FORM 10-Q/A
 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-Q/A

(Amendment No. 1)
     
(Mark One)
   
þ
  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the quarterly period ended March 31, 2004
or
 
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the transition period from           to

Commission File Number 1-8787


American International Group, Inc.

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

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

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


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

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of March 31, 2004: 2,608,225,354.




 

Explanatory Note

     This Form 10-Q/A for the Quarterly Period ended March 31, 2004 is being filed for the purpose of amending Items 1, 2, 3 and 4 of Part I and Item 6 of Part II of the Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2004 of American International Group, Inc. (AIG) to reflect the restatement of AIG’s financial results described herein for the quarterly periods ended March 31, 2004 and 2003. All other Items of the original filing on Form 10-Q for the quarterly period ended March 31, 2004, made on May 10, 2004, are unaffected by the changes described above and such items have not been included in this Amendment.

     Information in this Form 10-Q/A is generally stated as of March 31, 2004 and generally does not reflect any subsequent information or events other than the restatement and the fourth quarter 2004 changes in estimates, except that in certain cases forward looking statements have been revised to reflect events and developments subsequent to March 31, 2004. Current information with respect to AIG is contained in its Form 10-K for the year ended December 31, 2004 (2004 Form 10-K) and other filings with the Securities and Exchange Commission (SEC) with respect to subsequent periods.

Restatement of Previously Issued Financial Statements

     Subpoenas. In February 2005, AIG received subpoenas from the Office of the Attorney General for the State of New York (NYAG) and the SEC relating to investigations into the use of non-traditional insurance products and certain assumed reinsurance transactions and AIG’s accounting for such transactions. The United States Department of Justice and various state regulators are also investigating related issues. During these investigations, in March 2005, AIG’s then Chairman and Chief Executive Officer retired. In addition, AIG’s then Chief Financial Officer was terminated for failure to cooperate in the investigations. Subsequently, certain other AIG executives, including its former comptroller, were terminated for similar reasons. On May 26, 2005, the NYAG and the New York Superintendent of Insurance filed a civil complaint against AIG relating to these investigations. For more information on these investigations, see Item 3. Legal Proceedings in AIG’s 2004 Form 10-K.

     Internal Review. In connection with the preparation of AIG’s consolidated financial statements included in AIG’s 2004 Form 10-K, AIG’s current management initiated an internal review of AIG’s books and records, which was substantially expanded in mid-March 2005. The internal review, conducted under the direction of current senior management, with the oversight of the Audit Committee of the Board of Directors, spanned AIG’s major business units globally, and included a review of information and a number of transactions from 2000 to the present. In certain cases, items in periods prior to 2000 were examined due to the nature of the transactions under review. The business units subject to review were Domestic General Insurance, Foreign General Insurance, Reinsurance, Financial Services, Domestic and Foreign Life Insurance & Retirement Services and Asset Management. The internal review encompassed AIG’s books and records, thousands of files and e-mails and interviews with current and former employees and members of management. Management believes that the scope and process of its internal review was sufficient to identify issues of a material nature that could affect AIG’s financial statements.

     AIG’s internal review was complemented by investigations by outside counsel for AIG and for the Audit Committee of the Board of Directors. PricewaterhouseCoopers LLP, an independent registered public accounting firm (PwC or independent auditors), was consulted on the scope of the internal review for certain matters and reviewed the results of the internal review.

     As a result of the findings of the internal review, together with the results of investigations conducted by outside counsel at the request of AIG’s Audit Committee and in consultation with AIG’s independent auditors, AIG has concluded that the accounting for certain transactions and certain relationships needs to be restated or adjusted.

     Restatement. AIG has restated its financial statements for the years ended December 31, 2003, 2002, 2001 and 2000, the quarters ended March 31, June 30 and September 30, 2004 and 2003 and the quarter ended December 31, 2003. AIG’s previously issued financial statements for these and prior periods should no longer be relied upon. See Selected Financial Data, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Note 2 of Notes to Financial Statements in the 2004 Form 10-K and Note 2 of Notes to Financial Statements included herein for a discussion of the restatement and a reconciliation of previously reported amounts to the restated amounts.

     As part of its internal review, AIG evaluated the financial reporting consolidation process and the resulting financial statements as well as the appropriateness of AIG’s prior accounting and reporting decisions. Based on this evaluation, the restatement includes corrections of errors in current or prior accounting periods for improper or inappropriate transactions or entries identified by the review. In many cases these transactions or entries appear to have had the purpose of achieving an accounting result that would enhance measures believed to be important to the financial community and may have involved documentation that did not accurately reflect the true nature of the arrangements. In certain instances, these transactions or entries may also have involved misrepresentations to members of management, regulators and AIG’s independent auditors. The restatement includes adjustments, some of which had been previously identified but considered not to be sufficiently material to require correction.

1


 

Fourth Quarter 2004 Changes in Estimates

     In addition, AIG has determined that certain accounts should be adjusted for the year ended December 31, 2004 to reflect changes in estimates made in the fourth quarter of 2004. The aggregate effect of these changes in estimates resulted in an after tax charge of approximately $1.19 billion. Most significant of the changes in estimates was an after tax charge of $850 million representing an increase in reserve for asbestos and environmental losses and loss expenses. See “Fourth Quarter 2004 Changes in Estimates” and Note 1(cc) of Notes to Financial Statements in AIG’s 2004 Form 10-K.

Recent Developments

AIG’s Credit Ratings

The recent downgrades in AIG’s credit ratings will increase AIG’s borrowing costs, may lessen AIG’s ability to compete in certain businesses and will require AIG to post additional collateral.

     From March through June of 2005, the major rating agencies downgraded AIG’s ratings in a series of actions. Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (S&P), lowered the long-term senior debt and counterparty ratings of AIG from ‘AAA’ to ‘AA’ and changed the rating outlook to negative. Moody’s Investors Service (Moody’s) lowered AIG’s long-term senior debt rating from ‘Aaa’ to ‘Aa2’. Fitch Ratings (Fitch) downgraded the long-term senior debt ratings of AIG from ‘AAA’ to ‘AA’ and placed the ratings on Rating Watch Negative.

     The agencies also took rating actions on AIG’s insurance subsidiaries. S&P and Fitch lowered to ‘AA+’ the insurance financial strength ratings of most of AIG’s insurance companies. Moody’s lowered the insurance financial strength ratings generally to either ‘Aa1’ or ‘Aa2’. A.M. Best downgraded the financial strength ratings for most of AIG’s insurance subsidiaries from ‘A++’ to ‘A+’ and the issuer credit ratings from ‘aa+’ to ‘aa-’. Many of these companies’ ratings remain on a negative watch.

     In addition, S&P changed the outlook on ILFC’s ‘AA-’ long-term senior debt rating to negative. Fitch downgraded ILFC’s long-term senior debt rating from ‘AA-’ to ‘A+’ and placed the rating on Rating Watch Negative and downgraded ILFC’s short-term debt rating from ‘F1+’ to ‘F1’. Fitch also placed the ‘A+’ long-term senior debt ratings of American General Finance Corporation and American General Finance, Inc. on Rating Watch Negative.

     These debt and financial strength ratings are current opinions of the rating agencies. As such, they may be changed, suspended or withdrawn at any time by the rating agencies as a result of changes in, or unavailability of, information or based on other circumstances. Ratings may also be withdrawn at AIG management’s request. This discussion of ratings is not a complete list of ratings of AIG and its subsidiaries.

     These ratings actions have affected and will continue to affect AIG’s business and results of operations in a number of ways.

Downgrades in AIG’s debt ratings will adversely affect AIG’s results of operations. AIG relies on external sources of financing to fund several of its operations. The cost and availability of unsecured financing are generally dependent on the issuer’s long-term and short-term debt ratings. The recent downgrades and any future downgrades in AIG’s debt ratings will increase AIG’s borrowing costs and therefore adversely affect AIG’s results of operations.
 
The downgrade in AIG’s long-term senior debt ratings will adversely affect the ability of AIG Financial Products Corp. (AIGFP) to compete for certain businesses. Credit ratings are very important to the ability of financial institutions to compete in the derivative and structured transaction marketplaces. Historically, AIG’s triple-A ratings provided AIGFP a competitive advantage. The downgrades will reduce this advantage and, for specialized financial transactions that generally are conducted only by triple-A rated financial institutions, counterparties may be unwilling to transact business with AIGFP except on a secured basis. This could require AIGFP to post more collateral to counterparties in the future. See below for a further discussion of the effect that posting collateral may have on AIG’s liquidity.
 
Although the financial strength ratings of AIG’s insurance company subsidiaries remain high compared to many of their competitors, the downgrades have reduced the previous ratings differential. The competitive advantage of the ratings to AIG’s insurance company subsidiaries may be lessened accordingly. The recent regulatory inquiries, internal investigations, and delay in the filing of AIG’s 2004 Form 10-K, as well as negative publicity, had caused independent producers and distributors of AIG’s domestic life and retirement services products to be more cautious in placing business with AIG subsidiaries. AIG is unable to predict the effect of these issues on AIG’s business, including any increase in associated surrender or replacement activity.
 
As a result of the downgrades of AIG’s long-term senior debt ratings, AIG has been required to post approximately $1.16 billion of collateral with counterparties to municipal guaranteed investment agreements and financial derivatives transactions. In the event of a further downgrade, AIG will be required to post additional collateral. It is estimated that, as of the close of business on June 23, 2005, based on AIG’s outstanding municipal guaranteed investment agreements and financial derivatives transactions as of such date, a further downgrade of

2


 

AIG’s long-term senior debt ratings to ‘Aa3’ by Moody’s or ‘AA-’ by S&P would permit counterparties to call for approximately $2.10 billion of additional collateral. Further, additional downgrades could result in requirements for substantial additional collateral, which could have a material effect on how AIG manages its liquidity. The actual amount of additional collateral that AIG would be required to post to counterparties in the event of such downgrades depends on market conditions, the market value of the outstanding affected transactions and other factors prevailing at the time of the downgrade. The requirement to post additional collateral may increase if additional counterparties begin to require credit support from AIG through collateralization agreements. Additional obligations to post collateral will increase the demand on AIG’s liquidity.

Regulatory Investigations

     AIG’s ability to engage in certain businesses may be impaired by the regulatory investigations. The regulatory investigations and civil actions pending against AIG may reduce the willingness of counterparties to engage in business with AIG. Uncertainty concerning the ultimate outcome of these actions and proceedings may also make AIG products and services less attractive in the marketplace. Further, these matters may affect the manner in which certain AIG subsidiaries conduct business and AIG’s ability to obtain regulatory approvals for new lines of business or for further acquisitions.

     Significant legal proceedings could adversely affect AIG’s results of operations. AIG is party to numerous legal and regulatory proceedings, including matters relating to insurance brokerage practices and non-traditional insurance products. See also Item 3. Legal Proceedings in AIG’s 2004 Form 10-K.

     Significant investigations into AIG’s business are continuing and the commencement of additional investigations is possible. Broad-ranging investigations into AIG’s business practices continue in respect of structured transactions, transactions involving insurance brokers, non-traditional insurance products, workers compensation lines and other matters. These investigations are being conducted by a large number of regulators and governmental authorities, and related actions by regulators both within and outside the United States may be undertaken in response. The review of large amounts of information by various regulatory authorities may result in the commencement of new areas of inquiry and, possibly, new legal proceedings. Gathering, reviewing and supplying such large amounts of information and documents to so many regulatory authorities imposes significant demands upon management and may involve significant expense.

The Relationships Between AIG and Starr and SICO

     The relationships between AIG and The Starr Foundation, C.V. Starr & Co., Inc. (Starr) and Starr International Company, Inc. (SICO) may take an extended period of time to unwind and/or resolve. Although AIG is currently working on unwinding and resolving its relationships with Starr and SICO, AIG cannot predict what its future relationship with Starr and SICO will be.

     AIG will need to provide compensation programs that recognize the plans and programs previously provided to AIG executives by Starr and SICO. In addition, AIG has agreed, subject to certain conditions, to assure AIG’s current employees that all payments under the SICO Plans and redemption payments under the Starr stockholders’ agreement are made when required. See also Notes 5 and 6 of Notes to Financial Statements included herein and Note 12(f) of Notes to Financial Statements and Item 11. Executive Compensation in AIG’s 2004 Form 10-K.

Certain Material Weaknesses

     Management has identified a number of material weaknesses in AIG’s internal control over financial reporting. A discussion of these material weaknesses can be found in Item 9A of Part II of AIG’s 2004 Form 10-K. Although remediation of these weaknesses has begun, the process is not yet complete. Delay in the implementation of remedial actions could affect the accuracy or timing of future filings with the SEC and other regulatory authorities.

Access to Capital Markets

     AIG does not expect to be able to access the public capital markets until all of its filings with the SEC are up to date, including any amendments to previously filed reports. When AIG is current in its filings with the SEC, AIG anticipates that it will be able to access the Rule 144A and Euro-markets. However, AIG will be unable to access the U.S. public securities markets until it has filed and the SEC has declared effective a new registration statement or post-effective amendments to its existing registration statements under the Securities Act of 1933. Depending upon the SEC’s review of these filings, this process may take several months or more.

PNC Settlement

     In November 2004, AIG and AIGFP reached a final settlement with the SEC, the Fraud Section of the United States Department of Justice (DOJ) and the United States Attorney for the Southern District of Indiana with respect to issues arising from certain structured transactions entered into with Brightpoint, Inc. and The PNC Financial Services Group, Inc. (PNC), the marketing of transactions similar to the PNC transactions and related matters.

3


 

     As part of the settlement, the SEC filed a civil complaint against AIG, alleging violations of certain antifraud provisions of the federal securities laws and for aiding and abetting violations of reporting and record keeping provisions of those laws. The SEC’s complaint was based on the conduct of AIG, primarily through AIGFP (i) in developing, marketing and entering into three transactions during 2001 that were intended to enable PNC, a public company, to remove certain assets from its balance sheet and (ii) in marketing similar transaction structures to other potential counterparties. The complaint alleged, inter alia, that AIGFP recklessly misrepresented, and was reckless in not knowing, that the transactions entered into with PNC and marketed to other potential counterparties did not satisfy the requirements of GAAP for non-consolidation of special purpose entities.

     AIG, without admitting or denying the allegations in the SEC complaint, consented to the issuance of a final judgment: (a) permanently enjoining it and its employees and related persons from violating section 10(b) of the Securities Exchange Act of 1934 (Exchange Act), Exchange Act Rule 10b-5, and section 17(a) of the Securities Act of 1933 (Securities Act) and from aiding and abetting violations of sections 13(a) and 13(b)(2)(A) of the Exchange Act and Exchange Act Rules 12b-20, 13a-1, and 13a-13; (b) ordering it to disgorge the $39,821,000 in fees that it received from the PNC transactions, plus prejudgment interest of $6,545,000; and (c) providing for AIG to establish a transaction review committee to review the appropriateness of certain future transactions and to retain an independent consultant to examine certain transactions entered into between 2000 and 2004 and review the policies and procedures of the transaction review committee. The independent consultant has a broad mandate to review transactions entered into by AIG during this period. The review of the independent consultant is now ongoing and AIG cannot at this time predict the outcome of this review.

     The DOJ filed a criminal complaint against AIGFP PAGIC Equity Holding Corp. (AIGFP PAGIC), a wholly-owned subsidiary of AIGFP. The complaint alleged that AIGFP PAGIC violated federal securities laws by aiding and abetting securities law violations by PNC, in connection with a transaction entered into in 2001 with PNC that was intended to enable PNC to remove certain assets from its balance sheet. The complaint alleges that AIGFP PAGIC knew, or was deliberately ignorant in not knowing, that the PNC transaction did not satisfy the requirements of GAAP for non-consolidation of special purpose entities. The AIGFP PAGIC transaction was the last of three similar transactions developed, marketed and entered into by AIGFP and its subsidiaries with PNC during 2001. The DOJ had notified AIGFP that, in its view, AIGFP acting through certain of its employees may have violated federal criminal law in connection with the PNC transactions and the marketing of similar transaction structures to other potential counterparties.

     The settlement with the DOJ consists of separate agreements with AIG and AIGFP and a complaint filed against, and deferred prosecution agreement with, AIGFP PAGIC. Under the terms of the settlement, AIGFP paid a monetary penalty of $80 million and, provided that AIG, AIGFP and AIGFP PAGIC satisfy their obligations under the DOJ agreements, the DOJ will seek a dismissal with prejudice of the AIGFP PAGIC complaint after 13 months (by December 30, 2005) and will not prosecute AIG or AIGFP in connection with the PNC transactions or the Brightpoint transaction that was settled by AIG with the SEC in 2003. The obligations of AIG, AIGFP and AIGFP PAGIC under the DOJ agreements relate principally to cooperating with the DOJ and other federal agencies in connection with their related investigations.

