FORM 10-Q
Table of Contents

 
 
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 June 30, 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
Applicable only to corporate issuers
     As of July 31, 2006, there were 2,598,763,423 shares outstanding of each of the issuer’s classes of common stock.
 
 


 

TABLE OF CONTENTS
                 
    Page
Description   Number
 
 PART I — FINANCIAL INFORMATION     1  
     Item 1.       1  
     Item 2.       33  
     Item 3.       90  
     Item 4.       90  
 PART II — OTHER INFORMATION     91  
     Item 2.       91  
     Item 4.       91  
     Item 6.       91  
 SIGNATURES     92  
 EX-12: STATEMENT RE COMPUTATION OF RATIOS
 EX-31: CERTIFICATIONS
 EX-32: CERTIFICATIONS


Table of Contents

American International Group, Inc. and Subsidiaries
                                             
Part I – FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
CONSOLIDATED BALANCE SHEET
(in millions) (unaudited)
 
                       
    June 30,   December 31,
    2006   2005
 
Assets:
               
  Investments and financial services assets:                
    Fixed maturities:                
     
Bonds available for sale, at market value (amortized cost: 2006 – $362,825; 2005 – $349,612) (includes hybrid financial instruments: 2006 – $495)
  $ 362,183     $ 359,516  
     
Bonds held to maturity, at amortized cost (market value: 2006 – $21,522; 2005 – $22,047)
    21,510       21,528  
     
Bond trading securities, at market value (cost: 2006 – $6,565; 2005 – $4,623)
    6,487       4,636  
    Equity securities:                
     
Common stocks available for sale, at market value (cost: 2006 – $12,008; 2005 – $10,125)
    13,829       12,227  
     
Common and preferred stocks trading, at market value (cost: 2006 – $9,589; 2005 – $7,746)
    10,857       8,959  
     
Preferred stocks available for sale, at market value (cost: 2006 – $2,464; 2005 – $2,282)
    2,447       2,402  
   
Mortgage loans on real estate, net of allowance (2006 – $55; 2005 – $54)
    16,180       14,300  
   
Policy loans
    7,366       7,039  
   
Collateral and guaranteed loans, net of allowance (2006 – $10; 2005 – $10)
    4,058       3,570  
    Financial services assets:                
     
Flight equipment primarily under operating leases, net of accumulated depreciation (2006 – $8,100; 2005 – $7,419)
    39,307       36,245  
     
Securities available for sale, at market value (cost: 2006 – $38,386; 2005 – $37,572)
    38,678       37,511  
     
Trading securities, at market value
    5,165       6,499  
     
Spot commodities
    797       92  
     
Unrealized gain on swaps, options and forward transactions
    18,901       18,695  
     
Trading assets
    1,345       1,204  
     
Securities purchased under agreements to resell, at contract value
    14,085       14,547  
     
Finance receivables, net of allowance (2006 – $713; 2005 – $670)
    27,515       27,995  
    Securities lending collateral, at market value (which approximates cost)     68,732       59,471  
    Other invested assets     29,410       27,267  
    Short-term investments, at cost (which approximates market value)     21,186       15,342  
 
      Total investments and financial services assets     710,038       679,045  
  Cash     2,140       1,897  
  Investment income due and accrued     5,732       5,727  
 
Premiums and insurance balances receivable, net of allowance (2006 – $869; 2005 – $1,011)
    18,236       15,333  
  Reinsurance assets, net of allowance (2006 – $932; 2005 – $992)     24,271       24,978  
  Deferred policy acquisition costs     38,301       33,248  
  Investments in partially owned companies     1,375       1,158  
 
Real estate and other fixed assets, net of accumulated depreciation (2006 – $5,307; 2005 – $4,990)
    8,415       7,446  
  Separate and variable accounts     67,596       63,797  
  Goodwill     8,425       8,093  
  Other assets     16,141       12,329  
 
Total assets
  $ 900,670     $ 853,051  
 
See Accompanying Notes to Consolidated Financial Statements.

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Table of Contents

American International Group, Inc. and Subsidiaries
                                             
CONSOLIDATED BALANCE SHEET (continued)
(in millions, except share data) (unaudited)
 
                     
    June 30,   December 31,
    2006   2005
 
Liabilities:
               
 
Reserve for losses and loss expenses
  $ 78,966     $ 77,169  
 
Unearned premiums
    26,113       24,243  
 
Future policy benefits for life and accident and health insurance contracts
    117,645       108,807  
 
Policyholders’ contract deposits
    233,865       227,027  
 
Other policyholders’ funds
    11,157       10,870  
 
Commissions, expenses and taxes payable
    5,060       4,769  
 
Insurance balances payable
    4,362       3,564  
 
Funds held by companies under reinsurance treaties
    3,221       4,174  
 
Income taxes payable
    5,101       6,288  
 
Financial services liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    21,571       20,811  
   
Securities sold under agreements to repurchase, at contract value
    7,803       11,047  
   
Trading liabilities
    2,273       2,546  
   
Hybrid financial instrument liabilities, at fair value
    6,652        
   
Securities and spot commodities sold but not yet purchased, at market value
    5,727       5,975  
   
Unrealized loss on swaps, options and forward transactions
    11,956       12,740  
   
Trust deposits and deposits due to banks and other depositors
    4,542       4,877  
   
Commercial paper
    9,833       6,514  
   
Notes, bonds, loans and mortgages payable
    70,561       71,313  
 
Commercial paper
    3,230       2,694  
 
Notes, bonds, loans and mortgages payable
    12,851       7,126  
 
Liabilities connected to trust preferred stock
    1,399       1,391  
 
Separate and variable accounts
    67,596       63,797  
 
Securities lending payable
    69,754       60,409  
 
Minority interest
    6,038       5,124  
 
Other liabilities (includes hybrid financial instruments: 2006 — $138)
    25,492       23,273  
 
Total liabilities
    812,768       766,548  
 
Preferred shareholders’ equity in subsidiary companies
    193       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
    2,533       2,339  
 
Retained earnings
    78,192       72,330  
 
Accumulated other comprehensive income (loss)
    2,201       6,967  
 
Treasury stock, at cost; 2006 – 153,134,393; 2005 – 154,680,704 shares of common stock
    (2,095 )     (2,197 )
 
Total shareholders’ equity
    87,709       86,317  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 900,670     $ 853,051  
 
See Accompanying Notes to Consolidated Financial Statements.

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American International Group, Inc. and Subsidiaries
                                             
CONSOLIDATED STATEMENT OF INCOME
                                     
(in millions, except per share data) (unaudited)
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
    2006   2005   2006   2005
 
Revenues:
                               
 
Premiums and other considerations
  $ 18,303     $ 17,536     $ 36,545     $ 35,216  
 
Net investment income
    5,912       5,227       11,739       10,559  
 
Realized capital gains (losses)
    (214 )     (125 )     (45 )     12  
 
Other revenues
    2,742       5,265       5,763       9,318  
 
 
Total revenues
    26,743       27,903       54,002       55,105  
 
Benefits and expenses:
                               
 
Incurred policy losses and benefits
    13,988       14,283       28,988       29,156  
 
Insurance acquisition and other operating expenses
    7,514       6,919       14,980       13,599  
 
 
Total benefits and expenses
    21,502       21,202       43,968       42,755  
 
Income before income taxes, minority interest and cumulative effect of an accounting change
    5,241       6,701       10,034       12,350  
 
Income taxes
    1,688       2,083       3,123       3,789  
 
Income before minority interest and cumulative effect of an accounting change
    3,553       4,618       6,911       8,561  
 
Minority interest
    (363 )     (129 )     (560 )     (273 )
 
Income before cumulative effect of an accounting change
    3,190       4,489       6,351       8,288  
 
Cumulative effect of an accounting change, net of tax
                34        
 
Net income
  $ 3,190     $ 4,489     $ 6,385     $ 8,288  
 
Earnings per common share:
                               
 
Basic
                               
   
Income before cumulative effect of an accounting change
  $ 1.23     $ 1.73     $ 2.44     $ 3.19  
   
Cumulative effect of an accounting change, net of tax
                0.01        
   
Net income
  $ 1.23     $ 1.73     $ 2.45     $ 3.19  
 
 
Diluted
                               
   
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.71     $ 2.42     $ 3.16  
   
Cumulative effect of an accounting change, net of tax
                0.01        
   
Net income
  $ 1.21     $ 1.71     $ 2.43     $ 3.16  
 
Dividends declared per common share
  $ 0.165     $ 0.125     $ 0.315     $ 0.30  
 
Average shares outstanding:
                               
 
Basic
    2,606       2,596       2,606       2,596  
 
Diluted
    2,625       2,623       2,624       2,623  
 
See Accompanying Notes to Consolidated Financial Statements.

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American International Group, Inc. and Subsidiaries
                                             
CONSOLIDATED STATEMENT OF CASH FLOWS
                       
(in millions) (unaudited)
 
Six Months Ended June 30,   2006   2005
 
Summary:
               
 
Net cash provided by (used in) operating activities
  $ 6,978     $ 13,689  
 
Net cash used in investing activities
    (40,048 )     (35,230 )
 
Net cash provided by financing activities
    32,243       22,097  
 
Effect of exchange rate changes on cash
    1,070       (827 )
 
 
Change in cash
    243       (271 )
 
Cash at beginning of period
    1,897       2,009  
 
 
Cash at end of period
  $ 2,140     $ 1,738  
 
Cash flows from operating activities:
               
 
Net income
  $ 6,385     $ 8,288  
 
 
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
    12,434       7,562  
     
Premiums and insurance balances receivable and payable – net
    (1,229 )     87  
     
Reinsurance assets
    707       137  
     
Deferred policy acquisition costs
    (3,150 )     (1,267 )
     
Investment income due and accrued
    (5 )     (91 )
     
Funds held under reinsurance treaties
    (953 )     376  
     
Other policyholders’ funds
    287       52  
     
Income taxes payable
    918       1,170  
     
Commissions, expenses and taxes payable
    291       119  
     
Other assets and liabilities – net
    (1,869 )     (235 )
     
Bonds, common and preferred stocks trading, at market value
    (3,749 )     (1,775 )
     
Trading assets and liabilities – net
    (414 )     1,111  
     
Trading securities, at market value
    1,334       (1,181 )
     
Spot commodities
    (705 )     80  
     
Net unrealized (gain) loss on swaps, options and forward transactions
    (990 )     (788 )
     
Securities purchased under agreements to resell
    462       13,696  
     
Securities sold under agreements to repurchase
    (3,244 )     (13,084 )
     
Securities and spot commodities sold but not yet purchased, at market value
    (248 )     (534 )
   
Realized capital (gains) losses
    45       (12 )
   
Equity in income of partially owned companies and other invested assets
    (1,410 )     (899 )
   
Amortization of premium and discount on securities
    201       187  
   
Depreciation expenses, principally flight equipment
    1,137       836  
   
Provision for finance receivable losses
    245       175  
   
Finance receivables held for sale – originations and purchases
    (4,911 )     (5,144 )
   
Finance receivables sold
    5,250       4,775  
   
Other – net
    159       48  
 
   
Total adjustments
    593       5,401  
 
Net cash provided by (used in) operating activities
  $ 6,978     $ 13,689  
 
See Accompanying Notes to Consolidated Financial Statements.

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American International Group, Inc. and Subsidiaries
                                             
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
                 
(in millions) (unaudited)
 
Six Months Ended June 30,   2006   2005
 
Cash flows from investing activities:
               
    Cost of bonds, at market sold
  $ 50,578     $ 62,719  
    Cost of bonds, at market matured or redeemed
    8,087       7,717  
    Cost of equity securities sold
    6,739       5,896  
    Realized capital gains (losses)
    (45 )     12  
    Purchases of fixed maturities
    (71,965 )     (86,153 )
    Purchases of equity securities
    (8,615 )     (7,151 )
    Mortgage, policy, collateral and guaranteed loans granted
    (4,343 )     (2,702 )
    Repayments of mortgage, policy, collateral and guaranteed loans
    1,648       1,520  
    Sales of securities available for sale
    2,608       1,949  
    Maturities of securities available for sale
    210       2,451  
    Purchases of securities available for sale
    (3,604 )     (7,350 )
    Sales of flight equipment
    354       243  
    Purchases of flight equipment
    (4,171 )     (4,243 )
    Change in securities lending collateral
    (9,261 )     (7,156 )
    Net additions to real estate and other fixed assets
    (739 )     (400 )
    Sales or distributions of other invested assets
    7,814       5,835  
    Other invested assets
    (7,970 )     (7,169 )
    Change in short-term investments
    (6,529 )     1,992  
    Investments in partially owned companies
    (21 )     (3 )
    Finance receivables held for investment – originations and purchases
    (7,053 )     (9,267 )
    Finance receivable principal payments received
    6,230       6,030  
 
Net cash used in investing activities
  $ (40,048 )   $ (35,230 )
 
Cash flows from financing activities:
               
    Receipts from policyholders’ contract deposits
  $ 27,069     $ 26,038  
    Withdrawals from policyholders’ contract deposits
    (20,231 )     (17,032 )
    Change in trust deposits and deposits due to banks and other depositors
    (335 )     (94 )
    Change in commercial paper
    2,979       3,171  
    Proceeds from notes, bonds, loans and mortgages payable, and hybrid
    financial instrument liabilities
    22,392       25,645  
    Repayments on notes, bonds, loans and mortgages payable, and hybrid
    financial instrument liabilities
    (9,037 )     (23,903 )
    Proceeds from guaranteed investment agreements
    6,471       6,760  
    Maturities of guaranteed investment agreements
    (5,711 )     (4,880 )
    Change in securities lending payable
    9,345       7,156  
    Proceeds from common stock issued
    63       36  
    Cash dividends to shareholders
    (780 )     (641 )
    Acquisition of treasury stock
    (4 )     (168 )
    Other – net
    22       9  
 
Net cash provided by financing activities
  $ 32,243     $ 22,097  
 
Supplementary information:
               
Taxes paid
  $ 2,100     $ 1,466  
 
Interest paid
  $ 2,870     $ 2,649  
 
See Accompanying Notes to Consolidated Financial Statements.

