SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 OR [ ] 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 (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 70 PINE STREET, NEW YORK, NEW YORK 10270 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (212) 770-7000 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NAME OF EACH EXCHANGE ON TITLE OF EACH CLASS WHICH REGISTERED ------------------- ---------------- COMMON STOCK, PAR VALUE $2.50 PER SHARE NEW YORK STOCK EXCHANGE, INC. SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: TITLE OF EACH CLASS ------------------- NONE ______________ INDICATE BY CHECK MARK WHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12 MONTHS (OR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILE SUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FOR THE PAST 90 DAYS. YES [X] NO [ ] INDICATE BY CHECK MARK IF DISCLOSURE OF DELINQUENT FILERS PURSUANT TO ITEM 405 OF REGULATION S-K IS NOT CONTAINED HEREIN, AND WILL NOT BE CONTAINED, TO THE BEST OF REGISTRANT'S KNOWLEDGE, IN DEFINITIVE PROXY OR INFORMATION STATEMENTS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K OR ANY AMENDMENT TO THIS FORM 10-K. [ ]. INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS AN ACCELERATED FILER (AS DEFINED IN RULE 12B-2 OF THE ACT). YES [X] NO [ ] THE AGGREGATE MARKET VALUE OF THE VOTING AND NON-VOTING COMMON EQUITY HELD BY NONAFFILIATES OF THE REGISTRANT COMPUTED BY REFERENCE TO THE PRICE AT WHICH THE COMMON EQUITY WAS LAST SOLD AS OF JUNE 28, 2002 (THE LAST BUSINESS DAY OF THE REGISTRANT'S MOST RECENTLY COMPLETED SECOND FISCAL QUARTER), WAS APPROXIMATELY $140,718,844,000. AS OF JANUARY 31, 2003, THERE WERE OUTSTANDING 2,609,826,299 SHARES OF COMMON STOCK, $2.50 PAR VALUE PER SHARE, OF THE REGISTRANT. DOCUMENTS INCORPORATED BY REFERENCE: THE REGISTRANT'S DEFINITIVE PROXY STATEMENT FILED OR TO BE FILED WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO REGULATION 14A INVOLVING THE ELECTION OF DIRECTORS AT THE ANNUAL MEETING OF THE SHAREHOLDERS OF THE REGISTRANT SCHEDULED TO BE HELD ON MAY 14, 2003 IS INCORPORATED BY REFERENCE IN PART III OF THIS FORM 10-K.
PART I ITEM 1. BUSINESS American International Group, Inc. (AIG), a Delaware corporation, is a holding company which through its subsidiaries is engaged in a broad range of insurance and insurance-related activities in the United States and abroad. AIG's primary activities include both general and life insurance operations. Other significant activities include financial services, and retirement savings and asset management. The principal general insurance company subsidiaries are American Home Assurance Company (American Home), National Union Fire Insurance Company of Pittsburgh, Pa. (National Union), New Hampshire Insurance Company (New Hampshire), Lexington Insurance Company (Lexington), The Hartford Steam Boiler Inspection and Insurance Company (HSB), Transatlantic Reinsurance Company, American International Underwriters Overseas, Ltd. (AIUO) and United Guaranty Residential Insurance Company. Significant life insurance operations include those conducted through American Life Insurance Company (ALICO), American International Assurance Company Limited, together with American International Assurance Company (Bermuda) Limited (AIA), Nan Shan Life Insurance Company, Ltd. (Nan Shan), American International Reinsurance Company, Ltd., AIG Star Life Insurance Co., Ltd., AIG Annuity Insurance Company (AIG Annuity), the AIG American General Life Companies (American General Life), and SunAmerica Life Insurance Company (SunAmerica Life). AIG's financial services operations are conducted primarily through International Lease Finance Corporation (ILFC), AIG Financial Products Corp. and its subsidiaries (AIGFP), and American General Finance, Inc. and its subsidiaries (AGF), while retirement savings and asset management operations include The Variable Annuity Life Insurance Company (VALIC), AIG SunAmerica Asset Management Corp. (SAAMCo), AIG SunAmerica Life Assurance Company (formerly known as Anchor National Life Insurance Company) and AIG Global Investment Group, Inc. and its subsidiaries (AIG Global Investment Group). On August 29, 2001, AIG acquired American General Corporation (AGC). In connection with the acquisition, AIG issued approximately 290 million shares of common stock, $2.50 par value per share (common stock) in an exchange for all the outstanding common stock of AGC based on an exchange ratio of 0.5790 of a share of AIG common stock for each share of AGC common stock. The acquisition was accounted for as a pooling of interests and all prior historical financial information presented herein has been restated to include AGC. The merger of SunAmerica Inc., a leading company in the retirement savings and asset accumulation business, with and into AIG became effective January 1, 1999. The transaction was treated as a pooling of interests for accounting purposes. AIG issued 0.855 shares of common stock in exchange for each share of SunAmerica Inc. stock outstanding at the effective time of the merger for an aggregate issuance of approximately 187.5 million shares. For information on AIG's business segments, see Note 2 of Notes to Financial Statements. All per share information herein gives retroactive effect to all stock dividends and stock splits. As of January 31, 2003, beneficial ownership of approximately 12.0 percent, 2.2 percent and 1.8 percent of AIG common stock, was held by Starr International Company, Inc. (SICO), The Starr Foundation and C.V. Starr & Co., Inc. (Starr), respectively. At December 31, 2002, AIG and its subsidiaries had approximately 80,000 employees. AIG's Internet address for its corporate website is www.aigcorporate.com. AIG makes available free of charge, on or through the Investor Information section of AIG's corporate website, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the Securities and Exchange Commission. THROUGHOUT THIS ANNUAL REPORT ON FORM 10-K, AIG PRESENTS ITS OPERATIONS IN THE WAY IT BELIEVES WILL BE MOST MEANINGFUL, AS WELL AS MOST TRANSPARENT. CERTAIN OF THE MEASUREMENTS USED BY AIG MANAGEMENT ARE "NON-GAAP FINANCIAL MEASURES" UNDER SECURITIES AND EXCHANGE COMMISSION RULES AND REGULATIONS. OPERATING INCOME AND RELATED RATES OF PERFORMANCE ARE SHOWN EXCLUSIVE OF REALIZED CAPITAL GAINS (LOSSES) AND EXCLUSIVE OF ONE OR MORE OF THE 2002 RESERVE CHARGE WHICH IS DISCUSSED UNDER LOSS RESERVE CHARGE IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, 2001 ACQUISITION, RESTRUCTURING AND RELATED CHARGES, AND 2001 WORLD TRADE CENTER AND RELATED LOSSES (WTC LOSSES). PREMIUM INCOME, GROSS PREMIUMS WRITTEN, STATUTORY UNDERWRITING PROFIT (LOSS) AND COMBINED RATIOS ARE PRESENTED IN ACCORDANCE WITH ACCOUNTING PRINCIPLES PRESCRIBED BY INSURANCE REGULATORY AUTHORITIES. A RECONCILIATION OF THE "NON-GAAP FINANCIAL MEASURES" TO THE MOST EQUIVALENT MEASUREMENTS PRESENTED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) IS PRESENTED ON PAGE 20 OF THIS ANNUAL REPORT ON FORM 10-K. FOR AN EXPLANATION OF WHY AIG MANAGEMENT CONSIDERS THESE "NON-GAAP MEASURES" USEFUL TO INVESTORS, SEE EXECUTIVE SUMMARY IN MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. 1
THE FOLLOWING TABLE SHOWS THE GENERAL DEVELOPMENT OF THE BUSINESS OF AIG ON A CONSOLIDATED BASIS, THE CONTRIBUTIONS MADE TO AIG'S CONSOLIDATED REVENUES AND OPERATING INCOME AND THE ASSETS HELD, IN THE PERIODS INDICATED BY ITS GENERAL INSURANCE, LIFE INSURANCE, FINANCIAL SERVICES, AND RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS, EQUITY IN INCOME OF MINORITY-OWNED INSURANCE COMPANIES AND OTHER REALIZED CAPITAL GAINS (LOSSES). (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTES 1 AND 2 OF NOTES TO FINANCIAL STATEMENTS.) (dollars in millions) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998 ==================================================================================================================================== GENERAL INSURANCE OPERATIONS: Gross premiums written $ 37,537 $ 29,640 $ 25,050 $ 22,569 $ 20,684 Net premiums written 27,414 20,101 17,526 16,224 14,586 Net premiums earned 24,269 19,365 17,407 15,544 14,098 Adjusted underwriting profit (loss)(a) (1,235)(b) 88(c) 785 669 531 Net investment income 2,760 2,893 2,701 2,517 2,192 Realized capital gains (losses) (858) (130) 38 295 205 Operating income 667(b) 2,851(c) 3,524 3,481 2,928 Identifiable assets 109,068 91,544 85,270 76,725 73,226 - ------------------------------------------------------------------------------------------------------------------------------------ Loss ratio 85.8 79.5 75.3 75.5 75.6 Expense ratio 20.2 21.2 21.4 20.8 20.8 - ------------------------------------------------------------------------------------------------------------------------------------ Combined ratio 106.0(b) 100.7(c) 96.7 96.3 96.4 ==================================================================================================================================== LIFE INSURANCE OPERATIONS: Premium income 20,320 19,063 17,163 15,476 13,719 Net investment income 12,274 11,084 9,962 8,932 8,065 Realized capital losses (1,053) (254) (162) (148) (74) Operating income (d) 4,929 4,675 4,058 3,610 3,249 Identifiable assets 339,847 296,648 248,982 231,843 197,851 Insurance in-force at end of year 1,324,451 1,228,501 971,892 950,933 845,045 FINANCIAL SERVICES OPERATIONS: Commissions, transaction and other fees 6,815 6,485 5,954 5,069 4,653 Operating income 2,189 1,991 1,666 1,417 1,172 Identifiable assets 124,617 107,322 94,173 78,868 70,065 RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS: Commissions and other fees 3,485 3,712 3,465 3,093 2,715 Operating income 1,016 1,088 1,108 873 673 Identifiable assets 2,567 1,842 1,590 1,132 915 EQUITY IN INCOME OF MINORITY-OWNED INSURANCE OPERATIONS -- -- -- -- 40 OTHER REALIZED CAPITAL GAINS (LOSSES) (530) (452) (190) (44) (1) REVENUES (E) 67,482 61,766 56,338 50,734 45,612 TOTAL ASSETS 561,229 493,061 426,671 383,685 338,783 ==================================================================================================================================== (a) Adjusted underwriting profit, a GAAP measure, is statutory underwriting income adjusted primarily for changes in the deferral of acquisition costs. This adjustment is necessary to present the financial statements in accordance with generally accepted accounting principles. (b) In the fourth quarter of 2002, after completion of its annual review of General Insurance loss and loss adjustment expense reserves, AIG increased its net loss reserves pertaining to accident years 1997 through 2001 by $2.8 billion. Excluding the loss reserve charge, the general insurance combined ratio would have been 94.4. (c) Includes $769 million in World Trade Center and related losses ("WTC losses"). Excluding WTC losses, the general insurance combined ratio would have been 96.7. (d) Includes $131 million in WTC losses in 2001. (e) Represents the sum of general net premiums earned, life premium income, net investment income, financial services commissions, transaction and other fees, retirement savings & asset management commissions and other fees, equity in income of minority-owned insurance operations, and realized capital gains (losses). 2
THE FOLLOWING TABLE SHOWS IDENTIFIABLE ASSETS, REVENUES AND INCOME DERIVED FROM OPERATIONS IN THE UNITED STATES AND CANADA AND FROM OPERATIONS IN OTHER COUNTRIES FOR THE YEAR ENDED DECEMBER 31, 2002. (SEE ALSO NOTE 2 OF NOTES TO FINANCIAL STATEMENTS.) (dollars in millions) - ------------------------------------------------------------------------------------------------------------------------------ PERCENT OF TOTAL UNITED STATES OTHER UNITED STATES OTHER TOTAL AND CANADA COUNTRIES AND CANADA COUNTRIES ============================================================================================================================== GENERAL INSURANCE OPERATIONS: Net premiums earned $ 24,269 $ 17,821 $ 6,448 73.4% 26.6% Adjusted underwriting profit (loss)* (1,235) (1,756) 521 -- -- Net investment income 2,760 2,081 679 75.4 24.6 Realized capital losses (858) (510) (348) -- -- Operating income (loss)* 667 (185) 852 -- -- Identifiable assets 109,068 80,703 28,365 74.0 26.0 LIFE INSURANCE OPERATIONS: Premium income 20,320 4,622 15,698 22.7 77.3 Net investment income 12,274 8,325 3,949 67.8 32.2 Realized capital losses (1,053) (984) (69) -- -- Operating income 4,929 1,704 3,225 34.6 65.4 Identifiable assets 339,847 234,450 105,397 69.0 31.0 FINANCIAL SERVICES OPERATIONS: Commissions, transaction and other fees 6,815 5,889 926 86.4 13.6 Operating income 2,189 1,682 507 76.8 23.2 Identifiable assets 124,617 109,032 15,585 87.5 12.5 RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS: Commissions and other fees 3,485 3,041 444 87.3 12.7 Operating income 1,016 893 123 87.9 12.1 Identifiable assets 2,567 1,230 1,337 47.9 52.1 OTHER REALIZED CAPITAL LOSSES (530) (506) (24) -- -- INCOME BEFORE INCOME TAXES AND MINORITY INTEREST 8,142 3,379 4,763 41.5 58.5 REVENUES 67,482 39,779 27,703 58.9 41.1 TOTAL ASSETS 561,229 409,195 152,034 72.9 27.1 ============================================================================================================================== * Includes net loss reserve charge of $2.8 billion. GENERAL INSURANCE OPERATIONS AIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. One or more of these companies is licensed to write substantially all of these lines in all states of the United States and in approximately 70 foreign countries. Domestic general insurance operations are comprised of the Domestic Brokerage Group (DBG), which includes the operations of HSB; Transatlantic Holdings, Inc. (Transatlantic); Personal Lines, including 21st Century Insurance Group (21st Century); and Mortgage Guaranty. AIG's primary domestic division is DBG. DBG's business is derived from brokers in the United States and Canada and is conducted through its general insurance subsidiaries including American Home, National Union, Lexington and certain other general insurance company subsidiaries of AIG. The AIG Risk Management operation provides insurance and risk management programs for large corporate customers. The AIG Risk Finance division designs and implements risk financing alternatives using the insurance and financial services capabilities of AIG. Also included are the operations of AIG Environmental which focuses specifically on providing specialty products to clients with environmental exposures. DBG writes substantially all classes of business insurance accepting such business mainly from insurance brokers. This provides DBG the opportunity to select specialized markets and retain underwriting control. Any licensed broker is able to submit business to DBG without the traditional agent-company contractual relationship, but such broker usually has no authority to commit DBG to accept a risk. In addition to writing substantially all classes of business insurance, including large commercial or industrial property insurance, excess liability, inland marine, environmental, workers' compensation and excess and umbrella coverages, DBG offers many specialized forms of insurance such as equipment breakdown, directors and officers liability, difference-in-conditions, kidnap-ransom, export credit and political risk, and various types of professional errors and omissions coverages. Lexington writes surplus lines, those risks for which conventional insurance companies do not readily provide insurance coverage, either because of complexity or because the coverage does not lend itself to conventional contracts. 3
Transatlantic offers reinsurance capacity on both treaty and facultative basis. Transatlantic structures traditional and non-traditional programs for a full range of property and casualty products with an emphasis on specialty risk. AIG engages in mass marketing of personal lines coverages, primarily private passenger auto and homeowners and personal umbrella coverages, principally through American International Insurance Company and 21st Century. The business of United Guaranty Corporation (UGC) and its subsidiaries is also included in the domestic operations of AIG. The principal business of the UGC subsidiaries is the writing of residential mortgage loan insurance, which is guaranty insurance on conventional first mortgage loans on single-family dwellings and condominiums. Such insurance protects lenders against loss if borrowers default. UGC subsidiaries also write home equity and property improvement loan insurance on loans to finance residential property improvements, alterations and repairs and for other purposes not necessarily related to real estate. UGC had approximately $22 billion of mortgage guarantee risk in-force at December 31, 2002. AIG's Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance companies. The Foreign General insurance group also includes business written by AIG's foreign-based insurance subsidiaries for their own accounts. The Foreign General group uses various marketing methods to write both business and personal lines insurance with certain refinements for local laws, customs and needs. AIU operates in over 70 countries in Asia, the Pacific Rim, Europe, Africa, Middle East and Latin America. During 2002, DBG and the Foreign General insurance group accounted for 55.5 percent and 21.9 percent, respectively, of AIG's net premiums written. AIG's general insurance company subsidiaries worldwide operate primarily by underwriting and accepting risks for their direct account and securing reinsurance on that portion of the risk in excess of the limit which they wish to retain. This operating policy differs from that of many insurance companies which will underwrite only up to their net retention limit, thereby requiring the broker or agent to secure commitments from other underwriters for the remainder of the gross risk amount. THE FOLLOWING TABLE SUMMARIZES GENERAL INSURANCE PREMIUMS WRITTEN AND EARNED: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, WRITTEN EARNED ================================================================================ 2002 Gross premiums $ 37,537 $ 34,381 Ceded premiums (10,123) (10,112) - -------------------------------------------------------------------------------- Net premiums $ 27,414 $ 24,269 ================================================================================ 2001 Gross premiums $ 29,640 $ 28,850 Ceded premiums (9,539) (9,485) - -------------------------------------------------------------------------------- Net premiums $ 20,101 $ 19,365 ================================================================================ 2000 Gross premiums $ 25,050 $ 24,062 Ceded premiums (7,524) (6,655) - -------------------------------------------------------------------------------- Net premiums $ 17,526 $ 17,407 ================================================================================ The utilization of reinsurance is closely monitored by an internal reinsurance security committee, consisting of members of AIG's senior management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 5 of Notes to Financial Statements.) AIG is diversified both in terms of lines of business and geographic locations. Of the general insurance lines of business, workers' compensation was approximately 12 percent of AIG's net premiums written. This line of business is also diversified geographically. The majority of AIG's general insurance business is in the casualty classes, which tend to involve longer periods of time for the reporting and settling of claims. This may increase the risk and uncertainty with respect to AIG's loss reserve development. (See also the Discussion and Analysis of Consolidated Net Losses and Loss Expense Reserve Development and Management's Discussion and Analysis of Financial Condition and Results of Operations.) 4
LOSS AND EXPENSE RATIOS OF AIG'S CONSOLIDATED GENERAL INSURANCE OPERATIONS ARE SET FORTH IN THE FOLLOWING TABLE. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.) (dollars in millions) - ----------------------------------------------------------------------------------------------------------------------------------- RATIO OF RATIO OF LOSSES AND UNDERWRITING LOSS EXPENSES EXPENSES INCURRED TO INCURRED TO INDUSTRY NET PREMIUMS NET PREMIUMS NET PREMIUMS COMBINED UNDERWRITING COMBINED YEARS ENDED DECEMBER 31, WRITTEN EARNED EARNED WRITTEN RATIO MARGIN RATIO(c) =================================================================================================================================== 2002 $27,414 $24,269 85.8 20.2 106.0(a) (6.0) 109.0 2001 20,101 19,365 79.5 21.2 100.7(b) (0.7) 115.3 2000 17,526 17,407 75.3 21.4 96.7 3.3 108.6 1999 16,224 15,544 75.5 20.8 96.3 3.7 107.1 1998 14,586 14,098 75.6 20.8 96.4 3.6 104.9 =================================================================================================================================== (a) Excluding the net loss reserve charge of $2.8 billion, the general insurance combined ratio would have been 94.4. (b) Excluding WTC losses, the general insurance combined ratio would have been 96.7. (c) Source: Best's Aggregates & Averages (Stock insurance companies, after dividends to policyholders): the ratios for 2002 and 2001 were obtained from Fox-Pitt, Kelton Inc. The ratio for 2002 reflects estimated results. During 2002, of the direct general insurance premiums written (gross premiums less return premiums and cancellations, excluding reinsurance assumed and before deducting reinsurance ceded), 10.2 percent, 7.4 percent and 6.7 percent were written in California, New York and Illinois, respectively. No other state accounted for more than 5 percent of such premiums. There was no significant adverse effect on AIG's general insurance results of operations from the economic environments in any one state, country or geographic region for the year ended December 31, 2002. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) DISCUSSION AND ANALYSIS OF CONSOLIDATED NET LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT The reserve for net losses and loss expenses represents the accumulation of estimates for reported losses ("case basis reserves") and provisions for losses incurred but not reported (IBNR), both reduced by applicable reinsurance recoverable. Losses and loss expenses are charged to income as incurred. AIG discounts certain of its loss reserves principally related to workers' compensation lines of business. Loss reserves established with respect to foreign business are set and monitored in terms of the respective local or functional currency. Therefore, no assumption is included for changes in currency rates. (See also Note 1(v) of Notes to Financial Statements.) Management reviews the adequacy of established loss reserves through the utilization of a number of analytical reserve development techniques. Through the use of these techniques, management is able to monitor the adequacy of its established reserves and determine appropriate assumptions for inflation. Also, analysis of emerging specific development patterns, such as case reserve redundancies or deficiencies and IBNR emergence, allows management to determine any required adjustments. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) The "Analysis of Consolidated Net Losses and Loss Expense Reserve Development Excluding Asbestos and Environmental Net Losses and Loss Expense Reserve Development" table, which follows, presents the development of net losses and loss expense reserves for calendar years 1992 through 2002. The upper half of the table shows the cumulative amounts paid during successive years related to the opening loss reserves. For example, with respect to the net losses and loss expense reserve of $19.19 billion as of December 31, 1995, by the end of 2002 (seven years later) $15.49 billion had actually been paid in settlement of these net loss reserves. In addition, as reflected in the lower section of the table, the original reserve of $19.19 billion was reestimated to be $18.10 billion at December 31, 2002. This decrease from the original estimate would generally be a combination of a number of factors, including reserves being settled for smaller amounts than originally estimated. The original estimates will also be increased or decreased as more information becomes known about the individual claims and overall claim frequency and severity patterns. The redundancy (deficiency) depicted in the table, for any particular calendar year, shows the aggregate change in estimates over the period of years subsequent to the calendar year reflected at the top of the respective column heading. For example, the deficiency of $3.90 billion at December 31, 2002 related to December 31, 2001 net losses and loss expense reserves of $25.18 billion represents the cumulative amount by which reserves for 2001 and prior years have developed deficiently during 2002. The deficiency that has emerged in the last year can be attributed principally to a series of excessive jury awards in certain liability or casualty lines of business. Market rates in certain classes of business and expanded policy form coverages, which were prevalent in the marketplace in the accident years 1997 through 2001, contributed to this issue. Corrective pricing and revision of policy forms are taking place. Tort reform is still critically needed in the U.S. although a great deal of effort 5
has been undertaken in individual states to correct the abuse that has prevailed. The reserve for net losses and loss expenses with respect to Transatlantic and 21st Century are included only in the consolidated net losses and loss expenses commencing with the year ended December 31, 1998. Reserve development for these operations is included only for 1998 and subsequent periods. ANALYSIS OF CONSOLIDATED NET LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT EXCLUDING ASBESTOS AND ENVIRONMENTAL NET LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT THE FOLLOWING TABLE EXCLUDES FOR EACH CALENDAR YEAR THE NET LOSS AND LOSS EXPENSE RESERVES AND THE DEVELOPMENT THEREOF WITH RESPECT TO ASBESTOS AND ENVIRONMENTAL CLAIMS. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.) (in millions) - ----------------------------------------------------------------------------------------------------------------------------------- 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 =================================================================================================================================== Reserve for Net Losses and Loss Expenses, Excluding Asbestos and Environmental Losses and Loss Expenses, December 31, $16,503 $17,249 $18,089 $19,186 $19,664 $20,384 $23,754 $23,709 $24,097 $25,177 $29,653 Paid (Cumulative) as of: One Year Later 4,766 5,061 4,700 5,174 5,507 5,576 6,657 7,712 9,069 10,250 Two Years Later 8,088 8,082 7,891 8,515 8,832 9,305 11,373 13,426 15,804 Three Years Later 10,157 10,137 10,048 10,673 11,094 12,122 15,031 18,130 Four Years Later 11,337 11,726 11,683 12,128 12,948 14,172 18,284 Five Years Later 12,448 12,871 12,734 13,466 14,401 16,025 Six Years Later 13,274 13,560 13,689 14,601 15,653 Seven Years Later 13,771 14,285 14,421 15,487 Eight Years Later 14,310 14,866 15,114 Nine Years Later 14,768 15,405 Ten Years Later 15,255 Net Liability Reestimated as of: End of Year 16,503 17,249 18,089 19,186 19,664 20,384 23,754 23,709 24,097 25,177 29,653 One Year Later 16,382 17,019 17,556 18,568 19,118 19,903 23,229 23,345 24,563 29,131 Two Years Later 16,073 16,813 17,355 18,347 18,910 19,771 22,827 24,111 28,257 Three Years Later 15,997 16,790 17,293 18,141 18,934 19,428 23,306 26,951 Four Years Later 16,081 16,960 17,090 18,292 18,670 19,532 24,994 Five Years Later 16,362 16,969 17,155 18,161 18,568 20,213 Six Years Later 16,404 17,080 17,169 17,836 18,923 Seven Years Later 16,582 17,146 16,838 18,101 Eight Years Later 16,731 16,968 17,052 Nine Years Later 16,690 17,110 Ten Years Later 16,804 Redundancy/(Deficiency) (301) 139 1,037 1,085 741 171 (1,240) (3,242) (4,160) (3,954) Less effect of 21st Century homeowners and earthquake lines in runoff (117) (111) (110) (56) Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines (1,123) (3,131) (4,050) (3,898) =================================================================================================================================== 6
ANALYSIS OF CONSOLIDATED NET LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT THE FOLLOWING TABLE INCLUDES FOR EACH CALENDAR YEAR THE NET LOSS AND LOSS EXPENSE RESERVES AND THE DEVELOPMENT THEREOF WITH RESPECT TO ASBESTOS AND ENVIRONMENTAL CLAIMS. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.) (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 ==================================================================================================================================== Reserve for Net Losses and Loss Expenses, December 31, $16,757 $17,557 $18,419 $19,693 $20,407 $21,171 $24,619 $24,600 $24,952 $25,896 $30,350 Paid (Cumulative) as of: One Year Later 4,883 5,146 4,775 5,281 5,616 5,716 6,779 7,783 9,263 10,396 Two Years Later 8,289 8,242 8,073 8,726 9,081 9,559 11,565 13,690 16,144 Three Years Later 10,433 10,404 10,333 11,024 11,456 12,442 15,416 18,540 Four Years Later 11,718 12,095 12,107 12,591 13,376 14,684 18,815 Five Years Later 12,931 13,378 13,270 13,994 15,018 16,679 Six Years Later 13,894 14,179 14,290 15,317 16,412 Seven Years Later 14,502 14,968 15,209 16,344 Eight Years Later 15,105 15,735 16,043 Nine Years Later 15,749 16,414 Ten Years Later 16,375 Net Liability Reestimated as of: End of Year 16,757 17,557 18,419 19,693 20,407 21,171 24,619 24,600 24,952 25,896 30,350 One Year Later 16,807 17,434 18,139 19,413 20,009 20,890 24,237 24,265 25,471 29,969 Two Years Later 16,603 17,479 18,269 19,330 19,999 20,886 23,864 25,082 29,284 Three Years Later 16,778 17,782 18,344 19,327 20,151 20,572 24,392 28,043 Four Years Later 17,182 18,090 18,344 19,604 19,916 20,715 26,202 Five Years Later 17,600 18,300 18,535 19,500 19,851 21,513 Six Years Later 17,844 18,537 18,575 19,212 20,323 Seven Years Later 18,148 18,629 18,281 19,592 Eight Years Later 18,320 18,485 18,608 Nine Years Later 18,314 18,742 Ten Years Later 18,542 Redundancy/(Deficiency) (1,785) (1,185) (189) 101 84 (342) (1,583) (3,443) (4,332) (4,073) Less effect of 21st Century homeowners and earthquake lines in runoff (117) (111) (110) (56) Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines (1,466) (3,332) (4,222) (4,017) ==================================================================================================================================== 7
RECONCILIATION OF NET RESERVES FOR LOSSES AND LOSS EXPENSES (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Net reserve for losses and loss expenses at beginning of year $25,896 $24,952 $24,600 Acquisition (a) -- -- 236 - -------------------------------------------------------------------------------- Losses and loss expenses incurred: Current year 16,741 14,870 13,356 Prior years (b) 4,073 536 (252) - -------------------------------------------------------------------------------- 20,814 15,406 13,104 - -------------------------------------------------------------------------------- Losses and loss expenses paid: Current year 5,964 5,199 5,205 Prior years 10,396 9,263 7,783 - -------------------------------------------------------------------------------- 16,360 14,462 12,988 - -------------------------------------------------------------------------------- Net reserve for losses and loss expenses at end of year (c) $30,350 $25,896 $24,952 ================================================================================ (a) Acquisition includes the opening balances with respect to HSB in 2000. (b) Does not include the effects of foreign exchange adjustments which are reflected in the "Net Losses and Loss Expense Reserve Development" table. (c) See also Note 6(a) of Notes to Financial Statements. For further discussion regarding net reserves for losses and loss expenses, see Management's Discussion and Analysis of Financial Condition and Results of Operations. The reserve for losses and loss expenses as reported in AIG's Consolidated Balance Sheet at December 31, 2002, differs from the total reserve reported in the Annual Statements filed with state insurance departments and, where appropriate, with foreign regulatory authorities. The differences at December 31, 2002 relate primarily to reserves for certain foreign operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) The reserve for gross losses and loss expenses is prior to reinsurance and represents the accumulation for reported losses and IBNR. Management reviews the adequacy of established gross loss reserves in the manner previously described for net loss reserves. 8
ANALYSIS OF CONSOLIDATED GROSS LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT THE "ANALYSIS OF CONSOLIDATED GROSS LOSSES AND LOSS EXPENSE RESERVE DEVELOPMENT" TABLE, WHICH FOLLOWS, PRESENTS THE DEVELOPMENT OF GROSS LOSSES AND LOSS EXPENSE RESERVES FOR CALENDAR YEARS 1992 THROUGH 2002. (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 ==================================================================================================================================== Gross Losses and Loss Expenses, December 31, $28,157 $30,046 $31,435 $33,047 $33,430 $33,400 $38,310 $38,252 $40,613 $44,792 $51,539 Paid (Cumulative) as of: One Year Later 7,281 8,807 7,640 8,392 9,199 9,185 10,344 12,543 12,905 14,934 Two Years Later 13,006 13,279 13,036 15,496 15,043 14,696 19,155 19,350 24,079 Three Years Later 16,432 17,311 17,540 18,837 18,721 19,706 24,309 28,699 Four Years Later 18,550 20,803 20,653 21,811 21,729 22,659 30,301 Five Years Later 21,322 22,895 22,634 23,463 23,498 27,554 Six Years Later 22,807 23,779 24,205 24,927 26,649 Seven Years Later 23,684 25,239 24,882 28,234 Eight Years Later 25,060 26,314 27,404 Nine Years Later 26,094 28,221 Ten Years Later 27,556 Gross Liability Reestimated as of: End of Year 28,157 30,046 31,435 33,047 33,430 33,400 38,310 38,252 40,613 44,792 51,539 One Year Later 28,253 29,866 30,759 32,372 32,777 32,337 37,161 37,998 41,443 49,565 Two Years Later 27,825 29,537 30,960 32,398 31,719 32,251 37,959 40,454 46,259 Three Years Later 27,727 30,362 30,825 31,759 31,407 32,810 39,713 43,865 Four Years Later 28,625 31,020 30,508 31,604 32,388 34,449 41,828 Five Years Later 29,701 30,881 30,417 32,425 32,979 35,316 Six Years Later 29,605 30,969 31,128 32,869 33,328 Seven Years Later 29,929 31,546 31,524 33,227 Eight Years Later 30,452 31,841 31,875 Nine Years Later 30,956 32,044 Ten Years Later 30,968 Redundancy/(Deficiency) (2,811) (1,998) (440) (180) 102 (1,916) (3,518) (5,613) (5,646) (4,773) Less effect of 21st Century homeowners and earthquake lines in runoff (117) (111) (110) (56) Redundancy/(Deficiency) excluding 21st Century homeowners and earthquake lines (3,401) (5,502) (5,536) (4,717) ==================================================================================================================================== LIFE INSURANCE OPERATIONS AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. One or more of these subsidiaries is licensed to write life insurance in all states in the United States and in over 70 foreign countries. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) Life insurance operations in foreign countries comprised 77.3 percent of life premium income and 65.4 percent of operating income in 2002. AIG operates overseas principally through ALICO, AIA and Nan Shan. ALICO is incorporated in Delaware and all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in approximately 50 countries located in Europe, Africa, Latin America, the Caribbean, the Middle East, and the Far East, with Japan being the largest territory. AIG added significantly to its presence in Japan with the acquisition of AIG Star Life Insurance Co., Ltd. in 2001, as a result of the reorganization of Chiyoda Mutual Life Insurance Company. AIA operates primarily in China (including Hong Kong), Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. (See also Note 2 of Notes to Financial Statements.) AIG's principal domestic life insurance subsidiaries include AIG American General Life, AIG Annuity and SunAmerica Life. These companies utilize multiple distribution channels including brokerage and career and general agents to offer traditional life products as well as financial and 9
investment products. The domestic life operations comprised 22.7 percent of total life premium income in 2002. There was no significant adverse effect on AIG's life insurance results of operations from economic environments in any one state, country or geographic region for the year ended December 31, 2002. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) Traditional life insurance products such as whole life and endowment continue to be significant in the overseas companies, especially in Southeast Asia, while a mixture of traditional, accident and health and financial products are sold in Japan. In addition to the above, AIG also has subsidiary operations in the Philippines, Canada, Mexico, Poland, Switzerland, Puerto Rico, and conducts life insurance business through AIUO subsidiary companies, in Russia, Israel and in certain countries in Central and South America. The foreign life companies have over 195,000 career agents and sell their products largely to indigenous persons in local currencies. In addition to the agency outlets, these companies also distribute their products through direct marketing channels, such as mass marketing, and through brokers and other distribution outlets such as financial institutions. THE FOLLOWING TABLES SUMMARIZE THE LIFE INSURANCE OPERATING RESULTS PRESENTED ON A MAJOR PRODUCT BASIS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.) (in millions) - ------------------------------------------------------------------------------------------------------------------ 2002 2001(a) 2000(a) ================================================================================================================== GAAP PREMIUMS: Domestic: Life Insurance $ 1,626 $ 1,515 $ 1,522 Individual Fixed Annuities (b) 42 437 380 Guaranteed Investment Contracts 28 -- (7) Home Service 854 876 953 Group Life/Health 967 925 969 Pension and Investment Products (b) 1,105 1,144 665 Accident & Health (c) -- 51 327 - ------------------------------------------------------------------------------------------------------------------ Total Domestic 4,622 4,948 4,809 - ------------------------------------------------------------------------------------------------------------------ Foreign: Life Insurance 12,000 10,771 9,474 Personal Accident 2,491 2,196 1,924 Group Products 1,094 1,050 851 Guaranteed Investment Contracts 113 98 105 - ------------------------------------------------------------------------------------------------------------------ Total Foreign 15,698 14,115 12,354 - ------------------------------------------------------------------------------------------------------------------ Total GAAP premiums $ 20,320 $ 19,063 $ 17,163 ================================================================================================================== PREMIUM INCOME, DEPOSITS AND OTHER CONSIDERATIONS (d) (e): Domestic: Life Insurance (f) $ 2,411 $ 2,724 $ 2,256 Individual Fixed Annuities 10,328 7,605 5,079 Guaranteed Investment Contracts 9,078 8,242 6,752 Home Service 861 878 953 Group Life/Health 976 930 969 Pension and Investment Products 1,782 3,020 2,368 Accident & Health(c) -- 157 327 - ------------------------------------------------------------------------------------------------------------------ Total Domestic 25,436 23,556 18,704 - ------------------------------------------------------------------------------------------------------------------ Foreign: Life Insurance 13,440 12,066 10,256 Personal Accident 2,497 2,173 1,923 Group Products 1,579 1,660 1,266 Guaranteed Investment Contracts 5,710 4,162 6,070 - ------------------------------------------------------------------------------------------------------------------ Total Foreign 23,226 20,061 19,515 - ------------------------------------------------------------------------------------------------------------------ Total premium income, deposits and other considerations $ 48,662 $ 43,617 $ 38,219 ================================================================================================================== 10
(in millions) - ------------------------------------------------------------------------------------------------------------------ 2002 2001(a) 2000(a) ================================================================================================================== NET INVESTMENT INCOME: Domestic: Life Insurance $ 1,417 $ 1,329 $ 1,306 Individual Fixed Annuities 3,229 2,874 2,708 Guaranteed Investment Contracts 2,052 1,836 1.321 Home Service 683 653 669 Group Life/Health 108 105 107 Pension and Investment Products 836 702 662 Accident & Health (c) -- 5 8 - ------------------------------------------------------------------------------------------------------------------ Total Domestic 8,325 7,504 6,781 - ------------------------------------------------------------------------------------------------------------------ Foreign: Life Insurance 3,206 2,848 2,432 Personal Accident 141 128 129 Group Products 255 227 223 Guaranteed Investment Contracts 359 387 406 Intercompany Adjustments (12) (10) (9) - ------------------------------------------------------------------------------------------------------------------ Total Foreign 3,949 3,580 3,181 - ------------------------------------------------------------------------------------------------------------------ Total net investment income $ 12,274 $ 11,084 $ 9,962 ================================================================================================================== OPERATING INCOME BEFORE REALIZED CAPITAL LOSSES: Domestic: Life Insurance (g) $ 777 $ 555 $ 614 Individual Fixed Annuities 729 679 611 Guaranteed Investment Contracts 581 445 159 Home Service 382 374 353 Group Life/Health 101 87 69 Pension and Investment Products 118 144 150 Accident & Health (c) -- 4 23 - ------------------------------------------------------------------------------------------------------------------ Total Domestic (g) 2,688 2,288 1,979 - ------------------------------------------------------------------------------------------------------------------ Foreign: Life Insurance 2,411 1,914 1,558 Personal Accident 681 572 531 Group Products 175 127 107 Guaranteed Investment Contracts 39 38 54 Intercompany Adjustments (12) (10) (9) - ------------------------------------------------------------------------------------------------------------------ Total Foreign 3,294 2,641 2,241 - ------------------------------------------------------------------------------------------------------------------ Total operating income before realized capital losses 5,982 4,929 4,220 Realized capital losses (1,053) (254) (162) - ------------------------------------------------------------------------------------------------------------------ Total operating income (g) $ 4,929 $ 4,675 $ 4,058 ================================================================================================================== LIFE INSURANCE IN-FORCE: Domestic $ 577,686 $ 517,067 $ 477,576 Foreign (h) 746,765 711,434 494,316 - ------------------------------------------------------------------------------------------------------------------ Total $ 1,324,451 $ 1,228,501 $ 971,892 ================================================================================================================== (a) Restated to conform to the 2002 presentation. (b) 2001 and 2000 GAAP premiums included certain annuity products now reported in Pension and Investment Products. (c) Beginning 2001, certain Accident & Health operations are part of DBG. (d) Represents a non-GAAP measurement used by AIG to help manage its life insurance operation, and may not be comparable to similarly captioned measurements used by other life insurance companies. (e) Premium income, deposits and other considerations represent aggregate business activity during the respective periods. (f) The decline in life premiums is due primarily to lower private placement and corporate life market sales. (g) 2001 included WTC losses of $131 million. (h) Increase in 2001 reflects acquisition of AIG Star Life Insurance Co., Ltd. in April 2001. 11
INSURANCE INVESTMENT OPERATIONS A significant portion of AIG's general and life operating revenues are derived from AIG's insurance investment operations. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 2 and 8 of Notes to Financial Statements.) THE FOLLOWING TABLES SUMMARIZE THE COMPOSITION OF AIG'S INSURANCE INVESTED ASSETS BY INSURANCE SEGMENT, INCLUDING INVESTMENT INCOME DUE AND ACCRUED AND REAL ESTATE, AT DECEMBER 31, 2002 AND 2001: (dollars in millions) - ---------------------------------------------------------------------------------------------------------------------------------- GENERAL LIFE PERCENT PERCENT DISTRIBUTION -------------------- DECEMBER 31, 2002 INSURANCE INSURANCE TOTAL OF TOTAL DOMESTIC FOREIGN ================================================================================================================================== Fixed maturities, at market value (a) $ 35,990 $206,003 $241,993 76.9% 69.1% 30.9% Equity securities, at market value (b) 3,928 2,931 6,859 2.2 53.4 46.6 Mortgage loans on real estate, policy and collateral loans 35 18,901 18,936 6.0 68.8 31.2 Short-term investments, including time deposits, and cash 1,833 5,048 6,881 2.2 42.5 57.5 Real estate 488 2,367 2,855 0.9 24.8 75.2 Investment income due and accrued 729 3,489 4,218 1.4 64.2 35.8 Securities lending collateral 7,249 16,445 23,694 7.5 75.8 24.2 Other invested assets 5,226 3,954 9,180 2.9 82.1 17.9 - ---------------------------------------------------------------------------------------------------------------------------------- Total $ 55,478 $259,138 $314,616 100.0% 68.6% 31.4% ================================================================================================================================== (a) Includes $981 million of bond trading securities, at market value. (b) Includes $1.58 billion of non-redeemable preferred stocks, at market value. (dollars in millions) - ----------------------------------------------------------------------------------------------------------------------------------- General Life Percent Percent Distribution -------------------- December 31, 2001 Insurance Insurance Total of Total Domestic Foreign =================================================================================================================================== Fixed maturities, at market value (a) $ 29,602 $169,750 $199,352 77.6% 68.8% 31.2% Equity securities, at market value (b) 4,568 3,139 7,707 3.0 53.9 46.1 Mortgage loans on real estate, policy and collateral loans 58 17,975 18,033 7.0 68.0 32.0 Short-term investments, including time deposits, and cash 1,620 5,287 6,907 2.7 49.3 50.7 Real estate 410 2,106 2,516 1.0 21.5 78.5 Investment income due and accrued 573 3,001 3,574 1.4 63.9 36.1 Securities lending collateral 992 9,581 10,573 4.1 74.9 25.1 Other invested assets 5,336 2,937 8,273 3.2 82.2 17.8 - ----------------------------------------------------------------------------------------------------------------------------------- Total $ 43,159 $213,776 $256,935 100.0% 68.0% 32.0% =================================================================================================================================== (a) Includes $842 million of bond trading securities, at market value. (b) Includes $1.72 billion of non-redeemable preferred stocks, at market value. 12
THE FOLLOWING TABLE SUMMARIZES THE INVESTMENT RESULTS OF THE GENERAL INSURANCE OPERATIONS. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE 8 OF NOTES TO FINANCIAL STATEMENTS.) (dollars in millions) - ------------------------------------------------------------------------------------------------------------------ ANNUAL AVERAGE CASH AND INVESTED ASSETS --------------------------------------- CASH REALIZED (INCLUDING NET CAPITAL SHORT-TERM INVESTED INVESTMENT RATE OF RETURN ON GAINS YEARS ENDED DECEMBER 31, INVESTMENTS) ASSETS(a) TOTAL INCOME(b) INVESTED ASSETS (LOSSES) ================================================================================================================== 2002 $ 1,726 $47,592 $49,318 $ 2,760 5.6%(c) 5.8%(d) $ (858) 2001 1,533 41,492 43,025 2,893 6.7 (c) 7.0 (d) (130) 2000 1,212 39,801 41,013 2,701 6.6 (c) 6.8 (d) 38 1999 925 38,084 39,009 2,517 6.5 (c) 6.6 (d) 295 1998 745 34,619 35,364 2,192 6.2 (c) 6.3 (d) 205 ================================================================================================================== (a) Including investment income due and accrued and real estate. (b) Net investment income is after deduction of investment expenses and excludes realized capital gains (losses). (c) Net investment income divided by the annual average sum of cash and invested assets. (d) Net investment income divided by the annual average invested assets. THE FOLLOWING TABLE SUMMARIZES THE INVESTMENT RESULTS OF THE LIFE INSURANCE OPERATIONS. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE 8 OF NOTES TO FINANCIAL STATEMENTS.) (dollars in millions) - ----------------------------------------------------------------------------------------------------------------------- ANNUAL AVERAGE CASH AND INVESTED ASSETS --------------------------------------- CASH (INCLUDING NET REALIZED SHORT-TERM INVESTED INVESTMENT RATE OF RETURN ON CAPITAL YEARS ENDED DECEMBER 31, INVESTMENTS) ASSETS(a) TOTAL INCOME(b) INVESTED ASSETS LOSSES ======================================================================================================================= 2002 $ 5,167 $231,290 $236,457 $ 12,274 5.2%(c) 5.3%(d) $ (1,053) 2001 5,054 186,103 191,157 11,084 5.8 (c) 6.0 (d) (254) 2000 5,670 155,477 161,147 9,962 6.2 (c) 6.4 (d) (162) 1999 6,590 141,771 148,361 8,932 6.0 (c) 6.3 (d) (148) 1998 5,251 124,764 130,015 8,065 6.2 (c) 6.5 (d) (74) ======================================================================================================================= (a) Including investment income due and accrued, real estate. (b) Net investment income is after deduction of investment expenses and excludes realized capital gains (losses). (c) Net investment income divided by the annual average sum of cash and invested assets. (d) Net investment income divided by the annual average invested assets. 13
AIG's worldwide insurance investment policy places primary emphasis on investments in high quality, fixed income securities in all of its portfolios and, to a lesser extent, investments in marketable common stocks in order to preserve policyholders' surplus and generate net investment income. The ability to implement this policy is somewhat limited in certain territories as there may be a lack of qualified long term investments or investment restrictions may be imposed by the local regulatory authorities. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) FINANCIAL SERVICES OPERATIONS AIG's financial services subsidiaries engage in diversified financial products and services including aircraft leasing, consumer and insurance premium financing, capital markets structuring and market-making activities. ILFC engages primarily in the acquisition of commercial jet aircraft and the leasing and remarketing of such aircraft to airlines around the world. Also, ILFC provides, for a fee, fleet management services to certain third-party operators. (See also Note 2 of Notes to Financial Statements.) AIGFP engages in a wide variety of financial transactions, including long-dated interest rate, currency, equity and credit derivatives and structured borrowing through notes, bonds and guaranteed investment agreements. AIGFP does not engage in trading activities with respect to commodity contracts. (See also Note 2 of Notes to Financial Statements.) AIG's Consumer Finance operations include AGF as well as AIG Consumer Finance Group, Inc. (AIGCFG). (See also Note 2 of Notes to Financial Statements.) AGF provides a wide variety of consumer finance products, including real estate mortgages, consumer loans, retail sales finance and credit related insurance to customers in the United States. AIGCFG, through its subsidiaries, is engaged in developing a multi-product consumer finance business with an emphasis on emerging markets. Together ILFC, AIGFP and AIG's Consumer Finance operations comprise 97.2 percent of the commissions, transaction and other fees of AIG's consolidated financial services operations. THE FOLLOWING TABLE IS A SUMMARY OF THE REVENUES AND OPERATING INCOME OF AIG'S PRINCIPAL FINANCIAL SERVICES OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE 1 OF NOTES TO FINANCIAL STATEMENTS.) (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ REVENUES: ILFC (a) $2,845 $2,613 $2,441 AIGFP (b) 1,306 1,178 1,056 Consumer Finance (c) 2,473 2,560 2,325 OPERATING INCOME: ILFC $ 801 $ 749 $ 654 AIGFP 808 758 648 Consumer Finance 549 505 386 ================================================================================ (a) Revenues were primarily from aircraft lease rentals. (b) Revenues were primarily fees from proprietary positions entered into in connection with counterparty transactions. (c) Revenues were primarily finance charges. Imperial A.I. Credit Companies also contribute to financial services income. This operation engages principally in insurance premium financing. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations and Notes 1, 9 and 12 of Notes to Financial Statements.) RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS AIG's retirement savings & asset management operations offer a wide variety of investment vehicles and services, including variable annuities, mutual funds, and investment asset management. Such products and services are offered to individuals and institutions both domestically and overseas. AIG's principal retirement savings & asset management operations are conducted through AIG SunAmerica Inc. and its subsidiaries (AIG SunAmerica), VALIC and its related marketing entities (AIG VALIC) and AIG Global Investment Group. AIG SunAmerica develops and sells variable annuities and other investment products, sells and manages mutual funds and provides financial services. AIG VALIC provides tax qualified annuities to the employees of educational, healthcare and governmental entities. AIG Global Investment Group manages third-party institutional, retail and private equity funds invested assets on a global basis, provides securities lending and custodial services and organizes, and manages the invested assets of institutional private equity investment funds. Each of these subsidiary operations receives fees for investment products and services provided. 14
THE FOLLOWING TABLE IS A SUMMARY OF THE REVENUES AND OPERATING INCOME OF AIG'S PRINCIPAL RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE 1 OF NOTES TO FINANCIAL STATEMENTS.) (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ REVENUES: AIG VALIC $2,133 $2,110 $2,230 AIG SunAmerica 563 652 750 Other* 789 950 485 - -------------------------------------------------------------------------------- Total $3,485 $3,712 $3,465 ================================================================================ OPERATING INCOME: AIG VALIC $ 730 $ 630 $ 692 AIG SunAmerica 32 185 326 Other* 254 273 90 - -------------------------------------------------------------------------------- Total $1,016 $1,088 $1,108 ================================================================================ * Includes AIG Global Investment Group, John McStay Investment Counsel, L.P. and certain overseas variable annuity operations. THE FOLLOWING TABLE IS A SUMMARY OF THE COMPOSITION OF AIG'S FINANCIAL SERVICES INVESTED ASSETS AND LIABILITIES AT DECEMBER 31, 2002 AND 2001. (SEE ALSO MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE 1 OF NOTES TO FINANCIAL STATEMENTS.) (in millions) - ------------------------------------------------------------------------------------------ 2002 2001 ========================================================================================== Financial services invested assets: Flight equipment primarily under operating leases, net of accumulated depreciation $ 26,867 $ 22,710 Finance receivables, net of allowance 15,857 13,955 Unrealized gain on interest rate and currency swaps, options and forward transactions 15,376 11,493 Securities available for sale, at market value 16,687 17,801 Trading securities, at market value 4,146 5,733 Securities purchased under agreements to resell, at contract value 25,560 21,638 Trading assets 4,786 6,234 Spot commodities, at market value 489 352 Other, including short-term investments 5,110 4,379 - ------------------------------------------------------------------------------------------ Total $114,878 $104,295 ========================================================================================== Financial services liabilities: Borrowings under obligations of guaranteed investment agreements* $ 14,850 $ 16,392 Securities sold under agreements to repurchase, at contract value 9,162 11,818 Trading liabilities 3,825 4,372 Securities and spot commodities sold but not yet purchased, at market value 11,765 8,331 Unrealized loss on interest rate and currency swaps, options and forward transactions 11,265 8,813 Trust deposits and deposits due to banks and other depositors 2,987 2,290 Commercial paper* 7,467 8,523 Notes, bonds, loans and mortgages payable* 43,233 33,676 - ------------------------------------------------------------------------------------------ Total $104,554 $ 94,215 ========================================================================================== * See also Note 9 of Notes to Financial Statements. OTHER OPERATIONS Certain other AIG subsidiaries provide insurance-related services such as adjusting claims and marketing specialized products. AIG also has several other subsidiaries which engage in various businesses. For example, American International Technology Enterprises, Inc. provides information technology and processing services to businesses worldwide. Mt. Mansfield Company, Inc. owns and operates the ski slopes, lifts, school and an inn located at Stowe, Vermont. ADDITIONAL INVESTMENTS AIG holds a 24.3 percent interest in IPC Holdings, Ltd., a reinsurance holding company, a 23.4 percent interest in Allied World Assurance Holdings, Ltd., a property-casualty insurance holding company and a 22.1 percent interest in The Fuji Fire and Marine Insurance Co., Ltd., a general insurance company. (See also Note 1(q) of Notes to Financial Statements.) LOCATIONS OF CERTAIN ASSETS As of December 31, 2002, approximately 27 percent of the consolidated assets of AIG were located in foreign countries (other than Canada), including $1.44 billion of cash and securities on deposit with foreign regulatory authorities. Foreign operations and assets held abroad may be adversely affected by political developments in foreign countries, including such possibilities as tax changes, nationalization and changes in regulatory policy, as well as by consequence of hostilities and unrest. The risks of such occurrences and their overall effect upon AIG vary from country to country and cannot easily be predicted. If expropriation or nationalization does occur, AIG's policy is to take all appropriate measures to seek recovery of such assets. Certain of the countries in which AIG's business is conducted have currency restrictions which generally cause a delay in a company's ability to repatriate assets and profits. (See also Notes 1 and 2 of Notes to Financial Statements.) INSURANCE REGULATION AND COMPETITION Certain states require registration and periodic reporting by insurance companies which are licensed in such states and are controlled by other corporations. Applicable legislation typically requires periodic disclosure concerning the corporation which controls the registered insurer and the other companies in the holding company system and prior approval of intercorporate transfers of assets (including in some instances payment of dividends by the insurance subsidiary) within the holding company system. AIG's subsidiaries are registered under such legislation in those states which have such requirements. (See also Note 11 of Notes to Financial Statements.) 15
AIG's insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to approval of policy forms and rates, the standards of solvency that must be met and maintained, including risk based capital measurements, the licensing of insurers and their agents, the nature of and limitations on investments, restrictions on the size of risks which may be insured under a single policy, deposits of securities for the benefit of policyholders, methods of accounting, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed, and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than security holders. (See also Management's Discussion and Analysis of Financial Condition and Results of Operations.) Risk Based Capital (RBC) is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized general and life insurance companies may be identified. The RBC formula develops a risk adjusted target level of adjusted statutory capital by applying certain factors to various asset, premium and reserve items. Higher factors are applied to more risky items and lower factors are applied to less risky items. Thus, the target level of statutory surplus varies not only as a result of the insurer's size, but also on the risk profile of the insurer's operations. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The statutory surplus of each of AIG's domestic general and life insurance subsidiaries exceeded their RBC standards as of December 31, 2002. To the extent that any of AIG's insurance entities would fall below prescribed levels of surplus, it would be AIG's intention to infuse necessary capital to support that entity. Privacy provisions of the Gramm-Leach-Bliley Act became fully effective in 2001. These provisions established consumer protections regarding the security and confidentiality of nonpublic personal information and require full disclosure of the privacy policies of financial institutions to their consumer customers. There is also legislation pending in the United States Congress and various states designed to provide additional privacy protections to consumer customers of financial institutions. These statutes and similar legislation and regulations in the United States or other jurisdictions could impact AIG's ability to market its products or otherwise limit the nature or scope of AIG's insurance and financial services operations. A substantial portion of AIG's general insurance business and a majority of its life insurance business is carried on in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to AIG subsidiaries are subject to modification or revocation by such authorities, and AIU or other AIG subsidiaries could be prevented from conducting business in certain of the jurisdictions where they currently operate. In the past, AIU has been allowed to modify its operations to conform with new licensing requirements in most jurisdictions. In addition to licensing requirements, AIG's foreign operations are also regulated in various jurisdictions with respect to currency, policy language and terms, amount and type of security deposits, amount and type of reserves, amount and type of local investment and the share of profits to be returned to policyholders on participating policies. Some foreign countries regulate rates on various types of policies. Certain countries have established reinsurance institutions, wholly or partially owned by the state, to which admitted insurers are obligated to cede a portion of their business on terms which do not always allow foreign insurers, including AIG, full compensation. In some countries, regulations governing constitution of technical reserves and remittance balances may hinder remittance of profits and repatriation of assets. 16
The insurance industry is highly competitive. Within the United States, AIG's general insurance subsidiaries compete with approximately 3,000 other stock companies, specialty insurance organizations, mutual companies and other underwriting organizations. AIG's life insurance companies compete in the United States with approximately 1,800 life insurance companies and other participants in related financial service fields. Overseas, AIG subsidiaries compete for business with foreign insurance operations of the larger U.S. insurers and local companies in particular areas in which they are active. AIG's financial services subsidiaries operate in a highly competitive environment, both domestically and overseas. Principal sources of competition are banks, investment banks and other non-bank financial institutions. With the acquisition of AGC, the focus of AIG's financial services operations became more consumer-oriented, thereby increasing the risks of regulatory supervision and intervention. ITEM 2. PROPERTIES AIG and its subsidiaries operate from approximately 2,200 offices in the United States, 10 offices in Canada and numerous offices in approximately 100 foreign countries. The offices in Springfield, Illinois; Amarillo, Ft. Worth and Houston, Texas; Baton Rouge, Louisiana; Wilmington, Delaware; Hato Rey and Isabella, Puerto Rico; Tampa, Florida; Livingston, New Jersey; Evansville, Indiana; Nashville, Tennessee; 70 Pine Street, 72 Wall Street and 175 Water Street in New York City; and offices in approximately 30 foreign countries including Bermuda, Chile, Hong Kong, the Philippines, Japan, England, Singapore, Switzerland, Taiwan and Thailand are located in buildings owned by AIG and its subsidiaries. The remainder of the office space utilized by AIG subsidiaries is leased. ITEM 3. LEGAL PROCEEDINGS AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material adverse effect on its financial condition, future operating results or liquidity. (See also the Discussion and Analysis of Consolidated Net Losses and Loss Expense Reserve Development and Management's Discussion and Analysis of Financial Condition and Results of Operations.) In late 2002, a shareholder derivative action was filed in Delaware Chancery Court alleging breaches of fiduciary duty of loyalty and care against AIG's directors. AIG management believes the allegations of the complaint are without merit. AIG's Board of Directors has appointed a special committee of independent directors to review the complaint and respond to the lawsuit. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of 2002. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Set forth below is certain information concerning the directors and executive officers of AIG. All directors are elected at the annual meeting of shareholders. All officers serve at the pleasure of the Board of Directors, but subject to the foregoing, are elected for terms of one year expiring in May of each year. Except as hereinafter noted, each of the directors who is also an executive officer of AIG and each of the other executive officers has, for more than five years, occupied an executive position with AIG or companies that are now its subsidiaries. There are no other arrangements or understandings between any director or officer and any other person pursuant to which the director or officer was elected to such position. Prior to joining AIG in 1998, Mr. Patrikis was First Vice President at the Federal Reserve Bank of New York, previously having served as Executive Vice President and General Counsel. Prior to joining AIG in 2001, Mr. Rautenberg was Vice President and General Manager, Corporate Communications at Canon, U.S.A. from September 2000 to June, 2001 and for five years prior to that he was the senior corporate communications executive at Reliance Group Holdings. Prior to joining AIG in September 2002, Mr. Bensinger was Executive Vice President and Chief Financial Officer of Combined Specialty Group, Inc. (a division of Aon Corporation) commencing in March 2002, and served as Executive Vice President of Trenwick Group, Ltd. from October 1999 through December 2001 and as President of Chartwell Re Corp. from March 1993 until October 1999. 17
- ----------------------------------------------------------------------------------------------------------------- SERVED AS DIRECTOR NAME TITLE AGE OR OFFICER SINCE ================================================================================================================= M. Bernard Aidinoff* Director 74 1984 Eli Broad Director 69 1999 Pei-yuan Chia Director 64 1996 Marshall A. Cohen Director 68 1992 Barber B. Conable, Jr. Director 80 1991 Martin S. Feldstein Director 63 1987 Ellen V. Futter Director 53 1999 M. R. Greenberg* Director, Chairman and Chief Executive Officer 77 1967 Carla A. Hills* Director 69 1993 Frank J. Hoenemeyer* Director 83 1985 Richard C. Holbrooke Director 61 2001 Edward E. Matthews* Director and Senior Advisor 71 1973 Howard I. Smith Director, Vice Chairman, Chief Financial Officer and Chief 58 1984 Administrative Officer Martin J. Sullivan Director, Vice Chairman and Co-Chief Operating Officer 48 1997 Thomas R. Tizzio* Director and Senior Vice Chairman-General Insurance 65 1982 Edmund S. W. Tse Director, Senior Vice Chairman and Co-Chief Operating Officer 65 1991 Jay S. Wintrob Director and Executive Vice President-Retirement Savings 46 1999 Frank G. Wisner Director and Vice Chairman-External Affairs 64 1997 Frank G. Zarb* Director 67 2001 John A. Graf Executive Vice President-Retirement Savings 43 2002 Donald P. Kanak Executive Vice President and President of AIG Companies in 50 1998 Japan and Korea Rodney O. Martin, Jr. Executive Vice President-Life Insurance 50 2002 Kristian P. Moor Executive Vice President-Domestic General Insurance 43 1998 Win J. Neuger Executive Vice President and Chief Investment Officer 53 1995 R. Kendall Nottingham Executive Vice President-Life Insurance 64 1998 Robert M. Sandler Executive Vice President, Senior Casualty Actuary and Senior 60 1980 Claims Officer William N. Dooley Senior Vice President-Financial Services 50 1992 Lawrence W. English Senior Vice President-Administration 61 1985 Axel I. Freudmann Senior Vice President-Human Resources 56 1986 Ernest T. Patrikis Senior Vice President and General Counsel 59 1998 Richard W. Scott Senior Vice President-Investments 49 2002 Steven J. Bensinger Vice President and Treasurer 48 2002 Michael J. Castelli Vice President and Comptroller 47 1998 Keith L. Duckett Vice President and Director of Internal Audit 42 2001 Peter K. Lathrop Vice President and Director of Taxes 60 2001 Robert E. Lewis Vice President and Chief Credit Officer 52 1993 Charles M. Lucas Vice President and Director of Market Risk Management 64 1996 Steven A. Rautenberg Vice President-Communications 53 2001 Brian T. Schreiber Vice President-Strategic Planning 37 2002 Kathleen E. Shannon Vice President and Secretary 53 1986 ================================================================================================================= * Member of Executive Committee. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS (A) THE TABLE BELOW SHOWS THE HIGH AND LOW CLOSING SALES PRICES PER SHARE OF AIG'S COMMON STOCK ON THE NEW YORK STOCK EXCHANGE COMPOSITE TAPE, FOR EACH QUARTER OF 2002 AND 2001. - -------------------------------------------------------------------------------- 2002 2001 ------------------- ------------------- HIGH LOW High Low ================================================================================ First Quarter 79.61 70.15 96.88 75.12 Second Quarter 75.26 62.84 86.51 76.18 Third Quarter 67.91 51.10 87.06 67.05 Fourth Quarter 67.89 52.45 86.01 76.74 ================================================================================ (b) In 2002, AIG paid a quarterly dividend of 4.2 cents in March and June and 4.7 cents in September and December for a total cash payment of 17.8 cents per share of common stock. In 2001, AIG paid a quarterly dividend of 3.7 cents in March and June and 4.2 cents in September and December for a total cash payment of 15.8 cents per share of common stock. Subject to the dividend preference of any of AIG's serial preferred stock which may be outstanding, the holders of shares of common stock are entitled to receive such dividends as may be declared by the Board of Directors from funds legally available therefor. See Note 11(a) of Notes to Financial Statements for a discussion of certain restrictions on the payment of dividends to AIG by some of its insurance subsidiaries. (c) The approximate number of holders of common stock as of January 31, 2003, based upon the number of record holders, was 60,000. (d) Information relating to compensation plans under which equity securities of AIG are authorized for issuance is set forth under "Equity Compensation Plan Information" on page 12 of the Proxy Statement for AIG's 2003 Annual Meeting of Shareholders to be held on May 14, 2003 and all such information is incorporated herein by reference. 18
ITEM 6. SELECTED FINANCIAL DATA AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES SELECTED CONSOLIDATED FINANCIAL DATA THE FOLLOWING SELECTED CONSOLIDATED FINANCIAL DATA, WHICH HAS BEEN RESTATED TO GIVE RETROACTIVE EFFECT TO THE ACQUISITIONS OF AGC AND SUNAMERICA INC. ON A POOLING OF INTERESTS BASIS, IS PRESENTED IN ACCORDANCE WITH GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. THIS DATA SHOULD BE READ IN CONJUNCTION WITH THE SUPPLEMENTAL FINANCIAL STATEMENTS AND ACCOMPANYING NOTES INCLUDED ELSEWHERE HEREIN. (in millions, except per share amounts) - --------------------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998 ================================================================================================================================= Revenues (a): Premiums and other considerations $ 44,589 $ 38,428 $ 34,570 $ 31,020 $ 27,817 Net investment income 15,034 13,977 12,663 11,449 10,257 Realized capital gains (losses) (2,441) (836) (314) 103 130 Other revenues 10,300 10,197 9,419 8,162 7,408 Total revenues 67,482 61,766 56,338 50,734 45,612 Benefits and expenses Incurred policy losses and benefits 41,927 35,054 30,864 27,495 24,676 Insurance acquisition and other operating expenses 17,413 16,556 15,136 13,840 13,353 Acquisition, restructuring and related charges -- 2,017 315 -- -- Total benefits and expenses 59,340 53,627 46,315 41,335 38,029 Income before income taxes, minority interest and cumulative effect of accounting changes (b) 8,142 8,139 10,023 9,399 7,583 Income taxes 2,328 2,339 2,971 2,833 2,190 Income before minority interest and cumulative effect of accounting changes 5,814 5,800 7,052 6,566 5,393 Minority interest (295) (301) (413) (380) (347) Income before cumulative effect of accounting changes 5,519 5,499 6,639 6,186 5,046 Cumulative effect of accounting changes, net of tax -- (136) -- -- -- Net income 5,519 5,363 6,639 6,186 5,046 Earnings per common share (c): Basic Income before cumulative effect of accounting changes 2.11 2.10 2.55 2.37 1.96 Cumulative effect of accounting changes -- (0.05) -- -- -- Net income 2.11 2.05 2.55 2.37 1.96 Diluted Income before cumulative effect of accounting changes 2.10 2.07 2.52 2.34 1.92 Cumulative effect of accounting changes -- (0.05) -- -- -- Net income 2.10 2.02 2.52 2.34 1.92 Cash dividends per common share (d) .18 .16 .14 .13 .11 Total assets 561,229 493,061 426,671 383,685 338,783 Long-term debt (e) 49,416 46,395 38,069 34,583 33,655 Capital funds (shareholders' equity) 59,103 52,150 47,439 39,641 38,909 ================================================================================================================================= (a) Represents the sum of general net premiums earned, life premium income, net investment income, financial services commissions, transaction and other fees, retirement savings & asset management commissions and other fees, equity in income of minority-owned insurance operations, and realized capital gains (losses). (b) Includes net loss reserve charge of $2.8 billion in 2002 and WTC losses of $900 million in 2001. (c) Per share amounts for all periods presented have been retroactively adjusted to reflect all stock dividends and splits and reflect the adoption of the Statement of Financial Accounting Standards No. 128 "Earnings per Share." (d) Cash dividends have not been restated to reflect dividends paid by SunAmerica Inc., the Maryland corporation which was merged into AIG on January 1, 1999, nor AGC which was acquired by AIG on August 29, 2001. (e) Including commercial paper and excluding that portion of long-term debt maturing in less than one year. (See also Note 9 of Notes to Financial Statements.) 19
Set forth below are reconciliations of each "non-GAAP financial measure" used in this Annual Report on Form 10-K to its most equivalent measure presented on a GAAP basis. For an explanation of why AIG management considers these "non-GAAP measures" useful, see Executive Summary in Management's Discussion and Analysis of Financial Condition and Results of Operations. GENERAL INSURANCE REVENUES: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 Net premiums earned $ 24,269 $ 19,365 $ 17,407 Net investment income 2,760 2,893 2,701 Realized capital gains (losses) (858) (130) 38 - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $ 26,171 $ 22,128 $ 20,146 ================================================================================ GENERAL INSURANCE OPERATING INCOME AS REPORTED: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Net premiums written $ 27,414 $ 20,101 $ 17,526 Change in unearned premium reserve (3,145) (736) (119) - -------------------------------------------------------------------------------- Net premiums earned 24,269 19,365 17,407 Losses incurred 18,449 13,228 11,379 Loss expenses incurred 2,365 2,178 1,725 Underwriting expenses 4,690 3,871 3,518 - -------------------------------------------------------------------------------- Adjusted underwriting profit (loss) (1,235) 88 785 Net investment income 2,760 2,893 2,701 Realized capital gains (losses) (858) (130) 38 - -------------------------------------------------------------------------------- Operating income $ 667 $ 2,851 $ 3,524 ================================================================================ GENERAL INSURANCE OPERATING INCOME AS ADJUSTED: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $ 667 $ 2,851 $ 3,524 Loss reserve charge 2,800 -- -- WTC losses -- 769 -- Realized capital (gains) losses 858 130 (38) - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $ 4,325 $ 3,750 $ 3,486 ================================================================================ LIFE PREMIUM INCOME: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $20,320 $19,063 $17,163 Deposits and considerations not deemed to be GAAP revenue 28,342 24,554 21,056 - -------------------------------------------------------------------------------- Premium income, deposits and other considerations $48,662 $43,617 $38,219 ================================================================================ LIFE INSURANCE REVENUES: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Premium income $ 20,320 $ 19,063 $ 17,163 Net investment income 12,274 11,084 9,962 Realized capital gains (losses) (1,053) (254) (162) - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $ 31,541 $ 29,893 $ 26,963 ================================================================================ LIFE INSURANCE OPERATING INCOME: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $4,929 $4,675 $4,058 WTC losses -- 131 -- Realized capital losses 1,053 254 162 - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $5,982 $5,060 $4,220 ================================================================================ INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $ 8,142 $ 8,139 $10,023 Loss reserve charge 2,800 -- -- WTC losses -- 900 -- Realized capital losses 2,441 836 314 Acquisition, restructuring and related charges -- 2,017 315 - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $13,383 $11,892 $10,652 ================================================================================ NET INCOME: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $ 5,519 $ 5,363 $ 6,639 Loss reserve charge 1,794 -- -- WTC losses -- 533 -- Realized capital losses 1,596 542 214 Acquisition, restructuring and related charges -- 1,385 207 Cumulative effect of accounting changes -- 136 -- - -------------------------------------------------------------------------------- As adjusted - Management reporting basis $ 8,909 $ 7,959 $ 7,060 ================================================================================ 20
INDEX TO FINANCIAL INFORMATION American International Group, Inc. and Subsidiaries MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Management's Discussion and Analysis of Financial Condition and Results of Operations" is designed to provide the reader a narrative with respect to AIG's operations, financial condition and liquidity and certain other significant matters. INDEX Page Executive Summary 22 Consolidated Results 22 Critical Accounting Estimates 24 Operational Review 24 General Insurance Operations 24 General Insurance Results 25 Reinsurance 27 Reserve for Losses and Loss Expenses 28 Loss Reserve Charge 29 Asbestos and Environmental Claims 30 Life Insurance Operations 33 Life Insurance Results 34 Underwriting and Investment Risk 34 Financial Services Operations 36 Financial Services Results 36 Retirement Savings & Asset Management Operations 38 Retirement Savings & Asset Management Results 38 Other Operations 38 Capital Resources 39 Borrowings 39 Capital Funds 41 Stock Repurchase 41 Dividends from Insurance Subsidiaries 41 Regulation and Supervision 41 Contractual Obligations and Other Commercial Commitments 42 Special Purpose Vehicles 42 Liquidity 43 Invested Assets 44 Insurance Invested Assets 44 Fixed Maturity Investments 45 Credit Quality 45 Equity Investments 45 Valuation of Invested Assets 45 Mortgage Investments 47 Short-term Investments 47 Real Estate Investments 47 Other Investments 47 Managing Market Risk 48 Financial Services Invested Assets 49 Managing Market Risk 51 Derivatives 53 Counterparty Credit Quality 54 Fair Value Source 55 Notional Amounts 56 Accounting Standards 57 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION This Annual Report and other publicly available documents may include, and AIG's officers and representatives may from time to time make, statements which may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are not historical facts but instead represent only AIG's belief regarding future events, many of which, by their nature, are inherently uncertain and outside of AIG's control. These statements may address, among other things, AIG's strategy for growth, product development, regulatory approvals, market position, financial results and reserves. It is possible that AIG's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause AIG's actual results to differ, possibly materially, from those in the specific forward-looking statements are discussed throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations. AIG is not under any obligation to (and expressly disclaims any such obligations to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise. 21
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. EXECUTIVE SUMMARY AIG's operations are conducted principally through four business segments: general insurance, life insurance, financial services and retirement savings & asset management. Within each of these business segments are various operating groups generally formed based upon products or services which may be offered in different geographic locations. [FLOWCHART] 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, as well as most transparent. Operating income is shown exclusive of realized capital gains (losses) because the determination to realize capital gains or losses is generally independent of the insurance underwriting process. Operating income and the related performance rates are also shown exclusive of one or more of the 2002 reserve charge discussed under "Loss Reserve Charge" herein, 2001 acquisition, restructuring and related charges, and 2001 World Trade Center and related losses (WTC losses) because AIG believes that these items are sufficiently unusual that they do not reflect the underlying basic performance of the business. Net income is presented exclusive of these items as well as the cumulative effect of accounting changes for the same reason. Premium income, gross premiums written, statutory underwriting profit (loss) and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance used in the insurance industry and thus allow more meaningful comparisons with AIG's insurance competitors. A reconciliation of these measurements to the most equivalent measurements presented in accordance with Generally Accepted Accounting Principles (GAAP) is presented on page 20. CONSOLIDATED RESULTS AIG's revenues in 2002 increased 9.3 percent to $67.5 billion when compared to $61.8 billion in 2001. Growth in revenues was primarily attributable to the growth in net premiums earned from the general insurance operations. This growth was negatively impacted by realized capital losses incurred. The following tables reconcile results reported on a GAAP basis to the presentation AIG management believes is most meaningful. INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $ 8,142 $ 8,139 $10,023 Loss reserve charge 2,800 -- -- WTC losses -- 900 -- Realized capital losses 2,441 836 314 Acquisition, restructuring and related charges -- 2,017 315 - -------------------------------------------------------------------------------- As adjusted -- Management reporting basis $13,383 $11,892 $10,652 ================================================================================ NET INCOME: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $ 5,519 $ 5,363 $ 6,639 Loss reserve charge 1,794 -- -- WTC losses -- 533 -- Realized capital losses 1,596 542 214 Acquisition, restructuring and related charges -- 1,385 207 Cumulative effect of accounting changes -- 136 -- - -------------------------------------------------------------------------------- As adjusted -- Management reporting basis $ 8,909 $ 7,959 $ 7,060 ================================================================================ AIG's income before income taxes, minority interest and cumulative effect of accounting changes increased modestly in 2002 when compared to 2001. Factors influencing the growth were not only the increase in realized capital losses but also the impact of the $2.8 billion loss reserve charge in 2002. (See discussion under "Loss Reserve Charge" herein.) If the realized capital losses and such loss reserve charge were excluded from 2002 income and $836 million in realized capital losses, $900 million in WTC losses and $2.02 billion of acquisition, restructuring and related charges were excluded in 2001, AIG's growth in income before taxes, minority interest and cumulative effect of accounting changes would be 12.5 percent. AIG believes that the growth rates discussed above are more representative of the overall growth of its operations than the rates determined including the impact of events AIG views as unusual and unlikely to recur. 22
American International Group, Inc. and Subsidiaries AIG's net income in 2002 increased 2.9 percent to $5.52 billion when compared to $5.36 billion in 2001. Excluding net of tax, realized capital gains (losses), the $1.8 billion loss reserve charge in 2002, the $1.38 billion of acquisition, restructuring and related charges, $533 million in WTC losses, and $136 million cumulative effect of accounting changes incurred in 2001, AIG's net income in 2002 increased 11.9 percent. THE FOLLOWING TABLE SUMMARIZES THE OPERATIONS OF EACH PRINCIPAL SEGMENT FOR 2002, 2001 AND 2000. (SEE ALSO NOTE 2 OF NOTES TO FINANCIAL STATEMENTS.) : (in millions) - ------------------------------------------------------------------------------- 2002 2001 2000 =============================================================================== Revenues: General insurance(a) $ 26,171 $ 22,128 $ 20,146 Life insurance(b) 31,541 29,893 26,963 Financial services(c) 6,815 6,485 5,954 Retirement savings & asset management(d) 3,485 3,712 3,465 Other (530) (452) (190) - ------------------------------------------------------------------------------- Total $ 67,482 $ 61,766 $ 56,338 =============================================================================== Operating income: General insurance $ 667 $ 2,851 $ 3,524 Life insurance 4,929 4,675 4,058 Financial services 2,189 1,991 1,666 Retirement savings & asset management 1,016 1,088 1,108 Other (659) (2,466) (333) - ------------------------------------------------------------------------------- Total $ 8,142 $ 8,139 $ 10,023 =============================================================================== (a) Represents the sum of net premiums earned, net investment income and realized capital gains (losses). (b) Represents the sum of life premium income, net investment income and realized capital gains (losses). (c) Represents financial services commissions, transactions and other fees. (d) Represents retirement savings & asset management commissions and other fees. GENERAL INSURANCE General insurance operating income decreased 76.6 percent in 2002 compared to 2001. The primary reasons for this decline were the loss reserve charge of $2.8 billion and an increase in realized capital losses of over $700 million. Excluding realized capital gains (losses), the loss reserve charge in 2002 and WTC losses of $769 million, including $200 million from Transatlantic, in 2001, general insurance operating income increased 15.4 percent. LIFE INSURANCE Life insurance operating income increased 5.4 percent in 2002 compared to 2001, impacted by an increase in realized capital losses of nearly $800 million. Excluding realized capital gains (losses) and WTC losses of $131 million in 2001, life insurance operating income increased 18.2 percent, reflecting operating income growth in each of AIG's principal life insurance businesses. FINANCIAL SERVICES Financial services operating income increased 9.9 percent in 2002 compared to 2001, reflecting the continued growth of each of its principal operations. RETIREMENT SAVINGS & ASSET MANAGEMENT Retirement savings & asset management operating income decreased 6.6 percent in 2002 when compared to 2001. Results in the variable annuity business continue to be impacted by weak equity markets in the United States and around the world. REALIZED CAPITAL LOSSES During 2002, AIG incurred net realized capital losses of $2.44 billion, including $356 million from WorldCom Inc. securities. CAPITAL RESOURCES At December 31, 2002, AIG had total capital funds of $59.10 billion and total borrowings of $71.89 billion. At that date, $64.98 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable. During 2002, AIG repurchased in the open market 10,858,000 shares of its common stock. LIQUIDITY At December 31, 2002, consolidated invested assets were $432.36 billion including $8.16 billion in cash and short-term investments. Consolidated net cash provided from operating activities in 2002 amounted to $18.69 billion. AIG believes that its liquid assets, cash provided by operations and access to the capital markets will enable it to meet any forseeable cash requirements. OUTLOOK Premium rates in the General Insurance business are continuing to strengthen both domestically and in key international markets, along with policy restrictions and exclusions. AIG expects that such growth will continue through 2003. Such increases in premium growth will have a strong positive impact on cash flow available for investment. Thus, General Insurance's net investment income is expected to rise in future quarters even in the current interest rate environment. In the Life Insurance segment, AIG expects continued growth with respect to its domestic individual fixed annuity operation, while in overseas markets, AIG's life insurance operations are expected to continue double digit growth. AIG continues to expand its operations in China, becoming the first foreign insurance organization to have wholly owned life insurance operations in Beijing, Suzhou, Dongguan and Jiangmen, as well as previously established 23
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) operations in Shanghai, Foshan, Guangzhou and Shenzhen. AIG also expects India and Vietnam to offer additional opportunities for growth. AIG expects that ILFC will continue its growth and operating profitability even as the airline industry remains under stress. ILFC derives over 80 percent of its lease revenues from foreign carriers, thus limiting its exposure to the domestic commercial aviation market which is significantly more depressed than the rest of the industry. AIG is also optimistic about opportunities for growth in its consumer finance business through continued expansion of overseas credit card operations and alternative distribution systems such as the use of the Internet. During 2003, AIG also expects to expand its recently formed international retirement savings operations. CRITICAL ACCOUNTING ESTIMATES Note 1 of Notes to Financial Statements provides a summary of the GAAP accounting policies significant to AIG. Among these policies requiring significant judgment, AIG considers its most critical accounting estimates those with respect to reserves for losses and loss expenses, future policy benefits for life and accident and health contracts, deferred policy acquisition costs, and fair value determinations with respect to certain assets and liabilities of certain of the subsidiaries of AIG's financial services operations. These accounting estimates require the use of assumptions about matters that are highly uncertain at the time of estimation. Reserves for losses and loss expenses are estimated using data where the more recent accident years of long tail casualty lines have limited statistical credibility in reported net losses. (See also the discussions "Reserve for Losses and Loss Expenses", "Loss Reserve Charge", and "Asbestos and Environmental Claims" herein.) The liability for future policy benefits for life and accident and health contracts include estimates for interest rates, mortality and surrender rates and invested asset performance. (See also the discussion "Life Insurance Operations".) Recoverability of deferred policy acquisition costs are contingent upon the underlying insurance operations being profitable. (See also the discussions "General Insurance Operations", "Life Insurance Operations" and "Retirement Savings and Asset Management Operations" herein.) Fair value determinations with respect to certain assets and liabilities of certain subsidiaries of AIG's financial services operations are arrived at through the use of valuation models. (See also the discussion "Managing Market Risk" herein.) OPERATIONAL REVIEW On August 29, 2001, American General Corporation (AGC), was acquired by AIG. In connection with the acquisition, AIG issued approximately 290 million shares of its common stock in exchange for all the outstanding common stock of AGC based on an exchange ratio of 0.5790 of a share of AIG common stock for each share of AGC common stock. The acquisition was accounted for as a pooling of interests and the accompanying financial statements have been prepared to retroactively combine AGC's financial statements with AIG's financial statements. GENERAL INSURANCE OPERATIONS AIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. Domestic general insurance operations are comprised of the Domestic Brokerage Group (DBG), which includes The Hartford Steam Boiler Inspection and Insurance Company (HSB); Transatlantic Holdings, Inc. (Transatlantic); Personal Lines, including 21st Century Insurance Group (21st Century); and Mortgage Guaranty. AIG's Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG's foreign-based insurance subsidiaries for their own accounts. (See also Note 2 of Notes to Financial Statements.) GENERAL INSURANCE OPERATIONS FOR 2002, 2001 AND 2000 WERE AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------- 2002 2001 2000 =============================================================================== Net premiums written $ 27,414 $ 20,101 $ 17,526 Change in unearned premium reserve (3,145) (736) (119) - ------------------------------------------------------------------------------- Net premiums earned 24,269 19,365 17,407 Losses incurred 18,449(a) 13,228(c) 11,379 Loss expensesincurred 2,365(b) 2,178 1,725 Underwriting expenses 4,690 3,871 3,518 - ------------------------------------------------------------------------------- Adjusted underwriting profit (loss) (1,235) 88 785 Net investment income 2,760 2,893 2,701 Realized capital gains (losses) (858) (130) 38 - ------------------------------------------------------------------------------- Operating income $ 667 $ 2,851 $ 3,524 =============================================================================== (a) Includes loss reserve charge of $2.8 billion. (b) Includes 21st Century's loss adjustment expense pre-tax provision of $43 million for SB1899 Northridge earthquake claims. (c) Includes WTC losses of $769 million in the aggregate. 24
