surrendered without charge. Individual variable annuity surrenders primarily reflect the higher shock-lapse that occurs following expiration of the surrender charge period on certain 3-year and 7-year contracts (including a large closed block of acquired business). Reflecting a widespread industry phenomenon, this lapse rate, much of which was anticipated when the products were issued, has recently been affected by investor demand to exchange existing policies for new-generation contracts with living benefits or lower fees. In addition, partial withdrawals on certain variable annuity products have increased as AIG has introduced features designed to generate a stream of income to the participants. The following chart shows the amount of reserves by surrender charge category for Domestic Retirement Services as of March 31, 2006:

                           

Group Individual Individual
Retirement Fixed Variable
(in millions) Products* Annuities Annuities

Zero or no surrender charge
  $ 40,633     $ 9,927     $ 10,210  
Between 0 percent - 4 percent
    11,988       10,927       8,708  
Greater than 4 percent
    2,335       30,987       10,105  
Non-Surrenderable
    892       3,150       81  

 
Total
  $ 55,848     $ 54,991     $ 29,104  

* Excludes mutual funds.

     A continued increase in the level of surrenders in any of these businesses or in the individual fixed annuities runoff block could accelerate the amortization of deferred acquisition costs in future years and will negatively affect fee income earned on assets under management. The combination of deposits and surrenders resulted in negative net flows for the first three months of 2006. The following table reflects the net flows by line of business for Domestic Retirement Services as of March 31, 2006 and 2005:

                   
Domestic Retirement Services – Net Flows(a)

(in millions) 2006 2005

Group retirement products(b)
  $ 441     $ 279  
Individual fixed annuities
    (1 )     1,385  
Individual variable annuities
    (133 )     72  
Individual fixed annuities - runoff
    (826 )     (566 )

 
Total
  $ (519 )   $ 1,170  

(a) Net flows are defined as deposits received, less benefits, surrenders, withdrawals and death benefits.
 
(b) Includes mutual funds.

     Foreign Life Insurance & Retirement Services GAAP premiums increased by approximately 3 percent, or approximately 8 percent in original currency. AIG transacts business in most major foreign currencies. Globally, AIG’s deep and diverse distribution, which includes bancassurance, worksite marketing, direct marketing and strong agency organizations, provides a powerful distribution platform for our diverse product lines. In Japan, distribution of single premium life insurance products through banks was deregulated in December 2005 resulting in strong sales of products designed for that market during the first three months of 2006. This new distribution outlet adds to the existing multiple distribution platform in Japan where AIG remains the leading foreign provider. In Southeast Asia, there has been a continuing trend, as the market develops, for clients to purchase investment-oriented products. AIG’s life operations in that region have responded to this trend by offering a wide array of investment linked products, both periodic pay and single premium, with multiple fund selection, but with minimal investment guarantees. For GAAP reporting purposes, only revenues from policy charges for insurance, administration, and surrender charges are reported as GAAP premiums for these life products. This product mix shift contributed to the single digit growth rate in Foreign Life Insurance & Retirement Services GAAP premiums, while continuing to grow total reserves by double digits.

     Japanese tax authorities are expected to announce shortly a reduction in the amount of premium that policyholders may deduct from their Japanese tax returns for a certain group of accident and health products. Foreign life operations in Japan experienced a decline in sales of those specific products in the first three months of 2006; however, total accident and health sales continued to be strong overall due to growth in sales of core health products and the success of a new cancer insurance product sold by AIG Edison. In the first three months of 2006, Japan life operations launched a

45


 

American International Group, Inc. and Subsidiaries
                                             

new product for the corporate market and plans to launch additional products with full tax deductibility in the near future to replace those that will lose that feature. With respect to the existing products that have exposure to the change in tax regulation, the amount of first year premium reported for the full year 2005 was approximately $129 million and the deferred acquisition cost asset at December 31, 2005 was $267 million. To date, lapse experience has remained within pricing assumptions. Management continues to believe that any increase in policy lapses would not be material to AIG’s consolidated financial condition or results of operations.

     The Foreign Retirement Services business continued to grow in Japan and Korea by expanding distribution and leveraging AIG’s product expertise. Reserves for individual fixed annuities continue to grow although demand for multi-currency fixed annuities in Japan has slowed due to currency rate fluctuations, and rising local interest rates and equity markets. Growth of individual variable annuities has accelerated as those products have become more popular with consumers in Japan and Europe coupled with improved performance of equity markets.