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American International Group, Inc. and Subsidiaries
                                             
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
                                     
(in millions, except per share data) (unaudited)
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
    2006   2005   2006   2005
 
Comprehensive income (loss):
                               
 
Net income
  $ 3,190     $ 4,489     $ 6,385     $ 8,288  
 
Other comprehensive income (loss):
                               
 
Unrealized appreciation (depreciation) of investments – net of reclassification adjustments
    (5,734 )     4,817       (8,333 )     2,282  
   
Deferred income tax benefit (expense) on above changes
    1,743       (1,759 )     2,843       (503 )
 
Foreign currency translation adjustments
    520       (773 )     1,070       (826 )
   
Deferred income tax benefit (expense) on above changes
    (59 )     497       (349 )     501  
 
Net derivative gains (losses) arising from cash flow hedging activities
    4       (80 )     8       70  
   
Deferred income tax (expense) benefit on above changes
    (16 )     40       (3 )     (71 )
 
Retirement plan liabilities adjustment, net of tax
    34       2       (2 )     (28 )
 
Other comprehensive income (loss)
    (3,508 )     2,744       (4,766 )     1,425  
 
Comprehensive income (loss)
  $ (318 )   $ 7,233     $ 1,619     $ 9,713  
 
See Accompanying Notes to Consolidated Financial Statements.

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American International Group, Inc. and Subsidiaries
                                             
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
  1.  Financial Statement Presentation
These unaudited condensed consolidated financial statements do not include certain financial information required by U.S. generally accepted accounting principles (GAAP) for complete financial statements and should be read in conjunction with the audited consolidated financial statements and the related notes, included in the Annual Report on Form 10-K/A of American International Group, Inc. (AIG) for the year ended December 31, 2005 (2005 Annual Report on Form 10-K/A).
In the opinion of management, the consolidated financial statements contain the normal recurring adjustments necessary for a fair statement of the results presented herein. Intercompany accounts and transactions have been eliminated. Certain accounts have been reclassified in the 2005 financial statements to conform to their 2006 presentation. See also Note 11 herein.
During the second quarter of 2006, as part of its continuing remediation efforts, AIG identified and recorded an out of period adjustment related to the accounting for certain interests in unit investment trusts in accordance with FIN 46(R), “Consolidation of Variable Interest Entities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. These investments had previously been accounted for as available for sale securities, with changes in market values being reflected in other comprehensive income, net of deferred income taxes. Beginning with the second quarter of 2006, the changes in market values are included in AIG’s net investment income. The adjustment decreased Unrealized appreciation (depreciation) of investments – net of reclassification adjustments, and the related Deferred income tax benefit (expense), in the Consolidated Statement of Comprehensive Income (Loss) by approximately $576 million and approximately $202 million, respectively, for the three and six-month periods ended June 30, 2006 and increased Net investment income by $653 million, increased Incurred policy losses and benefits, related to certain participating policyholder funds, by $77 million, and increased Income taxes by $202 million in the Consolidated Statement of Income for the three and six-month periods ended June 30, 2006. There was no effect on Total shareholders’ equity as of June 30, 2006 or December 31, 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  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 major operating segment for the three and six-month periods ended June 30, 2006 and 2005:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Operating Segments        
(in millions)   2006   2005   2006   2005
 
Revenues(a):
                               
 
General Insurance(b)(h)
  $ 12,167     $ 11,405     $ 23,823     $ 22,624  
 
Life Insurance & Retirement Services(c)(h)
    11,705       11,517       24,344       23,292  
 
Financial Services(d)
    1,226       3,778       2,841       6,214  
 
Asset Management(e)
    1,621       1,219       2,860       2,596  
 
Other
    24       (16 )     134       379  
 
Consolidated
  $ 26,743     $ 27,903     $ 54,002     $ 55,105  
 
Operating income (loss)(a)(f):
                               
 
General Insurance(h)
  $ 2,863     $ 1,885     $ 5,194     $ 3,527  
 
Life Insurance & Retirement Services(g)(h)
    2,302       2,324       4,857       4,505  
 
Financial Services(g)
    (548 )     2,214       (707 )     3,259  
 
Asset Management
    811       524       1,272       1,114  
 
Other(i)
    (187 )     (246 )     (582 )     (55 )
 
Consolidated
  $ 5,241     $ 6,701     $ 10,034     $ 12,350  
 
(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 three-month periods ended June 30, 2006 and 2005, the effect was $(1.08) billion and $1.63 billion, respectively, in revenues and $(1.08) billion and $1.61 billion, respectively, in operating income. For the six-month periods ended June 30, 2006 and 2005, the effect was $(1.30) billion and $2.56 billion, respectively, in revenues and $(1.30) billion and $2.62 billion, respectively, in operating income. These amounts result primarily from interest rate and foreign currency derivatives which are 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 $(21) million and $(103) million in the three-month periods ended June 30, 2006 and 2005, respectively, and $335 million and $(183) million in the six-month periods ended June 30, 2006 and 2005, respectively.
(d)  Represents interest, lease and finance charges.
(e)  Represents management and advisory fees and net investment income with respect to Guaranteed Investment Contracts (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. Additional allowances of $44 million were recorded in the first quarter of 2006, by each segment, for losses in these credit card operations.
(h)  Includes the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. For the three and six-month periods ended June 30, 2006 the effect was an increase of $432 million in revenues and operating income for General Insurance and an increase of $221 million and $144 million in revenues and operating income, respectively, for Life Insurance & Retirement Services.
(i)  The operating loss for the Other category is as follows:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2006   2005   2006   2005
 
Operating income (loss):
                               
 
Equity earnings in unconsolidated subsidiaries
  $ 111     $ 36     $ 130     $ 96  
 
Compensation expense – SICO Plans
    (14 )     (60 )     (90 )     (67 )
 
Compensation expense – C.V. Starr tender offer
                (54 )      
 
Interest expense
    (223 )     (127 )     (406 )     (251 )
 
Unallocated corporate expenses
    (71 )     (108 )     (261 )     (195 )
 
Realized capital gains (losses)
    24       (16 )     134       379  
 
Other miscellaneous, net
    (14 )     29       (35 )     (17 )
 
Total Other
  $ (187 )   $ (246 )   $ (582 )   $ (55 )
 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  2.  Segment Information (continued)
Each of the General Insurance sub-segments is comprised of groupings of major products and services as follows: Domestic Brokerage Group is comprised of domestic commercial insurance products and services; Transatlantic is comprised of reinsurance products and services sold to other general insurance companies; Personal Lines are comprised of general insurance products and services sold to individuals; Mortgage Guaranty is comprised of products insuring against losses arising under certain loan agreements; and Foreign General is comprised of general insurance products sold overseas.
The following table summarizes AIG’s General Insurance operations by major internal reporting unit for the three and six-month periods ended June 30, 2006 and 2005:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
General Insurance        
(in millions)   2006   2005   2006   2005
 
Revenues:
                               
 
Domestic Brokerage Group
  $ 6,605     $ 6,241     $ 13,160     $ 12,530  
 
Transatlantic
    1,015       948       2,031       1,930  
 
Personal Lines
    1,223       1,209       2,438       2,380  
 
Mortgage Guaranty
    212       173       410       342  
 
Foreign General(a)
    3,112       2,835       5,782       5,437  
 
Reclassifications and Eliminations
          (1 )     2       5  
 
Total General Insurance
  $ 12,167     $ 11,405     $ 23,823     $ 22,624  
 
Operating Income(b):
                               
 
Domestic Brokerage Group
  $ 1,534     $ 805     $ 2,891     $ 1,518  
 
Transatlantic
    143       99       284       213  
 
Personal Lines
    118       102       219       211  
 
Mortgage Guaranty
    107       109       216       213  
 
Foreign General(a)
    961       771       1,582       1,367  
 
Reclassifications and Eliminations
          (1 )     2       5  
 
Total General Insurance
  $ 2,863     $ 1,885     $ 5,194     $ 3,527  
 
(a)  Includes the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. For the three and six-month periods ended June 30, 2006 the effect was an increase of $412 million in revenues and operating income.
 
(b)  Includes additional (reduction in) losses incurred and net reinstatement premiums primarily related to prior year catastrophes of $(51) million and $27 million, in the three-month periods ended June 30, 2006 and 2005, respectively. Such losses and premiums were $48 million and $198 million in the six-month periods ended June 30, 2006 and 2005, respectively.
Life Insurance & Retirement Services is comprised of two major groupings of products and services: insurance-oriented products and services and retirement savings products and services. Substantially all of the retirement savings products are reported in the VALIC, AIG Annuity and AIG SunAmerica sub-segment.
The following table summarizes AIG’s Life Insurance & Retirement Services operations by major internal reporting unit for the three and six-month periods ended June 30, 2006 and 2005:
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Life Insurance & Retirement Services        
(in millions)   2006   2005   2006   2005
 
Revenues:
                               
 
Foreign:
                               
   
AIA, AIRCO and Nan Shan(a) (e)
  $ 4,165     $ 3,858     $ 8,517     $ 7,924  
   
ALICO, AIG Star Life and AIG Edison Life(b)
    3,652       3,609       7,747       7,128  
   
Philamlife and Other
    153       127       277       257  
 
Domestic:
                               
   
AGLA and AG Life(c)
    2,222       2,114       4,589       4,502  
   
VALIC, AIG Annuity and AIG SunAmerica(d)
    1,513       1,809       3,214       3,481  
 
Total Life Insurance & Retirement Services
  $ 11,705     $ 11,517     $ 24,344     $ 23,292  
 
Operating Income:
                               
 
Foreign:
                               
   
AIA, AIRCO and Nan Shan(a) (e)
  $ 736     $ 649     $ 1,436     $ 1,237  
   
ALICO, AIG Star Life and AIG Edison Life(b)
    955       798       1,913       1,394  
   
Philamlife and Other
    30       17       41       33  
 
Domestic:
                               
   
AGLA and AG Life(c)
    235       240       601       706  
   
VALIC, AIG Annuity and AIG SunAmerica(d)
    346       620       866       1,135  
 
Total Life Insurance & Retirement Services
  $ 2,302     $ 2,324     $ 4,857     $ 4,505  
 
(a)  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 $(15) million and $110 million for the three-month periods ended June 30, 2006 and 2005, respectively, and $198 million and $176 million for the six-month periods ended June 30, 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are losses of $(131) million and gains of $50 million for the three-month periods ended June 30, 2006 and 2005, respectively, and gains of $112 million and $61 million for the six-month periods ended June 30, 2006 and 2005, respectively. Includes $44 million in additional allowances for losses recorded in the first quarter of 2006 from AIG Credit Card Company (Taiwan).

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  2.  Segment Information (continued)
(b)  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 $162 million and $11 million for the three-month periods ended June 30, 2006 and 2005, respectively, and gains of $311 million and losses of $(128) million for the six-month periods ended June 30, 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $111 million and losses of $(78) million for the three-month periods ended June 30, 2006 and 2005, respectively, and gains of $157 million and losses of $(263) million for the six-month periods ended June 30, 2006 and 2005, respectively.
(c)  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 losses of $(75) million and $(135) million for the three-month periods ended June 30, 2006 and 2005, respectively, and losses of $(67) million and $(63) million for the six-month periods ended June 30, 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are gains of $29 million and losses of $(171) million for the three-month periods ended June 30, 2006 and 2005, respectively, and gains of $115 million and losses of $(66) million for the six-month periods ended June 30, 2006 and 2005, respectively.
(d)  “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 $(307) million and gains of $57 million for the three-month periods ended June 30, 2006 and 2005, respectively, and losses of $(509) million and $(22) million for the six-month periods ended June 30, 2006 and 2005, respectively. The effects of FAS 133 and the application of FAS 52 included in realized capital gains (losses) are losses of $(42) million and gains of $96 million for the three month periods ended June 30, 2006 and 2005, respectively, and losses of $(36) million and gains of $85 million for the six-month periods ended June 30, 2006 and 2005, respectively.
(e)  Includes the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. For the three and six-month periods ended June 30, 2006 the effect was an increase of $221 million in revenues and $144 million in operating income.
The following table summarizes AIG’s Financial Services operations by major internal reporting unit for the three and six-month periods ended June 30, 2006 and 2005:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Financial Services        
(in millions)   2006   2005   2006   2005
 
Revenues(a):
                               
 
Aircraft Finance(b)
  $ 1,042     $ 891     $ 2,007     $ 1,718  
 
Capital Markets(c)(d)
    (788 )     1,975       (1,088 )     2,731  
 
Consumer Finance(e)
    939       891       1,863       1,724  
 
Other
    33       21       59       41  
 
Total Financial Services
  $ 1,226     $ 3,778     $ 2,841     $ 6,214  
 
Operating income (loss)(a):
                               
 
Aircraft Finance
  $ 189     $ 124     $ 318     $ 311  
 
Capital Markets(d)
    (952 )     1,836       (1,422 )     2,456  
 
Consumer Finance(f)
    199       238       374       459  
 
Other
    16       16       23       33  
 
Total Financial Services
  $ (548 )   $ 2,214     $ (707 )   $ 3,259  
 
(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 three and six-month periods ended June 30, 2005, the effect was $(64) million and $(49) million, respectively, in operating income for Aircraft Finance. During 2006, Aircraft Finance’s derivative gains and losses are reported as part of the Other category and not reported in Aircraft Finance’s operating income. For the three-month periods ended June 30, 2006 and 2005, the effect was $(1.16) billion and $1.70 billion in both revenues and operating income, respectively, for Capital Markets. For the six-month periods ended June 30, 2006 and 2005, the effect was $(1.84) billion and $2.16 billion in both revenues and operating income, respectively, for Capital Markets. These amounts result primarily from interest rate and foreign currency derivatives which are 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 three-month periods ended June 30, 2006 and 2005 are $8 million and $21 million, respectively. The amount of such tax credits and benefits for the six-month periods ended June 30, 2006 and 2005 are $26 million and $40 million, respectively.
(e)  Revenues are primarily finance charges.
(f)  Includes $44 million in additional allowances for losses recorded in the first quarter of 2006 from AIG Credit Card Company (Taiwan).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  2.  Segment Information (continued)
The following table summarizes AIG’s Asset Management revenues and operating income for the three and six-month periods ended June 30, 2006 and 2005:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Asset Management        
(in millions)   2006   2005   2006   2005
 