American International Group, Inc. and Subsidiaries GENERAL INSURANCE OPERATIONS BY MAJOR OPERATING UNIT FOR 2002, 2001 AND 2000 WERE AS FOLLOWS: (in millions) - ----------------------------------------------------------------------------------- 2002 2001 2000 =================================================================================== Net premiums written: Domestic General DBG(a) $ 15,214 $ 10,197 $ 7,934 Transatlantic 2,500 1,906 1,659 Personal Lines 3,182 2,454 2,510 Mortgage Guaranty 508 494 453 Foreign General(a) 6,010 5,050 4,970 - ----------------------------------------------------------------------------------- Total $ 27,414 $ 20,101 $ 17,526 =================================================================================== Net premiums earned: Domestic General DBG(a) $ 13,053 $ 9,776 $ 8,023 Transatlantic 2,369 1,790 1,632 Personal Lines 2,913 2,478 2,401 Mortgage Guaranty 502 489 452 Foreign General(a) 5,432 4,832 4,899 - ----------------------------------------------------------------------------------- Total $ 24,269 $ 19,365 $ 17,407 =================================================================================== Adjusted underwriting profit (loss): Domestic General DBG(a) $ (2,049)(b) $ (338)(c) $ 177 Transatlantic (58)(b) (274)(c) 1 Personal Lines 29(d) (92) (37) Mortgage Guaranty 278 311 270 Foreign General(a) 565 481(c) 374 - ----------------------------------------------------------------------------------- Total $ (1,235) $ 88 $ 785 =================================================================================== Net investment income: Domestic General DBG $ 1,609 $ 1,827 $ 1,614 Transatlantic 252 240 234 Personal Lines 122 114 113 Mortgage Guaranty 139 106 93 Intercompany adjustments and eliminations - net 23 23 77 Foreign General 615 583 570 - ----------------------------------------------------------------------------------- Total $ 2,760 $ 2,893 $ 2,701 =================================================================================== Operating income (loss) before realized capital gains (losses): Domestic General DBG(a) $ (440)(b) $ 1,489(c) $ 1,791 Transatlantic 194(b) (34)(c) 235 Personal Lines 151(d) 22 76 Mortgage Guaranty 417 417 363 Intercompany adjustments and eliminations - net 23 23 77 Foreign General(a) 1,180 1,064(c) 944 - ----------------------------------------------------------------------------------- Total 1,525 2,981 3,486 Realized capital gains (losses) (858) (130) 38 - ----------------------------------------------------------------------------------- Operating income $ 667(b) $ 2,851(c) $ 3,524 =================================================================================== (a) Reflects the realignment of certain internal divisions in each year. (b) Includes loss reserve charge of $2.8 billion in the aggregate. (c) Includes WTC losses of $769 million in the aggregate. (d) Includes 21st Century's loss adjustment expense pre-tax provision of $43 million for SB1899 Northridge earthquake claims. General Insurance Results NET PREMIUMS WRITTEN AND NET PREMIUMS EARNED in 2002 increased 36.4 percent and 25.3 percent, respectively, from those of 2001. In 2001, net premiums written increased 14.7 percent and net premiums earned increased 11.2 percent when compared to 2000. Commencing in the latter part of 1999 and continuing through 2002 and into the current quarter, the commercial property-casualty market place has experienced rate increases. Virtually all areas of DBG have experienced rate increases as well as maintaining an excellent retention rate for desired renewal business. The vast majority of the increase in 2002 resulted from rate increases with respect to renewed business. Overall, DBG's net premiums written increased $5.02 billion or 49.2 percent in 2002 over 2001. These increases compared to an increase of $2.26 billion or 28.5 percent in 2001 over 2000. DBG produced 55.5 percent of the general insurance net premiums written in 2002, 50.7 percent in 2001 and 45.3 percent in 2000. Personal Lines' net premiums written increased 29.7 percent or $728 million in 2002 over 2001, reflecting auto insurance rate increases in many states, compared to a decrease of 2.2 percent or $56 million in 2001 from 2000. Foreign General insurance net premiums written increased 19.0 percent and net premiums earned increased 12.4 percent. Foreign General insurance operations produced 21.9 percent of the general insurance net premiums written in 2002, 25.1 percent in 2001 and 28.4 percent in 2000. In comparing the foreign currency exchange rates used to translate the results of AIG's foreign general operations during 2002 to those foreign currency exchange rates used to translate AIG's Foreign General results during 2001, the U.S. dollar strengthened slightly in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, when foreign net premiums written were translated into U.S. dollars for the purposes of the preparation of the consolidated financial statements, total general insurance net premiums written were approximately 1.2 percentage points less than they would have been if translated utilizing those foreign currency exchange rates which prevailed during 2001. Net premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes deferred revenues which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period. 25
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) AIG, along with most general insurance entities, uses the loss ratio, the expense ratio and the combined ratio as measures of performance. The loss ratio is the sum of losses and loss expenses incurred divided by net premiums earned. The expense ratio is statutory underwriting expenses divided by net premiums written. The combined ratio is the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe for every $100 of net premiums earned or written, the cost of losses and statutory expenses, respectively. The combined ratio presents the total cost per $100 of premium production. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting loss. THE STATUTORY GENERAL INSURANCE RATIOS, INCLUDING THE $2.8 BILLION LOSS RESERVE CHARGE IN 2002 AND $769 MILLION OF WTC LOSSES IN 2001, WERE AS FOLLOWS: - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Domestic General: Loss Ratio 92.86 85.89 80.99 Expense Ratio 17.72 17.64 17.39 - -------------------------------------------------------------------------------- Combined Ratio 110.58 103.53 98.38 ================================================================================ Foreign General: Loss Ratio 61.13 60.51 60.71 Expense Ratio 28.99 31.67 31.69 - -------------------------------------------------------------------------------- Combined Ratio 90.12 92.18 92.40 ================================================================================ Consolidated: Loss Ratio* 85.76 79.55 75.28 Expense Ratio 20.19 21.16 21.45 - -------------------------------------------------------------------------------- Combined Ratio 105.95 100.71 96.73 ================================================================================ * The impact of the loss reserve charge and the WTC losses on the loss ratio was an increase of 11.54 in 2002 and 3.97 in 2001. AIG believes that underwriting profit is the true measure of the performance of the core business of a general insurance company. Underwriting profit is measured in two ways: statutory underwriting profit and Generally Accepted Accounting Principles (GAAP) underwriting profit. Statutory underwriting profit is arrived at by reducing net premiums earned by net losses and loss expenses incurred and net expenses incurred. Statutory accounting differs from GAAP, as statutory accounting, in general, requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, expenses are recognized immediately, not over the same period that the revenues are earned. A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred (deferred acquisition costs - DAC) and amortized over the period the related premiums written are earned. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. Thus, "adjusted underwriting profit" is a GAAP measurement which can be viewed as gross margin or an intermediate subtotal in calculating operating income and net income. DAC is reviewed for recoverability and such review requires significant management judgment. (See also Notes 1, 2 and 4 of Notes to Financial Statements.) A major part of the discipline of a successful general insurance company is to produce an underwriting profit, exclusive of investment income. If underwriting is not profitable, losses incurred are a major factor. The result is that the premiums are inadequate to pay for losses and expenses and produce a profit; therefore, investment income must be used to cover underwriting losses. If assets and the income therefrom are insufficient to pay claims and expenses over extended periods, an insurance company cannot survive. For these reasons, AIG views and manages its underwriting operations separately from its investment operations. (See also the discussion under "Liquidity" herein.) The underwriting environment varies from country to country, as does the degree of litigation activity. Regulation, product type and competition have a direct impact on pricing and consequently profitability as reflected by adjusted underwriting profit and statutory general insurance ratios. In 2002, AIG's general insurance results reflect the net impact of the loss reserve charge of $2.8 billion with respect to accident years 1997 through 2001. Such charge was the result of AIG's annual year-end review of general insurance loss reserves. (See also the discussion under "Loss Reserve Charge" herein.) In addition, these results reflect the net impact of catastrophe losses approximating $57 million in 2002, $867 million in 2001 (which include $769 million in WTC losses and $50 million with respect to the Northridge earthquake, following the unprecedented decision by the State of California to require all insurers to reopen claims nearly eight years after the occurrence), and $44 million in 2000. On a gross basis, incurred losses included $3.5 billion attributable to the loss reserve charge and approximately $245 million from catastrophes in 2002, and catastrophe losses of $2.15 billion in 2001 (which include $2.0 billion in WTC losses), and $112 million in 2000. With respect to catastrophe losses, AIG believes that it has taken appropriate steps to reduce the magnitude of possible future losses. The occurrence of one or more catastrophic events of unanticipated frequency or severity, such as a terrorist attack, earthquake or hurricane, that causes insured losses, however, could have a material adverse effect on AIG's results of operations, liquidity or financial condition. Current techniques and models may not accurately predict in the future the probability of catastrophic events and the extent of the resulting losses. Moreover, one or more catastrophe losses could impact negatively AIG's reinsurers and result in an inability of AIG to collect reinsurance recoverables. The impact of losses caused by catastrophes can fluctuate widely 26
American International Group, Inc. and Subsidiaries from year to year, making comparisons of recurring type business more difficult. The pro forma table below excludes the loss reserve charge in 2002, WTC losses in 2001 and catastrophe losses in all three years in order to present comparable results of AIG's ongoing underwriting operations. ON THE BASIS DISCUSSED ABOVE, THE PRO FORMA CONSOLIDATED STATUTORY GENERAL INSURANCE RATIOS WOULD BE AS FOLLOWS: - ------------------------------------------------------------------------------- 2002 2001 2000 =============================================================================== Published Loss Ratio 85.76 79.55 75.28 Loss reserve charge (11.54) -- -- WTC Losses -- (3.97) -- Catastrophes (0.23) (0.50) (0.25) - ------------------------------------------------------------------------------- Pro Forma 73.99 75.08 75.03 Expense Ratio 20.19 21.16 21.45 - ------------------------------------------------------------------------------- Combined Ratio 94.18 96.24 96.48 =============================================================================== AIG's historic ability to maintain its combined pro forma ratio below 100 is primarily attributable to the profitability of AIG's Foreign General insurance operations and AIG's emphasis on maintaining its disciplined underwriting, especially in the domestic specialty markets. In addition, AIG does not seek premium growth where rates do not adequately reflect its assessment of exposures. GENERAL INSURANCE NET INVESTMENT INCOME in 2002 decreased 4.6 percent when compared to 2001. In 2001, net investment income increased 7.1 percent over 2000. The decrease in net investment income in 2002 was primarily a result of lower earnings with respect to the general insurance private equity portfolio. Also, interest income earned from the general insurance bond portfolio was impacted by lower yields as the proceeds from maturing fixed income securities were reinvested. However, the cash flow resulting from the growth in net premiums written should have a positive impact on net investment income in future quarters. The growth in net investment income in 2001 and 2000 was primarily attributable to new cash flow for investment. The new cash flow was generated from net general insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein and Note 8 of Notes to Financial Statements.) GENERAL INSURANCE REALIZED CAPITAL LOSSES were $858 million in 2002 and $130 million in 2001, and realized capital gains were $38 million in 2000. These realized gains and losses resulted from the ongoing investment management of the general insurance portfolios within the overall objectives of the general insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities. (See the discussion on "Valuation of Invested Assets" herein.) THE FOLLOWING TABLE RECONCILES GENERAL INSURANCE OPERATING INCOME ON A GAAP BASIS TO MANAGEMENT'S PRESENTATION HEREIN: (in millions) - ------------------------------------------------------------------------------- 2002 2001 2000 =============================================================================== As reported $ 667 $ 2,851 $ 3,524 Loss reserve charge 2,800 -- -- WTC losses -- 769 -- Realized capital (gains) losses 858 130 (38) - --------------------------------=---------------------------------------------- As adjusted -- Management reporting basis $ 4,325 $ 3,750 $ 3,486 ================================--============================================= GENERAL INSURANCE OPERATING INCOME in 2002 decreased 76.6 percent when compared to 2001. This decline in the growth rate was caused by the $2.8 billion loss reserve charge as well as the $728 million increase in realized capital losses in 2002. If such loss reserve charge and realized capital losses were excluded from 2002 general insurance operations and the WTC losses and realized capital losses were excluded from 2001 general insurance operations, the growth in 2002 when compared to 2001 would be 15.4 percent. General insurance operating income in 2001 decreased 19.1 percent when compared to 2000 primarily due to the WTC losses. If the WTC losses, as well as realized capital losses, were excluded from 2001 general insurance operations and realized capital gains were excluded from 2000 general insurance operations, the increase would be 7.6 percent to $3.75 billion during 2001. The contribution of general insurance operating income to income before income taxes, minority interest and cumulative effect of accounting changes was 8.2 percent in 2002 compared to 35.0 percent in 2001 and 35.2 percent in 2000. If the loss reserve charge in 2002 and the WTC losses in 2001 were excluded from each year's general insurance operating income and each of these years excluded realized capital losses or gains, as well as acquisition, restructuring and related charges were excluded from income before income taxes, minority interest and cumulative effect of accounting changes in 2001 and 2000, the general insurance operating income contribution to income before income taxes, minority interest and cumulative effect of accounting changes would be 32.3 percent, 31.5 percent and 32.7 percent in 2002, 2001 and 2000, respectively. Reinsurance AIG is a major purchaser of reinsurance for its general insurance operations. AIG is cognizant of the need to exercise good judgment in the selection and approval of both domestic and foreign companies participating in its reinsurance programs. AIG insures risks in over 70 countries and its reinsurance programs must be coordinated in order to provide AIG the level of reinsurance protection that AIG desires. These reinsurance arrangements do not relieve AIG from its direct obligations to its insureds. 27
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) AIG'S GENERAL REINSURANCE ASSETS amounted to $28.77 billion and resulted from AIG's reinsurance arrangements. Thus, a credit exposure existed at December 31, 2002 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, 2002, approximately 40 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, the majority of these balances were collateralized. The remaining 60 percent of the general reinsurance assets were from authorized reinsurers and over 90 percent of such balances are from reinsurers rated A-(excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. AIG maintains an allowance for estimated unrecoverable reinsurance and has been largely successful in its previous recovery efforts. At December 31, 2002, AIG had allowances for unrecoverable reinsurance approximating $120 million. At that date, AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction). AIG's Reinsurance Security Department conducts ongoing detailed assessments of the reinsurance markets and current and potential reinsurers, both foreign and domestic. Such assessments include, but are not limited to, identifying if a reinsurer is appropriately licensed, and has sufficient financial capacity, and the local economic environment in which a foreign reinsurer operates. This department also reviews the nature of the risks ceded and the need for collateral. In addition, AIG's Credit Risk Committee reviews the credit limits for and concentrations with any one reinsurer. AIG enters into certain intercompany reinsurance transactions for its general and life operations. AIG enters these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among various legal entities. These reinsurance agreements have been approved by the appropriate regulatory authorities. All material intercompany transactions have been eliminated in consolidation. At December 31, 2002, the consolidated general reinsurance assets of $28.77 billion include reinsurance recoverables for paid losses and loss expenses of $4.19 billion and $21.19 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported (IBNR) (ceded reserves). The ceded reserves represent the accumulation of estimates of ultimate ceded losses including provisions for ceded IBNR and loss expenses. The methods used to determine such estimates and to establish the resulting ceded reserves are continually reviewed and updated. Any adjustments thereto are reflected in income currently. It is AIG's belief that the ceded reserves at December 31, 2002 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded. Reserve for Losses and Loss Expenses THE TABLE BELOW CLASSIFIES AS OF DECEMBER 31, 2002 THE COMPONENTS OF THE GENERAL INSURANCE RESERVE FOR LOSSES AND LOSS EXPENSES (LOSS RESERVES) WITH RESPECT TO MAJOR LINES OF BUSINESS ON A STATUTORY BASIS*: (in millions) - -------------------------------------------------------------------------------- Other Liability Occurrence $14,132 Other Liability Claims Made 8,559 Workers Compensation 6,064 Auto Liability 4,290 International 2,797 Property 2,691 Reinsurance 1,591 Medical Malpractice 1,560 Aircraft 1,448 Products Liability 1,262 Accident & Health 1,009 Fidelity/Surety 875 Other 5,261 - -------------------------------------------------------------------------------- Total $51,539 ================================================================================ * Presented pursuant to statutory reporting requirements as prescribed by the National Association of Insurance Commissioners. At December 31, 2002, the loss reserves amounted to $51.54 billion. These loss reserves represent the accumulation of estimates of ultimate losses, including IBNR and loss expenses. Certain of these loss reserves are discounted. These discounted reserves relate primarily to certain workers' compensation claims. At December 31, 2002, general insurance net loss reserves increased $4.45 billion from prior year end to $30.35 billion. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments resulting therefrom are reflected in operating income currently. It is management's belief that the general insurance net loss reserves are adequate to cover all general insurance net losses and loss expenses as at December 31, 2002. While AIG annually reviews the adequacy of established loss reserves, there can be no assurance that AIG's ultimate loss reserves will not adversely develop and materially exceed AIG's loss reserves as of December 31, 2002. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on future results of operations. See "Loss Reserve Charge" below. In a very broad sense, the general loss reserves can be categorized into two distinct groups, one group being long tail casualty lines of business. Such lines include excess and umbrella liability, directors and officers' liability, professional liability, medical malpractice, general liability, products' 28
American International Group, Inc. and Subsidiaries 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. Estimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. In the more recent accident years of long tail casualty lines there is limited statistical credibility in reported net losses. That is, a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. A relatively high proportion of net losses would therefore be IBNR. A variety of actuarial methods and assumptions are normally employed to estimate net losses for long tail casualty lines. These methods ordinarily involve the use of loss trend factors intended to reflect the estimated annual growth in loss costs from one accident year to the next. For the majority of long tail casualty lines, net loss trend factors approximated six percent. Loss trend factors reflect many items including changes in claims handling, exposure and policy forms; current and future estimates of monetary inflation and social inflation and increases in litigation and awards. Thus, many factors are implicitly considered in estimating the year to year growth in loss costs. Therefore, AIG's carried net long tail loss reserves are judgmentally set as well as tested for reasonableness using the most appropriate loss trend factors for each class of business. In the evaluation of AIG's net loss reserves, loss trend factors vary, depending on the particular class and nature of the business involved. These factors are periodically reviewed and subsequently adjusted, as appropriate, to reflect emerging trends which are based upon past loss experience. See "Loss Reserve Charge" below. Estimation of net losses for short tail business is less complex than for long tail casualty lines. Loss cost trends for many property lines can generally be assumed to be similar to the growth in exposure of such lines. For example, if the fire insurance coverage remained proportional to the actual value of the property, the growth in property's exposure to fire loss can be approximated by the amount of insurance purchased. AIG's annual reserve review does not calculate a range of loss reserve estimates. Because AIG's general insurance business is primarily in volatile long tail casualty lines driven almost entirely by severity rather than frequency of claims, developing a range around loss reserve estimates would not be meaningful. An estimate is calculated which AIG's actuaries believe provides a reasonable estimate of the required reserve. This amount is evaluated against actual carried reserves. It should also be noted that AIG's overall book of business consists of hundreds of segments or classes of business that are individually reviewed as part of the overall analysis of loss reserves. Most of these would fall into the category of longer tail lines of business. Due to the multitude of such classes and the volume of detail for each, it would not be possible to provide complete claim frequency, settlement, closure and other data for all such segments, nor does AIG believe that such disclosure by class of business would be meaningful or useful to the reader. It should be noted that none of the other segments or classes reflects the highly uncertain qualities that apply to the asbestos and environmental claims. For example, traditional actuarial methodologies can be applied to classes such as excess casualty, directors and officers liability, healthcare, and the other long tail coverages that AIG writes. These methodologies cannot be applied to asbestos and environmental exposures. Other than asbestos and environmental exposures, there is no area of significant exposure to AIG for which traditional actuarial methodologies cannot be applied. For other property and short tail casualty lines, the loss trend is implicitly assumed to develop at the rate that reported net losses develop from one year to the next. The concerns noted above for longer tail casualty lines with respect to the limited statistical credibility of reported net losses generally do not apply to shorter tail lines. Loss Reserve Charge Following completion of its annual year-end net loss reserve study, AIG increased general insurance loss and loss adjustment reserves, incurring a net, after-tax charge of $1.8 billion in the fourth quarter of 2002. THE TABLE BELOW CLASSIFIES THE COMPONENTS OF THE NET LOSS RESERVE CHARGE BY ACCIDENT YEAR AND MAJOR LINE OF BUSINESS: (in millions) - -------------------------------------------------------------------------------- Line of Accident Carried Reserves Loss Reserve Business Year December 31, 2001 Charge ================================================================================ Other Liability Occurrence(a) 1997 $ 359 $ 175 1998 594 352 1999 766 305 2000 998 335 2001 1,895 276 - -------------------------------------------------------------------------------- Total $ 1,443 - -------------------------------------------------------------------------------- Other Liability Claims Made(b) 1997 $ 271 $ -- 1998 444 135 1999 371 382 2000 893 185 2001 1,647 103 - -------------------------------------------------------------------------------- Total $ 805 - -------------------------------------------------------------------------------- Workers' Compensation(c) 1996 &Prior $ 1,102 $ 144 1997 206 58 1998 128 33 1999 214 29 2000 548 -- 2001 844 30 - -------------------------------------------------------------------------------- Total $ 294 - -------------------------------------------------------------------------------- Medical Malpractice 1997 $ 31 $ 58 1998 48 35 1999 70 46 2000 75 19 2001 121 -- - -------------------------------------------------------------------------------- Total $ 158 - -------------------------------------------------------------------------------- Reinsurance 1998 $ 126 $ 33 1999 113 34 2000 158 33 - -------------------------------------------------------------------------------- Total $ 100 ================================================================================ Total $ 2,800 ================================================================================ (a) Primarily excess casualty. (b) Primarily directors and officers. (c) Primarily excess workers' compensation. 29
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) In conducting its 2002 year end loss reserve analysis, AIG considered all classes of business that could be volatile and directly incorporated that specific class analysis into its overall results. AIG's method for determining reserves for volatile long tail lines relies on the use of expected loss ratios such as the method known as the "Bornhuetter/Ferguson" method. This methodology essentially ignores all recent accident years for which loss development is too immature to give reliable results and, instead, bases the reserve estimate on the more mature prior accident year results. In its 2002 year end analysis, AIG observed that the more recent immature accident years were showing significant increases in loss development. As a result, AIG modified its historical assumptions in producing an estimate of required reserves. A key modification was to give additional weight to the actual loss development in the immature years. For example, for AIG's excess casualty lead umbrella segment, AIG used the loss development for accident year 1999, even though that development normally would be considered too immature to produce reliable results (and therefore, not used under historical assumptions). Another key change for the most recent accident years (generally accident years 2000, 2001, 2002) is, although AIG continued to use actuarial assumptions that rely on expected loss ratios (such as the Bornhuetter/Ferguson method mentioned above), the expected loss ratio assumptions used gave far greater weight to more recent accident year experience than was the case in the historical assumptions. For example, for the excess casualty lead umbrella segment described above, AIG actuaries gave 100 percent weight to the results of the 1997 through 1999 accident years only, giving no weight to the more favorable development of all prior years, in setting expected loss ratio assumptions for accident years 2000 to 2002. Again, using the lead umbrella segment as an example, rather than using the historical trend factor of 2.5 percent per year as actually experienced, AIG used 7.5 percent as the annual loss cost trend factor reflecting the more current experience. Loss development trends for volatile long tail lines such as excess casualty and directors and officers liability have not followed any consistent trend. This has at times led to overstated loss ratio projections and is a key reason why AIG has customarily utilized the historical projection (Bornhuetter/ Ferguson) method. For long tail lines, judgment is required in analyzing the appropriate weighting of current trends to avoid overreacting to data anomalies that may distort such current trends. AIG's annual loss reserve review commences late in the third quarter and is completed late in the fourth quarter of each year. Although the year end 2001 annual loss reserve review, completed approximately one year ago, did show some indications of adverse development from most of the classes which required the increase in 2002, at that time, the indicated amount of reserve increase needed was immaterial. Furthermore, it was believed that the potential risk of adverse development from those reserves was mitigated for purposes of the overall loss development by what appeared at the time to be a potential redundancy in the adequacy of the unearned premium reserve as of year end 2001 as premium rates had been increased sharply in 2001. During 2002, however, there was substantial adverse development in AIG's excess casualty and directors and officers lines of business, as well as lesser amounts in certain other classes, including healthcare liability. These adverse developments were significant enough to not only cause a deficiency in the level of carried reserves, but to also suggest that AIG's assumptions for testing its reserves needed to be modified to account for the development in loss trends that was emerging for 1997 and subsequent accident years (as more fully discussed above). Using the modified assumptions, AIG's actuaries conducted further analysis of the reserves required as of December 31, 2002. Given the accuracy of the historical approach and the uncertainty of the more recent trends, AIG decided to give approximately equal weight to both sets of assumptions in establishing the carried reserves as of December 31, 2002. Given the scope and complexity of AIG's general insurance operations and the extensive work and time required to review reserves, AIG's annual year end loss reserve review commences late in the third quarter. Recognition of the adverse development occurred at the end of the fourth quarter of 2002 as this was the quarter in which the year end 2002 loss reserve review was completed. The year end 2001 loss reserve review indicated that AIG's carried reserves as of year end 2001 were reasonable. As described above, the trend AIG recognized as driving the change in the estimate is the adverse loss cost trend which occurred beginning with accident year 1997 and continued and accelerated in accident years 1998 and 1999. The increase in loss trends is concentrated in high severity coverages, such as excess casualty, excess workers' compensation, directors and officers liability, and healthcare liability. The change in the estimate correlates with this trend. Asbestos and Environmental Claims AIG continues to receive claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites (hereinafter referred to collectively as environmental claims) and indemnity claims asserting injuries from asbestos. The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. AIG established over a decade ago specialized toxic tort and environmental claim units, which investigate and adjust all such asbestos and environmental claims. These units utilize a comprehensive ground up approach to claim adjusting by thoroughly evaluating each exposure on a claim by claim basis. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage and an absolute asbestos exclusion was also implemented. However, AIG currently underwrites environmental impairment liability insurance on a claims made basis and has excluded such claims from the analyses included herein. Estimation of asbestos and environmental claims loss reserves is a difficult process. These asbestos and environmental claims cannot be estimated by conventional reserving techniques as previously described. Quantitative techniques frequently have to be supplemented by subjective considerations including managerial judgment. Significant factors which affect the trends which influence the development of asbestos and environmental claims are the inconsistent court 30
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving and there is little likelihood that any firm direction will develop in the near future. Additionally, the exposure for cleanup costs of hazardous waste dump sites involves issues such as allocation of responsibility among potentially responsible parties and the government's refusal to release parties. In the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. At the current time, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as is the case for other types of claims. Such development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by the changes in Superfund and waste dump site coverage issues. Although the estimated liabilities for these claims are subject to a significantly greater margin of error than for other claims, the reserves carried for these claims at December 31, 2002 are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG's net exposure retained relative to the gross exposure written was lower in 1984 and prior years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. In the future, if the environmental claims develop deficiently, such deficiency would have an adverse impact on future results of operations. (See the previous discussion on reinsurance collectibility herein.) The majority of AIG's exposures for asbestos and environmental claims are excess casualty coverages, not primary coverages. Thus, the litigation costs are treated in the same manner as indemnity reserves. That is, litigation expenses are included within the limits of the liability AIG incurs. Individual significant claim liabilities, where future litigation costs are reasonably determinable, are established on a case basis. In asbestos, for example, AIG has resolved all claims with respect to miners and product manufacturers (Tier 1), for which payments are completed or reserves are established to cover future payment obligations. Asbestos claims with respect to products containing asbestos (Tier 2) accounts are generally very mature losses, and have been appropriately recognized and reserved by AIG's asbestos claims operation. AIG believes that the vast majority of the incoming claims, with respect to products containing small amounts of asbestos and companies in the distribution chain and parties with remote, ill-defined involvement with asbestos (Tier 3 and 4), should not impact its coverage; this is due to a combination of factors, including the increasingly peripheral companies being named in asbestos litigation, smaller limits issued to peripheral defendants, tenuous liability cases against peripheral defendants, attachment points of the excess policies, and the manner in which resolution of these weaker cases would be allocated among all insurers, including non-AIG companies, over a long period of time. A SUMMARY OF RESERVE ACTIVITY, INCLUDING ESTIMATES FOR APPLICABLE IBNR, RELATING TO ASBESTOS AND ENVIRONMENTAL CLAIMS SEPARATELY AND COMBINED AT DECEMBER 31, 2002, 2001 AND 2000 FOLLOWS: (in millions) - -------------------------------------------------------------------------------------------------------------------------- 2002 2001 2000 ------------------ ------------------ ------------------ GROSS NET Gross Net Gross Net ========================================================================================================================== Asbestos: Reserve for losses and loss expenses at beginning of year $ 1,114 $ 312 $ 1,100 $ 338 $ 1,093 $ 306 Losses and loss expenses incurred* 395 168 358 92 405 80 Losses and loss expenses paid* (205) (80) (344) (118) (398) (48) - -------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 1,304 $ 400 $ 1,114 $ 312 $ 1,100 $ 338 ========================================================================================================================== Environmental: Reserve for losses and loss expenses at beginning of year $ 1,115 $ 407 $ 1,345 $ 517 $ 1,519 $ 585 Losses and loss expenses incurred* (140) (44) (41) (34) (44) (45) Losses and loss expenses paid* (143) (67) (189) (76) (130) (23) - -------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 832 $ 296 $ 1,115 $ 407 $ 1,345 $ 517 ========================================================================================================================== Combined: Reserve for losses and loss expenses at beginning of year $ 2,229 $ 719 $ 2,445 $ 855 $ 2,612 $ 891 Losses and loss expenses incurred* 255 124 317 58 361 35 Losses and loss expenses paid* (348) (147) (533) (194) (528) (71) - -------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 2,136 $ 696 $ 2,229 $ 719 $ 2,445 $ 855 ========================================================================================================================== * All amounts pertain to policies underwritten in prior years. THE GROSS AND NET IBNR INCLUDED IN THE RESERVE FOR LOSSES AND LOSS EXPENSES AT DECEMBER 31, 2002, 2001 AND 2000 WERE ESTIMATED AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------------------------------------------------- 2002 2001 2000 ------------------ ------------------ ------------------ GROSS NET Gross Net Gross Net ========================================================================================================================== Combined $ 1,022 $ 283 $ 1,038 $ 278 $ 1,042 $ 314 ========================================================================================================================== 31
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) A SUMMARY OF ASBESTOS AND ENVIRONMENTAL CLAIMS COUNT ACTIVITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WAS AS FOLLOWS: - ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 2000 --------------------------------- --------------------------------- --------------------------------- ASBESTOS ENVIRONMENTAL COMBINED Asbestos Environmental Combined Asbestos Environmental Combined ==================================================================================================================================== Claims at beginning of year 6,672 9,364 16,036 6,796 11,323 18,119 6,746 13,432 20,178 Claims during year: Opened 959 1,657 2,616 739 1,892 2,631 650 1,697 2,347 Settled (154) (546) (700) (124) (988) (1,112) (101) (584) (685) Dismissed or otherwise resolved (392) (1,480) (1,872) (739) (2,863) (3,602) (499) (3,222) (3,721) - ------------------------------------------------------------------------------------------------------------------------------------ Claims at end of year 7,085 8,995 16,080 6,672 9,364 16,036 6,796 11,323 18,119 ==================================================================================================================================== THE AVERAGE COST PER CLAIM SETTLED, DISMISSED OR OTHERWISE RESOLVED FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WAS AS FOLLOWS: - -------------------------------------------------------------------------------- Gross Net ================================================================================ 2002 ASBESTOS $375,500 $146,500 ENVIRONMENTAL 70,600 33,100 COMBINED 135,300 57,200 ================================================================================ 2001 Asbestos $398,600 $136,700 Environmental 49,100 19,700 Combined 113,100 41,200 ================================================================================ 2000 Asbestos $663,300 $ 80,000 Environmental 34,200 6,000 Combined 119,800 16,100 ================================================================================ A.M. Best, an insurance rating agency, has developed a survival ratio to measure the number of years it would take a company to exhaust both its asbestos and environmental reserves for losses and loss expenses based on that company's current level of asbestos and environmental claims payments. This is a ratio derived by taking the current ending losses and loss expense reserves and dividing by the average annual payments for the prior three years. Therefore, the ratio derived is a simplistic measure of an estimate of the number of years it would be before the current ending losses and loss expense reserves would be paid off using recent average payments. The higher the ratio, the more years the reserves for losses and loss expenses cover these claims payments. These ratios are computed based on the ending reserves for losses and loss expenses over the respective claims settlements during the fiscal year. Such payments include indemnity payments and legal and loss adjustment payments. It should be noted, however, that this is an extremely simplistic approach to measuring asbestos and environmental reserve levels. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments thereof and the resultant ratio. The developed survival ratios include both involuntary and voluntary indemnity payments. Involuntary payments are primarily attributable to court judgments, court orders, covered claims with no coverage defenses, state mandated cleanup costs, claims where AIG's coverage defenses are minimal, and settlements made less than six months before the first trial setting. Also, AIG considers all legal and loss adjustment payments as involuntary. AIG believes voluntary indemnity payments should be excluded from the survival ratio. The special asbestos and environmental claims unit actively manages AIG's asbestos and environmental claims and proactively pursues early settlement of environmental claims for all known and unknown sites. As a result, AIG reduces its exposure to future environmental loss contingencies. AIG'S SURVIVAL RATIOS FOR INVOLUNTARY ASBESTOS AND ENVIRONMENTAL CLAIMS, SEPARATELY AND COMBINED, WERE BASED UPON A THREE YEAR AVERAGE PAYMENT. THESE RATIOS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WERE AS FOLLOWS: - -------------------------------------------------------------------------------- Gross Net ================================================================================ 2002 INVOLUNTARY SURVIVAL RATIOS: ASBESTOS 4.1 4.9 ENVIRONMENTAL 17.6 13.3 COMBINED 7.3 7.9 ================================================================================ 2001 Involuntary survival ratios: Asbestos 3.3 4.3 Environmental 18.7 16.5 Combined 6.8 8.7 ================================================================================ 2000 Involuntary survival ratios: Asbestos 3.6 6.8 Environmental 20.0 16.9 Combined 7.6 11.5 ================================================================================ AIG's operations are negatively impacted under guarantee fund assessment laws which exist in most states. As a result of operating in a state which has guarantee fund assessment laws, a solvent insurance company may be assessed for certain obligations arising from the insolvencies of other insurance companies which operated in that state. AIG generally records these assessments upon notice. Additionally, certain states permit at least a portion of the assessed amount to be used as a credit against a company's future premium tax liabilities. Therefore, the ultimate net 32
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES assessment cannot reasonably be estimated. The guarantee fund assessments net of credits for 2002, 2001 and 2000 were $76 million, $24 million and $15 million, respectively. AIG is also required to participate in various involuntary pools (principally workers' compensation business) which provide insurance coverage for those not able to obtain such coverage in the voluntary markets. This participation is also recorded upon notification, as these amounts cannot reasonably be estimated. LIFE INSURANCE OPERATIONS AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. (See also Note 2 of Notes to Financial Statements.) LIFE INSURANCE OPERATIONS PRESENTED ON A MAJOR PRODUCT BASIS FOR 2002, 2001 AND 2000 WERE AS FOLLOWS: (in millions) - --------------------------------------------------------------------------------------------- 2002 2001(a) 2000(a) ============================================================================================= GAAP premiums: Domestic: Life Insurance $ 1,626 $ 1,515 $ 1,522 Individual Fixed Annuities(b) 42 437 380 Guaranteed Investment Contracts 28 -- (7) Home Service 854 876 953 Group Life/Health 967 925 969 Pension and Investment Products(b) 1,105 1,144 665 Accident & Health(c) -- 51 327 - --------------------------------------------------------------------------------------------- Total Domestic 4,622 4,948 4,809 - --------------------------------------------------------------------------------------------- Foreign: Life Insurance 12,000 10,771 9,474 Personal Accident 2,491 2,196 1,924 Group Products 1,094 1,050 851 Guaranteed Investment Contracts 113 98 105 - --------------------------------------------------------------------------------------------- Total Foreign 15,698 14,115 12,354 - --------------------------------------------------------------------------------------------- Total GAAP premiums $ 20,320 $ 19,063 $ 17,163 ============================================================================================= Premium income, deposits and other considerations(d)(e): Domestic: Life Insurance(f) $ 2,411 $ 2,724 $ 2,256 Individual Fixed Annuities 10,328 7,605 5,079 Guaranteed Investment Contracts 9,078 8,242 6,752 Home Service 861 878 953 Group Life/Health 976 930 969 Pension and Investment Products 1,782 3,020 2,368 Accident & Health(c) -- 157 327 - --------------------------------------------------------------------------------------------- Total Domestic $ 25,436 $ 23,556 $ 18,704 ============================================================================================= Foreign: Life Insurance 13,440 12,066 10,256 Personal Accident 2,497 2,173 1,923 Group Products 1,579 1,660 1,266 Guaranteed Investment Contracts 5,710 4,162 6,070 - --------------------------------------------------------------------------------------------- Total Foreign 23,226 20,061 19,515 - --------------------------------------------------------------------------------------------- Total premium income, deposits and other considerations $ 48,662 $ 43,617 $ 38,219 ============================================================================================= Net investment income: Domestic: Life Insurance $ 1,417 $ 1,329 $ 1,306 Individual Fixed Annuities 3,229 2,874 2,708 Guaranteed Investment Contracts 2,052 1,836 1,321 Home Service 683 653 669 Group Life/Health 108 105 107 Pension and Investment Products 836 702 662 Accident & Health(c) -- 5 8 - --------------------------------------------------------------------------------------------- Total Domestic 8,325 7,504 6,781 - --------------------------------------------------------------------------------------------- Foreign: Life Insurance 3,206 2,848 2,432 Personal Accident 141 128 129 Group Products 255 227 223 Guaranteed Investment Contracts 359 387 406 Intercompany Adjustments (12) (10) (9) - --------------------------------------------------------------------------------------------- Total Foreign 3,949 3,580 3,181 - --------------------------------------------------------------------------------------------- Total net investment income $ 12,274 $ 11,084 $ 9,962 ============================================================================================= Operating income before realized capital losses: Domestic: Life Insurance(g) $ 777 $ 555 $ 614 Individual Fixed Annuities 729 679 611 Guaranteed Investment Contracts 581 445 159 Home Service 382 374 353 Group Life/Health 101 87 69 Pension and Investment Products 118 144 150 Accident & Health(c) -- 4 23 - --------------------------------------------------------------------------------------------- Total Domestic(g) 2,688 2,288 1,979 - --------------------------------------------------------------------------------------------- Foreign: Life Insurance 2,411 1,914 1,558 Personal Accident 681 572 531 Group Products 175 127 107 Guaranteed Investment Contracts 39 38 54 Intercompany Adjustments (12) (10) (9) - --------------------------------------------------------------------------------------------- Total Foreign 3,294 2,641 2,241 - --------------------------------------------------------------------------------------------- Total operating income before realized capital losses 5,982 4,929 4,220 Realized capital losses (1,053) (254) (162) - --------------------------------------------------------------------------------------------- Total operating income(g) $ 4,929 $ 4,675 $ 4,058 ============================================================================================= Life insurance in-force: Domestic $ 577,686 $ 517,067 $ 477,576 Foreign(h) 746,765 711,434 494,316 - --------------------------------------------------------------------------------------------- Total $ 1,324,451 $ 1,228,501 $ 971,892 ============================================================================================= (a) Restated to conform to the 2002 presentation. (b) 2001 and 2000 GAAP premiums included certain annuity products now reported in Pension and Investment Products. (c) Beginning 2001, certain Accident & Health operations are part of DBG. (d) Represents a non-GAAP measurement used by AIG to help manage its life insurance operation, and may not be comparable to similarly captioned measurements used by other life insurance companies. (e) Premium income, deposits and other considerations represent aggregate business activity during the respective periods. (f) The decline in life premiums is due primarily to lower private placement and corporate life market sales. (g) 2001 included WTC losses of $131 million. (h) Increase in 2001 reflects acquisition of AIG Star Life Insurance Co., Ltd. in April 2001. 33
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Life Insurance Results LIFE INSURANCE OPERATING INCOME in 2002 increased 5.4 percent to $4.93 billion compared to an increase of 15.2 percent in 2001. This decline in the growth rate was caused by the $799 million increase in realized capital losses. If such losses were excluded from both the 2002 and 2001 life insurance operating income and WTC losses of $131 million excluded from 2001 life operating income, the growth in 2002 life operating income when compared to 2001 life operating income would be 18.2 percent. THE FOLLOWING TABLE RECONCILES THE LIFE OPERATING INCOME REPORTED ON A GAAP BASIS TO THE PRESENTATION AIG MANAGEMENT BELIEVES IS MOST MEANINGFUL: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ As reported $4,929 $4,675 $4,058 WTC losses -- 131 -- Realized capital losses 1,053 254 162 - -------------------------------------------------------------------------------- As adjusted -- Management reporting basis $5,982 $5,060 $4,220 ================================================================================ The contribution of life insurance operating income to income before income taxes, minority interest and cumulative effect of accounting changes and excluding acquisition, restructuring and related charges amounted to 60.5 percent in 2002 compared to 46.0 percent in 2001 and 39.3 percent in 2000. The increase in contribution percentage was influenced by the impact of the general insurance loss reserve charge in 2002 and the WTC losses in 2001 on general insurance operating income and its reduced contribution to income before income taxes, minority interest and cumulative effect of accounting changes. If the loss reserve charge and realized capital losses were excluded from 2002 income before income taxes, minority interest and cumulative effect of accounting changes and WTC losses from 2001 and realized capital losses and acquisition restructuring and related charges were excluded from 2001 and 2000 income before income taxes, minority interest and cumulative effect of accounting changes, the contribution of life operating income to income before income taxes, minority interest and cumulative effect of accounting changes would be 44.7 percent, 42.6 percent and 39.6 percent in 2002, 2001 and 2000, respectively. AIG'S GAAP LIFE PREMIUM INCOME IN 2002 REPRESENTED A 6.6 PERCENT INCREASE FROM THE PRIOR YEAR. The slowing in growth in 2002 reflected lower demand and sales of annuities in connection with corporate pension restructuring activities in domestic operations. This compares with an increase of 11.1 percent in 2001 over 2000. Foreign life operations produced 77.3 percent, 74.0 percent and 72.0 percent of the GAAP life premium income in 2002, 2001 and 2000, respectively. (See also Notes 1, 4 and 6 of Notes to Financial Statements.) The traditional life products, particularly individual life products, were major contributors to the growth in foreign premium income. These traditional life products, coupled with the increased distribution of financial and investment products contributed to the growth in foreign investment income. A mixture of traditional, accident and health and financial products are being sold in Japan through ALICO and AIG Star Life. Since AIG purchased AIG Star Life, a part of the income earned by AIG Star Life has resulted from surrender charges earned on policies that were either surrendered or lapsed. This favorable impact on operating income was anticipated when AIG took control. As these surrenders diminish in subsequent periods, operating income from that source will also be impacted. The majority of AIG Star Life's future income is expected to be related to continuing premiums paid on renewal business, and new business to be generated from a growing agency force. As previously discussed, the U.S. dollar strengthened slightly in relation to most major foreign currencies in which AIG transacts business. Accordingly for 2002, when foreign life premium income was translated into U.S. dollars for purposes of the preparation of the consolidated financial statements, total life premium income was approximately 1.6 percentage points less than it would have been if translated utilizing exchange rates prevailing in 2001. LIFE INSURANCE NET INVESTMENT INCOME increased 10.7 percent in 2002 compared to an increase of 11.3 percent in 2001. The growth in net investment income was attributable to both foreign and domestic new cash flow for investment. The new cash flow was generated from life insurance operations and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein.) LIFE INSURANCE REALIZED CAPITAL LOSSES were $1.05 billion in 2002, $254 million in 2001 and $162 million in 2000. These realized capital losses resulted from the ongoing investment management of the life insurance portfolios within the overall objectives of the life insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities. (See also the discussion on "Valuation of Invested Assets" herein.) Underwriting and Investment Risk The risks associated with the traditional life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is primarily investment risk. Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's foreign life companies limit their maximum underwriting exposure on traditional life insurance of 34
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES a single life to approximately $1.5 million dollars of coverage and AIG's domestic life companies, limit their maximum underwriting exposure on traditional life insurance of a single life to $2.5 million of coverage by using yearly renewable term reinsurance. (See also Note 5 of Notes to Financial Statements and the discussion under "Liquidity" herein.) The investment risk represents the exposure to loss resulting from the cash flows from the invested assets, primarily long-term fixed rate investments, being less than the cash flows required to meet the obligations of the expected policy and contract liabilities and the necessary return on investments. (See also the discussion under "Liquidity" herein.) To minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to assess whether there is a liquidity excess or deficit. If a rebalancing of the invested assets to the policy and contract claims became necessary and did not occur, a demand could be placed upon liquidity. (See also the discussion under "Liquidity" herein.) The asset-liability relationship is appropriately managed in AIG's foreign operations, as it has been throughout AIG's history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of the related policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the initial investments may be at a yield below that of the interest required for the accretion of the policy liabilities. Additionally, there exists a future investment risk associated with certain policies currently in force which will have premium receipts in the future. That is, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities. To maintain an adequate yield to match the interest necessary to support future policy liabilities, constant management focus is required to reinvest the proceeds of the maturing securities and to invest the future premium receipts while continuing to maintain satisfactory investment quality. To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and to support any operational shortfall through its international financial network. (See also the discussion under "Liquidity" herein.) The asset-liability relationship is appropriately managed in AIG's domestic operations, as there is ample supply of qualified long-term investments. AIG uses asset-liability matching as a management tool worldwide to determine the composition of the invested assets and appropriate marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in an unmatched position due to anticipated interest rate or other economic changes. For the ALICO operations in Japan, the variable life contract separate account fund performance has varied from the level assumed in the original pricing of the product. Thus, a general account liability has been established for the potential shortfall of future contract revenues. The ultimate liability is predominately dependent upon the fund performance in the future. Deferred policy acquisition costs (DAC) for life insurance products arises from the deferral of those costs that vary with, and are directly related to, the acquisition of new or renewal business. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs which relate to universal life and investment-type products (non-traditional life products) are deferred and amortized, with interest, in relation to the historical and future incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits include investment income and gains and losses on investments less interest required as well as other charges in the contract less actual mortality and expenses. Current experience and changes in the expected future gross profits are analyzed to determine the impact on the amortization of DAC. The estimation of projected gross profits requires significant management judgment. The elements with respect to the current and projected gross profits are reviewed and analyzed quarterly and are appropriately adjusted. DAC for both traditional life and non-traditional life products are subject to review for recoverability, which involve estimating the future profitability of current business. This review also involves significant management judgment. (See also Note 4 of Notes to Financial Statements.) 35
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) FINANCIAL SERVICES OPERATIONS AIG's financial services subsidiaries engage in diversified financial products and services including aircraft leasing, consumer and insurance premium financing, and capital markets structuring and market-making activities. (See also Note 2 of Notes to Financial Statements.) FINANCIAL SERVICES OPERATIONS FOR 2002, 2001 AND 2000 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Revenues: ILFC (a) $ 2,845 $ 2,613 $ 2,441 AIGFP (b) 1,306 1,178 1,056 Consumer Finance (c) 2,473 2,560 2,325 Other 191 134 132 - -------------------------------------------------------------------------------- Total $ 6,815 $ 6,485 $ 5,954 ================================================================================ Operating income: ILFC $ 801 $ 749 $ 654 AIGFP 808 758 648 Consumer Finance 549 505 386 Other, including intercompany adjustments 31 (21) (22) - -------------------------------------------------------------------------------- Total $ 2,189 $ 1,991 $ 1,666 ================================================================================ (a) Revenues were primarily from aircraft lease rentals. (b) Revenues were primarily fees from proprietary positions entered into in connection with counterparty transactions. (c) Revenues were primarily finance charges. FINANCIAL SERVICES RESULTS FINANCIAL SERVICES OPERATING INCOME increased 9.9 percent in 2002 over 2001. This compares with an increase of 19.5 percent in 2001 over 2000. Financial services operating income represented 26.9 percent of AIG's income before income taxes, minority interest and cumulative effect of accounting changes and excluding acquisition, restructuring and related charges in 2002. This compares to 19.6 percent and 16.1 percent in 2001 and 2000, respectively. The increase in contribution percentage was influenced by the impact of the general insurance loss reserve charge in 2002 and the WTC losses in 2001 on general insurance operating income and its reduced contribution to income before income taxes, minority interest and cumulative effect of accounting changes. ILFC generates its revenues primarily from leasing commercial jet aircraft to domestic and foreign airlines. Revenues also result from the remarketing of commercial jets for its own account, for airlines and for financial institutions. Revenues in 2002 increased 8.9 percent from 2001 compared to an 7.0 percent increase during 2001 from 2000. The revenue growth in each year resulted primarily from the increase in flight equipment under operating lease and the increase in the relative cost of the leased fleet. ILFC has historically derived over 80 percent of its lease revenues with respect to flight equipment from airlines based outside the United States and is not significantly exposed to current domestic airline difficulties. ILFC has historically re-leased aircraft returning at the end of a lease before the aircraft returns to ILFC. For aircraft returning before the end of their lease terms, ILFC has generally been able to re-lease aircraft returned from the prior lessee within two to three months of its return. As a lessor, ILFC considers an aircraft "idle" or "off lease" when the aircraft is not subject to a signed lease agreement or signed letter of intent. ILFC had one aircraft off lease at December 31, 2002 which had been off lease for less than three months. No impairments have been recognized related to these aircraft as ILFC believes that the existing service potential of the aircraft in ILFC's portfolio has not been diminished and ILFC has been able to re-lease the aircraft without diminution in lease rates from those previously obtained that would require an impairment write-down. ILFC management is very active in the airline industry. Management formally reviews regularly, and no less frequently than quarterly, issues affecting ILFC's fleet, including events and circumstances that may cause impairment of aircraft values. Management evaluates aircraft in the fleet as necessary, based on these events and circumstances in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144). No impairments have been recognized related to these aircraft. (See also the discussions under "Liquidity" herein.) During 2002, ILFC's operating income increased 6.9 percent from 2001 and 14.6 percent during 2001 from 2000. ILFC finances its purchases of aircraft primarily through the issuance of a variety of debt instruments. The composite borrowing rates at December 31, 2002, 2001 and 2000 were 4.73 percent, 5.07 percent and 6.37 percent, respectively. (See also the discussions under "Capital Resources" and "Liquidity" herein and Note 2 of Notes to Financial Statements.) ILFC is exposed to operating loss and liquidity strain through non-performance of aircraft lessees, through owning aircraft which it would be unable to sell or re-lease at acceptable rates at lease expiration and through committing to purchase aircraft which it would be unable to lease. ILFC manages its lessee non-performance exposure through credit reviews and security deposit requirements. As a result of these measures and its own contingency planning, ILFC did not suffer any material losses from airline shutdowns in the aftermath of the September 11 terrorist attacks, but there can be no assurance that ILFC will successfully manage the risks relating to the impact of possible future deterioration in the airline industry. Approximately 86 percent of ILFC's fleet is leased to non-U.S. carriers, and this fleet, the most efficient in the airline industry, continues to be in high demand from such carriers. (See also the discussions under "Capital Resources" and "Liquidity" herein.) AIGFP participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity and credit derivative products business. AIGFP also enters into structured transactions including long-dated 36
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES forward foreign exchange contracts, option transactions, liquidity facilities and investment agreements and invests in a diversified portfolio of securities. AIGFP derives substantially all its revenues from proprietary positions entered in connection with counterparty transactions rather than from speculative transactions. As a dealer, AIGFP marks its transactions daily to fair value. Thus, a gain or loss on each transaction is recognized daily. AIGFP hedges the market risks arising from its transactions. Therefore, revenues and operating income are not significantly exposed to or affected by market fluctuations and volatility. Revenues of AIGFP and the percentage change in revenues for any given period are significantly affected by the number and size of transactions entered into by AIGFP during that period relative to those entered into during the prior period. Operating income and the percentage change in operating income for any period are determined by the number, size and profitability of the transactions attributable to that period relative to those attributable to the prior period. The realization of operating income as measured by the receipt of funds is not a significant event as the profit or loss on each of AIGFP's transactions has already been reflected in operating income. Revenues in 2002 increased 10.9 percent from 2001 compared to a 11.6 percent increase during 2001 from 2000. During 2002, operating income increased 6.6 percent from 2001 and increased 17.0 percent during 2001 from 2000. As AIGFP is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance. THE BREAKDOWN BY PERCENTAGE CONTRIBUTION OF REVENUES AND OPERATING INCOME FOR AIGFP IN 2002, 2001 AND 2000 IS SET FORTH BELOW. THE PERCENTAGES FOR OPERATING INCOME ARE THE SAME AS THOSE FOR REVENUES BECAUSE EXPENSES ARE ALLOCATED ACROSS ALL PRODUCTS IN PROPORTION TO THE REVENUES GENERATED BY THAT PRODUCT. MATERIAL CHANGES IN THE DISTRIBUTION OF REVENUES AND OPERATING INCOME ARE NOT MEANINGFUL BECAUSE OF THE TRANSACTIONAL NATURE OF AIGFP'S BUSINESS. - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Spread Income on Investments and Borrowings 48% 36% 32% Interest Rate Products 19 29 30 Equity Linked Products 3 14 25 Credit Linked Products 29 11 12 Other revenue 1 10 1 ================================================================================ Financial market conditions in 2002 compared with 2001 were characterized by a continuing decline in interest rates across fixed income markets globally, a worldwide slump in credit prices with the concomitant widening of credit spreads, and a continuing decline in equity valuations. AIGFP's results in 2002 compared with 2001 reflected a shift in product segment activity to respond to these conditions. In particular, AIGFP experienced increases in demand for credit linked products that addressed the risk management needs of its counterparties (see also the discussion under "Derivatives" herein). The increase in spread income on investments and borrowings reflected the widening of credit spreads, as well as an increase in asset class diversification. Finally, the sharp decline in equity linked products reflected substantially reduced demand for products that hedge appreciated equity positions. Derivative transactions are entered into in the ordinary course of AIGFP's business. Therefore, income on interest rate, equity and credit derivatives along with their related hedges are recorded on a mark to market value or at estimated fair value where market prices are not readily available with the resulting unrealized gains or losses reflected in the income statement in the current year. In 2002, less than five percent of revenues resulted from transactions valued at estimated fair value. The mark to fair value of derivative transactions is reflected in the balance sheet in the captions "Unrealized gain on interest rate and currency swaps, options and forward transactions" and "Unrealized loss on interest rate and currency swaps, options and forward transactions". The unrealized gain represents the net receivable from counterparties, and the unrealized loss represents the net payable to counterparties. These amounts will change from one period to the next due to changes in interest rates, currency rates, equity prices and other market variables, as well as cash movements, execution of new transactions and the maturing of existing transactions. Spread income on investments and borrowings are recorded on an accrual basis over the life of the transaction. Investments are classified as available for sale securities and are marked to market with the resulting gains or losses reflected in the equity section. The most significant component of AIGFP's operating expenses is compensation, which approximated 36 percent, 31 percent and 31 percent of revenues in 2002, 2001 and 2000, respectively. Domestically, AIG's consumer finance operations derive a substantial portion of their revenues from finance charges assessed on outstanding mortgages and finance receivables from the sub-prime market, while overseas operations are engaged in developing a multi-product consumer finance business with an emphasis on emerging markets. Revenues in 2002 decreased 3.4 percent from 2001 compared to a 10.1 percent increase during 2001 from 2000, but 2002 operating income increased 8.9 percent from 2001 and 30.8 percent during 2001 from 2000. The decline in revenues was the result of lower yields on the finance receivables, but borrowing costs also declined significantly so that spreads, and therefore profits, increased as a result. The growth in revenues during 2001 was generally due to the growth in the average finance receivables. The increases in operating income resulted from the growth in finance charges inuring from larger loan balances and improved credit quality of the receivables portfolio, partially offset by lower yields on finance receivables in 2001. (See also the discussions under "Capital Resources" and "Liquidity" herein.) 37
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Consumer finance operations are exposed to loss when contractual payments are not received; collection exposure is managed through the mix of types of loans and security thereon. (See also Notes 8 and 9 of Notes to Financial Statements.) RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS AIG's retirement savings & asset management operations offer a wide variety of investment products, including variable annuities and mutual funds, as well as investment services, including investment asset management. Such products and services are offered to individuals and institutions both domestically and overseas. For variable annuities, AIG's policy has been to adjust amortization assumptions for deferred acquisition costs (DAC) when estimates of current or future gross profits to be realized from these contracts are revised. With respect to variable annuities sold domestically (representing the vast majority of AIG's variable annuity business), the assumption for the long-term annual net growth rate of the equity markets used in the determination of DAC amortization is approximately 10 percent. A methodology referred to as "reversion to the mean" is used to maintain this long-term net growth rate assumption, while giving consideration to short-term variations in equity markets. A number of guaranteed minimum death benefits (GMDB) and other similar benefits are offered on variable annuities. GMDB-related contract benefits incurred, net of reinsurance were $77 million, $20 million and $3 million for 2002, 2001 and 2000, respectively. The significant increase in 2002 is directly related to the worldwide slump in equity markets. In accordance with GAAP, AIG expenses these benefits in the period incurred. With respect to the other benefits, substantially all of AIG's policy obligations are reinsured. RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATIONS FOR 2002, 2001 AND 2000 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Revenues: AIG VALIC $2,133 $2,110 $2,230 AIG SunAmerica 563 652 750 Other* 789 950 485 - -------------------------------------------------------------------------------- Total $3,485 $3,712 $3,465 ================================================================================ Operating income: AIG VALIC $ 730 $ 630 $ 692 AIG SunAmerica 32 185 326 Other* 254 273 90 - -------------------------------------------------------------------------------- Total $1,016 $1,088 $1,108 ================================================================================ * Includes AIG Global Investment Group, John McStay Investment Counsel, L.P. and certain overseas variable annuity operations. Retirement Savings & Asset Management Results RETIREMENT SAVINGS & ASSET MANAGEMENT OPERATING INCOME decreased 6.6 percent in 2002 from 2001, reflecting the continued volatility in worldwide equity markets. This compares with a decrease of 1.8 percent in 2001 from 2000. Retirement savings & asset management operating income represented 12.5 percent of AIG's income before income taxes, minority interest and cumulative effect of accounting changes and excluding acquisition, restructuring and related charges. This compares to 10.7 percent in both 2001 and 2000. At December 31, 2002, AIG's third party assets under management, including both retail mutual funds and institutional accounts, approximated $40 billion. OTHER OPERATIONS Other realized capital losses amounted to $530 million, $452 million and $190 million in 2002, 2001 and 2000, respectively. Other income (deductions)-net includes income generated by the investment of capital held by AIG SunAmerica outside of its life insurance subsidiaries, AIG's equity in certain minor majority-owned subsidiaries and certain partially-owned companies, realized foreign exchange transaction gains and losses in substantially all currencies and unrealized gains and losses in hyperinflationary currencies, as well as the income and expenses of the parent holding company and other miscellaneous income and expenses. Other income (deductions)-net amounted to $(129) million, $3 million and $172 million in 2002, 2001 and 2000, respectively. This decline was primarily the result of weaker performance of 38
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES AIG SunAmerica investments in partnerships and private equities and 21st Century's third quarter 2002 pre-tax charge of $37 million to write off capitalized costs associated with a software development project. Acquisition, restructuring and related charges of $2.02 billion were incurred in 2001 in connection with the acquisition of AGC, including $654 million paid by AGC in connection with the termination of AGC's merger agreement with Prudential plc. Charges of $315 million in 2000 were incurred by AGC in connection with acquisitions by AGC prior to its acquisition by AIG. (See also Note 19 of Notes to Financial Statements.) Income before income taxes and minority interest amounted to $8.14 billion in 2002. Income before income taxes, minority interest and cumulative effect of accounting changes amounted to $8.14 billion in 2001. Income before income taxes and minority interest amounted to $10.02 billion in 2000. In 2002, AIG recorded a provision for income taxes of $2.33 billion compared to the provisions of $2.34 billion and $2.97 billion in 2001 and 2000, respectively. These provisions represent effective tax rates of 28.6 percent in 2002, 28.7 percent in 2001 and 29.6 percent in 2000. (See Note 3 of Notes to Financial Statements.) Minority interest represents minority shareholders' equity in income of certain majority-owned consolidated subsidiaries. Minority interest amounted to $295 million, $301 million and $413 million in 2002, 2001 and 2000, respectively. Income before the cumulative effect of accounting changes amounted to $5.52 billion in 2002, $5.50 billion in 2001 and $6.64 billion in 2000. Net income amounted to $5.52 billion in 2002, $5.36 billion in 2001 and $6.64 billion in 2000. The increase in 2002 and the decrease in 2001 in net income over the three year period resulted from those factors described above. CAPITAL RESOURCES At December 31, 2002, AIG had total capital funds of $59.10 billion and total borrowings of $71.89 billion. At that date, $64.98 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable. Borrowings TOTAL BORROWINGS AND BORROWINGS NOT GUARANTEED OR MATCHED AT DECEMBER 31, 2002 AND 2001 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- December 31, 2002 2001 ================================================================================ GIAs -- AIGFP $14,850 $16,392 - -------------------------------------------------------------------------------- Commercial Paper: ILFC (a) 4,213 3,494 AGF (a) 2,956 4,853 AIG Funding, Inc. 1,645 902 AIG Credit Card Company (Taiwan) (a) 234 68 AIG Finance (Taiwan) Limited (a) 64 107 AGC -- 2,468 - -------------------------------------------------------------------------------- Total 9,112 11,892 - -------------------------------------------------------------------------------- Medium Term Notes: AGF (a) 7,719 4,100 ILFC (a) 4,970 4,809 AIG 998 542 - -------------------------------------------------------------------------------- Total 13,687 9,451 - -------------------------------------------------------------------------------- Notes and Bonds Payable: AIGFP 16,940 13,920 ILFC (a) (b) 9,825 7,073 AGF (a) 2,266 2,201 AIG 1,608 1,577 AGC 1,542 1,340 - -------------------------------------------------------------------------------- Total 32,181 26,111 - -------------------------------------------------------------------------------- Loans and Mortgages Payable: AIGCFG (a) 735 885 AIG 697 345 ILFC (a) (c) 261 365 AIG Finance (Hong Kong) Limited (a) 229 290 Other subsidiaries (a) 133 -- - -------------------------------------------------------------------------------- Total 2,055 1,885 - -------------------------------------------------------------------------------- Total Borrowings 71,885 65,731 - -------------------------------------------------------------------------------- Borrowings not guaranteed by AIG 33,605 28,245 Matched GIA borrowings -- AIGFP 14,850 16,392 Matched notes and bonds payable -- AIGFP 16,526 12,185 - -------------------------------------------------------------------------------- 64,981 56,822 - -------------------------------------------------------------------------------- Remaining borrowings of AIG $ 6,904 $ 8,909 ================================================================================ (a) AIG does not guarantee these borrowings. (b) Includes borrowings under Export Credit Facility of $2.09 billion. (c) Capital lease obligations. 39
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) AT DECEMBER 31, 2002, THE COMMERCIAL PAPER ISSUED AND OUTSTANDING WAS AS FOLLOWS: (dollars in millions) - -------------------------------------------------------------------------------- UNAMORTIZED WEIGHTED WEIGHTED NET DISCOUNT AVERAGE AVERAGE BOOK AND ACCRUED FACE INTEREST MATURITY VALUE INTEREST AMOUNT RATE IN DAYS ================================================================================ ILFC $4,213 $ 6 $4,219 1.46% 35 AGF 2,956 3 2,959 1.43 33 Funding 1,645 1 1,646 1.45 20 AIGCCC -- Taiwan* 234 1 235 2.61 31 AIGF -- Taiwan* 64 -- 64 4.09 60 - -------------------------------------------------------------------------------- Total $9,112 $ 11 $9,123 -- -- ================================================================================ * Issued in Taiwan N.T. dollars at prevailing local interest rates. See also Note 9 of Notes to Financial Statements. During 2002, AIGFP increased the aggregate principal amount outstanding of its notes and bonds payable to $16.94 billion. AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities and derivative transactions. The funds may also be temporarily invested in securities purchased under agreements to resell. (See also the discussions under "Operational Review", "Liquidity" and "Derivatives" herein and Notes 1, 2, 8, 9, and 12 of Notes to Financial Statements.) AIG Funding, Inc. (Funding), through the issuance of commercial paper, helps fulfill the short-term cash requirements of AIG and its subsidiaries. Funding intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. The issuance of Funding's commercial paper is subject to the approval of AIG's Board of Directors. ILFC and A.I. Credit Corp. (AICCO), AIG Credit Card Company (Taiwan) -- (AIGCCC-Taiwan) and AIG Finance (Taiwan) Limited -- (AIGF-Taiwan), both consumer finance subsidiaries in Taiwan, AGC and AGF have issued commercial paper for the funding of their own operations. At December 31, 2002, AIG did not guarantee the commercial paper of any of its subsidiaries other than Funding. On July 8, 2002, AGC ceased issuing commercial paper under its program. AGC's funding requirements are now being met through Funding's commercial paper program. (See also the discussion under "Derivatives" herein and Note 9 of Notes to Financial Statements.) AIG and Funding are parties to unsecured syndicated revolving credit facilities (collectively, the Facility) aggregating $2.75 billion. The Facility consists of $1.375 billion in a short-term revolving credit facility and $1.375 billion in a five year revolving credit facility. The Facility can be used for general corporate purposes and also to provide backup for Funding's commercial paper programs. There are currently no borrowings outstanding under the Facility, nor were any borrowings outstanding as of December 31, 2002. AGF is a party to unsecured syndicated revolving credit facilities aggregating $3.0 billion. The facilities consist of $1.5 billion in a short-term revolving credit facility and $1.5 billion in a five year revolving credit facility, which support AGF's commercial paper borrowings. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2002. AGF had $4.3 billion in aggregate principal amount of debt securities registered and available for issuance at December 31, 2002. AGF uses the proceeds from the issuance of notes and bonds for the funding of its finance receivables. As of November 2001, AIG guaranteed the notes and bonds of AGC. During 2002, AGC issued $200 million in notes which matured in March 2003. These notes are included in Notes and Bonds Payable in the preceding table of borrowings. ILFC is a party to unsecured syndicated revolving credit facilities aggregating $3.15 billion to support its commercial paper program. The facilities consist of $2.15 billion in a short-term revolving credit facility and $1.0 billion in a three year revolving credit facility. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2002. At December 31, 2002, ILFC had increased the aggregate principal amount outstanding of its medium term and long-term notes to $14.80 billion, a net increase of $2.91 billion, and recorded a net decline in its capital lease obligations of $104 million and a net increase in its commercial paper of $719 million. ILFC had $6.08 billion of debt securities registered for public sale at December 31, 2002. During the second quarter of 2002, ILFC expanded its Euro Medium Term Note Program from $2.0 billion to $4.0 billion, under which $2.31 billion in notes were sold through December 31, 2002. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings. ILFC had a $4.3 billion Export Credit Facility for use in connection with the purchase of approximately 75 aircraft delivered through 2001. This facility was guaranteed by various European Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90 percent on these borrowings depending on the delivery date of the aircraft. At December 31, 2002, ILFC had $2.09 billion outstanding under this facility. The debt is collateralized by a pledge of the shares of a subsidiary of ILFC, which holds title to the aircraft financed under the facility. Borrowings with respect to this facility are included in Notes and Bonds Payable in the preceding table of borrowings. The proceeds of ILFC's debt financing are primarily used to purchase flight equipment, including progress payments during the construction phase. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight 40
AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES equipment and the rollover and refinancing of the prior debt. (See also the discussions under "Operational Review" and "Liquidity" herein.) AIGFP has established a Euro Medium Term Note Program under which an aggregate principal amount of up to $4.0 billion of notes may be issued. As of December 31, 2002, $2.09 billion of notes had been issued under the program, all of which are currently outstanding. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings. During 2002, AIG issued $504 million principal amount of Medium Term Notes, and $48 million of previously issued notes matured. At December 31, 2002, AIG had $140 million in aggregate principal amount of debt securities registered for issuance from time to time. On November 9, 2001, AIG received proceeds of approximately $1 billion from the issuance of Zero Coupon Convertible Senior Debentures Due 2031 with an aggregate principal amount at maturity of approximately $1.52 billion. Commencing January 1, 2002, the debentures are convertible into shares of AIG common stock at a conversion rate of 6.0627 shares per $1,000 principal amount of debentures if AIG common stock trades at certain levels for certain time periods. The debentures are callable by AIG on or after November 9, 2006. Also, holders can require AIG to repurchase these debentures once every five years. Capital Funds AIG's capital funds increased $6.95 billion during 2002. Unrealized appreciation of investments, net of taxes increased $3.15 billion. During 2002, the cumulative translation adjustment loss, net of taxes, increased $381 million. The change for 2002 with respect to the unrealized appreciation of investments, net of taxes, was primarily impacted by the decrease in domestic interest rates. The 2001 transfer of bonds in the held to maturity at amortized cost to the bonds available for sale at market value in accordance with the transition provisions of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities," resulted in a gain of $339 million recorded in the statement of comprehensive income as a cumulative effect of an accounting change adjustment. The 2001 capital funds included a cumulative effect of an accounting change adjustment gain of $150 million. During 2002, there was a loss of $293 million, net of taxes relating to derivative contracts designated as cash flow hedging instruments. (See also the discussion under "Operational Review" and "Liquidity" herein, Notes 1(y) and 8(d) of Notes to Financial Statements and the Consolidated Statement of Comprehensive Income.) During 2002, retained earnings increased $5.05 billion, resulting from net income less dividends. Stock Repurchase During 2002, AIG repurchased in the open market 10,858,000 shares of its common stock. During 2003 through March 20, 2003 AIG repurchased in the open market an additional 1,625,000 shares of its common stock. AIG intends to continue to buy its common shares in the open market for general corporate purposes, including to satisfy its obligations under various employee benefit plans. Dividends from Insurance Subsidiaries Payments of dividends to AIG by its insurance subsidiaries are subject to certain restrictions imposed by statutory authorities. AIG has in the past reinvested most of its unrestricted earnings in its operations and believes such continued reinvestment in the future will be adequate to meet any foreseeable capital needs. However, AIG may choose from time to time to raise additional funds through the issuance of additional securities. At December 31, 2002, there were no significant statutory or regulatory issues which would impair AIG's financial condition, results of operations or liquidity, but there can be no assurance that such issues will not arise in the future. To AIG's knowledge, no AIG company is on any regulatory or similar "watch list". (See also the discussion under "Liquidity" herein and Note 11 of Notes to Financial Statements.) Regulation and Supervision AIG's insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and jurisdictions in which they do business. The National Association of Insurance Commissioners (NAIC) has developed Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company's statutory surplus to the risk inherent in its overall operations. At December 31, 2002, the adjusted capital of each of AIG's domestic general companies and of each of AIG's domestic life companies exceeded each of their RBC standards. Federal, state or local legislation may affect AIG's ability to operate and expand its various financial services businesses and changes in the current laws, regulations or interpretations thereof may have a material adverse effect on these businesses. A substantial portion of AIG's general insurance business and a majority of its life insurance business are conducted in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies from minimal in some to stringent in others. Generally, AIG, as well as the underwriting companies operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to AIG subsidiaries are subject to modification and revocation. Thus, AIG's insurance subsidiaries could be prevented from conducting future business in certain of the jurisdictions where they currently operate. AIG's international operations include operations in various developing nations. Both current and future foreign operations could be adversely affected by unfavorable political developments up to and including nationalization of AIG's operations without compensation. Adverse effects resulting from any one country may impact AIG's results of operations, liquidity and financial condition depending on the magnitude of the event and AIG's net financial exposure at that time in that country. 41
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Contractual Obligations and Other Commercial Commitments THE MATURITY SCHEDULE OF AIG'S CONTRACTUAL OBLIGATIONS AT DECEMBER 31, 2002 WAS AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------------------- DECEMBER 31, 2002 PAYMENTS DUE BY PERIOD - ----------------- ---------------------------------------------------------- 2004 2006 REMAINING THROUGH THROUGH YEARS AFTER TOTAL 2003 2005 2007 2007 ============================================================================================ Borrowings* $62,773 $22,468 $13,485 $ 8,410 $18,410 Operating Leases 2,105 477 594 318 716 Aircraft Purchase Commitments 29,816 4,430 9,807 9,354 6,225 Other Long-Term Obligations: ILFC 853 391 462 -- -- Other 152 17 46 39 50 - -------------------------------------------------------------------------------------------- Total $95,699 $27,783 $24,394 $18,121 $25,401 ============================================================================================ *Excludes commercial paper and includes ILFC's capital lease obligations. THE MATURITY SCHEDULE OF AIG'S OTHER COMMERCIAL COMMITMENTS AT DECEMBER 31, 2002 WAS AS FOLLOWS: (in millions) - --------------------------------------------------------------------------------------- AMOUNT OF COMMITMENT EXPIRATION ------------------------------------------------------ TOTAL LESS AMOUNTS THAN 1 1-3 4-5 AFTER 5 COMMITTED YEAR YEARS YEARS YEARS ======================================================================================= Letters of Credit: AIGFP $ 811 $ 16 $ 9 $ 5 $ 781 Other 397 137 241 -- 19 Guarantees: AIG SunAmerica 5,103 118 2,137 -- 2,848 Other 663 473 66 20 104 Other Commercial Commitments: AIGFP (a) 4,232 3 12 337 3,880 ILFC (b) 2,109 232 706 816 355 AIG SunAmerica 1,144 228 458 458 -- Other 1,103 532 303 194 74 - --------------------------------------------------------------------------------------- Total $15,562 $1,739 $3,932 $1,830 $8,061 ======================================================================================= (a) Primarily liquidity facilities provided in connection with certain municipal swap transactions. (b) Primarily in connection with options to acquire aircraft. Special Purpose Vehicles AIG uses special purposes vehicles (SPVs) primarily in connection with certain guaranteed investment contract programs (GIC Programs) written by its life insurance subsidiaries, certain products provided by AIGFP, and certain invested asset and asset management activities. In the GIC Programs, AIG's life insurance subsidiaries (principally SunAmerica Life Insurance Company) provide guaranteed investment contracts (GICs) to SPVs which are not controlled by AIG. The SPVs issue notes or bonds which are sold to third party institutional investors. Neither AIG nor the insurance company issuing the GICs has any obligation to the investors in the notes or bonds. The proceeds from the securities issued by the SPV are invested by the SPV in the GICs. The insurance company subsidiaries use their proceeds to invest in a diversified portfolio of securities, primarily investment grade bonds (see also the discussion under "Liquidity: Insurance Invested Assets"). Both the assets and the liabilities of the insurance companies arising from these GIC Programs are presented in AIG's consolidated balance sheet. Thus, at December 31, 2002, approximately $29 billion of policyholders' contract deposits represented liabilities from issuances of GICs included in these GIC Programs, offset by the proceeds from the issuances, which are included as insurance invested assets. AIGFP uses SPVs as an integral part of its ongoing operations with respect to specific structured transactions with independent third parties. In most instances, AIGFP controls and manages the assets and liabilities with respect to these SPVs, subject to certain transaction specific limitations. These SPVs are fully consolidated by AIG (see the discussions of AIGFP under "Operations Review: Financial Services Operations"). AIGFP also sponsors an SPV that issues commercial paper and secured liquidity notes to third-party institutional investors. This SPV uses the proceeds of these offerings to obtain beneficial interests in certain financial assets (total assets of approximately $900 million), 42