Investigations of Insurance Brokerage Practices

     On October 14, 2004, the NYAG brought a lawsuit challenging certain insurance brokerage practices related to contingent commissions. Neither AIG nor any of its subsidiaries is a defendant in that action, although two employees of an AIG subsidiary pleaded guilty in connection with the Attorney General’s investigation in October 2004 and two additional employees of the same subsidiary pleaded guilty in February 2005. AIG has cooperated, and will continue to cooperate, in the investigation. Regulators from several additional states have commenced investigations into the same matters, and AIG expects there will be additional investigations as well. Various parties, including insureds and shareholders, have also asserted putative class action and other claims against AIG or its subsidiaries alleging, among other things, violations of the antitrust and federal securities laws, and AIG expects that additional claims may be made.

     Various federal and state regulatory agencies are reviewing certain other transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries.

Investigation and Civil Complaint Concerning Non-Traditional Insurance Products and Other Transactions

     In February 2005, AIG received subpoenas from the NYAG and the SEC relating to investigations into the use of non-traditional insurance products and certain assumed reinsurance transactions and AIG’s accounting for such transactions. In March and April 2005, the SEC and NYAG issued additional subpoenas relating to certain transactions and entities discussed more fully in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein and in AIG’s 2004 Form 10-K, including, among others, SICO, Union Excess, Capco and certain Life Settlements (as such transactions and entities are defined in Management’s Discussion and Analysis of Financial Condition and Results of Operations in AIG’s 2004 Form 10-K). In April 2005, AIG received a subpoena from the NYAG relating to AIG’s operations in Bermuda. The United States De-

4


 

partment of Justice and state regulators, including the New York Department of Insurance (NY DOI), are also investigating these issues. Regulators from several additional states have commenced investigations into some of these matters, and AIG expects there will be additional investigations. In addition, the SEC, the U.S. Attorney’s Office for the Southern District of New York and the NYAG are investigating certain transactions involving the purchase of AIG stock. The NYAG and insurance regulators are investigating issues relating to workers compensation insurance written by AIG subsidiaries. Various former and current employees of AIG have also received subpoenas from the SEC and NYAG seeking documents and testimony concerning some of these matters. AIG has cooperated, and will continue to cooperate, with all these investigations, including by producing documents and other information in response to the subpoenas. As more fully described in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein and in AIG’s 2004 Form 10-K, AIG has concluded that the accounting for certain transactions and certain relationships needs to be restated or adjusted. See Note 2 of Notes to Financial Statements in AIG’s 2004 Form 10-K and Note 2 of Notes to Financial Statements included herein.

     On May 26, 2005, the NYAG and the New York Superintendent of Insurance filed a civil complaint against AIG as well as its former Chairman and Chief Executive Officer M.R. Greenberg, and former Vice Chairman and Chief Financial Officer Howard Smith, in the Supreme Court of the State of New York. The complaint asserts claims under New York’s Martin Act and Insurance Law, among others, and makes allegations concerning certain of the transactions discussed more fully in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein and in AIG’s 2004 Form 10-K, including, among others, Gen Re, Capco, AIRCO Reinsurance, Life Settlements, Richmond and Union Excess. The complaint seeks disgorgement, injunctive relief, punitive damages and costs, among other things. The NYAG has also stated that it fully expects that all issues with AIG concerning these matters can be resolved civilly, as opposed to by means of criminal indictment of AIG.

Other Actions

     A number of lawsuits have been filed regarding the subject matter of the investigations of insurance brokerage practices, including derivative actions, individual actions and class actions under the federal securities laws, ERISA and state common and corporate laws in both federal and state courts, including the federal district court in the Southern District of New York, in the Commonwealth of Massachusetts Superior Court and in Delaware Chancery Court. All of these actions generally allege that AIG and its subsidiaries violated the law by allegedly concealing a scheme to “rig bids” and “steer” business between insurance companies and insurance brokers as described in “Investigation of Insurance Brokerage Practices” above.

     Between October 19, 2004 and May 23, 2005, AIG was named as a defendant in twelve complaints that were filed in federal court and one that was originally filed in Florida state court and removed to federal court. These cases generally allege that AIG and its subsidiaries violated federal and various state antitrust laws, as well as federal RICO laws, various state deceptive and unfair practice laws and certain state laws governing fiduciary duties. The alleged basis of these claims is that there was a conspiracy between insurance companies and insurance brokers with regard to the bidding practices for insurance coverage in certain sectors of the insurance industry. The Judicial Panel on Multidistrict Litigation entered an order consolidating most of these cases and transferring them to the United States District Court for the District of New Jersey. The remainder of these cases are in the process of being transferred to the District of New Jersey. In addition, two complaints were filed in Massachusetts state court making claims similar to those in the federal cases above.

     In April and May, amended complaints were filed in the consolidated derivative and securities cases, as well as in one of the ERISA lawsuits, pending in the federal district court in the Southern District of New York adding allegations concerning AIG’s accounting treatment for non-traditional insurance products that have been the subject of AIG’s press releases and are described more fully in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein and in AIG’s 2004 Form 10-K. Also in April, new actions were filed in the Delaware Chancery Court asserting claims premised on the same allegations concerning AIG’s accounting treatment for non-traditional insurance products.

     In late 2002, an unrelated derivative action was filed in Delaware Chancery Court in connection with AIG’s transactions with certain entities affiliated with Starr. AIG’s Board of Directors appointed a special committee of independent directors to review the complaint; the special committee has issued a report concluding that it was not in the best interest of AIG or its shareholders to pursue the litigation and moved the Delaware Chancery Court to terminate the litigation. In May 2005, the plaintiff filed an amended complaint which adds additional claims premised on allegations relating to insurance brokerage practices and AIG’s non-traditional insurance products.

Effect on AIG

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

5


 

INDEX OF AMENDED ITEMS

           
Page

PART I – FINANCIAL INFORMATION:
       
ITEM 1 – FINANCIAL STATEMENTS
       
      7  
      9  
      10  
      13  
    40  
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
       
ITEM 4 – CONTROLS AND PROCEDURES
       
PART II – OTHER INFORMATION:
       
ITEM 6 – EXHIBITS AND REPORTS ON FORM 8-K
       

6


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET

                       
(in millions) (unaudited)

March 31, December 31,
2004 2003
(Restated) (Restated)

Assets:
               
  Investments, financial services assets and cash:                
    Fixed maturities:                
     
Bonds available for sale, at market value (amortized cost: 2004 – $300,956; 2003 – $287,810)
  $ 319,182     $ 300,935  
     
Bonds held to maturity, at amortized cost (market value: 2004 – $10,039; 2003 – $8,173)
    9,823       8,037  
     
Bond trading securities, at market value (cost: 2004 – $1,884; 2003 – $252)
    1,966       282  
    Equity securities:                
     
Common stocks available for sale, at market value (cost: 2004 – $7,436; 2003 – $6,759)
    8,467       7,522  
     
Common stocks trading, at market value (cost: 2004 – $4,046; 2003 – $125)
    4,062       156  
     
Preferred stocks, at market value (cost: 2004 – $1,831; 2003 – $1,743)
    2,045       1,906  
   
Mortgage loans on real estate, net of allowance (2004 – $68; 2003 – $68)
    12,251       12,328  
   
Policy loans
    6,825       6,658  
   
Collateral and guaranteed loans, net of allowance (2004 – $15; 2003 – $15)
    2,210       2,241  
    Financial services assets:                
     
Flight equipment primarily under operating leases, net of accumulated depreciation (2004 – $5,484; 2003 – $5,458)
    30,807       30,343  
     
Securities available for sale, at market value (cost: 2004 – $24,549; 2003 – $22,587)
    26,260       24,042  
     
Trading securities, at market value
    5,381       4,418  
     
Spot commodities, at market value
    183       250  
     
Unrealized gain on swaps, options and forward transactions
    21,309       21,459  
     
Trading assets
    1,613       2,277  
     
Securities purchased under agreements to resell, at contract value
    19,026       20,845  
     
Finance receivables, net of allowance (2004 – $554; 2003 – $562)
    18,385       17,500  
    Securities lending collateral, at cost (approximates market value)     40,695       30,195  
    Other invested assets     20,568       18,484  
    Short-term investments, at cost (approximates market value)     16,766       8,908  
    Cash     1,920       922  

      Total investments, financial services assets and cash     569,744       519,708  
  Investment income due and accrued     4,999       4,612  
 
Premiums and insurance balances receivable, net of allowance (2004 – $257; 2003 – $235)
    14,672       13,189  
  Reinsurance assets, net     21,359       20,948  
  Deferred policy acquisition costs     26,196       25,920  
  Investments in partially owned companies     1,503       1,420  
 
Real estate and other fixed assets, net of accumulated depreciation (2004 – $4,397; 2003 – $4,282)
    5,960       5,966  
  Separate and variable accounts     51,962       60,536  
  Goodwill     7,714       7,664  
  Other assets     14,969       14,190  

Total assets
  $ 719,078     $ 674,153  

See Accompanying Notes to Financial Statements.

7


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET (continued)

(in millions, except share amounts) (unaudited)


                     
March 31, December 31,
2004 2003
(Restated) (Restated)

Liabilities:
               
 
Reserve for losses and loss expenses
  $ 54,218     $ 52,381  
 
Reserve for unearned premiums
    22,180       20,910  
 
Future policy benefits for life and accident and health insurance contracts
    94,470       92,912  
 
Policyholders’ contract deposits
    193,317       171,917  
 
Other policyholders’ funds
    9,597       9,124  
 
Reserve for commissions, expenses and taxes
    5,033       4,588  
 
Insurance balances payable
    3,729       2,915  
 
Funds held by companies under reinsurance treaties
    3,145       3,043  
 
Income taxes payable:
               
   
Current
    1,723       366  
   
Deferred
    5,917       4,633  
 
Financial services liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    15,414       15,337  
   
Securities sold under agreements to repurchase, at contract value
    16,201       15,813  
   
Trading liabilities
    4,817       6,153  
   
Securities and spot commodities sold but not yet purchased, at market value
    5,227       5,458  
   
Unrealized loss on swaps, options and forward transactions
    14,199       14,658  
   
Trust deposits and deposits due to banks and other depositors
    3,635       3,627  
   
Commercial paper
    5,294       4,715  
   
Notes, bonds, loans and mortgages payable
    52,954       51,389  
 
Commercial paper
    2,519       1,223  
 
Notes, bonds, loans and mortgages payable
    5,797       5,863  
 
Liabilities connected to trust preferred stock
    1,682       1,682  
 
Separate and variable accounts
    51,962       60,536  
 
Minority interest
    3,778       3,302  
 
Securities lending payable
    40,695       30,195  
 
Other liabilities
    25,638       21,191  

Total liabilities
    643,141       603,931  

Preferred shareholders’ equity in subsidiary companies
    193       192  

Shareholders’ equity:
               
 
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2004 – 2,751,327,476; 2003 – 2,751,327,476
    6,878       6,878  
 
Additional paid-in capital
    1,926       1,913  
 
Retained earnings
    57,779       55,392  
 
Accumulated other comprehensive income (loss)
    10,588       7,244  
 
Treasury stock, at cost; 2004 – 143,102,122; 2003 – 142,880,430 shares of common stock
    (1,427 )     (1,397 )

Total shareholders’ equity
    75,744       70,030  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 719,078     $ 674,153  

See Accompanying Notes to Financial Statements.

8


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

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

2004 2003
Three Months Ended March 31, (Restated) (Restated)

Revenues:
               
 
Premiums and other considerations
  $ 15,982     $ 12,884  
 
Net investment income
    4,575       3,515  
 
Realized capital gains (losses)
    115       157  
 
Other revenues
    2,703       1,636  

 
Total revenues
    23,375       18,192  

Benefits and expenses:
               
 
Incurred policy losses and benefits
    13,597       10,942  
 
Insurance acquisition and other operating expenses
    5,839       5,044  

 
Total benefits and expenses
    19,436       15,986  

Income before income taxes, minority interest and cumulative effect of an accounting change
    3,939       2,206  

Income taxes (benefits):
               
 
Current
    1,322       570  
 
Deferred
    (153 )     50  

      1,169       620  

Income before minority interest and cumulative effect of an accounting change
    2,770       1,586  

Minority interest
    (70 )     (61 )

Income before cumulative effect of an accounting change
    2,700       1,525  

Cumulative effect of an accounting change, net of tax
    (144 )      

Net income
  $ 2,556     $ 1,525  

Earnings per common share:
               
 
Basic
               
   
Income before cumulative effect of an accounting change
  $ 1.04     $ 0.58  
   
Cumulative effect of an accounting change, net of tax
    (0.06 )      
   
Net income
    0.98       0.58  

 
Diluted
               
   
Income before cumulative effect of an accounting change
  $ 1.03     $ 0.58  
   
Cumulative effect of an accounting change, net of tax
    (0.06 )      
   
Net income
    0.97       0.58  

Cash dividends per common share
  $ 0.065     $ 0.047  

Average shares outstanding:
               
 
Basic
    2,610       2,610  
 
Diluted
    2,642       2,637  

See Accompanying Notes to Financial Statements.

9


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

                       
(in millions) (unaudited)

2004 2003
Three Months Ended March 31, (Restated) (Restated)

Summary:
               
 
Net cash provided by operating activities
  $ 8,719     $ 7,920  
 
Net cash used in investing activities
    (19,725 )     (15,161 )
 
Net cash provided by financing activities
    11,802       6,720  
 
Change in cumulative translation adjustments
    202       16  

 
Change in cash
    998       (505 )
 
Cash at beginning of period
    922       1,165  

 
Cash at end of period
  $ 1,920     $ 660  

Cash flows from operating activities:
               
 
Net income
  $ 2,556     $ 1,525  

 
Adjustments to reconcile net income to net cash provided by operating activities:
               
   
Noncash revenues, expenses, gains and losses included in income:
               
   
Change in:
               
     
General and life insurance reserves
    6,700       4,949  
     
Premiums and insurance balances receivable and payable – net
    (670 )     (839 )
     
Reinsurance assets
    (411 )     (76 )
     
Deferred policy acquisition costs
    (1,081 )     (763 )
     
Investment income due and accrued
    (339 )     (199 )
     
Funds held under reinsurance treaties
    102       393  
     
Other policyholders’ funds
    473       229  
     
Current and deferred income taxes – net
    1,204       604  
     
Reserve for commissions, expenses and taxes
    443       (67 )
     
Other assets and liabilities – net
    (544 )     740  
     
Trading assets and liabilities – net
    (672 )     411  
     
Trading securities, at market value
    (962 )     (2,018 )
     
Spot commodities, at market value
    67       (117 )
     
Net unrealized (gain) loss on swaps, options and forward transactions
    (309 )     1,068  
     
Securities purchased under agreements to resell
    1,819       1,461  
     
Securities sold under agreements to repurchase
    388       2,306  
     
Securities and spot commodities sold but not yet purchased, at market value
    (231 )     (1,859 )
   
Realized capital (gains) losses
    (115 )     (157 )
   
Equity in income of partially owned companies and other invested assets
    (325 )     (40 )
   
Amortization of premium and discount on securities
    74       (2 )
   
Depreciation expenses, principally flight equipment
    486       446  
   
Provision for finance receivable losses
    90       102  
   
Other – net
    (24 )     (177 )

   
Total adjustments
    6,163       6,395  

Net cash provided by operating activities
  $ 8,719     $ 7,920  

See Accompanying Notes to Financial Statements.

10


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)

                 
(in millions) (unaudited)

2004 2003
Three Months Ended March 31, (Restated) (Restated)

Cash flows from investing activities:
               
    Cost of bonds, at market sold
  $ 30,088     $ 32,933  
    Cost of bonds, at market matured or redeemed
    4,122       3,661  
    Cost of equity securities sold
    3,664       1,479  
    Realized capital gains (losses)
    115       157  
    Purchases of fixed maturities
    (48,863 )     (47,224 )
    Purchases of equity securities
    (4,797 )     (1,483 )
    Mortgage, policy and collateral loans granted
    (537 )     (516 )
    Repayments of mortgage, policy and collateral loans
    539       418  
    Sales of securities available for sale
    620       915  
    Maturities of securities available for sale
    324       1,378  
    Purchases of securities available for sale
    (2,853 )     (3,033 )
    Sales of flight equipment
    1,080        
    Purchases of flight equipment
    (1,843 )     (1,757 )
    Net additions to real estate and other fixed assets
    (182 )     (244 )
    Sales or distributions of other invested assets
    2,171       2,187  
    Investments in other invested assets
    (3,748 )     (5,098 )
    Change in short-term investments
    1,356       775  
    Investments in partially owned companies
    (6 )     285  
    Finance receivable originations and purchases
    (5,579 )     (2,460 )
    Finance receivable principal payments received
    4,604       2,466  

Net cash used in investing activities
  $ (19,725 )   $ (15,161 )

Cash flows from financing activities:
               
    Receipts from policyholders’ contract deposits
    13,093       8,764  
    Withdrawals from policyholders’ contract deposits
    (4,507 )     (4,023 )
    Change in trust deposits and deposits due to banks and other depositors
    50       6  
    Change in commercial paper
    1,875       1,929  
    Proceeds from notes, bonds, loans and mortgages payable
    6,732       5,012  
    Repayments on notes, bonds, loans and mortgages payable
    (5,297 )     (4,590 )
    Proceeds from guaranteed investment agreements
    1,505       1,393  
    Maturities of guaranteed investment agreements
    (1,428 )     (1,214 )
    Redemption of subsidiary company preferred stock
          (371 )
    Proceeds from common stock issued
    40       12  
    Cash dividends to shareholders
    (170 )     (123 )
    Acquisition of treasury stock
    (92 )     (76 )
    Other – net
    1       1  

Net cash provided by financing activities
  $ 11,802     $ 6,720  

Supplementary information:
               
Taxes paid
  $ 493     $ 413  

Interest paid
  $ 1,032     $ 829  

See Accompanying Notes to Financial Statements.