Revenues:
                               
 
Guaranteed Investment Contracts
  $ 850     $ 903     $ 1,672     $ 1,799  
 
Institutional Asset Management
    619       178       898       497  
 
Brokerage Services and Mutual Funds
    73       62       146       125  
 
Other
    79       76       144       175  
 
Total Asset Management
  $ 1,621     $ 1,219     $ 2,860     $ 2,596  
 
Operating income:
                               
 
Guaranteed Investment Contracts(a)
  $ 242     $ 326     $ 460     $ 645  
 
Institutional Asset Management(b)(c)
    473       108       632       269  
 
Brokerage Services and Mutual Funds
    21       17       44       30  
 
Other
    75       73       136       170  
 
Total Asset Management
  $ 811     $ 524     $ 1,272     $ 1,114  
 
(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 three and six-month periods ended June 30, 2005, the effect was $47 million and $109 million, respectively, in operating income. During 2006, these derivative gains and losses are reported as part of the Other category, and not reported in Asset Management operating income.
(b)  Includes the full results of certain AIG managed private equity and real estate funds that are consolidated pursuant to FIN 46(R), “Consolidation of Variable Interest Entities”. Also includes $183 million and $37 million for the three-month periods ended June 30, 2006 and 2005, respectively, and $210 million and $112 million for the six-month periods ended June 30, 2006 and 2005, respectively, of third-party limited partner earnings offset in minority interest expense, which is not a component of operating income.
(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 three and six-month periods ended June 30, 2006, operating income includes $87 million and $156 million, respectively, of third-party limited partner earnings offset in minority interest expense, which is not a component of operating income.
  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 (EPS):
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions, except per share data)   2006   2005   2006   2005
 
Numerator for earnings per share:
                               
Income before cumulative effect of an accounting change
  $ 3,190     $ 4,489     $ 6,351     $ 8,288  
Cumulative effect of an accounting change, net of tax
                34        
 
Net income applicable to common stock for basic EPS
  $ 3,190     $ 4,489     $ 6,385     $ 8,288  
Interest on contingently convertible bonds, net of tax (a)
    3       2       6       5  
 
Net income applicable to common stock for diluted EPS
  $ 3,193     $ 4,491     $ 6,391     $ 8,293  
Cumulative effect of an accounting change, net of tax
                34        
 
Income before cumulative effect of an accounting change applicable to common stock for diluted EPS
  $ 3,193     $ 4,491     $ 6,357     $ 8,293  
 
Denominator for earnings per share:
                               
 
Weighted-average shares outstanding used in the computation of EPS:
                               
   
Common stock issued
    2,752       2,752       2,752       2,752  
   
Common stock in treasury
    (153 )     (156 )     (153 )     (156 )
   
Deferred shares
    7             7        
 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  3.  Earnings Per Share (continued)
                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions, except per share data)   2006   2005   2006   2005
 
Weighted-average shares outstanding — basic
    2,606       2,596       2,606       2,596  
Incremental shares from potential common stock:
                               
Weighted-average number of shares arising from outstanding employee stock plans (treasury stock method)(b)
    10       18       9       18  
Contingently convertible bonds(a)
    9       9       9       9  
 
Weighted-adjusted average shares outstanding — diluted (b)
    2,625       2,623       2,624       2,623  
 
Earnings per share:
                               
Basic:
                               
Income before cumulative effect of an accounting change
  $ 1.23     $ 1.73     $ 2.44     $ 3.19  
Cumulative effect of an accounting change, net of tax
                0.01        
 
Net Income
  $ 1.23     $ 1.73     $ 2.45     $ 3.19  
 
Diluted:
                               
Income before cumulative effect of an accounting change
  $ 1.21     $ 1.71     $ 2.42     $ 3.16  
Cumulative effect on an accounting change, net of tax
                0.01        
 
Net income
  $ 1.21     $ 1.71     $ 2.43     $ 3.16  
 
(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 share equivalents 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 share equivalents excluded were 15 million and 23 million for the first six months of 2006 and 2005, respectively.
     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 June 30, 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. During the six months ended June 30, 2005, AIG purchased in the open market 2,477,100 shares of its common stock.
  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 $14 million and $60 million for the three-month periods ended June 30, 2006 and 2005, respectively, and $90 million and $67 million for the six-month periods ended June 30, 2006 and 2005, respectively. Compensation expense in the first quarter of 2006 included various out of period

12


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  4.  Benefits Provided by Starr International Company, Inc. (continued)
adjustments totaling $61 million, primarily relating to stock-splits and other miscellaneous items. 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 recorded in the first quarter with respect to the Starr offer, was included in the first six 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. 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 May 26, 2006 by Starr, SICO, Edward E. Matthews, Maurice R. Greenberg, the Maurice R. and Corinne P. Greenberg Family Foundation, Inc., the Universal Foundation, Inc. and the Maurice R. and Corinne P. Greenberg Joint Tenancy Company, LLC, these reporting persons may be deemed to beneficially own 393,157,543 shares of common stock. Based on the shares of common stock outstanding as of July 31, 2006, this ownership represents approximately 15 percent of the voting stock of AIG.
     (b) Transactions with Related Parties: In the ordinary course of business during the first six months of 2006, AIG and its subsidiaries paid commissions to Starr and its subsidiaries for the production and management of insurance business. As of July 25, 2006, none of the Starr agencies serve as agents for AIG companies. There were no significant receivables from/payables to related parties at June 30, 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/A.)
     (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 June 30, 2006, ILFC had committed to purchase 266 new aircraft deliverable from 2006 through 2015 at an estimated aggregate purchase price of $18.9 billion and had options to purchase 13 new aircraft at an estimated aggregate purchase price of $1.4 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 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  6.  Commitments and Contingent Liabilities (continued)
     (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 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 for USLIFE to present its challenges to certain cessions to the contract. AIG holds a reserve of approximately $374 million related to this matter as of June 30, 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 six months of 2006 totaling approximately $1.64 billion, $225 million of which represented fines and penalties. Amounts held in escrow totaling $685 million, including interest thereon, are included in other assets and other liabilities at June 30, 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  6.  Commitments and Contingent Liabilities (continued)
     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 the consolidated action, in response to which defendants have filed an opposition. 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. A conditional transfer order was issued on May 31, 2006. 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. On April 17, 2006, the AIG defendants moved to stay this action pending resolution of the consolidated action.
     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. AIG filed answers in both securities actions in June 2006, as did other defendants.
     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.
     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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  6.  Commitments and Contingent Liabilities (continued)
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. The court approved a stipulation dismissing that action on May 15, 2006.
     On June 20, 2006, SICO filed suit in Delaware Chancery Court seeking the inspection of certain books and records of AIG.
     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 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. 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. In response to an order, dated July 5, 2006, dismissing certain of its claims, the plaintiff filed a second amended complaint on July 21, 2006, which adds additional claims against Starr.
     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 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 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 six months of 2006 have been reduced to reflect an estimated phase-out of the tax credits from 2006 synthetic fuel production based on the observed price of domestic crude oil. Since the phase-out of tax credits from 2006 synthetic fuel production will depend on the average wellhead price of domestic crude oil for the entire 2006 calendar year, it is not possible to determine the extent to which the 2006 tax credits actually will be phased-out. As a result, the actual level of tax credits from 2006 synthetic fuel production may be higher or lower than the current estimate. AIG evaluates the production levels of its synthetic fuel production facilities in light of the risk of phase-out of the associated tax credits. As a result of the current high domestic crude oil prices, AIG has determined to reduce its production levels for the month of August 2006 and intends to continue to evaluate and possibly adjust production levels in light of this risk for the remainder of 2006. Regardless of oil prices, the tax credits expire after 2007.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  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 and six-month periods ended June 30, 2006 and 2005:
                                                   
    Pensions   Postretirement
         
    Non-U.S.   U.S.       Non-U.S.   U.S.    
(in millions)   Plans   Plans   Total   Plans   Plans   Total
 
Three Months Ended June 30, 2006
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 18     $ 31     $ 49     $ 1     $ 2     $ 3  
 
Interest cost
    8       41       49             2       2  
 
Expected return on assets
    (7 )     (49 )     (56 )                  
 
Amortization of prior service cost
    (2 )           (2 )           (1 )     (1 )
 
Recognized actuarial loss
    4       19       23                    
 
Net period benefit cost
  $ 21     $ 42     $ 63     $ 1     $ 3     $ 4  
 
Three Months Ended June 30, 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 )           (3 )           (2 )     (2 )
 
FAS 88 loss due to settlements
    1             1                    
 
Recognized actuarial loss
    6       16       22             1       1  
 
Net period benefit cost
  $ 26     $ 38     $ 64     $ 1     $ 5     $ 6  
 
Six Months Ended June 30, 2006
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 37     $ 62     $ 99     $ 2     $ 3     $ 5  
 
Interest cost
    17       81       98       1       5       6  
 
Expected return on assets
    (14 )     (97 )     (111 )                  
 
Amortization of prior service cost
    (4 )     (1 )     (5 )           (3 )     (3 )
 
Recognized actuarial loss
    8       38       46                    
 
Net period benefit cost
  $ 44     $ 83     $ 127     $ 3     $ 5     $ 8  
 
Six Months Ended June 30, 2005
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 37     $ 52     $ 89     $ 2     $ 3     $ 5  
 
Interest cost
    16       74       90       1       7       8  
 
Expected return on assets
    (11 )     (82 )     (93 )                  
 
Amortization of prior service cost
    (5 )     (2 )     (7 )           (3 )     (3 )
 
FAS 88 loss due to settlements
    3             3                    
 
Amortization of transition liability
    1             1                    
 
Recognized actuarial loss
    11       33       44             1       1  
 
Net period benefit cost
  $ 52     $ 75     $ 127     $ 3     $ 8     $ 11  
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  8.  Recent Accounting Standards
Accounting Changes
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 and accretion of income. 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 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. AIG adopted the provisions of the revised FAS 123R and its related interpretive guidance on January 1, 2006.
     For its service-based awards under the 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, the AIG Deferred Compensation Profit Participant Plan and the AIG Partners 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 after the participant turns 65 and retires. 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 is 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, the 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.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  8.  Recent Accounting Standards (continued)
     On June 29, 2005, the 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 February 16, 2006, the 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 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.
     In connection with AIG’s early adoption of FAS 155, structured note liabilities of $6.7 billion, other structured liabilities in conjunction with equity derivative transactions of $138 million, and hybrid financial instruments of $495 million at June 30, 2006 are now carried at fair value. The effect on earnings for the three and six-month periods ended June 30, 2006, for changes in the fair value of hybrid financial instruments, was a pre-tax loss of $153 million and $123 million, respectively, and is reflected in income.
     On March 27, 2006, the 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.
     On June 29, 2006, AIG restructured its ownership of life settlement contracts with no effect on the economic substance of these investments. At the same time, AIG paid $610 million to its former co-investors to acquire all the remaining interests in life settlement contracts held in previously non-consolidated trusts.
     At June 30, 2006, the carrying value of AIG’s life settlement contracts was $1.20 billion, and is included in Other invested assets on the consolidated balance sheet. These investments are monitored for impairment on a contract by contract basis quarterly. During the three month period ended June 30, 2006, income recognized on life settlement contracts previously held in non-consolidated trusts was $5 million, and is included in net investment income on the consolidated statement of income. Such income totaled $13 million for the six month period then ended. Further information regarding life settlement contracts as of June 30, 2006 is as follows:
                           
(dollars in millions)            
 
Remaining Life
Expectancy   Number of   Carrying   Face Value
of Insureds   Contracts   Value   (Death Benefits)
 
0 – 1 year
    2     $ 3     $ 4  
1 – 2 years
    20       12       15  
2 – 3 years
    83       69       111  
3 – 4 years
    132       115       208  
4 – 5 years
    136       72       154  
Thereafter
    1,501       925       3,454  
 
 
Total
    1,874     $ 1,196     $ 3,946  
 
     As of June 30, 2006, the anticipated life insurance premiums required to keep the life settlement contracts in force, payable in the ensuing twelve months ending June 30, 2007, and the four succeeding years ending June 30, 2011 are $80 million, $83 million, $88 million, $89 million, and $89 million, respectively.
Future Application of Accounting Standards
     On September 19, 2005, the 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). SOP 05-1 provides guidance on accounting for deferred acquisition costs on internal 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

19


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
 8. Recent Accounting Standards (continued)
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 April 13, 2006, the 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. The requirements are effective beginning in the third quarter of 2006 and are to be applied to all new variable interest entities with which AIG becomes involved. 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.
     On July 13, 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in tax positions. This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and additional disclosures. The effective date of this implementation guidance is January 1, 2007, with the cumulative effect of the change in accounting principle recorded as an adjustment to opening retained earnings. AIG is currently assessing the effect of implementing this guidance.