American International Group, Inc. and Subsidiaries which serve as collateral for the securities issued by the SPV. AIGFP provides credit and liquidity support to this SPV, which is not consolidated by AIG. AIG's insurance operations also invest in assets of SPVs. These SPVs are established by unrelated third parties. Investments include collateralized mortgage backed securities and similar securities backed by pools of mortgages, consumer receivables or other assets. The investment in an SPV allows AIG's insurance entities to purchase assets permitted by insurance regulations while maximizing the return on these assets. AIG provides investment management services to certain SPVs. AIG receives management fees for these services and may take a minority ownership interest in these SPVs, which interests are then included as investments in AIG's consolidated balance sheet. AIG services may be terminated with or without cause. To facilitate and expand certain retirement savings and asset management activities, AIG establishes SPVs. AIG receives fees for management of the assets held in the SPV which support the issuance of securities such as collateralized bond obligations sold by the SPV to independent third party investors. These SPVs serve a variety of business purposes, including financing, liquidity, or to facilitate independent third party management participation. AIG has established stringent guidelines with respect to the formation of and investment in SPVs. (See also the discussion under "Accounting Standards" herein.) LIQUIDITY AIG's liquidity is primarily derived from the operating cash flows of its general and life insurance operations. At December 31, 2002, AIG's consolidated invested assets included $8.16 billion of cash and short-term investments. Consolidated net cash provided from operating activities in 2002 amounted to $18.69 billion. Sources of funds considered in meeting the objectives of AIG's financial services operations include guaranteed investment agreements, issuance of long-term and short-term debt, maturities and sales of securities available for sale, securities sold under repurchase agreements, trading liabilities, securities and spot commodities sold but not yet purchased, issuance of equity, and cash provided from such operations. AIG's strong capital position is integral to managing this liquidity, as it enables AIG to raise funds in diverse markets worldwide. (See also the discussion under "Capital Resources" herein.) Management believes that AIG's liquid assets, its net cash provided by operations, and access to the capital markets will enable it to meet any foreseeable cash requirements. The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $40.3 billion in pre-tax cash flow during 2002. Cash flow includes periodic premium collections, including policyholders' contract deposits, cash flows from investment operations and paid loss recoveries less reinsurance premiums, losses, benefits, and acquisition and operating expenses. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance investment operations generated approximately $12.5 billion in investment income cash flow during 2002. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains net of realized capital losses. (See also the discussions under "Operational Review: General Insurance Operations" and "Life Insurance Operations" herein.) With respect to general insurance operations, if paid losses accelerated beyond AIG's ability to fund such paid losses from current operating cash flows, AIG would need to liquidate a portion of its general insurance investment portfolio and/or arrange for financing. Potential events causing such a liquidity strain could be the result of several catastrophic events occurring in a relatively short period of time. Additional strain on liquidity could occur if the investments sold to fund such paid losses were sold into a depressed market place and/or reinsurance recoverable on such paid losses became uncollectible or collateral supporting such reinsurance recoverable significantly decreased in value. (See also the discussions under "Operational Review: General Insurance Operations" herein.) With respect to life insurance operations, if a substantial portion of the life insurance operations bond portfolio diminished significantly in value and/or defaulted, AIG would need to liquidate other portions of its life insurance investment portfolio and/or arrange financing. Potential events causing such a liquidity strain could be the result of economic collapse of a nation or region in which AIG life insurance operations exist, nationalization, terrorist acts or other such economic or political upheaval. (See also the discussions under "Operational Review: Life Insurance Operations" herein.) In addition to the combined insurance pre-tax operating cash flow, AIG's insurance operations held $6.88 billion in cash and short-term investments at December 31, 2002. Operating cash flow and the cash and short-term balances held provided AIG's insurance operations with a significant amount of liquidity. This liquidity is available, among other things, to purchase predominately high quality and diversified fixed income securities and, to a lesser extent, marketable equity securities, and to provide mortgage loans on real estate, policy loans and collateral loans. This cash flow coupled with proceeds of approximately $120 billion from the maturities, sales and redemptions of fixed income securities and from the sale of equity securities was used to purchase approximately $158 billion of fixed income securities and marketable equity securities during 2002. 43
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) INVESTED ASSETS THE FOLLOWING TABLE IS A SUMMARY OF AIG'S INVESTED ASSETS BY SIGNIFICANT SEGMENT, INCLUDING INVESTMENT INCOME DUE AND ACCRUED OF $4.30 BILLION AND $3.68 BILLION AND REAL ESTATE OF $3.30 BILLION AND $2.65 BILLION, AT DECEMBER 31, 2002 AND 2001, RESPECTIVELY: (dollars in millions) - -------------------------------------------------------------------------------- INVESTED PERCENT ASSETS OF TOTAL ================================================================================ 2002 GENERAL INSURANCE $ 55,478 12.8% LIFE INSURANCE 259,138 59.9 FINANCIAL SERVICES 114,878 26.6 OTHER 2,868 0.7 - -------------------------------------------------------------------------------- TOTAL $432,362 100.0% ================================================================================ 2001 General insurance $ 43,159 11.8% Life insurance 213,776 58.6 Financial services 104,295 28.6 Other 3,722 1.0 - -------------------------------------------------------------------------------- Total $364,952 100.0% ================================================================================ INSURANCE INVESTED ASSETS THE FOLLOWING TABLES SUMMARIZE THE COMPOSITION OF AIG'S INSURANCE INVESTED ASSETS BY INSURANCE SEGMENT, INCLUDING INVESTMENT INCOME DUE AND ACCRUED AND REAL ESTATE, AT DECEMBER 31, 2002 AND 2001: (dollars in millions) - ----------------------------------------------------------------------------------------------------------------------- PERCENT DISTRIBUTION GENERAL LIFE PERCENT -------------------- DECEMBER 31, 2002 INSURANCE INSURANCE TOTAL OF TOTAL DOMESTIC FOREIGN - ----------------------------------------------------------------------------------------------------------------------- FIXED MATURITIES AT MARKET VALUE (a) $35,990 $206,003 $241,993 76.9% 69.1% 30.9% EQUITY SECURITIES, AT MARKET VALUE (b) 3,928 2,931 6,859 2.2 53.4 46.6 MORTGAGE LOANS ON REAL ESTATE, POLICY AND COLLATERAL LOANS 35 18,901 18,936 6.0 68.8 31.2 SHORT-TERM INVESTMENTS, INCLUDING TIME DEPOSITS, AND CASH 1,833 5,048 6,881 2.2 42.5 57.5 REAL ESTATE 488 2,367 2,855 0.9 24.8 75.2 INVESTMENT INCOME DUE AND ACCRUED 729 3,489 4,218 1.4 64.2 35.8 SECURITIES LENDING COLLATERAL 7,249 16,445 23,694 7.5 75.8 24.2 OTHER INVESTED ASSETS 5,226 3,954 9,180 2.9 82.1 17.9 - ----------------------------------------------------------------------------------------------------------------------- TOTAL $55,478 $259,138 $314,616 100.0% 68.6% 31.4% ======================================================================================================================= (a) Includes $981 million of bond trading securities, at market value. (b) Includes $1.58 billion of non-redeemable preferred stocks, at market value. (dollars in millions) - ---------------------------------------------------------------------------------------------------------------------------- Percent Distribution General Life Percent -------------------- December 31, 2001 Insurance Insurance Total of Total Domestic Foreign ============================================================================================================================ Fixed maturities at market value (a) $29,602 $169,750 $199,352 77.6% 68.8% 31.2% Equity securities, at market value (b) 4,568 3,139 7,707 3.0 53.9 46.1 Mortgage loans on real estate, policy and collateral loans 58 17,975 18,033 7.0 68.0 32.0 Short-term investments, including time deposits, and cash 1,620 5,287 6,907 2.7 49.3 50.7 Real estate 410 2,106 2,516 1.0 21.5 78.5 Investment income due and accrued 573 3,001 3,574 1.4 63.9 36.1 Securities lending collateral 992 9,581 10,573 4.1 74.9 25.1 Other invested assets 5,336 2,937 8,273 3.2 82.2 17.8 - ---------------------------------------------------------------------------------------------------------------------------- Total $43,159 $213,776 $256,935 100.0% 68.0% 32.0% ============================================================================================================================ (a) Includes $842 million of bond trading securities, at market value. (b) Includes $1.72 billion of non-redeemable preferred stocks, at market value. 44
American International Group, Inc. and Subsidiaries Generally, insurance regulations restrict the types of assets in which an insurance company may invest. FIXED MATURITY INVESTMENTS With respect to fixed maturities, AIG's general strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations. With respect to general insurance, AIG's strategy is to invest in longer duration fixed maturities to maximize the yields at the date of purchase. With respect to life insurance, AIG's strategy is to produce cash flows required to meet maturing insurance liabilities. (See also the discussion under "Operational Review: Life Insurance Operations" herein.) The fair value of the fixed maturity available for sale portfolio is subject to decline as interest rates rise and subject to increase as interest rates decline. Such changes in fair value are presented as a component of comprehensive income in unrealized appreciation of investments, net of taxes. The fixed maturities held to maturity portfolio were transferred to bonds available for sale, at market value as at January 1, 2001 as permitted and in accordance with the transition provisions of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). (See Note 1(y) of Notes to Financial Statements.) CREDIT QUALITY At December 31, 2002, approximately 69 percent of the fixed maturities investments were domestic securities. Approximately 33 percent of such domestic securities were rated AAA by one or more of the principal rating agencies. Approximately 10 percent were below investment grade or not rated. A significant portion of the foreign insurance fixed income portfolio is rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At December 31, 2002, approximately 16 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG's internal analysis, were equivalent from a credit standpoint to securities so rated. Approximately 11 percent were below investment grade or not rated at that date. A large portion of the foreign insurance fixed income portfolio are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance. Any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date. EQUITY INVESTMENTS AIG invests in equities for various reasons, including diversifying its overall exposure to interest rate risk. Equity securities are subject to declines in fair value. Such declines in fair value are presented in unrealized appreciation of investments, net of taxes as a component of comprehensive income. VALUATION OF INVESTED ASSETS The valuation of invested assets involves obtaining a market value for each security. The source for the market value is generally from market exchanges, with the exception of non-traded securities. Another aspect of valuation pertains to impairment. As a matter of policy, the determination that a security has incurred an other-than-temporary decline in value and the amount of any loss recognition requires the judgment of AIG's management and a continual review of its investments. In general, a security is considered a candidate for impairment if it meets any of the following criteria: - Trading at a significant discount to par, amortized cost (if lower) or cost for an extended period of time; - The occurrence of a discrete credit event resulting in (i) the issuer defaulting on a material outstanding obligation; or (ii) the issuer seeking protection from creditors under the bankruptcy laws or any similar laws intended for the court supervised reorganization of insolvent enterprises; or (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or - In the opinion of AIG's management, it is unlikely that AIG will realize a full recovery on its investment, irrespective of the occurrence of one of the foregoing events. Once a security has been identified as potentially impaired, the amount of such impairment is determined by reference to that security's contemporaneous market price. However, the market price following a significant credit event of any issuer may be volatile after such an event. Factors such as market liquidity, hedge fund activity, sensitivity to "headline" risk, and the widening of bid/ask spreads contribute to price volatility. Because of such volatility, the market price may not be indicative of the fair value of such an investment; and consequently, not indicative of a reasonable estimate of realizable value. AIG has the ability to hold any security to its stated maturity. Therefore, the decision to sell reflects the judgment of AIG's management that the security sold is unlikely to provide, on a relative value basis, as attractive a return in the future as alternative securities entailing comparable risks. With respect to distressed securities, the sale decision reflects management's judgment that the risk-discounted anticipated ultimate recovery is less than the value achievable on sale. 45
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) As a result of these policies, AIG recorded in 2002 impairment losses net of taxes of approximately $795 million, of which $305 million was recognized in the three months ended December 31, 2002. The most significant impairment charge for any single credit for 2002 was approximately $231 million net of tax with respect to AIG's holdings in WorldCom Inc. (WorldCom). This charge was recorded in the quarter ended June 30, 2002. Excluding AIG's holdings in WorldCom for 2002, no impairment charge with respect to any one single credit was significant to AIG's consolidated financial condition or results of operations and no individual impairment loss exceeded approximately 1.4 percent of consolidated net income for 2002. At December 31, 2002, AIG believes that the circumstances which caused WorldCom's fair value to significantly decline were not characteristic of AIG's other holdings. AIG measured the impairment charge with respect to WorldCom by reference to the market price of the WorldCom securities as of June 30, 2002. Excluding the impairments noted above, the changes in market value for AIG's available for sale portfolio, which constitutes the vast majority of AIG's investments, were recorded in equity as unrealized gains or losses. At December 31, 2002, the unrealized losses after taxes of the fixed maturity securities were approximately $2.7 billion. At December 31, 2002, the unrealized losses after taxes of the equity securities portfolio were approximately $650 million. At December 31, 2002, aggregate unrealized gains after taxes were $9.6 billion and aggregate unrealized losses after taxes were $3.4 billion. No single issuer accounted for more than three percent of the unrealized losses. At December 31, 2002, the fair value of AIG's fixed maturities and equity securities aggregated to approximately $250.4 billion. Of this aggregate fair value, approximately 1.4 percent represented securities trading at or below 75 percent of amortized cost or cost. The impact on net income of unrealized losses after taxes will be further mitigated upon realization, because certain realized losses will be charged to participating policy-holder accounts, or realization will result in current decreases in the amortization of certain deferred acquisition costs. AT DECEMBER 31, 2002, THE UNREALIZED LOSSES AFTER TAXES FOR FIXED MATURITY SECURITIES AND EQUITY SECURITIES INCLUDED THE FOLLOWING INDUSTRY CONCENTRATIONS: (in millions) - -------------------------------------------------------------------------------- UNREALIZED LOSSES CONCENTRATION AFTER TAXES ================================================================================ INVESTMENT GRADE: Airline related $199 Cable and Media $ 28 Energy $153 Telecommunications $ 55 - -------------------------------------------------------------------------------- NOT RATED AND BELOW INVESTMENT GRADE: Airline related $131 Cable and Media $ 76 Energy $492 Telecommunications $111 ================================================================================ THE AMORTIZED COST OF FIXED MATURITIES AVAILABLE FOR SALE IN AN UNREALIZED LOSS POSITION AT DECEMBER 31, 2002, BY CONTRACTUAL MATURITY, IS SHOWN BELOW: (in millions) - -------------------------------------------------------------------------------- AMORTIZED COST ================================================================================ Due in one year or less $ 1,180 Due after one year through five years 7,096 Due after five years through ten years 12,144 Due after ten years 14,517 - -------------------------------------------------------------------------------- Total $34,937 ================================================================================ In the twelve months ended December 31, 2002, the pre-tax realized losses incurred with respect to the sale of fixed maturities and equity securities were $4.1 billion. The aggregate fair value of securities sold was $65.4 billion, which was approximately 94 percent of amortized cost. The average period of time that securities sold at a loss during the quarter and twelve months ended December 31, 2002 were trading continuously at a price below book value was approximately eight months. 46
American International Group, Inc. and Subsidiaries THE "AGING" OF PRE-TAX UNREALIZED LOSS POSITIONS AT DECEMBER 31, 2002, IS SHOWN BELOW: (dollars in millions) - -------------------------------------------------------------------------------- NUMBER BOOK UNREALIZED NUMBER OF MONTHS VALUE LOSSES* OF ITEMS ================================================================================ INVESTMENT GRADE BONDS 0-6 $16,980 $ 917 1,054 7-12 3,852 275 275 >12 5,455 774 513 - -------------------------------------------------------------------------------- BELOW INVESTMENT GRADE BONDS 0-6 $ 2,397 $ 433 347 7-12 2,404 524 270 >12 3,849 1,234 470 - -------------------------------------------------------------------------------- TOTAL BONDS 0-6 $19,377 $ 1,350 1,401 7-12 6,256 799 545 >12 9,304 2,008 983 ================================================================================ EQUITIES 0-6 $ 1,029 $ 217 536 7-12 1,515 591 469 >12 686 217 341 ================================================================================ * As more fully described above, upon realization, certain realized losses will be charged to participating policyholder accounts, or realization will result in a current decrease in the amortization of certain deferred acquisition costs. Note: At December 31, 2002, aggregate pre-tax unrealized gains were $14.7 billion. As stated previously, the valuation for AIG's investment portfolio comes from a market exchange, with the exception of non-traded securities. AIG considers non-traded securities to mean certain fixed income investments, certain structured securities, direct private equities, limited partnerships and hedge funds. The aggregate carrying value of these securities at December 31, 2002 was approximately $29.6 billion. The methodology used to estimate fair value of non-traded fixed income investments is by reference to traded securities with similar attributes and using a matrix pricing methodology. This technique takes into account such factors as the industry, the security's rating and tenor, its coupon rate, its position in the capital structure of the issuer, and other relevant factors. The change in fair value is recognized as a component of unrealized appreciation. For certain structured securities, the carrying value is based on an estimate of the security's future cash flows pursuant to the requirements of Emerging Issues Task Force Issue No. 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The change in carrying value is recognized in income. Direct private equities, hedge funds and limited partnerships in which AIG holds in the aggregate less than a five percent interest, are carried at fair value. The change in fair value is recognized as a component of Other comprehensive income. With respect to hedge funds and limited partnerships in which AIG holds in the aggregate a five percent or greater interest, AIG's carrying value is the net asset value. The changes in such net asset values are recorded in income. AIG obtains the fair value of its investments in limited partnerships and hedge funds from information provided by the sponsors of each of these investments, the accounts of which are generally audited on an annual basis. Each of these investment categories is regularly tested to determine if impairment in value exists. Various valuation techniques are used with respect to each category in this determination. MORTGAGE INVESTMENTS Mortgage loans on real estate, policy and collateral loans comprised 6.0 percent of AIG's insurance invested assets at December 31, 2002. AIG's insurance operations' holdings of real estate mortgages amounted to $11.45 billion of which 86.9 percent was domestic. At December 31, 2002, only a nominal amount was in default. It is AIG's practice to maintain a maximum loan to value ratio of 75 percent at loan origination. At December 31, 2002, AIG's insurance holdings of collateral loans amounted to $1.44 billion, all of which were foreign. It is AIG's strategy to enter into mortgage and collateral loans as an adjunct primarily to life insurance fixed maturity investments. AIG's policy loans increased from $5.79 billion at December 31, 2001 to $6.05 billion at December 31, 2002. SHORT-TERM INVESTMENTS Short-term investments represent amounts invested in various internal and external money market funds, time deposits and cash held. REAL ESTATE INVESTMENTS AIG's real estate investment properties are primarily occupied by AIG's various operations. The current market value of these properties considerably exceeds their carrying value. OTHER INVESTMENTS Other invested assets were primarily comprised of limited partnerships and outside managed funds. When permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from adverse movements in foreign currency exchange rates, interest rates and equity prices, AIG and its insurance subsidiaries may enter into derivative transactions as end users. (See also the discussion under "Derivatives" herein.) In certain jurisdictions, significant regulatory and/or foreign governmental barriers exist which may not permit the immediate free flow of funds between insurance subsidiaries or from the insurance subsidiaries to AIG parent. These barriers generally cause only minor delays in the outward remittance of the funds. 47
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Managing Market Risk AIG's insurance operations are exposed to market risk. Market risk is the risk of loss of fair value resulting from adverse fluctuations in interest and foreign currency exchange rates and equity prices. Measuring potential losses in fair values has recently become the focus of risk management efforts by many companies. Such measurements are performed through the application of various statistical techniques. One such technique is Value at Risk (VaR). VaR is a summary statistical measure that uses historical interest and foreign currency exchange rates and equity prices and estimates the volatility and correlation of each of these rates and prices to calculate the maximum loss that could occur over a defined period of time given a certain probability. AIG believes that statistical models alone do not provide a reliable method of monitoring and controlling market risk. While VaR models are relatively sophisticated, the quantitative market risk information generated is limited by the assumptions and parameters established in creating the related models. Therefore, such models are tools and do not substitute for the experience or judgment of senior management. AIG has performed a VaR analysis to estimate the maximum potential loss of fair value for each of AIG's insurance segments and for each market risk within each insurance segment. In this analysis, financial instrument assets include the domestic and foreign invested assets excluding real estate and investment income due and accrued. Financial instrument liabilities include reserve for losses and loss expenses, reserve for unearned premiums, future policy benefits for life and accident and health insurance contracts and policyholders' funds. Due to the nature of each insurance segment, AIG manages the general and life insurance operations separately. As a result, AIG manages separately the invested assets of each. Accordingly, the VaR analysis was separately performed for the general and the life insurance operations. AIG calculated the VaR with respect to the net fair value of each of AIG's insurance segments as of December 31, 2002 and December 31, 2001. AIG uses the historical simulation methodology which entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical market information for interest rates, foreign exchange rates, and equity index prices were used to construct the historical scenarios. For each scenario, each transaction was re-priced. Portfolio, business unit and finally AIG-wide scenario values were then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum potential loss incurred by these scenarios with 95 percent confidence (i.e., only 5 percent of historical scenarios show losses greater than the VaR figure). A one month holding period was assumed in computing the VaR figure. THE FOLLOWING TABLE PRESENTS THE VAR ON A COMBINED BASIS AND OF EACH COMPONENT OF MARKET RISK FOR EACH OF AIG'S INSURANCE SEGMENTS AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001. VAR WITH RESPECT TO COMBINED OPERATIONS CANNOT BE DERIVED BY AGGREGATING THE INDIVIDUAL RISK OR SEGMENT AMOUNTS PRESENTED HEREIN. (in millions) - -------------------------------------------------------------------------------- GENERAL INSURANCE LIFE INSURANCE ----------------- --------------------- 2002 2001 2002 2001 ================================================================================ Market Risk: Combined $809 $779 $1,798 $1,804 Interest rate 413 425 1,507 1,631 Currency 66 34 166 134 Equity 798 710 975 627 ================================================================================ THE FOLLOWING TABLE PRESENTS THE AVERAGE, HIGH AND LOW VARS ON A COMBINED BASIS AND OF EACH COMPONENT OF MARKET RISK FOR EACH OF AIG'S INSURANCE SEGMENTS AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001. (in millions) - ----------------------------------------------------------------------------------- 2002 2001 AVERAGE HIGH LOW Average High Low =================================================================================== General Insurance: Market Risk: Combined $ 778 $ 863 $ 643 $ 797 $ 837 $ 744 Interest rate 410 425 399 449 464 425 Currency 49 66 34 46 59 34 Equity 740 822 599 741 812 603 Life Insurance: Market Risk: Combined $1,876 $1,979 $1,798 $1,572 $1,804 $1,354 Interest rate 1,695 1,874 1,507 1,512 1,631 1,364 Currency 130 166 108 216 373 134 Equity 770 975 627 430 627 332 =================================================================================== 48
American International Group, Inc. and Subsidiaries FINANCIAL SERVICES INVESTED ASSETS THE FOLLOWING TABLE IS A SUMMARY OF THE COMPOSITION OF AIG'S FINANCIAL SERVICES INVESTED ASSETS AT DECEMBER 31, 2002 AND 2001. (SEE ALSO THE DISCUSSIONS UNDER "OPERATIONAL REVIEW: FINANCIAL SERVICES OPERATIONS", "CAPITAL RESOURCES" AND "DERIVATIVES" HEREIN.) (dollars in millions) - ------------------------------------------------------------------------------------------------------ 2002 2001 --------------------- --------------------- INVESTED PERCENT Invested Percent ASSETS OF TOTAL Assets of Total ====================================================================================================== Flight equipment primarily under operating leases, net of accumulated depreciation $ 26,867 23.4% $ 22,710 21.8% Finance receivables, net of allowance 15,857 13.8 13,955 13.4 Unrealized gain on interest rate and currency swaps, options and forward transactions 15,376 13.4 11,493 11.0 Securities available for sale, at market value 16,687 14.5 17,801 17.1 Trading securities, at market value 4,146 3.6 5,733 5.5 Securities purchased under agreements to resell, at contract value 25,560 22.2 21,638 20.7 Trading assets 4,786 4.2 6,234 6.0 Spot commodities, at market value 489 0.4 352 0.3 Other, including short-term investments 5,110 4.5 4,379 4.2 - ------------------------------------------------------------------------------------------------------ Total $114,878 100.0% $104,295 100.0% ====================================================================================================== As previously discussed, the cash used for the purchase of flight equipment is derived primarily from the proceeds of ILFC's debt financings. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover and refinancing of the prior debt. During 2002, ILFC acquired flight equipment costing $5.30 billion. (See also the discussion under "Operational Review: Financial Services Operations" and "Capital Resources" herein.) At December 31, 2002, ILFC had committed to purchase 523 aircraft deliverable from 2003 through 2010 at an estimated aggregate purchase price of $29.8 billion and had options to purchase 18 aircraft deliverable from 2003 through 2008 at an estimated aggregate purchase price of $1.3 billion. Subsequent to December 31, 2002, ILFC cancelled delivery of four of the 523 aircraft. As of March 20, 2003, ILFC has entered into leases for 86 of 90 aircraft to be delivered in 2003 and 49 of 82 aircraft to be delivered in 2004 and 26 of 347 aircraft to be delivered subsequent to 2004. ILFC will be required to find customers for any aircraft presently on order and any aircraft to be ordered, and it must arrange financing for portions of the purchase price of such equipment. In a rising interest rate environment, ILFC negotiates higher lease rates on any new contracts. ILFC has been successful to date both in placing its new aircraft on lease or under sales contract and obtaining adequate financing, but there can be no assurance that such success will continue in future environments. ILFC is exposed to market risk and the risk of loss of fair value and possible liquidity strain resulting from adverse fluctuations in interest rates. As of December 31, 2002 and December 31, 2001, AIG statistically measured the loss of fair value through the application of a VaR model. In this analysis, the net fair value of ILFC was determined using the financial instrument assets which included the tax adjusted future flight equipment lease revenue and the financial instrument liabilities which included the future servicing of the current debt. The estimated impact of the current derivative positions was also taken into account. AIG calculated the VaR with respect to the net fair value of ILFC using the historical simulation methodology, as previously described. As of December 31, 2002 and December 31, 2001, the VaR with respect to the net fair value of ILFC was approximately $20 million and $10 million, respectively. AIG's Consumer Finance operations provide a wide variety of consumer finance products both domestically and overseas. Such products include real estate mortgages, consumer loans, and retail sales finance. These products are funded through various borrowings including commercial paper and medium term notes. AIG's Consumer Finance operations are exposed to credit risk and risk of loss resulting from adverse fluctuations in interest rates. Over half of the loan balance is related to real estate loans which are substantially collateralized by the related properties. With respect to credit losses, the allowance for finance receivable losses is maintained at a level considered adequate to absorb anticipated credit losses existing in that portfolio. AIGFP's derivative transactions are carried at market value or at estimated fair value when market prices are not readily available. AIGFP reduces its economic risk exposure through similarly valued offsetting transactions including swaps, trading securities, options, forwards and futures. The estimated fair values of these transactions represent assessments of the present value of expected future cash flows. These transactions are exposed to liquidity risk if AIGFP were required to sell or close out the transactions prior to maturity. AIG believes that the impact of any such limited 49
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) liquidity would not be significant to AIG's financial condition or its overall liquidity. (See also the discussion under "Operational Review: Financial Services Operations" and "Derivatives" herein.) AIGFP uses the proceeds from the issuance of notes and bonds and GIA borrowings to invest in a diversified portfolio of securities, including securities available for sale, at market, and derivative transactions. The funds may also be temporarily invested in securities purchased under agreements to resell. The proceeds from the disposal of the aforementioned securities available for sale and securities purchased under agreements to resell have been used to fund the maturing GIAs or other AIGFP financings. (See also the discussion under "Capital Resources" herein.) Securities available for sale is mainly a portfolio of debt securities, where the individual securities have varying degrees of credit risk. At December 31, 2002, the average credit rating of this portfolio was AA or the equivalent thereto as determined through rating agencies or internal review. AIGFP has also entered into credit derivative transactions to hedge its credit risk associated with $66 million of these securities. Securities deemed below investment grade at December 31, 2002 amounted to approximately $100 million in fair value representing 0.6 of one percent of the total AIGFP securities available for sale. $30 million of this amount is hedged with a credit derivative. There have been no significant downgrades through March 1, 2003. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP takes possession of or obtains a security interest in securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring counterparty credit exposure and, when AIGFP deems necessary, it requires additional collateral to be deposited. Trading securities, at market value are marked to market daily and are held to meet the short-term risk management objectives of AIGFP. AIGFP is exposed to credit risk. If its securities available for sale portfolio were to suffer significant default and the collateral held declined significantly in value with no replacement or the credit default swap counterparty failed to perform, AIGFP could have a liquidity strain. AIG guarantees AIGFP's debt and, as a result, is responsible for all of AIGFP's obligations. AIG Trading Group Inc. (AIGTG) conducts, as principal, market making and trading activities in foreign exchange, and commodities, primarily precious and base metals. AIGTG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts. AIGTG uses derivatives to manage the economic exposure of its various trading positions and transactions from adverse movements of interest rates, foreign currency exchange rates and commodity prices. AIGTG supports its trading activities largely through trading liabilities, unrealized losses on swaps, short-term borrowings, securities sold under agreements to repurchase and securities and commodities sold but not yet purchased. (See also the discussions under "Capital Resources" and "Derivatives" herein.) THE GROSS UNREALIZED GAINS AND GROSS UNREALIZED LOSSES OF AIGFP AND AIGTG INCLUDED IN THE FINANCIAL SERVICES ASSETS AND LIABILITIES AT DECEMBER 31, 2002 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- GROSS GROSS UNREALIZED UNREALIZED GAINS LOSSES ================================================================================ Securities available for sale, at market value (a) $ 761 $ 789 Unrealized gain/loss on interest rate and currency swaps, options and forward transactions (b) (c) 15,376 11,265 Trading assets 9,271 7,685 Spot commodities, at market value -- 13 Trading liabilities -- 1,602 Securities and spot commodities sold but not yet purchased, at market value -- 204 ================================================================================ (a) See also Note 8(e) of Notes to Financial Statements. (b) These amounts are also presented as the respective balance sheet amounts. (c) At December 31, 2002, AIGTG's replacement values with respect to interest rate and currency swaps were $440 million. AIGFP's interest rate and currency risks on securities available for sale, at market, are managed by taking offsetting positions on a security by security basis, thereby offsetting a significant portion of the unrealized appreciation or depreciation. At December 31, 2002, the unrealized gains and losses remaining after the benefit of the offsets were $62 million and $90 million, respectively. Trading securities, at market value, and securities and spot commodities sold but not yet purchased, at market value are marked to market daily with the unrealized gain or loss being recognized in income at that time. These securities are held to meet the short-term risk management objectives of AIGFP and AIGTG. The senior management of AIG defines the policies and establishes general operating parameters for AIGFP and AIGTG. AIG's senior management has established various oversight committees to review the various financial market, operational and credit issues of AIGFP and AIGTG. The senior managements of AIGFP and AIGTG report the results of their respective operations to and review future strategies with AIG's senior management. AIG actively manages the exposures to limit potential losses, while maximizing the rewards afforded by these business opportunities. In doing so, AIG must continually manage a variety of exposures including credit, market, liquidity, operational and legal risks. 50
American International Group, Inc. and Subsidiaries Managing Market Risk Market risk arises principally from the uncertainty that future earnings are exposed to potential changes in volatility, interest rates, foreign currency exchange rates, and equity and commodity prices. AIG generally controls its exposure to market risk by taking offsetting positions. AIG's philosophy with respect to its financial services operations is to minimize or set limits for open or uncovered positions that are to be carried. Credit risk exposure is separately managed. (See the discussion on the management of credit risk below.) AIG's Market Risk Management Department provides detailed independent review of AIG's market exposures, particularly those market exposures of AIGFP and AIGTG. This department determines whether AIG's market risks, as well as those market risks of individual subsidiaries, are within the parameters established by AIG's senior management. Well established market risk management techniques such as sensitivity analysis are used. Additionally, this department verifies that specific market risks of each of certain subsidiaries are managed and hedged by that subsidiary. AIGFP is exposed to market risk due to changes in the level and volatility of interest rates and the shape and slope of the yield curve. AIGFP hedges its exposure to interest rate risk by entering into transactions such as interest rate swaps and options and purchasing U.S. and foreign government obligations. AIGFP is exposed to market risk due to changes in and volatility of foreign currency exchange rates. AIGFP hedges its foreign currency exchange risk primarily through the use of currency swaps, options, forwards and futures. AIGFP is exposed to market risk due to changes in the level and volatility of equity prices which affect the value of securities or instruments that derive their value from a particular stock, a basket of stocks or a stock index. AIGFP reduces the risk of loss inherent in its inventory in equity securities by entering into hedging transactions, including equity swaps and options and purchasing U.S. and foreign government obligations. AIGFP does not seek to manage the market risk of each of its transactions through an individual offsetting transaction. Rather, AIGFP takes a portfolio approach to the management of its market risk exposure. AIGFP values its portfolio, including interest rate swaps, currency swaps, equity swaps, swaptions, options and forwards, at market value or estimated fair value when market values are not readily available. Unrealized gains and losses, with respect to this portfolio are reflected in income currently. These valuations represent an assessment of the present values of expected future cash flows of AIGFP's transactions and may include reserves for such risks as are deemed appropriate by AIGFP's and AIG's management. AIGFP evaluates the portfolio's discounted cash flows with reference to current market conditions, maturities within the portfolio and other relevant factors. Estimated fair values are based upon the use of valuation models. These models utilize, among other things, market liquidity and current interest, foreign exchange and volatility rates. AIGFP attempts to secure reliable and independent current market prices, such as published exchange prices, external subscription services such as from Bloomberg or Reuters or third party broker quotes for use in this model. When such prices are not available, AIGFP uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. Historically, actual results have not materially deviated from these models. These valuation models are integrated into the evaluation of the portfolio, as described above, in order to provide timely information for the market risk management of the portfolio. Based upon this evaluation, AIGFP determines what, if any, offsetting transactions are necessary to reduce the market risk exposure of the portfolio. AIG manages its market risk with a variety of transactions, including swaps, trading securities, futures and forward contracts and other transactions as appropriate. The recorded values of these transactions may be different than the values that might be realized if AIGFP were required to sell or close out the transactions prior to maturity. AIG believes that such differences are not significant to the results of operations, financial condition or liquidity. Such differences would be immediately recognized when the transactions are sold or closed out prior to maturity. Additionally, depending upon the changes in interest rates and other market movements during the day, AIGFP's system will produce reports for management's consideration for intra-day offsetting positions. Overnight, the system generates reports which recommend the types of offsets management should consider for the following day. Additionally, AIGFP operates in major business centers overseas and is essentially open for business 24 hours a day. Thus, the market exposure and offset strategies are monitored, reviewed and coordinated around the clock. Therefore, offsetting adjustments can be made as and when necessary from any AIGFP office in the world. As part of its monitoring and controlling of its exposure to market risk, AIGFP applies various testing techniques which reflect potential market movements. These techniques vary by currency and are regularly changed to reflect factors affecting the derivatives portfolio. In addition to the daily monitoring, AIGFP's senior management and local risk managers conduct a weekly review of the derivatives portfolio and existing hedges. This review includes an examination of the portfolio's risk measures, such as aggregate option sensitivity to movements in market variables. AIGFP's management may change these measures to reflect 51
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) their judgment and evaluation of the dynamics of the markets. This management group will also determine whether additional or alternative action is required in order to manage the portfolio. All of AIGTG's market risk sensitive instruments are entered into for trading purposes. The fair values of AIGTG's financial instruments are exposed to market risk as a result of adverse market changes in interest rates, foreign currency exchange rates, commodity prices and adverse changes in the liquidity of the markets in which AIGTG trades. AIGTG's approach to managing market risk is to establish an appropriate offsetting position to a particular transaction or group of transactions depending upon the extent of market risk AIGTG expects to reduce. AIGTG's senior management has established positions and stop-loss limits for each line of business. AIGTG's traders are required to maintain positions within these limits. These positions are monitored during the day either manually and/or through on-line computer systems. In addition, these positions are reviewed by AIGTG's management. Reports which present each trading books' position and the prior day's profit and loss are reviewed by traders, head traders and AIGTG's senior management. Based upon these and other reports, AIGTG's senior management may determine to adjust AIGTG's risk profile. AIGTG attempts to secure reliable current market prices, such as published prices or third party quotes, to value its derivatives. Where such prices are not available, AIGTG uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. Historically, actual results have not materially deviated from these models. The methodology may reflect interest and exchange rates, commodity prices, volatility rates, market liquidity and other relevant factors. Unrealized gains and losses, with respect to AIGTG's positions are reflected in income currently. A significant portion of AIGTG's business is transacted in liquid markets. Certain of AIGTG's derivative product exposures are evaluated using simulation techniques which consider such factors as changes in currency and commodity prices, interest rates, volatility levels, market liquidity and the effect of time. AIGFP and AIGTG are both exposed to the risk of loss of fair value from adverse fluctuations in interest rate and foreign currency exchange rates and equity and commodity prices. AIG statistically measured the losses of fair value through the application of a VaR model. AIG separately calculated the VaR with respect to AIGFP and AIGTG, as AIG manages these operations separately. AIGFP's and AIGTG's asset and liability portfolios for which the VaR analyses were performed included over the counter and exchange traded investments, derivative instruments and commodities. Because the market risk with respect to securities available for sale, at market is substantially hedged, segregation of market sensitive instruments into trading and other than trading was not deemed necessary. AIG calculated the VaR with respect to AIGFP and AIGTG as of December 31, 2002 and December 31, 2001. AIG uses the historical simulation methodology which entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical market information for interest rates, foreign exchange rates, and equity index prices were used to construct the historical scenarios. For each scenario, each transaction was re-priced. Portfolio, business unit and finally AIG-wide scenario values were then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum potential loss incurred by these scenarios with 95 percent confidence (i.e., only 5 percent of historical scenarios show losses greater than the VaR figure). THE FOLLOWING TABLE PRESENTS THE VAR ON A COMBINED BASIS AND OF EACH COMPONENT OF AIGFP'S AND AIGTG'S MARKET RISK AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001. VAR WITH RESPECT TO COMBINED OPERATIONS CANNOT BE DERIVED BY AGGREGATING THE INDIVIDUAL RISK PRESENTED HEREIN. (in millions) - -------------------------------------------------------------------------------- AIGFP (A) AIGTG (B) ---------------- ---------------- 2002 2001 2002 2001 ================================================================================ Market Risk: Combined $ 4 $12 $ 2 $ 2 Interest rate 4 12 2 2 Currency -- -- -- 1 Equity 1 1 -- -- ================================================================================ (a) A one month holding period was used to measure the market exposures of AIGFP. (b) A one day holding period was used to measure the market exposures of AIGTG. 52
American International Group, Inc. and Subsidiaries THE FOLLOWING TABLE PRESENTS THE AVERAGE, HIGH AND LOW VARS ON A COMBINED BASIS AND OF EACH COMPONENT OF AIGFP'S AND AIGTG'S MARKET RISK AS OF DECEMBER 31, 2002 AND 2001. (in millions) - -------------------------------------------------------------------------------- 2002 2001 -------------------- -------------------- AVERAGE HIGH LOW Average High Low ================================================================================ AIGFP Market Risk: Combined $ 8 $12 $ 4 $12 $15 $ 9 Interest rate 7 12 4 11 15 8 Currency 1 4 -- -- 1 -- Equity 1 2 1 1 2 -- AIGTG Market Risk: Combined $ 2 $ 3 $ 2 $ 3 $ 6 $ 2 Interest rate 2 3 2 3 4 2 Currency 1 1 -- 2 3 1 ================================================================================ DERIVATIVES Derivatives are financial arrangements among two or more parties. The returns of the derivatives are linked to or "derived" from some underlying equity, debt, commodity or other asset, liability, or index. Derivatives payments may be based on interest rates and exchange rates and/or prices of certain securities, certain commodities, or financial or commodity indices. The more significant types of derivative arrangements in which AIG transacts are swaps, forwards, futures and options. In the normal course of business, with the agreement of the original counterparty, these contracts may be terminated early or assigned to another counter-party. The overwhelming majority of AIG's derivatives activities are conducted through AIGFP and AIGTG, thus permitting AIG to participate in the derivatives dealer market acting primarily as principal. In these derivative operations, AIG structures agreements which generally allow its counterparties to enter into transactions with respect to changes in interest and exchange rates, securities' prices and certain commodities and financial or commodity indices. AIG's customers such as corporations, financial institutions, multinational organizations, sovereign entities, government agencies and municipalities use derivatives to hedge their own market exposures. For example, a futures, forward or option contract can be used to protect the customers' assets or liabilities against price fluctuations. A counterparty may default on any obligation to AIG, including a derivative contract. Credit risk is a consequence of extending credit and/or carrying trading and investment positions. Credit risk exists for a derivative contract when that contract has a positive fair value to AIG. To help manage this risk, the credit departments of AIGFP and AIGTG operate within the guidelines set by the AIG Credit Risk Committee. This committee establishes the credit policy, sets limits for counterparties and provides limits for derivative transactions with counterparties having different credit ratings. In addition to credit ratings, this committee takes into account other factors, including the industry and country of the counterparty. Transactions which fall outside these pre-established guidelines require the approval of the AIG Credit Risk Committee. It is also AIG's policy to establish reserves for potential credit impairment when necessary. AIGFP and AIGTG determine the credit quality of each of their counterparties taking into account credit ratings assigned by recognized statistical rating organizations. If it is determined that a counterparty requires credit enhancement, then one or more enhancement techniques will be used. Examples of such enhancement techniques include letters of credit, guarantees, collateral, credit triggers, credit derivatives and margin agreements. A significant majority of AIGFP's transactions are contracted and documented under ISDA Master Agreements. Management believes that such agreements provide for legally enforceable set-off in the event of default. Also, under such agreements, in connection with a counterparty desiring to terminate a contract prior to maturity, AIGFP may be permitted to set-off its receivables from that counterparty against AIGFP's payables to that same counterparty arising out of all included transactions. Excluding regulated exchange transactions, AIGTG, whenever possible, enters into netting agreements with its counterparties which are similar in effect to those discussed above. Discussions with respect to AIGFP's and AIGTG's counterpart credit quality, fair value source and notional amounts follow. 53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) Counterparty Credit Quality The following tables provide the counterparty credit quality amounts of AIGFP's and AIGTG's derivatives transactions at December 31, 2002 and December 31, 2001. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss after the application of netting under ISDA Master Agreements and excluding collateral held. Subsequent to the application of such credit enhancements, the net exposure to credit risk or the net replacement value of all interest rate, currency and equity swaps, swaptions and forward commitments approximated $14.98 billion at December 31, 2002, including $1.9 billion of collateral held; and $10.84 billion at December 31, 2001. The net replacement value for futures and forward contracts approximated $110 million at December 31, 2002 and $64 million at December 31, 2001. AIGFP determines counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, by internal analysis. At December 31, 2002 and December 31, 2001, the concentration of credit exposure with respect to counterparties judged A or higher by AIGFP was 92 percent and 93 percent, respectively. THE COUNTERPARTY CREDIT QUALITY DETERMINED BY AIGFP BY DERIVATIVE PRODUCT WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGFP'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------- NET REPLACEMENT VALUE ---------------------------- SWAPS AND FUTURES AND TOTAL Total SWAPTIONS FORWARD CONTRACTS 2002 2001 =============================================================================== Counterparty credit quality: AAA $ 7,082 $ 95 $ 7,177 $ 4,388 AA 3,856 15 3,871 3,214 A 2,887 -- 2,887 2,498 BBB 1,120 -- 1,120 784 Below investment grade 35 -- 35 23 - ------------------------------------------------------------------------------- Total $14,980 $ 110 $15,090 $10,907 =============================================================================== AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGFP'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS: (in millions) - ---------------------------------------------------------------------------------------- NET REPLACEMENT VALUE ---------------------------- SWAPS AND FUTURES AND TOTAL Total SWAPTIONS FORWARD CONTRACTS 2002 2001 ======================================================================================== Non-U.S. banks $ 3,310 $ -- $ 3,310 $ 2,464 Insured municipalities 925 -- 925 638 U.S. industrials 2,773 -- 2,773 2,113 Governmental 520 -- 520 563 Non-U.S. financial service companies 474 -- 474 428 Non-U.S. industrials 1,452 -- 1,452 1,289 Special purpose 3,252 -- 3,252 1,851 U.S. banks 416 15 431 72 U.S. financial service companies 1,846 95 1,941 1,211 Supranationals 12 -- 12 278 - ---------------------------------------------------------------------------------------- Total $14,980 $ 110 $15,090 $10,907 ======================================================================================== With respect to AIGTG's derivatives contracts at December 31, 2002 and December 31, 2001, the net replacement values represent the net sum of estimated positive fair values after the application of legally enforceable master netting agreements and collateral held. The net replacement values most closely represent the net credit risk to AIGTG or the maximum amount exposed to potential loss. Subsequent to the application of such credit enhancements, the net exposure to credit risk or the net replacement value of all futures, forwards, swaptions and purchased options contracts and interest rate and currency swaps was $2.29 billion and $3.05 billion at December 31, 2002 and December 31, 2001, respectively. 54
American International Group, Inc. and Subsidiaries AIGTG'S NET REPLACEMENT VALUE AT DECEMBER 31, 2002 AND 2001 WAS AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------------------------------------------------------- REMAINING LIFE --------------------------------------------- TWO THROUGH SIX THROUGH AFTER TOTAL Total ONE YEAR FIVE YEARS TEN YEARS TEN YEARS 2002 2001 ================================================================================================================================ Credit exposure: Futures, forwards, swaptions and purchased options contracts and interest rate and currency swaps: Gross replacement value $ 5,678 $ 2,861 $ 2,735 $ 46 $ 11,320 $ 10,074 Master netting arrangements (3,895) (2,286) (2,563) (32) (8,776) (6,691) Collateral (85) (96) (63) (8) (252) (330) - -------------------------------------------------------------------------------------------------------------------------------- Net replacement value* $ 1,698 $ 479 $ 109 $ 6 $ 2,292 $ 3,053 ================================================================================================================================ * The net replacement values with respect to exchange traded futures and options, forward contracts and purchased over the counter options are presented as a component of trading assets in the accompanying balance sheet. The net replacement values with respect to interest rate and currency swaps are presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions in the accompanying balance sheet. AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, internal analysis. At December 31, 2002 and December 31, 2001, the concentration of credit exposure with respect to counterparties judged A or higher by AIGTG was 75 percent and 78 percent, respectively. ALSO, AS OF DECEMBER 31, 2002 AND 2001, THE COUNTERPARTY CREDIT QUALITY AND COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WERE AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ NET REPLACEMENT VALUE ------------------------ 2002 2001 ==================================================================================================================================== Counterparty credit quality: AAA $ 347 $ 391 AA 622 1,117 A 739 863 BBB 193 330 Below investment grade 63 130 Not externally rated, including exchange traded futures and options* 328 222 - ------------------------------------------------------------------------------------------------------------------------------------ Total $2,292 $3,053 ==================================================================================================================================== Counterparty breakdown by industry: Non U.S. banks $ 927 $1,151 U.S. industrials 369 503 Governmental 37 71 Non-U.S. financial service companies 105 187 Non-U.S. industrials 144 190 U.S. banks 157 353 U.S. financial service companies 225 376 Exchanges* 328 222 - ------------------------------------------------------------------------------------------------------------------------------------ Total $2,292 $3,053 ==================================================================================================================================== * Exchange traded futures and options are not deemed to have significant credit exposure as the exchanges guarantee that every contract will be properly settled on a daily basis. Fair Value Source The fair value sources of the net replacement values of AIGFP's derivatives portfolio were based on valuation models. Although these models are proprietary, the inputs were obtained from independently published exchange prices, external subscription services' prices such as Bloomberg or Reuters or third party broker quotes for use in these models. In the minimal instances when such prices are not available, AIGFP uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. 55
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE FAIR VALUE SOURCE OF THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ MATURITY OF FAIR VALUE OF CONTRACTS ------------------------------------------------------------------- TWO THROUGH SIX THROUGH AFTER TOTAL TOTAL SOURCE OF FAIR VALUE ONE YEAR FIVE YEARS TEN YEARS TEN YEARS 2002 2001 ==================================================================================================================================== Prices actively quoted $1,698 $ -- $ -- $ -- $1,698 $2,412 Prices provided by other external sources -- 357 -- -- 357 530 Prices based on models and other valuation methods -- 122 109 6 237 111 - ------------------------------------------------------------------------------------------------------------------------------------ Total $1,698 $ 479 $ 109 $ 6 $2,292 $3,053 ==================================================================================================================================== Notional Amounts The notional amounts used to express the extent of AIGFP's and AIGTG's involvement in swap transactions represent a standard of measurement of the volume of AIGFP's and AIGTG's swaps business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps. The timing and the amount of cash flows relating to AIGFP's and AIGTG's foreign exchange forwards and exchange traded futures and options contracts are determined by each of the respective contractual agreements. THE FOLLOWING TABLE PRESENTS THE CONTRACTUAL AND NOTIONAL AMOUNTS BY MATURITY AND TYPE OF DERIVATIVE OF AIGFP'S DERIVATIVES PORTFOLIO AT DECEMBER 31, 2002 AND DECEMBER 31, 2001. (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ REMAINING LIFE ---------------------------------------------- TWO THROUGH SIX THROUGH AFTER TOTAL Total ONE YEAR FIVE YEARS TEN YEARS TEN YEARS 2002 2001 ==================================================================================================================================== AIGFP interest rate, currency and equity swaps and swaptions: Notional amount:* Interest rate swaps $147,331 $289,463 $128,118 $ 15,082 $579,994 $436,669 Currency swaps 47,120 80,486 42,945 6,436 176,987 139,174 Swaptions and equity swaps 20,672 26,169 9,111 4,484 60,436 58,491 - ------------------------------------------------------------------------------------------------------------------------------------ Total $215,123 $396,118 $180,174 $ 26,002 $817,417 $634,334 ==================================================================================================================================== Exchange traded futures contracts contractual amount $ 10,524 $ -- $ -- $ -- $ 10,524 $ 10,036 ==================================================================================================================================== Over the counter forward contracts contractual amount $ 43,220 $ 220 $ 187 $ -- $ 43,627 $ 58,003 ==================================================================================================================================== * Notional amount is not representative of either market risk or credit risk. AIGFP enters into credit derivative transactions in the ordinary course of its business. The overwhelming majority of AIGFP's credit derivatives require AIGFP to provide credit protection on a designated portfolio of loans or debt securities. AIGFP provides such credit protection only on a "second loss" basis, under which AIGFP's payment obligations arise only after credit losses in the designated portfolio exceed a specified threshold amount or level of "first losses." The threshold amount of credit losses that must be realized before AIGFP has any payment obligation is negotiated by AIGFP for each transaction to provide that the likelihood of any payment obligation by AIGFP under each transaction is remote, even in severe recessionary market scenarios. In many cases, the credit risk associated with a designated portfolio is tranched into different layers of risk, which are then analyzed and rated by the credit rating agencies. Typically, there will be an equity layer covering the first credit losses in respect of the portfolio up to a specified percentage of the total portfolio, and then successive layers that are rated, generally a BBB rated layer, an A rated layer, an AA rated layer and an AAA rated layer. In transactions that are rated, the risk layer or tranche that is immediately junior to the threshold level above which AIGFP's payment obligation would arise is rated AAA by the rating agencies. For that reason, the risk layer assumed by AIGFP with respect to the designated portfolio in these transactions is often called the "super senior" risk layer, defined as the layer of credit risk senior to a risk layer that has been rated AAA by the credit rating agencies or if the transaction is not rated, equivalent thereto. For example, in a transaction with an equity layer covering credit losses from 0 to 2 percent of the total portfolio, a BBB rated layer covering credit losses from 2 to 4 percent, an A rated layer from 4 to 6 percent, an AA rated layer from 6 to 8 percent and an AAA rated layer from 8 to 11 percent, AIGFP would cover credit losses arising in respect of the portfolio that exceed an 11 percent first loss threshold amount, and thereby bear risk that is senior to the 8 to 11 percent AAA rated risk layer. 56
American International Group, Inc. and Subsidiaries AIGFP continually monitors the underlying portfolios to determine whether the credit loss experience for any particular portfolio has caused the likelihood of AIGFP having a payment obligation under the transaction to be greater than super senior risk. AIGFP maintains the ability opportunistically to hedge specific securities in a portfolio thereby further limiting its exposure to loss and has hedged outstanding transactions in this manner on occasion. AIGFP has never had a payment obligation under these credit derivatives transactions. Furthermore, based on portfolio credit losses experienced to date under all outstanding transactions, no transaction has experienced credit losses in an amount that has made the likelihood of AIGFP having to make a payment, in AIGFP's view, to be greater than remote, even in severe recessionary market scenarios. At December 31, 2002 the notional amount with respect to AIGFP's credit derivative portfolio was $125.7 billion. THE FOLLOWING TABLE PROVIDES THE CONTRACTUAL AND NOTIONAL AMOUNTS BY MATURITY AND TYPE OF DERIVATIVE OF AIGTG'S DERIVATIVES PORTFOLIO AT DECEMBER 31, 2002 AND DECEMBER 31, 2001. (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ REMAINING LIFE --------------------------------------------- TWO THROUGH SIX THROUGH AFTER TOTAL Total ONE YEAR FIVE YEARS TEN YEARS TEN YEARS 2002 2001 ==================================================================================================================================== Contractual amount of futures, forwards and options: Exchange traded futures and options $ 11,834 $ 1,451 $ 50 $ -- $ 13,335 $ 14,977 ==================================================================================================================================== Over the counter forwards $168,572 $ 13,562 $ 1,977 $ 36 $184,147 $184,102 ==================================================================================================================================== Over the counter purchased options $ 72,800 $ 17,657 $ 25,053 $ 252 $115,762 $138,655 ==================================================================================================================================== Over the counter sold options (a) $ 69,247 $ 16,771 $ 25,255 $ 401 $111,674 $137,661 ==================================================================================================================================== Notional amount (b) Interest rate swaps and forward rate agreements $ 16,440 $ 33,866 $ 4,613 $ 140 $ 55,059 $ 59,683 Currency swaps 2,351 5,866 327 -- 8,544 11,092 Swaptions 3,608 5,789 1,118 -- 10,515 7,280 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 22,399 $ 45,521 $ 6,058 $ 140 $ 74,118 $ 78,055 ==================================================================================================================================== (a) Sold options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposure. (b) Notional amount is not representative of either market risk or credit risk. In addition to its role as derivatives dealer through AIGFP and AIGTG, AIG and its subsidiaries, including its insurance subsidiaries, use derivatives primarily to minimize AIG's asset-liability exposure and foreign currency and interest rate exposures. These transactions are generally executed with AIGFP and AIGTG as counterparty, who in turn hedge these transactions in the market place. Thus, AIGFP and AIGTG assume the credit risk exposure. AIG also uses derivatives to help match assets and liabilities in several of its businesses, including its insurance operations. For example, AIG can use currency and interest rate swaps to convert foreign-currency investment contract liabilities into U.S. dollar-based exposures. Thus, these liabilities are more properly matched with U.S. dollar assets. In life insurance, AIG uses swaps to reduce the mismatch between long dated life insurance liabilities and shorter dated local currency assets. Swaps also enable AIG to balance its asset and liability durations in consumer finance operations. AIG's Derivatives Review Committee provides an independent review of any proposed derivative transaction. The committee examines, among other things, the nature and purpose of the derivative transaction, its potential credit exposure, if any, and the estimated benefits. This committee does not review those derivative transactions entered into by AIGFP and AIGTG for their own accounts. Generally, AIG conducts its businesses in the currencies of the local operating environment. Thus, exchange gains or losses occur when AIG's foreign currency net investment is affected by changes in the foreign exchange rates relative to the U.S. dollar from one reporting period to the next. Legal risk arises from the uncertainty of the enforceability, through legal or judicial processes, of the obligations of AIG's clients and counterparties, including contractual provisions intended to reduce credit exposure by providing for the netting of mutual obligations. (See also the discussion on master netting agreements above.) ACCOUNTING STANDARDS In June 2001, FASB issued Statement of Financial Accounting Standard No. 141 "Business Combinations" (FAS 141). FAS 141 requires AIG to apply the purchase method of accounting for all acquisitions initiated after June 30, 2001. In June 2001, FASB issued Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (FAS 142). As of January 1, 2002, AIG adopted FAS 142. FAS 142 requires AIG to discontinue the amortization of goodwill in its consolidated income statement. Amortization 57
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED) expense recorded in AIG's consolidated statement of income amounted to $163 million and $98 million pre-tax for 2001 and 2000, respectively. FAS 142 requires goodwill to be subject to an assessment of impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process prescribed in FAS 142, whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. FAS 142 also requires the completion of a transitional impairment test in the year of adoption, with any identified impairments recognized as a cumulative effect of a change in accounting principles. During the second quarter, AIG completed its transitional impairment test for 2002, resulting in no impairment. Changes in the carrying amount of goodwill are primarily caused as a result of foreign currency translation adjustments. In November 2002, FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN45). FIN45 requires that, for guarantees within its scope that are issued or amended after December 31, 2002, a liability for the fair value of the obligation undertaken in issuing the guarantee be established, and recognized through earnings. FIN45 also requires additional disclosures in financial statements starting with AIG's 2002 year-end financial statements. AIG believes that the impact of FIN45 on its results of operations and financial condition will not be significant. AIG guarantees the indebtedness of third parties principally in connection with AIG SunAmerica's investments in affordable housing properties. The guarantees are issued primarily to facilitate financing for the construction of the underlying properties, and range in duration of up to ten years. The loans are secured by the underlying real estate. Since the inception of this investment program over ten years ago, payments under these guarantees have been insignificant. This is due to the fact that the loans are first backed by the creditworthiness of the third party general partner, and secondly, are secured by the underlying properties. The maximum exposure under these guarantees as of December 31, 2002 is approximately $4.2 billion. In addition, AIG's real estate investment operations will occasionally extend guarantees to real estate partnerships in which they are an investor. The guarantees facilitate financing for the construction, and/or purchase of land. There have been no payments to date under these guarantees. This is due to the fact that the loans are first backed by the creditworthiness of the third party general partner, and secondly, are secured by the underlying properties. The maximum exposure under these guarantees as of December 31, 2002 is approximately $130 million. In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN46). FIN46 changes the method of determining whether certain entities should be consolidated in AIG's consolidated financial statements. An entity is subject to FIN46 and is called a variable interest entity (VIE) if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) equity investors that cannot make significant decisions about the entity's operations, or that do not absorb the expected losses or receive the expected returns of the entity. All other entities are evaluated for consolidation under existing guidance. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both. The provisions of FIN46 are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which AIG obtains an interest after that date. For VIEs in which AIG holds a variable interest that it acquired before February 1, 2003, FIN46 applies to the fiscal quarter ended September 30, 2003. For any VIE that must be consolidated under FIN46 that was created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIE would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. AIG is currently evaluating the impact of applying FIN46 to existing VIEs in which it has a variable interest, and believes that the impact on its results of operations and financial condition will not be significant. (See also the discussions under Note 20 of Notes to Financial Statements and "Special Purpose Vehicles" included herein.) 58
American International Group, Inc. and Subsidiaries ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk Included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. ITEM 8. Financial Statements and Supplementary Data AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES - -------------------------------------------------------------------------------- Page ================================================================================ Report of Independent Accountants 60 Consolidated Balance Sheet at December 31, 2002 and 2001 61 Consolidated Statement of Income for the years ended December 31, 2002, 2001 and 2000 63 Consolidated Statement of Capital Funds for the years ended December 31, 2002, 2001 and 2000 64 Consolidated Statement of Cash Flows for the years ended December 31, 2002, 2001 and 2000 65 Consolidated Statement of Comprehensive Income for the years ended December 31, 2002, 2001 and 2000 67 Notes to Financial Statements 68 Schedules: I -- Summary of Investments-Other Than Investments in Related Parties as of December 31, 2002 S-1 II -- Condensed Financial Information of Registrant as of December 31, 2002 and 2001 and for the years ended December 31, 2002, 2001 and 2000 S-2 III -- Supplementary Insurance Information as of December 31, 2002, 2001 and 2000 and for the years then ended S-4 IV -- Reinsurance as of December 31, 2002, 2001 and 2000 and for the years then ended S-5 59
The Board of Directors and Shareholders American International Group, Inc.: In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the consolidated financial position of American International Group, Inc. and subsidiaries (the "Company") at December 31, 2002 and 2001, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedules listed in the accompanying index present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. PricewaterhouseCoopers LLP New York, New York February 12, 2003 60
American International Group, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEET (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2002 2001 ==================================================================================================================================== ASSETS: Investments, financial services assets and cash: Fixed maturities: Bonds available for sale, at market value (amortized cost: 2002 - $232,121; 2001 - $196,111) $242,385 $199,774 Bond trading securities, at market value (cost: 2002 - $963; 2001 - $844) 981 842 Equity securities: Common stocks (cost: 2002 - $6,152; 2001 - $6,963) 5,482 6,188 Non-redeemable preferred stocks (cost: 2002 - $1,678; 2001 - $1,840) 1,584 1,749 Mortgage loans on real estate, net of allowance (2002 - $110; 2001 - $114) 11,541 10,774 Policy loans 6,046 5,786 Collateral and guaranteed loans, net of allowance (2002 - $54; 2001 - $23) 2,341 2,407 Financial services assets: Flight equipment primarily under operating leases, net of accumulated depreciation (2002 - $4,426; 2001 - $3,492) 26,867 22,710 Securities available for sale, at market value (cost: 2002 - $16,715; 2001 - $17,793) 16,687 17,801 Trading securities, at market value 4,146 5,733 Spot commodities, at market value 489 352 Unrealized gain on interest rate and currency swaps, options and forward transactions 15,376 11,493 Trading assets 4,786 6,234 Securities purchased under agreements to resell, at contract value 25,661 21,681 Finance receivables, net of allowance (2002 - $477; 2001 - $532) 15,857 13,955 Securities lending collateral 23,694 10,574 Other invested assets 12,680 12,704 Short-term investments, at cost (approximates market value) 6,993 7,168 Cash 1,165 698 - ------------------------------------------------------------------------------------------------------------------------------------ Total investments, financial services assets and cash 424,761 358,623 Investment income due and accrued 4,297 3,681 Premiums and insurance balances receivable, net of allowance (2002 - $150; 2001 - $127) 13,088 12,412 Reinsurance assets, net of allowances 29,882 27,199 Deferred policy acquisition costs 22,256 19,357 Investments in partially-owned companies 1,575 902 Real estate and other fixed assets, net of accumulated depreciation (2002 - $3,727; 2001 - $3,532) 5,382 4,833 Separate and variable accounts 46,248 51,954 Goodwill 6,079 6,102 Other assets 7,661 7,998 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL ASSETS $561,229 $493,061 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 61
American International Group, Inc. and Subsidiaries CONSOLIDATED BALANCE SHEET (CONTINUED) (in millions, except share amounts) - ------------------------------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2002 2001 ==================================================================================================================================== LIABILITIES: Reserve for losses and loss expenses $ 51,539 $ 44,792 Reserve for unearned premiums 16,336 13,148 Future policy benefits for life and accident and health insurance contracts 72,547 64,998 Policyholders' contract deposits 142,160 119,402 Other policyholders' funds 7,582 7,611 Reserve for commissions, expenses and taxes 3,429 3,381 Insurance balances payable 3,273 3,207 Funds held by companies under reinsurance treaties 3,425 2,685 Income taxes payable: Current 793 405 Deferred 4,289 2,881 Financial services liabilities: Borrowings under obligations of guaranteed investment agreements 14,850 16,392 Securities sold under agreements to repurchase, at contract value 9,162 11,818 Trading liabilities 3,825 4,372 Securities and spot commodities sold but not yet purchased, at market value 11,765 8,331 Unrealized loss on interest rate and currency swaps, options and forward transactions 11,265 8,813 Trust deposits and deposits due to banks and other depositors 2,987 2,290 Commercial paper 7,467 8,523 Notes, bonds, loans and mortgages payable 43,233 33,676 Commercial paper 1,645 3,369 Notes, bonds, loans and mortgages payable 4,690 3,771 Separate and variable accounts 46,248 51,954 Minority interest 1,580 1,509 Securities lending payable 23,694 10,574 Other liabilities 12,189 10,807 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES 499,973 438,709 - ------------------------------------------------------------------------------------------------------------------------------------ PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANIES 2,153 2,202 - ------------------------------------------------------------------------------------------------------------------------------------ Capital funds: Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2002 - 2,751,327,476; 2001 - 2,750,237,554 6,878 6,876 Additional paid-in capital 607 669 Retained earnings 52,270 47,218 Accumulated other comprehensive income (loss) 691 (1,725) Treasury stock, at cost; 2002 - 141,726,645; 2001 - 134,805,555 shares of common stock (including 119,244,379 and 133,200,400 shares, respectively, held by subsidiaries) (1,343) (888) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL CAPITAL FUNDS 59,103 52,150 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES, PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANIES AND CAPITAL FUNDS $ 561,229 $ 493,061 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 62
American International Group, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF INCOME (in millions, except per share amounts) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ==================================================================================================================================== REVENUES: Premiums and other considerations $ 44,589 $ 38,428 $ 34,570 Net investment income 15,034 13,977 12,663 Realized capital gains (losses) (2,441) (836) (314) Other revenues 10,300 10,197 9,419 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL REVENUES 67,482 61,766 56,338 - ------------------------------------------------------------------------------------------------------------------------------------ BENEFITS AND EXPENSES: Incurred policy losses and benefits 41,927 35,054 30,864 Insurance acquisition and other operating expenses 17,413 16,556 15,136 Acquisition, restructuring and related charges -- 2,017 315 - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL BENEFITS AND EXPENSES 59,340 53,627 46,315 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES 8,142 8,139 10,023 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME TAXES: Current 1,972 1,919 1,697 Deferred 356 420 1,274 - ------------------------------------------------------------------------------------------------------------------------------------ 2,328 2,339 2,971 - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES 5,814 5,800 7,052 - ------------------------------------------------------------------------------------------------------------------------------------ MINORITY INTEREST (295) (301) (413) - ------------------------------------------------------------------------------------------------------------------------------------ INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 5,519 5,499 6,639 - ------------------------------------------------------------------------------------------------------------------------------------ CUMULATIVE EFFECT OF ACCOUNTING CHANGES, NET OF TAX -- (136) -- - ------------------------------------------------------------------------------------------------------------------------------------ NET INCOME $ 5,519 $ 5,363 $ 6,639 ==================================================================================================================================== EARNINGS PER COMMON SHARE: Basic Income before cumulative effect of accounting changes $ 2.11 $ 2.10 $ 2.55 Cumulative effect of accounting changes -- (0.05) -- Net income 2.11 2.05 2.55 - ------------------------------------------------------------------------------------------------------------------------------------ Diluted Income before cumulative effect of accounting changes $ 2.10 $ 2.07 $ 2.52 Cumulative effect of accounting changes -- (0.05) -- Net income 2.10 2.02 2.52 ==================================================================================================================================== AVERAGE SHARES OUTSTANDING: Basic 2,612 2,621 2,607 Diluted 2,634 2,650 2,638 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 63
American International Group, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF CAPITAL FUNDS (in millions, except per share amounts) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ==================================================================================================================================== COMMON STOCK: Balance at beginning of year $ 6,876 $ 6,914 $ 4,870 Issuance of common stock -- -- 7 Adjustment in connection with AGC acquisition -- (43) -- Stock split effected as dividend -- -- 2,037 Issued under stock option and stock purchase plans 2 5 -- - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 6,878 6,876 6,914 - ------------------------------------------------------------------------------------------------------------------------------------ ADDITIONAL PAID-IN CAPITAL: Balance at beginning of year 669 2,830 2,324 Issuance of common stock -- -- (7) Excess of cost over proceeds of common stock issued under stock option and stock purchase plans (94) 2 (161) Excess of proceeds over cost of common stock issued in connection with acquisitions -- -- 616 Conversion of preferred stock and preferred securities -- -- (83) Adjustment in connection with AGC acquisition 5 (2,135) -- Other 27 (28) 141 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 607 669 2,830 - ------------------------------------------------------------------------------------------------------------------------------------ RETAINED EARNINGS: Balance at beginning of year 47,218 42,598 38,772 Net income 5,519 5,363 6,639 Stock dividends to shareholders -- -- (2,037) Cash dividends to shareholders: Preferred -- -- (1) Common ($.18, $.16 and $.14 per share, respectively) (467) (743) (775) - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 52,270 47,218 42,598 - ------------------------------------------------------------------------------------------------------------------------------------ ACCUMULATED OTHER COMPREHENSIVE INCOME: Balance at beginning of year (1,725) (2,440) (3,381) Unrealized appreciation of investments - net of reclassification adjustments 4,727 1,513 1,467 Deferred income tax expense on changes (1,579) (500) (316) Foreign currency translation adjustments (419) (455) (273) Applicable income tax benefit on changes 38 111 63 Net derivative losses arising from cash flow hedging activities (479) (541) -- Deferred income tax benefit on changes 186 98 -- Cumulative effect of accounting change, net of tax -- 489 -- Retirement plan liabilities adjustment, net of tax (58) -- -- - ------------------------------------------------------------------------------------------------------------------------------------ Other comprehensive income 2,416 715 941 - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year 691 (1,725) (2,440) - ------------------------------------------------------------------------------------------------------------------------------------ TREASURY STOCK, AT COST: Balance at beginning of year (888) (2,463) (2,944) Cost of shares acquired during year (734) (1,042) (1,407) Issued under stock option and stock purchase plans 260 271 343 Issued for conversion of preferred stock and preferred securities -- -- 418 Issued in connection with acquisitions -- -- 1,127 Adjustment in connection with AGC acquisition -- 2,311 -- Other 19 35 -- - ------------------------------------------------------------------------------------------------------------------------------------ Balance at end of year (1,343) (888) (2,463) - ------------------------------------------------------------------------------------------------------------------------------------ TOTAL CAPITAL FUNDS AT END OF YEAR $ 59,103 $ 52,150 $ 47,439 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 64
American International Group, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF CASH FLOWS (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ==================================================================================================================================== SUMMARY: NET CASH PROVIDED BY OPERATING ACTIVITIES $ 18,688 $ 8,362 $ 9,081 NET CASH USED IN INVESTING ACTIVITIES (46,598) (31,298) (20,828) NET CASH PROVIDED BY FINANCING ACTIVITIES 28,377 23,112 11,843 - ------------------------------------------------------------------------------------------------------------------------------------ CHANGE IN CASH 467 176 96 CASH AT BEGINNING OF YEAR 698 522 426 - ------------------------------------------------------------------------------------------------------------------------------------ CASH AT END OF YEAR $ 1,165 $ 698 $ 522 ==================================================================================================================================== CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,519 $ 5,363 $ 6,639 ==================================================================================================================================== ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Non-cash revenues, expenses, gains and losses included in income: Change in: General and life insurance reserves 16,725 7,405 7,928 Premiums and insurance balances receivable and payable - net (744) 588 1,016 Reinsurance assets (2,683) (4,590) (3,657) Deferred policy acquisition costs (3,850) (1,104) (1,465) Investment income due and accrued (616) (124) (346) Funds held under reinsurance treaties 740 1,228 572 Other policyholders' funds (29) 727 239 Current and deferred income taxes - net 745 648 1,408 Reserve for commissions, expenses and taxes 48 55 68 Other assets and liabilities - net 1,300 836 (1,068) Trading assets and liabilities - net 901 831 (721) Trading securities, at market value 1,587 1,614 (2,956) Spot commodities, at market value (137) 11 320 Net unrealized (gain) loss on interest rate and currency swaps, options and forward transactions (1,431) (1,026) (2,347) Securities purchased under agreements to resell (3,980) (6,690) (4,094) Securities sold under agreements to repurchase (2,656) 510 5,192 Securities and spot commodities sold but not yet purchased, at market value 3,434 630 1,288 Realized capital gains (losses) 2,441 836 314 Equity in income of partially-owned companies and other invested assets (229) (479) (327) Amortization of premium and discount on securities (195) (285) (269) Depreciation expenses, principally flight equipment 1,653 1,437 1,243 Change in cumulative translation adjustments (405) (439) (273) Provision for finance receivable losses 402 395 307 Other - net 148 (15) 70 - ------------------------------------------------------------------------------------------------------------------------------------ Total adjustments 13,169 2,999 2,442 - ------------------------------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY OPERATING ACTIVITIES $ 18,688 $ 8,362 $ 9,081 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 65
American International Group, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF CASH FLOWS (CONTINUED) (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ==================================================================================================================================== CASH FLOWS FROM INVESTING ACTIVITIES: Cost of fixed maturities, at amortized cost matured or redeemed $ -- $ -- $ 1,227 Cost of bonds, at market sold 99,777 94,825 37,700 Cost of bonds, at market matured or redeemed 13,666 14,403 7,359 Cost of equity securities sold 6,509 6,321 5,162 Realized capital gains (losses) (2,441) (836) (314) Purchases of fixed maturities (149,537) (132,961) (58,001) Purchases of equity securities (5,955) (6,619) (6,085) Acquisitions, net of cash acquired -- (383) (17) Mortgage, policy and collateral loans granted (2,867) (2,037) (2,341) Repayments of mortgage, policy and collateral loans 2,011 1,392 2,106 Sales of securities available for sale 4,382 5,816 5,588 Maturities of securities available for sale 3,882 2,303 1,559 Purchases of securities available for sale (7,134) (11,264) (8,890) Sales of flight equipment 184 220 713 Purchases of flight equipment (5,302) (4,415) (3,432) Net additions to real estate and other fixed assets (924) (700) (1,033) Sales or distributions of other invested assets 12,182 4,298 4,397 Investments in other invested assets (12,423) (5,531) (6,285) Change in short-term investments 175 5,434 1,314 Investments in partially-owned companies (479) (541) 79 Finance receivable originations and purchases (10,066) (8,774) (7,812) Finance receivable principal payments received 7,762 7,751 6,346 Other - net -- -- (168) - ------------------------------------------------------------------------------------------------------------------------------------ NET CASH USED IN INVESTING ACTIVITIES $ (46,598) $ (31,298) $ (20,828) ==================================================================================================================================== CASH FLOWS FROM FINANCING ACTIVITIES: Change in policyholders' contract deposits $ 22,758 $ 13,943 $ 5,451 Change in trust deposits and deposits due to banks and other depositors 697 395 (280) Change in commercial paper (2,421) (1,156) 2,222 Proceeds from notes, bonds, loans and mortgages payable 21,896 27,347 12,212 Repayments on notes, bonds, loans and mortgages payable (11,950) (17,597) (10,770) Proceeds from guaranteed investment agreements 7,167 10,410 9,957 Maturities of guaranteed investment agreements (8,709) (7,613) (5,792) Redemption of subsidiary company preferred stock (50) (1,248) -- Proceeds from common stock issued 168 239 144 Proceeds from subsidiary company issuance of preferred stock -- -- 742 Cash dividends to shareholders (467) (743) (776) Acquisition of treasury stock (734) (1,042) (1,402) Other - net 22 177 135 - ------------------------------------------------------------------------------------------------------------------------------------ NET CASH PROVIDED BY FINANCING ACTIVITIES $ 28,377 $ 23,112 $ 11,843 ==================================================================================================================================== SUPPLEMENTARY INFORMATION: TAXES PAID $ 1,203 $ 1,475 $ 1,345 ==================================================================================================================================== INTEREST PAID $ 3,590 $ 3,950 $ 3,524 ==================================================================================================================================== See Accompanying Notes to Financial Statements. 66
American International Group, Inc. and Subsidiaries CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ==================================================================================================================================== COMPREHENSIVE INCOME: Net income $ 5,519 $ 5,363 $ 6,639 - ------------------------------------------------------------------------------------------------------------------------------------ OTHER COMPREHENSIVE INCOME: Unrealized appreciation of investments - net of reclassification adjustments 4,727 1,513 1,467 Deferred income tax expense on above changes (1,579) (500) (316) Foreign currency translation adjustments (a) (419) (455) (273) Applicable income tax benefit on above changes 38 111 63 Net derivative losses arising from cash flow hedging activities (479) (541) -- Deferred income tax benefit on above changes 186 98 -- Retirement plan liabilities adjustment, net of tax (58) -- -- Cumulative effect of accounting change, net of tax (b) -- 150 -- Cumulative effect of accounting change, net of tax (c) -- 339 -- - ------------------------------------------------------------------------------------------------------------------------------------ OTHER COMPREHENSIVE INCOME 2,416 715 941 - ------------------------------------------------------------------------------------------------------------------------------------ COMPREHENSIVE INCOME $ 7,935 $ 6,078 $ 7,580 ==================================================================================================================================== (a) Includes insignificant derivative gains and losses arising from hedges of net investments in foreign operations. (b) Consists of derivative gains and losses qualifying for cash flow hedging arising from the adoption of Statement of Financial Accounting Standards No. 138 "Accounting for Derivative Instruments and Hedging Activities -- an amendment of FASB Statement No. 133" (collectively, FAS 133). (c) Represents the unrealized appreciation arising from the transfer of the bonds held to maturity portfolio to the bonds available for sale portfolio in connection with the implementation of FAS 133. See Accompanying Notes to Financial Statements. 67