11


 

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

                     
(in millions) (unaudited)

2004 2003
Three Months Ended March 31, (Restated) (Restated)

Comprehensive income:
               
 
Net income
  $ 2,556     $ 1,525  

Other comprehensive income:
               
 
Unrealized appreciation of investments – net of reclassification adjustments
    4,669       1,990  
   
Deferred income tax expense on above changes
    (1,494 )     (493 )
 
Foreign currency translation adjustments
    202       15  
   
Applicable income tax benefit on above changes
    2       16  
 
Net derivative (losses) gains arising from cash flow hedging activities
    (57 )     45  
   
Deferred income tax benefit (expense) on above changes
    49       (3 )
 
Retirement plan liabilities adjustment, net of tax
    (27 )     (40 )

Other comprehensive income
    3,344       1,530  

Comprehensive income
  $ 5,900     $ 3,055  

See Accompanying Notes to Financial Statements.

12


 

American International Group, Inc. and Subsidiaries

NOTES TO FINANCIAL STATEMENTS

 
  1.  Financial Statement Presentation

These statements are unaudited. In the opinion of management, all adjustments consisting only of normal recurring accruals have been made for a fair statement of the results presented herein. All material intercompany accounts and transactions have been eliminated. Certain accounts have been reclassified in the 2003 financial statements to conform to their 2004 presentation. For further information, refer to the Annual Report on Form 10-K of American International Group, Inc. (AIG) for the year ended December 31, 2004 (2004 Form 10-K).

 
  2.  Restatement of Previously Issued
Financial Statements

The following provides a description of the internal review process and details of the accounting adjustments included in the restatement of AIG’s consolidated financial statements and the effect of the adjustments on AIG’s Consolidated Balance Sheets at March 31, 2004 and December 31, 2003 and its Consolidated Statement of Income and Consolidated Statement of Cash Flows for the quarters ended March 31, 2004 and 2003.

     Internal Review. In connection with the preparation of AIG’s consolidated financial statements included in AIG’s 2004 Form 10-K, AIG’s current management initiated an internal review of AIG’s books and records, which was substantially expanded in mid-March 2005. The internal review, conducted under the direction of current senior management, with the oversight of the Audit Committee of the Board of Directors, spanned AIG’s major business units globally, and included a review of information and a number of transactions from 2000 to the present. In certain cases, items in periods prior to 2000 were examined due to the nature of the transactions under review. The business units subject to review were Domestic General Insurance, Foreign General Insurance, Reinsurance, Financial Services, Domestic and Foreign Life Insurance & Retirement Services and Asset Management. The internal review encompassed AIG’s books and records, thousands of files and e-mails and interviews with current and former employees and members of management. Management believes that the scope and process of its internal review was sufficient to identify issues of a material nature that could affect AIG’s financial statements.

     AIG’s internal review was complemented by investigations by outside counsel for AIG and for the Audit Committee of the Board of Directors. PricewaterhouseCoopers LLP, an independent registered public accounting firm (PwC or independent auditors), was consulted on the scope of the internal review for certain matters and reviewed the results of the internal review.

     As a result of the findings of the internal review, together with the results of investigations conducted by outside counsel at the request of AIG’s Audit Committee and in consultation with AIG’s independent auditors, AIG concluded that the accounting for certain transactions and certain relationships needed to be restated.

     Restatement. AIG has restated its financial statements for the years ended December 31, 2003, 2002, 2001 and 2000, the quarters ended March 31, June 30 and September 30, 2004 and 2003 and the quarter ended December 31, 2003. AIG’s previously issued financial statements for these and prior periods should no longer be relied upon. See Selected Financial Data and Note 2 of Notes to Financial Statements in the 2004 Form 10-K for a discussion of the restatement and a reconciliation of previously reported amounts to the restated amounts for the years ended December 31, 2003, 2002, 2001 and 2000, and see below for reconciliation of such amounts for the quarterly periods ended March 31, 2004 and 2003.

     As part of its internal review, AIG evaluated the financial reporting consolidation process and the resulting financial statements as well as the appropriateness of AIG’s prior accounting and reporting decisions. Based on this evaluation, the restatement includes corrections of errors in current or prior accounting periods for improper or inappropriate transactions or entries identified by the review. In many cases these transactions or entries appear to have had the purpose of achieving an accounting result that would enhance measures believed to be important to the financial community and may have involved documentation that did not accurately reflect the true nature of the arrangements. In certain instances, these transactions or entries may also have involved misrepresentations to members of management, regulators and AIG’s independent auditors. The restatement includes adjustments, some of which had been previously identified but considered not to be sufficiently material to require correction.

     Details of Accounting Adjustments included in the Restatement. The accounting adjustments relate primarily to the categories described below. Many of the adjustments that do not affect previously reported net income or consolidated shareholders’ equity do, however, change both the consolidated and business segment reporting of premiums, underwriting results, net investment income, realized capital gains and losses and operating income, as well as other items. Adjustments that affect reported net income and consolidated shareholders’ equity relate to both the timing and recognition of revenues and expenses and affect the comparison of period-to-period results.

Risk Transfer. To recognize the cash flows under an insurance contract as premium and losses, generally accepted accounting principles (GAAP) requires the transfer of risk. If risk transfer requirements are not met, an insurance contract is accounted for as a deposit, resulting in the recognition of cash flows under the contract as deposit assets or liabilities and not as revenues or expense. AIG has concluded, based upon its internal

13


 

 
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

review, that there was insufficient risk transfer to qualify for insurance accounting for certain transactions where AIG subsidiaries either wrote direct insurance or assumed or ceded reinsurance. These transactions are now recorded using deposit accounting. The changes resulting from the change to deposit accounting affect both the consolidated balance sheet and statement of income.

Union Excess: AIG has concluded, based on documents and information identified during the course of the internal review, that reinsurance ceded to Union Excess Reinsurance Company, Ltd., a Barbados-domiciled reinsurer (Union Excess), did not result in risk transfer because of AIG’s control over certain transactions undertaken directly or indirectly with Union Excess, including the timing and nature of certain commutations. Eliminating the cessions reduces reinsurance assets, effectively eliminates the inherent discount related to the loss reserves ceded under the contracts, and increases net premiums and losses.

In addition, as a result of certain facts and circumstances related to the formation of Union Excess, as well as certain relationships with Starr International Company, Inc. (SICO), Union Excess is now included in AIG’s consolidated financial statements. The facts and circumstances surrounding SICO’s involvement with Union Excess were not properly reflected in AIG’s books and records, were not known to all relevant AIG financial reporting personnel and, AIG now believes, were not known to AIG’s independent auditors. For example, a significant portion of the ownership interests of Union Excess shareholders are protected against loss under financial arrangements with SICO. Additionally, from its formation in 1991, Union Excess has reinsured risks emanating primarily or solely from AIG subsidiaries, both directly and indirectly. Further, it appears that the employees responsible for the reinsurance related to Union Excess managed that relationship to prevent significant losses or gains to Union Excess so that substantially all of the risks and rewards of the underlying reinsurance inured to AIG. This relationship allowed AIG to absorb substantially all the economic returns, which in turn caused Union Excess to be deemed a variable interest entity (VIE).

The effect of the restatement relating to Union Excess, as of March 31, 2004 and December 31, 2003, is total assets decreased by approximately $1.4 billion and $1.3 billion, respectively, and shareholders’ equity decreased by $893 million and $873 million, respectively. Net income decreased by approximately $20 million for the quarter ended March 31, 2004 and increased by $40 million for the quarter ended March 31, 2003.
 
Gen Re: In December 2000 and March 2001, an AIG subsidiary entered into an assumed reinsurance transaction with a subsidiary of General Re Corporation (Gen Re) involving two tranches of $250 million each. In connection with each tranche, consolidated net premiums written and consolidated incurred policy losses and benefits increased by $250 million in the fourth quarter of 2000 (with respect to the first tranche) and the first quarter of 2001 (with respect to the second tranche). The first tranche of the transaction was commuted in November 2004, reducing premiums and reserves for losses and loss expenses by approximately $250 million in the fourth quarter 2004. AIG has concluded that the transaction was done to accomplish a desired accounting result and did not entail sufficient qualifying risk transfer. As a result, AIG has determined that the transaction should not have been recorded as insurance. AIG’s restated financial statements recharacterize this transaction as a deposit rather than as insurance. Such recharacterization had virtually no effect on net income or consolidated shareholders’ equity, but increased other liabilities by $500 million and $500 million at March 31, 2004 and December 31, 2003, respectively and reduced reserves for loss and loss expenses by $500 million and $500 million at March 31, 2004 and December 31, 2003, respectively.
 
Other Risk Transfer: AIG has concluded that Richmond Insurance Company, Ltd., a Bermuda-based reinsurance holding company (Richmond) in which AIG held a 19.9 percent ownership interest at March 31, 2004, should be treated as a consolidated entity in AIG’s financial statements due to AIG’s ability to exert control over that entity. Such determination was based, in part, on arrangements and documents, including put agreements requiring an AIG subsidiary to purchase the Richmond shares, that appear not to have been previously disclosed to appropriate AIG financial personnel or AIG’s independent auditors. Although AIG currently owns only a minority ownership interest in Richmond, a review of the operations of Richmond and its subsidiaries has shown significant previously undisclosed evidence of AIG control causing Richmond to be deemed a VIE. The consolidation of Richmond had virtually no effect on net income or consolidated shareholders’ equity. AIG has received notice of exercise of a put with respect to 49.9 percent of the Richmond shares and expects to acquire the shares by June 30, 2005.

As a result of its internal review of AIG Re, AIG Risk Finance and AIG Risk Management and certain transactions, AIG determined that adjustments were required because certain transactions lacked sufficient risk transfer to qualify for insurance accounting under GAAP.

The effect of the restatement for Richmond, AIG Re, AIG Risk Finance, AIG Risk Management and certain

14


 

NOTES TO FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

other transactions, as of March 31, 2004 and December 31, 2003, is total assets decreased by approximately $544 million and $456 million, respectively, total liabilities decreased by approximately $501 million and $406 million, respectively, and shareholders’ equity decreased by $43 million and $51 million, respectively. Net income increased by approximately $8 million and decreased by approximately $9 million for the quarters ended March 31, 2004 and 2003, respectively.

Loss Reserves: Estimation of ultimate net losses and loss expenses is a complex process requiring the use of assumptions which may be highly uncertain at the time of estimation. As a result of its internal review, AIG has determined that the IBNR included in the General Insurance reserve for losses and loss expenses was adjusted on a regular basis without appropriate support for the changes requested to be made. Although AIG does not believe that any change materially affected the integrity of AIG’s loss reserve position because in each instance IBNR as adjusted was determined to be within an appropriate tolerance of the applicable actuarial point estimate, AIG has determined that the unsupported decreases in reserves generated independently from the actuarial process constituted errors which should be corrected and has restated the amounts of carried reserves accordingly.

The effect of the restatement is a decrease in consolidated shareholders’ equity of approximately $414 million and $375 million at March 31, 2004 and December 31, 2003, respectively, an increase in the reserve for losses and loss expenses of $638 million and $578 million at March 31, 2004 and December 31, 2003, respectively, and an increase in incurred policy losses and benefits of $60 million and $75 million at March 31, 2004 and 2003, respectively.
 
Net Investment Income. As a result of the internal review, AIG determined that the accounting for certain transactions had the effect of improperly converting capital gains into net investment income and was not consistent with GAAP. The most significant of these transactions are:

Covered Calls: From 2001 through 2003, certain AIG subsidiaries entered into a series of transactions with third parties whereby these subsidiaries sold in-the-money calls, principally on municipal bonds in their investment portfolios that had unrealized appreciation associated with them. Upon exercise of a call, the related bonds were delivered to the purchaser of the call and subsequently reacquired by the subsidiaries pursuant to contingent forward agreements which permitted the AIG subsidiaries to repurchase the bonds at the prevailing market value. In connection with selling the calls, the AIG subsidiaries also entered into interest rate swaps to protect them against the effects of changes in value of the applicable bonds as a result of movements in interest rates during the transaction period. These transactions were accounted for as sales and subsequent purchases and appear to have been initiated to increase net investment income. AIG has determined that, because AIG was able to cause the bonds to be returned from the third parties even after the third parties exercised the call options, AIG did not cede control over the bonds and therefore the transactions should not have been accounted for as sales and subsequent purchases but rather as financings. The restatement resulted in an increase in net investment income of $10 million and a decrease of $103 million and increases in realized capital gains of $18 million and $28 million for the quarters ended March 31, 2004 and 2003, respectively. The restatement had no net effect on consolidated shareholders’ equity at March 31, 2004 and December 31, 2003.
 
Synthetic Fuel Investment: AIG subsidiaries invest in certain limited liability companies that invest in synthetic fuel production facilities as a means of generating income tax credits. As a result of a misapplication of GAAP, AIG recorded net investment income or, in some cases, other revenues, on a pretax basis rather than reflecting the tax credit as a reduction of income tax expense, thereby increasing net investment income for AIG’s life insurance and retirement services segment and other revenues for the financial services segment. Certain of these entries were previously identified but not corrected as the amounts were viewed as not sufficiently material to require correction. In the fourth quarter of 2004, AIG changed its accounting to present these tax credits as a component of income taxes. AIG has now determined that it is necessary to record these adjustments for the periods prior to the fourth quarter of 2004. The restatement had the effect of decreasing net investment income by approximately $61 million and $40 million, decreasing other revenues by approximately $54 million and $45 million, and reflecting an income tax benefit of approximately $115 million and $85 million, for the quarters ended March 31, 2004 and 2003, respectively. There was no effect on consolidated net income or shareholders’ equity.
 
Hedge Fund Accounting: AIG subsidiaries invest in a variety of alternative asset classes, including hedge fund limited partnerships, that are accounted for as available for sale securities. As part of the underlying partnership agreements, such AIG subsidiaries have the right to redeem their interests at defined times. A redemption previously allowed AIG to record net investment income to the extent there were gains in the underlying funds at the time. However, as a result of its internal review, AIG has determined that, in certain cases, the redemp-

15


 

 
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

tion resulted in inappropriate gain recognition because the proceeds were required to be immediately reinvested in the funds. In addition, the cost bases of certain funds were misallocated in determining gains. The restated consolidated financial statements correct these errors. These corrections had virtually no effect on consolidated shareholders’ equity at March 31, 2004 and December 31, 2003.
 
Muni Tender Option Bond Program: From 2000 through early 2003, AIG subsidiaries participated in a program in which they transferred highly rated municipal bonds at market value to a third-party broker, which in turn transferred these securities to a trust that the broker had established. The trust then issued two sets of beneficial interests. Half of the beneficial interests were floating interest rate certificates. The remaining beneficial interests were “inverse” floating interest rate certificates. Third parties invested in the floating interest rate certificates, and AIG subsidiaries invested in the inverse floating interest rate certificates. AIG did not consolidate the trust into AIG’s balance sheet.

The AIG subsidiaries, as the holders of the residual interest inverse floating rate certificates, had the right to unilaterally liquidate the trust and cause the municipal bonds to be returned to AIG on short notice. Accordingly, the AIG subsidiaries did not cede control over the bonds. As a result, AIG now believes that the conclusion not to consolidate was an error in the application of GAAP. Therefore, AIG has now consolidated the trusts into its balance sheets at December 31, 2002. Because the program was discontinued in early 2003, there was no effect on the consolidated balance sheets as of March 31, 2004 or December 31, 2003. However, net investment income increased over previously reported amounts by $21 million and $12 million for the quarters ended March 31, 2004 and 2003, respectively, and realized capital gains increased by $8 million for the quarter ended March 31, 2004. There was no effect on realized capital gains for the quarter ended March 31, 2003.
 