20


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt
The following condensed consolidating financial statements are provided in compliance with Regulation S-X of the Securities and Exchange Commission.
(a) American General Corporation (AGC) is a holding company and a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all outstanding debt of AGC.
American General Corporation, as issuer:
Condensed Consolidating Balance Sheet
                                           
    American                
    International                
June 30, 2006   Group, Inc.       Other       Consolidated
(in millions)   Guarantor   AGC   Subsidiaries   Eliminations   AIG
 
Assets:
                                       
 
Invested assets
  $ 3,151     $     $ 722,978     $ (16,091 )   $ 710,038  
 
Cash
    53             2,087             2,140  
 
Carrying value of subsidiaries and partially owned companies, at equity
    95,249       25,747       14,784       (134,405 )     1,375  
 
Other assets
    3,788       2,607       183,147       (2,425 )     187,117  
 
Total assets
  $ 102,241     $ 28,354     $ 922,996     $ (152,921 )   $ 900,670  
 
Liabilities:
                                       
 
Insurance liabilities
  $ 355     $     $ 480,098     $ (64 )   $ 480,389  
 
Debt
    9,190       2,096       129,383       (14,572 )     126,097  
 
Other liabilities
    4,987       3,841       201,413       (3,959 )     206,282  
 
Total liabilities
    14,532       5,937       810,894       (18,595 )     812,768  
 
Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    87,709       22,417       111,909       (134,326 )     87,709  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 102,241     $ 28,354     $ 922,996     $ (152,921 )   $ 900,670  
 
                                           
    American                
    International                
December 31, 2005   Group, Inc.       Other       Consolidated
(in millions)   Guarantor   AGC   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  
 

21


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statement of Income
                                         
    American                
    International                
Three Months Ended June 30, 2006   Group, Inc.       Other       Consolidated
(in millions)   Guarantor   AGC   Subsidiaries   Eliminations   AIG
 
Operating income (loss)
  $ (436 )   $ (48 )   $ 5,725     $     $ 5,241  
Equity in undistributed net income of consolidated subsidiaries
    3,507       309             (3,816 )      
Dividend income from consolidated subsidiaries
    380       154             (534 )      
Income taxes (benefits)
    261       (17 )     1,444             1,688  
Minority interest
                (363 )           (363 )
 
Net income (loss)
  $ 3,190     $ 432     $ 3,918     $ (4,350 )   $ 3,190  
 
                                         
    American                
    International                
Three Months Ended June 30, 2005   Group, Inc.       Other       Consolidated
(in millions)   Guarantor   AGC   Subsidiaries   Eliminations   AIG
 
Operating income (loss)
  $ 150     $ (40 )   $ 6,591     $     $ 6,701  
Equity in undistributed net income of consolidated subsidiaries
    3,784       590             (4,374 )      
Dividend income from consolidated subsidiaries
    657                   (657 )      
Income taxes (benefits)
    102       (14 )     1,995             2,083  
Minority interest
                (129 )           (129 )
 
Net income (loss)
  $ 4,489     $ 564     $ 4,467     $ (5,031 )   $ 4,489  
 
                                         
    American                
    International                
Six Months Ended June 30, 2006   Group, Inc.       Other        
(in millions)   Guarantor   AGC   Subsidiaries   Eliminations   Consolidated
                    AIG
 
Operating income (loss)
  $ (722 )   $ (86 )   $ 10,842     $     $ 10,034  
Equity in undistributed net income of consolidated subsidiaries
    6,767       668             (7,435 )      
Dividend income from consolidated subsidiaries
    567       458             (1,025 )      
Income taxes (benefits)
    261       (30 )     2,892             3,123  
Minority interest
                (560 )           (560 )
Cumulative effect of an accounting change, net of tax
    34                         34  
 
Net income (loss)
  $ 6,385     $ 1,070     $ 7,390     $ (8,460 )   $ 6,385  
 
                                         
    American                
    International                
Six Months Ended June 30, 2005   Group, Inc.   AGC   Other       Consolidated
(in millions)   Guarantor   Issuer   Subsidiaries   Eliminations   AIG
 
Operating income (loss)
  $ 140     $ (76 )   $ 12,286     $     $ 12,350  
Equity in undistributed net income of consolidated subsidiaries
    7,430       1,291             (8,721 )      
Dividend income from consolidated subsidiaries
    928                   (928 )      
Income taxes (benefits)
    210       (26 )     3,605             3,789  
Minority interest
                (273 )           (273 )
 
Net income (loss)
  $ 8,288     $ 1,241     $ 8,408     $ (9,649 )   $ 8,288  
 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statements of Cash Flow
                                   
    American            
    International            
Six Months Ended June 30, 2006   Group, Inc.       Other   Consolidated
(in millions)   Guarantor   AGC   Subsidiaries   AIG
 
Net cash provided by operating activities
  $ (1,106 )   $ 112     $ 7,972     $ 6,978  
 
Cash flows from investing:
                               
 
Invested assets disposed
                77,673       77,673  
 
Invested assets acquired
    (1,577 )           (115,405 )     (116,982 )
 
Other
    (2,629 )     (17 )     1,907       (739 )
 
Net cash used in investing activities
    (4,206 )     (17 )     (35,825 )     (40,048 )
 
Cash flows from financing activities:
                               
 
Change in debts
    5,733             11,361       17,094  
 
Other
    (557 )     (95 )     15,801       15,149  
 
Net cash (used in) provided by financing activities
    5,176       (95 )     27,162       32,243  
 
Effect of exchange rate changes on cash
    (1 )           1,071       1,070  
 
Change in cash
    (137 )           380       243  
Cash at beginning of period
    190             1,707       1,897  
 
Cash at end of period
  $ 53     $     $ 2,087     $ 2,140  
 
                                   
    American            
    International            
Six Months Ended June 30, 2005   Group, Inc.       Other   Consolidated
(in millions)   Guarantor   AGC   Subsidiaries   AIG
 
Net cash provided by operating activities
  $ 721     $ 642     $ 12,326     $ 13,689  
 
Cash flows from investing:
                               
 
Invested assets disposed
    158             96,203       96,361  
 
Invested assets acquired
                (131,191 )     (131,191 )
 
Other
    (173 )     (270 )     43       (400 )
 
Net cash used in investing activities
    (15 )     (270 )     (34,945 )     (35,230 )
 
Cash flows from financing activities:
                               
 
Change in debts
    (35 )     (299 )     7,127       6,793  
 
Other
    (657 )     (73 )     16,034       15,304  
 
Net cash (used in) provided by financing activities
    (692 )     (372 )     23,161       22,097  
 
Effect of exchange rate changes on cash
    40             (867 )     (827 )
 
Change in cash
    54             (325 )     (271 )
Cash at beginning of period
    17             1,992       2,009  
 
Cash at end of period
  $ 71     $     $ 1,667     $ 1,738  
 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt (continued)
(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., as issuer:
Condensed Consolidating Balance Sheet
                                           
    American                
    International   AIG            
June 30, 2006   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   Eliminations   AIG
 
Assets:
                                       
 
Invested assets
  $ 3,151     $ *     $ 722,978     $ (16,091 )   $ 710,038  
 
Cash
    53       *       2,087             2,140  
 
Carrying value of subsidiaries and partially owned companies, at equity
    95,249             40,531       (134,405 )     1,375  
 
Other assets
    3,788       *       185,754       (2,425 )     187,117  
 
Total assets
  $ 102,241     $ *     $ 951,350     $ (152,921 )   $ 900,670  
 
Liabilities:
                                       
 
Insurance liabilities
  $ 355     $     $ 480,098     $ (64 )   $ 480,389  
 
Debt
    9,190       *       131,479       (14,572 )     126,097  
 
Other liabilities
    4,987       *       205,254       (3,959 )     206,282  
 
Total liabilities
    14,532       *       816,831       (18,595 )     812,768  
 
Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    87,709       *       134,326       (134,326 )     87,709  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 102,241     $ *     $ 951,350     $ (152,921 )   $ 900,670  
 
Amounts significantly less than $1 million.
                                           
    American                
    International   AIG            
December 31, 2005   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   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.

24


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statement of Income
                                         
    American                
    International   AIG            
Three Months Ended June 30, 2006   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   Eliminations   AIG
 
Operating income (loss)
  $ (436 )   $ *     $ 5,677     $     $ 5,241  
Equity in undistributed net income of consolidated subsidiaries
    3,507             309       (3,816 )      
Dividend income from consolidated subsidiaries
    380             154       (534 )      
Income taxes
    261       *       1,427             1,688  
Minority interest
                (363 )           (363 )
 
Net income (loss)
  $ 3,190     $ *     $ 4,350     $ (4,350 )   $ 3,190  
 
* Amounts significantly less than $1 million.
                                         
    American                
    International   AIG            
Three Months Ended June 30, 2005   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   Eliminations   AIG
 
Operating income
  $ 150     $ *     $ 6,551     $     $ 6,701  
Equity in undistributed net income of consolidated subsidiaries
    3,784             590       (4,374 )      
Dividend income from consolidated subsidiaries
    657                   (657 )      
Income taxes
    102       *       1,981             2,083  
Minority interest
                (129 )           (129 )
 
Net income (loss)
  $ 4,489     $ *     $ 5,031     $ (5,031 )   $ 4,489  
 
* Amounts significantly less than $1 million.
                                         
    American                
    International   AIG            
Six Months Ended June 30, 2006   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   Eliminations   AIG
 
Operating income (loss)
  $ (722 )   $ *     $ 10,756     $     $ 10,034  
Equity in undistributed net income of consolidated subsidiaries
    6,767             668       (7,435 )      
Dividend income from consolidated subsidiaries
    567             458       (1,025 )      
Income taxes
    261       *       2,862             3,123  
Minority interest
                (560 )           (560 )
Cumulative effect of an accounting change, net of tax
    34                         34  
 
Net income (loss)
  $ 6,385     $ *     $ 8,460     $ (8,460 )   $ 6,385  
 
Amounts significantly less than $1 million.
                                         
    American                
    International   AIG            
Six Months Ended June 30, 2005   Group, Inc.   Liquidity   Other       Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   Eliminations   AIG
 
Operating income
  $ 140     $ *     $ 12,210     $     $ 12,350  
Equity in undistributed net income of consolidated subsidiaries
    7,430             1,291       (8,721 )      
Dividend income from consolidated subsidiaries
    928                   (928 )      
Income taxes
    210       *       3,579             3,789  
Minority interest
                (273 )           (273 )
 
Net income (loss)
  $ 8,288     $ *     $ 9,649     $ (9,649 )   $ 8,288  
 
* Amounts significantly less than $1 million.

25


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  9.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statements of Cash Flow
                                   
    American            
    International   AIG        
Six Months Ended June 30, 2006   Group, Inc.   Liquidity   Other   Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   AIG
 
Net cash provided by operating activities
  $ (1,106 )   $ *     $ 8,084     $ 6,978  
 
Cash flows from investing:
                               
 
Invested assets disposed
                77,673       77,673  
 
Invested assets acquired
    (1,577 )           (115,405 )     (116,982 )
 
Other
    (2,629 )     *       1,890       (739 )
 
Net cash used in investing activities
    (4,206 )     *       (35,842 )     (40,048 )
 
Cash flows from financing activities:
                               
 
Change in debts
    5,733             11,361       17,094  
 
Other
    (557 )     *       15,706       15,149  
 
Net cash (used in) provided by financing activities
    5,176       *       27,067       32,243  
 
Effect of exchange rate changes on cash
    (1 )           1,071       1,070  
 
Change in cash
    (137 )     *       380       243  
Cash at beginning of period
    190             1,707       1,897  
 
Cash at end of period
  $ 53     $ *     $ 2,087     $ 2,140  
 
* Amounts significantly less than $1 million.
                                   
    American            
    International   AIG        
Six Months Ended June 30, 2005   Group, Inc.   Liquidity   Other   Consolidated
(in millions)   Guarantor   Corp.   Subsidiaries   AIG
 
Net cash (used in) provided by operating activities
  $ 721     $ *     $ 12,968     $ 13,689  
 
Cash flows from investing:
                               
 
Invested assets disposed
    158             96,203       96,361  
 
Invested assets acquired
                (131,191 )     (131,191 )
 
Other
    (173 )     *       (227 )     (400 )
 
Net cash used in investing activities
    (15 )     *       (35,215 )     (35,230 )
 
Cash flows from financing activities:
                               
 
Change in debts
    (35 )           6,828       6,793  
 
Other
    (657 )     *       15,961       15,304  
 
Net cash (used in) provided by financing activities
    (692 )     *       22,789       22,097  
 
Effect of exchange rate changes on cash
    40             (867 )     (827 )
 
Change in cash
    54       *       (325 )     (271 )
Cash at beginning of period
    17             1,992       2,009  
 
Cash at end of period
  $ 71     $ *     $ 1,667     $ 1,738  
 
* Amounts significantly less than $1 million.
  10.  Stock Compensation Plans
At June 30, 2006, AIG employees could be awarded 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 issued only restricted stock units (RSUs) and performance restricted stock units (Performance 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 replaces the AIG DCPPP. Stock-based compensation earned under the AIG DCPPP and the AIG Partners Plan is 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 June 30, 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.
     From January 1, 2003 through December 31, 2005, AIG accounted for share-based payment transactions with employ-

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)
ees under FAS 123, “Accounting for Stock-Based Compensation.” Share-based employee compensation expense from option awards was not recognized in the statement of income in prior periods. Effective January 1, 2006, AIG adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123R “Share-Based Payments” (FAS 123R). FAS 123R requires that companies use a fair value method to value share-based payments and recognize the related compensation expense in net earnings. AIG adopted FAS 123R using the modified prospective application method, and accordingly, financial statement amounts for the prior periods presented have not been restated to reflect the fair value method of expensing share-based compensation under FAS 123R. The modified prospective application method provides for the recognition of the fair value with respect to share-based compensation for shares subscribed for or granted on or after January 1, 2006 and all previously granted but unvested awards as of January 1, 2006.
     The adoption of FAS 123R resulted in share-based compensation expense of approximately $9 million during the first six months of 2006, related to awards which were accounted for under the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees.” AIG expects this expense to approximate $19 million for fiscal 2006. FAS 123R also requires AIG to estimate forfeitures in calculating the expense relating to share-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 of $46 million, was recorded as a cumulative effect of an accounting change, net of tax, in the first quarter of 2006. FAS 123R requires AIG to reflect the cash savings resulting from excess tax benefits in its financial statements as cash flow from financing activities, rather than as cash flow from operating activities as in prior periods. The amount of this excess tax benefit for the three and six-month periods ended June 30, 2006 was $0.6 million and $2.3 million, respectively.
The effect of the adoption of FAS 123R on the consolidated statements of income and cash flows was as follows:
                                                 