NOTES TO FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) PRINCIPLES OF CONSOLIDATION: On August 29, 2001 American General Corporation (AGC), was acquired by American International Group, Inc.(AIG). In connection with the acquisition, AIG issued approximately 290 million shares of its common stock in exchange for all the outstanding common stock of AGC based on an exchange ratio of 0.5790 of a share of AIG common stock for each share of AGC common stock. The acquisition was accounted for as a pooling of interests and the accompanying financial statements have been prepared to retroactively combine AGC's financial statements with AIG's financial statements for all periods presented. All of the share information included herein reflects the application of the exchange ratio to the number of shares of AGC common stock outstanding at the relevant times rather than the number of shares of AIG common stock actually issued or outstanding at such times. In addition, AGC convertible preferred stock has been included based on its AGC common stock equivalent in the restated capital accounts. THE FOLLOWING IS A RECONCILIATION OF THE INDIVIDUAL COMPANY RESULTS TO THE COMBINED RESULTS FOR 2000: (in millions) - -------------------------------------------------------------------------------- AIG AGC Total ================================================================================ Revenues $45,245 $11,093 $56,338 Net income 5,636 1,003 6,639 ================================================================================ AIG subsidiaries write property, casualty, marine, life and financial lines insurance in approximately 130 countries and jurisdictions. Certain of AIG's foreign subsidiaries included in the consolidated financial statements report on a fiscal year ending November 30. The consolidated financial statements include the accounts of AIG and its majority owned subsidiaries. All material intercompany accounts and transactions have been eliminated. HSB Group, Inc. (HSB) was acquired on November 22, 2000 and consolidated into AIG's financial statements during the fourth quarter of 2000. This acquisition was accounted for as a purchase. (B) BASIS OF PRESENTATION: The accompanying financial statements have been prepared on the basis of generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Certain accounts have been reclassified in the 2001 and 2000 financial statements to conform to their 2002 presentation. General Insurance Operations: AIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. Premiums are earned primarily on a pro rata basis over the term of the related coverage. The reserve for unearned premiums represents the portion of premiums written relating to the unexpired terms of coverage. Acquisition costs represent those costs, including commissions, that vary with and are primarily related to the acquisition of new business. These costs are deferred and amortized over the period in which the related premiums written are earned. The deferred acquisition cost (DAC) asset is reviewed for recoverability based on the profitability of the underlying insurance contracts. Investment income is not anticipated in the deferral of acquisition costs. Losses and loss expenses are charged to income as incurred. The reserve for losses and loss expenses represents the accumulation of estimates for reported losses and includes provisions for losses incurred but not reported. The methods of determining such estimates and establishing resulting reserves, including amounts relating to reserves for estimated unrecoverable reinsurance, are reviewed and updated. Adjustments resulting therefrom are reflected in income currently. AIG discounts certain of its loss reserves which are primarily related to certain workers' compensation claims. (See Note 6.) Life Insurance Operations: AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of single premium annuity, guaranteed investment contracts, universal life and pensions. Premiums for traditional life insurance products and life contingent annuities, excluding accident and health products, are recognized as revenues when due. Estimates for premiums due but not yet collected are accrued. Benefits and expenses are provided against such revenues to recognize profits over the estimated life of the policies. Revenues for universal life and investment-type products consist of policy charges for the cost of insurance, administration and surrenders during the period. Policy charges collected with respect to future services are deferred and recognized in a manner similar to the deferred policy acquisition costs related to such products. Expenses include interest credited to policy account balances and benefit payments made in excess of policy account balances. Accident and health products are accounted for in a manner similar to general insurance products described above. Investment income reflects certain amounts of realized capital gains where the gains are deemed to be an inherent element in pricing certain life products in some foreign countries. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs 68
American International Group, Inc. and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) and policy initiation costs related to universal life and investment-type products (non-traditional products) are deferred and amortized, with interest, in relation to the incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits are composed of net interest income, net realized investment gains and losses, variable annuity fees, surrender charges and direct administrative expenses. The resulting DAC asset is reviewed for recoverability based on the profitability (both current and projected future) of the underlying insurance contracts. The deferred acquisition costs with respect to non-traditional products are adjusted with respect to estimated gross profits as a result of changes in the net unrealized gains or losses on debt and equity securities available for sale. That is, as debt and equity securities available for sale are carried at aggregate fair value, an adjustment is made to deferred policy acquisition costs equal to the change in amortization that would have been recorded if such securities had been sold at their stated aggregate fair value and the proceeds reinvested at current yields. The change in this adjustment, net of tax, is included with the change in net unrealized gains/losses on debt and equity securities available for sale that is credited or charged directly to comprehensive income. Deferred policy acquisition costs have been decreased by $1.23 billion at December 31, 2002 and decreased by $280 million at December 31, 2001 for this adjustment. (See Note 4.) The liabilities for future policy benefits and policyholders' contract deposits are established using assumptions described in Note 6. Financial Services Operations: AIG participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity and credit derivative products business. AIG also enters into structured transactions, including long-dated forward foreign exchange contracts, option transactions, liquidity facilities and investment agreements, and invests in a diversified portfolio of securities. AIG engages in market making and trading activities, as principal, in foreign exchange, interest rates and precious and base metals. AIG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts. AIG, as lessor, leases flight equipment principally under operating leases. Accordingly, income is recognized over the life of the lease as rentals become receivable under the provisions of the lease or, in the case of leases with varying payments, under the straight-line method over the noncancelable term of the lease. In certain cases, leases provide for additional payments contingent on usage. Rental income is recognized at the time such usage occurs less a provision for future contractual aircraft maintenance. AIG is also a remarketer of flight equipment for its own account and for airlines and financial institutions, and provides, for a fee, fleet management services to certain third-party operators. AIG's revenues from such operations consist of net gains on sales of flight equipment and commissions. AIG provides a wide variety of consumer finance products, including mortgages, retail sales finance and credit related insurance. Retirement Savings & Asset Management Operations: AIG's retirement savings & asset management operations offer a wide variety of investment vehicles and services, including variable annuities, mutual funds and investment asset management. Such products and services are offered to individuals and institutions both domestically and internationally. The fees generated with respect to retirement savings & asset management operations are recognized as revenues when earned. Costs incurred in the sale of variable annuities and mutual funds are deferred and subsequently amortized. With respect to variable annuities, acquisition costs are amortized in relation to the incidence of estimated gross profits to be realized over the estimated lives of the variable annuity contracts. With respect to the sale of mutual funds, acquisition costs are amortized over the estimated lives of the funds obtained. (C) NON-CASH TRANSACTIONS: During 2001 and 2000, AIG issued 291.6 million and 17.8 million common shares, respectively, in connection with acquisitions. (D) INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES: Where AIG may not have the positive intent to hold bonds and preferred stocks until maturity, these securities are considered to be available for sale and carried at current market values. Interest income with respect to fixed maturity securities is accrued currently. Fixed maturities held to maturity, at amortized cost, were transferred to bonds available for sale, at market value, as of January 1, 2001 as permitted and in accordance with the transition provisions of the Financial Accounting Standards No. 138 "Accounting for Derivative Instruments and Hedging Activities - -- an amendment of FASB Statement No. 133" (collectively, FAS 133). (See Notes 1(y) and 8(d)). Included in the bonds available for sale are collateralized mortgage obligations (CMOs). Premiums and discounts arising from the purchase of CMOs are treated as yield adjustments over their estimated lives. Bond trading securities are carried at current market values, as it is AIG's intention to sell these securities in the near term. Common and non-redeemable preferred stocks are carried at current market values. Dividend income is generally recognized when receivable. 69
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Unrealized gains and losses from investments in equity securities and fixed maturities available for sale are reflected as a separate component of comprehensive income, net of deferred income taxes in capital funds currently. Unrealized gains and losses from investments in trading securities are reflected in income currently. Realized capital gains and losses are determined principally by specific identification. Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge is reflected in income for the difference between cost or amortized cost and estimated net fair value. In January 2001, the Emerging Issues Task Force (EITF) issued EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." EITF 99-20 provides guidance on the calculation of interest income and the recognition of impairments related to beneficial interests held in an investment portfolio. Beneficial interests are investments that represent rights to receive specified cash flows from a pool of underlying assets (e.g., collateralized debt obligations). In accordance with the transition provisions of EITF 99-20, AIG recorded in its consolidated income statement for 2001 a cumulative effect of an accounting change adjustment loss of $130 million ($200 million before tax). (E) MORTGAGE LOANS ON REAL ESTATE, POLICY AND COLLATERAL LOANS -- NET: Mortgage loans on real estate, policy loans and collateral loans are carried at unpaid principal balances. Interest income on such loans is accrued currently. Impairment of mortgage loans on real estate and collateral loans is based upon certain risk factors and when collection of all amounts due under the contractual term is not probable. This impairment is generally measured based on the present value of expected future cash flows discounted at the loan's effective interest rate subject to the fair value of underlying collateral. Interest income on such loans is recognized as cash is received. There is no allowance for policy loans, as these loans serve to reduce the death benefit paid when the death claim is made and the balances are effectively collateralized by the cash surrender value of the policy. (F) FLIGHT EQUIPMENT: Flight equipment is stated at cost. Major additions and modifications are capitalized. Normal maintenance and repairs, airframe and engine overhauls and compliance with return conditions of flight equipment on lease are provided by and paid for by the lessee. Under the provisions of most leases for certain airframe and engine overhauls, the lessee is reimbursed for costs incurred up to but not exceeding contingent rentals paid to AIG by the lessee. AIG provides a charge to income for such reimbursements based upon the expected reimbursements during the life of the lease. Depreciation and amortization are computed on the straight-line basis to a residual value of approximately 15 percent over the estimated useful lives of the related assets but not exceeding 25 years. AIG monitors the global aircraft market and the values of various types and models of aircraft within that market relative to the values of its own fleet. If events or circumstances were such that the carrying amount of AIG's aircraft might be impaired, AIG would determine if such impairment existed and recognize such impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This caption also includes deposits for aircraft to be purchased. At the time the assets are retired or disposed of, the cost and associated accumulated depreciation and amortization are removed from the related accounts and the difference, net of proceeds, is recorded as a gain or loss. (G) SECURITIES AVAILABLE FOR SALE, AT MARKET VALUE: These securities are held to meet long term investment objectives and are accounted for as available for sale, carried at current market values and recorded on a trade date basis. Unrealized gains and losses from valuing these securities and any related hedges are reflected in capital funds currently, net of any related deferred income taxes. When the underlying security is sold, the realized gain or loss resulting from the hedging derivative transaction is recognized in income in that same period as the realized gain or loss of the hedged security. (H) FINANCE RECEIVABLES: Finance charges are recognized as revenue using the interest method. Revenue ceases to be accrued when contractual payments are not received for four consecutive months for loans and retail sales contracts, and for six months for revolving retail accounts and private label receivables. Extension fees, late charges, and prepayment penalties are recognized as revenue when received. Direct costs of originating loans, net of non-refundable points and fees, are deferred and included in the carrying amount of the related loans. The amount deferred is recognized as an adjustment to finance charge revenues, using the interest method over the lesser of the contractual term or the expected life based on prepayment experience. If loans are prepaid, any remaining deferral is charged or credited to revenue. Foreclosure proceedings are initiated on real estate loans when four monthly installments are past due and these loans are charged off at foreclosure. All other finance receivables are charged off when minimal or no collections have been made for six months. The allowance for finance receivable losses is maintained at a level considered adequate to absorb anticipated credit losses in the existing portfolio. The portfolio is periodically evaluated on a pooled basis and considers factors such as economic conditions, portfolio composition, and loss and delinquency experience in the evaluation of the allowance. 70
American International Group, Inc. and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (I) TRADING SECURITIES, AT MARKET VALUE: Trading securities are held to meet short term investment objectives, including hedging securities. These securities are recorded on a trade date basis and carried at current market values. Unrealized gains and losses are reflected in income currently. (J) SPOT COMMODITIES, AT MARKET VALUE: Spot commodities are carried at current market values and are recorded on a trade date basis. The exposure to market risk may be reduced through the use of forwards, futures and option contracts. Unrealized gains and losses of both commodities and any derivative transactions are reflected in income currently. (K) UNREALIZED GAIN AND UNREALIZED LOSS ON INTEREST RATE AND CURRENCY SWAPS, OPTIONS AND FORWARD TRANSACTIONS: Interest rate swaps, currency swaps, equity swaps, swaptions, options and forward transactions are accounted for as contractual commitments recorded on a trade date basis and are carried at current market values or estimated fair values when market values are not available. Unrealized gains and losses are reflected in income currently. Estimated fair values are based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates. AIG Financial Products Corp. and its subsidiaries (AIGFP) attempt to secure reliable and independent current market prices, such as published exchange prices, external subscription services' prices such as Bloomberg or Reuters or third party broker quotes for use in these models. When such prices are not available, AIGFP uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. These valuations represent an assessment of the present values of expected future cash flows of these transactions and reflect market and credit risk. The portfolio's discounted cash flows are evaluated with reference to current market conditions, maturities within the portfolio and other relevant factors. Based upon this evaluation, it is determined what offsetting transactions, if any, are necessary to reduce the market risk of the portfolio. AIG manages its market risk with a variety of transactions, including swaps, trading securities, futures and forward contracts and other transactions as appropriate. Because of the limited liquidity of some of these instruments, the recorded values of these transactions may be different than the values that might be realized if AIG were to sell or close out the transactions prior to maturity. AIG believes that such differences are not significant to the results of operations, financial condition or liquidity. Such differences would be immediately recognized when the transactions are sold or closed out prior to maturity. (L) TRADING ASSETS AND TRADING LIABILITIES: Trading assets and trading liabilities include option premiums paid and received and receivables from and payables to counterparties which relate to unrealized gains and losses on futures, forwards and options and balances due from and due to clearing brokers and exchanges. Futures, forwards and options purchased and written are accounted for as contractual commitments on a trade date basis and are carried at fair values. Unrealized gains and losses are reflected in income currently. The fair values of futures contracts are based on closing exchange quotations. Commodity forward transactions are carried at fair values derived from dealer quotations and underlying commodity exchange quotations. For long dated forward transactions, where there are no dealer or exchange quotations, fair values are derived using internally developed valuation methodologies based on available market information. Options are carried at fair values based on the use of valuation models that utilize, among other things, current interest or commodity rates and foreign exchange and volatility rates, as applicable. (M) SECURITIES PURCHASED (SOLD) UNDER AGREEMENTS TO RESELL (REPURCHASE), AT CONTRACT VALUE: Purchases of securities under agreements to resell and sales of securities under agreements to repurchase are accounted for as collateralized lending transactions and are recorded at their contracted resale or repurchase amounts, plus accrued interest. Generally, it is AIG's policy to take possession of or obtain a security interest in securities purchased under agreements to resell. AIG minimizes the credit risk that counterparties to transactions might be unable to fulfill their contractual obligations by monitoring customer credit exposure and collateral value and generally requiring additional collateral to be deposited with AIG when deemed necessary. AIG also enters into dollar roll agreements. These are agreements to sell mortgage-backed securities and to repurchase substantially the same securities at a specified price and date in the future. The dollar rolls are accounted for as collateralized financings and the repurchase obligation is a component of other liabilities. At December 31, 2002, 2001 and 2000, there were no dollar rolls outstanding. (N) SECURITIES LENDING COLLATERAL AND SECURITIES LENDING PAYABLE: AIG's insurance operations lend their securities and primarily take cash as collateral with respect to the securities lent. Income earned on invested collateral, net of interest payable to the collateral provider is recorded in net investment income. (O) OTHER INVESTED ASSETS: Other invested assets consist primarily of investments by AIG's insurance operations in joint ventures and partnerships, and other investments not classified elsewhere herein. The joint ventures and partnerships are carried at equity or cost depending on the equity ownership position. Other investments are carried at cost or market values depending upon the nature of the underlying assets. 71
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) (P) REINSURANCE ASSETS: Reinsurance assets include the balances due from both reinsurance and insurance companies under the terms of AIG's reinsurance agreements for paid and unpaid losses and loss expenses, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. Amounts related to paid and unpaid losses and loss expenses with respect to these reinsurance agreements are substantially collateralized. (Q) INVESTMENTS IN PARTIALLY-OWNED COMPANIES: The equity method of accounting is used for AIG's investment in companies in which AIG's ownership interest approximates twenty but is not greater than fifty percent (minority-owned companies). At December 31, 2002, AIG's significant investments in partially-owned companies included its 24.3 percent interest in IPC Holdings, Ltd., its 23.4 percent interest in Allied World Assurance Holdings, Ltd. and its 22.1 percent interest in The Fuji Fire and Marine Insurance Co., Ltd. This balance sheet caption also includes investments in less significant partially-owned companies and in certain minor majority-owned subsidiaries. The amounts of dividends received from unconsolidated entities owned less than 50 percent were $13 million, $3 million and $3 million in 2002, 2001 and 2000, respectively. The undistributed earnings of unconsolidated entities owned less than 50 percent was $155 million as of December 31, 2002. (R) REAL ESTATE AND OTHER FIXED ASSETS: The costs of buildings and furniture and equipment are depreciated principally on a straight-line basis over their estimated useful lives (maximum of 40 years for buildings and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterments are capitalized and depreciated. From time to time, AIG assesses the carrying value of its real estate relative to the market values of real estate within the specific local area. At December 31, 2002, there were no impairments. (S) SEPARATE AND VARIABLE ACCOUNTS: Separate and variable accounts represent funds for which investment income and investment gains and losses accrue directly to the policyholders who predominantly bear the investment risk. Each account has specific investment objectives, and the assets are carried at market value. The assets of each account are legally segregated and are not subject to claims which arise out of any other business of AIG. The liabilities for these accounts are equal to the account assets. (T) SECURITIES AND SPOT COMMODITIES SOLD BUT NOT YET PURCHASED, AT MARKET VALUE: Securities and spot commodities sold but not yet purchased represent sales of securities and spot commodities not owned at the time of sale. The obligations arising from such transactions are recorded on a trade date basis and carried at the respective current market values or current commodity prices. Unrealized gains or losses are reflected in income currently. (U) PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANIES: Preferred shareholders' equity in subsidiary companies relates to outstanding preferred stock or interest of ILFC and certain subsidiaries of AIG SunAmerica, AGC and HSB, wholly owned subsidiaries of AIG. Cash distributions on such preferred stock or interest are accounted for as interest expense and included as minority interest in the consolidated statement of income. (V) TRANSLATION OF FOREIGN CURRENCIES: Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 "Foreign Currency Translation" (FAS 52). Under FAS 52, functional currency assets and liabilities are translated into U.S. dollars generally using current rates of exchange prevailing at the balance sheet date of each respective subsidiary and the related translation adjustments are recorded as a separate component of comprehensive income, net of any related taxes in capital funds. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates. The adjustments resulting from translation of financial statements of foreign entities operating in highly inflationary economies are recorded in income. Exchange gains and losses resulting from foreign currency transactions are also recorded in income currently. The exchange gain or loss with respect to utilization of foreign exchange hedging instruments is recorded as a component of comprehensive income. (W) INCOME TAXES: Deferred federal and foreign income taxes are provided for temporary differences for the expected future tax consequences of events that have been recognized in AIG's financial statements or tax returns. (X) EARNINGS PER SHARE: Basic earnings per common share are based on the weighted average number of common shares outstanding, retroactively adjusted to reflect all stock dividends and stock splits. Diluted earnings per share are based on those shares used in basic earnings per share plus shares that would have been outstanding assuming issuance of common shares for all dilutive potential common shares outstanding, retroactively adjusted to reflect all stock dividends and stock splits. 72
American International Group, Inc. and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) THE COMPUTATION OF EARNINGS PER SHARE FOR DECEMBER 31, 2002, 2001 AND 2000 WAS AS FOLLOWS: (in millions, except per share amounts) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 NUMERATOR FOR BASIC EARNINGS PER SHARE: Income before cumulative effect of accounting changes $ 5,519 $ 5,499 $ 6,639 Cumulative effect of accounting changes, net of tax -- (136) -- Net income 5,519 5,363 6,639 - -------------------------------------------------------------------------------- Net income applicable to common stock $ 5,519 $ 5,363 $ 6,639 ================================================================================ DENOMINATOR FOR BASIC EARNINGS PER SHARE: Average shares outstanding used in the computation of per share earnings: Common stock issued 2,752 2,762 2,796 Common stock in treasury (140) (141) (189) - -------------------------------------------------------------------------------- Average shares outstanding-- basic 2,612 2,621 2,607 ================================================================================ NUMERATOR FOR DILUTED EARNINGS PER SHARE: Income before cumulative effect of accounting changes $ 5,519 $ 5,499 $ 6,639 Cumulative effect of accounting changes, net of tax -- (136) -- Net income 5,519 5,363 6,639 Dividends on convertible preferred securities -- -- 5 - -------------------------------------------------------------------------------- Net income applicable to common stock $ 5,519 $ 5,363 $ 6,644 ================================================================================ DENOMINATOR FOR DILUTED EARNINGS PER SHARE: Average shares outstanding 2,612 2,621 2,607 Incremental shares from potential common stock: Average number of shares arising from outstanding employee stock plans (treasury stock method) 22 29 27 Average number of shares issuable upon conversion of convertible securities and preferred stock -- -- 4 - -------------------------------------------------------------------------------- Average shares outstanding-- diluted 2,634 2,650 2,638 ================================================================================ EARNINGS PER SHARE: Basic: Income before cumulative effect of accounting changes $ 2.11 $ 2.10 $ 2.55 Cumulative effect of accounting changes -- (0.05) -- Net income $ 2.11 $ 2.05 $ 2.55 - -------------------------------------------------------------------------------- Diluted: Income before cumulative effect of accounting changes $ 2.10 $ 2.07 $ 2.52 Cumulative effect of accounting changes -- (0.05) -- Net income $ 2.10 $ 2.02 $ 2.52 ================================================================================ (Y) DERIVATIVES: In June 1998, the Financial Accounting Standards Board (FASB) issued FAS 133. In June 2000, FASB issued Statement of Financial Accounting Standards No. 138 "Accounting for Derivative Instruments and Hedging Activities--an amendment of FASB Statement No. 133" (collectively, FAS 133). FAS 133 requires AIG to recognize all derivatives in the consolidated balance sheet at fair value. The financial statement recognition of the change in the fair value of a derivative depends on a number of factors, including the intended use of the derivative and the extent to which it is effective as part of a hedge transaction. The changes in fair value of the derivative transactions of AIGFP and AIG Trading Group Inc. and its subsidiaries (AIGTG) are currently presented, in all material respects, as a component of AIG's operating income. The discussion below relates to the derivative activities of AIG other than those of AIGFP and AIGTG. On the date the derivative contract is entered into, AIG designates the derivative as: (i) a hedge of the subsequent changes in the fair value of a recognized asset or liability or of an unrecognized firm commitment ("fair value" hedge); (ii) a hedge of a forecasted transaction, or the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge); or (iii) a hedge of a net investment in a foreign operation. Fair value and cash flow hedges may involve foreign currencies ("foreign currency hedges"). The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a fair value hedge is recorded in current period earnings, along with the loss or gain on the hedged item attributable to the hedged risk. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a cash flow hedge is recorded in other comprehensive income, until earnings are affected by the variability of cash flows. The gain or loss in the fair value of a derivative that is designated, qualifies and is highly effective as a hedge of a net investment in a foreign operation is recorded in the foreign currency translation adjustments account within other comprehensive income. Changes in the fair value of derivatives used for other than the above hedging activities are reported in current period earnings. AIG documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet, or specific firm commitments or forecasted transactions. AIG also assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. In accordance with the transition provisions of FAS 133, AIG recorded in its consolidated income statement for 2001 a cumulative effect of an accounting change adjustment loss of $6 million. This loss represents the net fair value of all previous unrecorded derivative instruments as of January 1, 2001, net of tax and after the application of hedge accounting. AIG also recorded in its consolidated statement of comprehensive income for 2001 a cumulative effect of an accounting change adjustment gain of $150 million. This gain represents the increase in other comprehensive income, net of taxes, 73
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) arising from recognizing the fair value of all derivative contracts designated as cash flow hedging instruments, and to a lesser extent, hedging instruments used to hedge net investments in foreign operations. AIG (excluding its two trading operations, AIGFP and AIGTG) uses derivative instruments (principally swap and forward contracts) to minimize AIG's asset-liability exposure and foreign currency and interest rate exposures. These risks arise primarily from available-for-sale fixed income securities, debt, and policyholder account balance liabilities associated with guaranteed investment contracts. Other hedging activities, such as those involving forecasted transactions or equity securities, are not significant. During 2002, there were no hedges that were discontinued or otherwise no longer qualify as hedges under FAS 133. With respect to both fair value hedges and cash flow hedges, hedge ineffectiveness was insignificant for 2002. During 2002, there were minor reclassifications to earnings from other comprehensive income under cash flow hedge accounting. These reclassifications were connected to programs of synthetically converting certain investment securities, debt issuances or policyholder account balance liabilities associated with guaranteed investment contracts, from a floating interest rate to a fixed interest rate. As at December 31, 2002, the maximum amount of net derivative losses to be reclassified into net income within the next twelve months is insignificant. The maximum length of time over which future cash flows are hedged is approximately 16 years. In addition to hedging activities, AIG also uses derivative instruments with respect to investment operations, which include, among other things, writing option contracts, and purchasing investments with embedded derivatives, such as equity linked notes and convertible bonds. All changes in the market value of these derivatives are recorded in earnings. AIG bifurcates an embedded derivative where: (i) the economic characteristics of the embedded instruments are not clearly and closely related to those of the remaining components of the financial instrument; and (ii) a separate instrument with the same terms as the embedded instrument meets the definition of a derivative under FAS 133. In accordance with the transition provisions of FAS 133, AIG transferred bonds in the held to maturity, at amortized cost category into the bonds available for sale, at market value category at January 1, 2001. The amortized cost of the bonds transferred was $11.53 billion. The unrealized appreciation, net of deferred tax expense was approximately $339 million at the date of transfer and was recorded as a cumulative effect of an accounting change within other comprehensive income. Under the provisions of FAS 133, such a transfer does not affect AIG's intent nor its ability to hold current or future bonds to their maturity. (Z) GOODWILL AND INTANGIBLE ASSETS: In June 2001, FASB issued Statement of Financial Accounting Standard No. 141 "Business Combinations" (FAS 141). FAS 141 requires AIG, among other things, to apply the purchase method of accounting for all acquisitions initiated after June 30, 2001. In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (FAS 142). As of January 1, 2002, AIG adopted FAS 142. FAS 142 requires AIG to discontinue the amortization of goodwill in its consolidated income statement. Amortization expense recorded in AIG's consolidated statement of income amounted to $163 million and $98 million pre-tax for 2001 and 2000, respectively. FAS 142 requires goodwill to be subject to an assessment of impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process prescribed in FAS 142, whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. FAS 142 also requires the completion of a transitional impairment test in the year of adoption, with any identified impairments recognized as a cumulative effect of change in accounting principles. During the second quarter, AIG completed its transitional impairment test for 2002, resulting in no impairment. Changes in the carrying amount of goodwill are primarily caused as a result of foreign currency translation adjustments. (AA) ACCOUNTING STANDARDS: In November 2002, FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN45). FIN45 requires that, for guarantees within its scope that are issued or amended after December 31, 2002, a liability for the fair value of the obligation undertaken in issuing the guarantee be established and recognized through earnings. FIN45 also requires additional disclosures in financial statements starting with AIG's 2002 year-end financial statements. AIG believes that the impact of FIN45 on its results of operations and financial condition will not be significant. AIG guarantees the indebtedness of third parties principally in connection with AIG SunAmerica Inc.'s (AIG SunAmerica) investments in affordable housing properties. The guarantees are issued primarily to facilitate financing for the construction of the underlying properties, and range in duration of up to ten years. The loans are secured by the underlying real estate. Since the inception of this investment program over ten years ago, payments under these guarantees have been insignificant. This is due to the fact that the loans are first backed by the creditworthiness of the third party general partner, and secondly, are secured by the underlying properties. The maximum exposure under these guarantees as of December 31, 2002 is approximately $4.2 billion. 74
American International Group, Inc. and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) In addition, AIG's real estate investment operations will occasionally extend guarantees to real estate partnerships in which they are an investor. The guarantees facilitate financing for the construction, and/or purchase of land. There have been no losses incurred on any guarantee to date. This is due to the fact that the loans are first backed by the creditworthiness of the third party general partner, and secondly, are secured by the underlying properties. The maximum exposure of these guarantees as of December 31, 2002 is approximately $130 million. In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN46). FIN46 changes the method of determining whether certain entities should be consolidated in AIG's consolidated financial statements. An entity is subject to FIN46 and is called a Variable Interest Entity (VIE) if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) equity investors that cannot make significant decisions about the entity's operations, or do not absorb the expected losses or receive the expected returns of the entity. All other entities are evaluated for consolidation under existing guidance. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both. The provisions of FIN46 are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which AIG obtains an interest after that date. For VIEs in which AIG holds a variable interest that it acquired before February 1, 2003, FIN46 applies to the fiscal quarter ended September 30, 2003. For any VIEs that must be consolidated under FIN46 that were created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIE would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change. AIG is currently evaluating the impact of applying FIN46 to existing VIEs in which it has a variable interest, and believes that the impact on its results of operations and financial condition will not be significant. (See Note 20 of Notes to Financial Statements.) 2. SEGMENT INFORMATION Certain subsidiaries operate solely outside of the United States. Their assets and liabilities are located principally in the countries where the insurance risks are written and/or investment and non-insurance related operations are located. In addition, certain of AIG's domestic subsidiaries have branch and/or subsidiary operations and substantial assets and liabilities in foreign countries. Certain countries have restrictions on the conversions of funds which generally cause a delay in the outward remittance of such funds. Approximately 27 percent and 26 percent of consolidated assets at December 31, 2002 and 2001, respectively, and 41 percent of revenues in each of the years ended December 31, 2002, 2001 and 2000, respectively, were located in or derived from foreign countries (other than Canada). (a) AIG's operations are conducted principally through four business segments. These segments and their respective operations are as follows: General Insurance: AIG's general insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance. The Domestic Brokerage Group (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. HSB's operations are included in this group. Transatlantic Holdings, Inc. (Transatlantic) offers through its reinsurance company subsidiaries reinsurance capacity both domestically and overseas on treaty and facultative basis for a full range of property and casualty products. Personal Lines engages in the mass marketing of personal lines insurance, primarily private passenger auto, homeowners and personal umbrella coverages. Mortgage Guaranty provides guaranty insurance primarily on conventional first mortgage loans on single family dwellings and condominiums. AIG's Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG's foreign-based insurance subsidiaries for their own accounts. The Foreign General group uses various marketing methods to write both business and personal lines insurance with certain refinements for local laws, customs and needs. AIU operates in over 70 countries in Asia, the Pacific Rim, Europe, Africa, Middle East and Latin America. Life Insurance: AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. AIG's three principal overseas life operations are American Life Insurance Company (ALICO), American International Assurance Company, Ltd. (AIA) and Nan Shan Life Insurance Company, Ltd. (Nan Shan). ALICO is 75
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SEGMENT INFORMATION (continued) incorporated in Delaware and all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in approximately 50 countries located in Europe, Africa, Latin America, the Caribbean, the Middle East, and the Far East, with Japan being the largest territory. In 2001, AIG added significantly to its presence in Japan with the acquisition of AIG Star Life Insurance Co, Ltd. (AIG Star Life) as a result of the reorganization of Chiyoda Mutual Life Insurance Company. AIA operates primarily in China, (including Hong Kong), Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. AIG's principal domestic life insurance subsidiaries include the AIG American General Life Companies, AIG Annuity Insurance Company and SunAmerica Life Insurance Company. These companies utilize multiple distribution channels including brokerage and career and general agents to offer traditional life products as well as financial investment products. Financial Services: AIG's financial services subsidiaries engage in diversified financial products and services including aircraft leasing, consumer and insurance premium financing, and capital markets structuring and market-making activities. International Lease Finance Corporation (ILFC) engages primarily in the acquisition of commercial jet aircraft and the leasing and remarketing of such aircraft to airlines around the world. Also, ILFC provides, for a fee, fleet management services to certain third-party operators. AIG Financial Products Corp. and its subsidiaries (AIGFP) engage in a wide variety of financial transactions, including long-dated interest rate, currency, equity and credit derivatives and structured borrowings through notes, bonds and guaranteed investment agreements. AIGFP does not engage in trading activities with respect to commodity contracts. AIG Trading Group Inc. through its subsidiaries (AIGTG) engages in various commodity trading, foreign exchange trading, and market making activities. AIG's Consumer Finance operations include American General Finance, Inc. as well as AIG Consumer Finance Group, Inc. (AIGCFG). AGF and AIGCFG provide a wide variety of consumer finance products, including real estate mortgages, consumer loans, retail sales finance and credit related insurance to customers both domestically and overseas, particularly emerging markets. Retirement Savings & Asset Management: AIG's retirement savings & asset management operations offer a wide variety of investment products, including variable annuities, and mutual funds, as well as investment services, including investment asset management. Such products and services are offered to individuals and institutions both domestically and overseas. AIG's principal retirement savings & asset management operations are conducted through AIG SunAmerica, The Variable Annuity Life Insurance Company (VALIC), and the subsidiaries and affiliated companies of AIG Global Investment Group, Inc. (AIG Global Investment Group). AIG SunAmerica develops and sells variable annuities and other investment products, sells and manages mutual funds and provides financial services. VALIC provides tax qualified annuities to employees of educational, healthcare and governmental entities. AIG Global Investment Group manages third-party institutional, retail and private equity funds' invested assets on a global basis, and provides securities lending and custodial services. An AIG Global Investment Group member organizes and manages the invested assets of institutional private equity investment funds. Each of these subsidiary operations receives fees for investment products and services provided. 76
American International Group, Inc. and Subsidiaries 2. SEGMENT INFORMATION (continued) (B) THE FOLLOWING TABLE SUMMARIZES THE OPERATIONS BY MAJOR OPERATING SEGMENT FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: OPERATING SEGMENTS-2002 --------------------------------------------------------------------------------------------------------- RETIREMENT SAVINGS TOTAL RECLASSIFICATIONS GENERAL LIFE FINANCIAL & ASSET REPORTABLE AND (in millions) INSURANCE INSURANCE SERVICES MANAGEMENT OTHER(A) SEGMENTS ELIMINATIONS CONSOLIDATED =================================================================================================================================== Revenues (b) $ 26,171 $ 31,541 $ 6,815 $ 3,485 $ (530) $ 67,482 $ -- $ 67,482 Interest revenue -- -- 3,787 65 -- 3,852 -- 3,852 Interest expense -- 76 3,327 11 215 3,629 -- 3,629 Realized capital gains (losses) (858) (1,053) -- -- (530) (2,441) -- (2,441) Operating income (loss) before minority interest 667(c) 4,929 2,189 1,016 (659) 8,142 -- 8,142 Income taxes (benefits) 210 1,979 765 355 (981) 2,328 -- 2,328 Depreciation expense 178 239 1,097 7 132 1,653 -- 1,653 Capital expenditures 323 725 5,395 59 150 6,652 -- 6,652 Identifiable assets 109,068 339,847 124,617 2,567 60,769 636,868 (75,639) 561,229 =================================================================================================================================== Operating Segments-2001 -------------------------------------------------------------------------------------------------------- Retirement Savings Total Reclassifications General Life Financial & Asset Reportable and (in millions) Insurance Insurance Services Management Other(a) Segments Eliminations Consolidated =================================================================================================================================== Revenues (b) $ 22,128 $ 29,893 $ 6,485 $ 3,712 $ (452) $ 61,766 $ -- $ 61,766 Interest revenue -- -- 3,983 84 -- 4,067 -- 4,067 Interest expense 2 109 3,596 17 314 4,038 -- 4,038 Realized capital gains (losses) (130) (254) -- -- (452) (836) -- (836) Operating income (loss) before minority interest 2,851(d) 4,675(d) 1,991 1,088 (2,466)(e) 8,139 -- 8,139 Income taxes (benefits) 742 1,579 706 366 (1,054) 2,339 -- 2,339 Depreciation expense 189 216 910 5 117 1,437 -- 1,437 Capital expenditures 290 842 4,529 11 156 5,828 -- 5,828 Identifiable assets 91,544 296,648 107,322 1,842 54,749 552,105 (59,044) 493,061 =================================================================================================================================== Operating Segments-2000 --------------------------------------------------------------------------------------------------------- Retirement Savings Total Reclassifications General Life Financial & Asset Reportable and (in millions) Insurance Insurance Services Management Other(a) Segments Eliminations Consolidated =================================================================================================================================== Revenues (b) $ 20,146 $ 26,963 $ 5,954 $ 3,465 $ (190) $ 56,338 $ -- $ 56,338 Interest revenue -- -- 3,557 94 -- 3,651 -- 3,651 Interest expense 5 144 3,276 15 265 3,705 -- 3,705 Realized capital gains (losses) 38 (162) -- -- (190) (314) -- (314) Operating income (loss) before minority interest 3,524 4,058 1,666 1,108 (333) 10,023 -- 10,023 Income taxes (benefits) 931 1,315 581 388 (244) 2,971 -- 2,971 Depreciation expense 149 149 833 4 108 1,243 -- 1,243 Capital expenditures 278 501 3,748 18 184 4,729 -- 4,729 Identifiable assets 85,270 248,982 94,173 1,590 41,460 471,475 (44,804) 426,671 =================================================================================================================================== (a) Includes AIG Parent and other operations which are not required to be reported separately. (b) Represents the sum of general net premiums earned, life premium income, net investment income, financial services commissions, transaction and other fees, retirement savings & asset management commissions and other fees and realized capital gains (losses). (c) Includes loss reserve charge of $2.8 billion. (d) Includes $769 million and $131 million with respect to WTC losses for general and life insurance operations, respectively. (e) Includes acquisition, restructuring and related charges of $2,017 million. 77
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SEGMENT INFORMATION (continued) (C) THE FOLLOWING IS AIG'S CONSOLIDATED STATEMENT OF SEGMENT OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: CONSOLIDATED STATEMENT OF SEGMENT OPERATIONS (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ General insurance operations: Net premiums written $ 27,414 $ 20,101 $ 17,526 Change in unearned premium reserve (3,145) (736) (119) - -------------------------------------------------------------------------------- Net premiums earned 24,269 19,365 17,407 Net investment income 2,760 2,893 2,701 Realized capital gains (losses) (858) (130) 38 - -------------------------------------------------------------------------------- General insurance revenues 26,171 22,128 20,146 ================================================================================ Losses incurred 18,449(A) 12,459 11,379 Losses incurred: World Trade Center and related losses (WTC) -- 769 -- Loss expenses incurred 2,365(B) 2,178 1,725 Underwriting expenses 4,690 3,871 3,518 - -------------------------------------------------------------------------------- General insurance benefits and expenses 25,504 19,277 16,622 ================================================================================ General insurance operating income 667(A)(B) 2,851 3,524 - -------------------------------------------------------------------------------- Life insurance Premium income 20,320 19,063 17,163 Net investment income 12,274 11,084 9,962 Realized capital gains (losses) (1,053) (254) (162) - -------------------------------------------------------------------------------- Life insurance revenues 31,541 29,893 26,963 ================================================================================ Death and other benefits 10,552 10,449 8,264 Death and other benefits: WTC -- 131 -- Increase in future policy benefits 10,561 9,068 9,496 Acquisition and insurance expenses 5,499 5,570 5,145 - -------------------------------------------------------------------------------- Life insurance benefits and expenses 26,612 25,218 22,905 ================================================================================ Life insurance operating income 4,929 4,675 4,058 - -------------------------------------------------------------------------------- Financial services operating income 2,189 1,991 1,666 Retirement savings & asset management operating income 1,016 1,088 1,108 Other realized capital gains (losses) (530) (452) (190) Other income (deductions) - net (129)(C) 3 172 Acquisition, restructuring and related charges -- (2,017) (315) - -------------------------------------------------------------------------------- Income before income taxes, minority interest and cumulative effect of accounting changes $ 8,142 $ 8,139 $ 10,023 ================================================================================ (a) Includes loss reserve charge of $2.8 billion. (b) Includes 21st Century's loss adjustment expense pre-tax provision of $43 million for SB 1899 Northridge earthquake claims. (c) Includes 21st Century's pre-tax charge of $37 million to write off capitalized costs associated with a software development project. 78
American International Group, Inc. and Subsidiaries 2. SEGMENT INFORMATION (continued) (D) THE FOLLOWING TABLE SUMMARIZES AIG'S GENERAL INSURANCE OPERATIONS BY MAJOR INTERNAL REPORTING GROUP FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: GENERAL INSURANCE-2002 ---------------------------------------------------------------------------------------------------------- DOMESTIC TOTAL RECLASSIFICATIONS TOTAL BROKERAGE PERSONAL MORTGAGE FOREIGN REPORTABLE AND GENERAL (in millions) GROUP TRANSATLANTIC LINES GUARANTY GENERAL SEGMENT ELIMINATIONS INSURANCE ==================================================================================================================================== Net premiums written $ 15,214 $ 2,500 $ 3,182 $ 508 $ 6,010 $ 27,414 $ -- $ 27,414 Net premiums earned 13,053 2,369 2,913 502 5,432 24,269 -- 24,269 Losses & loss expenses incurred 13,244 1,796 2,365 88 3,321 20,814 -- 20,814 Underwriting expenses 1,858 631 519 136 1,546 4,690 -- 4,690 Adjusted underwriting profit (loss)(a)(c) (2,049) (58) 29 278 565 (1,235) -- (1,235) Net investment income 1,609 252 122 139 615 2,737 23 2,760 Operating income (loss) before realized capital gains (b) (440)(C)(E) 194(C) 151 417 1,180 1,502 23 1,525 Depreciation expense 72 3 27 3 73 178 -- 178 Capital expenditures 101 1 38 2 181 323 -- 323 Identifiable assets 73,588 7,287 3,516 2,547 25,638 112,576 (3,508) 109,068 ========================================================================================================================== ========= General Insurance-2001 ----------------------------------------------------------------------------------------------------------- Domestic Total Reclassifications Total Brokerage Personal Mortgage Foreign Reportable and General (in millions) Group Transatlantic Lines Guaranty General Segment Eliminations Insurance ==================================================================================================================================== Net premiums written $ 10,197 $ 1,906 $ 2,454 $ 494 $ 5,050 $ 20,101 $ -- $ 20,101 Net premiums earned 9,776 1,790 2,478 489 4,832 19,365 -- 19,365 Losses & loss expenses incurred 8,728 1,562 2,130 63 2,923 15,406 -- 15,406 Underwriting expenses 1,386 502 440 115 1,428 3,871 -- 3,871 Adjusted underwriting profit (loss)(a)(d) (338) (274) (92) 311 481 88 -- 88 Net investment income 1,827 240 114 106 583 2,870 23 2,893 Operating income (loss) before realized capital gains (b) (d) 1,489(e) (34) 22 417 1,064 2,958 23 2,981 Depreciation expense 83 3 28 4 71 189 -- 189 Capital expenditures 106 2 69 3 110 290 -- 290 Identifiable assets 60,604 6,741 3,863 2,219 21,781 95,208 (3,664) 91,544 ==================================================================================================================================== General Insurance-2000 ----------------------------------------------------------------------------------------------------------- Domestic Total Reclassifications Total Brokerage Personal Mortgage Foreign Reportable and General (in millions) Group Transatlantic Lines Guaranty General Segment Eliminations Insurance ==================================================================================================================================== Net premiums written $ 7,934 $ 1,659 $ 2,510 $ 453 $ 4,970 $17,526 $ -- $17,526 Net premiums earned 8,023 1,632 2,401 452 4,899 17,407 -- 17,407 Losses & loss expenses incurred 6,843 1,197 2,022 68 2,974 13,104 -- 13,104 Underwriting expenses 1,003 434 416 114 1,551 3,518 -- 3,518 Adjusted underwriting profit (loss)(a) 177 1 (37) 270 374 785 -- 785 Net investment income 1,614 234 113 93 570 2,624 77 2,701 Operating income before realized capital gains(b) 1,791(e) 235 76 363 944 3,409 77 3,486 Depreciation expense 52 2 19 5 71 149 -- 149 Capital expenditures 102 2 75 4 95 278 -- 278 Identifiable assets 57,302 5,523 3,776 1,867 19,626 88,094 (2,824) 85,270 ==================================================================================================================================== (a) Adjusted underwriting profit (loss) is a GAAP measure that represents statutory underwriting profit or loss adjusted primarily for changes in deferred acquisition costs. (b) Realized capital gains are not deemed to be an integral part of AIG's general insurance operations' internal reporting groups. (c) Includes loss reserve charge of $2.7 billion and $100 million for DBG and Transatlantic, respectively. (d) Includes $769 million with respect to WTC losses: DBG: $544 million; Transatlantic: $200 million; Foreign General: $25 million. (e) Includes $333 million, $139 million ($198 million excluding WTC losses) and $224 million for the twelve months ended December 31, 2002, 2001 and 2000, respectively, with respect to the Lexington Surplus Lines Pool. 79
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SEGMENT INFORMATION (continued) (E) THE FOLLOWING TABLE SUMMARIZES AIG'S LIFE INSURANCE OPERATIONS BY MAJOR INTERNAL REPORTING GROUP FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: LIFE INSURANCE-2002 ----------------------------------------------------------------------------------------------- ALICO AIA TOTAL RECLASSIFICATIONS AND AND DOMESTIC REPORTABLE AND TOTAL LIFE (in millions) STAR LIFE(A) NAN SHAN LIFE OTHER SEGMENT ELIMINATIONS INSURANCE ================================================================================================================================ Premium income $ 5,747 $ 9,606 $ 4,622 $ 345 $ 20,320 $-- $ 20,320 Net investment income 1,605 2,156 8,325 188 12,274 -- 12,274 Operating income before realized capital gains (b) 1,562 1,622 2,688 110 5,982 -- 5,982 Depreciation expense 73 48 112 6 239 -- 239 Capital expenditures 245 148 330 2 725 -- 725 Identifiable assets 55,112 49,919 233,004 2,406 340,441 (594) 339,847 ================================================================================================================================ Life Insurance-2001 ------------------------------------------------------------------------------------------------ ALICO AIA Total Reclassifications and and Domestic Reportable and Total Life (in millions) Star Life(a) Nan Shan Life Other Segment Eliminations Insurance ==================================================================================================================================== Premium income $ 5,212 $ 8,485 $ 4,948 $ 418 $ 19,063 $ -- $ 19,063 Net investment income 1,502 1,880 7,504 198 11,084 -- 11,084 Operating income before realized capital gains (b) (c) 1,048 1,483 2,288 110 4,929 -- 4,929 Depreciation expense 65 40 104 7 216 -- 216 Capital expenditures 506 81 238 17 842 -- 842 Identifiable assets 45,767 41,854 206,734 2,877 297,232 (584) 296,648 ==================================================================================================================================== Life Insurance-2000 -------------------------------------------------------------------------------------------------- AIA Total Reclassifications and Domestic Reportable and Total Life (in millions) ALICO Nan Shan Life Other Segment Eliminations Insurance =================================================================================================================================== Premium income $ 4,134 $ 7,859 $ 4,809 $ 361 $ 17,163 $-- $ 17,163 Net investment income 1,346 1,688 6,781 147 9,962 -- 9,962 Operating income before realized capital gains (b) 757 1,409 1,979 75 4,220 -- 4,220 Depreciation expense 46 33 62 8 149 -- 149 Capital expenditures 313 58 98 32 501 -- 501 Identifiable assets 28,532 32,697 186,111 1,807 249,147 (165) 248,982 =================================================================================================================================== (a) Increase in 2001 reflects acquisition of AIG Star Life Insurance Co. Ltd. in April 2001. (b) Realized capital gains are not deemed to be an integral part of AIG's life insurance operations' internal reporting groups. (c) Includes $131 million with respect to WTC losses. 80
American International Group, Inc. and Subsidiaries 2. SEGMENT INFORMATION (continued) (F) THE FOLLOWING TABLE SUMMARIZES AIG'S FINANCIAL SERVICES OPERATIONS BY MAJOR INTERNAL REPORTING GROUP FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: FINANCIAL SERVICES-2002 ---------------------------------------------------------------------------------------------- TOTAL RECLASSIFICATIONS TOTAL CONSUMER REPORTABLE AND FINANCIAL (in millions) ILFC AIGFP(A) FINANCE OTHER SEGMENT ELIMINATIONS SERVICES ================================================================================================================================== Commissions, transaction and other fees and loan fees (b) $ 2,845 $ 1,306 $ 2,473 $ 807 $ 7,431 $ (616) $ 6,815 Interest revenue 25 1,471 2,180 247 3,923 (136) 3,787 Interest expense 900 1,731 639 133 3,403 (76) 3,327 Operating income (loss) 801 808 549 116 2,274 (85) 2,189 Depreciation expense 964 46 32 55 1,097 -- 1,097 Capital expenditures 5,304 27 24 40 5,395 -- 5,395 Identifiable assets 27,771 56,495 18,900 26,706 129,872 (5,255) 124,617 ================================================================================================================================== Financial Services-2001 ------------------------------------------------------------------------------------------------ Total Reclassifications Total Consumer Reportable and Financial (in millions) ILFC AIGFP(a) Finance Other Segment Eliminations Services ==================================================================================================================================== Commissions, transaction and other fees and loan fees (b) $ 2,613 $ 1,178 $ 2,560 $ 748 $ 7,099 $ (614) $ 6,485 Interest revenue 33 1,638 2,231 297 4,199 (216) 3,983 Interest expense 850 1,883 753 244 3,730 (134) 3,596 Operating income (loss) 749 758 505 66 2,078 (87) 1,991 Depreciation expense 811 9 34 56 910 -- 910 Capital expenditures 4,418 17 39 55 4,529 -- 4,529 Identifiable assets 23,424 50,324 16,945 20,008 110,701 (3,379) 107,322 ==================================================================================================================================== Financial Services-2000 ------------------------------------------------------------------------------------------------ Total Reclassifications Total Consumer Reportable and Financial (in millions) ILFC AIGFP(a) Finance Other Segment Eliminations Services ==================================================================================================================================== Commissions, transaction and other fees and loan fees (b) $ 2,441 $ 1,056 $ 2,325 $ 702 $ 6,524 $ (570) $ 5,954 Interest revenue 38 1,540 1,956 267 3,801 (244) 3,557 Interest expense 824 1,552 756 282 3,414 (138) 3,276 Operating income (loss) 654 648 386 52 1,740 (74) 1,666 Depreciation expense 729 8 29 67 833 -- 833 Capital expenditures 3,435 216 40 57 3,748 -- 3,748 Identifiable assets 19,984 41,837 15,460 19,341 96,622 (2,449) 94,173 ==================================================================================================================================== (a) AIGFP's interest revenue and interest expense are reported as net revenues in the caption "Commissions, transactions and other fees and loan fees". (b) Commissions, transaction and other fees and loan fees are the sum of the net gain or loss of trading activities, the net change in unrealized gain or loss, the net interest revenues from forward rate agreements and interest rate swaps, and where applicable, management and incentive fees from asset management activities. 81
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 2. SEGMENT INFORMATION (continued) (G) A SUBSTANTIAL PORTION OF AIG'S OPERATIONS IS CONDUCTED IN COUNTRIES OTHER THAN THE UNITED STATES AND CANADA. THE FOLLOWING TABLE SUMMARIZES AIG'S OPERATIONS BY MAJOR GEOGRAPHIC SEGMENT. ALLOCATIONS HAVE BEEN MADE ON THE BASIS OF THE LOCATION OF OPERATIONS AND ASSETS. GEOGRAPHIC SEGMENTS-2002 ------------------------------------------------ OTHER (in millions) DOMESTIC(A) FAR EAST FOREIGN CONSOLIDATED Revenues (b) $39,779 $19,223 $ 8,480 $67,482 Real estate and other fixed assets, net of accumulated depreciation 2,529 2,041 812 5,382 Flight equipment primarily under operating leases, net of accumulated depreciation 26,867 -- -- 26,867 Geographic Segments-2001 ------------------------------------------------ Other (in millions) Domestic(a) Far East Foreign Consolidated Revenues (b) $36,191 $17,128 $ 8,447 $61,766 Real estate and other fixed assets, net of accumulated depreciation 2,220 1,824 789 4,833 Flight equipment primarily under operating leases, net of accumulated depreciation 22,710 -- -- 22,710 Geographic Segments-2000 ------------------------------------------------ Other (in millions) Domestic(a) Far East Foreign Consolidated Revenues (b) $33,492 $15,311 $ 7,535 $56,338 Real estate and other fixed assets, net of accumulated depreciation 2,104 1,264 758 4,126 Flight equipment primarily under operating leases, net of accumulated depreciation 19,325 -- -- 19,325 (a) Including revenues from general insurance operations in Canada of $225 million, $158 million and $206 million in 2002, 2001 and 2000, respectively. (b) Represents the sum of general net premiums earned, life premium income, net investment income, financial services commissions, transaction and other fees, asset management commissions and other fees and realized capital gains (losses). 3. FEDERAL INCOME TAXES (a) AIG and its domestic subsidiaries, excluding the AGC and AIG SunAmerica life insurance companies and their subsidiaries, file a consolidated U.S. Federal income tax return. Each of AGC's and AIG SunAmerica's life insurance companies and their subsidiaries file a consolidated U.S. Federal income tax return. Revenue Agent's Reports proposing to assess additional taxes for the years 1989-1990 and 1991-1996 have been issued to AIG and Letters of Protest contesting the proposed assessments have been filed with the Internal Revenue Service (IRS). In addition, Revenue Agent's Reports proposing to assess additional taxes for the years ended September 30, 1993-1994 and 1995-1996 have been issued to AIG SunAmerica. Such proposed assessments relate to years prior to AIG's acquisition of SunAmerica Inc. Letters of Protest contesting the proposed assessments have been filed with the IRS. It is management's belief that there are substantial arguments in support of the positions taken by AIG and AIG SunAmerica in their Letters of Protest. AGC's tax years through 1999 have been audited and settled with the IRS. Although the final outcome of any issues raised in connection with these examinations is uncertain, AIG believes that the tax obligation, including interest thereon, will not be significant to AIG's financial condition, results of operations or liquidity. A component of life insurance surplus accumulated prior to 1984 is not taxable unless it exceeds certain statutory limitations or is distributed to shareholders. This surplus, accumulated in policyholder surplus accounts, totaled approximately $945 million at December 31, 2002. AIG has not made any provision in the accompanying financial statements for taxation of this amount as management has no intention of making any distributions from this surplus. Foreign income not expected to be taxed in the United States has arisen because AIG's foreign subsidiaries were generally not subject to U.S. income taxes on income earned prior to January 1, 1987. Such income would become subject to U.S. income taxes at current tax rates if remitted to the United States or if other events occur which would make these amounts currently taxable. The cumulative amount of translated undistributed earnings of AIG's foreign subsidiaries currently not subject to U.S. income taxes was approximately $5.1 billion at December 31, 2002. Management presently has not subjected and has no intention of subjecting these accumulated earnings to material U.S. income taxes and no provision has been made in the accompanying financial statements for such taxes. 82
American International Group, Inc. and Subsidiaries 3. FEDERAL INCOME TAXES (continued) (B) THE U.S. FEDERAL INCOME TAX RATE IS 35 PERCENT FOR 2002, 2001 AND 2000. ACTUAL TAX EXPENSE ON INCOME DIFFERS FROM THE "EXPECTED" AMOUNT COMPUTED BY APPLYING THE FEDERAL INCOME TAX RATE BECAUSE OF THE FOLLOWING: (dollars in millions) - ------------------------------------------------------------------------------------------------------------------------------------ YEARS ENDED DECEMBER 31, 2002 2001 2000 ---------------------- ---------------------- ----------------------- PERCENT Percent Percent OF PRE-TAX of pre-tax of pre-tax AMOUNT INCOME Amount income Amount income ==================================================================================================================================== "Expected" tax expense $ 2,850 35.0% $ 2,849 35.0% $ 3,508 35.0% Adjustments: Tax exempt interest (266) (3.4) (277) (3.4) (294) (2.9) Dividends received deduction (69) (0.8) (64) (0.8) (50) (0.5) State income taxes 38 0.5 49 0.6 52 0.5 Foreign income not expected to be taxed in the U.S., less foreign income taxes (93) (1.1) (149) (1.8) (110) (1.1) Affordable housing tax credits (35) (0.4) (37) (0.5) (48) (0.5) Other (97) (1.2) (32) (0.4) (87) (0.9) - ------------------------------------------------------------------------------------------------------------------------------------ Actual tax expense $ 2,328 28.6% $ 2,339 28.7% $ 2,971 29.6% Foreign and domestic components of actual tax expense: Foreign: Current $ 663 $ 449 $ 450 Deferred 516 304 131 Domestic*: Current 1,309 1,470 1,244 Deferred (160) 116 1,146 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 2,328 $ 2,339 $ 2,971 ==================================================================================================================================== * Including U.S. tax on foreign income. PRE-TAX DOMESTIC AND FOREIGN INCOME WAS AS FOLLOWS FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000: (in millions) - -------------------------------------------------------------------------------- 2002 2001 2000 - -------------------------------------------------------------------------------- Domestic* $ 3,397 $ 3,860 $ 6,471 Foreign* 4,745 4,279 3,552 - -------------------------------------------------------------------------------- Total $ 8,142 $ 8,139 $10,023 ================================================================================ * The components of domestic and foreign income and tax expense reflect the location in which the income and tax expense was generated and incurred, respectively. 83
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 3. FEDERAL INCOME TAXES (continued) (C) THE COMPONENTS OF THE NET DEFERRED TAX LIABILITY AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- 2002 2001 ================================================================================ Deferred tax assets: Loss reserve discount $ 1,317 $ 1,269 Unearned premium reserve reduction 465 365 Adjustment to life policy reserves 2,473 1,970 Accruals not currently deductible, cumulative translation adjustment and other 3,035 2,098 - -------------------------------------------------------------------------------- 7,290 5,702 - -------------------------------------------------------------------------------- Deferred tax liabilities: Deferred policy acquisition costs 5,534 4,357 Financial service products mark to market differential 641 622 Depreciation of flight equipment 2,403 1,928 Unrealized appreciation of investments 2,003 590 Other 998 1,086 - -------------------------------------------------------------------------------- 11,579 8,583 - -------------------------------------------------------------------------------- Net deferred tax liability $ 4,289 $ 2,881 ================================================================================ 4. DEFERRED POLICY ACQUISITION COSTS THE FOLLOWING REFLECTS THE POLICY ACQUISITION COSTS DEFERRED FOR AMORTIZATION AGAINST FUTURE INCOME AND THE RELATED AMORTIZATION CHARGED TO INCOME FOR GENERAL AND LIFE INSURANCE OPERATIONS, EXCLUDING CERTAIN AMOUNTS DEFERRED AND AMORTIZED IN THE SAME PERIOD: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 General insurance operations: Balance at beginning of year $ 2,651 $ 2,438 $ 2,132 - -------------------------------------------------------------------------------- Acquisition costs deferred Commissions 1,604 1,012 876 Other 1,505 1,217 1,138 - -------------------------------------------------------------------------------- 3,109 2,229 2,014 - -------------------------------------------------------------------------------- Amortization charged to income Commissions 1,025 880 748 Other 1,251 1,136 960 - -------------------------------------------------------------------------------- 2,276 2,016 1,708 - -------------------------------------------------------------------------------- Balance at end of year $ 3,484 $ 2,651 $ 2,438 ================================================================================ Life insurance operations: Balance at beginning of year $ 16,706 $ 15,298 $ 14,552 - -------------------------------------------------------------------------------- Addition from acquisitions 358 874 -- Acquisition costs deferred Commissions 2,714 2,244 2,117 Other 1,734 1,341 943 - -------------------------------------------------------------------------------- 4,806 4,459 3,060 - -------------------------------------------------------------------------------- Amortization charged to income Commissions 1,215 1,009 1,376 Other* 969 1,198 182 - -------------------------------------------------------------------------------- 2184 2,207 1,558 Effect of net unrealized gains (losses) on securities (951) (467) (361) - -------------------------------------------------------------------------------- Increase (decrease) due to foreign exchange 395 (377) (395) - -------------------------------------------------------------------------------- Balance at end of year $ 18,772 $ 16,706 $ 15,298 ================================================================================ Total deferred policy acquisition costs $ 22,256 $ 19,357 $ 17,736 ================================================================================ * Includes adjustments as a result of changes in the net unrealized gains or losses on debt and equity securities available for sale. Such adjustments were included with the change in net unrealized gains/losses on debt and equity securities available for sale that were credited or charged directly to comprehensive income. 84
American International Group, Inc. and Subsidiaries 5. REINSURANCE In the ordinary course of business, AIG's general and life insurance companies cede reinsurance to other insurance companies in order to provide greater diversification of AIG's business and limit the potential for losses arising from large risks. General reinsurance is effected under reinsurance treaties and by negotiation on individual risks. Certain of these reinsurance arrangements consist of excess of loss contracts which protect AIG against losses over stipulated amounts. Ceded premiums are considered prepaid reinsurance premiums and are amortized into income over the contract period in proportion to the protection received. Amounts recoverable from general reinsurers are estimated in a manner consistent with the claims liabilities associated with the reinsurance and presented as a component of reinsurance assets. AIG life companies limit exposure to loss on any single life. For ordinary insurance, AIG retains a maximum of approximately $1.5 million dollars of coverage per individual life with respect to AIG's overseas life operations and $2.5 million of coverage per individual life with respect to AIG's domestic life operations. There are smaller retentions for other lines of business. Life reinsurance is effected principally under yearly renewable term treaties. The premiums with respect to these treaties are considered prepaid reinsurance premiums and are amortized into income over the contract period in proportion to the protection provided. Amounts recoverable from life reinsurers are estimated in a manner consistent with the assumptions used for the underlying policy benefits and are presented as a component of reinsurance assets. GENERAL INSURANCE PREMIUMS WRITTEN AND EARNED WERE COMPRISED OF THE FOLLOWING: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, WRITTEN EARNED ================================================================================ 2002 GROSS PREMIUMS $ 37,537 $ 34,381 CEDED PREMIUMS (10,123) (10,112) - -------------------------------------------------------------------------------- NET PREMIUMS $ 27,414 $ 24,269 ================================================================================ 2001 Gross premiums $ 29,640 $ 28,850 Ceded premiums (9,539) (9,485) - -------------------------------------------------------------------------------- Net premiums $ 20,101 $ 19,365 ================================================================================ 2000 Gross premiums $ 25,050 $ 24,062 Ceded premiums (7,524) (6,655) - -------------------------------------------------------------------------------- Net premiums $ 17,526 $ 17,407 ================================================================================ For the years ended December 31, 2002, 2001 and 2000, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $10.28 billion, $8.80 billion and $6.00 billion, respectively. LIFE INSURANCE NET PREMIUM INCOME WAS COMPRISED OF THE FOLLOWING: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ Gross premium income $ 21,237 $ 19,978 $ 17,925 Ceded premiums (917) (915) (762) - -------------------------------------------------------------------------------- Net premium income $ 20,320 $ 19,063 $ 17,163 ================================================================================ Life insurance recoveries, which reduced death and other benefits, approximated $624 million, $646 million and $331 million, respectively, for the years ended December 31, 2002, 2001 and 2000. AIG's reinsurance arrangements do not relieve AIG from its direct obligation to its insureds. Thus, a credit exposure exists with respect to both general and life reinsurance ceded to the extent that any reinsurer is unable to meet the obligations assumed under the reinsurance agreements. AIG holds substantial collateral as security under related reinsurance agreements in the form of funds, securities and/or letters of credit. A provision has been recorded for estimated unrecoverable reinsurance. AIG has been largely successful in prior recovery efforts. AIG evaluates the financial condition of its reinsurers through an internal reinsurance security committee consisting of members of AIG's senior management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract. LIFE INSURANCE CEDED TO OTHER INSURANCE COMPANIES WAS AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ Life insurance in-force $278,704 $238,644 $185,705 Life insurance assumed represented 0.2 percent of gross life insurance in-force at December 31, 2002, 2001 and 2000 and life insurance premium income assumed represented 0.2 percent, 0.3 percent and 0.4 percent of gross premium income for the periods ended December 31, 2002, 2001 and 2000. 85
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 5. REINSURANCE (continued) SUPPLEMENTAL INFORMATION FOR GROSS LOSS AND BENEFIT RESERVES NET OF CEDED REINSURANCE AT DECEMBER 31, 2002 AND 2001 FOLLOWS: (in millions) - -------------------------------------------------------------------------------- AS NET OF REPORTED REINSURANCE ================================================================================ 2002 Reserve for losses and loss expenses $(51,539) $(30,350) Future policy benefits for life and accident and health insurance contracts (72,547) (71,436) Premiums and insurance balances receivable-net 13,088 17,279 Reserve for unearned premiums (16,336) (12,945) Reinsurance assets 29,882 -- ================================================================================ 2001 Reserve for losses and loss expenses $(44,792) $(25,896) Future policy benefits for life and accident and health insurance contracts (64,998) (63,894) Premiums and insurance balances receivable-net 12,412 16,233 Reserve for unearned premiums (13,148) (9,770) Reinsurance assets 27,199 -- ================================================================================ 6. RESERVE FOR LOSSES AND LOSS EXPENSES AND FUTURE LIFE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS (A) THE FOLLOWING ANALYSIS PROVIDES A RECONCILIATION OF THE ACTIVITY IN THE RESERVE FOR LOSSES AND LOSS EXPENSES: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ At beginning of year: Reserve for losses and loss expenses $ 44,792 $ 40,613 $ 38,252 Reinsurance recoverable (18,896) (15,661) (13,652) - -------------------------------------------------------------------------------- 25,896 24,952 24,600 - -------------------------------------------------------------------------------- Acquisitions -- -- 236 - -------------------------------------------------------------------------------- Losses and loss expenses incurred: Current year 16,741 14,870 13,356 Prior years 4,073 536 (252) - -------------------------------------------------------------------------------- Total 20,814 15,406 13,104 ================================================================================ Losses and loss expenses paid: Current year 5,964 5,199 5,205 Prior years 10,396 9,263 7,783 - -------------------------------------------------------------------------------- Total 16,360 14,462 12,988 ================================================================================ At end of year: Net reserve for losses and loss expenses 30,350 25,896 24,952 Reinsurance recoverable 21,189 18,896 15,661 - -------------------------------------------------------------------------------- Total $ 51,539 $ 44,792 $ 40,613 ================================================================================ (B) THE ANALYSIS OF THE FUTURE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS LIABILITIES AS AT DECEMBER 31, 2002 AND 2001 FOLLOWS: (in millions) - -------------------------------------------------------------------------------- 2002 2001 ================================================================================ Future policy benefits: Long duration contracts $ 70,096 $ 63,013 Short duration contracts 2,451 1,985 Total $ 72,547 $ 64,998 Policyholders' contract deposits: Annuities $ 84,903 $ 72,100 Guaranteed investment contracts (GICs)* 37,772 31,551 Corporate life products 2,124 1,977 Universal life 13,080 11,869 Other investment contracts 4,281 1,905 - -------------------------------------------------------------------------------- Total $142,160 $119,402 ================================================================================ * Includes approximately $29 billion and $22 billion in the respective years in connection with GIC Programs. See discussion in Note 20 "Special Purpose Vehicles." (C) Long duration contract liabilities included in future policy benefits, as presented in the table above, result from traditional life products. Short duration contract liabilities are primarily accident and health products. The liability for future life policy benefits has been established based upon the following assumptions: (i) Interest rates (exclusive of immediate/terminal funding annuities), which vary by territory, year of issuance and products, range from 1.5 percent to 12.0 percent within the first 20 years. Interest rates on immediate/terminal funding annuities are at a maximum of 11.2 percent and grade to not greater than 6.2 percent. (ii) Mortality and surrender rates are based upon actual experience by geographical area modified to allow for variations in policy form. The weighted average lapse rate, including surrenders, for individual and group life approximated 7.3 percent. (iii) The portions of current and prior net income and of current unrealized appreciation of investments that can inure to the benefit of AIG are restricted in some cases by the insurance contracts and by the local insurance regulations of the countries in which the policies are in force. (iv) Participating life business represented approximately 28 percent of the gross insurance in-force at December 31, 2002 and 39 percent of gross premium income in 2002. The amount of annual dividends to be paid is determined locally by the Boards of Directors. Provisions for future dividend payments are computed by jurisdiction, reflecting local regulations. (D) The liability for policyholders' contract deposits has been established based on the following assumptions: (i) Interest rates credited on deferred annuities, which vary by territory and year of issuance, range from 1.5 percent to 9.3 percent. Current declared interest rates are generally guaranteed to remain in effect for a period of one year though 86
American International Group, Inc. and Subsidiaries 6. RESERVE FOR LOSSES AND LOSS EXPENSES AND FUTURE LIFE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS (continued) some are guaranteed for longer periods. Withdrawal charges generally range from zero percent to 18.0 percent grading to zero over a period of zero to 15 years. (ii) Domestically, GICs have market value withdrawal provisions for any funds withdrawn other than benefit responsive payments. Interest rates credited generally range from 1.2 percent to 9.0 percent. The vast majority of these GICs mature within 10 years. Overseas, interest rates credited on GICs generally range from 2.1 percent to 7.3 percent and maturities range from 1 to 5 years. (iii) Interest rates on corporate life insurance products are guaranteed at 4.0 percent and the weighted average rate credited in 2002 was 5.8 percent. (iv) The universal life funds have credited interest rates of 3.8 percent to 7.5 percent and guarantees ranging from 3.0 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 11.4 percent of the aggregate fund balance grading to zero over a period not longer than 20 years. (E) Certain products, which are short duration contracts, are subject to experience adjustments. These include group life and group medical products, credit life contracts, accident & health insurance contracts/riders attached to life policies and, to a limited extent, reinsurance agreements with other direct insurers. Ultimate premiums from these contracts are estimated and recognized as revenue and the unearned portions of the premiums are held as reserves. Experience adjustments vary according to the type of contract and the territory in which the policy is in force and are subject to local regulatory guidance. 7. STATUTORY FINANCIAL DATA STATUTORY SURPLUS AND NET INCOME FOR GENERAL INSURANCE AND LIFE INSURANCE OPERATIONS AS REPORTED TO REGULATORY AUTHORITIES WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ Statutory surplus: General insurance $16,765(A) $17,717 $16,934 Life insurance 22,716 18,302 16,849 Statutory net income (b): General insurance 277(A) 1,922 2,508 Life insurance 2,529 2,106 2,314 ================================================================================ (a) Includes loss reserve charge, net of t ax of $1.8 billion. (b) Includes net realized capital gains and losses. AIG's insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulatory authorities. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect deferred policy acquisition costs and deferred income taxes, all bonds are carried at amortized cost and reinsurance assets and liabilities are presented net of reinsurance. AIG's use of permitted statutory accounting practices does not have a significant impact on statutory surplus. 8. INVESTMENT INFORMATION (A) STATUTORY DEPOSITS: Cash and securities with carrying values of $5.20 billion and $4.55 billion were deposited by AIG's subsidiaries under requirements of regulatory authorities as of December 31, 2002 and 2001, respectively. (B) NET INVESTMENT INCOME: AN ANALYSIS OF THE NET INVESTMENT INCOME FROM THE GENERAL AND LIFE INSURANCE OPERATIONS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ General insurance: Fixed maturities $ 1,793 $ 1,811 $ 1,815 Equity securities 245 269 214 Short-term investments 37 64 70 Other 804 941 745 - -------------------------------------------------------------------------------- Total investment income 2,879 3,085 2,844 Investment expenses 119 192 143 - -------------------------------------------------------------------------------- Net investment income $ 2,760 $ 2,893 $ 2,701 ================================================================================ Life insurance: Fixed maturities $10,381 $ 9,018 $ 8,263 Equity securities 98 146 112 Short-term investments 245 281 332 Interest on mortgage, policy and collateral loans 1,137 1,141 1,075 Other 669 863 479 - -------------------------------------------------------------------------------- Total investment income 12,530 11,449 10,261 Investment expenses 256 365 299 - -------------------------------------------------------------------------------- Net investment income $12,274 $11,084 $ 9,962 ================================================================================ 87
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. INVESTMENT INFORMATION (continued) (C) INVESTMENT GAINS AND LOSSES: THE REALIZED CAPITAL GAINS (LOSSES) AND INCREASE (DECREASE) IN UNREALIZED APPRECIATION OF INVESTMENTS WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ================================================================================ Realized capital gains (losses) on investments: Fixed maturities (a) $ (989) $ (525) $ (622) Equity securities (879) (114) 340 Other (573) (197) (32) - -------------------------------------------------------------------------------- Realized capital gains (losses) $(2,441) $ (836) $ (314) ================================================================================ Increase (decrease) in unrealized appreciation of investments: Fixed maturities $ 6,600 $ 3,827 $ 2,782 Equity securities 116 (528) (897) Other (b) (1,989) (1,264) (418) - -------------------------------------------------------------------------------- Increase (decrease) in unrealized appreciation $ 4,727 $ 2,035 $ 1,467 ================================================================================ (a) The realized gains (losses) resulted primarily from the disposition of available for sale fixed maturities. (b) Includes $758 million increase, $598 million increase and $51 million increase in unrealized appreciation attributable to participating policy-holders at December 31, 2002, 2001 and 2000, respectively. THE GROSS GAINS AND GROSS LOSSES REALIZED ON THE DISPOSITION OF AVAILABLE FOR SALE SECURITIES WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- GROSS GROSS REALIZED REALIZED GAINS LOSSES ================================================================================ 2002 Bonds $1,811 $2,800 Common stocks 363 1,192 Preferred stocks 12 62 Financial services securities available for sale 2 1 - -------------------------------------------------------------------------------- Total $2,188 $4,055 ================================================================================ 2001 Bonds $1,475 $1,969 Common stocks 437 527 Preferred stocks 14 38 Financial services securities available for sale 7 2 - -------------------------------------------------------------------------------- Total $1,933 $2,536 ================================================================================ 2000 Bonds $ 393 $1,001 Common stocks 791 397 Preferred stocks 47 27 Financial services securities available for sale 8 -- - -------------------------------------------------------------------------------- Total $1,239 $1,425 ================================================================================ (D) MARKET VALUE OF FIXED MATURITIES AND UNREALIZED APPRECIATION OF INVESTMENTS: At December 31, 2002 and 2001, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $261 million and $403 million and gross losses of approximately $1.0 billion and $1.3 billion, respectively. The deferred tax liability related to the net unrealized appreciation of investments was $2.0 billion at December 31, 2002 and the deferred tax liability related to the net unrealized appreciation of investments was $590 million at December 31, 2001. THE AMORTIZED COST AND ESTIMATED MARKET VALUE OF BONDS AVAILABLE FOR SALE AND CARRIED AT MARKET VALUE AT DECEMBER 31, 2002 AND 2001 WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ================================================================================ 2002 Fixed maturities available for sale: Bonds: U.S. Government (a) $ 4,916 $ 248 $ 12 $ 5,152 States (b) 41,533 1,984 106 43,411 Foreign governments 33,885 3,371 51 37,205 All other corporate 151,787 8,818 3,988 156,617 - -------------------------------------------------------------------------------- Total bonds $232,121 $ 14,421 $ 4,157 $242,385 ================================================================================ 2001 Fixed maturities available for sale: Bonds: U.S. Government (a) $ 3,750 $ 121 $ 28 $ 3,843 States (b) 34,202 939 320 34,821 Foreign governments 28,220 2,023 98 30,145 All other corporate 129,939 3,979 2,953 130,965 - -------------------------------------------------------------------------------- Total bonds $196,111 $ 7,062 $ 3,399 $199,774 ================================================================================ (a) Including U.S. Government agencies and authorities. (b) Including municipalities and political subdivisions. 88
American International Group, Inc. and Subsidiaries 8. INVESTMENT INFORMATION (continued) THE AMORTIZED COST AND ESTIMATED MARKET VALUES OF FIXED MATURITIES AVAILABLE FOR SALE AT DECEMBER 31, 2002, BY CONTRACTUAL MATURITY, ARE SHOWN BELOW. ACTUAL MATURITIES MAY DIFFER FROM CONTRACTUAL MATURITIES BECAUSE CERTAIN BORROWERS HAVE THE RIGHT TO CALL OR PREPAY CERTAIN OBLIGATIONS WITH OR WITHOUT CALL OR PREPAYMENT PENALTIES. (in millions) - -------------------------------------------------------------------------------- ESTIMATED AMORTIZED MARKET COST VALUE ================================================================================ Fixed maturities available for sale: Due in one year or less $ 11,943 $ 12,163 Due after one year through five years 48,802 50,446 Due after five years through ten years 72,297 75,497 Due after ten years 99,079 104,279 - -------------------------------------------------------------------------------- Total available for sale $232,121 $242,385 ================================================================================ (E) SECURITIES AVAILABLE FOR SALE: AIGFP follows a policy of minimizing interest rate, equity and currency risks associated with securities available for sale by entering into swap or other transactions. In addition, to reduce its credit risk, AIGFP has entered into credit derivative transactions with respect to $66 million of securities available for sale. At December 31, 2002, the cumulative decrease in carrying value of the securities available for sale and related hedges as a result of marking to market such securities net of hedging transactions was $28 million. THE AMORTIZED COST, RELATED HEDGES AND ESTIMATED MARKET VALUE OF SECURITIES AVAILABLE FOR SALE AND CARRIED AT MARKET VALUE AT DECEMBER 31, 2002 AND 2001 WERE AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------ UNREALIZED GAINS GROSS GROSS (LOSSES) - NET ESTIMATED AMORTIZED UNREALIZED UNREALIZED ON HEDGING MARKET COST GAINS LOSSES TRANSACTIONS* VALUE ====================================================================================================== 2002 Securities available for sale: Corporate and bank debt $ 9,595 $ 848 $ 86 $ (777) $ 9,580 Foreign government obligations 63 13 1 (12) 63 Asset-backed and collateralized 4,181 535 (10) (572) 4,154 Preferred stocks 1,192 40 7 (31) 1,194 U.S. Government obligations 1,684 147 (2) (137) 1,696 Total $16,715 $ 1,583 $ 82 $(1,529) $16,687 2001 Securities available for sale: Corporate and bank debt $10,936 $ 198 $ 352 $ 183 $10,965 Foreign government obligations 1,154 8 7 (1) 1,154 Asset-backed and collateralized 4,276 98 83 (41) 4,250 Preferred stocks 1,204 1 14 19 1,210 U.S. Government obligations 223 12 3 (10) 222 Total $17,793 $ 317 $ 459 $ 150 $17,801 * The cumulative decrease in carrying value of securities available for sale and related hedges as a result of marking to market such securities net of hedging transactions was $28 million. 89
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 8. INVESTMENT INFORMATION (continued) THE AMORTIZED COST AND ESTIMATED MARKET VALUES OF SECURITIES AVAILABLE FOR SALE AT DECEMBER 31, 2002, BY CONTRACTUAL MATURITY, ARE SHOWN BELOW. ACTUAL MATURITIES MAY DIFFER FROM CONTRACTUAL MATURITIES BECAUSE CERTAIN BORROWERS HAVE THE RIGHT TO CALL OR PREPAY CERTAIN OBLIGATIONS WITH OR WITHOUT CALL OR PREPAYMENT PENALTIES. (in millions) - -------------------------------------------------------------------------------- ESTIMATED AMORTIZED MARKET COST VALUE ================================================================================ Securities available for sale: Due in one year or less $ 3,393 $ 3,419 Due after one year through five years 3,801 3,807 Due after five years through ten years 1,480 1,478 Due after ten years 3,860 3,829 Asset-backed and collateralized 4,181 4,154 - -------------------------------------------------------------------------------- Total securities available for sale $16,715 $16,687 ================================================================================ Only an insignificant amount of securities available for sale were below investment grade at December 31, 2002. (F) FINANCE RECEIVABLES: FINANCE RECEIVABLES, NET OF UNEARNED FINANCE CHARGES, WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 Real estate loans $ 9,819 $ 7,980 $ 7,670 Non-real estate loans 3,138 3,288 3,157 Credit card loans 1,215 1,091 757 Retail sales finance 1,888 1,845 1,730 Other loans 274 283 505 - -------------------------------------------------------------------------------- Total finance receivables 16,334 14,487 13,819 Allowance for losses (477) (532) (492) - -------------------------------------------------------------------------------- Finance receivables, net $ 15,857 $ 13,955 $ 13,327 ================================================================================ (G) CMOS: At December 31, 2002, CMOs, held by AIG's life companies, were presented as a component of bonds available for sale, at market value. Substantially all of the CMOs were investment grade and approximately 24 percent of the CMOs were backed by various U.S. government agencies. The remaining 76 percent were corporate issuances. THE DISTRIBUTION OF THE CMOS AT DECEMBER 31, 2002 AND 2001 WAS AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- 2002 2001 ================================================================================ GNMA 1% 3% FHLMC 13 12 FNMA 9 10 VA 1 1 Non-governmental 76 74 - -------------------------------------------------------------------------------- 100% 100% ================================================================================ AIG is not exposed to any significant credit concentration risk of a single or group non-governmental issuer. At December 31, 2002, the gross weighted average coupon of this portfolio was 6.09 percent. The gross weighted average life of this portfolio was approximately 5.10 years. At December 31, 2002 and 2001, the market value of the CMO portfolio was $35.61 billion and $32.62 billion, respectively; the amortized cost was approximately $34.30 billion in 2002 and $32.20 billion in 2001. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 2002 and 2001. (H) FIXED MATURITIES BELOW INVESTMENT GRADE: At December 31, 2002, fixed maturities held by AIG that were below investment grade or not rated totaled $23.94 billion. (I) At December 31, 2002, non-income producing invested assets were insignificant. 90