     Foreign Life Insurance & Retirement Services operations produced 78 percent and 79 percent of Life Insurance & Retirement Services GAAP premiums in the first three months of 2006 and 2005, respectively.

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

         
2006

Growth in original currency
    7.1 %
Foreign exchange effect
    (4.0 )
Growth as reported in U.S. dollars
    3.1 %

     The growth in net investment income in the first three months of 2006 and 2005 parallels the growth in general account reserves and surplus for both Domestic and Foreign Life Insurance & Retirement Services companies. Also, net investment income was positively affected by the compounding of previously earned and reinvested investment cash flows along with the addition of new net cash flows from operations. Investment income includes income generated from traditional fixed income investments as well as income generated from other sources. The following table summarizes the components of net investment income for the three months ended March 31, 2006 and 2005:

                   

(in millions) 2006 2005

Domestic
               
 
Fixed maturities, including short term investments
  $ 2,308     $ 2,232  
 
Equity securities
    5        
 
Interest on mortgage, policy and collateral loans
    189       167  
 
Partnership income – excluding Synfuels
    141       154  
 
Partnership income – Synfuels
    (37 )     (36 )
 
Other
    (3 )     (27 )

 
Total investment income
    2,603       2,490  
 
Investment expenses
    24       27  

 
Net investment income
  $ 2,579     $ 2,463  

Foreign
               
 
Fixed maturities, including short term investments
  $ 1,531     $ 1,373  
 
Equity securities
    71       42  
 
Interest on mortgage, policy and collateral loans
    108       113  
 
Partnership income
    17       12  
 
Policyholder trading gains (losses)*
    385       278  
 
Other
    73       83  

 
Total investment income
    2,185       1,901  
 
Investment expenses
    55       47  

 
Net investment income
  $ 2,130     $ 1,854  

Total
               
 
Fixed maturities, including short term investments
  $ 3,839     $ 3,605  
 
Equity securities
    76       42  
 
Interest on mortgage, policy and collateral loans
    297       280  
 
Partnership income – excluding Synfuels
    158       166  
 
Partnership income – Synfuels
    (37 )     (36 )
 
Policyholder trading gains (losses)*
    385       278  
 
Other
    70       56  

 
Total investment income
    4,788       4,391  
 
Investment expenses
    79       74  

 
Net investment income
  $ 4,709     $ 4,317  

Relates principally to trading and investment activity in accordance with SOP 03-1. These amounts are offset by a similar change included in incurred policy losses and benefits.

     AIG generates income tax credits as a result of investing in synthetic fuel production (synfuels) related to the investment loss shown in the above table and records those benefits in its provision for income taxes. The amount of those income tax credits was $40 million and $54 million for the first three months of 2006 and 2005, respectively. See Note 6(l) of Notes to Consolidated Financial Statements for a further discussion of the effect of the change in oil prices on synfuel tax credits.

     Realized capital gains (losses) include normal portfolio transactions as well as derivative gains (losses) for transactions that do not qualify for hedge accounting treatment under FAS 133, transactional foreign exchange gains and losses and other-than-temporary decline in the value of investments, related primarily to declines in certain high-yield credit positions. The following table summarizes realized

46


 

American International Group, Inc. and Subsidiaries
                                             
capital gains (losses) by major category for the three months ended March 31, 2006 and 2005:
                     

(in millions) 2006 2005

Domestic life
               
 
Fixed maturities
  $ (22 )   $ (6 )
 
Equity securities
    2        
 
Other:
               
   
FAS 52
    (1 )      
   
FAS 133
    87       104  
   
Other-than-temporary decline
    (54 )     (23 )
   
Other
    (4 )     (3 )

Total domestic life
    8       72  

Domestic retirement services:
               
 
Fixed maturities
    (72 )     (60 )
 
Equity securities
    14       7  
 
Other:
               
   
FAS 133
    3       20  
   
Other-than-temporary decline
    (125 )     (42 )
   
Other
    (22 )     (4 )

Total domestic retirement services
    (202 )     (79 )

Foreign
               
 
Fixed maturities