    Three Months Ended June 30, 2006   Six Months Ended June 30, 2006
         
        Including       Including
        Effect of   Effect of       Effect of   Effect of
    Pre-adoption of   Adoption of   Adoption of   Pre-adoption of   Adoption of   Adoption of
(in millions, except per share data)   FAS 123R   FAS 123R   FAS 123R   FAS 123R   FAS 123R   FAS 123R
 
Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 5,242     $ (1 )   $ 5,241     $ 10,043     $ (9 )   $ 10,034  
 
Provision for income taxes
  $ 1,686     $ 2     $ 1,688     $ 3,124     $ (1 )   $ 3,123  
 
Income before minority interest and cumulative effect of an accounting change
  $ 3,556     $ (3 )   $ 3,553     $ 6,919     $ (8 )   $ 6,911  
 
Cumulative effect of an accounting change, net of tax
  $     $     $     $     $ 34     $ 34  
 
Net income
  $ 3,193     $ (3 )   $ 3,190     $ 6,359     $ 26     $ 6,385  
 
Net cash provided by operating activities
  $ 2,923     $     $ 2,923     $ 6,980     $ (2 )   $ 6,978  
 
Net cash provided by financing activities
  $ 16,571     $     $ 16,571     $ 32,241     $ 2     $ 32,243  
 
Basic earnings per share
  $ 1.23     $     $ 1.23     $ 2.44     $ 0.01     $ 2.45  
 
Diluted earnings per share
  $ 1.21     $     $ 1.21     $ 2.42     $ 0.01     $ 2.43  
 
     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   Six Months Ended
(in millions)   June 30, 2006   June 30, 2006
 
Share-based compensation expense before tax
  $ 57     $ 211  
Income tax benefit
  $ 16     $ 28  
 
After-tax share-based compensation expense
  $ 41     $ 183  
 
     Included in share-based compensation expense of $211 million for the six months ended June 30, 2006 was a one-time compensation cost of approximately $54 million related to the Starr tender offer and various out of period adjustments totalling $61 million, primarily relating to stock-splits 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. These items were recorded in the first quarter of 2006. See Note 4 herein for a discussion of the Starr tender offer and Note 8 herein for discussion of the prospective change to the accounting for retiree eligibility provisions and forfeiture treatment.
     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 and six-month periods ended June 30, 2005.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)
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.
     At June 30, 2006, there were 20,761,320 shares reserved for future grants under the 1999 Plan and 28,321,678 shares reserved for issuance under the 1999 and 1991 Plans.
Deferrals
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, non-employee 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.
Valuation Methodology
     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 six months of 2006 and 2005:
                 
    2006   2005
 
Expected annual dividend yield(a)
    0.71%       0.36%  
Expected volatility(b)
    27.3%       34.4%  
Risk-free interest rate(c)
    4.17%       3.87%  
Expected term(d)
    7  years       7  years  
 
(a)  The dividend yield is based on the dividend yield over the twelve month period prior to the grant date.
(b)  In 2006, 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 and in 2005, expected volatility is the historical volatility based on five years of daily stock price changes.
(c)  The interest rate curves used in the valuation model were the U.S. Treasury STRIP rates with terms from 3 months to 10 years.
(d)  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 June 30, 2006, and changes for the six months then ended, were as follows:
                 
        Weighted Average
Options:   Shares   Exercise Price
 
Outstanding at beginning of year
    52,545,425     $ 54.84  
Granted
    103,000     $ 65.43  
Exercised
    (858,053 )   $ 42.80  
Forfeited or expired
    (805,027 )   $ 68.50  
Outstanding at end of period
    50,985,345     $ 54.85  
Options exercisable at end of period
    39,907,861     $ 52.54  
Weighted average fair value per share of options granted
          $ 21.28  
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)
Information about stock options outstanding at June 30, 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
    6,685,805       0.81     $ 21.31     $ 252       6,685,805       0.81     $ 21.31     $ 252  
$30.44-$41.51
    5,374,574       2.04       36.86       119       5,374,574       2.04       36.86       119  
$43.31-$53.40
    6,936,485       4.34       48.59       73       6,136,895       4.03       48.80       63  
$54.11-$59.99
    8,337,923       4.58       57.84       11       6,280,376       3.06       57.34       11  
$60.13-$63.95
    9,083,916       6.44       62.33             5,974,994       6.02       61.92        
$64.01-$69.63
    8,208,831       7.30       65.45             3,822,360       5.35       65.67        
$70.35-$98.00
    6,357,811       4.91       83.87             5,632,857       4.82       84.47        
 
Total
    50,985,345       4.60     $ 54.85     $ 455       39,907,861       3.61     $ 52.54     $ 445  
 
     Vested and expected-to-vest options as of June 30, 2006, included in the table above, totaled 45,531,044, with a weighted average exercise price of $53.65, a weighted average contractual life of 4.06 years and an aggregate intrinsic value of $455 million.
     As of June 30, 2006, total unrecognized compensation cost (net of expected forfeitures) was $153 million, and $3 million related to non-vested share-based compensation awards granted under the 1999 Plan and the 1996 Plan, respectively, with blended weighted average periods of 1.38 years and 0.41 years, respectively. The cost of awards outstanding under these plans at June 30, 2006 is expected to be recognized over approximately three years and one year, respectively, for the 1999 Plan and the 1996 Plan.
     The intrinsic value of options exercised during the six months ended June 30, 2006 was approximately $20 million. The fair value of options vesting for the six months ended June 30, 2006 was approximately $42 million. AIG received $40 million and $22 million for the six-month periods ended June 30, 2006 and 2005, respectively, from the exercise of stock options. AIG did not cash-settle any share-based payment awards for the six-month periods ended June 30, 2006 and 2005. The tax benefits realized as a result of stock option exercises were $5 million and $6 million for the six-month periods ended June 30, 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 six-month periods ended June 30, 2006 and 2005, 3,663,835 RSUs, including performance RSUs, and 31,500 RSUs, respectively, were granted by AIG. There were 6,443,028 shares reserved for issuance in connection with future awards at June 30, 2006. Substantially all RSUs granted to date under the 2002 Plan other than Performance RSUs granted under the Partners 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 37,500 shares were granted during the six months ended June 30, 2006, and no shares were granted during the first six months of 2005.
     AIG also granted 7,500 shares and 3,000 shares, with delivery deferred, to directors for the six-month periods ended June 30, 2006 and 2005, respectively, under the Director Stock Plan. At June 30, 2006, there were 77,500 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 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.

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)
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 is 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 June 30, 2006, there were 11,740,679 non-vested AIG shares under the SICO Plans with a weighted-average fair value per share of $61.76.
     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 contingently allocates 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 June 30, 2006, there were units representing 4,674,382 shares granted to participants.
AIG Partners Plan
On June 26, 2006, AIG’s Compensation Committee approved two grants under the AIG Partners Plan. The first grant has a performance period which runs from January 1, 2006 through December 31, 2007. The second grant has a performance period which runs from January 1, 2007 through December 31, 2008. Both grants vest 50 percent on the fourth and sixth anniversaries of the first day of the related performance period. In addition, the Compensation Committee approved the performance metrics for the two grants prior to the date of grant. The measurement of the grants is deemed to have occurred on June 26, 2006 when there was mutual understanding of the key terms and conditions of the grants. Consistent with this treatment: a) 1,069,355 Performance RSUs for the first grant and 2,490,365 Performance RSUs for the second grant and b) Unrecognized Compensation of $60 million for the first grant and $139 million for the second grant are included in the related disclosure tables. Performance RSUs related to the first grant are excluded from AIG’s diluted shares calculation because an insufficient amount of time has elapsed to conclusively determine that the performance metric will be achieved at the end of the related performance period. Because the performance period for the second grant does not begin until January 1, 2007, compensation expense for the second grant is not included in AIG’s 2006 results and diluted shares calculation.
VALUATION
     The fair value of each award granted under the 2002 Plan, the AIG DCPPP, the AIG Partners Plan, and the SICO Plans is based on the closing price of AIG stock on the date of grant.

30


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  10.  Stock Compensation Plans (continued)
A summary of shares relating to outstanding awards unvested under the foregoing plans as of June 30, 2006, and changes during the six months ended June 30, 2006 is presented below:
                                                                         
    Number of Shares   Weighted Average Grant-Date Fair Value
         
        AIG   AIG Partners   Total   SICO       AIG   AIG Partners   SICO
    2002 Plan   DCPPP   Plan   2002 Plan   Plan   2002 Plan   DCPPP   Plan   Plan
 
Unvested at January 1, 2006
    4,322,265       4,898,880             9,221,145       12,650,292       $63.63     $ 52.55     $     $ 61.92  
Granted
    104,115             3,559,720       3,663,835             67.33             55.89        
Vested
    (5,080 )                 (5,080 )     (617,064 )     64.25                   65.53  
Forfeited
    (105,610 )     (224,498 )           (330,108 )     (292,549 )     61.95       59.40             58.92  
 
Unvested at June 30, 2006
    4,315,690       4,674,382       3,559,720       12,549,792       11,740,679       $63.76     $ 52.22     $ 55.89     $ 61.76  
 
At June 30, 2006, the total unrecognized compensation cost (net of expected forfeitures) related to non-vested share-based compensation awards granted under the 2002 Plan, the AIG DCPPP, the AIG Partners Plan and the SICO plans 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
  $ 183       1.71 years  
 
AIG DCPPP
  $ 239       11.12  years  
 
AIG Partners Plan
  $ 199       2.89 years  
Total 2002 Plan
  $ 621        
SICO Plans
    $327       6.07 years  
 
The total cost for awards outstanding as of June 30, 2006 under the 2002 Plan, the AIG DCPPP, the AIG Partners Plan, and the SICO Plans is expected to be recognized over approximately 4 years, 12 years, 6 years and 23 years, respectively.
  11.  Cash Flows 
During the second quarter of 2006, AIG began presenting cash flows related to the origination and sale of finance receivables held for sale as cash flows within operating activities in the Consolidated Statement of Cash Flows. Previously these amounts were presented as cash flows within investing activities. In addition, certain intercompany transactions included in Finance receivables held for sale — originations and purchases and Finance receivable principal payments received in the Consolidated Statement of Cash Flows were not eliminated in 2005. After evaluating the effect of these items during the second quarter of 2006, AIG has revised the 2005 presentation to conform to the 2006 presentation.
     The effect of these revisions are summarized in the table below:
                           
(in millions)
 
For the Three Months Ended   As Previously       As
March 31, 2006   Reported   Revisions   Revised
 
Cash flows from operating activities
                       
 
Finance receivables held for sale — originations and purchases
  $     $ (2,267 )   $ (2,267 )
 
Finance receivables sold
  $     $ 2,671     $ 2,671  
 
Other assets and liabilities — net
  $ (3,125 )   $ 585     $ (2,540 )
 
Net cash provided by (used in) operating activities
  $ 3,066     $ 989     $ 4,055  
Cash flows from investing activities
                       
 
Finance receivables held for investment — originations and purchases
  $ (7,696 )   $ 4,295     $ (3,401 )
 
Finance receivable principal payments received
  $ 8,312     $ (5,284 )   $ 3,028  
 
Net cash used in investing activities
  $ (19,937 )   $ (989 )   $ (20,926 )
 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                             
  11.  Cash Flows (continued)
                           
(in millions)
 
For the Six Months Ended   As Previously       As
June 30, 2005   Reported   Revisions   Revised
 
Cash flows from operating activities
                       
 
Finance receivables held for sale — originations and purchases
  $     $ (5,144 )   $ (5,144 )
 
Finance receivables sold
  $     $ 4,775     $ 4,775  
 
Other assets and liabilities — net
  $ (476 )   $ 241     $ (235 )
 
Net cash provided by (used in) operating activities
  $ 13,817     $ (128 )   $ 13,689  
Cash flows from investing activities
                       
 
Finance receivables held for investment — originations and purchases
  $ (23,778 )   $ 14,511     $ (9,267 )
 
Finance receivable principal payments received
  $ 20,413     $ (14,383 )   $ 6,030  
 
Net cash used in investing activities
  $ (35,358 )   $ 128     $ (35,230 )
 
                           
(in millions)
 
For the Year Ended   As Previously       As
December 31, 2005   Reported   Revisions   Revised
 
Cash flows from operating activities
                       
 
Finance receivables held for sale — originations and purchases
  $     $ (13,070 )   $ (13,070 )
 
Finance receivables sold
  $     $ 12,821     $ 12,821  
 
Other assets and liabilities — net
  $ 2,535     $ 162     $ 2,697  
 
Net cash provided by (used in) operating activities
  $ 25,138     $ (87 )   $ 25,051  
Cash flows from investing activities
                       
 
Finance receivables held for investment — originations and purchases
  $ (52,281 )   $ 35,005     $ (17,276 )
 
Finance receivable principal payments received
  $ 47,425     $ (34,918 )   $ 12,507  
 
Net cash used in investing activities
  $ (57,321 )   $ 87     $ (57,234 )
 

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American International Group, Inc. and Subsidiaries
                                             
ITEM 2. 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
 
    33  
    34  
      34  
    37  
    39  
      39  
        42  
        45  
        47  
        48  
        48  
        50  
        50  
      51  
        53  
        60  
      63  
      64  
        66  
        66  
      69  
        69  
        69  
        70  
        71  
        74  
      75  
        76  
      77  
 CAPITAL RESOURCES     77  
        77  
        81  
        82  
        82  
        82  
        82  
 LIQUIDITY     83  
    85  
 DERIVATIVES     85  
 MANAGING RISK     86  
      86  
      88  
 RECENT ACCOUNTING STANDARDS     89  
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 AIG’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006. 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.