American International Group, Inc. and Subsidiaries 9. DEBT OUTSTANDING AT DECEMBER 31, 2002, AIG'S DEBT OUTSTANDING OF $71.89 BILLION, SHOWN BELOW, INCLUDED BORROWINGS OF $64.98 BILLION WHICH WERE EITHER NOT GUARANTEED BY AIG OR WERE MATCHED BORROWINGS UNDER OBLIGATIONS OF GUARANTEED INVESTMENT AGREEMENTS (GIAS) OR MATCHED NOTES AND BONDS PAYABLE. (in millions) - -------------------------------------------------------------------------------- Borrowings under obligations of GIAs - AIGFP $14,850 ================================================================================ Commercial Paper: ILFC (a) 4,213 AGF (a) 2,956 Funding 1,645 AIGCCC - Taiwan (a) 234 AIGF - Taiwan (a) 64 - -------------------------------------------------------------------------------- Total 9,112 - -------------------------------------------------------------------------------- Medium Term Notes: AGF (a) 7,719 ILFC (a) 4,970 AIG 998 - -------------------------------------------------------------------------------- Total 13,687 - -------------------------------------------------------------------------------- Notes and Bonds Payable: AIGFP 16,940 ILFC(a) (b) 9,825 AGF (a) 2,266 AIG 1,608 AGC 1,542 - -------------------------------------------------------------------------------- Total 32,181 - -------------------------------------------------------------------------------- Loans and Mortgages Payable: AIGCFG (a) 735 AIG 697 ILFC (a) (c) 261 AIG Finance (Hong Kong) Limited (a) 229 Other subsidiaries (a) 133 - -------------------------------------------------------------------------------- Total 2,055 - -------------------------------------------------------------------------------- Total Borrowings 71,885 - -------------------------------------------------------------------------------- Borrowings not guaranteed by AIG 33,605 Matched GIA borrowings - AIGFP 14,850 Matched notes and bonds payable - AIGFP 16,526 64,981 Remaining borrowings of AIG $ 6,904 ================================================================================ (a) AIG does not guarantee these borrowings. (b) Includes borrowings under Export Credit Facility of $2.09 billion. (c) Capital lease obligations. The amount of long-term borrowings is $49.42 billion and the amount of short-term borrowings is $22.47 billion. Long-term borrowings include commercial paper and short-term borrowings represent borrowings that mature in less than one year. (A) BORROWINGS UNDER OBLIGATIONS OF GUARANTEED INVESTMENT AGREEMENTS: Borrowings under obligations of guaranteed investment agreements, which are guaranteed by AIG, are recorded at the amount outstanding under each contract. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings are primarily fixed, vary by maturity, and range up to 9.8 percent. PAYMENTS DUE UNDER THESE INVESTMENT AGREEMENTS IN EACH OF THE NEXT FIVE YEARS ENDING DECEMBER 31, AND THE PERIODS THEREAFTER BASED ON THE EARLIEST CALL DATES, WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $ 5,756 2004 677 2005 383 2006 196 2007 180 Remaining years after 2007 7,658 - -------------------------------------------------------------------------------- Total $14,850 ================================================================================ At December 31, 2002, the market value of securities pledged as collateral with respect to these obligations approximated $4.8 billion. Funds received from GIA borrowings are invested in a diversified portfolio of securities and derivative transactions. (B) COMMERCIAL PAPER: AT DECEMBER 31, 2002, THE COMMERCIAL PAPER ISSUED AND OUTSTANDING WAS AS FOLLOWS: (dollars in millions) - -------------------------------------------------------------------------------- UNAMORTIZED WEIGHTED WEIGHTED NET DISCOUNT AVERAGE AVERAGE BOOK AND ACCRUED FACE INTEREST MATURITY VALUE INTEREST AMOUNT RATE IN DAYS ================================================================================ ILFC $4,213 $ 6 $4,219 1.46% 35 AGF 2,956 3 2,959 1.43 33 Funding 1,645 1 1,646 1.45 20 AIGCCC - Taiwan* 234 1 235 2.61 31 AIGF - Taiwan* 64 -- 64 4.09 60 - -------------------------------------------------------------------------------- Total $9,112 $ 11 $9,123 -- -- ================================================================================ * Issued in Taiwan N.T. dollars at prevailing local interest rates. At December 31, 2002, AIG did not guarantee the commercial paper of any of its subsidiaries other than Funding. On July 8, 2002, AGC ceased issuing commercial paper under its program. AGC's funding requirements are now being met through Funding's commercial paper program. 91
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. DEBT OUTSTANDING (continued) (C) MEDIUM TERM NOTES PAYABLE: (i) Medium Term Notes Payable Issued by AGF: AGF's Medium Term Notes are unsecured obligations which generally may not be redeemed by AGF prior to maturity and bear interest at either fixed rates set by AGF at issuance or variable rates determined by reference to an interest rate or other formula. As of December 31, 2002, notes aggregating $7.72 billion were outstanding with maturity dates ranging from 2003 to 2012 at interest rates ranging from 1.48 percent to 7.95 percent. To the extent deemed appropriate, AGF may enter into swap transactions to reduce its effective borrowing rates with respect to these notes. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR AGF'S OUTSTANDING MEDIUM TERM NOTES WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $ 625 2004 1,898 2005 1,080 2006 1,274 2007 1,356 Remaining years after 2007 1,486 - -------------------------------------------------------------------------------- Total $7,719 ================================================================================ (ii) Medium Term Notes Payable Issued by ILFC: ILFC's Medium Term Notes are unsecured obligations which may not be redeemed by ILFC prior to maturity and bear interest at fixed rates set by ILFC at issuance. As of December 31, 2002, notes aggregating $4.97 billion were outstanding with maturity dates from 2003 to 2007 at interest rates ranging from 3.95 percent to 8.26 percent. These notes provide for a single principal payment at the maturity of each note. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR ILFC'S OUTSTANDING MEDIUM TERM NOTES WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $2,447 2004 1,053 2005 850 2006 250 2007 370 - -------------------------------------------------------------------------------- Total $4,970 ================================================================================ (iii) Medium Term Notes Payable Issued by AIG: AIG's Medium Term Notes are unsecured obligations which generally may not be redeemed by AIG prior to maturity and bear interest at either fixed rates set by AIG at issuance or variable rates determined by reference to an interest rate or other formula. AN ANALYSIS OF AIG'S MEDIUM TERM NOTES FOR THE YEAR ENDED DECEMBER 31, 2002 WAS AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- AIG SUNAMERICA INC. TOTAL ================================================================================ Balance December 31, 2001 $371 $171 $542 Issued during year 504 -- 504 Matured during year (24) (24) (48) - -------------------------------------------------------------------------------- BALANCE DECEMBER 31, 2002 $851 $147 $998 ================================================================================ The interest rates on AIG's Medium Term Notes range from 0.50 percent to 4.52 percent. To the extent deemed appropriate, AIG may enter into swap transactions to reduce its effective borrowing rates with respect to these notes. At December 31, 2002, Medium Term Notes issued by SunAmerica Inc. aggregating $147 million had maturity dates ranging from 2003 to 2026 at interest rates ranging from 6.03 percent to 7.34 percent. During 2000, AIG issued $210 million of equity-linked Medium Term Notes due May 15, 2007. These notes accrue interest at the rate of 0.50 percent and the total return on these notes is linked to the appreciation in market value of AIG's common stock. The notes may be redeemed, at the option of AIG, as a whole but not in part, at any time on or after May 15, 2003. In conjunction with the issuance of these notes, AIG entered into a series of swap transactions which effectively converted its interest expense to a fixed rate of 7.17 percent until May 15, 2003 and 0.50 percent thereafter and transferred the equity appreciation exposure to a third party for the life of the notes. AIG is exposed to credit risk with respect to the counterparties to these swap transactions. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR AIG'S OUTSTANDING MEDIUM TERM NOTES, INCLUDING THOSE ISSUED BY SUNAMERICA INC., WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $162 2004 23 2005 555 2006 24 2007 210 Remaining years after 2007 24 - -------------------------------------------------------------------------------- Total $998 ================================================================================ At December 31, 2002, AIG had $140 million of debt securities registered and available for issuance from time to time. 92
American International Group, Inc. and Subsidiaries 9. DEBT OUTSTANDING (continued) (D) NOTES AND BONDS PAYABLE: (I) NOTES AND BONDS PAYABLE ISSUED BY AIGFP: AT DECEMBER 31, 2002, AIGFP'S NOTES AND BONDS OUTSTANDING, THE PROCEEDS OF WHICH ARE INVESTED IN A SEGREGATED PORTFOLIO OF SECURITIES AVAILABLE FOR SALE, WERE AS FOLLOWS: (dollars in millions) - -------------------------------------------------------------------------------- RANGE OF RANGE OF INTEREST U.S. DOLLAR MATURITIES CURRENCY RATES CARRYING VALUE ================================================================================ 2003-2031 U.S. dollar 1.21-6.29% $ 8,016 2003-2026 United Kingdom pound 3.69-5.74 2,555 2003 Euro 2.82-7.76 1,612 2006-2008 New Zealand dollar 6.30-8.35 628 2003 Japanese yen 0.03-4.50 342 - -------------------------------------------------------------------------------- Total $13,153 ================================================================================ AIGFP is also obligated under various bonds maturing from 2003 through 2042. The majority of these notes are denominated in U.S. dollars, Euros and Japanese yen. The weighted average interest rate of these bonds is 4.06 percent. At December 31, 2002, the remaining bonds had a U.S. dollar carrying value of $3.79 billion. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR AIGFP'S NOTES AND BONDS PAYABLE WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $ 9,024 2004 1,706 2005 545 2006 596 2007 387 Remaining years after 2007 4,682 - -------------------------------------------------------------------------------- Total $16,940 ================================================================================ AIG guarantees all of AIGFP's debt. (ii) Notes Issued by ILFC: ILFC has issued unsecured obligations which may not be redeemed prior to maturity. As of December 31, 2002, notes aggregating $7.48 billion were outstanding with maturity dates from 2003 to 2009 and interest rates ranging from 3.32 percent to 8.38 percent. Notes aggregating $1.38 billion are at floating interest rates and the remainder are at fixed rates. These notes provide for a single principal payment at maturity. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR ILFC'S NOTES WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $ 950 2004 1,863 2005 826 2006 700 2007 1,954 Remaining years after 2007 1,182 - -------------------------------------------------------------------------------- Total $7,475 ================================================================================ ILFC had $6.08 billion of debt securities registered for public sale at December 31, 2002. During the second quarter of 2002, ILFC expanded its Euro Medium Term Note Program from $2.0 billion to $4.0 billion, under which $2.31 billion in notes were sold through December 31, 2002. ILFC has eliminated the currency exposure arising from the notes by either hedging the notes through swaps, or through the offset provided by operating lease payments. ILFC translates the debt into U.S. dollars using current exchange rates. The foreign exchange adjustment for the euro denominated note was $265 million at December 31, 2002. Notes issued under this program are included in Notes and Bonds Payable in the accompanying table of borrowings. ILFC had a $4.3 billion Export Credit Facility for use in connection with the purchase of approximately 75 aircraft delivered through 2001. This facility was guaranteed by various European Export Credit Agencies. The interest rate varies from 5.75 percent to 5.90 percent on these borrowings depending on the delivery date of the aircraft. At December 31, 2002, ILFC had $2.09 billion outstanding under this facility. The debt is collateralized by a pledge of the shares of a subsidiary of ILFC, which holds title to the aircraft financed under the facility. Borrowings with respect to this facility are included in Notes and Bonds Payable. AT DECEMBER 31, 2002, THE FUTURE MINIMUM PAYMENTS FOR ILFC'S BORROWINGS UNDER THE EXPORT CREDIT FACILITY WERE AS FOLLOWS: (in millions) 2003 $ 284 2004 284 2005 284 2006 284 2007 284 Remaining years after 2007 665 Total $2,085 AIG does not guarantee any of the debt obligations of ILFC. (iii) Notes and Bonds Payable Issued by AGF: As of December 31, 2002, AGF notes aggregating $2.27 billion were outstanding with maturity dates ranging from 2003 to 2009 at interest rates ranging from 5.75 percent to 8.45 percent. These notes provide for a single principal payment at maturity. 93
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 9. DEBT OUTSTANDING (continued) AT DECEMBER 31, 2002, THE MATURITY SCHEDULES FOR AGF TERM NOTES AND BONDS WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $1,368 2004 200 2005 399 2006 -- 2007 -- Remaining years after 2007 299 - -------------------------------------------------------------------------------- Total $2,266 ================================================================================ AGF had $4.3 billion of debt securities registered and available for issuance at December 31, 2002. AGF uses the proceeds from the issuance of notes and bonds for the funding of its finance receivables. AIG does not guarantee any of the debt obligations of AGF. (iv) Notes, Bonds and Debentures Issued by AIG. (A) Zero Coupon Notes: On October 1, 1984, AIG issued Eurodollar zero coupon notes in the aggregate principal amount at stated maturity of $750 million. The notes were offered at 12 percent of principal amount at stated maturity, bear no interest and are due August 15, 2004. The net proceeds to AIG from the issuance were $86 million. The notes are redeemable at any time in whole or in part at the option of AIG at 100 percent of their principal amount at stated maturity. The notes are also redeemable at the option of AIG or bearer notes may be redeemed at the option of the holder in the event of certain changes involving taxation in the United States at prices ranging from 80.78 percent currently, to 89.88 percent after August 15, 2003, of the principal amount at stated maturity together with accrued amortization of original issue discount from the preceding August 15. During 2002 and 2001, no notes were repurchased. At December 31, 2002, the notes outstanding after prior purchases had a face value of $189 million, an unamortized discount of $31 million and a net book value of $158 million. The amortization of the original issue discount was recorded as interest expense. (B) Zero Coupon Convertible Senior Debentures: On November 9, 2001, AIG issued zero coupon convertible senior debentures in the aggregate principal amount at stated maturity of $1.52 billion. The notes were offered at 65.8 percent of principal amount at stated maturity, bear no interest unless contingent interest becomes payable under certain conditions and are due November 9, 2031. The net proceeds to AIG were $990 million. Commencing January 1, 2002, holders may convert the debentures into shares of AIG common stock at a conversion rate of 6.0627 shares per $1,000 principal amount of debentures on any day if AIG's common stock price exceeds 120 percent of the conversion price on the last trading day of the preceding fiscal quarter for a set period of time, and after September 30, 2031, on any day if AIG's common stock price exceeds such amount for one day, subject to certain restrictions. The debentures are redeemable by AIG on or after November 9, 2006 at specified redemption prices. Holders may require AIG to repurchase the debentures at specified repurchase prices on November 9, 2006, 2011, 2016, 2021 and 2026. At December 31, 2002, the debentures outstanding had a face value of $1.52 billion, unamortized discount of $504 million and a net book value of $1.02 billion. The amortization of the original issue discount was recorded as a component of other income (deductions)-net. (C) Italian Lire Bonds: In December, 1991, AIG issued unsecured bonds denominated in Italian Lire that accrued interest at a rate of 11.7 percent per annum. The principal amount of 200 billion Italian Lire Bonds matured December 4, 2001. (D) Notes and Debentures Issued by SunAmerica Inc.: As of December 31, 2002, notes and debentures issued by SunAmerica Inc. aggregating $434 million (net of amortized discount of $41 million) were outstanding with maturity dates from 2007 to 2097 at interest rates ranging from 5.60 percent to 9.95 percent. (v) Notes and Bonds Payable Issued by AGC: As of December 31, 2002, AGC notes aggregating $1.54 billion were outstanding with maturity dates ranging from 2003 to 2029 at interest rates ranging up to 7.75 percent. AT DECEMBER 31, 2002, THE MATURITY SCHEDULES FOR AGC NOTES AND BONDS WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $ 300 2004 149 2005 297 2006 -- 2007 -- Remaining years after 2007 796 - -------------------------------------------------------------------------------- Total $1,542 ================================================================================ As of November 2001, AIG guaranteed the notes and bonds of AGC. During 2002, AGC issued $200 million in notes which matured in March 2003. These notes are included in Notes and Bonds Payable in the accompanying table of borrowings. 94
American International Group, Inc. and Subsidiaries 9. DEBT OUTSTANDING (continued) (E) LOANS AND MORTGAGES PAYABLE: LOANS AND MORTGAGES PAYABLE AT DECEMBER 31, 2002, CONSISTED OF THE FOLLOWING: (in millions) - -------------------------------------------------------------------------------- UNCOLLATERALIZED COLLATERALIZED LOANS LOANS AND PAYABLE MORTGAGES PAYABLE ================================================================================ ILFC $ -- $261 AIG Finance (Hong Kong) Limited 229 -- CFG 735 -- AIG 554 143 Other subsidiaries 67 66 - -------------------------------------------------------------------------------- Total $1,585 $470 ================================================================================ At December 31, 2002, ILFC's capital lease obligations were $261 million. Fixed interest rates with respect to these obligations range from 6.18 percent to 6.89 percent; variable rates are referenced to LIBOR. These obligations mature through 2005. The flight equipment associated with the capital lease obligations had a net book value of $892 million. AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR ILFC'S CAPITAL LEASE OBLIGATIONS, WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $128 2004 113 2005 45 - -------------------------------------------------------------------------------- Total minimum lease obligations 286 Less amount representing interest 25 - -------------------------------------------------------------------------------- Present value of net minimum capital lease obligations $261 ================================================================================ (F) AS OF DECEMBER 31, 2002, THE COMBINED PAYMENTS DUE OF ALL SIGNIFICANT DEBT, EXCLUDING COMMERCIAL PAPER, IN EACH OF THE NEXT FIVE YEARS AND PERIODS THEREAFTER WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $22,468 2004 8,186 2005 5,299 2006 3,406 2007 5,004 Remaining years after 2007 18,410 - -------------------------------------------------------------------------------- Total $62,773 ================================================================================ (G) REVOLVING CREDIT FACILITIES: AIG and Funding are parties to unsecured syndicated revolving credit facilities (collectively, the Facility) aggregating $2.75 billion. The Facility consists of $1.375 billion in a short-term revolving credit facility and $1.375 billion in a five year revolving credit facility. The Facility can be used for general corporate purposes and also to provide backup for AIG's commercial paper programs administered by Funding. There are currently no borrowings outstanding under the Facility, nor were any borrowings outstanding as of December 31, 2002. AGF is a party to unsecured syndicated revolving credit facilities aggregating $3.0 billion. The facilities consist of $1.5 billion in a short-term revolving credit facility and $1.5 billion in a five year revolving credit facility, which support AGF's commercial paper borrowings. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2002. ILFC is a party to unsecured syndicated revolving credit facilities aggregating $3.15 billion to support its commercial paper program. The facilities consist of $2.15 billion in a short-term revolving credit facility and $1.0 billion in a three year revolving credit facility. There are currently no borrowings under these facilities, nor were any borrowings outstanding as of December 31, 2002. (H) INTEREST EXPENSE FOR ALL INDEBTEDNESS: Total interest expense for all indebtedness, net of capitalized interest, aggregated $3.57 billion in 2002, $3.97 billion in 2001 and $3.64 billion in 2000. Capitalized interest was $61 million in 2002, $71 million in 2001 and $69 million in 2000. Cash distributions on the preferred shareholders' equity in subsidiary companies of ILFC and certain AIG SunAmerica, AGC and HSB subsidiaries are accounted for as interest expense and included as minority interest in the consolidated statement of income. The cash distributions for ILFC were approximately $5 million, $15 million and $19 million for the years ended December 31, 2002, 2001 and 2000, respectively. The cash distributions for the AIG SunAmerica subsidiaries were approximately $8 million, $46 million and $62 million for the years ended December 31, 2002, 2001 and 2000, respectively. The cash distributions for AGC subsidiaries were approximately $129 million, $153 million and $158 million for the years ended December 31, 2002, 2001 and 2000, respectively. 95
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 10. PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANIES Preferred shareholders' equity in subsidiary companies represents preferred stocks issued by ILFC and certain SunAmerica, AGC and HSB subsidiaries, wholly owned subsidiaries of AIG. (A) ILFC: At December 31, 2002, the preferred stock consists of 1,000 shares of market auction preferred stock ("MAPS") in two series (Series A and B) of 500 shares each. Each of the MAPS shares has a liquidation value of $100,000 per share and is not convertible. The dividend rate, other than the initial rate, for each dividend period for each series is reset approximately every seven weeks (49 days) on the basis of orders placed in an auction. ILFC repurchased all of the shares of five additional series for their liquidation value in the fourth quarter of 2001 and a sixth in the first six months of 2002. No gains or losses were recognized. During 2001, ILFC extended the term of the Series A to five years at a dividend rate of 5.90 percent. At December 31, 2002, the dividend rate for Series B was 2.15 percent. (B) AIG SUNAMERICA: The preferred stock consists of $350 million liquidation amount of 7.5% Non-Voting Preferred Interests issued by Total Return LLC, a wholly owned subsidiary of AIG SunAmerica, in March 2000. The preferred stock was redeemed in March 2003. In March 2001, SunAmerica Capital Trust II redeemed the 8.35% Trust Originated Preferred Securities for $185 million plus accrued and unpaid dividends to the redemption date. Concurrently, AIG SunAmerica redeemed all of the related 8.35% junior subordinated debentures, due 2044, for $191 million plus accrued interest. In December 2001, SunAmerica Capital Trust III redeemed the 8.30% Trust Originated Preferred Securities for $310 million plus accrued and unpaid dividends to the redemption date. Concurrently, AIG SunAmerica redeemed all of the related 8.30% junior subordinated debentures, due 2045, for $321 million plus accrued interest. (C) AGC: The preferred stock has been issued by five subsidiary trusts (the subsidiaries). The sole assets of these subsidiaries are Junior Subordinated Debentures (Subordinated Debentures) issued by AGC. These subsidiaries have no independent operations. The Subordinated Debentures are eliminated in consolidation. The interest terms and payment dates of the Subordinated Debentures held by the subsidiaries correspond to those of the subsidiaries' preferred securities. AGC's obligations under the Subordinated Debentures and related agreements, when taken together, constitute a full and unconditional guarantee by AGC of payments due on the preferred securities. The Subordinated Debentures are redeemable, under certain conditions, at the option of AGC on a proportionate basis. The preferred stock consists of $100 million liquidation value of 8.05% preferred stock issued by American General Capital III in December 2000, $300 million liquidation value of 8.5% preferred stock issued by American General Capital II in June 2000, $200 million liquidation value of 7.875% preferred stock issued by American General Capital I in September 1999, $500 million liquidation value of 8.125% preferred stock issued by American General Institutional Capital B in March 1997, and $500 million liquidation value of 7.57% preferred stock issued by American General Institutional Capital A in December 1996. In July 2001, $215 million liquidation value of 8.125% preferred stock were redeemed by American General Capital, L.L.C. and $287 million liquidation value of 8.45% preferred stock were redeemed by American General Capital, L.L.C. On March 1, 2000, AGC redeemed 2.3 million shares or $85 million of its 7 percent convertible preferred stock by issuing 3.8 million shares of AGC common stock. On June 30, 2000, holders converted approximately 5 million shares or $250 million of 6 percent convertible preferred securities issued by American General Delaware, L.L.C. into 12.3 million shares of AGC common stock. (D) HSB: The preferred stock consists of $95 million liquidation value of Exchange Capital Securities issued in July 1997 by HSB Capital I, a statutory business trust wholly owned by HSB. The sole assets of HSB Capital I are invested in debt securities of HSB. The capital securities accrue and pay quarterly cash distributions at a variable rate equal to 90 day LIBOR plus 0.91% of the stated liquidation amount of $1,000 per capital security, which rate was 2.29% at December 31, 2002. The capital securities are not redeemable prior to July 15, 2007 and are mandatorily redeemable upon the maturity of the debt securities on July 15, 2027 or the earlier redemption of the debt securities. AIG has issued a guarantee of the obligations of HSB, which together with the terms of the debt securities, the guarantee of HSB with respect to the capital securities, the indenture and the trust agreement with respect to the trust provide a full and unconditional guarantee of payments due on the capital securities. The trust is accounted for as a wholly owned subsidiary of AIG. The debt securities issued to the trust and the common securities issued by the trust to HSB are eliminated in the consolidated balance sheet. 96
American International Group, Inc. and Subsidiaries 11. CAPITAL FUNDS (a) AIG parent depends on its subsidiaries for cash flow in the form of loans, advances and dividends. AIG's insurance subsidiaries are subject to regulatory restrictions on the amount of dividends which can be remitted to AIG parent. These restrictions vary by state. For example, unless permitted by the New York Superintendent of Insurance, general insurance companies domiciled in New York may not pay dividends to shareholders which in any twelve month period exceed the lesser of 10 percent of the company's statutory policyholders' surplus or 100 percent of its "adjusted net investment income", as defined. Generally, less severe restrictions applicable to both general and life insurance companies exist in most of the other states in which AIG's insurance subsidiaries are domiciled. Certain foreign jurisdictions have restrictions which generally cause only a temporary delay in the remittance of dividends. There are also various local restrictions limiting cash loans and advances to AIG by its subsidiaries. Largely as a result of the restrictions, approximately 72 percent of consolidated capital funds were restricted from immediate transfer to AIG parent at December 31, 2002. (b) At December 31, 2002, there were 6,000,000 shares of AIG's $5 par value serial preferred stock authorized, issuable in series. (C) THE COMMON STOCK ACTIVITY FOR THE THREE YEARS ENDED DECEMBER 31, 2002 WAS AS FOLLOWS: ==================================================================================================================================== 2002 2001 2000(a) - ------------------------------------------------------------------------------------------------------------------------------------ Shares outstanding at beginning of year 2,615,431,999 2,622,605,925 1,836,381,824 Acquired during the year (10,959,815) (14,690,943) (19,677,939) Issued pursuant to Restricted Stock Unit Obligations -- 580,843 -- Conversion of preferred stock and securities -- -- 9,317,340 Issued under stock option and purchase plans 4,633,631 6,718,336 7,307,010 Issued in connection with acquisitions 176,076 510,684 17,774,094 Issued under contractual obligations 318,940 297,715 63,277 Stock split effected as stock dividend -- -- 814,956,829 Other (b) -- (590,561) (43,516,510) - ------------------------------------------------------------------------------------------------------------------------------------ Shares outstanding at end of year 2,609,600,831 2,615,431,999 2,622,605,925 ==================================================================================================================================== (a) Outstanding shares have been adjusted to reflect the conversion of all outstanding AGC shares by converting each outstanding share of AGC to 0.5790 shares of AIG. (b) Primarily shares issued to AIG and subsidiaries as part of stock split effected as stock dividend and conversion of SunAmerica Inc. non-transferrable Class B stock to common stock. Common stock increased and retained earnings decreased $2.04 billion in 2000 as a result of a common stock split in the form of 50 percent common stock dividend paid July 28, 2000. 12. 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) Commitments to extend credit are agreements to lend subject to certain conditions. These commitments generally have fixed expiration dates or termination clauses and typically require payment of a fee. These commitments approximated $400 million and $300 million for December 31, 2002 and 2001, respectively. AIG uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. AIG evaluates each counterparty's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by AIG upon extension of credit, is based on management's credit evaluation of the counterparty. (b) AIG and certain of its subsidiaries become parties to financial instruments with market risk resulting from both dealer and end user activities and to reduce currency, interest rate, equity and commodity exposures. To the extent those instruments are carried at their estimated fair value, the elements of currency, interest rate, equity and commodity risks are reflected in the consolidated balance sheet. Collateral is required, at the discretion of AIG, on certain transactions based on the creditworthiness of the counterparty. (c) AIGFP becomes a party to derivative financial instruments in the normal course of its business and to reduce its currency, interest rate and equity exposures. Interest rate, currency and equity risks related to such instruments are reflected in the consolidated financial statements to the extent these instruments are carried at a market or a fair value, whichever is appropriate. The recorded estimated fair values of such instruments may be different than the values that might be realized if AIGFP were required to sell or close out the transactions prior to maturity. AIGFP, in the ordinary course of its operations and as principal, structures derivative transactions to meet the needs of investors who may be seeking to hedge certain aspects of such investors' operations. AIGFP may also enter into derivative transactions for its own account. Such derivative 97
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) transactions include interest rate, currency and equity swaps, swaptions and forward commitments. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. AIGFP typically becomes a principal in the exchange of interest payments between the parties and, therefore, may be exposed to loss, if counter-parties default. Currency and equity swaps are similar to interest rate swaps, but involves the exchange of specific currencies or the cashflows based on the underlying equity securities or indices. Also, they may involve the exchange of principal amounts at the beginning and end of the transaction. Swaptions are options where the holder has the right but not the obligation to enter into a swap transaction or cancel an existing swap transaction. At December 31, 2002, the notional principal amount of the sum of the swap pays and receives approximated $817.4 billion, primarily related to interest rate swaps of approximately $580.0 billion. The notional amounts used to express the extent of involvement in swap transactions represent a standard of measurement of the volume of swaps business of AIGFP. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps. The timing and the amount of cash flows relating to AIGFP's foreign exchange forwards and exchange traded futures and options contracts are determined by each of the respective contractual agreements. THE FOLLOWING TABLE PRESENTS AIGFP'S DERIVATIVES PORTFOLIO BY MATURITY AND TYPE OF DERIVATIVE AT DECEMBER 31, 2002 AND DECEMBER 31, 2001: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ REMAINING LIFE --------------------------------------------- ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL Total YEAR FIVE YEARS TEN YEARS YEARS 2002 2001 ==================================================================================================================================== Interest rate, currency and equity swaps and swaptions: Notional amount:* Interest rate swaps $147,331 $289,463 $128,118 $ 15,082 $579,994 $436,669 Currency swaps 47,120 80,486 42,945 6,436 176,987 139,174 Swaptions and equity swaps 20,672 26,169 9,111 4,484 60,436 58,491 - ------------------------------------------------------------------------------------------------------------------------------------ Total $215,123 $396,118 $180,174 $ 26,002 $817,417 $634,334 ==================================================================================================================================== *Notional amount is not representative of either market risk or credit risk. Futures and forward contracts are contracts for delivery of foreign currencies or financial indices in which the seller/ purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise as a result of movements in current market prices from contracted prices and the potential inability of counter-parties to meet their obligations under the contracts. At December 31, 2002, the contractual amount of AIGFP's futures and forward contracts approximated $54.2 billion. THE FOLLOWING TABLE PRESENTS AIGFP'S FUTURES AND FORWARD CONTRACTS PORTFOLIO BY MATURITY AND TYPE OF DERIVATIVE AT DECEMBER 31, 2002 AND DECEMBER 31, 2001: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ REMAINING LIFE ------------------------------------------------- ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL Total YEAR FIVE YEARS TEN YEARS YEARS 2002 2001 ==================================================================================================================================== Exchange traded futures contracts contractual amount $10,524 -- -- -- $10,524 $10,036 ==================================================================================================================================== Over the counter forward contracts contractual amount $43,220 $ 220 $ 187 -- $43,627 $58,003 ==================================================================================================================================== AIGFP enters into credit derivative transactions in the ordinary course of its business. The overwhelming majority of AIGFP's credit derivatives require AIGFP to provide credit protection on a designated portfolio of loans or debt securities. AIGFP provides such credit protection only on a "second loss" basis, under which AIGFP's payment obligations arise only after credit losses in the designated portfolio exceed a specified threshold amount or level of "first losses." The threshold amount of credit losses that must be realized before AIGFP has any payment obligation is negotiated for each transaction by 98
American International Group, Inc. and Subsidiaries 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) AIGFP to provide that the likelihood of any payment obligation by AIGFP under each transaction is remote, even in severe recessionary market scenarios. In many cases, the credit risk associated with a designated portfolio is tranched into different layers of risk, which are then analyzed and rated by the credit rating agencies. Typically, there will be an equity layer covering the first credit losses in respect of the portfolio up to a specified percentage of the total portfolio, and then successive layers that are rated, generally a BBB rated layer, and A rated layer, an AA rated layer and an AAA rated layer. In transactions that are rated, the risk layer or tranche that is immediately junior to the threshold level above which AIGFP's payment obligation would arise is rated AAA by the rating agencies. For that reason, the risk layer assumed by AIGFP with respect to the designated portfolio in these transactions is often called the "super senior" risk layer, defined as the layer of credit risk senior to a risky layer that has been rated AAA by the credit rating agencies or if the transaction is not rated, equivalent thereto. For example, in a transaction with an equity layer covering credit losses from 0 to 2 percent of the total portfolio, a BBB rated layer covering credit losses from 2 to 4 percent, an A rated layer from 4 to 6 percent, an AA rated layer from 6 to 8 percent and a AAA rated layer from 8 to 11 percent. AIGFP would cover credit losses arising in respect of the portfolio that exceeded an 11 percent first loss threshold amount, and thereby bear risk that is senior to the 8 to 11 percent AAA rated risk layer. AIGFP continually monitors the underlying portfolios to determine whether the credit loss experience for any particular portfolio has caused the likelihood of AIGFP having a payment obligation under the transaction to be greater than super senior risk. AIGFP maintains the ability opportunistically to hedge specific securities in a portfolio and thereby further limit its exposure to loss, AIGFP has hedged outstanding transactions in this manner on occasion. AIGFP has never had a payment obligation under these credit derivatives transactions. Furthermore, based on portfolio credit losses experienced to date under all outstanding transactions, no transaction has experienced credit losses in an amount that has made the likelihood of AIGFP having to make a payment, in AIGFP's view, to be greater than remote, even in severe recessionary market scenarios. At December 31, 2002, the notional amount with respect to AIGFP's credit derivative portfolio was $125.7 billion. AIGFP utilizes various credit enhancements, including letters of credit, guarantees, collateral, credit triggers, credit derivatives and margin agreements to reduce the credit exposure relating to these off-balance sheet financial instruments. AIGFP requires credit enhancements in connection with specific transactions based on, among other things, the creditworthiness of the counterparties and the transaction's size and maturity. In addition, AIGFP's derivative transactions are generally documented under ISDA Master Agreements. Management believes that such agreements provide for legally enforceable set-off and close out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, AIGFP is permitted to set-off its receivables from a counter-party against its payables to the same counterparty arising out of all included transactions. As a result, the net replacement value represents the net sum of estimated positive fair values after the application of netting agreements excluding collateral held. The net exposure to credit risk or the net replacement value of all interest rate, currency, and equity swaps, swaptions and forward commitments approximated $14.98 billion at December 31, 2002 and $10.84 billion at December 31, 2001. The net replacement value for futures and forward contracts approximated $110 million at December 31, 2002 and $64 million at December 31, 2001. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss. AIGFP independently evaluates the creditworthiness of its counterparties, taking into account credit ratings assigned by recognized statistical rating organizations. In addition, AIGFP's credit approval process involves pre-set counterparty, country and industry credit exposure limits and, for particularly credit intensive transactions, obtaining approval from AIG's Credit Risk Committee. The average credit rating of AIGFP's counterparties as a whole (as measured by AIGFP) is equivalent to AA. The maximum potential loss will increase or decrease during the life of the derivative commitments as a function of maturity and market conditions. 99
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) AIGFP DETERMINES COUNTERPARTY CREDIT QUALITY BY REFERENCE TO RATINGS FROM INDEPENDENT RATING AGENCIES OR INTERNAL ANALYSIS. AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY CREDIT QUALITY BY DERIVATIVE PRODUCT WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGFP'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ NET REPLACEMENT VALUE --------------------------------- SWAPS AND FUTURES AND TOTAL Total SWAPTIONS FORWARD CONTRACTS 2002 2001 ==================================================================================================================================== Counterparty credit quality: AAA $ 7,082 $ 95 $ 7,177 $ 4,388 AA 3,856 15 3,871 3,214 A 2,887 -- 2,887 2,498 BBB 1,120 -- 1,120 784 Below investment grade 35 -- 35 23 - ------------------------------------------------------------------------------------------------------------------------------------ Total $14,980 $ 110 $15,090 $10,907 ==================================================================================================================================== AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGFP'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ NET REPLACEMENT VALUE ---------------------------- SWAPS AND FUTURES AND TOTAL Total SWAPTIONS FORWARD CONTRACTS 2002 2001 ==================================================================================================================================== Non-U.S. banks $ 3,310 $ -- $ 3,310 $ 2,464 Insured municipalities 925 -- 925 638 U.S. industrials 2,773 -- 2,773 2,113 Governmental 520 -- 520 563 Non-U.S. financial service 474 -- 474 428 companies Non-U.S. industrials 1,452 -- 1,452 1,289 Special purpose 3,252 -- 3,252 1,851 U.S. banks 416 15 431 72 U.S. financial service companies 1,846 95 1,941 1,211 Supranationals 12 -- 12 278 - ------------------------------------------------------------------------------------------------------------------------------------ Total $14,980 $ 110 $15,090 $10,907 ==================================================================================================================================== Securities sold, but not yet purchased represent obligations of AIGFP to deliver specified securities at their contracted prices, and thereby create a liability to repurchase the securities in the market at prevailing prices. AIGFP monitors and controls its risk exposure on a daily basis through financial, credit and legal reporting systems and, accordingly, believes that it has in place effective procedures for evaluating and limiting the credit and market risks to which it is subject. Management is not aware of any potentially significant counterparty defaults. Revenues for the twelve months ended December 31, 2002, 2001 and 2000 from AIGFP's operations were $1.31 billion, $1.18 billion and $1.06 billion, respectively. (d) AIGTG becomes a party to derivative financial instruments in the normal course of its business and to reduce its currency, interest rate and commodity exposures. Futures and forward contracts are contracts for delivery of foreign currencies, commodities or financial indices in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Options are contracts that allow the holder of the option to purchase or sell the underlying commodity, currency or index at a specified price and within, or at, a specified period of time. As a writer of options, AIGTG generally receives an option premium and then manages the risk of any unfavorable change in the value of the underlying commodity, currency or index. Risks arise as a result of movements in current market prices from contracted prices, and the potential inability of the counterparties to meet their obligations under the contracts. At December 31, 2002, the contractual amount of AIGTG's futures, forward and option contracts approximated $424.9 billion. 100
American International Group, Inc. and Subsidiaries 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) The following table provides the contractual and notional amounts and credit exposure, if applicable, by maturity and type of derivative of AIGTG's derivatives portfolio at December 31, 2002 and December 31, 2001. The gross replacement values presented represent the sum of the estimated positive fair values of all of AIGTG's derivatives contracts at December 31, 2002 and December 31, 2001. These values do not represent the credit risk to AIGTG. Net replacement values presented represent the net sum of estimated positive fair values after the application of legally enforceable master closeout netting agreements and collateral held. The net replacement values most closely represent the net credit risk to AIGTG or the maximum amount exposed to potential loss within a product category. At December 31, 2002, the net replacement value of AIGTG's futures, forward and option contracts and interest rate and currency swaps approximated $2.3 billion. (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ REMAINING LIFE ------------------------------------------------- ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL Total YEAR FIVE YEARS TEN YEARS YEARS 2002 2001 ==================================================================================================================================== Contractual amount of futures, forwards and options: Exchange traded futures and options $ 11,834 $ 1,451 $ 50 $ -- $ 13,335 $ 14,977 ==================================================================================================================================== Over the counter forwards $ 168,572 $ 13,562 $ 1,977 $ 36 $ 184,147 $ 184,102 ==================================================================================================================================== Over the counter purchased options $ 72,800 $ 17,657 $ 25,053 $ 252 $ 115,762 $ 138,655 ==================================================================================================================================== Over the counter sold options (a) $ 69,247 $ 16,771 $ 25,255 $ 401 $ 111,674 $ 137,661 Notional amount (c): Interest rate swaps and forward rate agreements $ 16,440 $ 33,866 $ 4,613 $ 140 $ 55,059 $ 59,683 Currency swaps 2,351 5,866 327 -- 8,544 11,092 Swaptions 3,608 5,789 1,118 -- 10,515 7,280 - ------------------------------------------------------------------------------------------------------------------------------------ Total $ 22,399 $ 45,521 $ 6,058 $ 140 $ 74,118 $ 78,055 ==================================================================================================================================== Credit exposure: Futures, forwards swaptions and purchased options contracts and interest rate and currency swaps: Gross replacement value $ 5,678 $ 2,861 $ 2,735 $ 46 $ 11,320 $ 10,074 Master netting arrangements (3,895) (2,286) (2,563) (32) (8,776) (6,691) Collateral (85) (96) (63) (8) (252) (330) - ------------------------------------------------------------------------------------------------------------------------------------ Net replacement value (b) $ 1,698 $ 479 $ 109 $ 6 $ 2,292 $ 3,053 ==================================================================================================================================== (a) Sold options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposure. (b) The net replacement values with respect to exchange traded futures and options, forward contracts and purchased over the counter options are presented as a component of trading assets in the accompanying balance sheet. The net replacement values with respect to interest rate and currency swaps are presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions in the accompanying balance sheet. (c) Notional amount is not representative of either market risk or credit risk. 101
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) AIGTG independently evaluates the creditworthiness of its counterparties, taking into account credit ratings assigned by recognized statistical rating organizations. In addition, AIGTG's credit approval process involves pre-set counterparty, country and industry credit exposure limits and, for particularly credit intensive transactions, obtaining approval from AIG's Credit Risk Committee. The maximum potential loss will increase or decrease during the life of the derivative commitments as a function of maturity and market conditions. AIGTG DETERMINES COUNTERPARTY CREDIT QUALITY BY REFERENCE TO RATINGS FROM INDEPENDENT RATING AGENCIES OR INTERNAL ANALYSIS. AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY CREDIT QUALITY AND COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WERE AS FOLLOWS: (in millions) - -------------------------------------------------------------------------------- NET REPLACEMENT VALUE 2002 2001 ================================================================================ Counterparty credit quality: AAA $ 347 $ 391 AA 622 1,117 A 739 863 BBB 193 330 Below investment grade 63 130 Not externally rated, including exchange traded futures and options* 328 222 - -------------------------------------------------------------------------------- Total $2,292 $3,053 ================================================================================ Counterparty breakdown by industry: Non-U.S. banks $ 927 $1,151 U.S. industrials 369 503 Governmental 37 71 Non-U.S. financial service companies 105 187 Non-U.S. industrials 144 190 U.S. banks 157 353 U.S. financial service companies 225 376 Exchanges* 328 222 - -------------------------------------------------------------------------------- Total $2,292 $3,053 ================================================================================ * Exchange traded futures and options are not deemed to have significant credit exposure as the exchanges guarantee that every contract will be properly settled on a daily basis. Spot commodities sold but not yet purchased represent obligations of AIGTG to deliver spot commodities at their contracted prices and thereby create a liability to repurchase the spot commodities in the market at prevailing prices. AIGTG limits its risks by holding offsetting positions. In addition, AIGTG monitors and controls its risk exposures through various monitoring systems which evaluate AIGTG's market and credit risks, and through credit approvals and limits. At December 31, 2002, AIGTG did not have a significant concentration of credit risk from either an individual counter-party or group of counterparties. AIG has issued unconditional guarantees with respect to the prompt payment, when due, of all present and future obligations and liabilities of AIGFP and AIGTG arising from transactions entered into by AIGFP and AIGTG. (e) At December 31, 2002, ILFC had committed to purchase 523 aircraft deliverable from 2003 through 2010 at an estimated aggregate purchase price of $29.8 billion and had options to purchase 18 aircraft deliverable from 2003 through 2008 at an estimated aggregate purchase price of $1.3 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. (f) AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material effect on its operating results and financial condition. However, the recent trend of increasing jury awards and settlements makes it somewhat more difficult to assess the ultimate outcome of such litigation. AIG continues to receive claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites (hereinafter collectively referred to as environmental claims) and indemnity claims asserting injuries from asbestos. Estimation of asbestos and environmental claims loss reserves is a difficult process, as these claims, which emanate from policies written in 1984 and prior years, cannot be estimated by conventional reserving techniques. Asbestos and environmental claims development is affected by factors such as inconsistent court resolutions, the broadening of the intent of policies and scope of coverage and increasing number of new claims. AIG and other industry members have and will continue to litigate the broadening judicial interpretation of policy coverage and the liability issues. If the courts continue in the future to expand the intent of the policies and the scope of the coverage, as they have in the past, additional liabilities would emerge for amounts in excess of reserves held. This emergence cannot now be reasonably estimated, but could have a material impact on AIG's future operating results. The reserves carried for these claims as at December 31, 2002 ($2.14 billion gross; $696 million net) are believed to be adequate as these reserves are based on known facts and current law. AIG's general insurance companies have a special asbestos and environmental (A & E) claims unit actively managing A & E claims. AIG's experienced claims professionals evaluate case reserves for AIG losses at the earliest possible time, reserving to ultimate probable loss based upon known facts, current law, jurisdiction, policy language and other factors. AIG routinely reviews the adequacy of A & E case reserves. AIG does not discount A & E reserves. 102
American International Group, Inc. and Subsidiaries 12. COMMITMENTS AND CONTINGENT LIABILITIES (continued) AIG uses primarily two methods to test the A & E reserves. One method, the Market Share method, produces indicated A & E reserve needs by applying the appropriate AIG company market share to estimated potential industry ultimate loss/loss expense based on the latest estimates from A.M. Best and Tillinghast. A second method, a frequency/severity approach, is also utilized. This approach utilizes current information as the basis of an analysis that predicts for the next 10 years (up to the year 2012 with respect to the year ended December 31, 2002), the number of future environmental claims expected and the average severity of each. The trend in frequency created is based upon assumptions judged by AIG to be the most reasonable. The trend in severity starts with initial severities based on actual average current severity (under the varying case adequacy assumptions) and trending forward under assumptions deemed most reasonable by AIG. A similar frequency/severity analysis is also performed for asbestos. A SUMMARY OF RESERVE ACTIVITY, INCLUDING ESTIMATES FOR APPLICABLE INCURRED BUT NOT REPORTED LOSSES AND LOSS EXPENSES, RELATING TO ASBESTOS AND ENVIRONMENTAL CLAIMS SEPARATELY AND COMBINED AT DECEMBER 31, 2002, 2001 AND 2000 FOLLOWS. (in millions) - ---------------------------------------------------------------------------------------------------------------------------------- 2002 2001 2000 -------------------- -------------------- --------------------- GROSS NET Gross Net Gross Net ================================================================================================================================== Asbestos: Reserve for losses and loss expenses at beginning of year $ 1,114 $ 312 $ 1,100 $ 338 $ 1,093 $ 306 Losses and loss expenses incurred* 395 168 358 92 405 80 Losses and loss expenses paid* (205) (80) (344) (118) (398) (48) - ---------------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 1,304 $ 400 $ 1,114 $ 312 $ 1,100 $ 338 ================================================================================================================================== Environmental: Reserve for losses and loss expenses at beginning of year $ 1,115 $ 407 $ 1,345 $ 517 $ 1,519 $ 585 Losses and loss expenses incurred* (140) (44) (41) (34) (44) (45) Losses and loss expenses paid* (143) (67) (189) (76) (130) (23) - ---------------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 832 $ 296 $ 1,115 $ 407 $ 1,345 $ 517 ================================================================================================================================== Combined: Reserve for losses and loss expenses at beginning of year $ 2,229 $ 719 $ 2,445 $ 855 $ 2,612 $ 891 Losses and loss expenses incurred* 255 124 317 58 361 35 Losses and loss expenses paid* (348) (147) (533) (194) (528) (71) - ---------------------------------------------------------------------------------------------------------------------------------- Reserve for losses and loss expenses at end of year $ 2,136 $ 696 $ 2,229 $ 719 $ 2,445 $ 855 ================================================================================================================================== * All amounts pertain to policies underwritten in prior years. (g) Risk Based Capital (RBC) is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized general and life insurance companies may be identified. The RBC formula develops a risk adjusted target level of adjusted statutory capital by applying certain factors to various asset, premium and reserve items. Higher factors are applied to more risky items and lower factors are applied to less risky items. Thus, the target level of statutory surplus varies not only as a result of the insurer's size, but also on the risk profile of the insurer's operations. The RBC Model Law provides for four incremental levels of regulatory attention for insurers whose surplus is below the calculated RBC target. These levels of attention range in severity from requiring the insurer to submit a plan for corrective action to actually placing the insurer under regulatory control. The statutory surplus of each of AIG's domestic general and life insurance subsidiaries exceeded their RBC standards as of December 31, 2002. To the extent that any of AIG's insurance entities would fall below prescribed levels of surplus, it would be AIG's intention to infuse necessary capital to support that entity. (h) 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. 103
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 13. FAIR VALUE OF FINANCIAL INSTRUMENTS Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments" (FAS 107) requires disclosure of fair value information about financial instruments, as defined therein, for which it is practicable to estimate such fair value. These financial instruments may or may not be recognized in the consolidated balance sheet. In the measurement of the fair value of certain financial instruments, quoted market prices were not available and other valuation techniques were utilized. These derived fair value estimates are significantly affected by the assumptions used. FAS 107 excludes certain financial instruments, including those related to insurance contracts. The following methods and assumptions were used by AIG in estimating the fair value of the financial instruments presented: Cash and short-term investments: The carrying amounts reported in the consolidated balance sheet for these instruments approximate fair values. Fixed maturity securities: Fair values for fixed maturity securities carried at amortized cost or at market value were generally based upon quoted market prices. For certain fixed maturity securities for which market prices were not readily available, fair values were estimated using values obtained from independent pricing services. No other fair valuation techniques were applied to these securities as AIG believes it would have to expend excessive costs for the benefits derived. Equity securities: Fair values for equity securities were based upon quoted market prices. Mortgage loans on real estate, policy and collateral loans: Where practical, the fair values of loans on real estate and collateral loans were estimated using discounted cash flow calculations based upon AIG's current incremental lending rates for similar type loans. The fair values of the policy loans were not calculated as AIG believes it would have to expend excessive costs for the benefits derived. Trading assets and trading liabilities: Fair values for trading assets and trading liabilities approximate the carrying values presented in the consolidated balance sheet. Finance receivables: the fair values of finance receivables were estimated using discounted cash flow calculations based upon the weighted average rates currently being offered for similar finance receivables. Securities available for sale: Fair values for securities available for sale and related hedges were based on quoted market prices. For securities and related hedges for which market prices were not readily available, fair values were estimated using quoted market prices of comparable investments. Trading securities: Fair values for trading securities were based on current market value where available. For securities for which market values were not readily available, fair values were estimated using quoted market prices of comparable investments. Spot commodities: Fair values for spot commodities were based on current market prices. Unrealized gains and losses on interest rate and currency swaps, options and forward transactions: Fair values for swaps, options and forward transactions were based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates, as applicable. Securities purchased (sold) under agreements to resell (repurchase), at contract value: As these securities (obligations) are short-term in nature, the contract values approximate fair values. Other invested assets: For assets for which market prices were not readily available, fair valuation techniques were not applied as AIG believes it would have to expend excessive costs for the benefits derived. Policyholders' contract deposits: Fair values of policy-holder contract deposits were estimated using discounted cash flow calculations based upon interest rates currently being offered for similar contracts with maturities consistent with those remaining for the contracts being valued. GIAs: Fair values of AIG's obligations under investment type agreements were estimated using discounted cash flow calculations based on interest rates currently being offered for similar agreements with maturities consistent with those remaining for the agreements being valued. Securities and spot commodities sold but not yet purchased: The carrying amounts for the financial instruments approximate fair values. Fair values for spot commodities sold short were based on current market prices. Trust deposits and deposits due to banks and other depositors: To the extent certain amounts are not demand deposits or certificates of deposit which mature in more than one year, fair values were not calculated as AIG believes it would have to expend excessive costs for the benefits derived. Commercial paper: The carrying amount of AIG's commercial paper borrowings approximates fair value. Notes, bonds, loans and mortgages: Where practical, the fair values of these obligations were estimated using discounted cash flow calculations based upon AIG's current incremental borrowing rates for similar types of borrowings with maturities consistent with those remaining for the debt being valued. 104
American International Group, Inc. and Subsidiaries 13. FAIR VALUE OF FINANCIAL INSTRUMENTS (continued) THE CARRYING VALUES AND FAIR VALUES OF AIG'S FINANCIAL INSTRUMENTS AT DECEMBER 31, 2002 AND DECEMBER 31, 2001 AND THE AVERAGE FAIR VALUES WITH RESPECT TO DERIVATIVE POSITIONS DURING 2002 AND 2001 WERE AS FOLLOWS: (in millions) - ------------------------------------------------------------------------------------------------------------------------------------ 2002 2001 -------------------------------- ------------------------------- AVERAGE Average CARRYING FAIR FAIR Carrying Fair Fair VALUE VALUE VALUE Value Value Value ==================================================================================================================================== Assets: Fixed maturities $243,366 $243,366 $ -- $200,616 $200,616 $ -- Equity securities 7,066 7,066 -- 7,937 7,937 -- Mortgage loans on real estate, policy and collateral loans 19,928 21,244 -- 18,967 19,615 -- Securities available for sale 16,687 16,687 16,796 17,801 17,801 17,096 Finance receivables, net of allowance 15,857 15,888 -- 13,955 13,253 -- Trading securities 4,146 4,146 5,071 5,733 5,733 6,387 Spot commodities 489 489 431 352 352 408 Unrealized gain on interest rate and currency swaps, options and forward transactions 15,376 15,376 13,112 11,493 11,493 11,792 Trading assets 4,786 4,786 4,769 6,234 6,234 7,111 Securities purchased under agreements to resell 25,661 25,661 -- 21,681 21,681 -- Other invested assets 12,680 12,680 -- 12,704 12,704 -- Securities lending collateral 23,694 23,694 -- 10,574 10,574 -- Short-term investments 6,993 6,993 -- 7,168 7,168 -- Cash 1,165 1,165 -- 698 698 -- Liabilities: Policyholders' contract deposits 142,160 143,519 -- 119,402 116,040 -- Borrowings under obligations of guaranteed investment agreements 14,850 17,256 -- 16,392 17,201 -- Securities sold under agreements to repurchase 9,162 9,162 -- 11,818 11,818 -- Trading liabilities 3,825 3,825 3,856 4,372 4,372 4,714 Securities and spot commodities sold but not yet purchased 11,765 11,765 9,103 8,331 8,331 7,268 Unrealized loss on interest rate and currency swaps, options and forward transactions 11,265 11,265 9,842 8,813 8,813 9,186 Trust deposits and deposits due to banks and other depositors 2,987 3,045 -- 2,290 2,589 -- Commercial paper 9,112 9,112 -- 11,892 11,892 -- Notes, bonds, loans and mortgages payable 47,923 49,071 -- 37,447 34,640 -- ==================================================================================================================================== 105
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. STOCK COMPENSATION PLANS (a) At December 31, 2002, AIG had three types of stock-based compensation plans: (i) a stock option plan; (ii) an incentive stock plan under which restricted stock units had been issued; and (iii) an employee stock purchase plan. AIG applied APB Opinion 25 "Accounting for Stock Issued to Employees" and related Interpretations (APB 25) in accounting for each plan. Accordingly, no compensation costs have been recognized for the plans. AIG will adopt Statement of Financial Accounting Standards No. 123 "Accounting for Awards of Stock Based Compensation to Employees" (FAS 123) and Statement of Financial Accounting Standards No. 148 "Accounting for Stock-Based Compensation--Transition and Disclosure" (FAS 148) effective January 1, 2003. FAS 123 requires that the fair value of shares granted under AIG's stock option plan, shares subscribed under AIG's employee stock purchase plan and AIG's restricted stock units be recognized in earnings over the respective vesting periods. The fair value of the stock options granted and the employee purchase plan shares subscribed will be determined through the use of an option-pricing model. The fair value of the restricted stock units is the share market value at the date of the grant. The impact of recognizing the fair value of the AIG's stock compensation is expected to be insignificant to AIG's earnings. FAS 148 provides transitioning guidance for a voluntary change of the application of FAS 123 and amends the disclosure requirements of FAS 123. Commencing January 1, 2003, AIG will be applying the "Prospective Method" in transitioning to the application of FAS 123. This method transitions the recognition with respect to stock based compensation to those awards granted or shares subscribed on or after January 1, 2003. The table which follows is not representative of the impact of AIG's 2003 adoption of the Prospective Method with respect to the implementation of FAS 123. HAD COMPENSATION COSTS FOR THESE PLANS BEEN DETERMINED CONSISTENT WITH THE METHOD OF FAS 123, AIG'S NET INCOME AND EARNINGS PER SHARE FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WOULD HAVE BEEN REDUCED TO THE PRO FORMA AMOUNTS AS FOLLOWS: (in millions, except per share amounts) - -------------------------------------------------------------------------------- 2002 2001 2000 ================================================================================ Net income: As reported $ 5,519 $ 5,363 $ 6,639 Pro forma 5,464 5,226 6,593 Earnings per share -- diluted: As reported $ 2.10 $ 2.02 $ 2.52 Pro forma 2.07 1.97 2.50 ================================================================================ At December 31, 2002, AIG changed its option-pricing model from the Black-Scholes model to a binomial model (AIG model) that takes possible early exercise of options into account. The model uses the forfeiture and exercise historical experiences to determine the option value. It also takes into account the illiquid nature of employee options, something that the Black-Scholes model does not consider. For these reasons, AIG believes that the AIG model provides a fair value that is more representative of actual historic experience than that value calculated in previous years. The fair values with respect to 2001 and 2000 were recalculated using the AIG model. The pro forma recognition of such fair value had insignificant impact on the pro forma amounts disclosed above. The fair values of stock options granted during the three years ended December 31, 2002, 2001, and 2000 were $140 million, $195 million, including $90 million in fair value with respect to shares granted in connection with the AGC acquisition, and $58 million, respectively. The fair value of those options granted in each of the three years was derived using the AIG model. The following weighted average assumptions were used for stock options granted in 2002, 2001 and 2000, respectively: dividend yields of 0.26 percent, 0.19 percent and 0.17 percent; expected volatilities of 34 percent, 32 percent and 31 percent; risk-free interest rates of 4.33 percent, 4.85 percent and 6.14 percent; and expected terms of 7 years in each year. Also, included in the above table is the compensation expense with respect to AIG's employee stock purchase plan. The fair value calculated was derived by using the AIG model. The pro forma recognition of such fair value had an insignificant impact on the pro forma amounts disclosed above. The fair values of purchase privileges granted during the years ended December 31, 2002, 2001 and 2000 were $8 million, $12 million and $9 million, respectively. The weighted average fair values per share of those purchase rights granted in 2002, 2001 and 2000 were $12.42, $17.69 and $18.65, respectively. The fair value of each purchase right was derived at the date of the subscription using the AIG model. The following weighted average assumptions were used for purchase privileges granted in 2002, 2001 and 2000, respectively: dividend yields of 0.26 percent, 0.19 percent and 0.17 percent; expected volatilities of 34.0 percent, 32.0 percent and 31.0 percent; risk-free interest rates of 1.26 percent, 3.17 percent and 5.92 percent; and expected terms of 1 year. (I) STOCK OPTION PLAN: On September 15, 1999, the AIG Board of Directors adopted a 1999 stock option plan (the 1999 Plan), which provides that options to purchase a maximum of 15,000,000 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 limits the maximum number of shares as 106
American International Group, Inc. and Subsidiaries 14. STOCK COMPENSATION PLANS (continued) to which stock options may be granted to any employee in any one year to 375,000 shares. Options granted under this Plan expire not more than 10 years from the date of the grant. Options with respect to 27,500 shares, 25,000 shares and 12,000 shares were granted to non-employee members of the Board of Directors on May 15, 2002, May 16, 2001 and May 17, 2000, respectively. These options become exercisable on the first anniversary of the date of grant, expire 10 years from the date of grant and do not qualify for Incentive Stock Option Treatment under the Section 422 of the Internal Revenue Code (ISO Treatment). The Plan, and the options previously granted thereunder, were approved by the shareholders at the 2000 Annual Meeting of Shareholders. At December 31, 2002, 4,140,235 shares were reserved for future grants under the 1999 Plan. The 1999 Plan superseded the 1991 employee stock option plan (the 1991 Plan) and the previously superseded 1987 employee stock option plan (the 1987 Plan), although outstanding options granted under the 1991 Plan continue in force until exercise or expiration. At December 31, 2002, there were 20,537,641 shares reserved for issuance under the 1999 and 1991 Plans. During 2002 and 2001, AIG granted options with respect to 356,034 shares and 837,275 shares, respectively, which become exercisable on the fifth anniversary of the date of grant and expire 10 years from the date of grant. These options do not qualify for ISO Treatment. The agreements with respect to all other options granted to employees under these plans provide that 25 percent of the options granted become exercisable on the anniversary of the date of grant in each of the four years following that grant and expire 10 years from the date of the grant. As of December 31, 2002, outstanding options granted with respect to 10,234,385 shares qualified for ISO Treatment. At January 1, 1999, the merger date, SunAmerica Inc. had five stock-based compensation plans pursuant to which options, restricted stock and deferred share and share unit obligations had been issued and remained outstanding. Options granted under these plans had an exercise price equal to the market price on the date of grant, had a maximum term of ten years and generally became exercisable ratably over a five-year period. Substantially all of the SunAmerica Inc. options outstanding at the merger date became fully vested on that date and were converted into options to purchase AIG common stock at the exchange ratio of 0.855 shares of AIG common stock for each share of SunAmerica Inc. common stock. No further options can be granted under the SunAmerica Inc. plans, but outstanding options so converted continue in force until exercise or expiration. At December 31, 2002, there were 18,401,020 shares of AIG common stock reserved for issuance on exercise of options under these plans. None of these options qualified for ISO Treatment as of December 31, 2002. During 1999, AIG issued 1,009,968 shares of AIG common stock which vested on the effectiveness of the merger with SunAmerica Inc., and an additional 993,031 shares were issued pursuant to deferred share and share unit obligations. During 2000, deferred share and share unit obligations with respect to an additional 1,224,214 shares of AIG common stock vested, 142,105 shares were issued pursuant to deferred share and share unit obligations and an additional 1,082,109 shares were delivered into a trust in connection with a deferred compensation plan. During 2002 and 2001, deferred share and share unit obligations with respect to an additional 1,895 shares and 19,930 shares, respectively, of AIG common stock vested and were issued. No additional deferred share or share unit obligations may be granted under the SunAmerica plans. As of December 31, 2002, deferred share and share unit obligations with respect to 65,657 shares remained outstanding under the SunAmerica plans. In 1999, the AIG Board of Directors construed the AIG stock option plans to allow deferral of delivery of AIG shares otherwise deliverable upon the exercise of an option to a date or dates specified by the optionee upon the request of an optionee. During 2002, options with respect to 590,048 shares were exercised with delivery deferred. At December 31, 2002, optionees had made valid elections to defer delivery of 439,635 shares of AIG common stock upon exercise of options expiring during 2003. As a result of the acquisition of HSB in November 2000, HSB options outstanding at the acquisition date were fully vested and were converted into options to purchase AIG common stock at the exchange ratio of 0.4178 shares of AIG common stock for each share of HSB common stock. No further options can be granted under the HSB option plans, but outstanding options so converted continue in force until exercise or expiration. At December 31, 2002, there were 1,413,268 shares of AIG common stock reserved for issuance under the HSB option plans, none of which qualified for ISO Treatment. At August 29, 2001, AGC had stock-based compensation plans pursuant to which options and restricted share units had been issued and remained outstanding. Options granted under these plans had an exercise price equal to the market price on the date of the grant, had a maximum term of ten years and generally became exercisable ratably over a three-year period. All of the AGC options outstanding at the acquisition date became fully vested on that date and were converted into options to purchase AIG common stock at an exchange ratio of 0.5790 shares of AIG common stock for each share of AGC common stock. No further options can be granted under the AGC plans, but outstanding options so converted continue in force until exercise or expiration. At December 31, 2002, there were 13,862,087 shares of AIG common stock reserved for issuance on exercise of options under these plans. Options with respect to 1,898,266 of these shares qualified for ISO Treatment as of December 31, 2002. 107
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 14. STOCK COMPENSATION PLANS (continued) ADDITIONAL INFORMATION WITH RESPECT TO AIG'S PLANS AT DECEMBER 31, 2002, AND CHANGES FOR THE THREE YEARS THEN ENDED, WERE AS FOLLOWS: - ---------------------------------------------------------------------------------------------------------------------- 2002 2001 --------------------------- --------------------------- WEIGHTED Weighted AVERAGE Average SHARES EXERCISE PRICE Shares Exercise Price ====================================================================================================================== Shares Under Option: Outstanding at beginning of year 54,295,320 $42.68 38,171,151 $31.53 Outstanding at beginning of year - AGC -- -- 15,100,013 51.87 Granted 5,683,324 66.17 8,771,982 71.56 Assumed upon acquisition from HSB -- -- -- -- Exercised (4,242,718) 35.04 (6,209,008) 41.16 Exercised, delivery deferred (590,048) 6.60 (847,128) 3.76 Forfeited (931,862) 72.29 (691,690) 55.55 - ---------------------------------------------------------------------------------------------------------------------- Outstanding at end of year 54,214,016 $45.63 54,295,320 $42.68 - ---------------------------------------------------------------------------------------------------------------------- Options exercisable at year-end 43,978,843 $39.30 47,346,372 $37.39 - ---------------------------------------------------------------------------------------------------------------------- Weighted average fair value per share of options granted $24.65 $22.25 ====================================================================================================================== - ----------------------------------------------------------------------------------------- 2000 --------------------------- Weighted Average Shares Exercise Price ========================================================================================= Shares Under Option: Outstanding at beginning of year 41,415,126 $23.29 Outstanding at beginning of year - AGC -- -- Granted 2,179,220 95.48 Assumed upon acquisition from HSB 1,605,468 81.43 Exercised (5,796,592) 13.80 Exercised, delivery deferred (760,070) 3.06 Forfeited (472,001) 36.70 - ----------------------------------------------------------------------------------------- Outstanding at end of year 38,171,151 $31.53 - ----------------------------------------------------------------------------------------- Options exercisable at year-end 32,778,411 $24.87 - ----------------------------------------------------------------------------------------- Weighted average fair value per share of options granted $34.22 ========================================================================================= In addition, at December 31, 2002, options to purchase 358,594 shares at a weighted average exercise price of $20.31 had been previously granted to AIG non-employee directors and remained outstanding. INFORMATION ABOUT STOCK OPTIONS OUTSTANDING AT DECEMBER 31, 2002, IS SUMMARIZED AS FOLLOWS: - ------------------------------------------------------------------------------------------------------------------------------------ OPTIONS OUTSTANDING OPTIONS EXERCISABLE ----------------------------------------------------- ------------------------------- WEIGHTED WEIGHTED WEIGHTED NUMBER AVERAGE REMAINING AVERAGE NUMBER AVERAGE OUTSTANDING CONTRACTUAL LIFE EXERCISE PRICE EXERCISABLE EXERCISE PRICE ==================================================================================================================================== Range of Exercise Prices: $ 4.47- 14.44 7,380,455 2.0 years $ 7.87 7,380,455 $ 7.87 15.31- 24.68 8,903,526 3.7 years 20.30 8,903,526 20.30 25.42- 38.43 7,974,008 5.1 years 34.52 7,974,008 34.52 40.24- 57.80 7,823,354 6.4 years 52.32 7,767,954 52.30 58.74- 63.67 9,869,612 7.8 years 60.10 5,346,248 59.17 64.01- 77.17 4,629,753 7.7 years 66.84 4,210,465 66.45 78.65 - 100.57 7,633,308 8.3 years 84.83 2,396,187 88.38 - ------------------------------------------------------------------------------------------------------------------------------------ 54,214,016 $45.63 43,978,843 $39.30 ==================================================================================================================================== (II) 2002 STOCK INCENTIVE PLAN: AIG's 2002 Stock Incentive Plan was adopted at its 2002 shareholders' meeting and amended and restated by the AIG Board of Directors on September 18, 2002. This plan provides that equity-based or equity-related awards with respect to up to a maximum of 16,000,000 shares of common stock can be issued to officers, employees or members of the Board of Directors of AIG. Under the Plan, no grantee may receive awards covering more than 250,000 shares of common stock. During 2002, AIG granted restricted stock units (RSUs) relating to 171,215 shares of common stock to employees. These RSUs will vest on the fourth anniversary of the date of grant assuming continued employment through such date. AIG reserves the right to make payment for the RSUs in shares of common stock or the cash equivalent on the date of vesting. At December 31, 2002, there were 15,828,785 shares of common stock reserved for issuance in connection with future grants of awards under the Plan. (III) PERFORMANCE-BASED RESTRICTED STOCK UNITS: During 2002 and 2001, AIG issued performance-based restricted stock units with respect to 4,783 shares and 124,365 shares, respectively, of AIG common stock in connection with contractual obligations as a result of the AGC acquisition. (IV) EMPLOYEE STOCK PURCHASE PLAN: AIG's 1996 Employee Stock Purchase Plan was adopted at its 1996 shareholders' meeting and became effective as of July 1, 1996. Eligible employees may receive privileges to purchase up to an aggregate of 4,218,750 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 annually and were originally limited to the number of whole shares that could be purchased by an amount equal to 5 percent of an employee's annual salary or $5,500, whichever was less. Beginning with the January 1, 1998 108
American International Group, Inc. and Subsidiaries 14. STOCK COMPENSATION PLANS (continued) subscription, the maximum allowable purchase limitation increased to 10 percent of an employee's annual salary or $10,000 per year, whichever is less, and the eligibility requirement was reduced from two years to one year. There were 274,442 shares, 503,847 shares and 742,773 shares issued under the 1996 plan at weighted average prices of $70.76, $62.02 and $52.66 for the years ended December 31, 2002, 2001 and 2000, respectively. The excess or deficit of the proceeds over the par value or cost of the common stock issued under these plans was credited or charged to additional paid-in capital. As of December 31, 2002, there were 636,853 shares of common stock subscribed to at a weighted average price of $54.52 per share pursuant to grants of privileges under the 1996 plan. There were 56,720 shares available for the grant of future purchase privileges under the 1996 plan at December 31, 2002. (b) The following are disclosures with respect to the stock compensation plans of AGC prior to its acquisition by AIG. Both share information and exercise price information have been recalculated to reflect the exchange ratio of 0.5790 shares of AIG common stock for each outstanding share of AGC's common stock. All of AGC's options vested immediately prior to the closing date of the acquisition. AGC's long-term incentive plans provide for the award of stock options, restricted stock awards, and performance awards to key employees and directors. Stock options constitute the majority of awards. AGC recognized no expense for stock options since the market price equaled the exercise price at the grant date. For restricted stock and performance awards, the grant date market value was amortized to expense over the vesting period. AGC adjusted the expense to reflect changes in market value of AGC's common stock and anticipated performance levels for those awards with performance criteria. AGC STOCK OPTION ACTIVITY WAS AS FOLLOWS: - -------------------------------------------------------------------------------- 2000 --------------------- Average Options Exercise (000's) Price - -------------------------------------------------------------------------------- Balance at January 1 11,405 $48.91 Granted 5,437 55.32 Exercised (1,084) 35.42 Forfeited (658) 56.41 - -------------------------------------------------------------------------------- Balance at December 31 15,100 $51.87 - -------------------------------------------------------------------------------- Exercisable at December 31 5,898 $44.87 - -------------------------------------------------------------------------------- Weighted average fair value per share of options granted $16.93 ================================================================================ Options could not be exercised prior to six months after, nor after 10 years from, grant date. For certain stock options, one reload option was granted for each previously-owned share of common stock tendered to exercise options. Reload options vested immediately and were exercisable for the remaining term of the original options. Reload options are no longer being granted. 109
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 15. EMPLOYEE BENEFITS (a) Employees of AIG, its subsidiaries and certain affiliated companies, including employees in foreign countries, are generally covered under various funded and insured pension plans. Eligibility for participation in the various plans is based on either completion of a specified period of continuous service or date of hire, subject to age limitation. The HSB retirement plan was merged into the AIG U.S. retirement plan effective April 1, 2001. The AGC retirement plan was merged into the AIG U.S. retirement plan effective January 1, 2002. AIG's U.S. retirement plan is a qualified, noncontributory, defined benefit plan. All qualified employees, other than those of 21st Century, who have attained age 21 and completed twelve months of continuous service are eligible to participate in this plan. An employee with 5 or more years of service is entitled to pension benefits beginning at normal retirement at age 65. Benefits are based upon a percentage of average final compensation multiplied by years of credited service limited to 44 years of credited service with the exception of AGC employees where the credited service limitation is 40 years of credited service. The average final compensation is subject to certain limitations. Annual funding requirements are determined based on the "projected unit credit" cost method which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service. AIG SunAmerica began participation in the plan on January 1, 2003. AIG has adopted a Supplemental Executive Retirement Plan (Supplemental Plan) to provide additional retirement benefits to designated executives and key employees. Under the Supplemental Plan, the annual benefit, not to exceed 60 percent of average final compensation, accrues at a percentage of average final pay multiplied for each year of credited service reduced by any benefits from the current and any predecessor retirement plans, Social Security, if any, and from any qualified pension plan of prior employers. The Supplemental Plan also provides a benefit equal to the reduction in benefits payable under the AIG U.S. retirement plan as a result of Federal tax limitations on benefits payable there-under. Currently, the Supplemental Plan is unfunded. AGC has adopted a Supplemental Plan which is similar to AIG's. HSB has adopted a separate Supplemental Plan. Eligibility for participation in the various non-U.S. retirement plans is either based on completion of a specified period of continuous service or date of hire, subject to age limitation. Where non-U.S. retirement plans are defined benefit plans, they are generally based on the employees' years of credited service and average compensation in the years preceding retirement. In addition to AIG's defined benefit pension plan, AIG and its subsidiaries provide a postretirement benefit program for medical care and life insurance, domestically and in certain foreign countries. Eligibility in the various plans is generally based upon completion of a specified period of eligible service and reaching a specified age. Benefits vary by geographic location. AIG's U.S. postretirement medical and life insurance benefits are based upon the employee electing immediate retirement and having a minimum of ten years of service. Retirees who were age 65 by May 1, 1989 and their dependents participate in the medical plan at no cost. Employees who retired after May 1, 1989 and on or prior to January 1, 1993 pay the active employee premium if under age 65 and 50 percent of the active employee premium if over age 65. Retiree contributions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance and Medicare coordination and a lifetime maximum benefit of $2.0 million. The maximum life insurance benefit prior to age 70 is $32,500, with a maximum of $25,000 thereafter. Effective January 1, 1993, both plans' provisions were amended. Employees who retire after January 1, 1993 are required to pay the actual cost of the medical benefits premium reduced by a credit which is based on years of service at retirement. The life insurance benefit varies by age at retirement from $5,000 for retirement at ages 55 through 59; $10,000 for retirement at ages 60 through 64 and $15,000 for retirement at ages 65 and over. (b) AIG sponsors a voluntary savings plan for domestic employees (a 401(k) plan), which, during the three years ended December 31, 2002, provided for salary reduction contributions by employees and matching contributions by AIG of up to 6 percent of annual salary depending on the employees' years of service. (c) AIG SunAmerica sponsors a voluntary savings plan for its employees (the SunAmerica 401(k) plan), which, during the three years ended December 31, 2002, provided for salary reduction contributions by qualifying employees and matching contributions by AIG SunAmerica of up to 4 percent of qualifying employees' annual salaries. Under an Executive Savings Plan, designated AIG SunAmerica executives also could defer up to 90 percent of cash compensation during the three years ended December 31, 2002, and AIG SunAmerica matched 4 percent of the participants' base salaries deferred. (d) AGC sponsors a voluntary savings plan for its employees (the AGC 401(k) plan), which provides for salary reduction contributions by employees and matching contributions by AGC of up to 4.5 percent of annual salary. (e) HSB sponsored a voluntary savings plan for its employees (the HSB 401(k) plan), which provided for salary reduction contributions by employees and matching contributions by HSB of up to 6 percent of annual salary. The HSB voluntary savings plan merged into the AIG voluntary savings plan on January 1, 2002. 110
American International Group, Inc. and Subsidiaries 15. EMPLOYEE BENEFITS (continued) (f) AIG has certain benefits provided to inactive employees who are not retirees. Certain of these benefits are insured and expensed currently; other expenses are provided for currently. Such uninsured expenses include medical and life insurance continuation, and COBRA medical subsidies. THE FOLLOWING TABLE SETS FORTH THE CHANGE IN BENEFIT OBLIGATION, CHANGE IN PLAN ASSETS AND WEIGHTED AVERAGE ASSUMPTIONS ASSOCIATED WITH VARIOUS PENSION PLAN AND POSTRETIREMENT BENEFITS. THE WEIGHTED AVERAGE ACTUARIAL ASSUMPTIONS WITH RESPECT TO ALL PLANS PRESENTED WERE 5.52 PERCENT DISCOUNT RATE, 7.96 PERCENT AS TO THE EXPECTED RETURN ON PLAN ASSETS AND 3.59 PERCENT AS TO THE RATE OF COMPENSATION INCREASE. THE AMOUNTS ARE RECOGNIZED IN THE ACCOMPANYING CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 2002 AND 2001: (in millions) - -------------------------------------------------------------------------------------------------------------------------------- PENSION BENEFITS OTHER BENEFITS ---------------------------------- ---------------------------------- NON-U.S. U.S. NON-U.S. U.S. 2002 PLANS PLANS TOTAL PLANS PLANS TOTAL ================================================================================================================================ Change in benefit obligation: Benefit obligation at beginning of year $ 958 $ 1,829 $ 2,787 $ 12 $ 233 $ 245 Service cost 48 74 122 1 4 5 Interest cost 30 141 171 1 16 17 Participant contributions 6 -- 6 -- -- -- Actuarial loss 18 182 200 2 24 26 Plan amendments and mergers (20) 3 (17) -- (19) (19) Benefits paid (64) (81) (145) -- (20) (20) Effect of foreign currency fluctuation 111 -- 111 -- -- -- Curtailment (16) (2) (18) -- -- -- - -------------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $ 1,071 $ 2,146 $ 3,217 $ 16 $ 238 $ 254 ================================================================================================================================ Change in plan assets: Fair value of plan assets at beginning of year $ 455 $ 1,930 $ 2,385 $ -- $ -- $ -- Actual return on plan assets net of expenses (22) (234) (256) -- -- -- Employer contributions 57 82 139 -- 20 20 Participant contributions 6 -- 6 -- -- -- Benefits paid (64) (81) (145) -- (20) (20) Effect of foreign currency fluctuation 53 -- 53 -- -- -- Curtailment (6) -- (6) -- -- -- - -------------------------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year* $ 479 $ 1,697 $ 2,176 $ -- $ -- $ -- ================================================================================================================================ Reconciliation of funded status: Funded status $ (592) $ (449) $(1,041) $ (16) $ (238) $ (254) Unrecognized actuarial (gain)/loss 189 809 998 -- 48 48 Unrecognized transition obligation 5 1 6 -- -- -- Unrecognized prior service cost (15) 20 5 -- (52) (52) - -------------------------------------------------------------------------------------------------------------------------------- Net amount recognized at year end $ (413) $ 381 $ (32) $ (16) $ (242) $ (258) ================================================================================================================================ Amounts recognized in the statement of financial position consist of: Prepaid benefit cost $ 2 $ 520 $ 522 $ -- $ -- $ -- Accrued benefit liability (583) (162) (745) (16) (242) (258) Intangible asset 168 23 191 -- -- -- - -------------------------------------------------------------------------------------------------------------------------------- Net amount recognized at year end $ (413) $ 381 $ (32) $ (16) $ (242) $ (258) ================================================================================================================================ For measurement purposes, a 7.5 percent annual rate of increase in the per capita cost of covered healthcare benefits was assumed for 2002. The rate was assumed to decrease gradually to 5.0 percent for 2008 and remain at that level thereafter. * Plan assets are invested primarily in fixed-income securities and listed stocks. 111