DBG/AIG Capital Corporation Intercompany Dividend: In 2002, AIG Capital Corporation issued shares of its preferred stock to National Union in exchange for shares of ILFC’s common stock. AIG did not eliminate the preferred stock investment in consolidation, instead recording the dividend as income in net investment income and as corresponding expense in other operating expenses. AIG has now determined that this accounting is a misapplication of GAAP. Accordingly, AIG has eliminated this intercompany investment and reversed the accounting entries in its consolidated statement of income. The restatement had no effect on consolidated net income or shareholders’ equity but net investment income decreased by approximately $25 million and insurance acquisition and other operating expenses decreased by approximately $25 million for both quarters ended March 31, 2004 and 2003.

“Top Level” Adjustments and Other Directed Entries (other than loss reserves). Certain accounting entries originated at the parent company level had the effect of reclassifying realized capital gains to net investment income, as well as adjusting other line item reclassifications and other segment financial information. In some cases, expense deferrals were increased or reserves decreased, both having the effect of increasing reported earnings. In other cases, the adjustments affected revenue and expense recognition between reporting periods or among business segments. Certain of these entries were previously identified but considered not to be sufficiently material to require correction. As part of its internal review, AIG analyzed and assessed “top level” adjustments since 2000 and determined that certain entries appear to have been made at the direction of certain former members of senior management without appropriate documentation or support.

Foreign Life Insurance Net Investment Income Reclassification: In addition to the matters described above, certain accounting entries, now determined to be errors, had the effect of reclassifying capital gains realized from investments made to match liabilities relating to policies in Japan and Southeast Asia. Due to the limited availability of long-duration bonds or bonds with sufficient yield to meet the policyholder liability requirements in Japan and Southeast Asia, AIG subsidiaries made alternative investments, including investments in equities. Until the fourth quarter of 2003, a portion of the capital gains realized on these alternative investments, including substantial amounts related to the sale of fixed income securities, was reclassified to net investment income in the consolidated statement of income to match these revenues against the incurred policy benefit expense of the underlying policies. Amounts so reflected, which were previously identified but not corrected as they were viewed as immaterial, are treated as corrections of errors in the restated financial statements.

Beginning in the first quarter of 2004, a process was implemented to identify only certain equity-related gains in Southeast Asia and a limited amount of fixed income and equity gains in Japan and to segregate and treat such realized capital gains separately for segment reporting purposes only. The new process and limits were applied retroactively for 2003, 2002, 2001 and 2000 as part of the restatement.

The restatement reverses all such unsupported “top level” and other directed entries, including the Foreign

16


 

NOTES TO FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

Life Insurance Net Investment Income Reclassification, and as a result, as of March 31, 2004 and December 31, 2003, total assets decreased by approximately $403 million and $413 million and shareholders’ equity decreased by approximately $398 million and $401 million, respectively. Net income increased by approximately $13 million and decreased by approximately $10 million, for the quarters ended March 31, 2004 and 2003, respectively.

Conversion of Underwriting Losses to Capital Losses. This category includes transactions and entries that had the principal effect of improperly recharacterizing underwriting losses as capital losses. This category also includes insurance and reinsurance transactions where AIG’s accounting resulted in errors relating to the timing and classification of income recognition as well as errors relating to the timing of premium recognition. The most significant transactions in this category are the following:

Capco: AIG has determined that a series of transactions with Capco Reinsurance Company, Ltd. (Capco), a Barbados-domiciled reinsurer, involved an improper structure created to recharacterize underwriting losses relating to auto warranty business as capital losses. That structure, which appears to have not been properly disclosed to appropriate AIG personnel or its independent auditors, consisted primarily of arrangements between subsidiaries of AIG and Capco that require Capco to be treated as a consolidated entity in AIG’s financial statements. The result of such consolidation is to reverse capital losses for the years 2000 through 2003 and recognize a corresponding amount of underwriting losses in 2000.
 
The Robert Plan: AIG has restated the accounting for surplus notes purchased as part of a litigation settlement in 2002 with The Robert Plan Corporation (The Robert Plan). Pursuant to the settlement agreement, the surplus notes were to be repaid through profits received from a managing general agency relationship with The Robert Plan. When AIG deemed that repayment under the surplus notes was unlikely, AIG recorded the impairment charge as realized capital losses rather than underwriting losses. AIG now believes that this accounting treatment was an error and has restated the impairment charges as underwriting losses.
 
AIRCO Reinsurance: In each of 1999 and 2000, AIRCO entered into stop loss reinsurance agreements with Union Excess relating to accident and health business of Nan Shan. Concurrently with each reinsurance agreement, AIRCO entered into a swap agreement with Union Excess, under which the payments were linked to payments under the reinsurance agreement. The transaction had the effect of converting incurred policy losses into capital losses. AIG has determined that its prior accounting was a misapplication of GAAP and has reversed both the cessions under the reinsurance agreement and the corresponding swaps.

Together the effect of the restatement for Capco, The Robert Plan and AIRCO was to decrease total assets by approximately $79 million and $62 million and decrease total shareholders’ equity by approximately $61 million and $109 million as of March 31, 2004 and December 31, 2003, respectively. Net income increased by approximately $48 million and $5 million, for the quarters ended March 31, 2004 and 2003, respectively.

Asset Realization. As a result of the internal review, AIG concluded that adjustments should be made to the value of certain assets included in its consolidated balance sheet. The most significant of these items are:

Domestic Brokerage Group (DBG) Issues: A review of allowances for doubtful accounts and other accruals recorded by certain DBG member companies has led AIG to conclude that the allowances related to certain premiums receivable, reinsurance recoverables and other assets were not properly analyzed in prior periods and that appropriate allowances were not properly recorded in AIG’s consolidated financial statements. Certain relevant information was known by certain members of senior management but, AIG now understands, not previously disclosed to the independent auditors. In addition, various accounts were not properly reconciled. AIG’s restated financial statements reflect the recording of appropriate amounts for these reserves and allowances for doubtful accounts for the appropriate time period, resulting in an after-tax reduction in consolidated shareholders’ equity at December 31, 1999 of $514 million. The effect of the restatement resulting from DBG issues was to decrease total assets by approximately $924 million and $872 million and decrease total shareholders’ equity by approximately $376 million and $324 million as of March 31, 2004 and December 31, 2003, respectively.
 
Other Than Temporary Declines: AIG’s investment accounting policies require that an investment that has been identified as impaired should be written down in the period in which such impairment is determined, and recorded as a realized capital loss. AIG has determined that realized capital losses with respect to certain impaired investments were not recorded in the appropriate periods, and the restatement will thus affect the timing of previously reported realized capital losses. The restatement resulting from other than temporary declines had only a minor effect on consolidated shareholders’ equity but net income increased by approxi-

17


 

 
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

mately $26 million and $327 million for the quarters ended March 31, 2004 and 2003, respectively.

Other GAAP Corrections. As part of its internal review, AIG has considered the application of certain accounting principles to specific businesses and transactions, and has determined that certain misapplications of GAAP are errors that require restatement of its financial statements. These adjustments include the following:

Accounting for Derivatives (FAS 133 Hedge Accounting): AIG and its subsidiaries, including AIGFP, engage in hedging activities for their own accounts, which AIG believes have been and remain economically effective. AIG and its subsidiaries enter into derivative contracts principally to hedge interest rate risk and foreign currency risk associated with their assets, liabilities and forecasted cash flows. Such derivative transactions include interest rate swaps, cross currency swaps and forwards, which are generally executed through AIGFP. Statement of Financial Accounting Standards No. 133 — “Accounting for Derivative Instruments and Hedging Activities” (FAS 133) requires that third-party derivatives used for hedging must be specifically matched with the underlying exposures to an outside third party and documented contemporaneously to qualify for hedge accounting treatment. The internal review determined that in many cases AIG did not meet these hedging requirements with respect to certain hedging transactions.

AIG has historically reported the changes in the fair value of certain derivatives used for hedging activities through other comprehensive income in consolidated shareholders’ equity or in net income with a corresponding adjustment to the hedged item, depending on the nature of the hedging relationship. In order to comply with FAS 133, the restated consolidated financial statements include the changes in fair value for certain derivatives, previously recorded through other comprehensive income, in current period income and reverse the previous adjustments on certain assets and liabilities recorded in income in connection with hedge accounting. Because these activities did not qualify for hedge accounting, Statement of Financial Accounting Standards No. 115 — “Accounting for Certain Investments in Debt and Equity Securities” requires AIG to recognize the corresponding changes in fair value, including foreign exchange gains and losses resulting from exchange rate fluctuations, relating to available-for-sale investments through accumulated other comprehensive income. These restatement adjustments with respect to FAS 133 do not result in any changes in AIG’s liquidity or its overall financial condition even though inter-period volatility of earnings increases.

AIG is assessing the cost and benefits of modifying its hedging activities to obtain hedge accounting under the requirements of FAS 133. The restatement to reflect appropriate GAAP accounting for these derivatives, which also included reclassifications between the accounts securities available for sale, at market value and securities purchased under agreements to resell, at contract value, increased total assets by approximately $1.4 billion and $2.0 billion and increased total shareholders’ equity by approximately $1.0 billion and $0.8 billion as of March 31, 2004 and December 31, 2003, respectively. Net income decreased by approximately $92 million and $548 million for the quarters ended March 31, 2004 and 2003, respectively.
 
Accounting for Deferred Taxes: AIG identified certain misapplications of GAAP in its provision for deferred income taxes as follows:

For certain foreign subsidiaries for which AIG has plans to permanently reinvest undistributed earnings, AIG incorrectly provided U.S. deferred taxes on the unrealized appreciation associated with investment securities in accumulated other comprehensive income.

For certain foreign subsidiaries for which AIG does not have plans for permanent reinvestment of undistributed earnings, U.S. deferred taxes were incorrectly omitted on certain components of other comprehensive income.

  The restatement increased total shareholders’ equity by $898 million and $761 million as of March 31, 2004 and December 31, 2003, respectively.

Foreign Currency Translation (FAS 52): FAS 52 is used to determine the timing of the recognition of income or expense resulting from foreign exchange rate changes for transactions denominated in other than a functional currency.

AIG has determined that, in certain cases, its application of FAS 52 in its consolidated financial statements did not comply with the functional currency determination requirements of the standard. As a result, AIG has recorded accounting adjustments to reclassify currency  transaction gains and losses from accumulated other comprehensive income to net income. These corrections affected consolidated net income in certain periods but had no effect on consolidated shareholders’ equity at March 31, 2004 or for prior periods.

AIG adopted a practice in the 1990s of recording adjustments to general insurance reserves to offset increases or decreases in such reserves through other comprehensive income, net of tax, resulting from translation of reserves denominated in foreign currencies. AIG now believes that this accounting practice was a

18


 

NOTES TO FINANCIAL STATEMENTS (continued)
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

  misapplication of GAAP. As a result of this adjustment, general insurance reserves denominated in foreign currencies have been restated to restore the translation effect back to reserve for losses and loss expenses.

Together, these restatements increased total assets by approximately $112 million and $143 million and increased total shareholders’ equity by approximately $238 million and $358 million, as of March 31, 2004 and December 31, 2003, respectively. Net income decreased by approximately $51 million and $38 million for the quarters ended March 31, 2004 and 2003, respectively.

Life Settlements. Life settlements are designed to assist life insurance policyholders to monetize the existing value of life insurance policies. AIG, through an insurance subsidiary and non-consolidated trusts, which are deemed to be a qualifying special purpose entity and a VIE, engages in this business. The non-consolidated trusts purchase life insurance policies from policyholders at an initial price and pay additional premiums to keep the policies in force until the insured dies. AIG’s proportionate share of the net death benefits from the purchased contracts, net of reinsurance to a third party reinsurer, was recorded as premium. The costs incurred by the trusts to acquire the contracts and keep them in force were recorded as paid losses by AIG, net of reinsurance. AIG’s accounting resulted in upfront gain recognition of expected profits and premium recognition for amounts loaned to the trusts by other AIG subsidiaries.

AIG has determined, in light of new information which was not available to management or AIG’s independent auditors at the time the initial accounting determination was made, that the accounting for these transactions as insurance and reinsurance is a misapplication of GAAP that should be corrected through restatement. This restatement results in life settlements being accounted for using an investment method of accounting under FASB Technical Bulletin (FTB) 85-4 “Accounting for Purchases of Life Insurance.” Under FTB 85-4, the carrying value of each contract at purchase and at the end of each reporting period is equal to the cash surrender value of the contract. Cash paid to purchase these contracts that is in excess of the cash surrender value at the date of purchase is recognized as a loss immediately and periodic maintenance costs, such as premiums necessary to keep the underlying contract in force, are charged to earnings immediately. The life insurance benefits at the insured’s death are payable to the AIG subsidiary and reflected in income at that time. The effect of the restatement was to decrease total assets by approximately $2.2 billion and $1.9 billion, decrease total liabilities by approximately $1.9 billion and $1.6 billion and decrease total shareholders’ equity by approximately $300 million and $270 million as of March 31, 2004 and December 31, 2003, respectively. Net income decreased by approximately $36 million and $22 million for the quarters ended March 31, 2004 and 2003, respectively.
 
Deferred Acquisition Costs (DAC): The internal review identified a misapplication of GAAP with respect to General Insurance DAC. As a result of “top-level” entries, substantially all costs associated with underwriting and marketing operations were deferred. The internal review determined that certain of these costs did not vary sufficiently with the production of business and should not have been deferred. These costs have been allocated to the periods in which they were incurred and the corresponding DAC asset has been adjusted accordingly. In addition, AIG determined that the amortization period for certain DAC was longer than the typical life of the underlying policies and needed to be shortened, and that certain deferrals associated with an inter-company reinsurance treaty were in error and required correction. This adjustment includes the recharacterization of certain incurred policy losses and benefits to insurance acquisition and other operating expenses. The effect of the restatement was to decrease total assets by approximately $521 million and $495 million and decrease total shareholders’ equity by approximately $328 million and $311 million, as of March 31, 2004 and December 31, 2003, respectively.
 
SICO Deferred Compensation: AIG has included in this restatement, expense amounts attributable to deferred compensation granted to certain AIG employees by SICO (pursuant to the SICO Plan described under Item 11. Executive Compensation in AIG’s 2004 Form 10-K), a private holding company that owns approximately 12 percent of AIG’s common stock. The amount of deferred compensation granted by SICO has previously been disclosed in the notes to AIG’s consolidated financial statements but was not included as an expense in the calculation of AIG’s consolidated net income because the amounts had been determined not to be material to AIG’s consolidated results of operations in any individual period. The expense related to SICO deferred compensation is recorded as a charge to reported earnings in the periods restated, with an offsetting entry to additional paid-in capital reflecting amounts deemed contributed by SICO. For periods prior to 2000, AIG has recorded a reduction of $905 million in retained earnings on its December 31, 1999 consolidated balance sheet and a corresponding increase to additional paid-in capital. The volatility in the expense is attributable to the variable accounting as well as the fact that shares are allocated only in alternate years. The inclusion of the expense attributable to the SICO Plans in AIG’s consoli-

19


 

 
 
American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

  dated financial statements had no effect on consolidated shareholders’ equity but decreased net income by approximately $14 million and $69 million for the quarters ended March 31, 2004 and 2003, respectively.
 
Commutations: Certain direct insurance, and ceded and assumed reinsurance contracts, were commuted prior to their natural expiration. For certain commutations, the cash received was recorded through negative paid losses in accordance with statutory guidance, while for others it was recorded as written premiums. Despite the lack of guidance under GAAP with respect to this issue, AIG has determined that the accounting for certain commutations was in error due to the inconsistency in AIG’s accounting for commutations and the fact that certain commutations were recorded through the written premium line when there was no unearned premium balance outstanding. As part of this restatement any commutations that were originally recorded through written premium are reclassified to paid losses in the period in which they occurred. The restatement had no effect on consolidated net income or shareholders’ equity but did decrease premiums and other considerations and incurred policy losses and benefits each by approximately $40 million for the quarter ended March 31, 2004 and increased premiums and other considerations and incurred policy losses and benefits each by approximately $35 million for the quarter ended March 31, 2003.
 
Dollar Roll Transactions: Certain AIG subsidiaries entered into dollar roll transactions with third parties designed to enhance the return on AIG’s mortgage backed securities (MBS) portfolio. In a dollar roll transaction, AIG subsidiaries agree to sell a pool of MBSs and simultaneously agree to repurchase substantially the same securities at a later date, typically in one month. AIG accounted for these transactions as collateralized financings under SFAS 140. Even though it had received collateral sufficient to fund substantially all of the cost of purchasing identical replacement securities at the time of transfer, AIG was not fully protected during the term of the contract to replace the asset in the event that the transferee defaulted. Accordingly, AIG should not have accounted for these transactions as financings, but rather as derivatives with mark-to-market changes reflected in earnings. The effect of the restatement increased net income by approximately $38 million for the quarter ended March 31, 2004 and decreased net income by approximately $14 million for the quarter ended March 31, 2003.
 
Affordable Housing: Through an investment limited partnership, an AIG subsidiary, as the general partner, syndicates the tax benefits (including both tax credits and tax losses) generated by affordable housing real estate properties. AIG guarantees the return of the tax benefits to the limited partner investors. Prior to the second quarter of 2003, these syndication transactions were accounted for as sales and the gain was recorded on a straight-line basis over ten years. Beginning in the third quarter of 2003, because of the guarantees, AIG changed its accounting for these partnerships to record all new syndications as financings, rather than sales. At the same time, AIG adjusted its consolidated balance sheet to reflect previous syndications as financings, but did not record the cumulative impact to earnings because the amounts were viewed as immaterial. AIG has now determined that it is necessary to record these adjustments for the periods prior to the third quarter of 2003, and the restatement decreased total assets by approximately $852 million and $611 million and decreased total shareholders’ equity by approximately $304 million and $297 million as of March 31, 2004 and December 31, 2003, respectively.
 
SunAmerica Partnerships: As part of the restatement, management has reclassified the earnings of the SunAmerica partnerships out of other operations, where previously reported, into the Asset Management segment. This revised presentation characterizes the partnership earnings as revenues rather than as a component of insurance acquisition and operating expenses in AIG’s consolidated statement of income. Within the Asset Management segment, this presentation divides the partnership earnings into those of SunAmerica Life, whose equity supports the GIC business, and those of AIG SunAmerica, which are now classified as other asset management revenues. The restatement had no effect on consolidated net income or total shareholders’ equity but increased other revenues by $155 million and $51 million for the quarters ended March 31, 2004 and 2003, respectively, and increased insurance and other operating expenses by $155 million and $81 million for the quarters ended March 31, 2004 and 2003, respectively.

20


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

The following tables present the previously reported and the restated Consolidated Balance Sheet, Consolidated Statement of Income, and Condensed Consolidated Statement of Cash Flows:

CONSOLIDATED BALANCE SHEET

                                       
March 31, 2004 December 31, 2003


As Previously As As Previously As
(in millions) Reported Restated Reported Restated

Assets:
                               
  Investments, financial services assets and cash:                                
    Fixed maturities:                                
     
Bonds available for sale, at market value
  $ 319,182     $ 319,182     $ 300,935     $ 300,935  
     
Bonds held to maturity, at amortized cost
    9,823       9,823       8,037       8,037  
     
Bond trading securities, at market value
    1,966       1,966       282       282  
    Equity securities:                                
     
Common stocks available for sale, at market value
    8,467       8,467       7,522       7,522  
     
Common stocks trading, at market value
    4,062       4,062       156       156  
     
Preferred stocks, at market value
    2,045       2,045       1,906       1,906  
   
Mortgage loans on real estate, net of allowance
    12,218       12,251       12,295       12,328  
   
Policy loans
    6,825       6,825       6,658       6,658  
   
Collateral and guaranteed loans, net of allowance
    2,283       2,210       2,296       2,241  
    Financial services assets:                                
     
Flight equipment primarily under operating leases, net of accumulated depreciation
    30,807       30,807       30,343       30,343  
     
Securities available for sale, at market value
    17,930       26,260       15,714       24,042  
     
Trading securities, at market value
    4,877       5,381       3,300       4,418  
     
Spot commodities, at market value
    183       183       250       250  
     
Unrealized gain on swaps, options and forward transactions
    21,452       21,309       21,599       21,459  
     
Trading assets
    1,886       1,613       2,548       2,277  
     
Securities purchased under agreements to resell, at contract value
    26,351       19,026       28,170       20,845  
     
Finance receivables, net of allowance
    18,494       18,385       17,609       17,500  
    Securities lending collateral, at cost     40,695       40,695       30,195       30,195  
    Other invested assets     19,124       20,568       16,787       18,484  
    Short-term investments, at cost     16,782       16,766       8,914       8,908  
    Cash     1,920       1,920       922       922  

      Total investments, financial services assets and cash     567,372       569,744       516,438       519,708  
  Investment income due and accrued     5,388       4,999       4,959       4,612  
 
Premiums and insurance balances receivable, net of allowance
    15,835       14,672       14,166       13,189  
  Reinsurance assets, net     28,167       21,359       27,962       20,948  
  Deferred policy acquisition costs     26,690       26,196       26,398       25,920  
  Investments in partially owned companies     1,497       1,503       1,428       1,420  
 
Real estate and other fixed assets, net of accumulated depreciation
    5,999       5,960       6,006       5,966  
  Separate and variable accounts     51,962       51,962       60,536       60,536  
  Goodwill     7,683       7,714       7,633       7,664  
  Other assets     13,561       14,969       12,820       14,190  

Total assets
  $ 724,154     $ 719,078     $ 678,346     $ 674,153  

21


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

CONSOLIDATED BALANCE SHEET (continued)

                                     
March 31, 2004 December 31, 2003


As Previously As As Previously As
(in millions) Reported Restated Reported Restated

Liabilities:
                               
 
Reserve for losses and loss expenses
  $ 57,725     $ 54,218     $ 56,118     $ 52,381  
 
Reserve for unearned premiums
    22,004       22,180       20,762       20,910  
 
Future policy benefits for life and accident and health insurance contracts
    94,613       94,470       92,970       92,912  
 
Policyholders’ contract deposits
    193,384       193,317       171,989       171,917  
 
Other policyholders’ funds
    9,581       9,597       9,100       9,124  
 
Reserve for commissions, expenses and taxes
    5,009       5,033       4,487       4,588  
 
Insurance balances payable
    3,352       3,729       2,592       2,915  
 
Funds held by companies under reinsurance treaties
    4,977       3,145       4,664       3,043  
 
Income taxes payable:
                               
   
Current
    2,778       1,723       1,977       366  
   
Deferred
    7,123       5,917       5,778       4,633  
 
Financial services liabilities:
                               
   
Borrowings under obligations of guaranteed investment agreements
    15,414       15,414       15,337       15,337  
   
Securities sold under agreements to repurchase, at contract value
    14,956       16,201       14,810       15,813  
   
Trading liabilities
    4,817       4,817       6,153       6,153  
   
Securities and spot commodities sold but not yet purchased, at market value
    5,227       5,227       5,458       5,458  
   
Unrealized loss on swaps, options and forward transactions
    15,731       14,199       15,268       14,658  
   
Trust deposits and deposits due to banks and other depositors
    3,516       3,635       3,491       3,627  
   
Commercial paper
    5,294       5,294       4,715       4,715  
   
Notes, bonds, loans and mortgages payable
    51,868       52,954       50,138       51,389  
 
Commercial paper
    2,519       2,519       1,223       1,223  
 
Notes, bonds, loans and mortgages payable
    5,813       5,797       5,865       5,863  
 
Liabilities connected to trust preferred stock
    1,682       1,682       1,682       1,682  
 
Separate and variable accounts
    51,962       51,962       60,536       60,536  
 
Minority interest
    3,792       3,778       3,311       3,302  
 
Securities lending payable
    40,695       40,695       30,195       30,195  
 
Other liabilities
    23,350       25,638       18,282       21,191  

Total liabilities
    647,182       643,141       606,901       603,931  

Preferred shareholders’ equity in subsidiary companies
    193       193       192       192  

Shareholders’ equity:
                               
 
Common stock
    6,878       6,878       6,878       6,878  
 
Additional paid-in capital
    567       1,926       568       1,913  
 
Retained earnings
    63,446       57,779       60,960       55,392  
 
Accumulated other comprehensive income (loss)
    7,315       10,588       4,244       7,244  
 
Treasury stock, at cost
    (1,427 )     (1,427 )     (1,397 )     (1,397 )

Total shareholders’ equity
    76,779       75,744       71,253       70,030  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 724,154     $ 719,078     $ 678,346     $ 674,153  

22


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

CONSOLIDATED STATEMENT OF INCOME

                                     
For the Quarter Ended For the Quarter Ended
March 31, 2004 March 31, 2003


As Previously As As Previously As
(in millions, except per share amounts) Reported Restated Reported Restated

Revenues:
                               
 
Premiums and other considerations
  $ 16,139     $ 15,982     $ 13,072     $ 12,884  
 
Net investment income
    4,720       4,575       3,966       3,515  
 
Realized capital gains (losses)
    83       115       (632 )     157  
 
Other revenues
    2,695       2,703       2,521       1,636  

 
Total revenues
    23,637       23,375       18,927       18,192  

Benefits and expenses:
                               
 
Incurred policy losses and benefits
    13,734       13,597       11,140       10,942  
 
Insurance acquisition and other operating expenses
    5,612       5,839       4,863       5,044  

 
Total benefits and expenses
    19,346       19,436       16,003       15,986  

Income before income taxes, minority interest and cumulative effect of an accounting change
    4,291       3,939       2,924       2,206  

Income taxes (benefits):
                               
 
Current
    1,473       1,322       689       570  
 
Deferred
    (117 )     (153 )     187       50  

      1,356       1,169       876       620  

Income before minority interest and cumulative effect of an accounting change
    2,935       2,770       2,048       1,586  

Minority interest
    (98 )     (70 )     (94 )     (61 )

Income before cumulative effect of an accounting change
    2,837       2,700       1,954       1,525  

Cumulative effect of an accounting change, net of tax
    (181 )     (144 )            

Net income
  $ 2,656     $ 2,556     $ 1,954     $ 1,525  

Earnings per common share:
                               
 
Basic
                               
   
Income before cumulative effect of an accounting change
  $ 1.09     $ 1.04     $ 0.75     $ 0.58  
   
Cumulative effect of an accounting change, net of tax
    (0.07 )     (0.06 )            
   
Net income
    1.02       0.98       0.75       0.58  

 
Diluted
                               
   
Income before cumulative effect of an accounting change
  $ 1.08     $ 1.03     $ 0.74     $ 0.58  
   
Cumulative effect of an accounting change, net of tax
    (0.07 )     (0.06 )            
   
Net income
    1.01       0.97       0.74       0.58  

Cash dividends per common share
  $ 0.065     $ 0.065     $ 0.047     $ 0.047  

Average shares outstanding:
                               
 
Basic
    2,610       2,610       2,610       2,610  
 
Diluted
    2,633       2,642       2,628       2,637  

23


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

                                 
Three Months Ended Three Months Ended
March 31, 2004 March 31, 2003


As As
Previously As Previously As
(in millions) Reported Restated Reported Restated

Net cash provided by operating activities
  $ 9,220     $ 8,719     $ 8,831     $ 7,920  
Net cash used in investing activities
    (20,265 )     (19,725 )     (16,037 )     (15,161 )
Net cash provided by financing activities
    11,992       11,802       6,642       6,720  
Change in cumulative translation adjustments
    51       202       59       16  

Change in cash
    998       998       (505 )     (505 )
Cash at beginning of period
    922       922       1,165       1,165  

Cash at end of period
  $ 1,920     $ 1,920     $ 660     $ 660  

24


 

  2.  Restatement of Previously Issued
Financial Statements 
(continued)
 
American International Group, Inc. and Subsidiaries

The following table reflects the effect of the aforementioned adjustments on each component of net income:

                 
For the Quarters Ended March 31,
(in millions) 2004 2003

Net Income as Previously Reported
  $ 2,656     $ 1,954  
Revenues
    (262 )     (735 )
Benefits and expenses
    90       (17 )
Income taxes
    (187 )     (256 )
Minority interest
    (28 )     (33 )
Cumulative effect of an accounting change, net of tax
    37        

Net Income as restated
  $ 2,556     $ 1,525  

The following two tables reflect the effect of the aforementioned adjustments on each component of revenue:

                                             
For the Quarter Ended March 31,
2004 Premiums and Net Investment Realized Capital Other Total
(in millions) Other Considerations Income Gains (Losses) Revenues Revenues

As Previously Reported
  $ 16,139     $ 4,720     $ 83     $ 2,695     $ 23,637  
Adjustments:
                                       
Risk Transfer:
                                       
 
Union Excess
    97       65       (12 )           150  
 
Other Risk Transfer
    (49 )     (2 )                 (51 )
Net Investment Income:
                                       
 
Covered Calls
          10       18             28  
 
Synthetic Fuel Investment
          (61 )           (54 )     (115 )
 
Hedge Fund Accounting
          13             (17 )     (4 )
 
Muni Tender Option Bond Program
          21       8             29  
 
DBG/AIG Capital Corporation Intercompany Dividend
          (25 )                 (25 )
“Top Level” Adjustments and Other Directed Entries (other than loss reserves)
    44       (99 )     22       12       (21 )
Conversion of Underwriting Losses to Capital Losses
                73             73  
Asset Realization:
                                       
 
Other Than Temporary Declines
                40             40  
Other GAAP Corrections:
                                       
 
Accounting for Derivatives (FAS 133 Hedge Accounting)
                (81 )     (80 )     (161 )
 
Foreign Currency Translation (FAS 52)
                (74 )           (74 )
 
Life Settlements
    (196 )     (39 )                 (235 )
 
Commutations
    (40 )                       (40 )
 
Dollar Roll Transactions
                38             38  
All Other Adjustments — Net
    (13 )     (28 )           147       106  

   
Total adjustments
    (157 )     (145 )     32       8       (262 )

As Restated
  $ 15,982     $ 4,575     $ 115     $ 2,703     $ 23,375  

25


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)

                                             
For the Quarter Ended March 31,
2003 Premiums and Net Investment Realized Capital Other Total
(in millions) Other Considerations Income Gains (Losses) Revenues Revenues

As Previously Reported
  $ 13,072     $ 3,966     $ (632 )   $ 2,521     $ 18,927  
Adjustments:
                                       
Risk Transfer:
                                       
 
Union Excess
    110       76       (4 )           182  
 
Other Risk Transfer
    (165 )     3                   (162 )
Net Investment Income:
                                       
 
Covered Calls
          (103 )     28             (75 )
 
Synthetic Fuel Investment
          (40 )           (45 )     (85 )
 
Muni Tender Option Bond Program
          12                   12  
 
DBG/AIG Capital Corporation Intercompany Dividend
          (25 )                 (25 )
“Top Level” Adjustments and Other Directed Entries (other than loss reserves)
          (297 )     203       1       (93 )
Conversion of Underwriting Losses to Capital Losses
                5             5  
Asset Realization:
                                       
 
Other Than Temporary Declines
                503             503  
Other GAAP Corrections:
                                       
 
Accounting for Derivatives (FAS 133 Hedge Accounting)
                6       (876 )     (870 )
 
Foreign Currency Translation (FAS 52)
                (31 )           (31 )
 
Life Settlements
    (190 )     (19 )                 (209 )
 
Commutations
    35                         35  
 
Dollar Roll Transactions
                (14 )           (14 )
All Other Adjustments — Net
    22       (58 )     93       35       92  

   
Total adjustments
    (188 )     (451 )     789       (885 )     (735 )

As Restated
  $ 12,884     $ 3,515     $ 157     $ 1,636     $ 18,192  

The following two tables reflect the effect of the aforementioned adjustments on each component of Benefits and Expenses:


                             
For the Quarter Ended March 31, 2004 Incurred Policy Insurance Acquisition and Total Benefits
(in millions) Losses and Benefits Other Operating Expenses and Expenses

As Previously Reported
  $ 13,734     $ 5,612     $ 19,346  
Adjustments:
                       
Risk Transfer:
                       
 
Union Excess
    168       12       180  
 
Other Risk Transfer
    (47 )     (16 )     (63 )
Loss Reserves
    60             60  
Net Investment Income:
                       
 
DBG/AIG Capital Corporation Intercompany Dividend
          (25 )     (25 )
“Top Level” Adjustments and Other Directed
Entries (other than loss reserves)
    25       (68 )     (43 )
Conversion of Underwriting Losses to Capital Losses
          (1 )     (1 )
Asset Realization:
                       
Domestic Brokerage Group (DBG) Issues
          47       47  
Other GAAP Corrections:
                       
 
Accounting for Derivatives (FAS 133 Hedge Accounting)
          (20 )     (20 )
 
Foreign Currency Translation (FAS 52)
          2       2  
 
Life Settlements
    (180 )           (180 )
 
Deferred Acquisition Costs (DAC)
    (74 )     105       31  
 
SICO Deferred Compensation
          14       14  
 
Commutations
    (40 )           (40 )
All Other — Net
    (49 )     177       128  

   
Total adjustments
    (137 )     227       90  

As Restated
  $ 13,597     $ 5,839     $ 19,436  

26


 

American International Group, Inc. and Subsidiaries
  2.  Restatement of Previously Issued
Financial Statements 
(continued)
                             
For the Quarter Ended March 31, 2003 Incurred Policy Insurance Acquisition and Total Benefits
(in millions) Losses and Benefits Other Operating Expenses and Expenses

As Previously Reported
  $ 11,140     $ 4,863     $ 16,003  
Adjustments:
                       
Risk Transfer:
                       
 
Union Excess
    108       12       120  
 
Other Risk Transfer
    (147 )     (2 )     (149 )
Loss Reserves
    75             75  
Net Investment Income:
                       
 
DBG/AIG Capital Corporation Intercompany Dividend
          (25 )     (25 )
“Top Level” Adjustments and Other Directed
Entries (other than loss reserves)
    (51 )     (25 )     (76 )
Asset Realization:
                       
 
Domestic Brokerage Group (DBG) Issues
          (11 )     (11 )
Other GAAP Corrections:
                       
 
Accounting for Derivatives (FAS 133 Hedge Accounting)
          (26 )     (26 )
 
Foreign Currency Translation (FAS 52)
          17       17  
 
Life Settlements
    (175 )           (175 )
 
Deferred Acquisition Costs (DAC)
    (44 )     58       14  
 
SICO Deferred Compensation
          69       69  
 
Commutations
    35             35  
All Other — Net
    1       114       115  

   
Total adjustments
    (198 )     181       (17 )

As Restated
  $ 10,942     $ 5,044     $ 15,986  

The following table reflects the effect of the aforementioned adjustments on income taxes:

                     
For the Quarters Ended March 31,
(in millions) 2004 2003

Income Taxes, as Previously Reported
  $ 1,356     $ 876  
Adjustments:
               
Risk Transfer:
               
 
Union Excess
    (11 )     22  
 
Other Risk Transfer
    2       (5 )
Loss Reserves
    (21 )     (26 )
Net Investment Income:
               
 
Covered Calls
    10       (26 )
 
Synthetic Fuel Investment
    (115 )     (85 )
“Top Level” Adjustments and Other Directed Entries (other than loss reserves)
    8       (8 )
Asset Realization:
               
 
Domestic Brokerage Group (DBG) Issues
    5       11  
 
Other Than Temporary Declines
    14       176  
Other GAAP Corrections:
               
 
Accounting for Derivatives (FAS 133 Hedge Accounting)
    (49 )     (295 )
 
Accounting for Deferred Taxes
    (4 )      
 
Foreign Currency Translation (FAS 52)
    (26 )     (11 )
 
Life Settlements
    (20 )     (12 )
 
Deferred Acquisition Costs (DAC)
    (9 )      
All Other — Net
    29       3  

   
Total adjustments
    (187 )     (256 )

Income Taxes, as Restated
  $ 1,169     $ 620  

27


 

American International Group, Inc. and Subsidiaries
 
3.  Segment Information

The following table summarizes the operations by major operating segment for the three months ended March 31, 2004 and 2003:

                   
Operating Segments 2004 2003
(in millions) (Restated) (Restated)

Revenues(a):
               
 
General Insurance(b)
  $ 10,075     $ 7,629  
 
Life Insurance & Retirement Services(c)
    10,523       9,046  
 
Financial Services(d)
    1,788       787  
 
Asset Management(e)
    1,032       864  
 
Other
    (43 )     (134 )

Consolidated
  $ 23,375     $ 18,192  

Operating income (loss)(a)(f):
               
 
General Insurance
  $ 1,441     $ 986  
 
Life Insurance & Retirement Services
    1,785       1,722  
 
Financial Services
    545       (376 )
 
Asset Management
    353       202  
 
Other(g)
    (185 )     (328 )

Consolidated
  $ 3,939     $ 2,206  

(a)  Revenues and operating income reflect the adjustments necessary pursuant to FAS 133. See Restatement of Previously Issued Financial Statements – Accounting for Derivatives (FAS 133 Hedge Accounting).
(b)  Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(c)  Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).
(d)  Represents interest, lease and finance charges.
(e)  Represents management and advisory fees, and net investment income with respect to GICs.
(f)  Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(g)  Represents other income (deductions) – net and other realized capital gains (losses).

The following table summarizes AIG’s General Insurance operations by major operating unit for the three months ended March 31, 2004 and 2003:

                   
General Insurance 2004 2003
(in millions) (Restated) (Restated)

Revenues:
               
 
Domestic Brokerage Group
  $ 5,514     $ 4,028  
 
Transatlantic
    972       758  
 
Personal Lines
    1,089       903  
 
Mortgage Guaranty
    162       178  
 
Foreign General
    2,331       1,772  
 
Reclassifications and Eliminations
    7       (10 )

Total General Insurance
  $ 10,075     $ 7,629  

Operating Income:
               
 
Domestic Brokerage Group
  $ 556     $ 418  
 
Transatlantic
    117       81  
 
Personal Lines
    98       97  
 
Mortgage Guaranty
    96       111  
 
Foreign General
    568       289  
 
Reclassifications and Eliminations
    6       (10 )

Total General Insurance
  $ 1,441     $ 986  

The following table summarizes AIG’s Life Insurance & Retirement Services operations by major operating unit for the three months ended March 31, 2004 and 2003:

                     
Life Insurance & Retirement Services 2004 2003
(in millions) (Restated) (Restated)

Revenues(a):
               
 
Foreign:
               
   
AIA, AIRCO, and Nan Shan
  $ 3,741     $ 3,338  
   
ALICO, AIG Star Life and AIG Edison Life
    2,865       1,939  
   
Philamlife and Other
    117       155  
 
Domestic:
               
   
AGLA and AG Life(b)
    2,094       2,194  
   
VALIC, AIG Annuity and AIG SunAmerica(c)
    1,706       1,420  

Total Life Insurance & Retirement Services
  $ 10,523     $ 9,046  

Operating Income:
               
 
Foreign:
               
   
AIA, AIRCO and Nan Shan
  $ 491     $ 444  
   
ALICO, AIG Star Life and AIG Edison Life
    377       390  
   
Philamlife and Other
    28       70  
 
Domestic:
               
   
AGLA and AG Life(b)
    257       399  
   
VALIC, AIG Annuity and AIG SunAmerica(c)
    632       419  

Total Life Insurance & Retirement Services
  $ 1,785     $ 1,722  

(a)  Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income, and realized capital gains (losses).
(b)  Includes the life operations of AIG Life Insurance Company and American International Life Assurance Company of New York.
(c)  “AIG SunAmerica” represents the annuity operations of AIG SunAmerica Life Assurance Company, as well as those of First SunAmerica Life Insurance Company and SunAmerica Life Insurance Company.

The following table summarizes AIG’s Financial Services operations by major operating unit for the three months ended March 31, 2004 and 2003:

                   
Financial Services 2004 2003
(in millions) (Restated) (Restated)

Revenues(a):
               
 
Aircraft Finance(b)
  $ 752     $ 722  
 
Capital Markets(c)(d)
    317       (601 )
 
Consumer Finance(e)
    693       639  
 
Other
    26       27  

Total Financial Services
  $ 1,788     $ 787  

Operating income (loss)(a):
               
 
Aircraft Finance
  $ 180     $ 201  
 
Capital Markets(d)
    167       (736 )
 
Consumer Finance
    183       142  
 
Other
    15       17  

Total Financial Services
  $ 545     $ (376 )

(a)  Includes the unrealized gain (loss) attributable to economic hedges not qualifying for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For March 31, 2004 and 2003, the effect was $20 million and $26 million, respectively, in operating income for Aircraft Finance, and $37 million and $(862) million, respectively, in both revenues and operating income for Capital Markets.

28


 

American International Group, Inc. and Subsidiaries
  3.  Segment Information (continued)

(b)  Revenues were primarily from ILFC aircraft lease rentals.
(c)  Revenues, shown net of interest expense, other than those attributable to the effect of not qualifying for hedge accounting as described in (a) above were primarily from AIGFP hedged proprietary positions entered into in connection with counterparty transactions.
(d)  Certain transactions entered into by AIGFP generate tax credits and benefits which are shown in the income tax line on the consolidated statement of income. The amount of tax credits and benefits for the three month periods ended March 31, 2004 and 2003 are $35 million and $29 million, respectively.
(e)  Revenues were primarily finance charges.

The following table summarizes AIG’s Asset Management revenues and operating income for the three month periods ending March 31, 2004 and 2003:

                   
2004 2003
(in millions) (Restated) (Restated)

Revenues:
               
 
Guaranteed investment contracts
  $ 730     $ 647  
 
Institutional Asset Management(a)
    183       151  
 
Brokerage Services and Mutual Funds
    61       48  
 
Other
    58       18  

Total
  $ 1,032     $ 864  

Operating income:
               
 
Guaranteed investment contracts
  $ 223     $ 137  
 
Institutional Asset Management(a)(b)
    55       37  
 
Brokerage Services and Mutual Funds
    20       12  
 
Other
    55       16  

Total
  $ 353     $ 202  

(a)  Includes AIG Global Investment Group and certain smaller asset management operations.
(b)  Includes the results of certain AIG managed private equity and real estate funds that are consolidated effective December 31, 2003 pursuant to FIN46R, “Consolidation of Variable Interest Entities”. For the first three months of 2004, operating income includes $4 million of third-party limited partner earnings offset in Minority interest expense.
 
  4.  Earnings Per Share

Earnings per share of AIG are based on the weighted average number of common shares outstanding during the period.

Computation of Earnings Per Share:

                   
Three Months Ended March 31, 2004 2003
(in millions, except per share amounts) (Restated) (Restated)

Numerator for basic earnings per share:
               
Income before cumulative effect of an accounting change
  $ 2,700     $ 1,525  
Cumulative effect of an accounting change, net of tax
    (144 )      

Net income applicable to common stock
  $ 2,556     $ 1,525  

Denominator for basic earnings per share:
               
Average shares outstanding used in the computation of per share earnings:
               
Common stock issued
      2,752       2,752  
Common stock in treasury
      (142 )     (142 )

Average shares outstanding – basic
    2,610       2,610  

Numerator for diluted earnings per share:
               
Income before cumulative effect of an accounting change
  $ 2,700     $ 1,525  
Cumulative effect of an accounting change, net of tax
    (144 )      

Net income applicable to common stock
    2,556       1,525  

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

Adjusted net income applicable to common stock(a)
  $ 2,559     $ 1,528  

Denominator for diluted earnings per share:
               
Average shares outstanding
    2,610       2,610  
Incremental shares from potential common stock:
               
Average number of shares arising from outstanding employee stock plans
               
(treasury stock method)(b)
      23       18  
Contingently convertible bonds(a)
    9       9  

Adjusted average shares outstanding – diluted
    2,642       2,637  

Earnings per share:
               
Basic:
               
Income before cumulative effect of an accounting change
  $ 1.04     $ 0.58  
Cumulative effect of an accounting change, net of tax
    (0.06 )      
Net income
  $ 0.98     $ 0.58  

Diluted:
               
Income before cumulative effect of an accounting change
  $ 1.03     $ 0.58  
Cumulative effect of an accounting change, net of tax
    (0.06 )      
Net income
  $ 0.97     $ 0.58  

(a)  Assumes conversion of contingently convertible bonds due to the adoption of EITF Issue No. 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.”

(b)  Certain shares arising from employee stock plans were not included in the computation of diluted earnings per share where the exercise price of the options exceeded the average market price and would have been antidilutive. The number of shares excluded were 8 million and 25 million for the first three months of 2004 and 2003, respectively.

     Pursuant to Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, an amendment to FASB Statement No. 123” (FAS 148), AIG adopted the “Prospec-

29


 

American International Group, Inc. and Subsidiaries
  4.  Earnings Per Share (continued)

tive Method” of accounting for stock-based employee compensation effective January 1, 2003. FAS 148 also requires that AIG disclose the effect of stock-based compensation expense that would have been recognized if the fair value based method had been applied to all the awards vesting in the current period.

     The effect with respect to stock-based compensation expense that would have been recognized if the fair value based method had been applied to all the awards vesting in both the first three months of 2004 and 2003 was less than $0.005 per share.

     The quarterly dividend rate per common share, commencing with the dividend paid September 19, 2003 is $0.065.

 
  5.  Benefits Provided by Starr International Company, Inc.

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

     Participation in the SICO Plans by any person, and the amount of such participation, has been at the sole discretion of SICO’s Board of Directors. None of the costs of the various benefits provided under the SICO Plans have been paid by AIG, although in its restated financial statements, AIG has recorded a charge to reported earnings in the periods restated for the deferred compensation amounts paid to AIG employees by SICO, with an offsetting entry to additional paid-in capital reflecting amounts deemed contributed by SICO. The SICO Plans provide 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 payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment with AIG prior to normal retirement age. In addition, SICO’s Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock.

     SICO has also provided certain personal benefits to AIG employees. The cost of such benefits, primarily attributable to personal use of corporate aircraft, has not been included in compensation expense.

     Compensation expense with respect to the SICO Plans aggregated $14 million and $69 million for the quarters ended March 31, 2004 and 2003, respectively.

 
  6.  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 SICO, a private holding company, owned or otherwise controlled approximately 19 percent of the voting stock of AIG at December 31, 2003.

     Five directors of AIG served as directors of Starr and SICO as of March 31, 2004 and December 31, 2003. As of April 30, 2005, no director of AIG serving as an executive officer of AIG served as a director of Starr or 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 March 31, 2004.

 
  7.  Commitments and Contingent Liabilities

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

     (a) AIG and certain of its subsidiaries become parties to derivative financial instruments with market risk resulting from both dealer and end user activities and to reduce currency, interest rate, equity and commodity exposures. These instruments are carried at their estimated fair values in the consolidated balance sheet. The vast majority of AIG’s derivative activity is transacted by AIGFP. (See also Note 20 in AIG’s 2004 Form 10-K.)

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

     AIG has issued unconditional guarantees with respect to the prompt payment, when due, of all present and future payment obligations and liabilities of AIGFP arising from transactions entered into by AIGFP. Net revenues for the three months ended March 31, 2004 and 2003 from Capital Markets operations were $317 million and $(601) million, respectively.

     (c) At March 31, 2004, ILFC had committed to purchase 419 new and used aircraft deliverable from 2004

30


 

American International Group, Inc. and Subsidiaries
  7.  Commitments and Contingent Liabilities (continued)

through 2010 at an estimated aggregate purchase price of $24.5 billion and had options to purchase 11 new aircraft deliverable from 2004 to 2008 at an estimated aggregate purchase price of $705 million. ILFC will be required to find customers for any aircraft acquired, and it must arrange financing for portions of the purchase price of such equipment.

     (d) AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. The recent trend of increasing jury awards and settlements makes it 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, together with other industry members, has 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 effect on AIG’s future operating results. The reserves carried for these claims at March 31, 2004 were $1.93 billion gross; $628 million net. In the fourth quarter of 2004 AIG increased its estimates for asbestos and environmental reserves by $1.45 billion gross and $850 million net of reinsurance. See footnote 1(cc) to Notes to Financial Statements in AIG’s 2004 Form 10-K.

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

     (f) On May 18, 2005, the AIG Board of Directors passed resolutions (Resolutions) pursuant to which AIG agrees, subject to certain conditions, to (i) make any payment that is not promptly paid with respect to the benefits accrued by current employees of AIG and its subsidiaries under the SICO Plan (as defined in Note 16 in AIG’s 2004 Form 10-K) and (ii) make any payment to the extent not promptly paid by Starr with respect to amounts that become payable to current employees of AIG and its subsidiaries who are also stockholders of Starr after the giving of a notice of repurchase or redemption under Starr’s organizational documents. AIG will accrue approximately $1 million for 2005 for these contingent liabilities.

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

     (h) On December 30, 2004, an arbitration panel issued its ruling in connection with a 1998 workers compensation quota share reinsurance agreement under which Superior National Insurance Company, among others, was reinsured by The United States Life Insurance Company in the City of New York (USLIFE), a subsidiary of American General Corporation. In its 2-1 ruling the arbitration panel refused to rescind the contract as requested by USLIFE. Instead, the panel reformed the contract to reduce USLIFE’s participation

31


 

American International Group, Inc. and Subsidiaries
 7. Commitments and Contingent Liabilities (continued)

by ten percent. USLIFE disagrees with the ruling and is pursuing all appropriate legal remedies. USLIFE has certain reinsurance recoverables in connection with the contract and the arbitration ruling established a second phase of arbitration in which USLIFE will present its challenges to cessions to the contract.

     AIG recorded approximately a $178 million pre-tax charge in the fourth quarter of 2004 related to this matter and holds a reserve of approximately $370 million as of December 31, 2004.

     (i) As previously disclosed, on October 14, 2004, the Office of the Attorney General of the State of New York (NYAG) brought a lawsuit challenging certain insurance brokerage practices related to contingent commissions. Neither AIG nor any of its subsidiaries is a defendant in that action, although two employees of an AIG subsidiary pleaded guilty in connection with the Attorney General’s investigation in October 2004, and two additional employees of the same subsidiary pleaded guilty in February 2005. AIG has cooperated, and will continue to cooperate, in the investigation. Regulators from several additional states have commenced investigations into the same matters, and AIG expects there will be additional investigations as well. Various parties, including insureds and shareholders, have also asserted putative class action and other claims against AIG or its subsidiaries alleging, among other things, violations of the antitrust and federal securities laws, and AIG expects that additional claims may be made.

     Various federal and state regulatory agencies are reviewing certain other transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries.

     In February 2005, AIG received subpoenas from the NYAG and the SEC relating to investigations into the use of non-traditional insurance products and certain assumed reinsurance transactions and AIG’s accounting for such transactions. The United States Department of Justice and various state regulators are also investigating related issues. AIG has cooperated, and will continue to cooperate, in producing documents and other information in response to the subpoenas. As more fully described in Note 2 herein, AIG has concluded that the accounting for certain transactions and certain relationships needs to be restated or adjusted.

     A number of lawsuits have been filed regarding the subject matter of the investigations of insurance brokerage practices and non-traditional insurance products, including derivative actions in New York state courts and civil actions under the federal securities laws and the Employee Retirement Income Security Act (ERISA) in the U.S. district court for the Southern District of New York. These actions are in the early pleadings stage.

     In addition, in late 2002, a shareholder derivative action was filed in Delaware Chancery Court alleging breaches of fiduciary duty of loyalty and care against AIG’s directors. AIG’s Board of Directors appointed a special committee of independent directors to review the complaint and respond to the lawsuit. The special committee has issued a report that concluded that it was not in the best interests of AIG or its shareholders to pursue the litigation and moved the Delaware Chancery Court to terminate the litigation. The Plaintiff filed an amended complaint on May 17, 2005. The amendment includes additional claims of breach of fiduciary duty by current and former directors of AIG based on, among other things, AIG’s transactions with reinsurers (including reinsurers in which AIG has an ownership interest) and accounting for these transactions, AIG’s broker compensation practices, and AIG’s sale of finite insurance products.

     On May 26, 2005, the NYAG and the New York Superintendent of Insurance filed a civil complaint against AIG as well as its former Chairman and Chief Executive Officer M.R. Greenberg, and former Vice Chairman and Chief Financial Officer Howard Smith, in the Supreme Court of the State of New York. The complaint asserts claims under New York’s Martin Act and Insurance Law, among others, and makes allegations concerning certain of the transactions discussed more fully in AIG’s 2004 Form 10-K, including, among others, Gen Re, Capco, AIRCO Reinsurance, Life Settlements, Richmond and Union Excess. The complaint seeks disgorgement, injunctive relief, punitive damages and costs, among other things.

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

32


 

American International Group, Inc. and Subsidiaries

  8.  Employee Benefits

The following table presents the components of the net periodic benefit costs with respect to pensions and other benefits for the three months ended March 31, 2004 and 2003:

                                                   
Pensions Postretirement


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

2004
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 15     $ 23     $ 38     $     $ 1     $ 1  
 
Interest cost
    8       40       48             4       4  
 
Expected return on assets
    (5 )     (43 )     (48 )                  
 
Amortization of prior service cost
    (1 )     1                   (1 )     (1 )
 
Amortization of transitional liability
    1             1                    
 
Recognized actuarial loss
    5       14       19                    

Net period benefit cost
  $ 23     $ 35     $ 58     $     $ 4     $ 4  

2003
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 13     $ 20     $ 33     $     $ 1     $ 1  
 
Interest cost
    8       38       46             4       4  
 
Expected return on assets
    (5 )     (36 )     (41 )                  
 
Amortization of prior service cost
    (1 )     1                   (1 )     (1 )
 
Amortization of transitional liability
    1             1                    
 
Recognized actuarial loss
    5       16       21                    
 
Other
    (7 )           (7 )                  

Net period benefit cost
  $ 14     $ 39     $ 53     $     $ 4     $ 4  

 
  9.  Recent Accounting Standards

In January 2003, FASB issued FIN 46. FIN 46 changes the method of determining whether certain entities should be consolidated in AIG’s consolidated financial statements. An entity is subject to FIN 46 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. 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. All other entities not considered VIEs are evaluated for consolidation under other guidance. In December 2003, FASB issued a revision to Interpretation No. 46 (FIN 46R).

     The provisions of FIN 46R had 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 held a variable interest that it acquired before February 1, 2003, FIN 46R was applied as of December 31, 2003. For any VIEs that must be consolidated under FIN 46R that were created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIEs 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. In accordance with the transition provisions of FIN 46R, AIG recorded a gain of $9 million ($14 million before tax) reported as a cumulative effect of an accounting change for the fourth quarter of 2003 and added approximately $4.7 billion of assets and liabilities in its consolidated balance sheet at December 31, 2003.

     In July 2003, the American Institute of Certified Public Accountants issued Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (SOP 03-1). This statement was effective as of January 1, 2004, and requires AIG to recognize a liability for guaranteed minimum death benefits and other living benefits related to its variable annuity and variable life contracts and modifies certain disclosures and financial statement presentations for these products. AIG reported for the first quarter of 2004 a one-time cumulative accounting charge upon adoption of $144 million ($222 million pretax) to reflect the liability as of January 1, 2004. For the first quarter of 2004, the ongoing earnings impact of AIG’s adoption of SOP 03-1 was a $3 million charge ($5 million pretax).

     As of January 1, 2004, approximately $11 billion of assets and liabilities were reclassified representing most of the non-U.S. portion of AIG’s separate and variable account assets and liabilities to several invested asset captions and the Policyholders’ contract deposits liability caption, respectively. The $11 billion of separate and variable account assets were reclassified as follows: $4 billion to Short-term investments; $4 billion to Equity securities – common stocks; $2 billion to Fixed maturities – bond trading securities; and $1 billion to various other asset captions.

     Except as noted above, AIG reports variable contracts through separate and variable accounts when investment in-

33


 

American International Group, Inc. and Subsidiaries
  9.  Recent Accounting Standards (continued)

come and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). AIG also reports variable annuity and life contracts through separate and variable accounts where AIG contractually guarantees to the contract holder (variable contracts with guarantees) either (a) total deposits made to the contract less any partial withdrawals plus a minimum return (and in minor instances, no minimum returns), (Net Deposits Plus a Minimum Return) or (b) the highest contract value attained, typically on any anniversary date minus any subsequent withdrawals following the contract anniversary (Highest Contract Value Attained). These guarantees include benefits that are payable in the event of death, annuitization, or in other instances, at specified dates during the accumulation period. Such benefits are referred to as guaranteed minimum death benefits (GMDB), guaranteed minimum income benefits (GMIB), and guaranteed minimum withdrawal benefit (GMWB) or guaranteed minimum account value benefits (GMAV), respectively. For AIG, GMDB is by far the most widely offered benefit.

     The assets supporting the variable portion of both traditional variable annuities and variable contracts with guarantees are carried at fair value and reported as summary total separate and variable account assets with an equivalent summary total reported for liabilities. Amounts assessed against the contract holders for mortality, administrative, and other services are included in revenue and changes in liabilities for minimum guarantees are included in policyholder benefits in the Consolidated Statement of Income. Separate and variable account net investment income, net investment gains and losses, and the related liability changes are offset within the same line item in the Consolidated Statement of Income.

     The vast majority of AIG’s exposure on guarantees made to variable contract holders arises from GMDB. Details concerning AIG’s GMDB exposures as of March 31, 2004 are as follows:

                 
Net Deposits Highest
Plus a Minimum Contract
(dollars in billions) Return Value Attained

Account Value(a)
  $ 51     $ 13  
Amount at Risk(b)
    9       2  
Average Attained Age of Contract Holders by Product
    50-70 years       50-70 years  

Range of Guaranteed Minimum Return Rates
    0-5%       0%  

(a)  Included in Policyholders’ Contract Deposits in the Consolidated Balance Sheet.
(b)  Represents the amount of death benefit currently in excess of Account Value.

     The following summarizes GMDB liabilities for guarantees on variable contracts reflected in the general account.

         
(in millions)

Balance at January 1, 2004*
  $ 479  
Reserve increase
    30  
Benefits paid
    (21 )

Balance at March 31, 2004
  $ 488  

Includes amounts from the one-time cumulative accounting charge resulting from the adoption of SOP 03-1.

     The GMDB liability is determined each period end by estimating the expected value of death benefits in excess of the projected account balance and recognizing the excess ratably over the accumulation period based on total expected assessments. AIG regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised.

     The following assumptions and methodology were used to determine the domestic and foreign GMDB liability as of March 31, 2004:

Data used was up to 5,000 stochastically generated investment performance scenarios.
 
Mean investment performance assumptions ranged from approximately 5 percent to 10 percent depending on the block of business.
 
Volatility assumptions ranged from 16 percent to 19 percent depending on the block of business.
 
Mortality was assumed at between 60 percent and 100 percent of various life and annuity mortality tables.
 
For domestic contracts, lapse rates vary by contract type and duration and ranged from 1 percent to 30 percent. For Japan, lapse rates ranged from 0 percent to 8 percent depending on the type of contract.
 
For domestic contracts, the discount rate was approximately 8 percent. For Japan, the discount rate ranged from 1.5 percent to 7 percent.

     In addition to GMDB, AIG’s contracts currently include to a lesser extent GMIB. The GMIB liability is determined each period end by estimating the expected value of the annuitization benefits in excess of the projected account balance at the date of annuitization and recognizing the excess ratably over the accumulation period based on total expected assessments. AIG regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit expense, if actual experience or other evidence suggests that earlier assumptions should be revised. As of March 31, 2004, most of AIG’s GMIB exposure was transferred via reinsurance agreements.

     AIG contracts currently include a minimal amount of GMAV and GMWB. GMAV and GMWB are considered to be derivatives and are recognized at fair value through earn-

34


 

American International Group, Inc. and Subsidiaries
  9.  Recent Accounting Standards (continued)

ings. AIG enters into derivative contracts to partially hedge the economic exposure that arises from GMAV and GMWB.

     In December 2003, FASB issued Statement of Financial Accounting Standards No. 132 (Revised) “Employers’ Disclosures About Pensions and Other Post Retirement Benefits” which revised disclosure requirements with respect to defined benefit plans. (See also Note 8.)

     At the March 2004 meeting, the Emerging Issue Task Force (EITF) reached a consensus with respect to Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” On September 30, 2004, the FASB issued FASB Staff Position (FSP) EITF No. 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” delaying the effective date of this guidance until the FASB has resolved certain implementation issues with respect to this guidance. The disclosure requirements of EITF 03-1 were previously adopted by AIG as of December 31, 2003 and reflected in the Annual Report on Form 10-K for that year for investments accounted for under FAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” For all other investments within the scope of this Issue, the disclosures are effective for the year ended December 31, 2004.

35


 

American International Group, Inc. and Subsidiaries
10.  Information Provided in Connection with Outstanding Debt

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

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

American General Corporation:

Condensed Consolidating Balance Sheet

                                           
American
International
March 31, 2004 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,686     $     $ 576,112     $ (9,974 )   $ 567,824  
 
Cash
    4             1,916             1,920  
 
Carrying value of subsidiaries and partially owned companies, at equity
    75,518       22,398       9,141       (105,554 )     1,503  
 
Other assets
    2,939       3,332       150,095       (8,535 )     147,831  

Total assets
  $ 80,147     $ 25,730     $ 737,264     $ (124,063 )   $ 719,078  

Liabilities:
                                       
 
Insurance liabilities
  $ 396     $     $ 385,305     $ (12 )   $ 385,689  
 
Debt
    3,917       2,677       87,084       (10,018 )     83,660  
 
Other liabilities
    90       3,819       178,435       (8,552 )     173,792  

Total liabilities
    4,403       6,496       650,824       (18,582 )     643,141  

Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    75,744       19,234       86,247       (105,481 )     75,744  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 80,147     $ 25,730     $ 737,264     $ (124,063 )   $ 719,078  

                                           
American
International
December 31, 2003 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,811     $     $ 527,475     $ (10,500 )   $ 518,786  
 
Cash
    19             903             922  
 
Carrying value of subsidiaries and partially owned companies, at equity
    69,718       21,489       11,126       (100,913 )     1,420  
 
Other assets
    2,662       2,602       148,604       (843 )     153,025  

Total assets
  $ 74,210     $ 24,091     $ 688,108     $ (112,256 )   $ 674,153  

Liabilities:
                                       
 
Insurance liabilities
  $ 358     $     $ 357,463     $ (31 )   $ 357,790  
    Debt
    3,932       2,824       83,416       (9,963 )     80,209  
 
Other liabilities
    (110 )     3,849       163,651       (1,458 )     165,932  

Total liabilities
    4,180       6,673       604,530       (11,452 )     603,931  

Preferred shareholders’ equity in subsidiary companies
                192             192  
Total shareholders’ equity
    70,030       17,418       83,386       (100,804 )     70,030  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 74,210     $ 24,091     $ 688,108     $ (112,256 )   $ 674,153  

36


 

American International Group, Inc. and Subsidiaries
10.  Information Provided in Connection with Outstanding Debt (continued)

Condensed Consolidating Statement of Income

                                         
American
International
Three Months Ended March 31, 2004 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ 98 (a)   $ (30 ) (b)   $ 3,871 (c)   $     $ 3,939 (d)
Equity in undistributed net income of consolidated subsidiaries
    2,297       566             (2,863 )      
Dividend income from consolidated subsidiaries
    322       24             (346 )      
Income taxes (benefits)
    161       (11 )     1,019             1,169  
Minority interest
                (70 )           (70 )
Cumulative effect of an accounting change, net of tax
                (144 )           (144 )

Net income (loss)
  $ 2,556     $ 571     $ 2,638     $ (3,209 )   $ 2,556  

                                         
American
International
Three Months Ended March 31, 2003 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ (121 )(e)   $     $ 2,327 (f)   $     $ 2,206 (g)
Equity in undistributed net income of consolidated subsidiaries
    1,502       499             (2,001 )      
Dividend income from consolidated subsidiaries
    208       5             (213 )      
Income taxes
    64       11       545             620  
Minority interest
                (61 )           (61 )

Net income (loss)
  $ 1,525     $ 493     $ 1,721     $ (2,214 )   $ 1,525  

(a)  Includes other income (deductions) — net and other realized capital gains (losses) of $17 million.
(b)  Includes other income (deductions) — net and other realized capital gains (losses) of $(30) million.
(c)  Includes other income (deductions) — net and other realized capital gains (losses) of $(172) million.
(d)  Includes other income (deductions) — net and other realized capital gains (losses) of $(185) million.
(e)  Includes other income (deductions) — net and other realized capital gains (losses) of $(181) million.
(f)  Includes other income (deductions) — net and other realized capital gains (losses) of $(147) million.
(g)  Includes other income (deductions) — net and other realized capital gains (losses) of $(328) million.

Condensed Consolidating Statements of Cash Flow

                                   
American
International
Three Months Ended March 31, 2004 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries AIG

Net cash provided by operating activities
  $ 527     $ 468     $ 7,724     $ 8,719  

Cash flows from investing:
                               
 
Invested assets disposed
    315             48,362       48,677  
 
Invested assets acquired
    (176 )           (68,044 )     (68,220 )
 
Other
    (345 )     (302 )     465       (182 )

Net cash used in investing activities
    (206 )     (302 )     (19,217 )     (19,725 )

Cash flows from financing activities:
                               
 
Change in debts
    (24 )     (147 )     3,558       3,387  
 
Other
    (192 )     (19 )     8,626       8,415  

Net cash provided by (used in) financing activities
    (216 )     (166 )     12,184       11,802  

Change in cumulative translation adjustments
    (120 )           322       202  

Change in cash
    (15 )           1,013       998  
Cash at beginning of period
    19             903       922  

Cash at end of period
  $ 4     $     $ 1,916     $ 1,920  

37


 

American International Group, Inc. and Subsidiaries
10.  Information Provided in Connection with Outstanding Debt (continued)
                                   
American
International
Three Months Ended March 31, 2003 (As Restated) Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries AIG

Net cash provided by (used in) operating activities
  $ (11 )   $ 473     $ 7,458     $ 7,920  

Cash flows from investing:
                               
 
Invested assets disposed
    125             46,529       46,654  
 
Invested assets acquired
                (61,571 )     (61,571 )
 
Other
    (71 )     (80 )     (93 )     (244 )

Net cash provided by (used in) investing activities
    54       (80 )     (15,135 )     (15,161 )

Cash flows from financing activities:
                               
 
Change in debts
    56       (378 )     2,852       2,530  
 
Other
    (114 )     (14 )     4,318       4,190  

Net cash provided by (used in) financing activities
    (58 )     (392 )     7,170       6,720  

Change in cumulative translation adjustments
    1             15       16  

Change in cash
    (14 )     1       (492 )     (505 )
Cash at beginning of period
    18       1       1,146       1,165  

Cash at end of period
  $ 4     $ 2     $ 654     $ 660  

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

AIG Liquidity Corp.:

Condensed Consolidating Balance Sheet

                                           
American
International AIG
March 31, 2004 (As Restated) Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,686     $ *     $ 576,112     $ (9,974 )   $ 567,824  
 
Cash
    4       *       1,916             1,920  
 
Carrying value of subsidiaries and partially owned companies, at equity
    75,518             31,539       (105,554 )     1,503  
 
Other assets
    2,939       *       153,427       (8,535 )     147,831  

Total assets
  $ 80,147     $ *     $ 762,994     $ (124,063 )   $ 719,078  

Liabilities:
                                       
 
Insurance liabilities
  $ 396     $     $ 385,305     $ (12 )   $ 385,689  
 
Debt
    3,917       *       89,761       (10,018 )     83,660  
 
Other liabilities
    90       *       182,254       (8,552 )     173,792  

Total liabilities
    4,403       *       657,320       (18,582 )     643,141  

Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    75,744       *       105,481       (105,481 )     75,744  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 80,147     $ *     $ 762,994     $ (124,063 )   $ 719,078  

Amounts significantly less than $1 million.

38


 

American International Group, Inc. and Subsidiaries
10.  Information Provided in Connection with Outstanding Debt (continued)
                                           
American
International AIG
December 31, 2003 (As Restated) Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,811     $ *     $ 527,475     $ (10,500 )   $ 518,786  
 
Cash
    19       *       903             922  
 
Carrying value of subsidiaries and partially owned companies, at equity
    69,718             32,615       (100,913 )     1,420  
 
Other assets
    2,662       *       151,206       (843 )     153,025  

Total assets
  $ 74,210     $ *     $ 712,199     $ (112,256 )   $ 674,153  

Liabilities:
                                       
 
Insurance liabilities
  $ 358     $     $ 357,463     $ (31 )   $ 357,790  
 
Debt
    3,932       *       86,240       (9,963 )     80,209  
 
Other liabilities
    (110 )     *       167,500       (1,458 )     165,932  

Total liabilities
    4,180       *       611,203       (11,452 )     603,931  

Preferred shareholders’ equity in subsidiary companies
                192             192  
Total shareholders’ equity
    70,030       *       100,804       (100,804 )     70,030  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 74,210     $ *     $ 712,199     $ (112,256 )   $ 674,153  

* Amounts significantly less than $1 million.

Condensed Consolidating Statement of Income

                                         
American
Three Months Ended March 31, 2004 International AIG
(As Restated) Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Operating income
  $ 98 (a)   $ *     $ 3,841 (b)   $     $ 3,939 (c)
Equity in undistributed net income of consolidated subsidiaries
    2,297             566       (2,863 )      
Dividend income from consolidated subsidiaries
    322             24       (346 )      
Income taxes
    161       *       1,008             1,169  
Minority interest
                (70 )           (70 )
Cumulative effect of an accounting change, net of tax
                (144 )           (144 )

Net income (loss)
  $ 2,556     $ *     $ 3,209     $ (3,209 )   $ 2,556  

* Amounts significantly less than $1 million.
(a)  Includes other income (deductions) — net and other realized capital gains (losses) of $17 million.
(b)  Includes other income (deductions) — net and other realized capital gains (losses) of $(202) million.
(c)  Includes other income (deductions) — net and other realized capital gains (losses) of $(185) million.

Condensed Consolidating Statements of Cash Flow

                                   
American
International AIG
Three Months Ended March 31, 2004 (As Restated) Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries AIG

Net cash provided by operating activities
  $ 527     $ *     $ 8,192     $ 8,719  

Cash flows from investing:
                               
 
Invested assets disposed
    315             48,362       48,677  
 
Invested assets acquired
    (176 )           (68,044 )     (68,220 )
 
Other
    (345 )     *       163       (182 )

Net cash used in investing activities
    (206 )     *       (19,519 )     (19,725 )

Cash flows from financing activities:
                               
 
Change in debts
    (24 )           3,411       3,387  
 
Other
    (192 )     *       8,607       8,415  

Net cash provided by financing activities
    (216 )     *       12,018       11,802  

Change in cumulative translation adjustments
    (120 )           322       202  

Change in cash
    (15 )     *       1,013       998  
Cash at beginning of period
    19             903       922  

Cash at end of period
  $ 4     $ *     $ 1,916     $ 1,920  

* Amounts significantly less than $1 million.

39


 

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

    40  
    41  
    42  
      42  
    44  
    44  
      44  
        46  
        47  
        48  
        51  
      54  
        55  
        56  
      57  
        58  
        58  
      61  
        62  
        63  
      65  
        65  
      66  
 CAPITAL RESOURCES     66  
        66  
        68  
        69  
        70  
        70  
        70  
 LIQUIDITY     70  
    72  
 DERIVATIVES     72  
 MANAGING MARKET RISK     72  
        73  
        73  
 RECENT ACCOUNTING STANDARDS     75  
 CONTROLS AND PROCEDURES     75  

Cautionary Statement Regarding
Forward-Looking Information

This Quarterly 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 the status and potential future outcome of the current regulatory and civil proceedings against AIG and their potential effect on AIG’s businesses, financial position, results of operations, cash flows and liquidity, the effect of the credit rating downgrades on AIG’s businesses and competitive position, the unwinding and resolving of various relationships between AIG and Starr and SICO, AIG’s strategy for growth, product development, market position, financial results and reserves. It is possible that AIG’s actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these 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 (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.

40


 

American International Group, Inc. and Subsidiaries

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

Restatement of Previously Issued
Financial Statements

     Internal Review. In connection with the preparation of AIG’s consolidated financial statements included in AIG’s 2004 Form 10-K, AIG’s current management initiated an internal review of AIG’s books and records, which was substantially expanded in mid-March 2005. The internal review, conducted under the direction of current senior management, with the oversight of the Audit Committee of the Board of Directors, spanned AIG’s major business units globally, and included a review of information and a number of transactions from 2000 to the present. In certain cases, items in periods prior to 2000 were examined due to the nature of the transactions under review. The business units subject to review were Domestic General Insurance, Foreign General Insurance, Reinsurance, Financial Services, Domestic and Foreign Life Insurance & Retirement Services and Asset Management. The internal review encompassed AIG’s books and records, thousands of files and e-mails and interviews with current and former employees and members of management. Management believes that the scope and process of its internal review was sufficient to identify issues of a material nature that could affect AIG’s financial statements.

     AIG’s internal review was complemented by investigations by outside counsel for AIG and for the Audit Committee of the Board of Directors. PricewaterhouseCoopers LLP, an independent registered public accounting firm (PwC or independent auditors), was consulted on the scope of the internal review for certain matters and reviewed the results of the internal review.

     As a result of the findings of the internal review, together with the results of investigations conducted by outside counsel at the request of AIG’s Audit Committee and in consultation with AIG’s independent auditors, AIG concluded that the accounting for certain transactions and certain relationships needed to be restated.

     Restatement. AIG has restated its financial statements for the years ended December 31, 2003, 2002, 2001 and 2000, the quarters ended March 31, June 30 and September 30, 2004 and 2003 and the quarter ended December 31, 2003. See Selected Financial Data and Note 2 of Notes to Financial Statements in the 2004 Form 10-K and Note 2 of Notes to Financial Statements included herein for a discussion of the restatement and a reconciliation of previously reported amounts to the restated amounts for the years ended December 31, 2003, 2002, 2001 and 2000, and the quarterly periods ended March 31, 2004 and 2003.

41


 

American International Group, Inc. and Subsidiaries

Overview of Operations and Business Results

AIG’s operations in 2004 are conducted by its subsidiaries principally through four operating segments: General Insurance, Life Insurance & Retirement Services, Financial Services and Asset Management. All financial information herein gives effect to the restatement and adjustments for changes in estimate described in “Restatement of Previously Issued Financial Statements,” herein. Through these segments, AIG provided insurance and investment products and services to both businesses and individuals in over 130 countries and jurisdictions. This geographic product and service diversification is one of AIG’s major strengths and sets it apart from its competitors. Although regional economic downturns or political upheaval could negatively affect parts of AIG’s operations, AIG believes that this diversification makes it unlikely that regional difficulties would have a material impact on its operating results, financial condition or liquidity.

     Beginning in the first quarter of 2004, AIG is reporting Retirement Services results in the same segment as Life Insurance, reflecting the convergence of protective and retirement products and AIG’s current management of these operations.

     For further detail, see the discussions with respect to the results of the Life Insurance & Retirement Services and Asset Management in the respective Operational Review discussion herein.

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

     AIG’s first quarter 2004 operating performance reflects implementation of various long-term strategies and defined goals in its various operating segments.

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

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

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

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

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

The following table summarizes AIG’s revenues, income before income taxes, minority interest and cumulative effect of an accounting change and net income for the three months ended March 31, 2004 and 2003:

                 
2004 2003
(in millions) (Restated) (Restated)

Total revenues
  $ 23,375     $ 18,192  

Income before income taxes, minority interest and cumulative effect of an accounting change
    3,939       2,206  

Net income
  $ 2,556     $ 1,525  

Consolidated Results

The 28.5 percent growth in revenues in the first three months of 2004 was primarily attributable to the growth in net premiums earned from global General Insurance operations as well as growth in both General Insurance and Life Insurance & Retirement Services net investment income and GAAP Life Insurance & Retirement Services premiums.

     AIG’s income before income taxes, minority interest and cumulative effect of an accounting change increased 78.6 percent in the first three months of 2004 when compared to the

42


 

American International Group, Inc. and Subsidiaries
same period of 2003. General Insurance operating income gains and improved Financial Services results were the primary factors for the increase over 2003 in both pretax income and net income.

The following table summarizes the operations of each principal segment for the three months ended March 31, 2004 and 2003. (See also Note 3 of Notes to Financial Statements.)

                   
2004 2003
(in millions) (Restated) (Restated)

Revenues:(a)
               
 
General Insurance(b)
  $ 10,075     $ 7,629  
 
Life Insurance & Retirement Services(c)
    10,523       9,046  
 
Financial Services(d)
    1,788       787  
 
Asset Management(e)
    1,032       864  
 
Other
    (43 )     (134 )

Total
  $ 23,375     $ 18,192  

Operating Income (loss)(a)(f):
               
 
General Insurance
  $ 1,441     $ 986  
 
Life Insurance & Retirement Services
    1,785       1,722  
 
Financial Services
    545       (376 )
 
Asset Management
    353       202  
 
Other(g)
    (185 )     (328 )

Total
  $ 3,939     $ 2,206  

(a) Revenues and operating income reflect the adjustments necessary pursuant to FAS 133. See Restatement of Previously Issued Financial Statements – Accounting for Derivatives (FAS 133 Hedge Accounting).
(b) Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(c) Represents the sum of Life Insurance & Retirement Services GAAP premiums, net investment income and realized capital gains (losses).
(d) Represents interest, lease and finance charges.
(e) Represents management and advisory fees, and net investment income with respect to GICs.
(f) Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(g) Represents other income (deductions) – net and other realized capital gains (losses).

General Insurance

AIG’s General Insurance operations provide property and casualty products and services throughout the world. The increase in General Insurance operating income in the first three months of 2004 compared to the same period of 2003 was primarily attributable to strong growth in operating income with respect to Domestic Brokerage Group’s and Foreign General’s operations. In addition, General Insurance operations had realized capital gains in 2004 compared to realized capital losses in 2003.

Life Insurance & Retirement Services

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

     Life Insurance & Retirement Services operating income increased by 3.7 percent in the first three months of 2004 compared to the same period of 2003. This increase resulted from growth in each of AIG’s principal Life Insurance & Retirement Services businesses, offset by realized capital losses in 2004 rather than the realized capital gains in 2003.

Financial Services

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

     Financial Services operating income increased in the first three months of 2004 compared to the same period in 2003 primarily due to the fluctuation in earnings resulting from derivative activities that did not qualify for hedge accounting under FAS 133. Offsetting this increase is the effect of ILFC’s disposition of approximately $2 billion in aircraft through securitizations in the third quarter of 2003 and first quarter of 2004. Fluctuations in revenues and operating income from quarter to quarter are not unusual because of the transaction-oriented nature of Capital Markets operations and the effect of the FAS 133 adjustments. Consumer Finance operations increased revenues and operating income, both domestically and internationally.

Asset Management

AIG’s Asset Management operations provide asset management services and sell GICs. These products and services are offered to individuals, and institutions both domestically and overseas.

     Asset Management operating income increased 74.8 percent in the first three months of 2004 when compared to the same period of 2003 as a result of the upturn in worldwide financial markets and a strong global product portfolio.

Capital Resources

At March 31, 2004, AIG had total consolidated shareholders’ equity of $75.74 billion and total consolidated borrowings of $83.66 billion. At that date, $74.84 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs), liabilities connected to trust preferred stock, or matched notes and bonds payable.

     During the period from January 1, 2004 through March 31, 2004, AIG repurchased in the open market 1,313,300 shares of its common stock.

Liquidity

At March 31, 2004, consolidated invested assets included $18.69 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first three months of 2004 amounted to $8.72 billion. AIG believes that its liquid assets, cash provided by operations and access to short-term funding through commercial paper and

43


 

American International Group, Inc. and Subsidiaries
bank credit facilities will enable it to meet any anticipated cash requirements.

Critical Accounting Estimates

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

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

Reserves for Losses and Loss Expenses (General Insurance):

Loss trend factors: used to establish expected loss ratios for subsequent accident years based on premium rate adequacy and the projected loss ratio with respect to prior accident years.
Expected loss ratios for the latest accident year: in this case, accident year 2003 for the year end 2003 loss reserve analysis. For low frequency, high severity classes such as excess casualty and directors and officers liability (D&O), expected loss ratios generally are utilized for at least the three most recent accident years.
Loss development factors: used to project the reported losses for each accident year to an ultimate amount.

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

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

Estimated Gross Profits (Life Insurance & Retirement Services):

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

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

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

Deferred Policy Acquisition Costs (General Insurance):

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

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

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

Other Than Temporary Declines in Value – Investments:

Securities are considered a candidate for impairment based upon the following criteria:

Trading at a significant (25 percent or more) discount to par, amortized cost (if lower) or cost for an extended period of time (nine months or longer).
 
The occurrence of a discrete credit event resulting in the debtor default, seeking protection or voluntary reorganization.
 
The possibility of non realization of a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.

Operating Review

General Insurance Operations

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

     Domestic general insurance operations are comprised of 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 United Guaranty Corporation (Mortgage Guaranty).

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

44


 

American International Group, Inc. and Subsidiaries

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

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

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

     AIG’s Foreign General insurance group accepts risks primarily underwritten through AIU, a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG’s foreign-based insurance subsidiaries for their own accounts. (See also Note 3 of Notes to Financial Statements.)

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

     A critical discipline of a successful general insurance business is the objective to produce operating income from underwriting exclusive of investment related income. When underwriting is not profitable, premiums are inadequate to pay for insured losses and underwriting related expenses. In these situations, the addition of general insurance related investment income and realized capital gains may, however, enable a general insurance business to produce operating income. If underwriting losses persist over extended periods, an insurance company will likely not continue to exist as a going concern. For these reasons, AIG views underwriting profit to be critical in the overall evaluation of performance. Although in and of itself not a GAAP measurement, AIG believes this measurement is a useful and meaningful disclosure. (See also the discussion under “Liquidity” herein.)

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

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

     A basic premise of GAAP accounting is the recognition of expenses at the same time revenues are earned, the accounting principle of matching. Therefore, to convert underwriting results to a GAAP basis, acquisition expenses are deferred (deferred policy acquisition costs (DAC)) and amortized over the period the related net premiums written are earned. Accordingly, the statutory underwriting profit has been adjusted as a result of acquisition expenses being deferred as required by GAAP. DAC is reviewed for recoverability, and such review requires management judgment. (See also Critical Accounting Estimates herein and Notes 1, 2 and 4 of Notes to Financial Statements in AIG’s 2004 Form 10-K.)

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

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

General Insurance operating income is comprised of underwriting profit, net investment income and realized capital gains and losses. These components, as well as net premiums written, net premiums earned and statutory ratios for the three month periods ending March 31, 2004 and 2003 were as follows:

                     
2004 2003
(in millions, except ratios) (Restated) (Restated)

Net premiums written:
               
 
Domestic General
               
   
DBG
  $ 5,355     $ 4,380  
   
Transatlantic
    907       768  
   
Personal Lines
    1,119       891  
   
Mortgage Guaranty
    154       121  
 
Foreign General
    2,500       1,959  

Total
  $ 10,035     $ 8,119  

Net premiums earned:
               
 
Domestic General
               
   
DBG
  $ 4,938     $ 3,808  
   
Transatlantic
    893       692