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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/A for the year ended December 31, 2005 (2005 Annual Report on Form 10-K/A) 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. The Other category consists of items not allocated to AIG’s operating segments.
     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 to institutions and individuals. As part of its spread-based business activities, AIG issues various debt instruments in the public and private markets.
     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 six 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 acquired Travel Guard International, one of the nation’s leading providers of travel insurance programs and emergency travel assistance, and acquired Central Insurance Co., Ltd., a leading general insurance company in Taiwan.
Consolidated Results
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 and six-month periods ended June 30, 2006 and 2005:
                                 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2006   2005   2006   2005
 
Total revenues
  $ 26,743     $ 27,903     $ 54,002     $ 55,105  
 
Income before income taxes, minority interest and cumulative effect of an accounting change
    5,241       6,701       10,034       12,350  
 
Net income
  $ 3,190     $ 4,489     $ 6,385     $ 8,288  
 
     Revenues in the second quarter and first six months of 2006 decreased 4 percent and 2 percent, respectively, largely as a result of decreased revenues in the Financial Services segment from hedging activities that do not qualify for hedge accounting treatment under FAS 133, the effects of which are reported in other revenues. The decrease was offset by the growth in net premiums earned from global General Insurance operations as well as growth in both General Insurance

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and Life Insurance & Retirement Services net investment income, Life Insurance & Retirement Services GAAP premiums and increased revenues from Asset Management activities.
     Income before income taxes, minority interest and cumulative effect of an accounting change in the three and six-month periods ended June 30, 2006 decreased 22 percent and 19 percent, respectively. Increases in General Insurance and Asset Management operating income were more than 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. Life Insurance & Retirement Services operating income decreased slightly in the second quarter of 2006 from the comparable prior year period, and increased 8 percent on a year-to-date basis.
     Results for the first six months of 2006 were negatively affected by a one-time charge relating to the Starr tender offer ($54 million before and after tax) and an additional allowance for losses in AIG Credit Card Company (Taiwan) ($88 million before and after tax), both of which were recorded in first quarter of 2006.
     During the second quarter of 2006, as part of its continuing remediation efforts, AIG identified and recorded an out of period adjustment related to the accounting for certain interests in unit investment trusts in accordance with FIN 46(R), “Consolidation of Variable Interest Entities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” These investments had previously been accounted for as available for sale securities, with changes in market values being reflected in other comprehensive income, net of deferred income taxes. Beginning with the second quarter of 2006, the changes in market values are included in AIG’s net investment income. The adjustment decreased Unrealized appreciation (depreciation) of investments — net of reclassification adjustments, and the related Deferred income tax benefit (expense), in the Consolidated Statement of Comprehensive Income (Loss) by approximately $576 million and approximately $202 million, respectively, for the three and six-month periods ended June 30, 2006 and increased Net investment income by $653 million, increased Incurred policy losses and benefits, related to certain participating policyholder funds, by $77 million, and increased Income taxes by $202 million in the Consolidated Statement of Income for the three and six-month periods ended June 30, 2006. There was no effect on Total shareholders’ equity as of June 30, 2006 or December 31, 2005.
     In the second quarter of 2006, AIG also recorded other out of period adjustments of $85 million ($55 million after tax) of interest income related to interest earned on deposit contracts and $32 million ($21 million after tax) of expenses related to the remediation of a material weakness in controls over certain balance sheet reconciliations. AIG also recorded other out of period adjustments in the first quarter of 2006 of $61 million (before and after tax) of expenses related to the SICO plans, $59 million ($38 million after tax) of expenses related to deferred advertising costs in General Insurance, $300 million ($145 million after tax) of revenues related to the remediation of a material weakness in accounting for certain derivative transactions under FAS 133, and $126 million of income tax expense related to AIG’s remediation of a material weakness in controls over income tax accounting.
     The effective income tax rate increased from 29.9 percent in the first quarter of 2006 to 32.2 percent and 31.1 percent for the three and six-month periods ended June 30, 2006, respectively, reflecting changes in the sources of foreign taxable income and the effect of the phase out of synfuel tax credits on the estimated full year tax rate.
The following table summarizes the operations of each principal segment for the three and six-month periods ended June 30, 2006 and 2005. (See also Note 2 of Notes to Consolidated Financial Statements).
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2006   2005   2006   2005
 
Revenues(a):
                               
 
General Insurance(b)(h)
  $ 12,167     $ 11,405     $ 23,823     $ 22,624  
 
Life Insurance & Retirement Services(c)(h)
    11,705       11,517       24,344       23,292  
 
Financial Services(d)
    1,226       3,778       2,841       6,214  
 
Asset Management(e)
    1,621       1,219       2,860       2,596  
 
Other
    24       (16 )     134       379  
 
Consolidated
  $ 26,743     $ 27,903     $ 54,002     $ 55,105  
 
Operating Income (loss)(a)(f):
                               
 
General Insurance(h)
  $ 2,863     $ 1,885     $ 5,194     $ 3,527  
 
Life Insurance & Retirement Services(g)(h)
    2,302       2,324       4,857       4,505  
 
Financial Services(g)
    (548 )     2,214       (707 )     3,259  
 
Asset Management
    811       524       1,272       1,114  
 
Other
    (187 )     (246 )     (582 )     (55 )
 
Consolidated
  $ 5,241     $ 6,701     $ 10,034     $ 12,350  
 
(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 three-month periods ended June 30, 2006 and 2005, the effect was $(1.08) billion and $1.63 billion, respectively, in revenues and $(1.08) billion and $1.61 billion, respectively, in operating income. For the six-month periods ended June 30, 2006 and 2005, the effect was $(1.30) billion and $2.56 billion, respectively, in revenues and $(1.30) billion and $2.62 billion, respectively, in operating income. These amounts result primarily from interest rate and foreign currency derivatives which are hedging available for sale securities and borrowings.

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(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. Additional allowances of $44 million were recorded in the first quarter of 2006, by each segment, for losses in these credit card operations.
(h) Includes the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. For the three and six- month periods ended June 30, 2006 the effect was an increase of $432 million in revenues and operating income for General Insurance and an increase of $221 million and $144 million in revenues and operating income, respectively, for Life Insurance & Retirement Services.
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 three and six-month periods ended June 30, 2006 compared to the same periods of 2005 was primarily attributable to improvement in underwriting results for the Domestic Brokerage Group (DBG). General Insurance operating income included adverse development in the first six months of 2006 and 2005 from catastrophes in prior years, which were more than offset by favorable development on non-catastrophe losses. Operating income for the three and six-month periods ended June 30, 2006 also increased due to the effect of the out of period adjustment related to the accounting for certain interests in unit investment trusts.
Life Insurance & Retirement Services
AIG’s Life Insurance & Retirement Services operations provide insurance, financial and investment products throughout the world. Foreign operations provided approximately 75 percent and 63 percent of AIG’s Life Insurance & Retirement Services operating income for the three months ended June 30, 2006 and 2005, respectively, and 70 percent and 59 percent, respectively, for the first six months of 2006 and 2005.
     Life Insurance & Retirement Services operating income decreased slightly in the second quarter of 2006 when compared to the same period of 2005 as a result of lower earnings in the Domestic Life Operations and higher realized capital losses, which were partially offset by the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts and growth in earnings from Foreign Life and Domestic Retirement Services. Realized capital losses included in revenues and operating income were $218 million in the second quarter of 2006 compared to realized capital gains of $46 million in the same period of 2005.
     Life Insurance & Retirement Services operating income increased by 8 percent in the first six months of 2006 when compared to the same period of 2005 due, in part, to the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. Realized capital losses included in revenues and operating income were $60 million in the first six months of 2006 compared to realized capital losses of $36 million in the same period of 2005.
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 incurred operating losses in the three and six-month periods ended June 30, 2006 compared to the same periods of 2005, due to the effect of hedge activities that do not qualify for hedge accounting treatment under 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.
Asset Management
AIG’s Asset Management operations include institutional and retail asset management and broker dealer services and AIG’s spread-based investment businesses. The AIG Matched Investment Program (MIP), which was launched in September of 2005, is replacing AIG’s GIC program as AIG’s principal spread-based investment activity. The GIC program products and services are offered to individuals and institutions, both domestically and overseas.
     Asset Management operating income increased 55 percent for the second quarter of 2006 when compared to the same period of 2005 due to continued strong asset flows and increased transaction driven fees and the effects of FIN 46(R) and EITF 04-5 which are offset in minority interest expense, which is not a component of operating income; operating income also increased 14 percent in the first six months of 2006 when compared to the same period of 2005 reflecting strong results in the segment’s core businesses and the effects of FIN 46(R) and EITF 04-5 which are offset in minority interest expense, which is not a component of operating income.
Capital Resources
At June 30, 2006, AIG had total consolidated shareholders’ equity of $87.71 billion and total consolidated borrowings of $126.1 billion. At that date, $110.8 billion of such borrowings were either not guaranteed by AIG or were AIGFP’s

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matched borrowings under obligations of guaranteed investment agreements (GIAs), liabilities connected to trust preferred stock, or matched notes and bonds payable.
     AIG has not purchased any shares of its common stock under its existing common stock repurchase authorization during 2006.
Liquidity
At June 30, 2006, AIG’s consolidated invested assets included $23.33 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first six months of 2006 amounted to $7.0 billion. AIG believes that its liquid assets, cash provided by operations and access to the capital markets 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.
     During the second quarter of 2006, the Canadian Parliament passed legislation that will allow UGC to begin writing business in Canada, the world’s second largest mortgage guaranty market, when provincial licenses are issued.
     In China, AIG currently has wholly-owned life insurance operations in eight cities. 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. AIG’s operations are expanding resources in these regions with the opening of additional sales and service centers. AIG’s application to serve the group insurance market was also approved.
     In Japan, earnings growth for AIG Star Life Insurance Co., Ltd. and AIG Edison Life Insurance Company reflects the runoff of the more profitable in-force business in comparison to new business currently being generated. In May 2006, AIG announced the merger of these companies, which is expected to be completed by October 2007 after meeting all regulatory requirements. The merger is expected to enhance the combined entity’s ability to grow new business by expanding distribution and gaining efficiency of scale. In the fiscal year ended March 31, 2006, AIG’s life operations in Japan retained their position as the largest foreign life operation on a total premium basis. 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 & 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 which may result in the exiting of 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, while variable annuity products with living benefits will continue to be the product of consumer choice.
     Changes in market conditions in the aircraft leasing business are not immediately apparent in operating results. Lease rates have firmed as a result of strong demand from the global commercial aviation market, especially in Asia. Sales have increased 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 were negatively affected in the first quarter of 2006 by industry-wide credit deterioration in the Taiwan credit card market. The operating results of AIG’s Consumer Finance operations in the U.S. could be affected by the residential housing market, interest rates and unemployment.
     AIG’s GIC program is in runoff and is being replaced by the new MIP, which was launched in September 2005. AIG expects the MIP to be AIG’s principal spread-based investment activity. AIG’s credit spreads will affect the profitability of this business.
     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,

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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 and Reinsurance Recoverable (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, 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.
Reinsurance recoverable on unpaid losses: the expected recoveries from reinsurers on losses that have not yet been reported and/or settled.
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, 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.

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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, both domestically and internationally, 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 critical in the overall evaluation of performance.
     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).

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     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 and six-month periods ended June 30, 2006 and 2005 were as follows:
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions, except ratios)   2006   2005   2006   2005
 
Net premiums written:
                               
 
Domestic General
                               
   
DBG
  $ 6,480     $ 5,846     $ 12,380     $ 11,566  
   
Transatlantic
    914       884       1,828       1,769  
   
Personal Lines
    1,180       1,173       2,378       2,359  
   
Mortgage Guaranty
    193       145       390       310  
 
Foreign General
    2,867       2,596       5,913       5,430  
 
Total
  $ 11,634     $ 10,644     $ 22,889     $ 21,434  
 
Net premiums earned:
                               
 
Domestic General
                               
   
DBG
  $ 5,836     $ 5,587     $ 11,599     $ 11,160  
   
Transatlantic
    909       862       1,817       1,750  
   
Personal Lines
    1,167       1,157       2,326       2,277  
   
Mortgage Guaranty
    179       143       345       283  
 
Foreign General(a)
    2,587       2,483       5,061       4,902  
 
Total
  $ 10,678     $ 10,232     $ 21,148     $ 20,372  
 
Net investment income:
                               
 
Domestic General
                               
   
DBG
  $ 813     $ 555     $ 1,558     $ 1,214  
   
Transatlantic
    108       84       210       169  
   
Personal Lines
    55       54       112       106  
   
Mortgage Guaranty
    36       31       68       59  
   
Intercompany adjustments and eliminations – net
          (1 )            
 
Foreign General(b)
    602       337       784       527  
 
Total
  $ 1,614     $ 1,060     $ 2,732     $ 2,075  
 

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American International Group, Inc. and Subsidiaries
                                             
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions, except ratios)   2006   2005   2006   2005
 
Realized capital gains (losses)
    (125 )     113       (57 )     177  
 
Operating Income(c):
                               
 
Domestic General
                               
   
DBG
  $ 1,534     $ 805     $ 2,891     $ 1,518  
   
Transatlantic
    143       99       284       213  
   
Personal Lines
    118       102       219       211  
   
Mortgage Guaranty
    107       109       216       213  
 
Foreign General(b)(d)
    961       771       1,582       1,367  
Reclassifications and Eliminations
          (1 )     2       5  
 
Total
  $ 2,863     $ 1,885     $ 5,194     $ 3,527  
 
Statutory underwriting profit(c)(f)
                               
 
Domestic General
                               
   
DBG
  $ 696     $ 190     $ 1,223     $ 246  
   
Transatlantic
    33       12       63       32  
   
Personal Lines
    53       44       93       85  
   
Mortgage Guaranty
    73       83       143       152  
 
Foreign General(d)
    368       411       658       741  
 
Total
  $ 1,223     $ 740     $ 2,180     $ 1,256  
 
Domestic General:
                               
 
Loss Ratio
    67.79       75.07       69.36       76.15  
 
Expense Ratio
    19.97       19.93       20.07       19.85  
 
Combined Ratio
    87.76       95.00       89.43       96.00  
 
Foreign General:
                               
 
Loss Ratio(a)
    49.43       52.31       51.04       53.35  
 
Expense Ratio(d)(e)
    32.82       29.75       30.77       28.44  
 
Combined ratio
    82.25       82.06       81.81       81.79  
 
Consolidated:
                               
 
Loss Ratio(c)
    63.34       69.55       64.98       70.66  
 
Expense Ratio
    23.13       22.33       22.84       22.03  
 
Combined Ratio
    86.47       91.88       87.82       92.69  
 
(a)  Income statement accounts expressed in non-functional currencies are translated into U.S. dollars using average exchange rates.
 