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 15. EMPLOYEE BENEFITS (continued) (in millions) - ------------------------------------------------------------------------------------------------------------------------------- Pension Benefits Other Benefits ---------------------------------- ---------------------------------- Non-U.S. U.S. Non-U.S. U.S. 2001 Plans Plans Total Plans Plans Total =============================================================================================================================== Change in benefit obligation: Benefit obligation at beginning of year $ 462 $ 1,415 $ 1,877 $ 10 $ 197 $ 207 Acquisition 533 211 744 -- 28 28 Service cost 38 70 108 1 4 5 Interest cost 25 127 152 -- 16 16 Participant contributions 5 -- 5 -- -- -- Actuarial loss 38 102 140 1 9 10 Plan amendment -- 4 4 -- -- -- Benefits paid (75) (90) (165) -- (21) (21) Effect of foreign currency fluctuation (59) -- (59) -- -- -- Curtailment (9) (10) (19) -- -- -- - ------------------------------------------------------------------------------------------------------------------------------- Benefit obligation at end of year $ 958 $ 1,829 $ 2,787 $ 12 $ 233 $ 245 =============================================================================================================================== Change in plan assets: Fair value of plan assets at beginning of year $ 255 $ 1,936 $ 2,191 $ -- $ -- $ -- Acquisition 203 277 480 -- -- -- Actual return on plan assets net of expenses (32) (227) (259) -- -- -- Employer contributions 126 45 171 -- 21 21 Participant contributions 5 -- 5 -- -- -- Benefits paid (75) (90) (165) -- (21) (21) Asset adjustment -- (1) (1) -- -- -- Effect of foreign currency fluctuation (25) -- (25) -- -- -- Curtailment (2) (10) (12) -- -- -- - ------------------------------------------------------------------------------------------------------------------------------- Fair value of plan assets at end of year* $ 455 $ 1,930 $ 2,385 $ -- $ -- $ -- =============================================================================================================================== Reconciliation of funded status: Funded status $ (503) $ 101 $ (402) $ (12) $ (233) $ (245) Unrecognized actuarial (gain)/loss 131 224 355 -- 25 25 Unrecognized transition obligation 6 2 8 -- -- -- Unrecognized prior service cost 4 21 25 -- (38) (38) Benefit payments -- -- -- -- 2 2 - ------------------------------------------------------------------------------------------------------------------------------- Net amount recognized at year end $ (362) $ 348 $ (14) $ (12) $ (244) $ (256) =============================================================================================================================== Amounts recognized in the statement of financial position consist of: Prepaid benefit cost $ 1 $ 492 $ 493 $ -- $ -- $ -- Accrued benefit liability (458) (172) (630) (12) (244) (256) Intangible asset 95 28 123 -- -- -- - ------------------------------------------------------------------------------------------------------------------------------- Net amount recognized at year end $ (362) $ 348 $ (14) $ (12) $ (244) $ (256) =============================================================================================================================== For measurement purposes, an 8.0 percent annual rate of increase in the per capita cost of covered healthcare benefits was assumed for 2001. The rate was assumed to decrease gradually to 5.0 percent for 2007 and remain at that level thereafter. * Plan assets are invested primarily in fixed-income securities and listed stocks. 112
American International Group, Inc. and Subsidiaries 15. EMPLOYEE BENEFITS (continued) THE NET BENEFIT COST FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 INCLUDED THE FOLLOWING COMPONENTS: (in millions) - ----------------------------------------------------------------------------------------------------------- PENSION BENEFITS OTHER BENEFITS ----------------------------- ---------------------------- NON-U.S. U.S. NON-U.S. U.S. PLANS PLANS TOTAL PLANS PLANS TOTAL =========================================================================================================== 2002 Components of net period benefit cost: Service cost $ 48 $ 74 $ 122 $ 1 $ 4 $ 5 Interest cost 30 141 171 1 16 17 Expected return on assets (19) (176) (195) -- -- -- Amortization of prior service cost -- 2 2 -- (6) (6) Amortization of transitional liability 2 1 3 -- -- -- Recognized actuarial loss 15 3 18 -- -- -- Gain due to Curtailment on Settlement (10) 3 (7) -- 1 1 - ----------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 66 $ 48 $ 114 $ 2 $ 15 $ 17 =========================================================================================================== 2001 Components of net period benefit cost: Service cost $ 38 $ 70 $ 108 $ 1 $ 4 $ 5 Interest cost 25 127 152 -- 16 16 Expected return on assets (16) (204) (220) -- -- -- Amortization of prior service cost 2 3 5 -- (4) (4) Amortization of transitional liability 2 1 3 -- -- -- Recognized actuarial loss 5 2 7 -- -- -- Gain due to Curtailment on Settlement (7) 18 11 -- -- -- - ----------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 49 $ 17 $ 66 $ 1 $ 16 $ 17 =========================================================================================================== 2000 Components of net period benefit cost: Service cost $ 32 $ 57 $ 89 $ 1 $ 4 $ 5 Interest cost 15 101 116 -- 16 16 Expected return on assets (12) (172) (184) -- -- -- Amortization of prior service cost 2 2 4 -- (4) (4) Amortization of transitional liability 2 1 3 -- -- -- Recognized actuarial loss 2 (11) (9) -- -- -- - ----------------------------------------------------------------------------------------------------------- Net periodic benefit cost $ 41 $ (22) $ 19 $ 1 $ 16 $ 17 =========================================================================================================== The projected benefit obligation, accumulated benefit obligation, and fair value of plan assets for pension plans with accumulated benefit obligations in excess of plan assets were $1.32 billion, $1.18 billion and $535 million, respectively, as of December 31, 2002 and $1.19 billion, $1.06 billion and $499 million as of December 31, 2001. At December 31, 2002, there were 1.2 million shares of AIG common stock with a value of $69.9 million included in the plan assets. The benefit plans have purchased annuity contracts from AIG's subsidiaries to provide $56 million of future annual benefits principally to certain AGC retirees. On December 31, 1998, AIG amended its retirement and postretirement healthcare plan to provide increased benefits to certain employees who retire prior to age 65. Assumed healthcare cost trend rates have a significant effect on the amounts reported for the healthcare plan. A ONE-PERCENTAGE-POINT CHANGE IN ASSUMED HEALTHCARE COST TREND RATES WOULD HAVE THE FOLLOWING EFFECTS: (in millions) - -------------------------------------------------------------------------------- 1-PERCENTAGE 1-PERCENTAGE POINT INCREASE POINT DECREASE ================================================================================ Effect on total of service and interest cost components $1 $1 Effect on postretirement benefit obligation 7 7 ================================================================================ 16. STARR INTERNATIONAL COMPANY, INC. PLAN Starr International Company, Inc. (SICO) provides a Deferred Compensation Profit Participation Plan (SICO Plan) to certain AIG employees. The SICO Plan came into being in 1975 when the voting shareholders and Board of Directors of SICO, a private holding company whose principal asset consists of 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. 113
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 16. STARR INTERNATIONAL COMPANY, INC. PLAN (continued) Participation in the SICO Plan by any person, and the amount of such participation, is at the sole discretion of SICO's Board of Directors, and none of the costs of the various benefits provided under such plan is paid by or charged to AIG. The SICO Plan provides that shares currently owned by SICO may be set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors may permit an early pay-out of units under certain circumstances. Prior to pay-out, 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. In addition, SICO's Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. If the expenses of the SICO Plan had been reflected by AIG, the pre-tax amounts accrued would have been $49.4 million, $55.7 million and $76.8 million for 2002, 2001 and 2000, respectively. 17. LEASES (a) AIG and its subsidiaries occupy leased space in many locations under various long-term leases and have entered into various leases covering the long-term use of data processing equipment. AT DECEMBER 31, 2002, THE FUTURE MINIMUM LEASE PAYMENTS UNDER OPERATING LEASES WERE AS FOLLOWS: (in millions) ================================================================================ 2003 $ 477 2004 346 2005 248 2006 179 2007 139 Remaining years after 2007 716 - -------------------------------------------------------------------------------- Total $2,105 ================================================================================ Rent expense approximated $503 million, $472 million and $412 million for the years ended December 31, 2002, 2001 and 2000 respectively. (B) MINIMUM FUTURE RENTAL INCOME ON NONCANCELABLE OPERATING LEASES OF FLIGHT EQUIPMENT WHICH HAVE BEEN DELIVERED AT DECEMBER 31, 2002 WAS AS FOLLOWS: (in millions) ================================================================================ 2003 $ 2,306 2004 2,081 2005 1,790 2006 1,451 2007 1,145 Remaining years after 2007 2,913 - -------------------------------------------------------------------------------- Total $11,686 ================================================================================ Flight equipment is leased, under operating leases, with remaining terms ranging from one to 15 years. 18. OWNERSHIP AND TRANSACTIONS WITH RELATED PARTIES (A) OWNERSHIP: The directors and officers of AIG, together with C.V. Starr & Co., Inc. (Starr), a private holding company, The Starr Foundation and Starr International Company, Inc. (SICO), a private holding company, owned or otherwise controlled approximately 21 percent of the voting stock of AIG at December 31, 2002. Six directors of AIG also serve as directors of Starr and SICO. (B) TRANSACTIONS WITH RELATED PARTIES: During the ordinary course of business, AIG and its subsidiaries pay commissions to Starr and its subsidiaries for the production and management of insurance business. There are no significant receivables from/payables to related parties at December 31, 2002. Payment for the production of insurance business to Starr aggregated approximately $116 million in 2002, $88 million in 2001 and $60 million in 2000, from which Starr generally is required to pay commissions due originating brokers and its operating expenses. AIG also received approximately $17 million in 2002 and $14 million in both 2001 and 2000 from Starr and paid approximately $352,000 in 2002, $320,000 in 2001 and $224,000 in 2000 to Starr in rental fees and $262,000 for services in 2002, 2001 and 2000. AIG also received approximately $3 million in 2002 and $4 million in 2001 and $1 million in 2000, respectively, from SICO and paid approximately $1 million in each of the years 2002, 2001 and 2000 to SICO as reimbursement for services rendered at cost. AIG also paid to SICO $5 million in 2002, and $4 million in both 2001 and 2000 in rental fees. 19. ACQUISITION, RESTRUCTURING AND RELATED CHARGES During the third quarter of 2001, AGC was consolidated into AIG and charges in connection with this acquisition totaled $1.36 billion for that quarter. During the second quarter of 2001, AGC incurred $654 million in connection with the termination of its merger agreement with Prudential plc. Thus, for all of 2001, AIG incurred $2.02 billion of charges in connection with the acquisition of AGC. With respect to the charges of $1.36 billion incurred in the third quarter of 2001, approximately $512 million was related to direct costs of the acquisition. Of the $512 million, $85 million was attributable to investment banking, legal and accounting fees. The remaining direct costs of $427 million were related to employee severance and other termination benefits, and other compensation costs related to change in control agreements with AGC executives. The costs were also based in part on a projected elimination of positions, in accordance with AIG's post-business combination plans, which were intended to enhance the effectiveness and efficiency of the combined operations. 114
American International Group, Inc. and Subsidiaries 19. ACQUISITION, RESTRUCTURING AND RELATED CHARGES (continued) Of the total direct costs of $512 million, $416 million or 82 percent have been paid as of December 31, 2002, including approximately $305 million paid during 2001. In addition, during 2002, $32 million of liabilities were utilized to absorb other insignificant merger-related expenses. The balance, $64 million, is recorded as a component of "Other Liabilities" as of December 31, 2002. With respect to the elimination of positions, 2,287 terminations were included in AIG's original post-business combination plans. As of December 31, 2002, terminations totaled 1,714, including 609 made during 2001. The remaining 573 terminations are scheduled to occur in 2003, in accordance with AGC's employee termination program. The indirect costs of $851 million represented charges resulting from post-business combination plans, recognizing that certain assets will have no future economic benefit or ability to generate future revenues. Such charges include asset impairments charges related to software, leasehold improvements and certain goodwill. Also included were certain adjustments associated with conforming AGC's balances to AIG's existing accounting policies and methodologies. Of the $851 million, $782 million had been applied as of December 31, 2002, including $669 million in 2001. The balance, $69 million, remains outstanding and is reflected as a component of "Other Liabilities" as of December 31, 2002. 20. SPECIAL PURPOSE VEHICLES AIG is a party to numerous entities that may be considered to be Variable Interest Entities (VIEs) under FIN46. Principally, such entities include special purpose vehicles (SPVs). AIG uses SPVs primarily in connection with certain guaranteed investment contract programs (GIC Programs) written by its life insurance subsidiaries, certain products provided by AIGFP, and certain invested asset and asset management activities. In the GIC Programs, AIG's life insurance subsidiaries (principally SunAmerica Life Insurance Company) provide guaranteed investment contracts (GICs) to SPVs which are not controlled by AIG. The SPVs issue notes or bonds which are sold to third party institutional investors. Neither AIG nor the insurance company issuing the GICs has any obligation to the investors in the notes or bonds. The proceeds from the SPVs issuance of securities are used to invest in the GICs. The insurance company subsidiaries use these proceeds to invest in a diversified portfolio of securities, primarily investment grade bonds. Both the assets and the liabilities of the insurance companies arising from these GIC Programs are presented in AIG's consolidated balance sheet. Thus, at December 31, 2002, approximately $29 billion of policyholders' contract deposits represented liabilities from issuances of GICs included in these GIC Programs, offset by the proceeds from the issuances included as insurance invested assets. AIGFP uses SPVs as an integral part of its ongoing operations with respect to specific structured transactions with independent third parties. In most instances, AIGFP controls and manages the assets and liabilities with respect to these SPVs, subject to certain transaction specific limitations. These SPVs are fully consolidated by AIG. AIGFP also sponsors an SPV that issues commercial paper and secured liquidity notes to third-party institutional investors. This SPV uses the proceeds of these offerings to obtain beneficial interests in certain financial assets (total assets of approximately $900 million), which serve as collateral for the securities issued by the SPV. AIGFP provides credit and liquidity support to this SPV, which is not consolidated by AIG. AIG's insurance operations also invest in assets of SPVs. These SPVs are established by unrelated third parties. Investments include collateralized mortgage backed securities and similar securities backed by pools of mortgages, consumer receivables or other assets. The investment in an SPV allows AIG's insurance entities to purchase assets permitted by insurance regulations while maximizing the return on these assets. AIG provides investment management services to certain SPVs. AIG receives management fees for these services and may take a minority ownership interest in these SPVs, which interests are then included as investments in AIG's consolidated balance sheet. AIG services may be terminated with or without cause. To facilitate and expand certain retirement savings and asset management activities, AIG establishes SPVs. AIG receives fees for management of the assets held in the SPV which support the issuance of securities such as collateralized bond obligations sold by the SPV to independent third party investors. These SPVs serve a variety of business purposes, including financing, liquidity, or to facilitate independent third party management participation. 115
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 21. SUMMARY OF QUARTERLY FINANCIAL INFORMATION UNAUDITED THE FOLLOWING QUARTERLY FINANCIAL INFORMATION FOR EACH OF THE THREE MONTHS ENDED MARCH 31, JUNE 30, SEPTEMBER 30 AND DECEMBER 31, 2002 AND 2001 IS UNAUDITED. HOWEVER, IN THE OPINION OF MANAGEMENT, ALL ADJUSTMENTS (CONSISTING OF NORMAL RECURRING ADJUSTMENTS) NECESSARY TO PRESENT FAIRLY THE RESULTS OF OPERATIONS FOR SUCH PERIODS, HAVE BEEN MADE FOR A FAIR PRESENTATION OF THE RESULTS SHOWN. THREE MONTHS ENDED -------------------------------------------------------------------------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, ------------------- ------------------- ------------------- -------------------- (in millions, except per share amounts) 2002 2001 2002 2001 2002 2001 2002 2001 ================================================================================================================================ Revenues $ 16,137 $ 14,793 $ 16,662 $ 15,153 $ 17,150 $ 15,582 $ 17,533 $ 16,238 Net income (loss) 1,980 1,855 1,801 1,315 1,841 327 (103) 1,866 ================================================================================================================================ Net income per common share: Basic $ 0.76 $ 0.71 $ 0.69 $ 0.50 $ 0.70 $ 0.12 $ (0.04) $ 0.72 Diluted 0.75 0.70 0.68 0.50 0.70 0.12 (0.03) 0.70 Average shares outstanding: Basic 2,615 2,623 2,613 2,621 2,610 2,620 2,610 2,615 Diluted 2,641 2,651 2,640 2,651 2,634 2,651 2,633 2,645 ================================================================================================================================ 116
American International Group, Inc. and Subsidiaries 22. INFORMATION PROVIDED IN CONNECTION WITH OUTSTANDING DEBT BY AGC THE FOLLOWING CONDENSED CONSOLIDATING FINANCIAL STATEMENTS ARE PROVIDED IN COMPLIANCE WITH REGULATION S-X OF THE SECURITIES AND EXCHANGE COMMISSION. 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. CONDENSED CONSOLIDATING BALANCE SHEET DECEMBER 31, 2002 - ------------------------------------------------------------------------------------------------------------------------------------ AMERICAN INTERNATIONAL GROUP, INC. AGC OTHER CONSOLIDATED (in millions) GUARANTOR ISSUER SUBSIDIARIES ELIMINATIONS AIG ==================================================================================================================================== Assets: Invested assets $ 1,208 $ -- $428,496 $ (6,108) $423,596 Cash 18 1 1,146 -- 1,165 Carrying value of subsidiaries and partially owned companies, at equity 59,003 17,981 12,607 (88,016) 1,575 Other assets 2,450 2,714 130,049 (320) 134,893 - ------------------------------------------------------------------------------------------------------------------------------------ Total Assets $ 62,679 $ 20,696 $572,298 $(94,444) $561,229 ==================================================================================================================================== Liabilities: Insurance liabilities $ 422 $ -- $296,474 $ (30) $296,866 Debt 2,606 3,200 72,356 (6,277) 71,885 Other liabilities 548 3,197 127,716 (239) 131,222 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities 3,576 6,397 496,546 (6,546) 499,973 ==================================================================================================================================== Preferred shareholders' equity in subsidiary companies -- -- 2,153 -- 2,153 Total Capital Funds 59,103 14,299 73,599 (87,898) 59,103 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities, Preferred Shareholders' Equity in Subsidiary Companies and Capital Funds $ 62,679 $ 20,696 $572,298 $(94,444) $561,229 - ------------------------------------------------------------------------------------------------------------------------------------ December 31, 2001 ==================================================================================================================================== American International Group, Inc. AGC Other Consolidated (in millions) Guarantor Issuer Subsidiaries Eliminations AIG ==================================================================================================================================== Assets: Invested assets $ 1,405 $ -- $359,891 $ (3,371) $357,925 Cash 1 1 696 -- 698 Carrying value of subsidiaries and partially owned companies, at equity 52,117 12,022 3,509 (66,746) 902 Other assets 2,395 2,799 129,276 (934) 133,536 - ------------------------------------------------------------------------------------------------------------------------------------ Total Assets $ 55,918 $ 14,822 $493,372 $(71,051) $493,061 ==================================================================================================================================== Liabilities: Insurance liabilities $ 320 $ -- $256,219 $ -- $256,539 Debt 2,119 5,500 61,048 (2,936) 65,731 Other liabilities 1,329 1,267 114,735 (892) 116,439 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities 3,768 6,767 432,002 (3,828) 438,709 - ------------------------------------------------------------------------------------------------------------------------------------ Preferred shareholders' equity in subsidiary companies -- -- 2,602 (400) 2,202 Total Capital Funds 52,150 8,055 58,768 (66,823) 52,150 - ------------------------------------------------------------------------------------------------------------------------------------ Total Liabilities, Preferred Shareholders' Equity in Subsidiary Companies and Capital Funds $ 55,918 $ 14,822 $493,372 $(71,051) $493,061 ==================================================================================================================================== 117
NOTES TO FINANCIAL STATEMENTS (CONTINUED) 22. INFORMATION PROVIDED IN CONNECTION WITH OUTSTANDING DEBT BY AGC (continued) CONDENSED CONSOLIDATING STATEMENT OF INCOME YEAR ENDED DECEMBER 31, 2002 - -------------------------------------------------------------------------------------------------------------------------------- AMERICAN INTERNATIONAL GROUP, INC. AGC OTHER CONSOLIDATED (in millions) GUARANTOR ISSUER SUBSIDIARIES ELIMINATIONS AIG ================================================================================================================================ Operating Income $ 398 $ -- $ 8,403 $ -- $ 8,801 Equity in undistributed net income of consolidated subsidiaries 4,547 1,182 -- (5,729) -- Dividend income from consolidated subsidiaries 1,644 532 -- (2,176) -- Other (905) (192) 438 -- (659) Income taxes (benefits) 165 (56) 2,219 -- 2,328 Minority interest -- -- (295) -- (295) - -------------------------------------------------------------------------------------------------------------------------------- Net income (loss) $ 5,519 $ 1,578 $ 6,327 $(7,905) $ 5,519 ================================================================================================================================ Year ended December 31, 2001 - ------------------------------------------------------------------------------------------------------------------------------------ American International Group, Inc. AGC Other Consolidated (in millions) Guarantor Issuer Subsidiaries Eliminations AIG ==================================================================================================================================== Operating Income $ 368 $ -- $ 10,237 $ -- $ 10,605 Equity in undistributed net income of consolidated subsidiaries 3,340 199 -- (3,539) -- Dividend income from consolidated subsidiaries 2,236 826 -- (3,062) -- Other (204) (1,525) (737) -- (2,466) Income taxes (benefits) 352 (514) 2,501 -- 2,339 Minority interest -- -- (301) -- (301) Cumulative effect of accounting changes (25) (49) (62) -- (136) - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ 5,363 $ (35) $ 6,636 $ (6,601) $ 5,363 ==================================================================================================================================== Year ended December 31, 2000 - ------------------------------------------------------------------------------------------------------------------------------------ American International Group, Inc. AGC Other Consolidated (in millions) Guarantor Issuer Subsidiaries Eliminations AIG ==================================================================================================================================== Operating Income $ 264 $ -- $ 10,092 $ -- $ 10,356 Equity in undistributed net income of consolidated subsidiaries 5,233 659 -- (5,892) -- Dividend income from consolidated subsidiaries 1,514 557 -- (2,071) -- Other (87) (324) 78 -- (333) Income taxes (benefits) 285 (111) 2,797 -- 2,971 Minority interest -- -- (413) -- (413) - ------------------------------------------------------------------------------------------------------------------------------------ Net income (loss) $ 6,639 $ 1,003 $ 6,960 $ (7,963) $ 6,639 ==================================================================================================================================== 118
American International Group, Inc. and Subsidiaries 22. INFORMATION PROVIDED IN CONNECTION WITH OUTSTANDING DEBT BY AGC (continued) CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOW YEAR ENDED DECEMBER 31, 2002 - -------------------------------------------------------------------------------------------------------------------------------- AMERICAN INTERNATIONAL GROUP, INC. AGC OTHER CONSOLIDATED (in millions) GUARANTOR ISSUER SUBSIDIARIES AIG ================================================================================================================================ Net cash provided by operating activities $ 2,235 $ 4,054 $ 12,399 $ 18,688 - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing: Invested assets disposed (1,203) -- 148,813 147,610 Invested assets acquired (83) -- (193,201) (193,284) Other 16 (1,684) 744 (924) - -------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (1,270) (1,684) (43,644) (46,598) - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Change in debts 68 (2,300) 8,215 5,983 Other (1,016) (70) 23,480 22,394 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (948) (2,370) 31,695 28,377 - -------------------------------------------------------------------------------------------------------------------------------- Change in cash 17 -- 450 467 Cash at beginning of year 1 1 696 698 - -------------------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 18 $ 1 $ 1,146 $ 1,165 ================================================================================================================================ Year Ended December 31, 2001 - -------------------------------------------------------------------------------------------------------------------------------- American International Group, Inc. AGC Other Consolidated (in millions) Guarantor Issuer Subsidiaries AIG ================================================================================================================================ Net cash provided by operating activities $ 2,019 $ 51 $ 6,292 $ 8,362 - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing: Invested assets disposed (879) -- 142,265 141,386 Invested assets acquired (535) -- (171,449) (171,984) Other (75) (276) (349) (700) - -------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (1,489) (276) (29,533) (31,298) - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Change in debts 627 604 10,160 11,391 Other (1,157) (381) 13,259 11,721 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (530) 223 23,419 23,112 - -------------------------------------------------------------------------------------------------------------------------------- Change in cash -- (2) 178 176 Cash at beginning of year 1 3 518 522 - -------------------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 1 $ 1 $ 696 $ 698 ================================================================================================================================ Year Ended December 31, 2000 - -------------------------------------------------------------------------------------------------------------------------------- American International Group, Inc. AGC Other Consolidated (in millions) Guarantor Issuer Subsidiaries AIG ================================================================================================================================ Net cash provided by operating activities $ 1,358 $ 464 $ 7,259 $ 9,081 - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from investing: Invested assets disposed (677) -- 73,745 73,068 Invested assets acquired (131) -- (92,732) (92,863) Other (26) (72) (935) (1,033) - -------------------------------------------------------------------------------------------------------------------------------- Net cash used in investing activities (834) (72) (19,922) (20,828) - -------------------------------------------------------------------------------------------------------------------------------- Cash flows from financing activities: Change in debts 579 479 6,771 7,829 Other (1,105) (869) 5,988 4,014 - -------------------------------------------------------------------------------------------------------------------------------- Net cash provided by (used in) financing activities (526) (390) 12,759 11,843 - -------------------------------------------------------------------------------------------------------------------------------- Change in cash (2) 2 96 96 Cash at beginning of year 3 1 422 426 - -------------------------------------------------------------------------------------------------------------------------------- Cash at end of year $ 1 $ 3 $ 518 $ 522 ================================================================================================================================ 119
NOTES TO FINANCIAL STATEMENTS (CONTINUED) ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure There have been no changes in or disagreements with accountants on accounting and financial disclosure within the twenty-four months ending December 31, 2002. PART III ITEM 10. Directors and Executive Officers of the Registrant Except for the information provided in Part I under the heading "Directors and Executive Officers of the Registrant", this item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A. ITEM 11. Executive Compensation This item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A. ITEM 12. Security Ownership of Certain Beneficial Owners and Management This item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A. ITEM 13. Certain Relationships and Related Transactions This item is omitted because a definitive proxy statement which involves the election of directors will be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year pursuant to Regulation 14A. ITEM 14. Controls and Procedures AIG's disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports that AIG files or submits under the Securities Exchange Act of 1934, as amended (Exchange Act), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed by AIG in the reports that it files or submits under the Exchange Act is accumulated and communicated to AIG's management, including AIG's Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. AIG's Chief Executive Officer and the Chief Financial Officer have reviewed the effectiveness of AIG's disclosure controls and procedures within 90 days of the filing date of this Annual Report on Form 10-K and have concluded that the disclosure controls and procedures are effective. There were no significant changes in AIG's internal controls or in other factors that could significantly affect these controls subsequent to the most recent date of evaluation by AIG's Chief Executive Officer and Chief Financial Officer. PART IV ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) FINANCIAL STATEMENTS AND EXHIBITS. 1. Financial Statements and Schedules. See accompanying Index to Financial Statements. 2. Exhibits. See accompanying Exhibit Index. (b) REPORTS ON FORM 8-K. During the three months ended December 31, 2002, there were no Current Reports filed on Form 8-K. 120
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SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS DULY CAUSED THIS ANNUAL REPORT ON FORM 10-K TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF NEW YORK AND STATE OF NEW YORK, ON THE 31ST OF MARCH, 2003. AMERICAN INTERNATIONAL GROUP, INC. By /S/ M.R. GREENBERG ---------------------------- (M.R. Greenberg, Chairman and Chief Executive Officer) PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THIS ANNUAL REPORT ON FORM 10-K HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS IN THE CAPACITIES INDICATED ON THE 31ST OF MARCH, 2003 AND EACH OF THE UNDERSIGNED PERSONS, IN ANY CAPACITY, HEREBY SEVERALLY CONSTITUTES M.R. GREENBERG, MARTIN J. SULLIVAN AND HOWARD I. SMITH AND EACH OF THEM, SINGULARLY, HIS TRUE AND LAWFUL ATTORNEY WITH FULL POWER TO THEM AND EACH OF THEM TO SIGN FOR HIM, AND IN HIS NAME AND IN THE CAPACITIES INDICATED BELOW, THIS ANNUAL REPORT ON FORM 10-K AND ANY AND ALL AMENDMENTS THERETO. SIGNATURE TITLE /s/ M.R. Greenberg Chairman, Chief Executive Officer - --------------------------------- (M.R. GREENBERG) and Director (Principal Executive Officer) /s/ Howard I. Smith - --------------------------------- (HOWARD I. SMITH) Vice Chairman, Chief Administrative Officer, Chief Financial Officer and Director (Principal Financial Officer) /s/ Michael J. Castelli - --------------------------------- (MICHAEL J. CASTELLI) Vice President and Comptroller (Principal Accounting Officer) /s/ M. Bernard Aidinoff - --------------------------------- Director (M. BERNARD AIDINOFF) /s/ Eli Broad - --------------------------------- Director (ELI BROAD) /s/ Pei-yuan Chia - --------------------------------- Director (PEI-YUAN CHIA) /s/ Marshall A. Cohen - --------------------------------- Director (MARSHALL A. COHEN) /s/ Barber B. Conable, Jr. - --------------------------------- Director (BARBER B. CONABLE, JR.) II-1
SIGNATURES - (CONTINUED) SIGNATURE TITLE --------- ----- /s/ Martin S. Feldstein Director - ------------------------------------------- (MARTIN S. FELDSTEIN) /s/ Ellen V. Futter Director - ------------------------------------------- (ELLEN V. FUTTER) /s/ Carla A. Hills Director - ------------------------------------------- (CARLA A. HILLS) /s/ Frank J. Hoenemeyer Director - ------------------------------------------- (FRANK J. HOENEMEYER) /s/ Richard C. Holbrooke Director - ------------------------------------------- (RICHARD C. HOLBROOKE) /s/ Edward E. Matthews Director - ------------------------------------------- (EDWARD E. MATTHEWS) /s/ Martin J. Sullivan - ------------------------------------------- Director (MARTIN J. SULLIVAN) /s/ Thomas R. Tizzio Director - ------------------------------------------- (THOMAS R. TIZZIO) /s/ Edmund S.W. Tse Director - ------------------------------------------- (EDMUND S.W. TSE) /s/ Jay S. Wintrob Director - ------------------------------------------- (JAY S. WINTROB) /s/ Frank G. Wisner Director - ------------------------------------------- (FRANK G. WISNER) /s/ Frank G. Zarb Director - ------------------------------------------- (FRANK G. ZARB) II-2
CERTIFICATIONS PURSUANT TO SECTION 302 OF SARBANES-OXLEY ACT OF 2002 CERTIFICATION I, M.R. Greenberg, certify that: 1. I have reviewed this annual report on Form 10-K of American International Group, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report. 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report. 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ M.R. Greenberg ------------------------------------ M.R. Greenberg Chairman and Chief Executive Officer Date: March 31, 2003 II-3
CERTIFICATION I, Howard I. Smith, certify that: 1. I have reviewed this annual report on Form 10-K of American International Group, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. /s/ Howard I. Smith ------------------------------------- Howard I. Smith Vice Chairman, Chief Financial Officer and Chief Administrative Officer Date: March 31, 2003 II-4
SCHEDULE I AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES SUMMARY OF INVESTMENTS-- OTHER THAN INVESTMENTS IN RELATED PARTIES AS OF DECEMBER 31, 2002 (in millions) - -------------------------------------------------------------------------------------------------------------------------- AMOUNT AT WHICH SHOWN IN THE COST* VALUE BALANCE SHEET ========================================================================================================================== Fixed maturities: Bonds: United States Government and government agencies and authorities $ 4,928 $ 5,165 $ 5,165 States, municipalities and political subdivisions 41,535 43,413 43,413 Foreign governments 34,487 37,818 37,818 Public utilities 15,793 16,383 16,383 All other corporate 136,341 140,587 140,587 - ----------------------------------------------------------------------------------------------------------------------- Total bonds 233,084 243,366 243,366 - ----------------------------------------------------------------------------------------------------------------------- Total fixed maturities 233,084 243,366 243,366 - ----------------------------------------------------------------------------------------------------------------------- Equity securities: Common stocks: Public utilities 172 155 155 Banks, trust and insurance companies 554 547 547 Industrial, miscellaneous and all other 5,426 4,780 4,780 - ----------------------------------------------------------------------------------------------------------------------- Total common stocks 6,152 5,482 5,482 Non-redeemable preferred stocks 1,678 1,584 1,584 - ----------------------------------------------------------------------------------------------------------------------- Total equity securities 7,830 7,066 7,066 - ----------------------------------------------------------------------------------------------------------------------- Mortgage loans on real estate, policy and collateral loans 19,928 19,928 19,928 Financial services assets: Flight equipment primarily under operating leases, net of accumulated depreciation 26,867 -- 26,867 Securities available for sale, at market value 16,715 16,687 16,687 Trading securities, at market value -- 4,146 4,146 Spot commodities, at market value -- 489 489 Unrealized gain on interest rate and currency swaps options and forward transactions -- 15,376 15,376 Trading assets -- 4,786 4,786 Securities purchased under agreements to resell, at contract value 25,661 -- 25,661 Securities lending collateral 23,694 23,694 Other invested assets 12,680 -- 12,680 Finance receivables, net of allowance 15,857 -- 15,857 Short-term investments, at cost (approximates market value) 6,993 -- 6,993 - ----------------------------------------------------------------------------------------------------------------------- Total investments -- -- $423,596 ======================================================================================================================= *Original cost of equity securities and, as to fixed maturities, original cost reduced by repayments and adjusted for amortization of premiums or accrual of discounts. S-1
SCHEDULE II AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEET -- PARENT COMPANY ONLY (in millions) - ------------------------------------------------------------------------------------------------------------ DECEMBER 31, 2002 2001 - ------------------------------------------------------------------------------------------------------------ ASSETS: Cash $ 18 $ 1 Short-term investments 144 7 Invested assets 1,064 1,398 Carrying value of subsidiaries and partially-owned companies, at equity 59,003 52,117 Premiums and insurance balances receivable-- net 199 145 Other assets 2,251 2,250 - ------------------------------------------------------------------------------------------------------------ TOTAL ASSETS 62,679 55,918 - ------------------------------------------------------------------------------------------------------------ LIABILITIES: Insurance balances payable 422 320 Due to affiliates-- net 2,142 894 Medium term notes payable 998 542 Term notes payable 434 433 Zero coupon notes 1,174 1,144 Other liabilities (1,594) 435 - ------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES 3,576 3,768 - ------------------------------------------------------------------------------------------------------------ CAPITAL FUNDS: Common stock 6,878 6,876 Additional paid-in capital 607 669 Retained earnings 52,270 47,218 Accumulated other comprehensive income (loss) 691 (1,725) Treasury stock (1,343) (888) - ------------------------------------------------------------------------------------------------------------ TOTAL CAPITAL FUNDS 59,103 52,150 - ------------------------------------------------------------------------------------------------------------ TOTAL LIABILITIES AND CAPITAL FUNDS $ 62,679 $ 55,918 ============================================================================================================ STATEMENT OF INCOME -- PARENT COMPANY ONLY (in millions) - ---------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ====================================================================================================================== Agency loss $ (12) $ (4) $ (11) Financial services income 419 360 280 Asset management income (loss) (9) 12 (5) Dividend income from consolidated subsidiaries: Cash 1,644 2,194 1,514 Other -- 42 -- Dividend income from partially-owned companies -- 2 -- Equity in undistributed net income of consolidated subsidiaries and partially-owned companies 4,547 3,340 5,233 Other income (deductions)-- net (905) (206) (87) - ---------------------------------------------------------------------------------------------------------------------- Income before income taxes and cumulative effect of accounting changes 5,684 5,740 6,924 Income taxes 165 352 285 - ---------------------------------------------------------------------------------------------------------------------- Income before cumulative effect of accounting changes 5,519 5,388 6,639 - ---------------------------------------------------------------------------------------------------------------------- Cumulative effect of accounting changes, net of tax -- (25) -- - ---------------------------------------------------------------------------------------------------------------------- Net income $ 5,519 $ 5,363 $ 6,639 ====================================================================================================================== See Accompanying Notes to Financial Statements. S-2
SCHEDULE II AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED) STATEMENT OF CASH FLOWS -- PARENT COMPANY ONLY (in millions) - ----------------------------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 ============================================================================================================================= CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 5,519 $ 5,363 $ 6,639 - ----------------------------------------------------------------------------------------------------------------------------- ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Non-cash revenues, expenses, gains and losses included in income: Equity in undistributed net income of consolidated subsidiaries and partially-owned companies (4,547) (3,340) (5,233) Change in premiums and insurance balances receivable and payable-- net 48 (4) 7 Change in cumulative translation adjustments (15) 21 85 Other-- net 1,230 (21) (140) - ----------------------------------------------------------------------------------------------------------------------------- Total adjustments (3,284) (3,344) (5,281) - ----------------------------------------------------------------------------------------------------------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 2,235 2,019 1,358 - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investments (83) (535) (131) Sale of investments 415 -- 1 Change in short-term investments (137) (5) (1) Change in collateral and guaranteed loans -- 10 10 Contributions to subsidiaries and investments in partially-owned companies (1,481) (884) (687) Other-- net 16 (75) (26) - ----------------------------------------------------------------------------------------------------------------------------- NET CASH USED IN INVESTING ACTIVITIES (1,270) (1,489) (834) - ----------------------------------------------------------------------------------------------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Change in medium term notes 456 (40) 101 Change in term notes 1 -- 1 Proceeds from issuance of zero coupon notes -- 1,000 -- Redemption of Italian Lire bonds -- (159) -- Proceeds from common stock issued 168 233 142 Change in loans payable (389) (174) 477 Cash dividends to shareholders (467) (383) (335) Acquisition of treasury stock (734) (978) (947) Other-- net 17 (29) 35 - ----------------------------------------------------------------------------------------------------------------------------- NET CASH USED IN FINANCING ACTIVITIES (948) (530) (526) - ----------------------------------------------------------------------------------------------------------------------------- CHANGE IN CASH 17 -- (2) CASH AT BEGINNING OF YEAR 1 1 3 - ----------------------------------------------------------------------------------------------------------------------------- CASH AT END OF YEAR $ 18 $ 1 $ 1 ============================================================================================================================= NOTES TO FINANCIAL STATEMENTS-- PARENT COMPANY ONLY (1) Agency operations conducted in New York through the North American Division of AIU are included in the financial statements of the parent company. (2) Certain accounts have been reclassified in the 2001 and 2000 financial statements to conform to their 2002 presentation. (3) "Equity in undistributed net income of consolidated subsidiaries and partially-owned companies" in the accompanying Statement of Income-- Parent Company Only-- includes equity in income of the minority-owned insurance operations. (4) See also Notes to Consolidated Financial Statements. S-3
SCHEDULE III AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION AS OF DECEMBER 31, 2002, 2001 AND 2000 AND FOR THE YEARS THEN ENDED (in millions) Reserves for Losses and Losses and Amortization Deferred Loss Reserve Policy Loss of Deferred Policy Expenses, for and Net Expenses Policy Other Net Acquisition Future Policy Unearned Contract Premium Investment Incurred, Acquisition Operating Premiums Segment Costs Benefits(a) Premiums Claims(b) Revenue Income Benefits Costs(c) Expenses Written ================================================================================================================================== 2002 GENERAL INSURANCE $ 3,484 $ 51,539 $16,336 $ -- $24,269 $ 2,760 $20,814 $2,276 $ 2,414 $27,414 LIFE INSURANCE 18,772 72,547 -- 1,649 20,320 12,274 21,113 2,184 3,315 -- - ---------------------------------------------------------------------------------------------------------------------------------- $ 22,256 $124,086 $16,336 $ 1,649 $44,589 $15,034 $41,927 $4,460 $ 5,729 $27,414 ================================================================================================================================== 2001 General insurance $ 2,651 $ 44,792 $13,148 $ -- $19,365 $ 2,893 $15,406 $2,016 $ 1,855 $20,101 Life insurance 16,706 64,998 -- 1,473 19,063 11,084 19,648 2,207 3,350 -- - ---------------------------------------------------------------------------------------------------------------------------------- $ 19,357 $109,790 $13,148 $ 1,473 $38,428 $13,977 $35,054 $4,223 $ 5,205 $20,101 ================================================================================================================================== 2000 General insurance $ 2,438 $ 40,613 $12,510 $ -- $17,407 $ 2,701 $13,104 $1,708 $ 1,810 $17,526 Life insurance 15,298 51,532 -- 1,414 17,163 9,962 17,760 1,558 2,011 -- - ---------------------------------------------------------------------------------------------------------------------------------- $ 17,736 $ 92,145 $12,510 $ 1,414 $34,570 $12,663 $30,864 $3,266 $ 3,821 $17,526 ================================================================================================================================== (a) Reserves for losses and loss expenses with respect to the general insurance operations are net of discounts of $1.50 billion, $1.42 billion and $1.29 billion for 2002, 2001 and 2000, respectively. (b) Reflected in insurance balances payable on the accompanying balance sheet. (c) Amounts shown for general insurance segment exclude amounts deferred and amortized in the same period. S-4
SCHEDULE IV AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES REINSURANCE AS OF DECEMBER 31, 2002, 2001 AND 2000 AND FOR THE YEARS THEN ENDED (dollars in millions) - ------------------------------------------------------------------------------------------------- PERCENT OF CEDED ASSUMED AMOUNT TO OTHER FROM OTHER NET ASSUMED GROSS AMOUNT COMPANIES COMPANIES AMOUNT TO NET ================================================================================================= 2002 LIFE INSURANCE IN-FORCE $1,322,404 $278,704 $2,047 $1,045,747 0.2% - ------------------------------------------------------------------------------------------------ PREMIUMS: GENERAL INSURANCE $ 32,718 $ 10,123 $4,819 $ 27,414 17.6% LIFE INSURANCE 21,201 917 36 20,320* 0.2 - ------------------------------------------------------------------------------------------------ TOTAL PREMIUMS $ 53,919 $ 11,040 $4,855 $ 47,734 10.2% ================================================================================================ 2001 Life insurance in-force $1,226,339 $238,644 $2,162 $ 989,857 0.2% - ------------------------------------------------------------------------------------------------ Premiums: General insurance $ 25,279 $ 9,539 $4,361 $ 20,101 21.7% Life insurance 19,920 915 58 19,063* 0.3 - ------------------------------------------------------------------------------------------------ Total premiums $ 45,199 $ 10,454 $4,419 $ 39,164 11.3% ================================================================================================ 2000 Life insurance in-force $ 969,919 $185,705 $1,973 $ 786,187 0.3% ================================================================================================ Premiums: General insurance $ 20,116 $ 7,524 $4,934 $ 17,526 28.1% Life insurance 17,850 762 75 17,163* 0.4 - ------------------------------------------------------------------------------------------------ Total premiums $ 37,966 $ 8,286 $5,009 $ 34,689 14.4% ================================================================================================ *Includes accident and health premiums of $3.45 billion, $3.18 billion and $2.58 billion in 2002, 2001 and 2000, respectively. S5
EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION LOCATION - ------ ----------- -------- 2 Plan of acquisition, reorganization, arrangement, liquidation or succession Agreement and Plan of Merger, dated as of May 11, Incorporated by reference to Exhibit 2.1(i)(a) to 2001, among American International Group, Inc., AIG's Registration Statement on Form S-4 (File Washington Acquisition Corporation and American No.333-62688) General Corporation 3(i)(a) Restated Certificate of Incorporation of AIG Incorporated by reference to Exhibit 3(i) to AIG's Annual Report on Form 10-K for the year ended December 31, 1996 (File No. 1-8787). 3(i)(b) Certificate of Amendment of Certificate of Incorporation of Incorporated by reference to Exhibit 3(i) to AIG's AIG, filed June 3, 1998 Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 1-8787). 3(i)(c) Certificate of Merger of SunAmerica Inc. with and into AIG, Incorporated by reference to Exhibit 3(i) to AIG's filed December 30, 1998 and effective January 1, 1999 Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-8787). 3(i)(d) Certificate of Amendment of Certificate of Incorporation Incorporated by reference to Exhibit 3(i)(c) to of AIG, filed June 5, 2000 AIG's Registration Statement on Form S-4 (File No. 333-45828). 3(ii) By-laws of AIG Incorporated by reference to Exhibit 3(ii) to AIG's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-8787). 4 Instruments defining the rights of security holders, Certain instruments defining the rights of holders including indentures of long-term debt securities of AIG and its subsidiaries are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K. AIG hereby undertakes to furnish to the Commission, upon request, copies of any such instruments. 9 Voting Trust Agreement None. 10 Material contracts* (a) AIG 1969 Employee Stock Option Plan and Filed as exhibit to AIG's Registration Statement Agreement Form (File No. 2-44043) and incorporated herein by reference. (b) AIG 1972 Employee Stock Option Plan Filed as exhibit to AIG's Registration Statement (File No. 2-44702) and incorporated herein by reference. (c) AIG 1972 Employee Stock Purchase Plan Filed as exhibit to AIG's Registration Statement (File No. 2-44043) and incorporated herein by reference. (d) AIG 1984 Employee Stock Purchase Plan Filed as exhibit to AIG's Registration Statement (File No. 2-91945) and incorporated herein by reference. (e) AIG 1996 Employee Stock Purchase Plan Filed as exhibit to AIG's Definitive Proxy Statement dated April 2, 1996 (File No. 1- 8787) and incorporated herein by reference. - ------------------ * All material contracts are management contracts or compensatory plans or arrangements. II-5
EXHIBIT NUMBER DESCRIPTION LOCATION - ------ ----------- -------- (f) AIG 1977 Stock Option and Stock Appreciation Filed as exhibit to AIG's Registration Statement Rights Plan (File No. 2-59317) and incorporated herein by reference. (g) AIG 1982 Employee Stock Option Plan Filed as exhibit to AIG's Registration Statement (File No. 2-78291) and incorporated herein by reference. (h) AIG 1987 Employee Stock Option Plan Filed as exhibit to AIG's Definitive Proxy Statement dated April 6, 1987 (File No. 0- 4652) and incorporated herein by reference. (i) AIG 1991 Employee Stock Option Plan Filed as exhibit to AIG's Definitive Proxy Statement dated April 4, 1997 (File No. 1- 8787) and incorporated herein by reference. (j) AIG 1999 Stock Option Plan Filed as exhibit to AIG's Definitive Proxy Statement dated April 6, 2000 (File No. 1- 8787) and incorporated herein by reference. (k) AIG Amended and Restated 2002 Stock Incorporated by reference to Exhibit 4(a) to AIG's Incentive Plan Registration Statement on Form S-8 (File No. 333-101967). (l) AIG Executive Deferred Compensation Plan Incorporated by reference to Exhibit 4(a) to AIG's Registration Statement on Form S-8 (File No. 333-101640). (m) AIG Supplemental Incentive Savings Plan Incorporated by reference to Exhibit 4(b) to AIG's Registration Statement on Form S-8 (File No. 333-101640). (n) AIRCO 1972 Employee Stock Option Plan Incorporated by reference to AIG's Joint Proxy Statement and Prospectus (File No. 2-61994). (o) AIRCO 1977 Stock Option and Stock Incorporated by reference to AIG's Joint Proxy Appreciation Rights Plan Statement and Prospectus (File No. 2-61994). (p) Purchase Agreement between AIA and Mr. Incorporated by reference to Exhibit 10(l) to AIG's E.S.W. Tse. Annual Report on Form 10-K for the year ended December 31, 1997 (File No. 1-8787). (q) Retention and Employment Agreement between Incorporated by reference to Exhibit 10(m) to AIG and Jay S. Wintrob AIG's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1- 8787). (r) SunAmerica Inc. 1988 Employee Stock Plan Incorporated by reference to Exhibit 4(a) to AIG's Registration Statement on Form S-8 (File No. 333-70069). (s) SunAmerica 1997 Employee Incentive Stock Incorporated by reference to Exhibit 4(b) to AIG's Plan Registration Statement on Form S-8 (File No. 333-70069). (t) SunAmerica Non-employee Directors' Stock Incorporated by reference to Exhibit 4(c) to AIG's Option Plan Registration Statement on Form S-8 (File No. 333-70069). (u) SunAmerica 1995 Performance Stock Plan Incorporated by reference to Exhibit 4(d) to AIG's Registration Statement on Form S-8 (File No. 333-70069). (v) SunAmerica Inc. 1998 Long-Term Performance- Incorporated by reference to Exhibit 4(e) to AIG's Based Incentive Plan For the Chief Executive Registration Statement on Form S-8 (File No. Officer 333-70069). II-6
EXHIBIT NUMBER DESCRIPTION LOCATION - ------ ----------- -------- (w) SunAmerica Inc. Long-Term Performance-Based Incorporated by reference to Exhibit 4(f) to AIG's Incentive Plan Amended and Restated 1997 Registration Statement on Form S-8 (File No. 333-70069). (x) SunAmerica Five Year Deferred Cash Plan Incorporated by reference to Exhibit 4(a) to AIG's Registration Statement on Form S-8 (File No. 333-31346). (y) SunAmerica Executive Savings Plan Incorporated by reference to Exhibit 4(b) to AIG's Registration Statement on Form S-8 (File No. 333-31346). (z) HSB Group, Inc. 1995 Stock Option Plan Incorporated by reference to Exhibit 10(iii)(f) to HSB's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-13135). (aa) HSB Group, Inc. 1985 Stock Option Plan Incorporated by reference to Exhibit 10(iii)(a) HSB's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (File No. 1- 13135). (bb) HSB Group, Inc. Employee's Thrift Incentive Incorporated by reference to Exhibit 4(i)(c) to The Plan Hartford Steam Boiler Inspection and Insurance Company's Registration Statement on Form S- 8 (File No. 33-36519). (cc) American General Corporation 1984 Stock and Incorporated by reference to Exhibit 10.1 to Incentive Plan American General Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No.1-7981) (dd) Amendment to American General Corporation Incorporated by reference to Exhibit 10.2 to 1984 Stock and Incentive Plan (January 2000) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-7981) (ee) American General Corporation 1994 Stock and Incorporated by reference to Exhibit 10.2 to Incentive Plan (January 2000) American General Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 1-7981) (ff) Amendment to American General Corporation Incorporated by reference to Exhibit 10.4 to 1994 Stock and Incentive Plan (January 1999) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-7981) (gg) Amendment to American General Corporation Incorporated by reference to Exhibit 10.5 to 1994 Stock and Incentive Plan (January 2000) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-7981) (hh) Amendment to American General Corporation Incorporated by reference to Exhibit 10.1 to 1994 Stock and Incentive Plan (November 2000) American General Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30,2000 (File No. 1-7981) II-7
EXHIBIT NUMBER DESCRIPTION LOCATION - ------ ----------- -------- (ii) American General Corporation 1997 Stock and Incorporated by reference to Exhibit 10.3 to Incentive Plan American General Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 1-7981) (jj) Amendment to American General Corporation Incorporated by reference to Exhibit 10.7 to 1997 Stock and Incentive Plan (January 1999) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-7981) (kk) Amendment to American General Corporation Incorporated by reference to Exhibit 10.2 to 1997 Stock and Incentive Plan (November 2000) American General Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 2000 (File No. 1-7981) (ll) American General Corporation 1999 Stock and Incorporated by reference to Exhibit 10.4 to Incentive Plan American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1998 (File No. 1-7981) (mm) Amendment to American General Corporation Incorporated by reference to Exhibit 10.9 to 1999 Stock and Incentive Plan (January 1999) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 1999 (File No. 1-7981) (nn) Amendment to American General Corporation Incorporated by reference to Exhibit 10.3 to 1999 Stock and Incentive Plan (November 2000) American General Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30,2000 (File No. 1-7981) (oo) Amended and Restated American General Incorporated by reference to Exhibit 10.13 to Corporation Deferred Compensation Plan American General Corporation's Annual Report (12/11/00) on Form 10-K for the year ended December 31, 2000 (File No. 1-7981) (pp) Amended and Restated Restoration of Retirement Incorporated by reference to Exhibit 10.14 to Income Plan for Certain Employees Participating American General Corporation's Annual Report in the Restated American General Retirement on Form 10-K for the year ended December 31, Plan (Restoration of Retirement Income Plan) 2000 (File No. 1-7981) (12/31/98) (qq) Amended and Restated American General Incorporated by reference to Exhibit 10.15 to Supplemental Thrift Plan (12/31/98) American General Corporation's Annual Report on Form 10-K for the year ended December 31, 2000 (File No. 1-7981) (rr) American General Employees' Thrift and Incorporated by reference to Exhibit 4(a) to AIG's Incentive Plan (restated July 1, 2001) Registration Statement on Form S-8 (File No. 333-68640) II-8
EXHIBIT NUMBER DESCRIPTION LOCATION - ------ ----------- -------- (ss) American General Agents' and Managers' Thrift Incorporated by reference to Exhibit 4(b) to AIG's and Incentive Plan (restated July 1, 2001) Registration Statement on Form S-8 (File No. 333-68640) (tt) CommLoCo Thrift Plan (restated July 1, 2001) Incorporated by reference to Exhibit 4(c) to AIG's Registration Statement on Form S-8 (File No. 68640) (uu) Western National Corporation 1993 Stock and Incorporated by reference to Exhibit 10.18 to Incentive Plan, as amended Western National Corporation's Annual Report on Form 10-K for the year ended December 31, 1995 (File No. 1-12540) (vv) USLIFE Corporation 1991 Stock Option Plan, as Incorporated by reference to USLIFE Corporation's amended Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 (File No. 1-5683) (ww) Employment Agreement, Amendment to Employment Filed herewith. Agreement, Second Amendment to Employment Agreement, Split-Dollar Agreement, including Assignment of Life Insurance Policy as Collateral, and First Amendment to Split-Dollar Agreement, with John A. Graf (xx) Employment Agreement, Amendment to Employment Filed herewith. Agreement, and Split-Dollar Agreement, including Assignment of Life Insurance Policy as Collateral, with Rodney O. Martin, Jr. 11 Statement re computation of per share earnings Included in Note 1(x) of Notes to Financial Statements. 12 Statements re computation of ratios Filed herewith. 13 Annual report to security holders Not required to be filed. 16 Letter re change in certifying accountant Not required to be filed. 18 Letter re change in accounting principles None. 21 Subsidiaries of the Registrant Filed herewith. 23 Consent of PricewaterhouseCoopers LLP Filed herewith. 24 Power of attorney Included on the signature page hereof. 99 Additional exhibits None. II-9
EXHIBIT 10(ww) EMPLOYMENT AGREEMENT AGREEMENT by and among American International Group, Inc., a Delaware corporation (the "Parent"), American General Corporation, a Texas corporation (the "Company"), and John A. Graf (the "Executive") dated as of the 11th day of May, 2001. Parent has determined that it is in the best interests of Parent and the Company and their respective shareholders to assure that the Company will have the continued services of the Executive following the merger (the "Merger") of the Company and Washington Acquisition Corporation, a Texas corporation and a wholly owned subsidiary of Parent ("Merger Sub"), pursuant to the Agreement and Plan of Merger dated as of May 11th, 2001 (the "Merger Agreement"), to provide the surviving corporation after the Merger with continuity of management. Pursuant to the terms of the Prior Agreement (as defined below), Executive would have had the right to terminate his employment upon consummation of the Merger. However, Parent desires to retain the Executive's continued services pursuant to the terms of this Agreement. Therefore, in order to accomplish these objectives, Parent, the Company and the Executive agree as follows: NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS: 1. Effective Date. The "Effective Date" shall mean the "Effective Date" (as defined in the Merger Agreement) of the Merger. This Agreement shall be and become effective on the Effective Date. If the Effective Date does not occur on or before February 28, 2002 or if the Merger Agreement is earlier terminated in accordance with its terms, then this Agreement shall terminate automatically on February 28, 2002 or on such earlier Merger Agreement termination date and none of Parent, the Company or the Executive shall have any obligation to the other hereunder. 2. Employment Period. The Company hereby agrees to employ the Executive, and the Executive hereby agrees to continue to serve the Company, subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary thereof (the "Employment Period"). 3. Terms of Employment. (a) Position and Duties. (i) During the Employment Period, (A) the Executive shall serve in the position set forth on Exhibit A attached hereto, with the duties and responsibilities associated with such position on the Effective Date (except to the extent expressly provided in Exhibit A) as shall be assigned to him by the Board of Directors or Chief Executive Officer of the Company and (B) the Executive's services shall be performed in the location set forth on Exhibit A hereto. (ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote substantially all of his attention and time during normal business hours to the business and affairs of the Company and Parent and to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this
Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not interfere with the performance of the Executive's responsibilities as an employee of the Company and Parent in accordance with this Agreement, and with respect to the activities described in clauses (A) and (C) hereof subject to Parent's policies as in effect from time to time. (b) Compensation. (i) Initial Payment. On the Effective Date, the Company shall pay to the Executive a lump sum payment equal to the amount set forth on Exhibit A hereto, which is equal to the cash payment that the Executive would have been entitled to receive pursuant to Section 4.5 (the "Cash Severance") of the Change in Control Severance Agreement between the Company and the Executive dated as of April 1, 2000 (the "Severance Agreement"), had he been terminated by the Company without "cause" (as defined therein) upon the Effective Date. In addition, on the Effective Date, the Company shall pay to the insurance company which has issued the policy which is the subject of the Split-Dollar Agreement between the Executive and the Company, dated as of May 15, 1998 (the "Split-Dollar Agreement"); the amount set forth on Exhibit A hereto (the "Split Dollar Payment"), which is equal to the projected amount of the premium payments that the Company would have been required to make during the three-year period immediately following the Effective Date on the policy underlying the Split-Dollar Agreement, pursuant to Paragraph 5(b) of the Split-Dollar Agreement. The Executive shall also be entitled to an excise tax gross-up payment as set forth in Section 4.7 of the Severance Agreement solely with respect to the payments and benefits that the Executive was entitled to receive under the terms of the Severance Agreement, the Employment Agreement between the Executive and the Company dated as of May 1, 2000 (the "Prior Employment Agreement"), the Supplemental Executive Retirement Agreement between the Company and the Executive, dated as of May 1, 2000 (the "SERA") and the Split-Dollar Agreement (collectively, the "Pre-Effective Date Agreements") or with respect to the vesting of or lapse of restrictions on, as a direct result of the Merger, compensation earned, benefits accrued or equity awards granted prior to the Effective Date (including, without limitation, benefits due and owing under the Pre-Effective Date Agreements and specifically incorporated herein). Except as set forth in the preceding sentence, in no event shall the Executive be entitled to an excise tax gross-up payment with respect to any amounts payable or benefits provided under the terms of this Agreement. The Executive acknowledges and agrees that in no event shall he be entitled to the payments or benefits under the Severance Agreement based upon a termination during a "Period of Anticipated Change in Control" (as defined in the Severance Agreement). (ii) Base Salary. During the Employment Period, the Executive shall receive an annual base salary ("Annual Base Salary") of no less than the annual base salary in effect with respect to the Executive for calendar year 2001. (iii) Annual Bonus. For each calendar year ending during the Employment Period, the Executive shall receive (or at his election pursuant to the deferred compensation plan of the Company (if any) defer part or all of) an annual cash bonus at least equal to the amount set forth on Exhibit A hereto (the "Annual Bonus") no later than January 31 of the following year, and the Annual Bonus hereunder shall be in lieu of any bonus amount (or portion -2-
thereof) payable to the Executive under any agreement or bonus plan of the Company, including without limitation, the Company Performance-Based Plan for Executive Officers with respect to the calendar year in which the Effective Date occurs, and the Executive hereby waives all right under any such agreements or plans. For the calendar year within which the Employment Period ends, the Executive shall receive no later than January 31 of the following year (or at his election pursuant to the applicable deferred compensation plan of the Company (if any) defer part or all of) a bonus which shall equal or exceed an amount determined by multiplying the Annual Bonus amount set forth on Exhibit A by a fraction the numerator of which shall be the number of days in such calendar year which were included in the Employment Period and the denominator of which shall be 365. (iv) Incentive Awards. At the time equity grants are made to other employees of the Company pursuant to the Merger Agreement, the Executive will be granted equity based awards with respect to the common stock of Parent (the "2001 Service Awards"), pursuant to the terms of the applicable Parent plan as in effect from time to time, that is equal in value to the value of all options (valued using a Black-Scholes value of $10.00, after giving effect to the stock split in 2001), restricted shares and Performance Awards contained in a Performance Based Restricted Stock/Restricted Share Unit Award (valued using the fair market value of the Company's common stock on the date of grant) with respect to restricted share units and performance awards that were granted to the Executive by the Company on January 17, 2001, and with the ratio of the options, restricted shares and performance awards being the same as the ratio of the awards granted to the Executive on January 17, 2001. For purposes of the immediately preceding sentence, the value of the options in Parent's common stock shall be determined using the Black-Scholes valuation model, using assumptions established in manner consistent with the assumptions applied by Parent, consistent with past practices, in respect of stock option grants in 2001. Any stock options on Parent common stock granted in connection with the 2001 Service Awards will have an exercise price equal to the fair market value of the Parent common stock subject thereto on the date of grant and, except as otherwise provided herein, shall vest in four equal installments on each of the first, second, third and fourth anniversaries of the date of grant. Any restricted shares and Performance Awards granted in respect of Parent common stock shall have terms and conditions that are substantially comparable to those applied in respect of the 2001 awards made by the Company. In the event that the Executive receives any equity award grants (other than reload options) from the Company after the date hereof, the 2001 Service Awards shall be reduced by the value of any such awards (determined using a Black-Scholes value with respect to options, using assumptions established on a basis consistent with those applied by the Company in determining such Black-Scholes value in respect of the 2001 grants to the Executive, and the fair market value on the date of grant with respect to performance based or restricted stock awards). (v) Retirement Benefits. On the Effective Date, the Executive shall be paid the benefits payable to the Executive under the SERA, which benefits shall be calculated under the terms and conditions thereof (including without limitation, any enhanced service and age credits provided under Section 2.6 in respect of a termination of the Executive's employment following the occurrence of a Change of Control) as though the Executive's employment terminated on the Effective Date without Cause and the Executive elected to receive a lump sum distribution of such benefits, with any offset against such benefits related to the benefits payable to the Executive under any other retirement plan maintained by the Company based on the benefits -3-
accrued by the Executive thereunder as of the Effective Date. From and after the Effective Date, the Executive shall not be entitled to accrue any additional benefit under the SERA. From and after the Effective Date, the Executive shall participate in the applicable retirement plans of the Company as though no SERA benefit was accrued, provided that the Executive shall not become a participant in the Company's or Parent's Supplemental Executive Retirement Plan and that in no event shall the Executive be entitled to duplicate benefits with respect to the same period of service. To the extent anything contained in this Section 3(b)(v) is inconsistent with the terms and conditions of the SERA, the SERA shall be deemed amended hereby. (vi) Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs generally applicable to similarly situated executives of the Company, provided that, in no event shall the Executive be entitled to receive duplicate benefits with respect to the same period of service under any plans, practices, policies or programs of the Company and/or Parent. Notwithstanding anything contained herein to the contrary, the Executive expressly understands and agrees that he will not initially be entitled to become a participant in the STARR International Co., Inc. ("SICO") Deferred Compensation Profit Participation Plan ("SICO Plan") or to become a stockholder of C.V. STARR & Co., Inc. ("STARR"), but that following the first anniversary of the Effective Date, Parent will recommend to the Boards of Directors of SICO and of STARR that the Executive be eligible to commence participation in the SICO Plan and to become a stockholder of STARR, consistent with similarly situated executives of subsidiaries of Parent. Any participation in the SICO Plan or STARR will require a mutually agreeable reduction in the other compensation payable or provided to the Executive, including without limitation the Base Salary and the Annual Bonus, and such reduction will be a condition to participation in such plans and will in no event be deemed a breach of this Agreement. Any reduction in the compensation otherwise payable hereunder shall be agreed to, in writing, by the parties in advance of the time such reduction is to be effective, and such writing shall set forth, in reasonable detail sufficient for the Executive to understand, the compensation being provided in lieu thereof and all vesting and forfeiture provisions related thereto (and other restrictions, if any, on the ability of the Executive to access or receive such compensation). (vii) Indemnification. The Company shall indemnify the Executive during his employment hereunder and following the termination of the Executive's employment hereunder, on the same basis as the Company indemnifies similarly situated executives of the Company. (viii) Expenses. During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the Company's policies. (ix) Perquisites. During the Employment Period, the Executive shall be entitled to perquisites in accordance with the plans, practices, policies and programs generally applicable to similarly situated executives of the Company. -4-
(x) Vacation. During the Employment Period, the Executive shall be entitled to paid vacation in accordance with the plans, policies, programs and practices of the Company as in effect with respect to the similarly situated executives of the Company. (xi) Other Benefits From Prior Employment Agreement. Upon and following any termination of the Executive's employment with the Company following the Effective Date, regardless of the reason, the Company shall provide the Executive with the benefits described in Section 8(c)(iv) of the Prior Employment Agreement for the duration described in the Prior Employment Agreement, based on the comparable benefits provided immediately prior to the Date of Termination. 4. Termination of Employment. (a) Death or Disability. The Executive's employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company or Parent determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 10(b) of this Agreement of its intention to terminate the Executive's employment. In such event, the Executive's employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the "Disability Effective Date"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executive's duties. For purposes of this Agreement, "Disability" shall mean the absence of the Executive from the Executive's duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and reasonably acceptable to the Executive or the Executive's legal representative. (b) With or Without Cause. The Company or Parent may terminate the Executive's employment during the Employment Period with or without Cause. For purposes of this Agreement, "Cause" shall mean: (i) the continued failure of the Executive to perform substantially the Executive's duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by Parent that specifically identifies the manner in which Parent believes that the Executive has not substantially performed the Executive's duties, or (ii) the engaging by the Executive in illegal conduct or gross misconduct that is materially and demonstrably injurious to the Company or one of its affiliates, or (iii) conviction of a felony or guilty or nolo contendere plea by the Executive with respect thereto. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Parent Board or the Board of Directors of the Company or upon the instructions of the Chief Executive Officer of Parent or the Company or based upon the advice of counsel for Parent or the Company shall be conclusively presumed to be done, or omitted to be done, by the -5-
Executive in good faith and in the best interests of the Company. The acts and/or omissions which are alleged to constitute the basis for a Cause termination shall be identified to the Executive in reasonable detail in writing, at the time of any such termination of the Executive's employment for Cause. (c) Good Reason. The Executive's employment may be terminated by the Executive for Good Reason. For purposes of this Agreement, "Good Reason" shall mean a material breach by the Company or Parent of a material provision of this Agreement. Without limiting the generality of the foregoing, Parent and the Executive agree that any of the following would constitute a material breach of this Agreement by Parent: (i) any reduction in the Executive's base salary or annual bonus (other than a reduction consented to by the Executive in writing, including, without limitation, any reduction contemplated by Section 3(b)(vi)); (ii) any material adverse change (without his prior written consent) in the Executive's duties and responsibilities, or titles, as set forth in Section 3(a)(i) and Exhibit A attached hereto; and (iii) any relocation of his principal place of employment in violation of Section 3(a)(i) and Exhibit A attached hereto. (d) Notice of Termination. Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 10(b) of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive, the Company or Parent to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive, the Company or Parent, respectively, hereunder or preclude the Executive, the Company or Parent, respectively, from asserting such fact or circumstance in enforcing the Executive's, the Company's or Parent's rights hereunder. (e) Date of Termination. "Date of Termination" means (i) if the Executive's employment is terminated by the Company or Parent for Cause, or by the Executive with or without Good Reason, the date of receipt of the Notice of Termination or any later date specified therein within 30 days of such notice, as the case may be, (ii) if the Executive's employment is terminated by the Company or Parent other than for Cause or Disability, the Date of Termination shall be the date on which the Company or Parent notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be. 5. Obligations of the Company upon Termination, (a) Good Reason; Other Than for Cause, Death or Disability. If, during the Employment Period, the Company or Parent shall terminate the Executive's employment other than for Cause, death or Disability or the Executive shall terminate employment for Good Reason: -6-
(i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts: A. (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid ("Accrued Salary"), (2) the benefits described in Section 3(b)(xi) hereof and (3) any benefits to which the Executive is entitled under the terms and conditions of any applicable employee benefits plan, program or agreement (collectively, subclause (l)-(3) shall be referred to as the "Accrued Obligations"); and B. a lump sum amount equal to the greater of (x) the severance under the severance policy applicable to similarly situated executives of the Company, as in effect from time to time, and (y) the sum of the Executive's Annual Base Salary and the Annual Bonus amount set forth in Section 3(b)(iii); and C. a pro-rata portion of the Annual Bonus payable to the Executive under Section 3(b)(iii), which shall be determined by multiplying such bonus by a fraction, the numerator of which is the number of days in the calendar year in which the Executive's date of termination occurs which have elapsed prior to such date of termination and the denominator of which is 365; and D. outplacement services for the duration and of the nature described in Section 8(c)(v) of the Prior Employment Agreement; and (ii) to the extent granted prior to the Date of Termination, the 2001 Service Awards shall vest immediately. (b) Death. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than the Accrued Obligations (to the extent applicable upon the Executive's death). Accrued Salary shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. In addition, (i) to the extent granted prior to the Date of Termination, all of the 2001 Service Awards shall become fully vested and, to the extent applicable, exercisable for the maximum period allowable under the applicable plan for a termination due to death and (ii) the Executive's estate shall be entitled to the death benefits as in effect on the date of the Executive's death with respect to similarly situated executives of the Company (including, without limitation, any rights to accelerated vesting and enhanced exercise periods applicable in respect of any equity awards made to the Executive in connection with his employment after the Effective Date (excluding the 2001 Service Awards, which are addressed in subclause (i)) that are generally available to similarly situated executives of subsidiaries of Parent whose employment has terminated for such reason under the terms of the plan, program or arrangement under which such awards have been made (the "Equity Enhancements")). (c) Disability. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than in respect of the Accrued Obligations. Accrued -7-
Salary shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. In addition, (i) to the extent granted prior to the Date of Termination, all of the 2001 Service Awards shall become fully vested and, to the extent applicable, exercisable for the maximum period allowable under the applicable Parent plan for a termination due to disability and (ii) the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits as in effect at any time thereafter generally with respect to similarly situated executives of the Company and to the Equity Enhancements). (d) Cause; Other than for Good Reason. If the Executive's employment shall be terminated for Cause or the Executive terminates his employment without Good Reason during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive the Accrued Obligations and the only duties, obligations and liabilities of the Executive to the Company or Parent thereafter shall be the restrictive covenants set forth in Section 7 hereof. 6. Full Settlement. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company or Parent may have against the Executive or others. 7. Confidential Information; Noncompetition; Nonsolicitation. (a) The Executive shall hold in a fiduciary capacity for the benefit of the Company and Parent all secret or confidential information, knowledge or data relating to the Company, Parent or any of their affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company, Parent or any of their affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, Parent or any of their affiliated companies, the Executive shall not, without the prior written consent of Parent or as may otherwise be required by law or legal process, communicate or divulge any such information, knowledge or data to anyone other than the Company, Parent or any of their affiliated companies and those designated by them. (b) The Executive agrees that until the earlier of (i) the fourth anniversary of the Effective Date and (ii) the first anniversary of the Executive's termination of employment for any reason (the "Restricted Period"), the Executive will not, without the written consent of Parent, engage in any business of, or enter the employ of, or have any interest in, directly or indirectly, any other person, firm, corporation or other entity engaged in a business that competes with, or provides services and/or products of a nature substantially similar to those provided by, the Company, Parent or their affiliates, with an office or facility in any geographic area in which the Company, Parent or their affiliates do business. Nothing herein shall restrict the Executive from owning 1% or less of the outstanding securities of any corporation or other entity whose securities are listed on any national securities exchange or traded over-the-counter, if the Executive has no other connection or relationship with the issuer of such securities. -8-
(c) During the Restricted Period, the Executive will not, directly or indirectly, on behalf of the Executive or any other person, solicit for employment or employ by other than the Company or Parent any person who, at any time during the six-month period immediately preceding the date of such solicitation, was an employee of the Company, Parent or any of their affiliates. (d) The Executive acknowledges and agrees that due to the nature of the business in which the Company, Parent and their affiliates are engaged and because of the nature of the confidential information to which the Executive has access, it would be impractical and excessively difficult to determine the actual damages of the Company or Parent in the event the Executive breached any of the covenants of this Section 7 and that remedies at law (such as monetary damages) for any breach of the Executive's obligations under this Section 7 would be inadequate. The Executive therefore agrees and consents that, if the Executive commits any breach of a covenant under this Section 7 or threatens to commit any such breach, the Company and Parent shall have the right (in addition to, and not in lieu of, any other right or remedy that may be available to each of them) to temporary and permanent injunctive relief from a court of competent jurisdiction. With respect to any provision of this Section 7 finally determined by a court of competent jurisdiction to be unenforceable, the Executive, the Company and Parent hereby agree that such court shall have jurisdiction to reform this Agreement or any provision hereof so that it is enforceable to the maximum extent permitted by law, and the parties agree to abide by such court's determination. (e) The provisions of this Section 7 shall remain in full force and effect until the expiration of the period specified therein, notwithstanding the earlier termination of the Executive's employment hereunder, the Employment Period or this Agreement, provided that the Effective Date has occurred. 8. Successors. (a) This Agreement is personal to the Executive and without the prior written consent of the Company and Parent shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives. (b) This Agreement shall inure to the benefit of and be binding upon the Company and Parent and their respective successors and assigns. (c) The Company and Parent will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company or Parent, as applicable, to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company and/or Parent would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" and "Parent" shall mean the Company and Parent as hereinbefore defined and any successor to their respective businesses and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. As used in this Agreement, the term "affiliated companies" and "affiliates" shall include any company controlled by, controlling or under common control with the Company. -9-
9. Dispute Mechanism. (a) Pre-Effective Date Agreements. To the extent that there is any dispute between the parties with respect to any benefits payable hereunder which are due and payable under a Pre-Effective Date Agreement (including, without limitation, the amounts payable under Section 3(b)(i), the SERA benefits payable under Section 3(b)(v) and the benefits payable or provided under Section 5(a)(i)(D)), such dispute shall be resolved pursuant to the mechanism set forth in Section 20 of the Prior Employment Agreement, which is incorporated by reference herein and made a part hereof, and Parent shall be obligated to pay (or shall cause the Company to pay) the Executive's legal and arbitration fees and expenses as provided under Section 10 of the Prior Employment Agreement, which is incorporated by reference herein and made a part hereof. (b) Benefits and Claims Not Related to the Pre-Effective Date Agreements. To the extent that there is any dispute between the parties with respect to any benefits payable hereunder which are not due and payable under a Pre-Effective Date Agreement (and therefore not subject to the dispute mechanism set forth in Section 9(a) above), Parent shall be obligated to pay (or shall cause the Company to pay) the Executive's legal and arbitration fees and expenses related to such dispute in the event that the Executive prevails at arbitration or trial as to any material issue presented in such dispute. 10. Miscellaneous. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. (b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to the Executive: At the most recent address on file at the Company -10-
If to the Company: American General Corporation 2929 Allen Parkway Houston, Texas 77019 Attention: General Counsel Copy to Parent: American International Group, Inc. 70 Pine Street New York, New York 10270 Attention: General Counsel or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. (c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (d) The Company's obligations (i) to indemnify the Executive pursuant to Section 3(vii), (ii) to provide the Executive with benefits and compensation pursuant to Section 5, (iii) to pay any gross-up payment required to be paid under Section 3(b)(i), and (iv) to pay any amount not previously paid (and required to be paid hereunder ) in respect of any Pre-Effective Date Agreement, as well as the dispute mechanisms set forth in Section 9, shall survive the termination of the Executive's employment hereunder, the Employment Period or this Agreement, provided that the Effective Date has occurred. (e) None of the benefits provided to the Executive under any of the Pre-Effective Date Agreements or under Section 5 hereof shall be subject to any mitigation or offset, except as may otherwise be expressly provided hereunder. (f) The Company or Parent may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (g) The Executive's or the Company's or Parent's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive, the Company or Parent may have hereunder shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (h) From and after the Effective Date, this Agreement shall supersede and terminate the Severance Agreement, the Prior Employment Agreement, and any amendments thereto, except to the extent that any of the benefits made available under the Prior Employment Agreement are expressly intended to continue under the terms of this Agreement. From and after the Effective Date, the SERA and the Split-Dollar Agreement shall be amended in accordance with the terms hereof, and, upon satisfaction of the Company's obligations as set forth herein, the Company and Parent shall have no further obligations under such agreements. -11-
IN WITNESS WHEREOF, the Executive has hereunto set the Executive's hand and, pursuant to the authorization from their respective Boards of Directors, each of the Company and Parent has caused these presents to be executed in its name on its behalf, all as of the day and year first above written. /s/ John A. Graf --------------------------------------------------- JOHN A. GRAF AMERICAN GENERAL CORPORATION BY /s/ Mark S. Berg ----------------------------------------------- Name: Mark S. Berg Title: Executive Vice President and General Counsel AMERICAN INTERNATIONAL GROUP, INC. BY /s/ Ernest T. Patrikis ----------------------------------------------- Name: Ernest T. Patrikis Title: Senior Vice President and General Counsel -12-
Exhibit A Name: John A. Graf Position: Senior Vice Chairman Adjustments to Responsibilities: Excluding responsibilities related to investments. Location: Houston, Texas Cash Severance Amount: $4,875,000 Split-Dollar Payment: $222,387 Annual Bonus: $1,250,000
AMERICAN INTERNATIONAL GROUP, INC. 70 PINE STREET, NEW YORK, N.Y. 10270 TELEPHONE: (212) 770-7000 July 27, 2001 John A. Graf 6340 Brompton Houston, Texas 77005 Re: Amendment to Employment Agreement dated as of May 11, 2001 Dear Mr. Graf: This letter confirms the following understandings reached among you, American International Group, Inc. ("Parent"), SunAmerica Inc., a Delaware corporation and a wholly-owned subsidiary of Parent ("SunAmerica"), and American General Corporation ("Company") with respect to the Employment Agreement dated as of May 11,2001( the "Agreement") and constitutes an amendment to such Agreement: 1. As of the Effective Date (as defined in the Agreement"), (a) the Company's rights and obligations under the Agreement will be assigned to SunAmerica without further action required, (b) SunAmerica will assume all rights and obligations of the Company under the Agreement, and (c) all references in the Agreement to the Company (other than references to specifically identified employee benefits or benefit or other plans of the Company which remain in effect subsequent to the Effective Date (which references will remain references to such continuing plans of the Company so long as such plans remain in effect in accordance with the terms of the Merger Agreement (as defined in the Agreement)) will be deemed to be references to SunAmerica. 2. Exhibit A to the Agreement is amended as follows: "Position: Vice Chairman, SunAmerica Inc. You will be elected as a member of the Board of Directors of SunAmerica Inc.
Adjustments to Responsibilities: The Executive acknowledges and agrees that the businesses comprising the Retirement Services Division of American General Corporation are being integrated into SunAmerica Inc. and its subsidiaries (excluding American General Investment Management, which is being integrated into the Fixed Income operations of Parent). The Executive's responsibilities will include the Fixed Annuity business, the non-profit group Retirement Plan business (i.e., Variable Annuity Life Insurance Company) and the Broker-Dealer business (i.e., The SunAmerica Financial Network) (these businesses collectively referred to herein as the "Reference Businesses"). The Executive's responsibilities will exclude responsibilities related to investments, the mutual fund business (acknowledging that the mutual fund business of American General Corporation is being combined with SunAmerica Asset Management Corp.) and Individual Variable Annuities Location: Houston, Texas, then Los Angeles, California (after an agreed upon transitional period not to exceed 12 months." 3. Section 3(b)(iii) of the Agreement is amended as follows: "Bonus. For each calendar year ending during the Employment Period, (a) the Executive shall receive (or at his election pursuant to the deferred compensation plan of the Company, if any, defer part or all of) an annual cash bonus of not less than $1,250,000 (the "Annual Bonus") no later than January 31 of the following year and (b) the Annual Bonus hereunder shall be in lieu of any bonus amount (or portion thereof) payable to the Executive under any agreement or bonus plan of the Company, Parent or any subsidiary of Parent (other than the Supplementary Bonus as hereinafter described), including without limitation, the Company Performance-Based Plan for Executive Officers with respect to the calendar year in which the Effective Date occurs, and the Executive hereby waives all rights under such agreement or plans. For the calendar year within which the Employment Period ends, the Executive shall receive no later than January 31 of the following year (or at his election pursuant to the applicable deferred compensation plan of the Company, if any, defer part or all of) a bonus which shall 2
equal or exceed an amount determined by multiplying the Annual Bonus by a fraction the numerator of which shall be the number of days in such calendar year which were included in the Employment Period and the denominator of which shall be 365. For each calendar year ending during the Employment Period, the Executive will receive a minimum of $90,000 of bonus compensation (the "Supplementary Bonus") payable in equal quarterly amounts with regard to services performed in that year provided the Executive is employed by Parent or a subsidiary of Parent at the time of the respective quarterly payment when such payment becomes due." 4. Section 3(b)(iv) of the Agreement is amended as follows: "Incentive Awards. At the time equity grants are made to executive officers of the Parent in respect of services performed in the calendar year ending December 31, 2001, the Executive will be granted equity-based awards with respect to the common stock of Parent (the "2001 Service Awards"), pursuant to the terms of the applicable Parent plans or the applicable plans of Starr International Company, Inc. ("SICO"), which the parties agree has an aggregate value as of the date of this letter of at least $8,731,163 comprised of the following: - stock options with an exercise price equal to the fair market value of Parent common stock on the date of grant, vesting (subject to your continued employment with Parent or its subsidiaries on the vesting dates) in four equal installments on each of the first, second, third and fourth anniversaries of the date of grant having an aggregate Black-Scholes valuation of $2,148,023 using a Black-Scholes factor of 0.4059; - Five year cliff vesting stock options vesting (subject to your continued employment with Parent or its subsidiaries on the vesting date) in full on the fifth anniversary of the date of grant with an exercise price equal to the fair market value of Parent common stock on the date of grant having an aggregate Black Scholes valuation of $2,520,000 using a Black-Scholes factor of 0.40; 3
- Performance share units having a maximum aggregate value of $3,825,000 based upon the fair market value on the date of grant which shall vest (subject to your continued employment with the Parent or its subsidiaries on the vesting date) from 0 to 100 percent as soon as administratively feasible after December 31, 2004 (provided that, the receipt of shares of Parent common stock pursuant to such units may be deferred, at the election of the Executive, pursuant to an applicable deferral program of the Parent, if any ) upon achievement of the following implied growth rates of Cumulative Pre-Tax Operating Earnings of (a) the Reference Businesses (with respect to 50% of the maximum shares earned shown below) and (b) SunAmerica (with respect to the other 50% of the maximum shares earned shown below): Maximum Implied Growth Rate--------- 15.0% Maximum Shares Earned------ 100% Target Implied Growth Rate---------- 12.5% Maximum Shares Earned------ 50% Threshold Implied Growth Rate---- -- 8.5% Maximum Shares Earned------ 25% Below Implied Growth Rate-------- -- 8.50% Maximum Shares Earned------ 0% Cumulative Pre-Tax Operating Earnings means the consolidated pretax operating earnings of the Reference Businesses or SunAmerica, as applicable, excluding net realized investment gains, non-recurring items, and the cumulative effect of accounting changes under generally accepted accounting principles; and - 900 participation units in the then current SICO Deferred Compensation Profit Participation Plan ("SICO Plan") (number of units determined using a valuation model for the shares of Parent common stock expected to be distributable with respect to such units in accordance with the terms of the SICO Plan using assumptions established on a basis consistent with those applied by Parent in valuing participation units for similarly situated executives of Parent.) In the event that the Executive receives any equity award grants (other than reload options) from the Company after the date hereof prior to the Effective Date, the 2001 4
Service Awards shall be reduced by the value of any such awards (determined using a Black-Scholes value with respect options, using assumptions established on a basis consistent with those applied by the Company in determining such Black-Scholes value in respect of the 2001 grants to the Executive, and the fair market value on the date of grant with respect to performance based and restricted stock awards.)" 5. Section 3(b)(vi) of the Agreement is amended as follows: "Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs generally applicable to similarly situated executives of the Company, provided that in no event shall the Executive be entitled to receive duplicate benefits with respect to the same period of service under any plans, practices, policies or programs of the Company and/or Parent. Notwithstanding anything contained herein to the contrary, the Executive expressly understands and agrees that he will not initially be entitled to become a stockholder of C.V. Starr & Co., Inc. ("Starr"), but that following the first anniversary of the Effective Time, Parent will recommend to the Board of Directors of Starr that the Executive be eligible to become a stockholder of Starr, consistent with similarly situated executives of subsidiaries of Parent. Any Participation as a stockholder of Starr will require a mutually agreeable reduction in other compensation payable or provided to the Executive, including without limitation the Base Salary, the Annual Bonus and the Supplementary Bonus, and such reduction will be a condition to such participation and will in no way be deemed a breach of this Agreement. Any reduction in the compensation otherwise payable hereunder shall be agreed to, in writing, by the parties in advance of the time such reduction is to be effective, and such writing shall set forth, in reasonable detail sufficient for the Executive to understand, the compensation being provided in lieu thereof and all vesting and forfeiture provisions related thereto (and other restrictions, if any, on the ability of the Executive to access or receive such compensation). 6. The Executive agrees that this letter agreement constitutes his written consent to changes in his compensation arrangements, duties and responsibilities and principal 5
place of employment and under no circumstances shall such changes constitute "Good Reason" for termination by the Executive as defined in Section 4(c) of the Agreement. 7. From and after the date hereof, the Agreement is hereby amended by this letter agreement, in accordance with Section 10 of the Agreement. Very truly yours, American International Group, Inc. American General Corporation By: /s/ M.R. Greenberg By: /s/ Gary D. Reddick ------------------------- ---------------------------- Name: M.R. Greenberg Name: Gary D. Reddick Title: Chairman Title: Executive Vice President SunAmerica Inc. By: /s/ Jay S. Wintrob ------------------------- Name: Jay S. Wintrob Title: President and CEO Accepted and Agreed as of August 6, 2001: /s/ John A. Graf - ----------------------------- John A. Graf 6
March 25, 2003 John A. Graf 6340 Brompton Houston, Texas 77005 Re: Second Amendment to Employment Agreement dated as of May 11, 2001 Dear Mr. Graf: This letter confirms the following understandings reached among you, American International Group, Inc. ("Parent"), AIG SunAmerica Inc. (formerly SunAmerica Inc.), a Delaware corporation and a wholly-owned subsidiary of Parent ("AIG SunAmerica"), and American General Corporation ("Company") with respect to the Employment Agreement dated as of May 11, 2001 (the "Original Agreement") and the Amendment to the Original Agreement dated July 27, 2001 (the "First Amendment" and, together with the Original Agreement, the "Agreements") and constitutes an amendment to the Agreements: 1. As of November 6, 2002, (a) AIG SunAmerica's rights and obligations under the Agreements will be assigned to Parent without further action required, (b) Parent will assume all rights and obligations of AIG SunAmerica under the Agreements, and (c) all references in the Agreements to the Company or AIG SunAmerica (other than references to specifically identified employee benefits or benefit or other plans of the Company which remain in effect subsequent to the Effective Date (which references will remain references to such continuing plans of the Company so long as such plans remain in effect)), will be deemed to be references to Parent. 2. Exhibit A to the Original Agreement is amended as follows (superceding Section 2 of the First Amendment): "POSITION: Executive Vice President, Retirement Savings, American International Group, Inc. Vice Chairman, AIG SunAmerica Inc. Executive will continue to serve as a member of the Board of Directors of AIG SunAmerica Inc. ADJUSTMENTS TO RESPONSIBILITIES: The Executive will head the international retirement savings operations of the AIG companies. The operations include the pension, annuity, and retail asset management businesses of the AIG companies internationally. LOCATION: New York, New York." 3. Section 4 of the First Amendment (amending Section 3(b)(iv) of the Original Agreement) is amended to delete the third bullet point contained therein in its entirety and to insert in lieu thereof the following: "Performance share units having a maximum aggregate value of $3,825,000 based upon the fair market value on the date of grant which shall vest (subject to your continued employment with the Parent or its subsidiaries on the vesting date) from 25 to 100 percent as soon as administratively feasible after December 31, 2004 (provided that, the receipt of shares of Parent common stock pursuant to such units may be deferred, at the election of the Executive, pursuant to an applicable deferral program of the Parent, if any), such vesting percentage to be at the discretion of the Chief Executive Officer of Parent based upon his assessment of the growth and profitability of (i) the international retirement savings operations and (ii) the domestic fixed annuity and non-profit group retirement plan businesses of AIG SunAmerica, otherwise referred to as AIG Annuity and AIG VALIC." 4. The Executive agrees that this letter agreement constitutes his written consent to changes in his compensation arrangements, duties and responsibilities and principal place of employment and under no circumstances shall change constitute
"Good Reason" for termination by the Executive as defined in Section 4(c) of the Original Agreement. 5. From and after the date hereof, the Agreements are hereby amended by this letter agreement, in accordance with Section 10 of the Original Agreement. Very truly yours, American International Group, Inc. American General Corporation By: /s/ M.R. Greenberg By: /s/ Ernest T. Patrikis ------------------------- -------------------------- Name: M.R. Greenberg Name: Ernest T. Patrikis Title: Chairman and Chief Title: Executive Vice President Executive Officer AIG SunAmerica Inc. By: /s/ Jay S. Wintrob ------------------------- Name: Jay S. Wintrob Title: President and Chief Executive Officer Accepted and Agreed as of March 25, 2003: /s/ John A. Graf - ----------------------- John A. Graf 2
SPLIT-DOLLAR AGREEMENT THIS SPLIT-DOLLAR AGREEMENT (this "Agreement") is made and entered into effective as of May 15, 1998 (the "Effective Date"), by and among AMERICAN GENERAL CORPORATION, a Texas corporation, with principal offices and place of business in Houston, Texas (hereinafter referred to as the "Company"), JOHN A. GRAF (hereinafter referred to as the "Executive"), and Susan Marineau, Trustee of the Graf 1998 Family Trust (hereinafter referred to as the "Owner"),(1/) WITNESSETH THAT: WHEREAS, the Executive is currently employed by the Company or an affiliate of the Company; and WHEREAS, in order to retain the benefits of the services of the Executive for the Company and its affiliates, the Company desires to assist the Executive in providing life insurance protection for the Executive's family under a policy of life insurance (hereinafter referred to as the "Policy") insuring the life of the Executive, which Policy is described in Exhibit A attached hereto and by this reference made a part hereof, and which is being issued by American General Life Insurance Company (hereinafter referred to as the "Insurer"); and WHEREAS, the Company is willing to pay all of the premiums due on the Policy as an additional employment benefit for the Executive, on the terms and conditions hereinafter set forth; and WHEREAS, the Owner will be the owner of the Policy and, as such, will possess all incidents of ownership in and to the Policy; and WHEREAS, the Company wishes to have the Policy collaterally assigned to it by the Owner in order to secure the repayment of the amounts which it will pay toward the premiums on the Policy; NOW, THEREFORE, in consideration of the premises and of the mutual promises contained herein, the parties hereto agree as follows: - ---------------- (1/) If the Executive will be the owner of the policy (as opposed to an insurance trust or other entity), then the Executive's name should be inserted in each of the blank spaces provided for the name of the Executive and the name of the Owner. If the space provided for the name of the Owner is not completed, then the Executive shall be deemed to be the Owner.
1. DEFINED TERMS. The terms "Agreement," "Company," "Effective Date," "Executive," "Insurer," "Owner," and "Policy" shall have the meanings assigned to such terms in the preceding provisions of this Agreement. Where the following words and terms are used in this Agreement, they shall have the respective meanings set forth below, unless the context clearly indicates to the contrary: (a) AFFILIATE: The term "Affiliate" shall have the meaning set forth in Rule 12b-2 promulgated under Section 12 of the Securities Exchange Act of 1934, as amended from time to time. (b) ANNIVERSARY DATE: Each annual anniversary of the Effective Date; provided, however, that for purposes of Paragraph l(d) below, the Effective Date shall also be considered an Anniversary Date. (c) AVERAGE ANNUAL BONUS: As of any date for which the Benefit Amount must be determined pursuant to the terms of this Agreement that occurs (1) during the period beginning on the Effective Date and ending on the first Anniversary Date, an amount equal to 75% of the Executive's annual base salary from the Company or an Affiliate of the Company at the rate in effect on the Effective Date (the "Deemed Bonus"), (2) during the period beginning on the day immediately following the first Anniversary Date and ending on the second Anniversary Date, an amount equal to the average of the Deemed Bonus and the most recent annual incentive bonus paid in cash by the Company (or an Affiliate of the Company) to the Executive on or before the first Anniversary Date, (3) during the period beginning on the day immediately following the second Anniversary Date and ending on the third Anniversary Date, an amount equal to the average of the Deemed Bonus and the two most recent annual incentive bonuses paid in cash by the Company (or an Affiliate of the Company) to the Executive on or before the second Anniversary Date, and (4) after the third Anniversary Date, an amount equal to the average of the three most recent annual incentive bonuses paid in cash by the Company (or an Affiliate of the Company) to the Executive on or before the Anniversary Date next preceding such date for which the Benefit Amount is determined. (d) BASE SALARY: As of any date for which the Benefit Amount must be determined pursuant to the terms of this Agreement, the Executive's annual base salary from the Company or an Affiliate of the Company at the rate in effect on the Anniversary Date next preceding such date. (e) BENEFIT AMOUNT: As of any given date, an amount equal to 200% of the sum of the Executive's Base Salary and Average Annual Bonus as of such date; provided, however, that on the Executive's Normal Retirement Date, the Benefit Amount shall be reduced to 100% of the sum of the Executive's Base Salary and Average Annual Bonus as of the Measurement Date (except that if the Executive continues his or her employment beyond the Executive's Normal Retirement Date, then such reduction shall occur on the date -2-
of the Executive's termination of employment with the Company for a reason other than death). Notwithstanding the foregoing or any provision in this Agreement to the contrary, the Benefit Amount shall not be increased at any time after the Effective Date to the extent such increase is subject to the medical underwriting requirements of the Insurer and the Insurer refuses to increase the face amount of the Policy based upon the health or medical condition of the Executive. (f) CAUSE: The term "Cause" shall have the meaning assigned to such term in the Change in Control Severance Agreement. (g) CHANGE IN CONTROL: The term "Change in Control" shall have the meaning assigned to such term in the Change in Control Severance Agreement. (h) CHANGE IN CONTROL SEVERANCE AGREEMENT: The Change in Control Severance Agreement between the Company and the Executive that is in effect on the Effective Date (or any successor agreement thereto). (i) CLAIMANT: The term "Claimant" shall have the meaning assigned to such term in Paragraph 10 hereof. (j) DISABLED: The Executive shall be considered "Disabled" for purposes of this Agreement at such time as the Executive becomes entitled to receive long-term disability benefits under a long-term disability plan maintained by the Company or an Affiliate of the Company. (k) MEASUREMENT DATE: The earlier of (1) the date upon which the Executive's employment with the Company terminates for any reason whatsoever (including, without limitation, termination of employment by reason of the death or retirement of the Executive), (2) the date upon which the Executive becomes Disabled, or (3) the effective date of the termination of this Agreement pursuant to Paragraph 8 hereof. (l) NORMAL RETIREMENT DATE: The term "Normal Retirement Date" shall have the meaning assigned to such term in the Company's Supplemental Executive Retirement Plan that is in effect on the Effective Date. (m) PREMIUM PAYMENT PERIOD: A period of 10 years commencing on the Effective Date; provided, however, that upon written notice to the Owner and the Executive prior to the occurrence of a Change in Control, the Company may from time to time extend the Premium Payment Period for any period determined by the Company that ends on or before the later of (1) the Executive's Normal Retirement Date or (2) the fifteenth Anniversary Date. -3-
(n) RELEVANT ASSUMPTIONS: As of any given date, (1) the Company's assumption as of such date with respect to the rate of increase, if any, in the Benefit Amount from such date to the Executive's Normal Retirement Date (or, if the Executive continues his or her employment with the Company beyond the Executive's Normal Retirement Date, to the Executive's projected date of retirement from the Company) and (2) current mortality rates and charges, crediting rates, expenses, and other relevant matters applicable to the Policy as of such date. Notwithstanding the foregoing, the assumed rate of increase in the Benefit Amount shall be 0% from and after the Measurement Date. 2. ACQUISITION AND OWNERSHIP OF POLICY; LIMITATIONS ON OWNER'S RIGHTS IN POLICY. (a) The Owner shall contemporaneously purchase the Policy from the Insurer in the initial total face amount specified in Exhibit A attached hereto. The parties hereto agree that they shall take all reasonable action necessary to cause the Insurer to issue the Policy, and shall take any further reasonable action which may be necessary to cause the Policy to conform to the provisions of this Agreement. The parties hereto agree that the Policy shall be subject to the terms and conditions of this Agreement and of the collateral assignment filed with the Insurer relating to the Policy. (b) The Policy names the Owner, and the Owner shall be, the sole and absolute owner of the Policy. The Owner shall not exercise any of the ownership rights granted to the owner of the Policy by the terms thereof except with the express written consent of the Company. Without limiting the scope of the foregoing, the Owner shall not sell, assign, transfer, borrow against or withdraw from the cash surrender value of the Policy, change the beneficiary designation provision of the Policy, change the elected death benefit option provisions of the Policy, decrease or increase the face amount of insurance, surrender or cancel the Policy, or take any other action with respect to the Policy without, in any such case, the express written consent of the Company. (c) Notwithstanding the provisions of Paragraph 2(b) above, the Owner shall have the right to take any of the following actions without the express written consent of the Company, provided that the Owner provides the Company with 15 days prior written notice of any such action: (1) designate the beneficiary or beneficiaries to receive the portion of the proceeds payable under the Policy specified in Paragraph 7(b) hereof; (2) elect the settlement option with respect to such proceeds from among the settlement options available under the Policy; and (3) change such beneficiary designation and settlement option from time to time. 3. COLLATERAL ASSIGNMENT: LIMITATION ON COMPANY'S RIGHTS IN POLICY. (a) To secure the repayment to the Company of the amount of the premiums on the Policy paid by the Company hereunder, the Owner has, contemporaneously herewith, assigned the Policy to the Company as collateral under a separate assignment instrument The collateral assignment of the Policy to the Company shall not be terminated, altered or amended by the Owner, without the express written consent of the Company. The parties hereto agree to take all action -4-
necessary to cause such collateral assignment to conform to the provisions of this Agreement and to be accepted by the Insurer. Without limiting the scope of the preceding provisions of this Paragraph 3, the parties hereto agree that the Company shall have an interest in the cash surrender value and the death benefits under the Policy to secure the amounts due to the Company hereunder, which interest shall in no event be less than the aggregate premium payments made with respect to the Policy by the Company pursuant to Paragraph 5 below. (b) The Company shall not at any time prior to the termination of this Agreement (1) take any action that would cause the death benefits under the Policy that would be available for distribution to the beneficiary or beneficiaries designated by the Owner as provided herein to be less than the Benefit Amount (determined as of the earlier of the Measurement Date or the date such action was taken by the Company) and (2) from and after the date upon which a Change in Control occurs, borrow against the Policy, pledge the Policy as collateral for a loan, withdraw any amount from the Policy or otherwise access any funds held under the Policy until such time as the beneficiary or beneficiaries designated by the Owner have received all of the Policy death benefits to which they are entitled pursuant to the provisions of this Agreement. 4. ADJUSTMENTS TO POLICY FACE AMOUNT. On each Anniversary Date that occurs prior to the Measurement Date, the parties hereto shall cause the total face amount of the Policy to be adjusted to the extent necessary, if any, so that such face amount is equal to the Benefit Amount (which Benefit Amount shall be determined as of the day immediately following such Anniversary Date); provided, however, that if any such adjustment would require a reduction in the face amount of the Policy, then the Company may, in its sole discretion, determine that no such adjustment to the face amount of the Policy shall be made for such Anniversary Date. Further, on, or as soon as administratively practicable after, the Executive's Normal Retirement Date (or, if later, the date of the termination of the Executive's employment with the Company for a reason other than death), the parties hereto shall cause the total face amount of the Policy to be reduced to the extent necessary, if any, so that such face amount is equal to the Benefit Amount in effect at such time. The parties hereto agree that they shall take all reasonable action necessary to cause the Insurer to adjust the face amount of the Policy as provided in the preceding provisions of this Paragraph 4. Without limiting the scope of the foregoing, (a) the Executive and the Owner shall furnish any and all information requested by the Company or the Insurer to facilitate an adjustment to the face amount of the Policy and (b) the Executive shall take such physical examinations as the Insurer may deem necessary. 5. PAYMENT OF PREMIUMS. (a) On the Effective Date and on or before each Anniversary Date, the Company shall pay to the Insurer, as premium payments with respect to the Policy, the amount, if any, determined by the Company in its sole discretion; provided, however, that: (1) on the Effective Date and on each Anniversary Date that occurs during the Premium Payment Period and prior to the termination of this Agreement, the Company shall make substantially level premium payments with respect to the Policy based upon a -5-
premium payment policy established by the Company that is designed to (i) maintain the Policy in a manner sufficient to provide the level of death benefits to the Owner's beneficiary or beneficiaries pursuant to Paragraph 7(b) hereof in the event of the Executive's death prior to the end of the Premium Payment Period and (ii) accumulate sufficient funds under the Policy (based upon the assumption that the Executive will retire as of the Executive's Normal Retirement Date) so that as of the end of the Premium Payment Period the Policy is projected to have sufficient funds to (A) at all times thereafter provide a minimum death benefit in an amount equal to the Benefit Amount without any further premium payments and (B) permit the Owner to terminate this Agreement as of the later of the Executive's Normal Retirement Date or the fifteenth Anniversary Date and use accumulations under the Policy to obtain the release of the collateral assignment of the Policy to the Company; and (2) on each Anniversary Date that occurs after the end of the Premium Payment Period and prior to the termination of this Agreement, the Company shall make a premium payment with respect to the Policy in at least the amount required so that as of such Anniversary Date the Policy is projected to have sufficient funds to (i) at all times thereafter provide a minimum death benefit in an amount equal to the Benefit Amount without any further premium payments and (ii) permit the Owner to terminate this Agreement as of the later of the Executive's Normal Retirement Date or the fifteenth Anniversary Date and use accumulations under the Policy to obtain the release of the collateral assignment of the Policy to the Company. The amount of each premium payment required pursuant to clauses (1) and (2) of the preceding sentence shall be determined based upon (i) the Relevant Assumptions in effect as of the date such premium payment is required to be paid by the Company pursuant to this Paragraph 5(a) and (ii) if the Measurement Date has not occurred as of such premium payment date, the Company's estimate of the date upon which the Measurement Date will occur (which date shall be estimated to be no earlier than the Executive's Normal Retirement Date). The Owner and the Executive acknowledge and agree that (A) the Company is agreeing to make premium payments with respect to the Policy as described above based upon the Relevant Assumptions and for the period of time set forth in this Agreement, (B) the actual crediting rates under the Policy and the charges and expenses incurred with respect to the Policy may deviate from the rates, charges and expenses utilized from time to time under the Relevant Assumptions, and (C) accordingly, the Company makes no guarantee that the Policy will, in fact, have sufficient funds to provide a minimum death benefit in an amount equal to the Benefit Amount at all times after the termination of this Agreement without any further premium payments. The Company shall promptly notify the Owner of the date and the amount of each premium payment made by the Company with respect to the Policy and, promptly upon receipt, the Owner shall furnish the Company with a copy of the annual report for the Policy received by the Owner from the Insurer. (b) If the Executive's employment with the Company is terminated under circumstances pursuant to which the Executive is entitled to a severance benefit under the Change in Control Severance Agreement, then the Company shall promptly pay into a rabbi trust a single -6-
lump sum cash payment in an amount equal to the projected amount of premium payments that the Company would be required to make with respect to the Policy pursuant to Paragraph 5(a) hereof during the 36 month period immediately following such termination of employment. Pursuant to the terms of the rabbi trust, on each of the first three Anniversary Dates that occur after the termination of the Executive's employment with the Company, the trustee of the rabbi trust shall pay to the Insurer as a premium with respect to the Policy one-third of the amount initially deposited in the rabbi trust by the Company. After the trustee has made three such premium payments, the rabbi trust shall terminate and any remaining funds held by the trustee shall be returned to the Company. Notwithstanding the foregoing, the Company shall remain obligated to make all premium payments required pursuant to Paragraph 5(a) hereof; provided, however, that the Company shall be relieved of such obligation to the extent of the amount of each premium payment made by the trustee of the rabbi trust with respect to the Policy. All costs and expenses associated with the establishment and maintenance of the rabbi trust shall be paid by the Company. (c) Neither the Executive nor the Owner shall have any obligation to pay any premiums with respect to the Policy prior to the termination of this Agreement. The Company shall have no obligation to pay any premiums with respect to the Policy from and after the termination of this Agreement pursuant to Paragraph 8 below. 6. PROVISION OF INFORMATION. On or before January 31 of each calendar year, the Company shall furnish to the Executive a statement of the amount of income, if any, reportable by the Executive for federal and state income tax purposes for the preceding calendar year as a result of the existence and maintenance of the Policy. The Owner and the Executive shall promptly furnish the Company with (a) copies of any information or notices provided by the Insurer from time to time with respect to the Policy and (b) any other material or information relating to the Policy and reasonably requested by the Company from time to time. Upon request, the Company shall promptly furnish to the Owner evidence of timely payment of any amount required to be paid by the Company pursuant to Paragraph 5 hereof. 7. COLLECTION AND DISTRIBUTION OF DEATH PROCEEDS. (a) Upon the death of the Executive prior to the termination of this Agreement during the Executive's lifetime, the Company and the Owner shall cooperate with the beneficiary or beneficiaries designated by the Owner to take whatever action is necessary to collect the death benefit provided under the Policy. When such benefit has been collected and paid as provided herein, this Agreement shall thereupon terminate. (b) Upon the death of the Executive prior to the termination of this Agreement during the Executive's lifetime, the beneficiary or beneficiaries designated by the Owner pursuant to Paragraph 2(c) hereof shall be entitled to receive a portion of the death benefits provided under the Policy in an amount equal to the Benefit Amount determined as of the Measurement Date (which amount shall be reduced as provided in Paragraph 1(e) hereof upon the later of the Executive's Normal Retirement Date or the date of the termination of the Executive's employment with the -7-
Company for a reason other than death). This amount shall be paid under the settlement option elected by the Owner. (c) Upon the death of the Executive prior to the termination of this Agreement during the Executive's lifetime, the Company shall have the unqualified right to receive any and all of the death benefits provided under the Policy in excess of the amount payable pursuant to Paragraph 7(b) above to the beneficiary or beneficiaries designated by the Owner. This amount shall be paid to the Company in a single lump sum cash payment. (d) The parties hereto agree that, upon the request of the Company, the beneficiary designation provision of the Policy shall conform to the provisions hereof. 8. TERMINATION OF AGREEMENT. (a) This Agreement may be terminated by the Owner at any time during the Executive's lifetime and after the fifteenth Anniversary Date upon written notice to the Company and payment to the Company by the Owner at the time of such notice of a single lump sum cash payment in an amount equal to the aggregate premium payments made by the Company pursuant to Paragraph 5 hereof on or before the date of such termination, less any withdrawals from the Policy by the Company prior to the date of such termination and any indebtedness secured by the Policy which was incurred by the Company and remains outstanding as of the date of such termination, including any unpaid accrued interest on such indebtedness. Upon receipt of such amount, the Company shall release the collateral assignment of the Policy by the execution and delivery of an appropriate instrument of release. (b) This Agreement may be terminated by the Company at any time during the Executive's lifetime (including, without limitation, upon the Executive's termination of employment with the Company or at any time before or after such termination); provided, however, that (i) from and after the Executive's Normal Retirement Date, this Agreement may not be terminated by the Company until the later of such Normal Retirement Date, the date upon which the Executive's employment with the Company terminates, the expiration of the Premium Payment Period or the fifteenth Anniversary Date, (ii) from and after the date upon which the Executive becomes Disabled, this Agreement may not be terminated by the Company until the earlier of the Executive's Normal Retirement Date, the expiration of the Premium Payment Period, the fifteenth Anniversary Date, or the third anniversary of the date upon which the Executive becomes Disabled, and (iii) from and after the date upon which a Change in Control occurs, this Agreement may be terminated by the Company only on or after the date upon which the Executive's employment with the Company terminates (except that, if the Executive's employment with the Company terminates under circumstances pursuant to which the Executive is entitled to a severance benefit under the Change in Control Severance Agreement, then this Agreement may not be terminated by the Company until the third anniversary of the date of such termination of employment). The Company shall provide the Owner and the Executive with 30 days' prior written notice of any such termination of this Agreement by the Company. If this Agreement is terminated by the Company as provided in the -8-
preceding provisions of this Paragraph 8(b), then for 60 days after the effective date of the termination of this Agreement, the Owner shall have the option of obtaining the release of the collateral assignment of the Policy to the Company. To obtain such release, the Owner shall repay to the Company the total amount of the premium payments made by the Company hereunder, less any withdrawals from the Policy by the Company prior to the date of such termination and any indebtedness secured by the Policy which was incurred by the Company and remains outstanding as of the date of such termination, including any unpaid accrued interest on such indebtedness. Upon receipt of such amount, the Company shall release the collateral assignment of the Policy by the execution and delivery of an appropriate instrument of release. If the Owner fails to exercise such option within such 60 day period, then the interest of the Owner in the Policy shall automatically be transferred to the Company and the Owner shall execute any document or documents requested by the Company or the Insurer to effect such transfer. Alternatively, the Company may enforce its right to be repaid the amount due it hereunder from the cash surrender value of the Policy under the collateral assignment of the Policy; provided that in the event the cash surrender value of the Policy exceeds the amount due the Company, such excess shall be paid to the Owner. Thereafter, neither the Owner nor any person claiming under the Owner shall have any further interest in and to the Policy, either under the terms thereof or under this Agreement. (c) Notwithstanding any provision in this Agreement to the contrary, if the Executive's employment with the Company is terminated for Cause at any time (whether before or after the Executive attains his or her Normal Retirement Date), then (i) this Agreement shall automatically terminate upon such termination of employment, (ii) the interest of the Owner in the Policy shall automatically be transferred to the Company and the Owner shall execute any document or documents requested by the Company or the Insurer to effect such transfer, (iii) the Company may exercise all rights of ownership of the Policy, take all proceeds of the Policy, take proceeds designated for the beneficiary or beneficiaries designated by the Owner, assign its ownership interest in the Policy to any other party or take any other action the Company determines in its sole discretion, and (iv) neither the Owner, the Executive nor their respective heirs, assigns, personal representatives, or beneficiaries shall have any further rights, claims, or interests of any nature whatsoever in the Policy or in this Agreement. (d) It is a condition precedent to the execution of this Agreement that the Owner and the Executive acknowledge and agree that the Company has the right, subject to certain limitations set forth in Paragraph 8(b) hereof, to terminate this Agreement at any time for any reason whatsoever or for no reason at all. Without limiting the scope of the foregoing, the Owner and the Executive specifically acknowledge and agree that the Company shall have the right to terminate this Agreement prior to the occurrence of a Change in Control in the event that the premiums required to be paid under the Policy are increased due to a deterioration in the health or medical condition of the Executive after the Effective Date. In such event, the Owner and the Executive hereby waive, and agree that they shall not assert, any claim or cause of action, in contract, tort or otherwise, against the Company, any Affiliate of the Company or any employee, director, officer or agent of the Company or any such Affiliate with respect to the termination of this Agreement, including, without limitation, any claim or cause of action based on any alleged discriminatory practice. By -9-
entering into this Agreement, the parties hereto agree that the conditions and provisions set forth in this Paragraph 8(d) are an essential component of this Agreement, and it is their intent that such conditions and provisions not be severed from the other terms and provisions of this Agreement. 9. INSURER NOT A PARTY. Subject to the terms and conditions of the Policy, the Insurer shall be fully discharged from its obligations under the Policy by payment of the Policy death benefit to the beneficiary or beneficiaries named in the Policy and upon the performance of its other obligations in accordance with the terms of the Policy. In no event shall the Insurer be considered a party to this Agreement, or any modification or amendment hereof. No provision of this Agreement, nor of any modification or amendment hereof, shall in any way be construed as enlarging, changing, varying, or in any other way affecting the obligations of the Insurer as expressly provided in the Policy. 10. NAMED FIDUCIARY, DETERMINATION OF BENEFITS, CLAIMS PROCEDURE AND ADMINISTRATION. (a) NAMED FIDUCIARY. The Company is hereby designated as the named fiduciary under this Agreement. The named fiduciary shall have authority to control and manage the operation and administration of this Agreement, and it shall be responsible for establishing and carrying out a premium payment policy and method consistent with the objectives of this Agreement. (b) (1) CLAIM. A person who believes that he or she is being denied a benefit to which he or she is entitled under this Agreement (hereinafter referred to as a "Claimant") may file a written request for such benefit with the Company, setting forth his or her claim. The request must be addressed to the Company at its then principal place of business. (2) CLAIM DECISION. Upon receipt of a claim, the Company shall advise the Claimant that a reply will be forthcoming within 90 days and shall, in fact, deliver such reply within such period. The Company may, however, extend the reply period for an additional 90 days for reasonable cause. If the claim is denied in whole or in part, the Company shall adopt a written opinion, using language calculated to be understood by the Claimant, setting forth: (i) the specific reason or reasons for such denial; (ii) the specific reference to pertinent provisions of this Agreement on which such denial is based; (iii) a description of any additional material or information necessary for the Claimant to perfect his or her claim and an explanation why such material or such information is necessary; (iv) appropriate information as to the steps to be taken if the Claimant wishes to submit the claim for review; and (v) the time limits for requesting a review under subsection (3) and for review under subsection (4) hereof. -10-
(3) REQUEST FOR REVIEW. Within 60 days after the receipt by the Claimant of the written opinion described above, the Claimant may request in writing that the Company review its determination. Such request must be addressed to the Company, at its then principal place of business. The Claimant or his or her duly authorized representative may, but need not, review the pertinent documents and submit issues and comments in writing for consideration by the Company. If the Claimant does not request a review of the Company's determination within such 60 day period, he or she shall be barred and estopped from challenging the Company's determination. (4) REVIEW OF DECISION. Within 60 days after the Company's receipt of a request for review, it will review the determination. After considering all materials presented by the Claimant, the Company will render a written opinion, written in a manner calculated to be understood by the Claimant, setting forth the specific reasons for the decision and containing specific references to the pertinent provisions of this Agreement on which the decision is based. If special circumstances require that the 60 day time period be extended, the Company will so notify the Claimant and will render the decision as soon as possible, but no later than 120 days after receipt of the request for review. 11. ARBITRATION. (a) Upon completion of the claims procedure described in Paragraph 10(b) hereof (if applicable), all claims, demands, causes of action, disputes, controversies, and other matters in questions arising out of or relating to this Agreement, any provision hereof, the alleged breach thereof, or in any way relating to the subject matter of this Agreement involving the parties hereto and/or their respective representatives, even though some or all of such claims allegedly are extra-contractual in nature, whether such claims sound in contract, tort, or otherwise, at law or in equity, under state or federal law, whether provided by statute or the common law, for damages or any other relief, shall be resolved by binding arbitration pursuant to the Federal Arbitration Act in accordance with the Employment Dispute Resolution Rules then in effect with the American Arbitration Association. The arbitration proceeding shall be conducted in Houston, Texas. This agreement to arbitrate shall be enforceable in either federal or state court. (b) The enforcement of this agreement to arbitrate and all procedural aspects of this agreement to arbitrate, including but not limited to, the construction and interpretation of this agreement to arbitrate, the issues subject to arbitration (i.e., arbitrability), the scope of the arbitrable issues, allegations of waiver, delay or defenses to arbitrability, and the rules governing the conduct of the arbitration, shall be governed by and construed pursuant to the Federal Arbitration Act and shall be decided by the arbitrators. In deciding the substance of any such claims, the arbitrators shall apply the substantive laws of the State of Texas (excluding Texas choice-of-law principles that might call for the application of some other state's law); provided, however, it is expressly agreed that the arbitrators shall have no authority to award treble, exemplary, or punitive damages under any circumstances regardless of whether such damages may be available under Texas law, the parties hereby waiving their right, if any, to recover treble, exemplary, or punitive damages in connection -11-
with any such claims. If any party to this Agreement institutes arbitration to enforce the terms of this Agreement, the party who prevails in such arbitration, whether plaintiff or defendant, in addition to the remedy or relief obtained in such arbitration proceeding shall be entitled to recover its or his expenses incurred in connection with such arbitration proceeding, including, without limitation, arbitrators and attorneys fees, and the arbitrators are authorized to so award such costs and fees. (c) The arbitration may be initiated by any party by providing to the other parties a written notice of arbitration specifying the claims. Within 30 days of the notice of initiation of the arbitration procedure, (1) the Owner and the Executive, acting together, shall denominate one arbitrator and (2) the Company shall denominate one arbitrator. The two arbitrators shall select a third arbitrator failing agreement on which within 60 days of the original notice, either the Owner, the Executive or the Company shall apply to the Senior Active United States District Judge for the Southern District of Texas, who shall appoint a third arbitrator. While the third arbitrator shall be neutral, the two party-appointed arbitrators are not required to be neutral and it shall not be grounds for removal of either of the two party-appointed arbitrators or for vacating the arbitrators' award that either of such arbitrators has past or present minimal relationships with the party that appointed such arbitrator. Evident partiality on the part of an arbitrator exists only where the circumstances are such that a reasonable person would have to conclude there in fact existed actual bias. A mere appearance or impression of bias will not constitute evident partiality or otherwise disqualify an arbitrator. (d) The three arbitrators shall by majority vote resolve all disputes between the parties. There shall be no transcript of the hearing before the arbitrators. The arbitrators' decision shall be in writing, but shall be as brief as possible. The arbitrators shall not assign the reasons for their decision. The arbitrators shall certify in their award that they have faithfully applied the terms and conditions of this Agreement and that no part of their award includes any amount for exemplary or punitive damages. All proceedings conducted hereunder and the decision of the arbitrators shall be kept confidential by the parties, e.g., the arbitrators' award shall not be released to the press or published in any of the various arbitration reporters. Judgment upon any award rendered in any such arbitration proceeding may be entered by any federal or state court having jurisdiction. 12. AMENDMENT. This Agreement may not be amended, altered, or modified, except by a written instrument signed by the parties hereto, or their respective successors or assigns. Notwithstanding the foregoing or any other provision herein to the contrary, the Premium Payment Period, the face amount of the Policy, the amount of premiums to be paid by the Company, and/or the references in this Agreement to the fifteenth Anniversary Date may be changed by the Company without the consent of the Owner or the Executive to the extent necessary to (a) maintain the Policy as a "life insurance contract" (within the meaning of Section 7702 of the Internal Revenue Code of 1986, as amended (the "Code"), and the interpretative authority promulgated thereunder) and (b) prevent the Policy from constituting a "modified endowment contract" (within the meaning of Section 7702A of the Code and the interpretative authority promulgated thereunder). The Company shall provide the Owner and the Executive with prompt written notice of any such change. -12-
13. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns, and the Owner, the Executive and their respective successors, assigns, heirs, executors, administrators, and beneficiaries; provided, however, that the rights and obligations of the Owner and the Executive hereunder are personal and neither this Agreement, nor any right, benefit, or obligation of the Owner or the Executive hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the Company. 14. NOTICE. Any notice, consent or demand required or permitted to be given under the provisions of this Agreement shall be in writing, and shall be signed by the party giving or making the same. If such notice, consent or demand is mailed to a party hereto, it shall be sent by United States registered or certified mail, postage prepaid, addressed to such party's last known address as shown on the records of the Company. The date of such mailing shall be deemed the date of notice, consent or demand. 15. EMPLOYMENT RELATIONSHIP. For all purposes of this Agreement, the Executive shall be considered to be in the employment of the Company as long as the Executive remains an employee of the Company or any Affiliate of the Company. However, this Agreement is not an employment agreement This Agreement shall not be construed as creating an express or implied contact of employment and does not modify the nature of the Executive's employment relationship with the Company or its Affiliates, as the case may be. Except as otherwise agreed in writing between the Executive and the Company or an Affiliate of the Company, the employment relationship between the Executive and the Company or its Affiliates is at-will, i.e., the employment relationship may be terminated at any time at the will of either the Company or the Executive for any reason or no reason at all. 16. TAXES AND POLICY ILLUSTRATIONS. The Company makes no guarantees and assumes no obligations or responsibilities with respect to the Owner's or the Executive's federal, state, or local income, estate, inheritance, and gift tax obligations, if any, under this Agreement, the Policy or the collateral assignment of the Policy to the Company. The Executive and the Owner agree and acknowledge that the Policy illustrations provided prior to the Effective Date and any Policy illustrations that may be provided from time to time thereafter by the Company, the Insurer or their respective agents and representatives are not guaranteed and are not a part of the Policy or this Agreement. Such Policy illustrations shall not create any additional obligations or responsibilities to the Executive or the Owner by the Company, the Insurer, or their respective agents and representatives. 17. GOVERNING LAW. This Agreement, and the rights of the parties hereunder, shall be governed by and construed in accordance with the laws of the State of Texas. -13-
IN WITNESS WHEREOF, the parties hereto have executed this Agreement on this the 15th day of May, 1998, effective as of the Effective Date. AMERICAN GENERAL CORPORATION By: /s/ Beth Dobbs -------------------- Name: Beth Dobbs Title: Vice President - Benefits/Payroll "COMPANY" JOHN A. GRAF /s/ John A. Graf ---------------------- "EXECUTIVE" /s/ Susan G. Marineau ---------------------- SUSAN G. MARINEAU "OWNER" Notarized for Susan G. Marineau [NOTARY PUBLIC STAMP] State of New York SS County of New York Subscribed and sworn (affirmed) before me this 23 day of Dec. 1998 L.S. /s/ Alex Karpinski ------------------ -14-
EXHIBIT A The following life insurance policy is subject to the attached Split-Dollar Agreement: Insurer: American General Life Insurance Company Insured: John A. Graf Policy Number: CM0002178L Face Amount on the Effective Date: $ 1,266,824.00 Effective Date of Policy: May 15, 1998 -15-
ASSIGNMENT OF LIFE INSURANCE POLICY AS COLLATERAL A. FOR VALUE RECEIVED, the undersigned (hereinafter the "Owner") hereby assigns, transfers and sets over to American General Corporation, with principal offices and place of business in Houston, Texas, its successors and assigns (hereinafter the "Assignee"), Policy No. CM0002178L issued by American General Life Insurance Company (hereinafter the "Insurer"), and any supplementary contracts issued in connection therewith (said policy and contracts hereinafter the "Policy"), insuring the life of JOHN A. GRAF (the "Executive"), and all claims, options, privileges, rights, title and interest therein and thereunder (except as otherwise provided herein), subject to all the terms and conditions of the Policy and to all superior liens, if any, which the Insurer may have against the Policy. The Owner, by this Assignment, and the Assignee, by acceptance of the assignment of the Policy to it hereunder, agree to the terms and conditions contained herein. B. This Assignment is made and the Policy is to be held as collateral security for any and all liabilities and obligations of the Owner to the Assignee, either now existing or that may hereafter arise, under and pursuant to that certain Split-Dollar Agreement by and among the Owner, the Assignee, and the Executive, dated effective as of May 15, 1998 (hereinafter the "Split-Dollar Agreement"). The liabilities and obligations described in the preceding sentence are hereinafter referred to as the "Liabilities." C. It is expressly agreed that, without detracting from the generality of the foregoing, the following specific rights are included in this Assignment and pass to the Assignee by virtue hereof: 1. The sole right to collect from the Insurer the net proceeds of the Policy when it becomes a claim by death or maturity; 2. The sole right to surrender the Policy and receive the surrender value thereof at any time provided by the terms of the Policy and at such other times as the Insurer may allow; and 3. The sole right to obtain one or more withdrawals, loans or advances on the Policy, either from the Insurer or, at any time, from other persons, and to pledge or assign the Policy as security for such loans or advances. D. It is expressly agreed that the following specific rights, so long as the Policy has not been surrendered and to the extent permitted under the Split-Dollar Agreement, are reserved by the Owner and excluded from this Assignment and do not pass by virtue hereof: 1. The right to designate and change the beneficiary to receive the portion of the proceeds under the Policy specified in Paragraph 7(b) of the Split-Dollar Agreement; and
2. The right to elect any optional mode of settlement permitted by the Policy or allowed by the Insurer with respect to such proceeds. However, the reservation of these rights by the Owner shall in no way impair the right of the Assignee to surrender the Policy nor impair any other right of the Assignee hereunder. Further, any exercise of these rights shall be made subject to this Assignment and to the rights of the Assignee hereunder. E. Notwithstanding the foregoing, the Assignee covenants and agrees with the Owner as follows: 1. Any balance of sums received hereunder from the Insurer remaining after payment of the then existing Liabilities shall be paid by the Assignee to the persons entitled thereto under the terms of the Policy, had this Assignment not been executed; 2. The Assignee will not exercise the right to surrender the Policy, nor the right to make withdrawals from the Policy or obtain policy loans from the Insurer, unless and until there has been default in any of the Liabilities or the Split-Dollar Agreement has been terminated, pursuant to its terms; in any event, the Assignee will not exercise any such right until 15 days after the Assignee shall have mailed notice of intention to exercise such right, by first class mail, to the Owner at the address last supplied in writing to the Assignee specifically referring to this Assignment; and 3. The Assignee will, upon request, forward the Policy to the Insurer without unreasonable delay, for endorsement of any designation or change of beneficiary or any election of an optional mode of settlement that has been elected by the Owner. F. The Insurer is hereby authorized to recognize the Assignee's claims to rights hereunder without investigating the reason for any action taken by the Assignee, the validity or the amount of the Liabilities, the existence of any default therein, termination of the Split-Dollar Agreement, the giving of any notice hereunder, or the application to be made by the Assignee of any amounts to be paid to the Assignee. The sole signature of the Assignee shall be sufficient for the exercise of any rights under the Policy assigned hereby and the sole receipt of the Assignee for any sums received shall be a full discharge and release therefor to the Insurer. Payment for all or any part of the sums due under the policy and assigned herein shall be drawn to the exclusive order of or as directed by the Assignee if, when, and in such amounts as may be requested by the Assignee. G. The Assignee shall be under no obligation to pay any premium on the Policy nor the principal of or interest on any loans or advances on the Policy, whether or not obtained by the Assignee, or any other charges on the Policy. H. The exercise of any right, option, privilege or power given herein to the Assignee shall be at the option of the Assignee, and (except as provided herein) the Assignee may exercise any -2-
such right, option, privilege or power without notice to, or assent by, or affecting the liability of, or releasing any interest hereby assigned by the Owner. I. If applicable, the Assignee may take or release other security, may release any party primarily or secondarily liable for any of the Liabilities, may grant extensions, renewals or indulgences with respect to the Liabilities, or may apply the proceeds of the Policy hereby assigned or any amount received on account of the Policy by the exercise of any right permitted under this Assignment to the Liabilities in such order as the Assignee shall determine, without resorting to or regard to other security. J. As applied to the duties and responsibilities of the Insurer, in the event of any conflict between the provisions of this Assignment and the provisions of the Split-Dollar Agreement with respect to the Policy or the Assignee's rights of collateral security therein, the provisions of this Assignment shall prevail. As applied between the Owner and the Assignee, in the event of any such conflict, the provisions of the Split-Dollar Agreement shall prevail. K. The Owner declares that no proceedings in bankruptcy are pending against the Owner and that the Owner's property is not subject to any assignment for the benefit of creditors of the Owner. SIGNED this 15th day of May, 1998, effective as of May 15, 1998. /s/ Susan G. Marineau ----------------------- _______________________ _______________________ "OWNER" This Assignment is hereby accepted and agreed to by the Assignee. AMERICAN GENERAL CORPORATION By: /s/ Beth Dobbs --------------- Name: Beth Dobbs Title: Vice President- Benefits/Payroll "ASSIGNEE" -3-
STATE OF N.Y. Section ) Section ) N.Y. COUNTY Section ) On the 23 day of Dec., 1998, before me personally came, SUSAN G. MARINEAU, to me known to be the individual who executed the Assignment on the preceding pages hereof and acknowledged to me that he or she executed the same. /s/ Alex Karpinski ------------------ Notary Public in and for THE STATE OF___________________ My Commission Expires: [NOTARY PUBLIC STAMP] -4-
FIRST AMENDMENT TO SPLIT-DOLLAR AGREEMENT WHEREAS, the Personnel Committee of the Board of Directors of the Company initially authorized the Company to establish and pay premiums under a split-dollar life insurance arrangement relating to a life insurance policy insuring the life of the Executive and providing the Executive's family with a death benefit equal to 200% of the sum of the Executive's base salary and average annual incentive bonus (the death benefit) being reduced to 100% of the sum of the Executive's base salary and average annual incentive bonus upon Executive's Normal Retirement Date; and WHEREAS, the Personnel Committee has subsequently authorized the Company, to amend Executive's Split Dollar Agreement so that Executive's death benefit upon his Normal Retirement Date shall not be reduced to 100% of the sum of the Executive's base salary and average annual incentive bonus, but remain at 200% of the sum of the Executive's base salary and average annual incentive bonus; and WHEREAS, the Personnel Committee has subsequently authorized the Company to enter into an employment agreement with the Executive which was not in effect at the time of Executive's Split Dollar Agreement and which contains certain provisions with respect to split-dollar insurance following termination of Executive's employment. Now, THEREFORE, this First Amendment to the Split-Dollar Agreement made as of May 15,1998 (the "Agreement"), by and among American General Corporation, a Texas corporation (the "Company"), JOHN A. GRAF (the "Executive") and Susan Marineau as Trustee of the Graf 1998 Family Trust (the "Owner") is made as of May 15,2000 by amending the Agreement as follows: 1. Paragraph 1(e) is hereby amended to read, in its entirety, as follows: Benefit Amount: As of any given date, an amount equal to 200% of the sum of the Executive's Base Salary and Average Annual Bonus as of such date. Notwithstanding the foregoing or any provision in this Agreement to the contrary, the Benefit Amount shall not be increased at any time after the Effective Date to the extent such increase is subject to the medical underwriting requirements of the Insurer and the Insurer refuses to increase the face amount of the Policy based upon the health or medical condition of the Executive. 2. Paragraph 1(l) is hereby amended to read, in its entirety, as follows:
Normal Retirement Date: The term "Normal Retirement Date" shall have the meaning assigned to such term in the Supplemental Executive Retirement Agreement between the Company and the Executive that is in effect on the date of the execution of the First Amendment to this Agreement. 3. Paragraph 4 is hereby amended to read, in its entirety, as follows: Adjustments to Policy Face Amount. On each Anniversary Date that occurs prior to the Measurement Date, the parties hereto shall cause the total face amount of the Policy to be adjusted to the extent necessary, if any, so that such face amount is equal to the Benefit Amount (which Benefit Amount shall be determined as of the day immediately following such Anniversary Date); provided, however, that if any such adjustment would require a reduction in the face amount of the Policy, then the Company may, in its sole discretion, determine that no such adjustment to the face amount of the Policy shall be made for such Anniversary Date. The parties hereto agree that they shall take all reasonable action necessary to cause the Insurer to adjust the face amount of the Policy as provided in the preceding provisions of this Paragraph 4. Without limiting the scope of the foregoing, (a) the Executive and the Owner shall furnish any and all information requested by the Company or the Insurer to facilitate an adjustment to the face amount of the Policy and (b) the Executive shall take such physical examinations as the Insurer may deem necessary. 4. Paragraph 8(e) is added to read as follows: Should Executive and Company enter into an Employment Agreement which is in effect on the date of the termination of Executive's employment, and which contains specific terms with respect to the treatment of Executive's split-dollar insurance following termination of employment, such terms of the Employment Agreement shall control notwithstanding any provisions to the contrary set forth in Paragraph 8 herein. 5. As amended by this First Amendment, the Agreement is hereby specifically ratified and reaffirmed. 2
IN WITNESS WHEREOF, the parties hereto have executed this First Amendment on October 12, 2000. AMERICAN GENERAL CORPORATION By:/s/ Gary D. Reddick ------------------------- Gary D. Reddick Executive Vice President and Chief Administrative Officer - Corporate Operations /s/ John A. Graf ---------------------------- John A. Graf Executive THE GRAF 1998 FAMILY TRUST By:/s/ Susan Marineau ------------------------- Susan Marineau, Trustee Owner 3
EXHIBIT 10(xx) EMPLOYMENT AGREEMENT AGREEMENT by and among American International Group, Inc., a Delaware corporation (the "Parent"), American General Corporation, a Texas corporation (the "Company"), and Rodney O. Martin (the "Executive") dated as of the 11th day of May, 2001. Parent has determined that it is in the best interests of Parent and the Company and their respective shareholders to assure that the Company will have the continued services of the Executive following the merger (the "Merger") of the Company and Washington Acquisition Corporation, a Texas corporation and a wholly owned subsidiary of Parent ("Merger Sub"), pursuant to the Agreement and Plan of Merger dated as of May 11th, 2001 (the "Merger Agreement"), to provide the surviving corporation after the Merger with continuity of management. Pursuant to the terms of the Prior Agreement (as defined below), Executive would have had the right to terminate his employment upon consummation of the Merger. However, Parent desires to retain the Executive's continued services pursuant to the terms of this Agreement. Therefore, in order to accomplish these objectives, Parent, the Company and the Executive agree as follows: NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS: 1. Effective Date. The "Effective Date" shall mean the "Effective Date" (as defined in the Merger Agreement) of the Merger. This Agreement shall be and become effective on the Effective Date. If the Effective Date does not occur on or before February 28, 2002 or if the Merger Agreement is earlier terminated in accordance with its terms, then this Agreement shall terminate automatically on February 28, 2002 or on such earlier Merger Agreement termination date and none of Parent, the Company or the Executive shall have any obligation to the other hereunder. 2. Employment Period. The Company hereby agrees to employ the Executive, and the Executive hereby agrees to continue to serve the Company, subject to the terms and conditions of this Agreement, for the period commencing on the Effective Date and ending on the third anniversary thereof (the "Employment Period"). 3. Terms of Employment. (a) Position and Duties. (i) During the Employment Period, (A) the Executive shall serve in the position set forth on Exhibit A attached hereto, with the duties and responsibilities associated with such position on the Effective Date (except to the extent expressly provided in Exhibit A) as shall be assigned to him by the Board of Directors or Chief Executive Officer of the Company and (B) the Executive's services shall be performed in the location set forth on Exhibit A hereto. (ii) During the Employment Period, and excluding any periods of vacation and sick leave to which the Executive is entitled, the Executive agrees to devote substantially all of his attention and time during normal business hours to the business and affairs of the Company and Parent and to use the Executive's reasonable best efforts to perform faithfully and efficiently such responsibilities. During the Employment Period it shall not be a violation of this
Agreement for the Executive to (A) serve on corporate, civic or charitable boards or committees, (B) deliver lectures, fulfill speaking engagements or teach at educational institutions and (C) manage personal investments, so long as such activities do not interfere with the performance of the Executive's responsibilities as an employee of the Company and Parent in accordance with this Agreement, and with respect to the activities described in clauses (A) and (C) hereof subject to Parent's policies as in effect from time to time. (b) Compensation. (i) Initial Payment. On the Effective Date, the Company shall pay to the Executive a lump sum payment equal to the amount set forth on Exhibit A hereto, which is equal to the cash payment that the Executive would have been entitled to receive pursuant to Section 4.5 (the "Cash Severance") of the Change in Control Severance Agreement between the Company and the Executive dated as of April 1, 2000 (the "Severance Agreement"), had he been terminated by the Company without "cause" (as defined therein) upon the Effective Date. In addition, on the Effective Date, the Company shall pay to the insurance company which has issued the policy which is the subject of the Split-Dollar Agreement between the Executive and the Company, dated as of May 15, 1998 (the "Split-Dollar Agreement"), the amount set forth on Exhibit A hereto (the "Split Dollar Payment"), which is equal to the projected amount of the premium payments that the Company would have been required to make during the three-year period immediately following the Effective Date on the policy underlying the Split-Dollar Agreement, pursuant to Paragraph 5(b) of the Split-Dollar Agreement. The Executive shall also be entitled to an excise tax gross-up payment as set forth in Section 4.7 of the Severance Agreement solely with respect to the payments and benefits that the Executive was entitled to receive under the terms of the Severance Agreement, the Employment Agreement between the Executive and the Company dated as of May 1, 2000 (the "Prior Employment Agreement"), the Supplemental Executive Retirement Agreement between the Company and the Executive, dated as of May 1, 2000, as amended (the "SERA") and the Split-Dollar Agreement (collectively, the "Pre-Effective Date Agreements") or with respect to the vesting of or lapse of restrictions on, as a direct result of the Merger, compensation earned, benefits accrued or equity awards granted prior to the Effective Date (including, without limitation, benefits due and owing under the Pre-Effective Date Agreements and specifically incorporated herein). Except as set forth in the preceding sentence, in no event shall the Executive be entitled to an excise tax gross-up payment with respect to any amounts payable or benefits provided under the terms of this Agreement. The Executive acknowledges and agrees that in no event shall he be entitled to the payments or benefits under the Severance Agreement based upon a termination during a "Period of Anticipated Change in Control" (as defined in the Severance Agreement). (ii) Base Salary. During the Employment Period; the Executive shall receive an annual base salary ("Annual Base Salary") of no less than the annual base salary in effect with respect to the Executive for calendar year 2001. (iii) Annual Bonus. For each calendar year ending during the Employment Period, the Executive shall receive (or at his election pursuant to the deferred compensation plan of the Company (if any) defer part or all of) an annual cash bonus at least equal to the amount set forth on Exhibit A hereto (the "Annual Bonus") no later than January 31 of the following year, and the Annual Bonus hereunder shall be in lieu of any bonus amount (or portion -2-
thereof) payable to the Executive under any agreement or bonus plan of the Company, including without limitation, the Company Performance-Based Plan for Executive Officers with respect to the calendar year in which the Effective Date occurs, and the Executive hereby waives all right under any such agreements or plans. For the calendar year within which the Employment Period ends, the Executive shall receive no later than January 31 of the following year (or at his election pursuant to the applicable deferred compensation plan of the Company (if any) defer part or all of) a bonus which shall equal or exceed an amount determined by multiplying the Annual Bonus amount set forth on Exhibit A by a fraction the numerator of which shall be the number of days in such calendar year which were included in the Employment Period and the denominator of which shall be 365. (iv) Incentive Awards. At the time equity grants are made to other employees of the Company pursuant to the Merger Agreement, the Executive will be granted equity based awards with respect to the common stock of Parent (the "2001 Service Awards"), pursuant to the terms of the applicable Parent plan as in effect from time to time, that is equal in value to the value of all options (valued using a Black-Scholes value of $10.00, after giving effect to the stock split in 2001), restricted shares and Performance Awards contained in a Performance Based Restricted Stock/Restricted Share Unit Award (valued using the fair market value of the Company's common stock on the date of grant) with respect to restricted share units and performance awards that were granted to the Executive by the Company on January 17, 2001, and with the ratio of the options, restricted shares and performance awards being the same as the ratio of the awards granted to the Executive on January 17, 2001. For purposes of the immediately preceding sentence, the value of the options in Parent's common stock shall be determined using the Black-Scholes valuation model, using assumptions established in manner consistent with the assumptions applied by Parent, consistent with past practices, in respect of stock option grants in 2001. Any stock options on Parent common stock granted in connection with the 2001 Service Awards will have an exercise price equal to the fair market value of the Parent common stock subject thereto on the date of grant and, except as otherwise provided herein, shall vest in four equal installments on each of the first, second, third and fourth anniversaries of the date of grant. Any restricted shares and Performance Awards granted in respect of Parent common stock shall have terms and conditions that are substantially comparable to those applied in respect of the 2001 awards made by the Company. In the event that the Executive receives any equity award grants (other than reload options) from the Company after the date hereof, the 2001 Service Awards shall be reduced by the value of any such awards (determined using a Black-Scholes value with respect to options, using assumptions established on a basis consistent with those applied by the Company in determining such Black-Scholes value in respect of the 2001 grants to the Executive, and the fair market value on the date of grant with respect to performance based or restricted stock awards). (v) Retirement Benefits. On the Effective Date, the Executive shall be paid the benefits payable to the Executive under the SERA, which benefits shall be calculated under the terms and conditions thereof (including without limitation, any enhanced service and age credits provided under Section 2.6 in respect of a termination of the Executive's employment following the occurrence of a Change of Control) as though the Executive's employment terminated on the Effective Date without Cause and the Executive elected to receive a lump sum distribution of such benefits, with any offset against such benefits related to the benefits payable to the Executive under any other retirement plan maintained by the Company based on the benefits -3-
accrued by the Executive thereunder as of the Effective Date. From and after the Effective Date, the Executive shall not be entitled to accrue any additional benefit under the SERA. From and after the Effective Date, the Executive shall participate in the applicable retirement plans of the Company as though no SERA benefit was accrued, provided that the Executive shall not become a participant in the Company's or Parent's Supplemental Executive Retirement Plan and that in no event shall the Executive be entitled to duplicate benefits with respect to the same period of service. To the extent anything contained in this Section 3(b)(v) is inconsistent with the terms and conditions of the SERA, the SERA shall be deemed amended hereby. (vi) Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs generally applicable to similarly situated executives of the Company, provided that, in no event shall the Executive be entitled to receive duplicate benefits with respect to the same period of service under any plans, practices, policies or programs of the Company and/or Parent. Notwithstanding anything contained herein to the contrary, the Executive expressly understands and agrees that he will not initially be entitled to become a participant in the STARR International Co., Inc. ("SICO") Deferred Compensation Profit Participation Plan ("SICO Plan") or to become a stockholder of C.V. STARR & Co., Inc. ("STARR"), but that following the first anniversary of the Effective Date, Parent will recommend to the Boards of Directors of SICO and of STARR that the Executive be eligible to commence participation in the SICO Plan and to become a stockholder of STARR, consistent with similarly situated executives of subsidiaries of Parent. Any participation in the SICO Plan or STARR will require a mutually agreeable reduction in the other compensation payable or provided to the Executive, including without limitation the Base Salary and the Annual Bonus, and such reduction will be a condition to participation in such plans and will in no event be deemed a breach of this Agreement. Any reduction in the compensation otherwise payable hereunder shall be agreed to, in writing, by the parties in advance of the time such reduction is to be effective, and such writing shall set forth, in reasonable detail sufficient for the Executive to understand, the compensation being provided in lieu thereof and all vesting and forfeiture provisions related thereto (and other restrictions, if any, on the ability of the Executive to access or receive such compensation). (vii) Indemnification. The Company shall indemnify the Executive during his employment hereunder and following the termination of the Executive's employment hereunder, on the same basis as the Company indemnifies similarly situated executives of the Company. (viii) Expenses. During the Employment Period, the Executive shall be entitled to receive prompt reimbursement for all reasonable expenses incurred by the Executive in accordance with the Company's policies. (ix) Perquisites. During the Employment Period, the Executive shall be entitled to perquisites in accordance with the plans, practices, policies and programs generally applicable to similarly situated executives of the Company. -4-
(x) Vacation. During the Employment Period, the Executive shall be entitled to paid vacation in accordance with the plans, policies, programs and practices of the Company as in effect with respect to the similarly situated executives of the Company. (xi) Other Benefits From Prior Employment Agreement. Upon and following any termination of the Executive's employment with the Company following the Effective Date, regardless of the reason, the Company shall provide the Executive with the benefits described in Section 8(c)(iv) of the Prior Employment Agreement for the duration described in the Prior Employment Agreement, based on the comparable benefits provided immediately prior to the Date of Termination. 4. Termination of Employment. (a) Death or Disability. The Executive's employment shall terminate automatically upon the Executive's death during the Employment Period. If the Company or Parent determines in good faith that the Disability of the Executive has occurred during the Employment Period (pursuant to the definition of Disability set forth below), it may give to the Executive written notice in accordance with Section 10(b) of this Agreement of its intention to terminate the Executive's employment. In such event, the Executive's employment with the Company shall terminate effective on the 30th day after receipt of such notice by the Executive (the "Disability Effective Date"), provided that, within the 30 days after such receipt, the Executive shall not have returned to full-time performance of the Executive's duties. For purposes of this Agreement, "Disability" shall mean the absence of the Executive from the Executive's duties with the Company on a full-time basis for 180 consecutive business days as a result of incapacity due to mental or physical illness which is determined to be total and permanent by a physician selected by the Company or its insurers and reasonably acceptable to the Executive or the Executive's legal representative. (b) With or Without Cause. The Company or Parent may terminate the Executive's employment during the Employment Period with or without Cause. For purposes of this Agreement, "Cause" shall mean: (i) the continued failure of the Executive to perform substantially the Executive's duties with the Company or one of its affiliates (other than any such failure resulting from incapacity due to physical or mental illness), after a written demand for substantial performance is delivered to the Executive by Parent that specifically identifies the manner in which Parent believes that the Executive has not substantially performed the Executive's duties, or (ii) the engaging by the Executive in illegal conduct or gross misconduct that is materially and demonstrably injurious to the Company or one of its affiliates, or (iii) conviction of a felony or guilty or nolo contendere plea by the Executive with respect thereto. Any act, or failure to act, based upon authority given pursuant to a resolution duly adopted by the Parent Board or the Board of Directors of the Company or upon the instructions of the Chief Executive Officer of Parent or the Company or based upon the advice of counsel for Parent or the Company shall be conclusively presumed to be done, or omitted to be done, by the -5-
Executive in good faith and in the best interests of the Company. The acts and/or omissions which are alleged to constitute the basis for a Cause termination shall be identified to the Executive in reasonable detail in writing, at the time of any such termination of the Executive's employment for Cause. (c) Good Reason. The Executive's employment may be terminated by the Executive for Good Reason. For purposes of this Agreement, "Good Reason" shall mean a material breach by the Company or Parent of a material provision of this Agreement. Without limiting the generality of the foregoing, Parent and the Executive agree that any of the following would constitute a material breach of this Agreement by Parent: (i) any reduction in the Executive's base salary or annual bonus (other than a reduction consented to by the Executive in writing, including, without limitation, any reduction contemplated by Section 3(b)(vi)); (ii) any material adverse change (without his prior written consent) in the Executive's duties and responsibilities, or titles, as set forth in Section 3(a)(i) and Exhibit A attached hereto; and (iii) any relocation of his principal place of employment in violation of Section 3(a)(i) and Exhibit A attached hereto. (d) Notice of Termination. Any termination by the Company for Cause, or by the Executive for Good Reason, shall be communicated by Notice of Termination to the other party hereto given in accordance with Section 10(b) of this Agreement. For purposes of this Agreement, a "Notice of Termination" means a written notice which (i) indicates the specific termination provision in this Agreement relied upon, (ii) to the extent applicable, sets forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated and (iii) if the Date of Termination (as defined below) is other than the date of receipt of such notice, specifies the termination date (which date shall be not more than thirty days after the giving of such notice). The failure by the Executive, the Company or Parent to set forth in the Notice of Termination any fact or circumstance which contributes to a showing of Good Reason or Cause shall not waive any right of the Executive, the Company or Parent, respectively, hereunder or preclude the Executive, the Company or Parent, respectively, from asserting such fact or circumstance in enforcing the Executive's, the Company's or Parent's rights hereunder. (e) Date of Termination. "Date of Termination" means (i) if the Executive's employment is terminated by the Company or Parent for Cause, or by the Executive with or without Good Reason, the date of receipt of the Notice of Termination or any later date specified therein within 30 days of such notice, as the case may be, (ii) if the Executive's employment is terminated by the Company or Parent other than for Cause or Disability, the Date of Termination shall be the date on which the Company or Parent notifies the Executive of such termination and (iii) if the Executive's employment is terminated by reason of death or Disability, the Date of Termination shall be the date of death of the Executive or the Disability Effective Date, as the case may be. 5. Obligations of the Company upon Termination, (a) Good Reason; Other Than for Cause, Death or Disability. If, during the Employment Period, the Company or Parent shall terminate the Executive's employment other than for Cause, death or Disability or the Executive shall terminate employment for Good Reason: -6-
(i) the Company shall pay to the Executive in a lump sum in cash within 30 days after the Date of Termination the aggregate of the following amounts: A. (1) the Executive's Annual Base Salary through the Date of Termination to the extent not theretofore paid ("Accrued Salary"), (2) the benefits described in Section 3(b)(xi) hereof and (3) any benefits to which the Executive is entitled under the terms and conditions of any applicable employee benefits plan, program or agreement (collectively, subclause (l)-(3) shall be referred to as the "Accrued Obligations"); and B. a lump sum amount equal to the greater of (x) the severance under the severance policy applicable to similarly situated executives of the Company, as in effect from time to time, and (y) the sum of the Executive's Annual Base Salary and the Annual Bonus amount set forth in Section 3(b)(iii); and C. a pro-rata portion of the Annual Bonus payable to the Executive under Section 3(b)(iii), which shall be determined by multiplying such bonus by a fraction, the numerator of which is the number of days in the calendar year in which the Executive's date of termination occurs which have elapsed prior to such date of termination and the denominator of which is 365; and D. outplacement services for the duration and of the nature described in Section 8(c)(v) of the Prior Employment Agreement; and (ii) to the extent granted prior to the Date of Termination, the 2001 Service Awards shall vest immediately. (b) Death. If the Executive's employment is terminated by reason of the Executive's death during the Employment Period, this Agreement shall terminate without further obligations to the Executive's legal representatives under this Agreement, other than the Accrued Obligations (to the extent applicable upon the Executive's death). Accrued Salary shall be paid to the Executive's estate or beneficiary, as applicable, in a lump sum in cash within 30 days of the Date of Termination. In addition, (i) to the extent granted prior to the Date of Termination, all of the 2001 Service Awards shall become fully vested and, to the extent applicable, exercisable for the maximum period allowable under the applicable plan for a termination due to death and (ii) the Executive's estate shall be entitled to the death benefits as in effect on the date of the Executive's death with respect to similarly situated executives of the Company (including, with out limitation, any rights to accelerated vesting and enhanced exercise periods applicable in respect of any equity awards made to the Executive in connection with his employment after the Effective Date (excluding the 2001 Service Awards, which are addressed in subclause (i)) that are generally available to similarly situated executives of subsidiaries of Parent whose employment has terminated for such reason under the terms of the plan, program or arrangement under which such awards have been made (the "Equity Enhancements")). (c) Disability. If the Executive's employment is terminated by reason of the Executive's Disability during the Employment Period, this Agreement shall terminate without further obligations to the Executive, other than in respect of the Accrued Obligations. Accrued -7-
Salary shall be paid to the Executive in a lump sum in cash within 30 days of the Date of Termination. In addition, (i) to the extent granted prior to the Date of Termination, all of the 2001 Service Awards shall become fully vested and, to the extent applicable, exercisable for the maximum period allowable under the applicable Parent plan for a termination due to disability and (ii) the Executive shall be entitled after the Disability Effective Date to receive, disability and other benefits as in effect at any time thereafter generally with respect to similarly situated executives of the Company and to the Equity Enhancements). (d) Cause; Other than for Good Reason. If the Executive's employment shall be terminated for Cause or the Executive terminates his employment without Good Reason during the Employment Period, this Agreement shall terminate without further obligations to the Executive other than the obligation to pay to the Executive the Accrued Obligations and the only duties, obligations and liabilities of the Executive to the Company or Parent thereafter shall be the restrictive covenants set forth in Section 7 hereof. 6. Full Settlement. The Company's obligation to make the payments provided for in this Agreement and otherwise to perform its obligations hereunder shall not be affected by any set-off, counterclaim, recoupment, defense or other claim, right or action which the Company or Parent may have against the Executive or others. 7. Confidential Information; Noncompetition; Nonsolicitation. (a) The Executive shall hold in a fiduciary capacity for the benefit of the Company and Parent all secret or confidential information, knowledge or data relating to the Company, Parent or any of their affiliated companies, and their respective businesses, which shall have been obtained by the Executive during the Executive's employment by the Company, Parent or any of their affiliated companies and which shall not be or become public knowledge (other than by acts by the Executive or representatives of the Executive in violation of this Agreement). After termination of the Executive's employment with the Company, Parent or any of their affiliated companies, the Executive shall not, without the prior written consent of Parent or as may otherwise be required by law or legal process, communicate or divulge any such in formation, knowledge or data to anyone other than the Company, Parent or any of their affiliated companies and those designated by them. (b) The Executive agrees that until the earlier of (i) the fourth anniversary of the Effective Date and (ii) the first anniversary of the Executive's termination of employment for any reason (the "Restricted Period"), the Executive will not, without the written consent of Parent, engage in any business of, or enter the employ of, or have any interest in, directly or indirectly, any other person, firm, corporation or other entity engaged in a business that competes with, or provides services and/or products of a nature substantially similar to those provided by, the Company, Parent or their affiliates, with an office or facility in any geographic area in which the Company, Parent or their affiliates do business. Nothing herein shall restrict the Executive from owning 1% or less of the outstanding securities of any corporation or other entity whose securities are listed on any national securities exchange or traded over-the-counter, if the Executive has no other connection or relationship with the issuer of such securities. -8-
(c) During the Restricted Period, the Executive will not, directly or indirectly, on behalf of the Executive or any other person, solicit for employment or employ by other than the Company or Parent any person who, at any time during the six-month period immediately preceding the date of such solicitation, was an employee of the Company, Parent or any of their affiliates. (d) The Executive acknowledges and agrees that due to the nature of business in which the Company, Parent and their affiliates are engaged and because of the nature of the confidential information to which the Executive has access, it would be impractical and excessively difficult to determine the actual damages of the Company or Parent in the event the Executive breached any of the covenants of this Section 7 and that remedies at law (such as monetary damages) for any breach of the Executive's obligations under this Section 7 would be inadequate. The Executive therefore agrees and consents that, if the Executive commits any breach of a covenant under this Section 7 or threatens to commit any such breach, the Company and Parent shall have the right (in addition to, and not in lieu of, any other right or remedy that may be available to each of them) to temporary and permanent injunctive relief from a court of competent jurisdiction. With respect to any provision of this Section 7 finally determined by a court of competent jurisdiction to be unenforceable, the Executive, the Company and Parent hereby agree that such court shall have jurisdiction to reform this Agreement or any provision hereof so that it is enforceable to the maximum extent permitted by law, and the parties agree to abide by such court's determination. (e) The provisions of this Section 7 shall remain in full force and effect until the expiration of the period specified therein, notwithstanding the earlier termination of the Executive's employment hereunder, the Employment Period or this Agreement, provided that the Effective Date has occurred. 8. Successors. (a) This Agreement is personal to the Executive and without the prior written consent of the Company and Parent shall not be assignable by the Executive otherwise than by will or the laws of descent and distribution. This Agreement shall inure to the benefit of and be enforceable by the Executive's legal representatives. (b) This Agreement sha11 inure to the benefit of and be binding upon the Company and Parent and their respective successors and assigns. (c) The Company and Parent will require any successor (whether direct or in-direct, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of the Company or Parent, as applicable, to assume expressly and agree to perform this Agreement in the same manner and to the same extent that the Company and/or Parent would be required to perform it if no such succession had taken place. As used in this Agreement, "Company" and "Parent" shall mean the Company and Parent as hereinbefore defined and any successor to their respective businesses and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law, or otherwise. As used in this Agreement, the term "affiliated companies" and "affiliates" shall include any company controlled by, controlling or under common control with the Company. -9-
9. Dispute Mechanism. (a) Pre-Effective Date Agreements. To the extent that there is any dispute between the parties with respect to any benefits payable hereunder which are due and payable under a Pre-Effective Date Agreement (including, without limitation, the amounts payable under Section 3(b)(i), the SERA benefits payable under Section 3(b)(v) and the benefits payable or provided under Section 5(a)(i)(D)), such dispute shall be resolved pursuant to the mechanism set forth in Section 20 of the Prior Employment Agreement, which is incorporated by reference herein and made a part hereof, and Parent shall be obligated to pay (or shall cause the Company to pay) the Executive's legal and arbitration fees and expenses as provided under Section 10 of the Prior Employment Agreement, which is incorporated by reference herein and made a part hereof. (b) Benefits and Claims Not Related to the Pre-Effective Date Agreements. To the extent that there is any dispute between the parties with respect to any benefits payable hereunder which are not due and payable under a Pre-Effective Date Agreement (and therefore not subject to the dispute mechanism set forth in Section 9(a) above), Parent shall be obligated to pay (or shall cause the Company to pay) the Executive's legal and arbitration fees and expenses related to such dispute in the event that the Executive prevails at arbitration or trial as to any material issue presented in such dispute. 10. Miscellaneous. (a) This Agreement shall be governed by and construed in accordance with the laws of the State of New York, without reference to principles of conflict of laws. The captions of this Agreement are not part of the provisions hereof and shall have no force or effect. This Agreement may not be amended or modified otherwise than by a written agreement executed by the parties hereto or their respective successors and legal representatives. (b) All notices and other communications hereunder shall be in writing and shall be given by hand delivery to the other party or by registered or certified mail, return receipt requested, postage prepaid, addressed as follows: If to the Executive: At the most recent address on file at the Company -10-
If to the Company: American General Corporation 2929 Allen Parkway Houston, Texas 77019 Attention: General Counsel Copy to Parent: American International Group, Inc. 70 Pine Street New York, New York 10270 Attention: General Counsel or to such other address as either party shall have furnished to the other in writing in accordance herewith. Notice and communications shall be effective when actually received by the addressee. (c) The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement. (d) The Company's obligations (i) to indemnify the Executive pursuant to Section 3(vii), (ii) to provide the Executive with benefits and compensation pursuant to Section 5, (iii) to pay any gross-up payment required to be paid under Section 3(b)(i), and (iv) to pay any amount not previously paid (and required to be paid hereunder) in respect of any Pre-Effective Date Agreement, as well as the dispute mechanisms set forth in Section 9, shall survive the termination of the Executive's employment hereunder, the Employment Period or this Agreement, provided that the Effective Date has occurred. (e) None of the benefits provided to the Executive under any of the Pre-Effective Date Agreements or under Section 5 hereof shall be subject to any mitigation or offset, except as may otherwise be expressly provided hereunder. (f) The Company or Parent may withhold from any amounts payable under this Agreement such Federal, state, local or foreign taxes as shall be required to be withheld pursuant to any applicable law or regulation. (g) The Executive's or the Company's or Parent's failure to insist upon strict compliance with any provision of this Agreement or the failure to assert any right the Executive, the Company or Parent may have hereunder shall not be deemed to be a waiver of such provision or right or any other provision or right of this Agreement. (h) From and after the Effective Date, this Agreement shall supersede and terminate the Severance Agreement, the Prior Employment Agreement, and any amendments thereto, except to the extent that any of the benefits made available under the Prior Employment Agreement are expressly intended to continue under the terms of this Agreement. From and after the Effective Date, the SERA and the Split-Dollar Agreement shall be amended in accordance with the terms hereof, and, upon satisfaction of the Company's obligations as set forth herein, the Company and Parent shall have no further obligations under such agreements. -11-
IN WITNESS WHEREOF, THE Executive has hereunto set the Executive's hand and, pursuant to the authorization from their respective Boards of Directors, each of the Company and Parent has caused these presents to be executed in its name on its behalf, all as of the day and year first above written. /s/ Rodney O. Martin ----------------------- RODNEY O. MARTIN AMERICAN GENERAL CORPORATION By /s/ Mark S. Berg ------------------------- Name: Mark S. Berg Title: Executive Vice President and General Counsel AMERICAN INTERNATIONAL GROUP, INC. By /s/ Ernest T. Patrikis _____________________________ Name: Ernest T. Patrikis Title: Senior Vice President and General Counsel -12-
Exhibit A Name: Rodney O. Martin Position: Senior Vice Chairman Adjustments to Responsibilities: Excluding responsibilities related to consumer finance. Location: Houston, Texas Cash Severance Amount: $5,062,500 Split-Dollar Payment: $572,052 Annual Bonus: $1,250,000
AMERICAN INTERNATIONAL GROUP, INC. 70 PINE STREET, NEW YORK. N.Y. 1O27O TELEPHONE: 212 77O-7OOO July 27, 2001 Rodney O. Martin 8855 Stable Lane Houston, Texas 77024 Re: Amendment to Employment Agreement dated as of May 11, 2001 Dear Mr. Martin: This letter confirms the following understandings reached among you, American International Group, Inc. ("Parent") and American General Corporation ("Company") with respect to the Employment Agreement dated as of May 11,2001 (the "Agreement") and constitutes an amendment to such Agreement: 1. Exhibit A to the Agreement is amended as follows: Adjustments to Responsibilities: The Executive's responsibilities will include the life insurance business of the Company on the Effective Date, together with the domestic life business of the Parent known as the AIG Life Companies (U.S.), AIG Life Company and American International Life Assurance Company of New York (these businesses collectively referred to herein as the "Reference Businesses"). The Executive's responsibilities will exclude responsibilities related to the consumer finance operations of the Company. 2. Section 3(b)(iii) of the Agreement is amended as follows: "Bonus. For each calendar year ending during the Employment Period, (a) the Executive shall receive (or at his election pursuant to the deferred compensation plan of the Company, if any, defer part or all of) an annual cash bonus of not less than $1,250,000 (the "Annual Bonus") no later than January 31 of the following year and (b) the Annual Bonus hereunder shall be in lieu of any bonus amount (or portion thereof) payable to the Executive under any agreement or bonus plan of the Company, Parent or any subsidiary of
Parent (other than the Supplementary Bonus as hereinafter described), including without limitation, the Company Performance-Based Plan for Executive Officers with respect to the calendar year in which the Effective Date occurs, and the Executive hereby waives all rights under such agreement or plans. For the calendar year within which the Employment Period ends, the Executive shall receive no later than January 31 of the following year (or at his election pursuant to the applicable deferred compensation plan of the Company, if any, defer part or all of) a bonus which shall equal or exceed an amount determined by multiplying the Annual Bonus by a fraction the numerator of which shall be the number of days in such calendar year which were included in the Employment Period and the denominator of which shall be 365. For each calendar year ending during the Employment Period, the Executive will receive a minimum of $90,000 of bonus compensation (the "Supplementary Bonus") payable in equal quarterly amounts with regard to services performed in that year provided the Executive is employed by Parent or a subsidiary of Parent at the time of the respective quarterly payment when such payment becomes due." 3. Section 3(b)(iv) of the Agreement is amended as follows: "Incentive Awards. At the time equity grants are made to executive officers of the Parent in respect of services performed in the calendar year ending December 31, 2001, the Executive will be granted equity-based awards with respect to the common stock of Parent (the "2001 Service Awards"), pursuant to the terms of the applicable Parent plans or the applicable plans of Starr International Company, Inc. ("SICO"), as follows: - stock options with an exercise price equal to the fair market value of Parent common stock on the date of grant, vesting (subject to your continued employment with Parent or its subsidiaries on the vesting dates) in four equal installments on each of the first, second, third and fourth anniversaries of the date of grant, having an aggregate Black-Scholes valuation of $2,148,023 using a Black-Scholes factor of 0.4059; - Five year cliff vesting stock options (vesting (subject to your continued employment with Parent or its subsidiaries on the vesting 2
date) in full on the fifth anniversary of the date of grant) with an exercise price equal to the fair market value of Parent common stock on the date of grant having an aggregate Black-Scholes valuation of $2,520,000 using a Black-Scholes factor of 0.40; - Performance share units having a maximum aggregate value of $3,825,000 based upon the fair market value on the date of grant which shall vest (subject to your continued employment with Parent or its subsidiaries on the vesting date) from 0 to 100 percent as soon as administratively feasible after December 31, 2004 (provided that, the receipt of shares of Parent common stock pursuant to such units may be deferred, at the election of the Executive, pursuant to an applicable deferral program of the Parent, if any) subject to achievement of mutually agreed performance standards to be established by you and Parent for the Reference Businesses: Maximum [Performance Standard] Maximum Shares Earned------100% Target [Performance Standard] Maximum Shares Earned------ 50% Threshold [Performance Standard] Maximum Shares Earned------ 25% Below[Performance Standard] Maximum Shares Earned------ 0% and - 900 participation units in the then current SICO Deferred Compensation Profit Participation Plan ("SICO Plan") (number of units determined using a valuation model for the shares of Parent common stock expected to be distributable with respect to such units in accordance with the terms of the SICO Plan using assumptions established on a basis consistent with those applied by Parent in valuing participation units for similarly situated executives of Parent). In the event that the Executive receives any equity award grants (other than reload options) from the Company after the date hereof prior to the Effective Date, the 2001 Service Awards shall be reduced by the value of any such awards (determined using a Black-Scholes value with respect to options, using assumptions established on a basis consistent with those applied by the Company in determining such Black-Scholes 3
value in respect of the 2001 grants to the Executive, and the fair market value on the date of grant with respect to performance based and restricted stock awards)." 4. Section 3(b)(vi) of the Agreement is amended as follows: "Other Employee Benefit Plans. During the Employment Period, except as otherwise expressly provided herein, the Executive shall be entitled to participate in all employee benefit, welfare and other plans, practices, policies and programs generally applicable to similarly situated executives of the Company, provided that in no event shall the Executive be entitled to receive duplicate benefits with respect to the same period of service under any plans, practices, policies or programs of the Company and/or Parent. Notwithstanding anything contained herein to the contrary, the Executive expressly understands and agrees that he will not initially be entitled to become a stockholder of C.V. Starr & Co., Inc. ("Starr"), but that following the first anniversary of the Effective Time, Parent will recommend to the Board of Directors of Starr that the Executive be eligible to become a stockholder of Starr, consistent with similarly situated executives of subsidiaries of Parent. Any Participation as a stockholder of Starr will require a mutually agreeable reduction in other compensation payable or provided to the Executive, including without limitation the Base Salary, the Annual Bonus and the Supplementary Bonus, and such reduction will be a condition to such participation and will in no way be deemed a breach of this Agreement. Any reduction in the compensation otherwise payable hereunder shall be agreed to, in writing, by the parties in advance of the time such reduction is to be effective, and such writing shall set forth, in reasonable detail sufficient for the Executive to understand, the compensation being provided in lieu thereof and all vesting and forfeiture provisions related thereto (and other restrictions, if any, on the ability of the Executive to access or receive such compensation). 5. The Executive agrees that this letter agreement constitutes his written consent to changes in his compensation arrangements and duties and responsibilities and under no circumstances shall such changes constitute "Good Reason" for termination by the Executive as defined in Section 4(c) of the Agreement. 4
6. From and after the date hereof, the Agreement is hereby amended by this letter agreement, in accordance with Section 10(a) of the Agreement. Very truly yours, American International Group, Inc. American General Corporation By: /s/ M.R.Greenberg By: /s/ Gary D.Reddick ---------------------- ---------------------- Name: M.R. Greenberg Name: Gary D.Reddick Title: Chairman Title: Executive Vice President Accepted and Agreed as of August 7, 2001 /s/ Rodney O. Martin ----------------------- Rodney O. Martin 5
SPLIT-DOLLAR AGREEMENT THIS SPLIT-DOLLAR AGREEMENT (this "Agreement") is made and entered into effective as of May 15, 2000 (the "Effective Date"), by and among AMERICAN GENERAL CORPORATION, a Texas corporation, with principal offices and place of business in Houston, Texas (hereinafter referred to as the "Company"), RODNEY O. MARTIN, JR. (hereinafter referred to as the "Executive"), and Rodney O. Martin, Sr., Trustee of the Martin 1996 Children's Trusts Agreement dated December 10,1996 (hereinafter referred to as the "Owner"), WITNESSETH THAT: WHEREAS, the Executive is currently employed by the Company or an affiliate of the Company; and WHEREAS, the Personnel Committee of the Board of Directors of the Company initially authorized the Company to establish and pay premiums under a split-dollar life insurance arrangement relating to a life insurance policy insuring the life of the Executive and providing the Executive's family with a death benefit equal to 200% of the sum of the Executive's base salary and average annual incentive bonus; and WHEREAS, the Personnel Committee has subsequently authorized the Company, at the Owner's election, to pay such premium amounts with respect to a new life insurance policy insuring the lives of the Executive and his spouse as of the Effective Date (the "Spouse"); and WHEREAS, the Owner has elected that this split-dollar arrangement should relate to a life insurance policy insuring the lives of the Executive and the Spouse; and WHEREAS, in order to retain the benefits of the services of the Executive for the Company and its affiliates, the Company desires to assist the Executive in providing life insurance protection for the Executive's family under a policy of life insurance (hereinafter referred to as the "Policy") insuring the lives of the Executive and the Spouse, which Policy is described in Exhibit A attached hereto and by this reference made a part hereof, and which is being issued by American General Life Insurance Company (hereinafter referred to as the "Insurer"); and WHEREAS, the Company is willing to pay all of the premiums due on the Policy as an additional employment benefit for the Executive, on the terms and conditions hereinafter set forth; and WHEREAS, the Owner will be the owner of the Policy and, as such, will possess all incidents of ownership in and to the Policy; and
WHEREAS, the Company wishes to have the Policy collaterally assigned to it by the Owner in order to secure the repayment of the amounts which it will pay toward the premiums on the Policy; NOW, THEREFORE, in consideration of the premises and of the mutual promises contained herein, the parties hereto agree as follows: 1. DEFINED TERMS. The terms "Agreement," "Company," "Effective Date," "Executive," "Insurer," "Owner," "Policy," and "Spouse" shall have the meanings assigned to such terms in the preceding provisions of this Agreement. Where the following words and terms are used in this Agreement, they shall have the respective meanings set forth below, unless the context clearly indicates to the contrary: (a) AFFILIATE: The term "Affiliate" shall have the meaning set forth in Rule 12b-2 promulgated under Section 12 of the Securities Exchange Act of 1934, as amended from time to time. (b) ANNIVERSARY DATE: Each annual anniversary of the Effective Date; provided, however, that for purposes of Paragraph l(d) below, the Effective Date shall also be considered an Anniversary Date. (c) AVERAGE ANNUAL BONUS: As of any date for which the Benefit Amount must be determined pursuant to the terms of this Agreement, an amount equal to the average of the three most recent annual incentive bonuses paid in cash by the Company (or an Affiliate of the Company) to the Executive on or before the Anniversary Date next preceding such date for which the Benefit Amount is determined. (d) BASE SALARY: As of any date for which the Benefit Amount must be determined pursuant to the terms of this Agreement, the Executive's annual base salary from the Company or an Affiliate of the Company at the rate in effect on the Anniversary Date next preceding such date. (e) BENEFIT AMOUNT: As of any given date, an amount equal to 445.15% of the sum of the Executive's Base Salary and Average Annual Bonus as of such date. Notwithstanding the foregoing or any provision in this Agreement to the contrary, the Benefit Amount shall not be increased at any time after the Effective Date to the extent such increase is subject to the medical underwriting requirements of the Insurer and the Insurer refuses to increase the face amount of the Policy based upon the health or medical condition of the Executive or the Spouse. (f) CAUSE: The term "Cause" shall have the meaning assigned to such term in the Change in Control Severance Agreement. (g) CHANGE IN CONTROL: The term "Change in Control" shall have the meaning assigned to such term in the Change in Control Severance Agreement. -2-
(h) CHANGE IN CONTROL SEVERANCE AGREEMENT: The Change in Control Severance Agreement between the Company and the Executive that is in effect on the Effective Date (or any successor agreement thereto). (i) CLAIMANT: The term "Claimant" shall have the meaning assigned to such term in Paragraph 10 hereof. (j) DISABLED: The Executive shall be considered "Disabled" for purposes of this Agreement at such time as the Executive becomes entitled to receive* long-term disability benefits under a long-term disability plan maintained by the Company or an Affiliate of the Company. (k) MEASUREMENT DATE: The earlier of (1) the date upon which the Executive's employment with the Company terminates for any reason whatsoever (including, without limitation, termination of employment by reason of the death or retirement of the Executive), (2) the date upon which the Executive becomes Disabled, or (3) the effective date of the termination of this Agreement pursuant to Paragraph 8 hereof. (1) NORMAL RETIREMENT DATE: The term "Normal Retirement Date" shall have the meaning assigned to such term in the Supplemental Executive Retirement Agreement between the Company and the Executive that is in effect on the date of the execution of this Agreement. (m) PREMIUM PAYMENT PERIOD: A period of 8 years commencing on the Effective Date; provided, however, that upon written notice to the Owner and the Executive prior to the occurrence of a Change in Control, the Company may from time to time extend the Premium Payment Period for any period determined by the Company that ends on or before the later of (1) the Executive's Normal Retirement Date or (2) the fifteenth Anniversary Date. (n) RELEVANT ASSUMPTIONS: As of any given date, (1) the Company's assumption as of such date with respect to the rate of increase, if any, in the Benefit Amount from such date to the Executive's Normal Retirement Date (or, if the Executive continues his or her employment with the Company beyond the Executive's Normal Retirement Date, to the Executive's projected date of retirement from the Company) and (2) current mortality rates and charges, crediting rates, expenses, and other relevant matters applicable to the Policy as of such date. Notwithstanding the foregoing, the assumed rate of increase in the Benefit Amount shall be 0% from and after the Measurement Date. 2. ACQUISITION AND OWNERSHIP OF POLICY; LIMITATIONS ON OWNER'S RIGHTS IN POLICY. (a) The Owner shall contemporaneously purchase the Policy from the Insurer in the initial total face amount specified in Exhibit A attached hereto. The parties hereto agree that they shall take all reasonable action necessary to cause the Insurer to issue the Policy, and -3-
shall take any further reasonable action which may be necessary to cause the Policy to conform to the provisions of this Agreement. The parties hereto agree that the Policy shall be subject to the terms and conditions of this Agreement and of the collateral assignment filed with the Insurer relating to the Policy. (b) The Policy names the Owner, and the Owner shall be, the sole and absolute owner of the Policy. The Owner shall not exercise any of the ownership rights granted to the owner of the Policy by the terms thereof except with the express written consent of the Company. Without limiting the scope of the foregoing, the Owner shall not sell, assign, transfer, borrow against or withdraw from the cash surrender value of the Policy, change the beneficiary designation provision of the Policy, change the elected death benefit option provisions of the Policy, decrease or increase the face amount of insurance, surrender or cancel the Policy, or take any other action with respect to the Policy without, in any such case, the express written consent of the Company. (c) Notwithstanding the provisions of Paragraph 2(b) above, the Owner shall have the right to take any of the following actions without the express written consent of the Company, provided that the Owner provides the Company with 15 days prior written notice of any such action: (1) designate the beneficiary or beneficiaries to receive the portion of the proceeds payable under the Policy specified in Paragraph 7(b) hereof; (2) elect the settlement option with respect to such proceeds from among the settlement options available under the Policy; and (3) change such beneficiary designation and settlement option from time to time. 3. COLLATERAL ASSIGNMENT; LIMITATION ON COMPANY'S RIGHTS IN POLICY. (a) To secure the repayment to the Company of the amount of the premiums on the Policy paid by the Company hereunder, the Owner has, contemporaneously herewith, assigned the Policy to the Company as collateral under a separate assignment instrument. The collateral assignment of the Policy to the Company shall not be terminated, altered or amended by the Owner, without the express written consent of the Company. The parties hereto agree to take all action necessary to cause such collateral assignment to conform to the provisions of this Agreement and to be accepted by the Insurer. Without limiting the scope of the preceding provisions of this Paragraph 3, the parties hereto agree that the Company shall have an interest in the cash surrender value and the death benefits under the Policy to secure the amounts due to the Company hereunder, which interest shall in no event be less than the aggregate premium payments made with respect to the Policy by the Company pursuant to Paragraph 5 below. (b) The Company shall not at any time prior to the termination of this Agreement (1) take any action that would cause the death benefits under the Policy that would be available for distribution to the beneficiary or beneficiaries designated by the Owner as provided herein to be less than the Benefit Amount (determined as of the earlier of the Measurement Date or the date such action was taken by the Company) and (2) from and after the date upon which a Change in Control occurs, borrow against the Policy, pledge the Policy as collateral for a loan, withdraw any amount from the Policy or otherwise access any funds held under the Policy until such time as the beneficiary or beneficiaries designated by the Owner have received all of the Policy death benefits to which they are entitled pursuant to the provisions of this Agreement. -4-
4. ADJUSTMENTS TO POLICY FACE AMOUNT. On each Anniversary Date that occurs prior to the Measurement Date, the parties hereto shall cause the total face amount of the Policy to be adjusted to the extent necessary, if any, so that such face amount is equal to the Benefit Amount (which Benefit Amount shall be determined as of the day immediately following such Anniversary Date); provided, however, that if any such adjustment would require a reduction in the face amount of the Policy, then the Company may, in its sole discretion, determine that no such adjustment to the face amount of the Policy shall be made for such Anniversary Date. The parties hereto agree that they shall take all reasonable action necessary to cause the Insurer to adjust the face amount of the Policy as provided in the preceding provisions of this Paragraph 4. Without limiting the scope of the foregoing, (a) the Executive, the Spouse and the Owner shall furnish any and all information requested by the Company or the Insurer to facilitate an adjustment to the face amount of the Policy and (b) the Executive and the Spouse shall take such physical examinations as the Insurer may deem necessary. 5. PAYMENT OF PREMIUMS. (a) On the Effective Date and on or before each Anniversary Date, the Company shall pay to the Insurer, as premium payments with respect to the Policy, the amount, if any, determined by the Company in its sole discretion; provided, however, that: (1) on the Effective Date and on each Anniversary Date that occurs during the Premium Payment Period and prior to the termination of this Agreement, the Company shall make substantially level premium payments with respect to the Policy based upon a premium payment policy established by the Company that is designed to (i) maintain the Policy in a manner sufficient to provide the level of death benefits to the Owner's beneficiary or beneficiaries pursuant to Paragraph 7(b) hereof in the event of the deaths of both the Executive and the Spouse prior to the end of the Premium Payment Period and (ii) accumulate sufficient funds under the Policy (based upon the assumption that the Executive will retire as of the Executive's Normal Retirement Date) so that as of the end of the Premium Payment Period the Policy is projected to have sufficient funds to (A) at all times thereafter provide a minimum death benefit in an amount equal to the Benefit Amount without any further premium payments and (B) permit the Owner to terminate this Agreement as of the later of the Executive's Normal Retirement Date or the fifteenth Anniversary Date and use accumulations under the Policy to obtain the release of the collateral assignment of the Policy to the Company; and (2) on each Anniversary Date that occurs after the end of the Premium Payment Period and prior to the termination of this Agreement, the Company shall make a premium payment with respect to the Policy in at least the amount required so that as of such Anniversary Date the Policy is projected to have sufficient funds to (i) at all times thereafter provide a minimum death benefit in an amount equal to the Benefit Amount without any further premium payments and (ii) permit the Owner to terminate this Agreement as of the later of the Executive's Normal Retirement Date or the fifteenth Anniversary Date and use accumulations under the Policy to obtain the release of the collateral assignment of the Policy to the Company. -5-
The amount of each premium payment required pursuant to clauses (1) and (2) of the preceding sentence shall be determined based upon (i) the Relevant Assumptions in effect as of the date such premium payment is required to be paid by the Company pursuant to this Paragraph 5(a) and (ii) if the Measurement Date has not occurred as of such premium payment date, the Company's estimate of the date upon which the Measurement Date will occur (which date shall be estimated to be no earlier than the Executive's Normal Retirement Date). The Owner and the Executive acknowledge and agree that (A) the Company is agreeing to make premium payments with respect to the Policy as described above based upon the Relevant Assumptions and for the period of time set forth in this Agreement, (B) the actual crediting rates under the Policy and the charges and expenses incurred with respect to the Policy may deviate from the rates, charges and expenses utilized from time to time under the Relevant Assumptions, and (C) accordingly, the Company makes no guarantee that the Policy will, in fact, have sufficient funds to provide a minimum death benefit in an amount equal to the Benefit Amount at all times after the termination of this Agreement without any further premium payments. The Company shall promptly notify the Owner of the date and the amount of each premium payment made by the Company with respect to the Policy and, promptly upon receipt, the Owner shall furnish the Company with a copy of the annual report for the Policy received by the Owner from the Insurer. (b) If the Executive's employment with the Company is terminated under circumstances pursuant to which the Executive is entitled to a severance benefit under the Change in Control Severance Agreement, then the Company shall promptly pay into a rabbi trust a single lump sum cash payment in an amount equal to the projected amount of premium payments that the Company would be required to make with respect to the Policy pursuant to Paragraph 5(a) hereof during the 36 month period immediately following such termination of employment. Pursuant to the terms of the rabbi trust, on each of the first three Anniversary Dates that occur after the termination of the Executive's employment with the Company, the trustee of the rabbi trust shall pay to the Insurer as a premium with respect to the Policy one- third of the amount initially deposited in the rabbi trust by the Company. After the trustee has made three such premium payments, the rabbi trust shall terminate and any remaining funds held by the trustee shall be returned to the Company. Notwithstanding the foregoing, the Company shall remain obligated to make all premium payments required pursuant to Paragraph 5(a) hereof; provided, however, that the Company shall be relieved of such obligation to the extent of the amount of each premium payment made by the trustee of the rabbi trust with respect to the Policy. All costs and expenses associated with the establishment and maintenance of the rabbi trust shall be paid by the Company. (c) Neither the Executive, the Spouse, nor the Owner shall have any obligation to pay any premiums with respect to the Policy prior to the termination of this Agreement. The Company shall have no obligation to pay any premiums with respect to the Policy from and after the termination of this Agreement pursuant to Paragraph 8 below. 6. PROVISION OF INFORMATION. On or before January 31 of each calendar year, the Company shall furnish to the Executive a statement of the amount of income, if any, reportable by the Executive for federal and state income tax purposes for the preceding calendar year as a result of the existence and maintenance of the Policy. The Owner and the Executive shall -6-
promptly furnish the Company with (a) copies of any information or notices provided by the Insurer from time to time with respect to the Policy and (b) any other material or information relating to the Policy and reasonably requested by the Company from time to time. Upon request, the Company shall promptly furnish to the Owner evidence of timely payment of any amount required to be paid by the Company pursuant to Paragraph 5 hereof. 7. COLLECTION AND DISTRIBUTION OF DEATH PROCEEDS. (a) Upon the death of the second to die of the Executive and the Spouse prior to the termination of this Agreement, the Company and the Owner shall cooperate with the beneficiary or beneficiaries designated by the Owner to take whatever action is necessary to collect the death benefit provided under the Policy. When such benefit has been collected and paid as provided herein, this Agreement shall thereupon terminate. (b) Upon the death of the second to die of the Executive and the Spouse prior to the termination of this Agreement, the beneficiary or beneficiaries designated by the Owner pursuant to Paragraph 2(c) hereof shall be entitled to receive a portion of the death benefits provided under the Policy in an amount equal to the Benefit Amount determined as of the Measurement Date. This amount shall be paid under the settlement option elected by the Owner. (c) Upon the death of the second to die of the Executive and the Spouse prior to the termination of this Agreement, the Company shall have the unqualified right to receive any and all of the death benefits provided under the Policy in excess of the amount payable pursuant to Paragraph 7(b) above to the beneficiary or beneficiaries designated by the Owner. This amount shall be paid to the Company in a single lump sum cash payment. (d) The parties hereto agree that, upon the request of the Company, the beneficiary designation provision of the Policy shall conform to the provisions hereof. 8. TERMINATION OF AGREEMENT. (a) This Agreement may be terminated by the Owner at any time during the lifetime of the Executive or the Spouse after the fifteenth Anniversary Date upon written notice to the Company and payment to the Company by the Owner at the time of such notice of a single lump sum cash payment in an amount equal to the aggregate premium payments made by the Company pursuant to Paragraph 5 hereof on or before the date of such termination, less any withdrawals from the Policy by the Company prior to the date of such termination and any indebtedness secured by the Policy which was incurred by the Company and remains outstanding as of the date of such termination, including any unpaid accrued interest on such indebtedness. Upon receipt of such amount, the Company shall release the collateral assignment of the Policy by the execution and delivery of an appropriate instrument of release. (b) This Agreement may be terminated by the Company at any time during the Executive's lifetime (including, without limitation, upon the Executive's termination of employment with the Company or at any time before or after such termination); provided, however, that (i) from and after the Executive's Normal Retirement Date, this Agreement may -7-
not be terminated by the Company until the later of such Normal Retirement Date, the date upon which the Executive's employment with the Company terminates, the expiration of the Premium Payment Period or the fifteenth Anniversary Date, (ii) from and after the date upon which the Executive becomes Disabled, this Agreement may not be terminated by the Company until the earlier of the Executive's Normal Retirement Date, the expiration of the Premium Payment Period, the fifteenth Anniversary Date or the third anniversary of the date upon which the Executive becomes Disabled, and (iii) from and after the date upon which a Change in Control occurs, this Agreement may be terminated by the Company only on or after the date upon which the Executive's employment with the Company terminates (except that, if the Executive's employment with the Company terminates under circumstances pursuant to which the Executive is entitled to a severance benefit under the Change in Control Severance Agreement, then this Agreement may not be terminated by the Company until the third anniversary of the date of such termination of employment). The Company shall provide the Owner and the Executive with 30 days' prior written notice of any such termination of this Agreement by the Company. If this Agreement is terminated by the Company as provided in the preceding provisions of this Paragraph 8(b), then for 60 days after the effective date of the termination of this Agreement, the Owner shall have the option of obtaining the release of the collateral assignment of the Policy to the Company. To obtain such release, the Owner shall repay to the Company the total amount of the premium payments made by the Company hereunder, less any withdrawals from the Policy by lie Company prior to the date of such termination and any indebtedness secured by the Policy which was incurred by the Company and remains outstanding as of the date of such termination, including any unpaid accrued interest on such indebtedness. Upon receipt of such amount, the Company shall release the collateral assignment of the Policy by the execution and delivery of an appropriate instrument of release. If the Owner fails to exercise such option within such 60 day period, then the interest of the Owner in the Policy shall automatically be transferred to the Company and the Owner shall execute any document or documents requested by the Company or the Insurer to effect such transfer. Alternatively, the Company may enforce its right to be repaid the amount due it hereunder from the cash surrender value of the Policy under the collateral assignment of the Policy; provided that in the event the cash surrender value of the Policy exceeds the amount due the Company, such excess shall be paid to the Owner. Thereafter, neither the Owner nor any person claiming under the Owner shall have any further interest in and to the Policy, either under the terms thereof or under this Agreement. (c) Notwithstanding any provision in this Agreement to the contrary, if the Executive's employment with the Company is terminated for Cause at any time (whether before or after the Executive attains his or her Normal Retirement Date), then (i) this Agreement shall automatically terminate upon such termination of employment, (ii) the interest of the Owner in the Policy shall automatically be transferred to the Company and the Owner shall execute any document or documents requested by the Company or the Insurer to effect such transfer, (iii) the Company may exercise all rights of ownership of the Policy, take all proceeds of the Policy, take proceeds designated for the beneficiary or beneficiaries designated by the Owner, assign its ownership interest in the Policy to any other party or take any other action the Company determines in its sole discretion, and (iv) neither the Owner, the Executive nor their respective heirs, assigns, personal representatives, or beneficiaries shall have any further rights, claims, or interests of any nature whatsoever in the Policy or in this Agreement. -8-
(d) It is a condition precedent to the execution of this Agreement that the Owner and the Executive acknowledge and agree that the Company has the right, subject to certain limitations set forth in Paragraph 8(b) hereof, to terminate this Agreement at any time for any reason whatsoever or for no reason at all. Without limiting the scope of the foregoing, the Owner and the Executive specifically acknowledge and agree that the Company shall have the right to terminate this Agreement prior to the occurrence of a Change in Control in the event that the premiums required to be paid under the Policy are increased due to a deterioration in the health or medical condition of the Executive after the Effective Date. In such event, the Owner and the Executive hereby waive, and agree that they shall not assert, any claim or cause of action, in contract, tort or otherwise, against the Company, any Affiliate of the Company or any employee, director, officer or agent of the Company or any such Affiliate with respect to the termination of this Agreement, including, without limitation, any claim or cause of action based on any alleged discriminatory practice. By entering into this Agreement, the parties hereto agree that the conditions and provisions set forth in this Paragraph 8(d) are an essential component of this Agreement, and it is their intent that such conditions and provisions not be severed from the other terms and provisions of this Agreement. (e) Should Executive and Company enter into an Employment Agreement which is in effect on the date of the termination of Executive's employment, and which contains specific terms with respect to the treatment of Executive's split-dollar insurance following termination of employment, such terms of the Employment Agreement shall control notwithstanding any provisions to the contrary set forth in Paragraph 8 herein. 9. INSURER NOT A PARTY. Subject to the terms and conditions of the Policy, the Insurer shall be folly discharged from its obligations under the Policy by payment of the Policy death benefit to the beneficiary or beneficiaries named in the Policy and upon the performance of its other obligations in accordance with the terms of the Policy. In no event shall the Insurer be considered a party to this Agreement, or any modification or amendment hereof. No provision of this Agreement, nor of any modification or amendment hereof, shall in any way be construed as enlarging, changing, varying, or in any other way affecting the obligations of the Insurer as expressly provided in the Policy. 10. NAMED FIDUCIARY, DETERMINATION OF BENEFITS, CLAIMS PROCEDURE AND ADMINISTRATION. (a) NAMED FIDUCIARY. The Company is hereby designated as the named fiduciary under this Agreement. The named fiduciary shall have authority to control and manage the operation and administration of this Agreement, and it shall be responsible for establishing and carrying out a premium payment policy and method consistent with the objectives of this Agreement. (b) (1) CLAIM. A person who believes that he or she is being denied a benefit to which he or she is entitled under this Agreement (hereinafter referred to as a "Claimant") may file a written request for such benefit with the Company, setting forth his or her claim. The request must be addressed to the Company at its then principal place of business. -9-
(2) CLAIM DECISION. Upon receipt of a claim, the Company shall advise the Claimant that a reply will be forthcoming within 90 days and shall, in fact, deliver such reply within such period. The Company may, however, extend the reply period for an additional 90 days for reasonable cause. If the claim is denied in whole or in part, the Company shall adopt a written opinion, using language calculated to be understood by the Claimant, setting forth: (i) the specific reason or reasons for such denial; (ii) the specific reference to pertinent provisions of this Agreement on which such denial is based; (iii) a description of any additional material or information necessary for the Claimant to perfect his or her claim and an explanation why such material or such information is necessary; (iv) appropriate information as to the steps to be taken if the Claimant wishes to submit the claim for review; and (v) the time limits for requesting a review under subsection (3) and for review under subsection (4) hereof. (3) REQUEST FOR REVIEW. Within 60 days after the receipt by the Claimant of the written opinion described above, the Claimant may request in writing that the Company review its determination. Such request must be addressed to the Company, at its then principal place of business. The Claimant or his or her duly authorized representative may, but need not, review the pertinent documents and submit issues and comments in writing for consideration by the Company. If the Claimant does not request a review of the Company's determination within such 60 day period, he or she shall be barred and estopped from challenging the Company's determination. (4) REVIEW OF DECISION. Within 60 days after the Company's receipt of a request for review, it will review the determination. After considering all materials presented by the Claimant, the Company will render a written opinion, written in a manner calculated to be understood by the Claimant, setting forth the specific reasons for the decision and containing specific references to the pertinent provisions of this Agreement on which the decision is based. If special circumstances require that the 60 day time period be extended, the Company will so notify the Claimant and will render the decision as soon as possible, but no later than 120 days after receipt of the request for review. 11. ARBITRATION. (a) Upon completion of the claims procedure described in Paragraph 10(b) hereof (if applicable), all claims, demands, causes of action, disputes, controversies, and other matters in questions arising out of or relating to this Agreement, any provision hereof, the alleged breach thereof, or in any way relating to the subject matter of this Agreement involving the parties hereto and/or their respective representatives, even though some or all of such claims allegedly are extra-contractual in nature, whether such claims sound in contract, tort, or otherwise, at law or in equity, under state or federal law, whether provided by statute or the common law, for damages or any other relief, shall be resolved by binding arbitration pursuant to the Federal Arbitration Act in accordance with the Employment Dispute Resolution Rules then in effect with the American Arbitration Association. The arbitration proceeding shall be -10-
conducted in Houston, Texas. This agreement to arbitrate shall be enforceable in either federal or state court. (b) The enforcement of this agreement to arbitrate and all procedural aspects of this agreement to arbitrate, including but not limited to, the construction and interpretation of this agreement to arbitrate, the issues subject to arbitration (i.e., arbitrability), the scope of the arbitrable issues, allegations of waiver, delay or defenses to arbitrability, and the rules governing the conduct of the arbitration, shall be governed by and construed pursuant to the Federal Arbitration Act and shall be decided by the arbitrators. In deciding the substance of any such claims, the arbitrators shall apply the substantive laws of the State of Texas (excluding Texas choice-of-law principles that might call for the application of some other state's law); provided, however, it is expressly agreed that the arbitrators shall have no authority to award treble, exemplary, or punitive damages under any circumstances regardless of whether such damages may be available under Texas law, the parties hereby waiving their right, if any, to recover treble, exemplary, or punitive damages in connection with any such claims. If any party to this Agreement institutes arbitration to enforce the terms of this Agreement, the party who prevails in such arbitration, whether plaintiff or defendant, in addition to the remedy or relief obtained in such arbitration proceeding shall be entitled to recover its or his expenses incurred in connection with such- arbitration proceeding, including, without limitation, arbitrators and attorneys fees, and the arbitrators are authorized to so award such costs and fees. (c) The arbitration may be initiated by any party by providing to the other parties a written notice of arbitration specifying the claims. Within 30 days of the notice of initiation of the arbitration procedure, (1) the Owner and the Executive, acting together, shall denominate one arbitrator and (2) the Company shall denominate one arbitrator. The two arbitrators shall select a third arbitrator failing agreement on which within 60 days of the original notice, either the Owner, the Executive or the Company shall apply to the Senior Active United States District Judge for the Southern District of Texas, who shall appoint a third arbitrator. While the third arbitrator shall be neutral, the two party-appointed arbitrators are not required to be neutral and it shall not be grounds for removal of either of the two party-appointed arbitrators or for vacating the arbitrators' award that either of such arbitrators has past or present minimal relationships with the party that appointed such arbitrator. Evident partiality on the part of an arbitrator exists only where the circumstances are such that a reasonable person would have to conclude there in fact existed actual bias. A mere appearance or impression of bias will not constitute evident partiality or otherwise disqualify an arbitrator. (d) The three arbitrators shall by majority vote resolve all disputes between the parties. There shall be no transcript of the hearing before the arbitrators. The arbitrators' decision shall be in writing, but shall be as brief as possible. The arbitrators shall not assign the reasons for their decision. The arbitrators shall certify in their award that they have faithfully applied the terms and conditions of this Agreement and that no part of their award includes any amount for exemplary or punitive damages. All proceedings conducted hereunder and the decision of the arbitrators shall be kept confidential by the parties, e.g., the arbitrators' award shall not be released to the press or published in any of the various arbitration reporters. Judgment upon any award rendered in any such arbitration proceeding may be entered by any federal or state court having jurisdiction. -11-
12. AMENDMENT. This Agreement may not be amended, altered, or modified, except by a written instrument signed by the parties hereto, or their respective successors or assigns. Notwithstanding the foregoing or any other provision herein to the contrary, the Premium Payment Period, the face amount of the Policy, the amount of premiums to be paid by the Company, and/or the references in this Agreement to the fifteenth Anniversary Date may be changed by the Company without the consent of the Owner or the Executive to the extent necessary to (a) maintain the Policy as a "life insurance contract" (within the meaning of Section 7702 of the Internal Revenue Code of 1986, as amended (the "Code"), and the interpretative authority promulgated thereunder) and (b) prevent the Policy from constituting a "modified endowment contract" (within the meaning of Section 7702A of the Code and the interpretative authority promulgated thereunder). The Company shall provide the Owner and the Executive with prompt written notice of any such change. 13. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of the Company and its successors and assigns, and the Owner, the Executive and their respective successors, assigns, heirs, executors, administrators, and beneficiaries; provided, however, that the rights and obligations of the Owner and the Executive hereunder are personal and neither this Agreement, nor any right, benefit, or obligation of the Owner or the Executive hereto, shall be subject to voluntary or involuntary assignment, alienation or transfer, whether by operation of law or otherwise, without the prior written consent of the Company. 14. NOTICE. Any notice, consent or demand required or permitted to be given under the provisions of this Agreement shall be in writing, and shall be signed by the party giving or making the same. If such notice, consent or demand is mailed to a party hereto, it shall be sent by United States registered or certified mail, postage prepaid, addressed to such party's last known address as shown on the records of the Company. The date of such mailing shall be deemed the date of notice, consent or demand. 15. EMPLOYMENT RELATIONSHIP. For all purposes of this Agreement, the Executive shall be considered to be in the employment of the Company as long as the Executive remains an employee of the Company or any Affiliate of the Company. However, this Agreement is not an employment agreement. This Agreement shall not be construed as creating an express or implied contract of employment and does not modify the nature of the Executive's employment relationship with the Company or its Affiliates, as the case may be. Except as otherwise agreed in writing between the Executive and the Company or an Affiliate of the Company, the employment relationship between the Executive and the Company or its Affiliates is at-will, i.e., the employment relationship may be terminated at any time at the will of either the Company or the Executive for any reason or no reason at all. 16. TAXES AND POLICY ILLUSTRATIONS. The Company makes no guarantees and assumes no obligations or responsibilities with respect to the Owner's, the Executive's or the Spouse's federal, state, or local income, estate, inheritance, and gift tax obligations, if any, under this Agreement, the Policy or the collateral assignment of the Policy to the Company. The Executive and the Owner agree and acknowledge that the Policy illustrations provided prior to the Effective Date and any Policy illustrations that may be provided from time to time thereafter -12-
by the Company, the Insurer or their respective agents and representatives are not guaranteed and are not a part of the Policy or this Agreement. Such Policy illustrations shall not create any additional obligations or responsibilities to the Executive or the Owner by the Company, the Insurer, or their respective agents and representatives. 17. Governing Law. This Agreement, and the rights of the parties hereunder, shall be governed by and construed in accordance with the laws of the State of Texas. IN WITNESS WHEREOF, the parties hereto have executed this Agreement on this the 26th day of October, 2000, effective as of the Effective Date. AMERICAN GENERAL CORPORATION By: /S/ Gary D. Reddick -------------------------------------- Gary D. Reddick Executive Vice President and Chief Administrative Officer - Corporate Operations COMPANY RODNEY O. MARTIN, JR. /s/ Rodney O. Martin, Jr. ------------------------------------------- EXECUTIVE THE MARTIN 1996 CHILDREN'S TRUSTS AGREEMENT /s/ Rodney O. Martin, Jr. ------------------------------------------- Trustee OWNER -13-
EXHIBIT A The following life insurance policy is subject to the attached Split-Dollar Agreement: Insurer: American General Life Insurance Company Insured: Rodney O. Martin, Jr. AND Deborah S. Martin Policy Number: A10192468L Face Amount on the Effective Date: $ 10,355,710.00 Effective Date of Policy: May 15, 2000 -14-
ASSIGNMENT OF LIFE INSURANCE POLICY AS COLLATERAL A. FOR VALUE RECEIVED, the undersigned (hereinafter the "Owner") hereby assigns, transfers and sets over to American General Corporation, with principal offices and place of business in Houston, Texas, its successors and assigns (hereinafter the "Assignee"), Policy No. A10192468L issued by American General Life Insurance Company (hereinafter the "Insurer"), and any supplementary contracts issued in connection therewith (said policy and contracts hereinafter the "Policy"), insuring the lives of RODNEY O. MARTIN, JR. (the "Executive") and his spouse, Deborah S. Martin as of the date hereof, and all claims, options, privileges, rights, title and interest therein and thereunder (except as otherwise provided herein), subject to all the terms and conditions of the Policy and to all superior liens, if any, which the Insurer may have against the Policy. The Owner, by this Assignment, and the Assignee, by acceptance of the assignment of the Policy to it hereunder, agree to the terms and conditions contained herein. B. This Assignment is made and the Policy is to be held as collateral security for any and all liabilities and obligations of the Owner to the Assignee, either now existing or that may hereafter arise, under and pursuant to that certain Split-Dollar Agreement by and among the Owner, the Assignee, and the Executive, dated effective as of May 15, 2000 (hereinafter the "Split-Dollar Agreement"). The liabilities and obligations described in the preceding sentence are hereinafter referred to as the "Liabilities." C. It is expressly agreed that, without detracting from the generality of the foregoing, the following specific rights are included in this Assignment and pass to the Assignee by virtue hereof: 1. The sole right to collect from the Insurer the net proceeds of the Policy when it becomes a claim by death or maturity; 2. The sole right to surrender the Policy and receive the surrender value thereof at any time provided by the terms of the Policy and at such other times as the Insurer may allow; and 3. The sole right to obtain one or more withdrawals, loans or advances on the Policy, either from the Insurer or, at any time, from other persons, and to pledge or assign the Policy as security for such loans or advances. D. It is expressly agreed that the following specific rights, so long as the Policy has not been surrendered and to the extent permitted under the Split-Dollar Agreement, are reserved by the Owner and excluded from this Assignment and do not pass by virtue hereof: 1. The right to designate and change the beneficiary to receive the portion of the proceeds under the Policy specified in Paragraph 7(b) of the Split-Dollar Agreement; and
2. The right to elect any optional mode of settlement permitted by the Policy or allowed by the Insurer with respect to such proceeds. However, the reservation of these rights by the Owner shall in no way impair the right of the Assignee to surrender the Policy nor impair any other right of the Assignee hereunder. Further, any exercise of these rights shall be made subject to this Assignment and to the rights of the Assignee hereunder. E. Notwithstanding the foregoing, the Assignee covenants and agrees with the Owner as follows: 1. Any balance of sums received hereunder from the Insurer remaining after payment of the then existing Liabilities shall be paid by the Assignee to the persons entitled thereto under the terms of the Policy, had this Assignment not been executed; 2. The Assignee will not exercise the right to surrender the Policy, nor the right to make withdrawals from the Policy or obtain policy loans from the Insurer, unless and until there has been default in any of the Liabilities or the Split-Dollar Agreement has been terminated, pursuant to its terms; in any event, the Assignee will not exercise any such right until 15 days after the Assignee shall have mailed notice of intention to exercise such right, by first class mail, to the Owner at the address last supplied in writing to the Assignee specifically referring to this Assignment; and 3. The Assignee will, upon request, forward the Policy to the Insurer without unreasonable delay, for endorsement of any designation or change of beneficiary or any election of an optional mode of settlement that has been elected by the Owner. F. The Insurer is hereby authorized to recognize the Assignee's claims to rights hereunder without investigating the reason for any action taken by the Assignee, the validity or the amount of the Liabilities, the existence of any default therein, termination of the Split-Dollar Agreement, the giving of any notice hereunder, or the application to be made by the Assignee of any amounts to be paid to the Assignee. The sole signature of the Assignee shall be sufficient for the exercise of any rights under the Policy assigned hereby and the sole receipt of the Assignee for any sums received shall be a full discharge and release therefor to the Insurer. Payment for all or any part of the sums due under the Policy and assigned herein shall be drawn to the exclusive order of or as directed by the Assignee if, when, and in such amounts as may be requested by the Assignee. G. The Assignee shall be under no obligation to pay any premium on the Policy nor the principal of or interest on any loans or advances on the Policy, whether or not obtained by the Assignee, or any other charges on the Policy. H. The exercise of any right, option, privilege or power given herein to the Assignee shall be at the option of the Assignee, and (except as provided herein) the Assignee may exercise any such right, option, privilege or power without notice to, or assent by, or affecting the liability of, or releasing any interest hereby assigned by the Owner. -2-
I. If applicable, the Assignee may take or release other security, may release any party primarily or secondarily liable for any of the Liabilities, may grant extensions, renewals or indulgences with respect to the Liabilities, or may apply the proceeds of the Policy hereby assigned or any amount received on account of the Policy by the exercise of any right permitted under this Assignment to the Liabilities in such order as the Assignee shall determine, without resorting to or regard to other security. J. As applied to the duties and responsibilities of the Insurer, in the event of any conflict between the provisions of this Assignment and the provisions of the Split-Dollar Agreement with respect to the Policy or the Assignee's rights of collateral security therein, the provisions of this Assignment shall prevail. As applied between the Owner and the Assignee, in the event of any such conflict, the provisions of the Split-Dollar Agreement shall prevail. K. The Owner declares that no proceedings in bankruptcy are pending against the Owner and that the Owner's property is not subject to any assignment for the benefit of creditors of the Owner. SIGNED this 26th day of December, 2000, effective as of May 15, 2000. THE MARTIN 1996 CHILDREN'S TRUSTS AGREEMENT /s/ Rodney O. Martin ------------------------------------- TRUSTEE "OWNER" This Assignment is hereby accepted and agreed to by the Assignee. AMERICAN GENERAL CORPORATION BY: /s/ Gary D. Reddick --------------------------------- Gary D. Reddick Executive Vice President and Chief Administrative Officer- Corporate Operations "ASSIGNEE" -3-
STATE OF Texas Section ) Section ) HARRIS COUNTY Section ) On the 26th day of October, 2000, before me personally came Rodney O. Martin, to me known to be the individual who executed the Assignment on the preceding pages hereof and acknowledged to me that he or she executed the same. /S/ Robin Sellers ------------------------------------ Notary Public in and for THIS STATE OF Texas My Commission Expires: 11/04/02 [NOTARY PUBLIC STAMP] -4-
. . . EXHIBIT 12 American International Group, Inc. and Subsidiaries Computation of Ratios of Earnings to Fixed Charges (in millions, except ratios) - ----------------------------------------------------------------------------------------------------------- YEARS ENDED DECEMBER 31, 2002 2001 2000 1999 1998 =========================================================================================================== Income before income taxes, minority interest and cumulative effect of accounting changes $ 8,142 $ 8,139 $10,023 $ 9,399 $ 7,583 Less - Equity income of less than 50% owned persons 132 15 9 22 98 Add - Dividends from less than 50% owned persons 13 3 3 13 24 - ----------------------------------------------------------------------------------------------------------- 8,023 8,127 10,017 9,390 7,509 Add - Fixed charges 3,797 4,195 3,842 3,152 2,884 Less - Capitalized interest 61 71 69 60 86 - ----------------------------------------------------------------------------------------------------------- Income before income taxes, minority interest, cumulative effect of accounting changes and fixed charges $11,759 $12,251 $13,790 $12,482 $10,307 =========================================================================================================== Fixed charges: Interest costs $ 3,629 $ 4,038 $ 3,705 $ 3,022 $ 2,769 Rental expense* 168 157 137 130 115 - ----------------------------------------------------------------------------------------------------------- Total fixed charges $ 3,797 $ 4,195 $ 3,842 $ 3,152 $ 2,884 =========================================================================================================== Ratio of earnings to fixed charges 3.10 2.92 3.59 3.96 3.57 =========================================================================================================== *The proportion deemed representative of the interest factor. The ratios shown are significantly affected as a result of the inclusion of the fixed charges and operating results of AIG Financial Products Corp. and its subsidiaries (AIGFP). AIGFP structures borrowings through guaranteed investment agreements and engages in other complex financial transactions, including interest rate and currency swaps. In the course of its business, AIGFP enters into borrowings that are primarily used to purchase assets that yield rates greater than the rates on the borrowings with the intent of earning a profit on the spread and to finance the acquisition of securities utilized to hedge certain transactions. The pro forma ratios of earnings to fixed charges, excluding the effects of the operating results of AIGFP, are 4.46, 4.16, 5.06, 5.51, and 4.76 for 2002, 2001, 2000, 1999 and 1998, respectively. As AIGFP will continue to be a subsidiary, AIG expects that these ratios will continue to be lower than they would be if the fixed charges and operating results of AIGFP were not included therein. Excluding $900 million with respect to the World Trade Center and related losses and $2.02 billion with respect to acquisition, restructuring and related charges, the ratio of earnings to fixed charges was 3.62 for 2001. II-10
. . . EXHIBIT 21 Subsidiaries of Registrant % OF VOTING SECURITIES JURISDICTION OF OWNED BY ITS INCORPORATION IMMEDIATE OR ORGANIZATION PARENT((2) - ---------------------------------------------------------------------------------------------------------------------------- American International Group, Inc. (Registrant)(1) Delaware (3) AIG Assurance Canada Canada 100%(4) AIG Aviation, Inc. Georgia 100% AIG Bulgaria Insurance and Reinsurance Company AD Bulgaria 100% AIG Capital Corporation Delaware 100% International Lease Finance Corporation California 64.85%(5) AIG Capital Management Corp. Delaware 100% AIG Claim Services, Inc. Delaware 100% AIG Consumer Finance Group, Inc. Delaware 100% AIG Bank Polska S.A. Poland 97.23% AIG Credit S.A. Poland 80% Compania Financiera Argentina S.A. Argentina 92.7% AIG Credit Corp. Delaware 100% A.I. Credit Corp. New Hampshire 100% Imperial Premium Finance, Inc. California 100% Imperial Premium Finance, Inc. Delaware 100% AIG Equity Sales Corp. New York 100% AIG Federal Savings Bank Delaware 100% AIG Finance Holdings, Inc. New York 100% AIG Finance (Hong Kong) Limited Hong Kong 100% AIG Financial Products Corp. Delaware 100% AIG Matched Funding Corp. Delaware 100% Banque AIG France 90%(6) AIG Funding, Inc. Delaware 100% AIG Global Investment Group, Inc. Delaware 100% AIG Capital Partners, Inc. Delaware 100% AIG Global Investment Corp. New Jersey 100% John McStay Investment Counsel, L.P. Texas 83.84% AIG Global Real Estate Investment Corp. Delaware 100% AIG Global Trade & Political Risk Insurance Company New Jersey 100% A.I.G. Golden Insurance Ltd. Israel 50.01% AIG Life Insurance Company Delaware 78.9%(7) AIG Life Insurance Company of Canada Canada 100% AIG Life Insurance Company of Puerto Rico Puerto Rico 100% AIG Marketing, Inc. Delaware 100% AIG Memsa, Inc. Delaware 100% Tata AIG General Insurance Company Limited India 26% AIG Private Bank Ltd. Switzerland 100% AIG Risk Management, Inc. New York 100% AIG Star Life Insurance Co., Ltd. Japan 100%(4) AIGTI, Inc. Delaware 100% AIG Trading Group Inc. Delaware 100% AIG International Inc. Delaware 100% AIU Insurance Company New York 52%(8) AIU North America, Inc. New York 100% American General Corporation Texas 100% American General Bancassurance Services, Inc. Illinois 100% USMRP, Ltd. Turks & Caicos 100% AGC Life Insurance Company Missouri 100% AIG Life of Bermuda, Ltd. Bermuda 100% American General Life and Accident Insurance Company Tennessee 100% American General Life Insurance Company Texas 100% American General Annuity Service Corporation Texas 100% II-11
Subsidiaries of Registrant--(continued) % OF VOTING SECURITIES JURISDICTION OF OWNED BY ITS INCORPORATION IMMEDIATE OR ORGANIZATION PARENT((2) - ---------------------------------------------------------------------------------------------------------------------------- American General Enterprise Services, LLC Delaware 100% American General Equity Services Corporation Delaware 100% American General Life Companies, LLC Delaware 100% The Variable Annuity Life Insurance Company Texas 100% VALIC Retirement Services Company Texas 100% VALIC Trust Company Texas 100% American General Property Insurance Company Tennessee 51.85%(9) American General Property Insurance Company of Florida Florida 100% AIG Annuity Insurance Company Texas 100% North Central Life Insurance Company Minnesota 100% North Central Caribbean Life, Ltd. Nevis 100% The Old Line Life Insurance Company of America Wisconsin 100% The United States Life Insurance Company in the City of New York New York 100% American General Finance, Inc. Indiana 100% AGF Investment Corp. Indiana 100% American General Auto Finance, Inc. Delaware 100% American General Finance Corporation Indiana 100% MorEquity, Inc. Nevada 100% Wilmington Finance, Inc. Delaware 100% The National Life and Accident Insurance Company Texas 100% CommoLoCo, Inc. Puerto Rico 100% Merit Life Insurance Co. Indiana 100% Yosemite Insurance Company Indiana 100% American General Financial Services of Alabama, Inc. Alabama 100% HSA Residential Mortgage Services of Texas, Inc. Delaware 100% American General Investment Management Corporation Delaware 100% American General Realty Investment Corporation Texas 100% American General Assurance Company Illinois 100% American General Indemnity Company Nebraska 100% USLIFE Credit Life Insurance Company of Arizona Arizona 100% Knickerbocker Corporation Texas 100% American Home Assurance Company New York 100% AIG Hawaii Insurance Company, Inc. Hawaii 100% American Pacific Insurance Company, Inc. Hawaii 100% American International Insurance Company New York 100% American International Insurance Company of California, Inc. California 100% American International Insurance Company of New Jersey New Jersey 100% Minnesota Insurance Company Minnesota 100% American International Realty Corp. Delaware 31.47%(10) Pine Street Real Estate Holdings Corp. New Hampshire 31.47%(10) Transatlantic Holdings, Inc. Delaware 33.63%(11) Transatlantic Reinsurance Company New York 100% Putnam Reinsurance Company New York 100% Trans Re Zurich Switzerland 100% American International Group Data Center, Inc. New Hampshire 100% American International Insurance Company of Delaware Delaware 100% American International Life Assurance Company of New York New York 77.52%(12) American International Reinsurance Company, Ltd. Bermuda 100% American International Assurance Company, Limited Hong Kong 100% American International Assurance Company (Australia) Limited Australia 100% American International Assurance Company (Bermuda) Limited Bermuda 100% American International Assurance Co. (Vietnam) Limited Vietnam 100% Tata AIG Life Insurance Company Limited India 26% II-12
Subsidiaries of Registrant--(continued) % OF VOTING SECURITIES JURISDICTION OF OWNED BY ITS INCORPORATION IMMEDIATE OR ORGANIZATION PARENT((2) - ---------------------------------------------------------------------------------------------------------------------------- Nan Shan Life Insurance Company, Ltd. Taiwan 95% American International Underwriters Corporation New York 100% American International Underwriters Overseas, Ltd. Bermuda 100% AIG Europe (Ireland) Ltd. Ireland 100% AIG Europe (U.K.) Limited England 100% AIG Interamericana Compania de Seguros Gerais (Brazil) Brazil 50% Universal Insurance Co., Ltd. Thailand 100% La Seguridad de Centroamerica, Compania de Seguros, Sociedad Anonima Guatemala 100% American International Insurance Company of Puerto Rico Puerto Rico 100% La Interamerica Compania de Seguros Generales S.A. Colombia 100% American International Underwriters G.m.b.H Germany 100% Underwriters Adjustment Company, Inc. Panama 100% American Life Insurance Company Delaware 100% AIG Life (Bulgaria) Z.D. A.D. Bulgaria 100% AIG Participacoes do Brasil, S.A. Brazil 100% ALICO, S.A. France 100% American Life Insurance Company (Kenya) Limited Kenya 66.7% Pharaonic American Life Insurance Company Egypt 71.6% American Security Life Insurance Company, Ltd. Switzerland 100% American Security Life Insurance Company Lichtenstein 100% Birmingham Fire Insurance Company of Pennsylvania Pennsylvania 100% China America Insurance Company, Ltd. Delaware 50% Commerce and Industry Insurance Company New York 100% Commerce and Industry Insurance Company of Canada Ontario 100% Delaware American Life Insurance Company Delaware 100% Hawaii Insurance Consultants, Ltd. Hawaii 100% HSB Group, Inc. Delaware 100% The Hartford Steam Boiler Inspection and Insurance Company Connecticut 100% Allen Insurance Company Ltd. (Bermuda) Bermuda 100% The Hartford Steam Boiler Inspection and Insurance Company of Connecticut Connecticut 100% HSB Engineering Insurance Limited England 100% The Boiler Inspection and Insurance Company of Canada Canada 100% The Insurance Company of the State of Pennsylvania Pennsylvania 100% Landmark Insurance Company California 100% Mt. Mansfield Company, Inc. Vermont 100% National Union Fire Insurance Company of Pittsburgh, Pa. Pennsylvania 100% American International Specialty Lines Insurance Company Alaska 70%(13) Lexington Insurance Company Delaware 70%(13) JI Accident & Fire Insurance Co. Ltd. Japan 50% National Union Fire Insurance Company of Louisiana Louisiana 100% National Union Fire Insurance Company of Vermont Vermont 100% 21st Century Insurance Group California 33.03%(14) 21st Century Insurance Company California 100% 21st Century Casualty Company California 100% 21st Century Insurance Company of Arizona Arizona 100% Starr Excess Liability Insurance Company, Ltd. Delaware 100% Starr Excess Liability Insurance International Limited Ireland 100% NHIG Holding Corp. Delaware 100% Audubon Insurance Company Louisiana 100% Audubon Indemnity Company Mississippi 100% Agency Management Corporation Louisiana 100% The Gulf Agency, Inc. Alabama 100% New Hampshire Insurance Company Pennsylvania 100% II-13
Subsidiaries of Registrant--(continued) % OF VOTING SECURITIES JURISDICTION OF OWNED BY ITS INCORPORATION IMMEDIATE OR ORGANIZATION PARENT((2) - ---------------------------------------------------------------------------------------------------------------------------- AIG Europe, S.A. France (15) AI Network Corporation Delaware 100% American International Pacific Insurance Company Colorado 100% American International South Insurance Company Pennsylvania 100% Granite State Insurance Company Pennsylvania 100% New Hampshire Indemnity Company, Inc. Pennsylvania 100% AIG National Insurance Company, Inc. New York 100% Illinois National Insurance Co. Illinois 100% New Hampshire Insurance Services, Inc. New Hampshire 100% Pharaonic Insurance Company, S.A.E. Egypt 90% The Philippine American Life and General Insurance Company Philippines 99% Pacific Union Assurance Company California 100% The Philippine American General Insurance Company, Inc. Philippines 100% Philam Insurance Company, Inc. Philippines 100% Risk Specialist Companies, Inc. Delaware 100% AIG SunAmerica Inc. Delaware 100% SunAmerica Investments, Inc. Georgia 50%(16) AIG Advisor Group, Inc. Maryland 100% Advantage Capital Corporation New York 100% FSC Securities Corporation Delaware 100% Sentra Securities Corporation California 100% Spelman & Co., Inc. California 100% SunAmerica Securities, Inc. Delaware 100% SunAmerica Life Insurance Company Arizona 100% AIG SunAmerica Life Assurance Company Arizona 100%(17) First SunAmerica Life Insurance Company New York 100% Saamsun Holdings Corp. Delaware 100% AIG SunAmerica Capital Services, Inc. Delaware 100% SAM Holdings Corporation California 100% AIG SunAmerica Asset Management Corp. Delaware 100% Sun Royal Holdings Corporation California 100% Royal Alliance Associates, Inc. Delaware 100% United Guaranty Corporation North Carolina 36.31%(18) United Guaranty Insurance Company North Carolina 100% United Guaranty Mortgage Insurance Company North Carolina 100% United Guaranty Mortgage Insurance Company of North Carolina North Carolina 100% United Guaranty Partners Insurance Company Vermont 80% United Guaranty Residential Insurance Company of North Carolina North Carolina 100% United Guaranty Residential Insurance Company North Carolina 75%(19) United Guaranty Commercial Insurance Company of North Carolina North Carolina 100% United Guaranty Mortgage Indemnity Company North Carolina 100% United Guaranty Credit Insurance Company North Carolina 100% United Guaranty Services, Inc. North Carolina 100% II-14
Subsidiaries of Registrant--(continued) ================================================================================ (1) All subsidiaries listed are consolidated in the accompanying financial statements. Certain subsidiaries have been omitted from the tabulation. The omitted subsidiaries, when considered in the aggregate as a single subsidiary, do not constitute a significant subsidiary. (2) Percentages include directors' qualifying shares. (3) The common stock is owned approximately 12.0 percent by SICO, 1.8 percent by Starr and 2.2 percent by The Starr Foundation. (4) Indirect wholly-owned subsidiary. (5) Also owned 35.15 percent by National Union. (6) Also owned 10 percent by AIG Matched Funding Corp. (7) Also owned 21.1 percent by Commerce & Industry Insurance Company. (8) Also owned 8 percent by The Insurance Company of the State of Pennsylvania, 32 percent by National Union, and 8 percent by Birmingham. (9) Also owned 48.15 percent by American General Life and Accident Insurance Company. (10) Also owned by 11 other AIG subsidiaries. (11) Also owned 26.08 percent by AIG. (12) Also owned 22.48 percent by American Home. (13) Also owned 20 percent by The Insurance Company of the State of Pennsylvania and 10 percent by Birmingham. (14) Also owned 16.85 percent by American Home, 6.34 percent by Commerce & Industry Insurance Company and 6.34 percent by New Hampshire. (15) 100 percent to be held with other AIG companies. (16) Also owned 50 percent by SunAmerica Life Insurance Company. (17) Formerly known as Anchor National Life Insurance Company. (18) Also owned 45.88 percent by National Union, 16.95 percent by New Hampshire and 0.86 percent by The Insurance Company of the State of Pennsylvania. (19) Also owned 25 percent by United Guaranty Residential Insurance Company of North Carolina. II-15
EXHIBIT 23 Consent of Independent Accountants We hereby consent to the incorporation by reference in the Registration Statements on Form S-3 and S-8 (No. 2-38768, No. 2-44043, No. 2-45346, No. 2-51498, No. 2-59317, No. 2-61858, No. 2-62760, No. 2-64336, No. 2-67600, No. 2-72058, No. 2-75874, No. 2-75875, No. 2-78291, No. 2-87005, No. 2-82989, No. 2-90756, No. 2-91945, No. 2-95589, No. 2-97439, No. 33-8495, No. 33-13874, No. 33-18073, No. 33-25291, No. 33-41643, No. 33-48996, No. 33-57250, No. 33-60327, No. 33-60827, No. 33-62821, No. 333-21365, No. 333-48639, No. 333-58095, No. 333-70069, No. 333-74187, No. 333-83813, No. 333-31024, No. 333-31346, No. 333-39976, No. 333-45828, No. 333-50198, No. 333-52938, 333-39976, 333-50198, 333-45828, 333-68640, 333-69546, 333-72876, 333-101640 and 333-101967) of American International Group, Inc. of our report dated February 12, 2003, relating to the consolidated financial statements and financial statement schedules, which appears in this Form 10-K. PricewaterhouseCoopers LLP New York, New York March 31, 2003 II-16