(b)  Includes the effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. For the three and six-month periods ended June 30, 2006 the effect was an increase of $412 million.
(c)  Includes a reduction in incurred losses in the three-month period ended June 30, 2006 of $51 million and additional losses incurred and net reinstatement premiums in the three-month period ended June 30, 2005 of $27 million, related primarily to prior year catastrophes, resulting in (decreases) increases of (0.49) points and 0.26 points, respectively, in the consolidated General Insurance loss ratio. The effect on the six-month periods ended June 30, 2006 and 2005 included $48 million and $198 million, respectively, of additional losses incurred and net reinstatement premiums primarily relating to prior year catastrophes, resulting in increases of 0.22 points and 0.96 points, respectively, in the consolidated General Insurance loss ratio.
(d)  Includes the results of wholly owned AIU agencies.
(e)  Includes amortization of advertising costs.

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(f)  Statutory underwriting profit (loss) is a measure that U.S. domiciled insurance companies are required to report to their regulatory authorities. The following table reconciles statutory underwriting profit (loss) to income before income taxes, minority interest and cumulative effect of an accounting change for the General Insurance segment for the three and six month periods ended June 30, 2006 and 2005.
                                                         
    Domestic                        
    Brokerage       Personal   Mortgage   Foreign   Reclassifications    
(in millions)   Group   Transatlantic   Lines   Guaranty   General   and Eliminations   Total
 
Three months ended June 30, 2006:
                                                       
Statutory underwriting profit
  $ 696     $ 33     $ 53     $ 73     $ 368     $     $ 1,223  
Increase in deferred acquisition costs
    69       4       9       1       68             151  
Net investment income
    813       108       55       36       602             1,614  
Realized capital gains (losses)
    (44 )     (2 )     1       (3 )     (77 )           (125 )
 
Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 1,534     $ 143     $ 118     $ 107     $ 961     $     $ 2,863  
 
Three months ended June 30, 2005:
                                                       
Statutory underwriting profit
  $ 190     $ 12     $ 44     $ 83     $ 411     $     $ 740  
Increase (decrease) in deferred acquisition costs
    (39 )     1       6       (4 )     8             (28 )
Net investment income
    555       84       54       31       337       (1 )     1,060  
Realized capital gains (losses)
    99       2       (2 )     (1 )     15             113  
 
Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 805     $ 99     $ 102     $ 109     $ 771     $ (1 )   $ 1,885  
 
Six months ended June 30, 2006:
                                                       
Statutory underwriting profit
  $ 1,223     $ 63     $ 93     $ 143     $ 658     $     $ 2,180  
Increase in deferred acquisition costs
    107       7       14       8       203             339  
Net investment income
    1,558       210       112       68       784             2,732  
Realized capital gains (losses)
    3       4             (3 )     (63 )     2       (57 )
 
Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 2,891     $ 284     $ 219     $ 216     $ 1,582     $ 2     $ 5,194  
 
Six months ended June 30, 2005:
                                                       
Statutory underwriting profit
  $ 246     $ 32     $ 85     $ 152     $ 741     $     $ 1,256  
Increase (decrease) in deferred acquisition costs
    (98 )     1       23       2       91             19  
Net investment income
    1,214       169       106       59       527             2,075  
Realized capital gains (losses)
    156       11       (3 )           8       5       177  
 
Income before income taxes, minority interest and cumulative effect of an accounting change
  $ 1,518     $ 213     $ 211     $ 213     $ 1,367     $ 5     $ 3,527  
 
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 three and six-month periods ended June 30, 2006:
                 
    Three Months Ended   Six Months Ended
    June 30, 2006   June 30, 2006
 
Growth in original currency
    9.7 %     7.9 %
Foreign exchange effect
    (0.4 )     (1.1 )
Growth as reported in U.S. dollars
    9.3 %     6.8 %
 
General Insurance Results
General Insurance operating income increased 52 percent in the second quarter of 2006 compared to the same period in 2005 due primarily to improvement in statutory underwriting profit for DBG as a result of improved loss ratios for the current accident year compared to the loss ratios recorded in the second quarter of 2005 for accident year 2005, as well as growth in net investment income. Included in net investment income in the second quarter of 2006 is the $432 million effect of an out of period adjustment related to the accounting for certain interests in unit investment trusts. The combined ratio improved to 86.5 during the second quarter of 2006, a reduction of 5.4 points from the prior period in 2005, led by a reduction in the loss ratio of 6.2 points. Net premiums written increased 9 percent in the second quarter of 2006 compared to the same period in 2005 as domestic property rates improved and submission activity increased in the aftermath of the 2005 hurricanes and through the expansion of distribution channels within Foreign General. The increase in

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net premiums written was tempered by an increase in ceded reinsurance necessary to manage the increase in property exposures retained by AIG. AIG is evaluating additional reinsurance programs to manage retained property exposures as direct property business increases.
General Insurance operating income increased 47 percent in the first six months of 2006 compared to the same period of 2005 due to improvement in statutory underwriting profit for DBG as a result of improved loss ratios for the current accident year compared to the loss ratios recorded in the first six months of 2005 for accident year 2005, as well as growth in net investment income. Included in net investment income for the first six months of 2006 is the $432 million effect of the aforementioned out of period adjustment. The combined ratio improved to 87.8, a reduction of 4.9 points from the first six months of 2005, led by a reduction in the loss ratio of 5.7 points. Net premiums written increased 7 percent as domestic property rates improved and submission activity increased in the aftermath of the 2005 hurricanes and through the expansion of distribution channels within Foreign General.
Quarterly DBG Results
DBG’s net premiums written increased 11 percent in the second quarter of 2006 compared to the same period in 2005 as property rates improved and submission activity increased in the aftermath of the 2005 hurricanes. DBG attributes the increase in submissions to its strong distribution channels and overall financial strength in comparison to many insurers that experienced significant losses and reductions of surplus as a result of the hurricanes. This increase was tempered by an increase in ceded reinsurance necessary to manage the level of property exposures retained by DBG.
Operating income increased 91 percent to $1.53 billion in the second quarter of 2006 compared to the same period in 2005, reflecting increases in statutory underwriting profit and net investment income. The improvement in DBG’s statutory underwriting profit for the second quarter of 2006 was primarily due to lower accident year loss ratios for the 2006 accident year compared to the loss ratios recorded in the second quarter of 2005 for accident year 2005. In addition, the second quarter of 2006 includes a $53 million reduction in the estimated ultimate losses related to prior year hurricanes compared to the same period of 2005 which included an insignificant increase in losses related to prior year hurricanes. Favorable reserve development on non-catastrophic prior year losses totaled $57 million for the second quarter of 2006 compared to adverse development of $112 million for the same period of 2005. The 2006 development relates primarily to classes of business which did not require reserve strengthening in connection with AIG’s year-end 2005 reserve study.
DBG’s expense ratio decreased slightly in the second quarter of 2006 to 17.9 compared to 18.1 in the same period of 2005. Direct acquisition expenses declined, reflecting an increase in lines of business, such as property, that have a lower commission rate, as well as a modest decrease in overall commission rates. Net acquisition expenses declined due to the items cited above as well as the new quota share reinsurance program added in 2006 to manage the level of property exposures retained by DBG. Other operating expense as a percent of net premium written increased primarily due to an increase in bad debt expense, due largely to an out of period adjustment of $32 million relating to reconciliation remediation activities.
Year-to-date DBG Results
DBG’s net premiums written increased 7 percent in the first six months of 2006 compared to the same period of 2005 due to property rate increases as well as increases in submission activity in the aftermath of the 2005 hurricanes. Operating income increased 90 percent to $2.89 billion in the first six months of 2006 reflecting increases in statutory underwriting profit and net investment income. The improvement in DBG’s statutory underwriting profit for 2006 was due to lower accident year loss ratios for the 2006 accident year compared to the loss ratios recorded in the first six months of 2005 for accident year 2005. In addition, year to date 2006 operating income includes a $25 million reduction in the estimated ultimate losses related to prior year hurricanes compared to the same period of 2005 which included $118 million of increased losses related to prior year hurricanes. Favorable reserve development on non-catastrophic prior year losses totaled $62 million for the first six months of 2006 compared to adverse development of $215 million for the same period of 2005. The 2006 development relates primarily to classes of business which did not require reserve strengthening in connection with AIG’s year-end 2005 reserve study.
DBG’s expense ratio decreased slightly to 18.1 compared to 18.3 in the first six months of 2006. Direct acquisition expenses declined, reflecting an increase in lines of business such as property that have a lower commission rate as well as a modest decrease in overall commission rates. Net acquisition expenses declined due to the items cited above as well as the new quota share reinsurance program added in 2006 to manage the level of property exposures retained by DBG. Other operating expenses increased primarily due to an increase in bad debt expense, partially offset by a favorable $23 million out of period adjustment relating to reconciliation remediation activities.

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Quarterly Transatlantic Results
Transatlantic’s net premiums written and net premiums earned in the second quarter of 2006 increased by 3 percent and 5 percent, respectively, when compared to the same period in 2005 primarily due to increases in domestic auto liability and specialty casualty net premiums written. These increases were partially offset by decreases in international property and auto liability premiums. Second quarter 2006 operating income increased $44 million, due largely to increased net investment income and lower catastrophe incurred losses and net reinstatement premiums related to prior year catastrophes.
Year-to-date Transatlantic Results
Transatlantic’s net premiums written and net premiums earned increased in the first six months of 2006 by 3 percent and 4 percent, respectively, compared to the same period of 2005 due primarily to increases in domestic specialty casualty and property net premiums written. These increases were offset, in part, by decreases in international premiums caused, in part, by the adverse effect of changes in foreign currency exchange rates between periods, with the most significant decreases in the auto liability and property lines. Operating income increased in the first six months of 2006 compared to the same period of 2005 due to increased net investment income and improved statutory underwriting profit, resulting largely from reduced net catastrophe costs (including the effect of net reinstatement premiums), and lower net adverse development on loss reserves, offset, in part, by higher commission costs.
Quarterly Personal Lines Results
Personal Lines net premiums written increased slightly in the second quarter of 2006 compared to the same period in 2005, as growth in the Private Client Group and Agency Auto divisions was offset by 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 was a result of terminating an MGA relationship on December 31, 2005. Growth in the Private Client Group spans multiple products as it continues to penetrate the high net worth market. Agency Auto growth was due to expanded agent/broker appointments and enhanced product offerings. AIG Direct premiums were down due to a decline in response rates. 21st Century experienced strong growth outside of California, but not enough to offset the decline in the soft California market. Operating income in the second quarter of 2006 increased from the same period in 2005 driven by a lower combined ratio. The improved loss ratio reflects favorable prior year loss reserve development in the direct businesses. The expense ratio increased from a year ago as 21st Century expenses were up due primarily to its national expansion efforts and higher stock-based compensation. AIG Direct acquisition expenses were up primarily due to lower response rates driving up acquisition cost per policy.
Year-to-date Personal Lines Results
Personal Lines net premiums written increased slightly in the first six months of 2006 compared to the same period in 2005, reflecting growth in the Private Client Group and Agency Auto divisions which offset the runoff of the involuntary auto business and a small decline in the AIG Direct and 21st Century divisions. Operating income was up slightly for the first six months of 2006 compared to the same period of 2005, driven primarily by an increase in net investment income as the combined ratio remained relatively unchanged. The loss ratio in the first six months of 2006 improved from a year ago due to favorable prior year loss development in the AIG Direct and 21st Century businesses, while the expense ratio increased as a result of, among other things, investment in people, technology, national expansion efforts and lower response rates.
Quarterly UGC Results
UGC’s net premiums written increased in the second quarter of 2006 when compared to the same period in 2005, primarily driven by growth in domestic second lien and international operations. Operating income during the second quarter of 2006 was down slightly when compared to the same period in 2005 as improved underwriting results in the domestic second lien and international groups and increased investment income were offset by a decline in the domestic first lien business. The loss ratio increased to 33.1 in the second quarter of 2006 from 17.4 in the year ago quarter, a period with an unusually low frequency of defaults. Operating income for the second quarter of 2006 includes favorable development on prior accident years, offset by higher 2006 accident year loss ratios. The increase in the loss ratio also reflects UGC’s change in business mix.
Year-to-date UGC Results
UGC’s net premiums written were up 26 percent in the first six months of 2006 compared to the same period in 2005 on growth from all business units. Operating income was up slightly for the first six months of 2006 when compared to the same period in 2005, primarily due to an increase in net investment income, which was offset by a 10.6 point increase in the loss ratio to 31.8. The loss ratio for the first six months of 2005 was unusually low due to historically low defaults in the first half of 2005. Operating income for the first six months of 2006 includes favorable development on prior accident years, offset by higher 2006 accident year loss ratios. The increase in the loss ratio also reflects UGC’s change in business mix.

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Quarterly Foreign General Insurance Results
Foreign General Insurance’s net premiums written as reported in U.S. dollars and in original currency increased 10 percent and 12 percent, respectively, in the second quarter of 2006 when compared to the same period in 2005, reflecting growth in both the commercial and consumer lines due to new business, as well as new distribution channels. Foreign General Insurance net premiums written were essentially equally derived from the commercial insurance and consumer lines. The personal accident business in the Far East region increased net premiums written in the second quarter of 2006 from a year ago, but an increase in loss frequency negatively affected operating income. Southeast Asia had increased net premiums written in the second quarter of 2006 when compared to the same period in 2005 in the personal accident business which led to increased operating income. The commercial lines business in both Europe and the United Kingdom increased net premiums written from a year ago due to new business with a resulting increase in operating income compared to the second quarter of 2005. Energy had modest growth in net premiums written, but several high severity losses caused a reduction in second quarter 2006 operating income when compared to the same period of 2005. The Ascot Lloyd’s syndicate reported strong growth in net premiums written during the second quarter of 2006 due to rate increases on its U.S. book of business along with contractual terms on renewals that reflect better conditions and higher deductibles. This led to improved operating income from a year ago, but higher than expected profit commission payments related to prior underwriting years totaling $34 million negatively affected operating income during the second quarter of 2006.
The combined ratio for Foreign General Insurance for the second quarter of 2006 was 82.25, slightly higher than the 82.06 in the comparable period of 2005. The Foreign General Insurance loss ratio decreased 2.88 points in the second quarter of 2006 compared to the same period of 2005 due to lower current accident year losses and favorable loss development from prior accident years. The Foreign General Insurance expense ratio increased 3.07 points in the second quarter of 2006 from the same period in 2005 principally due to higher commissions, employee compensation costs and accelerated amortization of advertising costs.
Year-to-date Foreign General Insurance Results
Foreign General Insurance’s net premiums written as reported in U.S. dollars and in original currency increased 9 percent and 13 percent, respectively, in the first six months of 2006 when compared to the same period in 2005, reflecting growth in both the commercial and consumer lines. The personal accident business in the Far East region, the commercial lines business in both Europe and the United Kingdom, and the Ascot Lloyd’s syndicate all contributed to the growth in net premiums written. Rate decreases in the commercial lines business in the United Kingdom, additional losses incurred relating to 2005 catastrophes and higher than expected profit commission payments related to prior underwriting years for Ascot Lloyd’s had a negative effect on operating income in the first six months of 2006 when compared to the same period of 2005.
The combined ratio for Foreign General Insurance for the first six months of 2006 was 81.81, essentially unchanged from the comparable period of 2005. The Foreign General Insurance loss ratio decreased 2.31 points in the first six months of 2006 from the same period of 2005 due to lower current accident year losses for 2006 and favorable loss development from prior accident years, excluding catastrophe losses. The Foreign General Insurance expense ratio increased 2.33 points in the first six months of 2006 from the same period in 2005 principally due to higher commissions, employee compensation costs and accelerated amortization of advertising costs.
General Insurance Net Investment Income
General Insurance net investment income increased by $554 million and $657 million in the second quarter and the first six months of 2006, respectively, when compared to the same periods of 2005, principally due to the effects of an out of period adjustment of $432 million related to the accounting for certain interests in unit investment trusts and an $85 million out of period adjustment related to interest earned on a DBG deposit contract. The increase also reflects higher interest income, strong cash flows, including the effect of capital contributions from the parent, higher interest rates and the positive effect of compounding previously earned and reinvested net investment income as well as higher dividend and partnership income for DBG. Foreign General Insurance net investment income increased in the three and six-month periods ended June 30, 2006 when compared to the same periods of 2005 due to the effects of the aforementioned out of period adjustment, offset by a decline in partnership income. Foreign General partnership income in the second quarter and first half of 2005 benefited from increases in market valuations due to increased initial public offering activity. Foreign General cash flows declined for the first six months of 2006 compared to the year ago period, due to payments related to catastrophe related losses incurred in 2005.
     Realized capital gains and losses resulted from the ongoing investment management of the General Insurance portfolios within the overall objectives of the General Insurance operations. See the discussion on “Valuation of Invested Assets” herein.
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

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American International Group, Inc. and Subsidiaries
                                             
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. For a further discussion of catastrophe exposures, see “Managing Risk – Catastrophe Exposures”. Although reinsurance arrangements do not relieve AIG from its direct obligations to its insureds, an efficient and effective reinsurance program substantially limits AIG’s exposure to potentially significant losses. AIG continually evaluates the reinsurance markets and the relative attractiveness of various arrangements for coverage, including structures such as catastrophe bonds, insurance risk securitizations and “sidecar” and similar vehicles. 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 $22.87 billion at June 30, 2006 and resulted from AIG’s reinsurance arrangements. Thus, a credit exposure existed at June 30, 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). These ratings are measures of financial strength. Through June 30, 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.
     AIG maintains an allowance for estimated unrecoverable reinsurance. Although AIG has been largely successful in its previous recovery efforts, at June 30, 2006, AIG had an allowance for unrecoverable reinsurance approximating $932 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 June 30, 2006, approximately $3.7 billion of letters of credit were outstanding to cover intercompany reinsurance transactions with AIRCO or other General Insurance subsidiaries.
     At June 30, 2006, consolidated general reinsurance assets of $22.87 billion include reinsurance recoverables for paid losses and loss expenses of $1.05 billion and $18.75 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported

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(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 involve significant judgment in projecting the frequency and severity of losses over multiple years and 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 June 30, 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.
Reserve for Losses and Loss Expenses
The table below classifies as of June 30, 2006 and December 31, 2005 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)   June 30, 2006   December 31, 2005
 
Other liability occurrence
  $ 18,666     $ 18,116  
Other liability claims made
    12,526       12,447  
Workers compensation
    12,318       11,630  
Property
    7,028       7,217  
Auto liability
    6,318       6,569  
International
    5,409       4,939  
Reinsurance
    3,194       2,886  
Medical malpractice
    2,196       2,363  
Products liability
    1,988       1,937  
Accident and health
    1,700       1,678  
Aircraft
    1,615       1,844  
Commercial multiple peril
    1,449       1,359  
Fidelity/ surety
    1,006       1,072  
Other
    3,553       3,112  
 
Total
  $ 78,966     $ 77,169  
 
* Presented by lines of business pursuant to statutory reporting requirements as prescribed by the National Association of Insurance Commissioners.
     AIG’s gross 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 adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development.
     At June 30, 2006, General Insurance net loss reserves increased $2.74 billion from the prior year end to $60.21 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 June 30, 2006 and December 31, 2005.
                 
(in millions)   June 30, 2006   December 31, 2005
 
DBG(a)
  $ 42,508     $ 40,782  
Transatlantic
    5,893       5,690  
Personal Lines(b)
    2,533       2,578  
Mortgage Guaranty
    367       340  
Foreign General(c)
    8,913       8,086  
 
Total Net Loss Reserve
  $ 60,214     $ 57,476  
 
(a) At June 30, 2006 and December 31, 2005, DBG loss reserves include approximately $3.55 billion and $3.77 billion, respectively, ($3.96 billion and $4.26 billion, respectively, 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 $498 million and $407 million related to business included in AIUO’s statutory filings at June 30, 2006 and December 31, 2005, respectively.
(b) At June 30, 2006 and December 31, 2005, Personal Lines loss reserves include $885 million and $878 million, respectively, related to business ceded to DBG and reported in DBG’s statutory filings.
(c) At June 30, 2006 and December 31, 2005, Foreign General loss reserves include approximately $2.68 billion and $2.15 billion, respectively, related to business reported in DBG’s statutory filings.
     The DBG net loss reserve of $42.51 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 June 30, 2006, AIRCO carried a discount of approximately $410 million applicable to the $3.96 billion in undiscounted reserves it assumed from the American Home/National Union pool via this quota share cession. AIRCO also carries approximately $478 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

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pool relating to this cession amounted to $885 million as of June 30, 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 June 30, 2006, these AIU reserves carried by participants in the American Home/National Union pool amounted to approximately $2.68 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 June 30, 2006 by AIUO and AIRCO were approximately $4.21 billion and $4.03 billion, respectively. AIRCO’s $4.03 billion in total general insurance reserves consist of approximately $3.55 billion from business assumed from the American Home/ National Union pool and an additional $478 million relating to Foreign General Insurance business.
Discounting of Reserves
At June 30, 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; $1.19 billion – non-tabular discount for workers compensation in DBG; and, $410 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 $10.2 billion as of June 30, 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 $3.96 billion at June 30, 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 June 30, 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 June 30, 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 General Insurance net loss reserves for the three and six-month periods ended June 30, 2006 and 2005 as follows:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2006   2005   2006   2005
 
Net reserve for losses and loss expenses at beginning of period
  $ 58,892       $49,334     $ 57,476       $47,254  
Foreign exchange effect
    370       (349 )     487       (321 )
 
Losses and loss expenses incurred:
                               
 
Current year
    6,911       7,032       13,752       14,071  
 
Prior years, other than accretion of discount*
    (248 )     (13 )     (213 )     130  
 
Prior years, accretion of discount
    101       97       202       194  
 
Losses and loss expenses incurred
    6,764       7,116       13,741       14,395  
 
Losses and loss expenses paid
    5,812       5,537       11,490       10,764  
 
Net reserve for losses and loss expenses at end of period
  $ 60,214       $50,564     $ 60,214       $50,564  
 
* Includes $30 million and $35 million in the three-month periods ended June 30, 2006 and 2005, respectively, for the general reinsurance operations of Transatlantic and $(63) million and $0, respectively, of additional losses incurred resulting from increased costs related to the 2005 and 2004 catastrophes. Includes $65 million and $90 million in the six-month periods ended June 30, 2006 and 2005, respectively, for the general reinsurance operations of Transatlantic and $35 million and $118 million, respectively, of additional losses incurred resulting from increased costs related to the 2005 and 2004 catastrophes. Transatlantic includes $10 million of prior year adverse catastrophe development in both the three months and six months ended June 30, 2006.

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     The loss ratios recorded by AIG for the first six 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/A, 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 six months of 2006, AIG enhanced its process of determining the quarterly loss development from prior accident years. In the first quarter of 2006, AIG began conducting additional analyses 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 and second quarters of 2006 to determine the loss development from prior accident years for the first and second quarters of 2006.
     In the second quarter of 2006, net loss development from prior accident years was favorable by approximately $248 million. This reflects approximately $63 million of favorable development pertaining to catastrophes in 2005, partially offset by adverse development of approximately $30 million from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $101 million, net loss development from prior accident years in the second quarter of 2006 was favorable by approximately $215 million. The majority of the favorable development was attributable to shorter tail classes of business throughout General Insurance. This favorable development relates primarily to classes of business which did not require reserve strengthening in connection with AIG’s year-end 2005 reserve study. DBG accounted for approximately $57 million of the $215 million of overall favorable development in the second quarter of 2006, excluding catastrophes. Accident years 2003 through 2005 continued to develop favorably in the second quarter for most classes of business throughout AIG. Accident years 2001 and prior continued to develop adversely in the quarter, primarily due to approximately $125 million of adverse development from excess casualty business and approximately $35 million from the excess workers compensation class of business. The $215 million of overall net favorable development was comprised of approximately $190 million of adverse development from accident years 2002 and prior, offset by approximately $410 million of favorable development from accident years 2003 through 2005.
     In the first six months of 2006, net loss development from prior accident years was favorable by approximately $213 million. This reflects approximately $35 million of adverse development pertaining to catastrophes in 2004 and 2005 and approximately $65 million of adverse development from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $202 million, net loss development from prior accident years in the first six months of 2006 was favorable by approximately $313 million. The majority of the favorable development was attributable to shorter tail classes of business throughout General Insurance. DBG accounted for approximately $62 million of the $313 million of overall favorable development in the first six months of 2006, excluding catastrophes. Accident years 2003 through 2005 developed favorably in the first six months of 2006 for most classes of business throughout AIG. Accident years 2002 and prior developed adversely in the first six months, primarily due to approximately $300 million of adverse development from excess casualty business and approximately $70 million from the excess workers compensation class of business. The $313 million of overall net favorable development was comprised of approximately $420 million of adverse development from accident years 2002 and prior, offset by approximately $735 million of favorable development from accident years 2003 through 2005.
     In the second quarter of 2005, net loss development from prior accident years was favorable by approximately $13 million, including negligible development pertaining to catastrophes and approximately $35 million of adverse development from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $97 million, net loss development from prior accident years in the second quarter of 2005 was favorable by approximately $48 million. In the second quarter of 2005, most classes of business experienced favorable development for accident years 2002 through 2004, with the exception of D&O which continued to experience adverse development for accident year 2002. The $48 million of overall net favorable development was comprised of approximately $400 million of adverse development from accident years 2001 and prior, offset by approximately $350 million of favorable development from accident year 2004 and approximately $100 million of favorable development from accident

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year 2003. The majority of the adverse developments from accident years 2001 and prior pertained to the excess casualty and D&O classes of business.
     In the first six months of 2005, net loss development from prior accident years was adverse by approximately $130 million, including approximately $118 million pertaining to catastrophes in 2004 and approximately $90 million of adverse development from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $194 million, net loss development from prior accident years in the first six months of 2005 was favorable by approximately $78 million. In the first six months of 2005, most classes of business experienced favorable development for accident years 2002 through 2004, with the exception of D&O which experienced approximately $100 million of adverse development for accident year 2002. The $78 million of overall net favorable development included approximately $750 million of adverse development pertaining to accident years 2001 and prior, offset by approximately $250 million of favorable development from accident year 2003 and $570 million of favorable development from accident year 2004. The majority of the adverse development from accident years 2001 and prior emanated from the excess casualty and D&O classes of business.
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/A.
         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/A. AIG uses the process described above to update AIG’s reserves on a quarterly basis. AIG’s 2005 Annual Report on Form 10-K/A 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/A, 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 six 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 six months of 2006, as depicted in the table that follows. This minor development is primarily attributable to the general reinsurance operations of Transatlantic.
A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined for the six months ended June 30, 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*
    (1 )     4       96       27  
Losses and loss expenses paid*
    (277 )     (96 )     (151 )     (51 )
 
Reserve for losses and loss expenses at end of period
  $ 4,163     $ 1,748     $ 2,504     $ 1,036  
 
Environmental:
                               
Reserve for losses and loss expenses at beginning of year
  $ 926     $ 410     $ 974     $ 451  
Losses and loss expenses incurred*
    1             (12 )     (3 )
Losses and loss expenses paid*
    (55 )     (33 )     (56 )     (31 )
 
Reserve for losses and loss expenses at end of period
  $ 872     $ 377     $ 906     $ 417  
 
Combined: