FORM 10-Q
Table of Contents



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


Form 10-Q

     
(Mark One)
   
þ
  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the quarterly period ended September 30, 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 September 30, 2004: 2,604,570,819.




Table of Contents

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET

(in millions) (unaudited)


                       
September 30, December 31,
2004 2003

Assets:
               
  Investments, financial services assets and cash:                
    Fixed maturities:                
     
Bonds available for sale, at market value (amortized cost: 2004 – $317,392; 2003 – $288,160)
  $ 330,735     $ 300,935  
     
Bonds held to maturity, at amortized cost (market value: 2004 – $15,790; 2003 – $8,173)
    15,415       8,037  
     
Bond trading securities, at market value (cost: 2004 – $2,379; 2003 – $252)
    2,399       282  
    Equity securities:                
     
Common stocks, at market value (cost: 2004 – $13,348; 2003 – $6,884)
    14,235       7,678  
     
Preferred stocks, at market value (cost: 2004 – $1,879; 2003 – $1,743)
    1,915       1,906  
   
Mortgage loans on real estate, net of allowance (2004 – $106; 2003 – $101)
    12,833       12,295  
   
Policy loans
    6,784       6,658  
   
Collateral and guaranteed loans, net of allowance (2004 – $17; 2003 – $15)
    2,293       2,296  
    Financial services assets:                
     
Flight equipment primarily under operating leases, net of accumulated depreciation (2004 – $6,104; 2003 – $5,458)
    32,180       30,343  
     
Securities available for sale, at market value (cost: 2004 – $19,622; 2003 – $15,732)
    19,630       15,714  
     
Trading securities, at market value
    3,551       3,300  
     
Spot commodities, at market value
    133       250  
     
Unrealized gain on interest rate and currency swaps, options and forward transactions
    20,793       21,599  
     
Trading assets
    2,360       2,548  
     
Securities purchased under agreements to resell, at contract value
    38,354       28,170  
     
Finance receivables, net of allowance (2004 – $462; 2003 – $453)
    21,531       17,609  
    Securities lending collateral, at cost (approximates market value)     53,803       30,195  
    Other invested assets     21,524       16,787  
    Short-term investments, at cost (approximates market value)     14,672       8,914  
    Cash     2,072       922  

      Total investments, financial services assets and cash     617,212       516,438  
  Investment income due and accrued     5,886       4,959  
 
Premiums and insurance balances receivable, net of allowance (2004 – $278; 2003 – $235)
    16,934       14,166  
  Reinsurance assets     26,730       27,962  
  Deferred policy acquisition costs     28,656       26,398  
  Investments in partially owned companies     1,359       1,428  
 
Real estate and other fixed assets, net of accumulated depreciation (2004 – $4,599; 2003 – $4,247)
    5,999       6,006  
  Separate and variable accounts     52,664       60,536  
  Goodwill     8,407       7,633  
  Other assets     12,573       12,820  

Total assets
  $ 776,420     $ 678,346  

See Accompanying Notes to Financial Statements.

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Table of Contents

American International Group, Inc. and Subsidiaries

CONSOLIDATED BALANCE SHEET (continued)

(in millions, except share amounts) (unaudited)


                     
September 30, December 31,
2004 2003

Liabilities:
               
 
Reserve for losses and loss expenses
  $ 62,150     $ 56,118  
 
Reserve for unearned premiums
    23,275       20,762  
 
Future policy benefits for life and accident and health insurance contracts
    98,105       92,970  
 
Policyholders’ contract deposits
    208,497       171,989  
 
Other policyholders’ funds
    9,704       9,100  
 
Reserve for commissions, expenses and taxes
    4,584       4,487  
 
Insurance balances payable
    3,422       2,592  
 
Funds held by companies under reinsurance treaties
    5,522       4,664  
 
Income taxes payable:
               
   
Current
    2,709       1,977  
   
Deferred
    6,564       5,778  
 
Financial services liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    18,461       15,337  
   
Securities sold under agreements to repurchase, at contract value
    19,473       14,810  
   
Trading liabilities
    2,651       6,153  
   
Securities and spot commodities sold but not yet purchased, at market value
    4,895       5,458  
   
Unrealized loss on interest rate and currency swaps, options and forward transactions
    18,724       15,268  
   
Trust deposits and deposits due to banks and other depositors
    3,610       3,491  
   
Commercial paper
    6,059       4,715  
   
Notes, bonds, loans and mortgages payable
    56,925       50,138  
 
Commercial paper
    3,165       1,223  
 
Notes, bonds, loans and mortgages payable
    5,599       5,865  
 
Preferred shareholders’ equity in subsidiary companies subject to mandatory redemption
    1,488       1,682  
 
Separate and variable accounts
    52,664       60,536  
 
Minority interest
    4,159       3,311  
 
Securities lending payable
    53,803       30,195  
 
Other liabilities
    21,116       18,282  

Total liabilities
    697,324       606,901  

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
    575       568  
 
Retained earnings
    68,456       60,960  
 
Accumulated other comprehensive income
    4,700       4,244  
 
Treasury stock, at cost; 2004 – 146,756,657; 2003 – 142,880,430 shares of common stock
    (1,706 )     (1,397 )

Total shareholders’ equity
    78,903       71,253  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 776,420     $ 678,346  

See Accompanying Notes to Financial Statements.

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Table of Contents

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF INCOME

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


                                     
Nine Months Three Months
Ended Ended
September 30, September 30,


2004 2003 2004 2003

Revenues:
                               
 
Premiums and other considerations
  $ 50,150     $ 40,316     $ 17,690     $ 13,869  
 
Net investment income
    14,084       12,203       4,708       4,088  
 
Realized capital gains (losses)
    (72 )     (1,348 )     (12 )     (359 )
 
Other revenues
    8,695       7,953       3,025       2,708  

 
Total revenues
    72,857       59,124       25,411       20,306  

Benefits and expenses:
                               
 
Incurred policy losses and benefits
    42,709       33,989       15,434       11,523  
 
Insurance acquisition and other operating expenses
    17,510       15,277       6,019       5,279  

 
Total benefits and expenses
    60,219       49,266       21,453       16,802  

Income before income taxes, minority interest and cumulative effect of an accounting change
    12,638       9,858       3,958       3,504  

Income taxes:
                               
 
Current
    3,207       2,384       607       873  
 
Deferred
    830       621       673       196  

      4,037       3,005       1,280       1,069  

Income before minority interest and cumulative effect of an accounting change
    8,601       6,853       2,678       2,435  

Minority interest
    (390 )     (286 )     (166 )     (98 )

Income before cumulative effect of an accounting change
    8,211       6,567       2,512       2,337  

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

Net income
  $ 8,030     $ 6,567     $ 2,512     $ 2,337  

Earnings per common share:
                               
 
Basic
                               
   
Income before cumulative effect of an accounting change
  $ 3.15     $ 2.52     $ 0.97     $ 0.90  
   
Cumulative effect of an accounting change, net of tax
    (0.07 )                  
   
Net income
  $ 3.08     $ 2.52     $ 0.97     $ 0.90  

 
Diluted
                               
   
Income before cumulative effect of an accounting change
  $ 3.12     $ 2.50     $ 0.95     $ 0.89  
   
Cumulative effect of an accounting change, net of tax
    (0.07 )                  
   
Net income
  $ 3.05     $ 2.50     $ 0.95     $ 0.89  

Cash dividends per common share
  $ 0.205     $ 0.159     $ 0.075     $ 0.065  

Average shares outstanding:
                               
 
Basic
    2,608       2,610       2,606       2,610  
 
Diluted
    2,630       2,628       2,628       2,628  

See Accompanying Notes to Financial Statements.

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American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS

(in millions) (unaudited)


                       
Nine Months Ended September 30, 2004 2003

Summary:
               
 
Net cash provided by operating activities
  $ 20,432     $ 20,557  
 
Net cash used in investing activities
    (54,578 )     (40,086 )
 
Net cash provided by financing activities
    35,295       19,289  
 
Change in cumulative translation adjustments
    1       24  

 
Change in cash
    1,150       (216 )
 
Cash at beginning of period
    922       1,165  

 
Cash at end of period
  $ 2,072     $ 949  

Cash flows from operating activities:
               
 
Net income
  $ 8,030     $ 6,567  

 
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
    16,288       16,843  
     
Premiums and insurance balances receivable and payable – net
    (1,939 )     (1,795 )
     
Reinsurance assets
    1,232       (2,962 )
     
Deferred policy acquisition costs
    (2,366 )     (2,128 )
     
Investment income due and accrued
    (880 )     (546 )
     
Funds held under reinsurance treaties
    858       792  
     
Other policyholders’ funds
    604       380  
     
Current and deferred income taxes – net
    1,562       1,513  
     
Reserve for commissions, expenses and taxes
    96       132  
     
Other assets and liabilities – net
    1,417       (472 )
     
Trading assets and liabilities – net
    (3,314 )     959  
     
Trading securities, at market value
    (251 )     877  
     
Spot commodities, at market value
    117       165  
     
Net unrealized (gain) loss on interest rate and currency swaps, options and forward transactions
    4,262       (147 )
     
Securities purchased under agreements to resell
    (10,184 )     2,310  
     
Securities sold under agreements to repurchase
    4,663       2,050  
     
Securities and spot commodities sold but not yet purchased, at market value
    (563 )     (6,524 )
   
Realized capital (gains) losses
    72       1,348  
   
Equity in income of partially owned companies and other invested assets
    (935 )     (389 )
   
Amortization of premium and discount on securities
    231       (59 )
   
Depreciation expenses, principally flight equipment
    1,514       1,386  
   
Provision for finance receivable losses
    282       312  
   
Other – net
    (364 )     (55 )

   
Total adjustments
    12,402       13,990  

Net cash provided by operating activities
  $ 20,432     $ 20,557  

See Accompanying Notes to Financial Statements.

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American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF CASH FLOWS (Continued)

(in millions) (unaudited)


                 
Nine Months Ended September 30, 2004 2003

Cash flows from investing activities:
               
    Cost of bonds, at market sold
  $ 92,777     $ 73,483  
    Cost of bonds, at market matured or redeemed
    10,776       10,668  
    Cost of equity securities sold
    10,621       6,277  
    Realized capital gains (losses)
    (72 )     (1,348 )
    Purchases of fixed maturities
    (140,608 )     (112,221 )
    Purchases of equity securities
    (13,490 )     (6,542 )
    Mortgage, policy and collateral loans granted
    (2,257 )     (1,835 )
    Repayments of mortgage, policy and collateral loans
    1,655       1,282  
    Sales of securities available for sale
    2,032       4,410  
    Maturities of securities available for sale
    3,603       4,143  
    Purchases of securities available for sale
    (9,444 )     (8,037 )
    Sales of flight equipment
    1,155       808  
    Purchases of flight equipment
    (3,932 )     (4,313 )
    Net additions to real estate and other fixed assets
    (531 )     (776 )
    Sales or distributions of other invested assets
    5,434       5,055  
    Acquisitions, net of cash acquired
          (2,091 )
    Investments in other invested assets
    (8,551 )     (7,737 )
    Change in short-term investments
    454       (319 )
    Investments in partially owned companies
    3       219  
    Finance receivable originations and purchases
    (18,026 )     (9,466 )
    Finance receivable principal payments received
    13,823       8,254  

Net cash used in investing activities
  $ (54,578 )   $ (40,086 )

Cash flows from financing activities:
               
    Receipts from policyholders’ contract deposits
  $ 40,393     $ 27,399  
    Withdrawals from policyholders’ contract deposits
    (16,965 )     (12,364 )
    Change in trust deposits and deposits due to banks and other depositors
    136       480  
    Change in commercial paper
    3,286       (1,488 )
    Proceeds from notes, bonds, loans and mortgages payable
    22,471       17,827  
    Repayments on notes, bonds, loans and mortgages payable
    (15,849 )     (10,891 )
    Liquidation of zero coupon notes payable
    (189 )      
    Proceeds from guaranteed investment agreements
    8,006       3,957  
    Maturities of guaranteed investment agreements
    (4,882 )     (4,714 )
    Redemption of subsidiary company preferred stock
    (200 )     (371 )
    Proceeds from common stock issued
    130       44  
    Cash dividends to shareholders
    (535 )     (415 )
    Acquisition of treasury stock
    (508 )     (176 )
    Other – net
    1       1  

Net cash provided by financing activities
  $ 35,295     $ 19,289  

Supplementary information:
               
Taxes paid
  $ 2,011     $ 1,861  

Interest paid
  $ 3,119     $ 2,792  

See Accompanying Notes to Financial Statements.

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Table of Contents

American International Group, Inc. and Subsidiaries

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

(in millions) (unaudited)


                                     
Nine Months Three Months
Ended Ended
September 30, September 30,


2004 2003 2004 2003

Comprehensive income:
                               
 
Net income
  $ 8,030     $ 6,567     $ 2,512     $ 2,337  

Other comprehensive income (loss):
                               
 
Unrealized appreciation (depreciation) of investments – net of reclassification adjustments
    274       4,340       5,135       (3,249 )
   
Deferred income tax (expense) benefit on above changes
    (55 )     (1,529 )     (1,850 )     1,159  
 
Foreign currency translation adjustments*
    155       (38 )     198       (494 )
   
Applicable income tax (expense) benefit on above changes
    (40 )     54       (62 )     133  
 
Net derivative gains (losses) arising from cash flow hedging activities
    240       383       (451 )     261  
   
Deferred income tax (expense) benefit on above changes
    (55 )     (122 )     144       (94 )
 
Retirement plan liabilities adjustment, net of tax
    (63 )     (68 )     (54 )     (2 )

Other comprehensive income (loss)
    456       3,020       3,060       (2,286 )

Comprehensive income
  $ 8,486     $ 9,587     $ 5,572     $ 51  

* Includes insignificant derivative gains and losses arising from hedges of net investments in foreign operations.
See Accompanying Notes to Financial Statements.

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Table of Contents

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, 2003.

 
2.  Segment Information

Beginning with the first quarter of 2004, AIG reported 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. To conform to 2004 presentation, 2003 accounts have been restated.

The following table summarizes the operations by major operating segment for the nine months and quarter ended September 30, 2004 and 2003:

                                   
Nine Months Three Months
Ended Ended
September 30, September 30,
Operating Segments

(in millions) 2004 2003 2004 2003

Revenues:
                               
 
General Insurance(a)
  $ 31,686     $ 25,258     $ 11,153     $ 8,958  
 
Life Insurance & Retirement Services(b)
    32,637       26,273       11,213       8,800  
 
Financial Services (c)
    5,768       5,495       2,038       1,885  
 
Asset Management(d)
    2,927       2,458       987       823  
 
Other
    (161 )     (360 )     20       (160 )

Consolidated
  $ 72,857     $ 59,124     $ 25,411     $ 20,306  

Operating income(e)(f):
                               
 
General Insurance
  $ 4,004     $ 3,596     $ 855     $ 1,240  
 
Life Insurance & Retirement Services
    6,302       4,659       2,167       1,705  
 
Financial Services
    1,788       1,762       656       609  
 
Asset Management
    869       578       353       208  
 
Other(g)
    (325 )     (737 )     (73 )     (258 )

Consolidated
  $ 12,638     $ 9,858     $ 3,958     $ 3,504  

(a)  Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(b)  Represents the sum of GAAP Life Insurance & Retirement Services premiums, net investment income and realized capital gains (losses).
(c)  Represents interest, lease and finance charges.
(d)  Represents management and advisory fees, and net investment income with respect to guaranteed investment contracts.
(e)  Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(f)  Catastrophe losses for the first nine months and third quarter of 2004 were $814 million compared to $73 million for the same periods of 2003.
(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 nine months and quarter ended September 30, 2004 and 2003:

                                   
Nine Months Three Months
Ended Ended
September 30, September 30,
General Insurance

(in millions) 2004 2003 2004 2003

Revenues:
                               
 
Domestic Brokerage Group
  $ 17,947     $ 13,916     $ 6,539     $ 4,905  
 
Transatlantic
    2,964       2,528       1,021       939  
 
Personal Lines
    3,312       2,761       1,128       959  
 
Mortgage Guaranty
    485       489       165       155  
 
Foreign General
    6,955       5,597       2,293       1,996  
 
Reclassifications and Eliminations
    23       (33 )     7       4  

Total General Insurance
  $ 31,686     $ 25,258     $ 11,153     $ 8,958  

Operating Income (loss):
                               
 
Domestic Brokerage Group*
  $ 2,156     $ 1,808     $ 519     $ 547  
 
Transatlantic*
    188       284       (43 )     107  
 
Personal Lines*
    253       190       72       75  
 
Mortgage Guaranty
    294       332       95       100  
 
Foreign General*
    1,090       1,015       205       407  
 
Reclassifications and Eliminations
    23       (33 )     7       4  

Total General Insurance
  $ 4,004     $ 3,596     $ 855     $ 1,240  

Catastrophe losses for the first nine months and third quarter of 2004 by segment were: Domestic Brokerage Group $406 million, Personal Lines $25 million, Transatlantic $165 million and Foreign General $140 million. Catastrophe losses for the first nine months and third quarter of 2003 by segment were: Domestic Brokerage Group $48 million, Personal Lines $5 million, Transatlantic $4 million and Foreign General $16 million.

The following table summarizes AIG’s Life Insurance & Retirement Services operations by major operating unit for the nine months and quarter ended September 30, 2004 and 2003:

                                     
Nine Months Three Months
Ended Ended
Life Insurance & September 30, September 30,
Retirement Services

(in millions) 2004 2003 2004 2003

Revenues:
                               
 
Foreign:
                               
   
American International Assurance and Nan Shan Life
  $ 11,446     $ 9,458     $ 4,044     $ 3,141  
   
ALICO, AIG Star Life and AIG Edison Life
    9,145       5,985       3,038       1,996  
   
Other
    396       352       146       119  
 
Domestic:
                               
   
AGLA and AG Life(a)
    6,784       6,349       2,300       2,102  
   
VALIC, AIG Annuity and AIG SunAmerica(b)
    4,866       4,129       1,685       1,442  

Total Life Insurance & Retirement Services
  $ 32,637     $ 26,273     $ 11,213     $ 8,800  

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American International Group, Inc. and Subsidiaries
 
  2.  Segment Information (continued)
                                     
Nine Months Three Months
Ended Ended
Life Insurance & September 30, September 30,
Retirement Services

(in millions) 2004 2003 2004 2003

Operating Income:
                               
 
Foreign:
                               
   
American International Assurance and Nan Shan Life
  $ 1,515     $ 1,170     $ 472     $ 494  
   
ALICO, AIG Star Life and AIG Edison Life
    2,005       1,301       730       474  
   
Other
    65       72       21       25  
 
Domestic:
                               
   
AGLA and AG Life(a)
    1,196       1,117       396       362  
   
VALIC, AIG Annuity and AIG SunAmerica(b)
    1,521       999       548       350  

Total Life Insurance & Retirement Services
  $ 6,302     $ 4,659     $ 2,167     $ 1,705  

(a)  Includes the life operations of AIG Life Insurance Company and American International Life Assurance Company of New York.
 
(b)  “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 nine months and quarter ended September 30, 2004 and 2003:

                                   
Nine Months Three Months
Ended Ended
September 30, September 30,
Financial Services

(in millions) 2004 2003 2004 2003

Revenues:
                               
 
Aircraft Finance
  $ 2,404     $ 2,272     $ 842     $ 785  
 
Capital Markets*
    1,161       1,242       426       434  
 
Consumer Finance
    2,178       1,957       762       664  
 
Other
    25       24       8       2  

Total Financial Services
  $ 5,768     $ 5,495     $ 2,038     $ 1,885  

Operating income:
                               
 
Aircraft Finance
  $ 547     $ 548     $ 204     $ 190  
 
Capital Markets*
    664       729       248       241  
 
Consumer Finance
    579       489       204       174  
 
Other
    (2 )     (4 )           4  

Total Financial Services
  $ 1,788     $ 1,762     $ 656     $ 609  

Represents AIG Financial Products Corp. and AIG Trading Group Inc.

The following table summarizes AIG’s Asset Management revenues and operating income for the nine months and quarter ended September 30, 2004 and 2003:

                                   
Nine Months Three Months
Ended Ended
September 30, September 30,
Asset Management

(in millions) 2004 2003 2004 2003

Revenues:
                               
 
Guaranteed Investment Contracts
  $ 2,024     $ 1,854     $ 682     $ 617  
 
Institutional Asset Management(a)
    718       456       243       156  
 
Brokerage Services and Mutual Funds
    185       148       62       50  

Total Asset Management
  $ 2,927     $ 2,458     $ 987     $ 823  

Operating income:
                               
 
Guaranteed Investment Contracts
  $ 477     $ 393     $ 142     $ 135  
 
Institutional Asset Management(a)(b)
    338       141       194       53  
 
Brokerage Services and Mutual Funds
    54       44       17       20  

Total Asset Management
  $ 869     $ 578     $ 353     $ 208  

(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 consolidated effective December 31, 2003 pursuant to FIN46R, “Consolidation of Variable Interest Entities”. For the first nine months and third quarter of 2004, operating income includes $147 million and $116 million, respectively, of third-party limited partner earnings offset in Minority interest expense.
 
  3.  Earnings Per Share

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

Computation of Earnings Per Share:

                                   
Nine Months Three Months
Ended Ended
September 30, September 30,


(in millions, except per share amounts) 2004 2003 2004 2003

Numerator for basic earnings per share:
                               
Income before cumulative effect of an accounting change
  $ 8,211     $ 6,567     $ 2,512     $ 2,337  
Cumulative effect of an accounting change, net of tax
    (181 )                  

Net income applicable to common stock
  $ 8,030     $ 6,567     $ 2,512     $ 2,337  

Denominator for basic earnings per share:
                               
Average shares outstanding used in the computation of per share earnings:
                               
 
Common stock issued
    2,752       2,752       2,752       2,752  
 
Common stock in treasury
    (144 )     (142 )     (146 )     (142 )

Average shares outstanding – basic
    2,608       2,610       2,606       2,610  

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American International Group, Inc. and Subsidiaries

  3.  Earnings Per Share (continued)
                                 
Nine Months Three Months
Ended Ended
September 30, September 30,


(in millions, except per share amounts) 2004 2003 2004 2003

Numerator for diluted earnings per share:
                               
Income before cumulative effect of an accounting change
  $ 8,211     $ 6,567     $ 2,512     $ 2,337  
Cumulative effect of an accounting change, net of tax
    (181 )                  

Net income applicable to common stock
  $ 8,030     $ 6,567     $ 2,512     $ 2,337  

Denominator for diluted earnings per share:
                               
Average shares outstanding
    2,608       2,610       2,606       2,610  
Incremental shares from potential common stock:
                               
Average number of shares arising from outstanding employee stock plans (treasury stock method)*
    22       18       22       18  

Average shares outstanding – diluted
    2,630       2,628       2,628       2,628  

Earnings per share:
                               
Basic:
                               
Income before cumulative effect of an accounting change
  $ 3.15     $ 2.52     $ 0.97     $ 0.90  
Cumulative effect of an accounting change, net of tax
    (0.07 )                  
Net income
  $ 3.08     $ 2.52     $ 0.97     $ 0.90  

Diluted:
                               
Income before cumulative effect of an accounting change
  $ 3.12     $ 2.50     $ 0.95     $ 0.89  
Cumulative effect of an accounting change, net of tax
    (0.07 )                  
Net income
  $ 3.05     $ 2.50     $ 0.95     $ 0.89  

* Certain shares related to employee stock plans were not included in the computation of diluted earnings per share where the exercise price of the options exceeded the average market price and would have been antidilutive. The number of shares excluded were 7.9 million and 24.9 million for the first nine 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 “Prospective Method” of accounting for stock-based employee compensation effective January 1, 2003. FAS 148 also requires that AIG disclose the impact 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 impact 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 the first nine months of 2004 and the third quarter of 2004 was approximately $0.01 per share and less that $0.005 per share, respectively.

     The quarterly dividend rate per common share, commencing with the dividend paid September 17, 2004 is $0.075.

 
  4.  Starr International Company, Inc. Plan

Starr International Company, Inc. (SICO) provides a Deferred Compensation Profit Participation Plan (SICO Plan) to certain AIG employees. The SICO Plan came into being in 1975 when the voting shareholders and Board of Directors of SICO, a private holding company whose principal asset consists of AIG common stock, decided that a portion of the capital value of SICO should be used to provide an incentive plan for the current and succeeding managements of all American International companies, including AIG. Participation in the SICO Plan by any person, and the amount of such participation, is at the sole discretion of SICO’s Board of Directors, and none of the costs of the various benefits provided under such plan is paid by or charged to AIG. The SICO Plan provides that shares currently owned by SICO may be set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors may permit an early pay-out under certain circumstances. Prior to pay-out, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment with AIG prior to normal retirement age. In addition, SICO’s Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. If the expenses of the SICO Plan had been reflected by AIG, the pre-tax amounts accrued would have been $39 million for the first nine months of 2004 and $96 million for the same period of 2003 and $13 million and $32 million for the third quarter of 2004 and 2003, respectively.

 
  5.  Commitments and Contingent Liabilities

(a) 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.

     (i) 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 AIG Financial Products Corp. and its subsidiaries (AIGFP) and AIG Trading Group Inc. and

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

its subsidiaries (AIGTG). For further discussion on AIG’s derivative activities, see also Note 21 of the Notes to Financial Statements in AIG’s December 31, 2003 10-K.

     (ii) 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, and thereby record 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 and AIGTG arising from transactions entered into by AIGFP and AIGTG. Net revenues for the nine months ended September 30, 2004 and 2003 from Capital Markets operations were $1.16 billion and $1.24 billion, respectively. The Capital Markets operating and reporting unit was established by integrating the operations of AIGTG with AIGFP.

     (iii) At September 30, 2004, International Lease Finance Corporation (ILFC) had committed to purchase 378 new and used aircraft deliverable from 2004 through 2010 at an estimated aggregate purchase price of $22.5 billion and had options to purchase nine new aircraft at an estimated aggregate purchase price of $650 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.

     (iv) 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.

     (b) Various federal and state regulatory agencies are reviewing certain transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries. See discussion under “Recent Developments” in Management’s Discussion and Analysis of Financial Condition and Results of Operations herein.

  6.  Employee Benefits

The following table presents the components of the net periodic benefit costs with respect to pensions and other benefits for the nine months and quarter ended September 30, 2004 and 2003:

                                                   
Pensions Postretirement


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

Nine Months Ended September 30, 2004
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 45     $ 69     $ 114     $     $ 3     $ 3  
 
Interest cost
    24       120       144             12       12  
 
Expected return on assets
    (15 )     (129 )     (144 )                  
 
Amortization of prior service cost
    (2 )     3       1             (5 )     (5 )
 
Amortization of transitional liability
    2             2                    
 
Recognized actuarial loss
    15       42       57             2       2  

Net period benefit cost
  $ 69     $ 105     $ 174     $     $ 12     $ 12  

Three Months Ended September 30, 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                   (2 )     (2 )
 
Amortization of transitional liability
    1             1                    
 
Recognized actuarial loss
    5       14       19             1       1  

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

Nine Months Ended September 30, 2003
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 39     $ 60     $ 99     $ 1     $ 3     $ 4  
 
Interest cost
    24       112       136             12       12  
 
Expected return on assets
    (13 )     (108 )     (121 )                  
 
Amortization of prior service cost
    (2 )     3       1             (5 )     (5 )
 
Amortization of transitional liability
    2       1       3                    
 
Recognized actuarial loss
    15       46       61             1       1  
 
Other
    (20 )           (20 )                  

Net period benefit cost
  $ 45     $ 114     $ 159     $ 1     $ 11     $ 12  

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American International Group, Inc. and Subsidiaries
 
  6.  Employee Benefit (continued)
                                                   
Pensions Postretirement


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

Three Months Ended September 30, 2003
                                               
 
Components of net period benefit cost:
                                               
 
Service cost
  $ 13     $ 20     $ 33     $ 1     $ 1     $ 2  
 
Interest cost
    8       37       45             4       4  
 
Expected return on assets
    (4 )     (36 )     (40 )                  
 
Amortization of prior service cost
    (1 )     2       1             (2 )     (2 )
 
Amortization of transitional liability
    1             1                    
 
Recognized actuarial loss
    5       15       20                    
 
Other
    (7 )           (7 )                  

Net period benefit cost
  $ 15     $ 38     $ 53     $ 1     $ 3     $ 4  

 
  7.  Recent Accounting Standards

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (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 are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which AIG obtains an interest after that date. For VIEs in which AIG holds a variable interest that it acquired before February 1, 2003, 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 were 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 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.

     For further discussion on AIG’s involvement with special purpose vehicles, see also Note 20 of Notes to Financial Statements in AIG’s December 31, 2003 10-K.

     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 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 $181 million to reflect the liability as of January 1, 2004. For the first nine months of 2004, the ongoing earnings impact of AIG’s adoption of SOP 03-1 was a charge of $10 million to benefit expense.

     As of January 1, 2004, approximately $11 billion of assets and liabilities representing most of the non-U.S. portion of AIG’s separate and variable account assets and liabilities were reclassified in accordance with SOP 03-1 to several invested asset captions and to the Policyholders’ contract deposits liability caption, respectively. Approximately $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 income 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,

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  7.  Recent Accounting Standards (continued)

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 September 30, 2004 are as follows:

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

Account Value(a)
  $ 53     $ 11  
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*
  $ 479  
Guaranteed benefits incurred
    116  
Guaranteed benefits paid
    (78 )

Balance at September 30, 2004
  $ 517  

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 September 30, 2004:

Data used was up to 5,000 stochastically generated investment performance scenarios.
 
Mean investment performance assumptions ranged from approximately 4 percent to 10 percent depending on the block of business.
 
Volatility assumptions ranged from 16 percent to 27 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 20 percent depending on the type of contract.
 
For domestic contracts, the discount rate was approximately 8 percent. For Japan, the discount rate ranged from 2 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 September 30, 2004, most of AIG’s GMIB exposure was transferred via reinsurance agreements. Contracts with GMIB not reinsured have account values of $1.0 billion.

     AIG’s contracts currently include a minimal amount of GMAV and GMWB. GMAV and GMWB are considered to be derivatives under Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and are recognized at fair value through earnings. 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 (FAS) 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 6.)

     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)

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  7.  Recent Accounting Standards (continued)

EITF Issue 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 ending December 31, 2004.

     At the September 2004 meeting, the EITF reached a consensus with respect to Issue No. 04-8, “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.” This Issue addresses when the dilutive effect of contingently convertible debt (Co-Cos) with a market price trigger should be included in diluted earnings per share (EPS). The EITF concluded that these securities should be treated as convertible securities and included in a dilutive EPS calculation (if dilutive), regardless of whether the market price triggers (or other contingent features) have been met. Co-Cos are generally convertible into common shares of the issuer after the common stock has exceeded a predetermined threshold for a specific time period. The predetermined threshold is greater than the conversion price of the debt. The guidance is effective for the year ending December 31, 2004 and would be applied by retroactively restating previously reported EPS. The adoption of Issue No. 04-8 will not have a material impact on AIG’s diluted EPS.

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American International Group, Inc. and Subsidiaries

  8.  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
September 30, 2004 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 2,096     $     $ 624,695     $ (11,651 )   $ 615,140  
 
Cash
    14             2,058             2,072  
 
Carrying value of subsidiaries and partially owned companies, at equity
    79,399       24,668       8,934       (111,642 )     1,359  
 
Other assets
    2,972       2,663       155,410       (3,196 )     157,849  

Total assets
  $ 84,481     $ 27,331     $ 791,097     $ (126,489 )   $ 776,420  

Liabilities:
                                       
 
Insurance liabilities
  $ 362     $     $ 414,970     $ (73 )   $ 415,259  
 
Debt
    3,743       2,482       96,052       (12,068 )     90,209  
 
Other liabilities
    1,473       4,229       188,935       (2,781 )     191,856  

Total liabilities
    5,578       6,711       699,957       (14,922 )     697,324  

Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    78,903       20,620       90,947       (111,567 )     78,903  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 84,481     $ 27,331     $ 791,097     $ (126,489 )   $ 776,420  

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

Assets:
                                       
 
Invested assets
  $ 1,865     $     $ 524,151     $ (10,500 )   $ 515,516  
 
Cash
    19             903             922  
 
Carrying value of subsidiaries and partially owned companies, at equity
    71,318       21,434       9,534       (100,858 )     1,428  
 
Other assets
    2,885       2,602       155,836       (843 )     160,480  

Total assets
  $ 76,087     $ 24,036     $ 690,424     $ (112,201 )   $ 678,346  

Liabilities:
                                       
 
Insurance liabilities
  $ 358     $     $ 362,355     $ (31 )   $ 362,682  
 
Debt
    3,932       2,824       80,485       (9,963 )     77,278  
 
Other liabilities
    544       3,849       164,006       (1,458 )     166,941  

Total liabilities
    4,834       6,673       606,846       (11,452 )     606,901  

Preferred shareholders’ equity in subsidiary companies
                192             192  
Total shareholders’ equity
    71,253       17,363       83,386       (100,749 )     71,253  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 76,087     $ 24,036     $ 690,424     $ (112,201 )   $ 678,346  

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

Condensed Consolidating Statement of Income

                                         
American
International
Nine Months Ended September 30, 2004 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ 329     $     $ 12,634     $     $ 12,963  
Equity in undistributed net income of consolidated subsidiaries
    7,480       1,670             (9,150 )      
Dividend income from consolidated subsidiaries
    943       65             (1,008 )      
Other
    (435 )     (84 )     194             (325 )
Income taxes (benefits)
    287       (56 )     3,806             4,037  
Minority interest
                (390 )           (390 )
Cumulative effect of an accounting change, net of tax
                (181 )           (181 )

Net income (loss)
  $ 8,030     $ 1,707     $ 8,451     $ (10,158 )   $ 8,030  

                                         
American
International
Nine Months Ended September 30, 2003 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ 354     $     $ 10,241     $     $ 10,595  
Equity in undistributed net income of consolidated subsidiaries
    5,887       1,254             (7,141 )      
Dividend income from consolidated subsidiaries
    832       180             (1,012 )      
Other
    (334 )     (72 )     (331 )           (737 )
Income taxes (benefits)
    172       (14 )     2,847             3,005  
Minority interest
                (286 )           (286 )

Net income (loss)
  $ 6,567     $ 1,376     $ 6,777     $ (8,153 )   $ 6,567  

                                         
American
International
Three Months Ended September 30, 2004 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ 128     $     $ 3,903     $     $ 4,031  
Equity in undistributed net income of consolidated subsidiaries
    2,307       563             (2,870 )      
Dividend income from consolidated subsidiaries
    297       25             (322 )      
Other
    (102 )     (43 )     72             (73 )
Income taxes (benefits)
    118       (42 )     1,204             1,280  
Minority interest
                (166 )           (166 )

Net income (loss)
  $ 2,512     $ 587     $ 2,605     $ (3,192 )   $ 2,512  

                                         
American
International
Three Months Ended September 30, 2003 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries Eliminations AIG

Operating income
  $ 105     $     $ 3,657     $     $ 3,762  
Equity in undistributed net income of consolidated subsidiaries
    2,217       447             (2,664 )      
Dividend income from consolidated subsidiaries
    287       72             (359 )      
Other
    (140 )     (32 )     (86 )           (258 )
Income taxes (benefits)
    132       (11 )     948             1,069  
Minority interest
                (98 )           (98 )

Net income (loss)
  $ 2,337     $ 498     $ 2,525     $ (3,023 )   $ 2,337  

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

Condensed Consolidating Statements of Cash Flow

                                   
American
International
Nine Months Ended September 30, 2004 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries AIG

Net cash provided by operating activities
  $ 1,782     $ 780     $ 17,870     $ 20,432  

Cash flows from investing:
                               
 
Invested assets disposed
    (399 )           142,660       142,261  
 
Invested assets acquired
    (176 )           (196,132 )     (196,308 )
 
Other
    (34 )     (378 )     (119 )     (531 )

Net cash used in investing activities
    (609 )     (378 )     (53,591 )     (54,578 )

Cash flows from financing activities:
                               
 
Change in debts
    (216 )     (342 )     13,401       12,843  
 
Other
    (854 )     (60 )     23,366       22,452  

Net cash provided by (used in) financing activities
    (1,070 )     (402 )     36,767       35,295  

Change in cumulative translation adjustments
    (107 )           108       1  

Change in cash
    (4 )           1,154       1,150  
Cash at beginning of period
    19             903       922  

Cash at end of period
  $ 15     $     $ 2,057     $ $2,072  

                                   
American
International
Nine Months Ended September 30, 2003 Group, Inc. AGC Other Consolidated
(in millions) Guarantor Issuer Subsidiaries AIG

Net cash provided by operating activities
  $ 806     $ 1,269     $ 18,482     $ 20,557  

Cash flows from investing:
                               
 
Invested assets disposed
    (1,795 )           114,727       112,932  
 
Invested assets acquired
                (150,151 )     (150,151 )
 
Acquisitions, net of cash acquired
                (2,091 )     (2,091 )
 
Other
    (45 )     (836 )     105       (776 )

Net cash used in investing activities
    (1,840 )     (836 )     (37,410 )     (40,086 )

Cash flows from financing activities:
                               
 
Change in debts
    1,554       (377 )     3,514       4,691  
 
Other
    (531 )     (57 )     15,186       14,598  

Net cash provided by (used in) financing activities
    1,023       (434 )     18,700       19,289  

Change in cumulative translation adjustments
                24       24  

Change in cash
    (11 )     (1 )     (204 )     (216 )
Cash at beginning of period
    18       1       1,146       1,165  

Cash at end of period
  $ 7     $     $ 942     $ 949  

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

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

AIG Liquidity Corp.:

Condensed Consolidating Balance Sheet

                                           
American
International AIG
September 30, 2004 Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 2,096     $ *     $ 624,695     $ (11,651 )   $ 615,140  
 
Cash
    14       *       2,058             2,072  
 
Carrying value of subsidiaries and partially owned companies, at equity
    79,399             33,602       (111,642 )     1,359  
 
Other assets
    2,972       *       158,073       (3,196 )     157,849  

Total assets
  $ 84,481     $ *     $ 818,428     $ (126,489 )   $ 776,420  

Liabilities:
                                       
 
Insurance liabilities
  $ 362     $     $ 414,970     $ (73 )   $ 415,259  
 
Debt
    3,743       *       98,534       (12,068 )     90,209  
 
Other liabilities
    1,473       *       193,164       (2,781 )     191,856  

Total liabilities
    5,578       *       706,668       (14,922 )     697,324  

Preferred shareholders’ equity in subsidiary companies
                193             193  
Total shareholders’ equity
    78,903       *       111,567       (111,567 )     78,903  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 84,481     $ *     $ 818,428     $ (126,489 )   $ 776,420  

* Amounts significantly less than $1 million.
                                           
American
International AIG
December 31, 2003 Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Assets:
                                       
 
Invested assets
  $ 1,865     $ *     $ 524,151     $ (10,500 )   $ 515,516  
 
Cash
    19       *       903             922  
 
Carrying value of subsidiaries and partially owned companies, at equity
    71,318             30,968       (100,858 )     1,428  
 
Other assets
    2,885       *       158,438       (843 )     160,480  

Total assets
  $ 76,087     $ *     $ 714,460     $ (112,201 )   $ 678,346  

Liabilities:
                                       
 
Insurance liabilities
  $ 358     $     $ 362,355     $ (31 )   $ 362,682  
 
Debt
    3,932       *       83,309       (9,963 )     77,278  
 
Other liabilities
    544       *       167,855       (1,458 )     166,941  

Total liabilities
    4,834       *       613,519       (11,452 )     606,901  

Preferred shareholders’ equity in subsidiary companies
                192             192  
Total shareholders’ equity
    71,253       *       100,749       (100,749 )     71,253  

Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 76,087     $ *     $ 714,460     $ (112,201 )   $ 678,346  

* Amounts significantly less than $1 million.

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

Condensed Consolidating Statement of Income

                                         
American
International AIG
Nine Months Ended September 30, 2004 Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Operating income
  $ 329     $ *     $ 12,634     $     $ 12,963  
Equity in undistributed net income of consolidated subsidiaries
    7,480             1,670       (9,150 )      
Dividend income from consolidated subsidiaries
    943             65       (1,008 )      
Other
    (435 )           110             (325 )
Income taxes
    287       *       3,750             4,037  
Minority interest
                (390 )           (390 )
Cumulative effect of an accounting change, net of tax
                (181 )           (181 )

Net income (loss)
  $ 8,030     $ *     $ 10,158     $ (10,158 )   $ 8,030  

* Amounts significantly less than $1 million.
                                         
American
International AIG
Three Months Ended September 30, 2004 Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries Eliminations AIG

Operating income
  $ 128     $ *     $ 3,903     $     $ 4,031  
Equity in undistributed net income of consolidated subsidiaries
    2,307             563       (2,870 )      
Dividend income from consolidated subsidiaries
    297             25       (322 )      
Other
    (102 )           29             (73 )
Income taxes
    118       *       1,162             1,280  
Minority interest
                (166 )           (166 )

Net income (loss)
  $ 2,512     $ *     $ 3,192     $ (3,192 )   $ 2,512  

* Amounts significantly less than $1 million.

Condensed Consolidating Statements of Cash Flow

                                   
American
International AIG
Nine Months Ended September 30, 2004 Group, Inc. Liquidity Other Consolidated
(in millions) Guarantor Corp. Subsidiaries AIG

Net cash provided by operating activities
  $ 1,782     $ *     $ 18,650     $ 20,432  

Cash flows from investing:
                               
 
Invested assets disposed
    (399 )           142,660       142,261  
 
Invested assets acquired
    (176 )           (196,132 )     (196,308 )
 
Other
    (34 )     *       (497 )     (531 )

Net cash used in investing activities
    (609 )     *       (53,969 )     (54,578 )

Cash flows from financing activities:
                               
 
Change in debts
    (216 )           13,059       12,843  
 
Other
    (854 )     *       23,306       22,452  

Net cash provided by (used in) financing activities
    (1,070 )     *       36,365       35,295  

Change in cumulative translation adjustments
    (107 )           108       1  

Change in cash
    (4 )     *       1,154       1,150  
Cash at beginning of period
    19             903       922  

Cash at end of period
  $ 15     $ *     $ 2,057     $ 2,072  

* Amounts significantly less than $1 million.

18


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

    20  
      21  
    23  
    24  
      24  
        25  
        26  
        28  
        31  
      34  
        35  
        36  
      37  
        38  
        38  
      41  
        42  
        43  
      45  
        45  
      45  
 CAPITAL RESOURCES     46  
        46  
        48  
        48  
        48  
        48  
        49  
    50  
 LIQUIDITY     50  
 MANAGING MARKET RISK     51  
        51  
        52  
 DERIVATIVES     53  
 RECENT ACCOUNTING STANDARDS     54  
 CONTROLS AND PROCEDURES     54  
 EX-10.A FORMS OF STOCK OPTION GRANT AGREEMENTS
 EX-10.B FORM OF RESTRICTED STOCK UNIT AWARD AGREEMENT
 EX-12 STATEMENT RE COMPUTATION OF RATIOS
 EX-31 CERTIFICATIONS
 EX-32 CERTIFICATIONS

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, AIG’s strategy for growth, product development, regulatory approvals, market position, financial results and reserves. It is possible that AIG’s actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause AIG’s actual results to differ, possibly materially, from those in the specific forward-looking statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations. AIG is not under any obligation to (and expressly disclaims any such obligations to) update or alter any forward-looking statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.

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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 to assist readers seeking related information on a particular subject.

Overview

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. Through these segments, AIG provided insurance and investment products and services to both businesses and individuals in over 130 countries and jurisdictions. This geographic product and service diversification is one of AIG’s major strengths and sets it apart from its competitors. Although regional economic downturns or political upheaval could negatively impact parts of AIG’s operations, AIG believes that this diversification makes it unlikely that regional difficulties would have a material impact on its operating results, financial condition or liquidity.

     Beginning with the first quarter of 2004, AIG reported 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. To conform to 2004 presentation, 2003 accounts have been restated.

     For further detail, see the respective discussions on the results of the Life Insurance & Retirement Services and Asset Management in the Operating Review 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 2004 performance reflects implementation of various long-term strategies and defined goals in its various operating segments.

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

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

     Another central focus of AIG operations in current years is the development and expansion of new distribution channels. During the third quarter of 2004, AIG entered into an agreement with the Sumitomo Life Insurance Company (Sumitomo) to market insurance products underwritten by American Life Insurance Company (ALICO) in Japan. Sumitomo will initially market ALICO’s cancer insurance coverage through the Sumitomo sales channel of approximately 40,000 sales representatives. ALICO and Sumitomo have also agreed to consider expanding the relationship to include other insurance products in the future. 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. AIG participates in the underwriting results through a reinsurance agreement. 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,

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American International Group, Inc. and Subsidiaries

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 nine months ended September 30, 2004 and 2003:

                 
(in millions) 2004 2003

Total revenues
  $ 72,857     $ 59,124  

Income before income taxes, minority interest and cumulative effect of an accounting change
    12,638       9,858  

Net income
  $ 8,030     $ 6,567  

Consolidated Results

The 23.2 percent growth in revenues in the first nine 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. An additional factor in 2004 was the significant decline in aggregate realized capital losses in the first nine months of 2004 compared to the realized capital losses included in the same period of 2003.

     The decline in realized capital losses in 2004 reflects an improved economy, stronger corporate balance sheets and a significantly lower level of impairment loss provisions. The realized capital losses in 2003 reflect primarily impairment loss provisions. Upon the ultimate disposition of these holdings, a portion of these losses may be recovered depending on future market conditions.

     AIG’s income before income taxes, minority interest and cumulative effect of an accounting change increased 28.2 percent in the first nine months of 2004 when compared to the same period of 2003. General Insurance and Life Insurance & Retirement Services operating income gains, together with the decrease in realized capital losses, generated the increase over 2003 in both pretax income and net income. Catastrophe losses in the first nine months of 2004 were $814 million pretax and $512 million, net of tax and minority interest, compared to $73 million pretax and $46 million, net of tax and minority interest, in the same period of 2003.

The following table summarizes the operations of each principal segment for the nine months ended September 30, 2004 and 2003. (See also Note 2 of Notes to Financial Statements.)

                   
(in millions) 2004 2003

Revenues:
               
 
General Insurance(a)
  $ 31,686     $ 25,258  
 
Life Insurance & Retirement Services(b)
    32,637       26,273  
 
Financial Services(c)
    5,768       5,495  
 
Asset Management(d)
    2,927       2,458  
 
Other
    (161 )     (360 )

Consolidated
  $ 72,857     $ 59,124  

Operating Income(e)(f):
               
 
General Insurance
  $ 4,004     $ 3,596  
 
Life Insurance & Retirement Services
    6,302       4,659  
 
Financial Services
    1,788       1,762  
 
Asset Management
    869       578  
 
Other(g)
    (325 )     (737 )

Consolidated
  $ 12,638     $ 9,858  

(a) Represents the sum of General Insurance net premiums earned, net investment income and realized capital gains (losses).
(b) Represents the sum of GAAP Life Insurance & Retirement Services premiums, net investment income and realized capital gains (losses).
(c) Represents interest, lease and finance charges.
(d) Represents management and advisory fees, and net investment income with respect to GICs.
(e) Represents income before income taxes, minority interest and cumulative effect of an accounting change.
(f) Catastrophe losses for the first nine months of 2004 were $814 million compared to $73 million for the same period of 2003.
(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 nine 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 operations. General Insurance operating income in 2004 includes $736 million of catastrophe losses from hurricanes and typhoons compared to $73 million in the same period of 2003. 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 insurance, financial and investment products throughout the world. AIG’s foreign operations provide over 50 percent of AIG’s Life Insurance & Retirement Services operating income.

     Life Insurance & Retirement Services operating income increased by 35.3 percent in the first nine months of 2004 compared to the same period of 2003. This increase resulted from growth in each of AIG’s principal Life Insurance &

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Retirement Services businesses and the capital gains realized in 2004 rather than the capital losses realized in 2003.

Financial Services

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

     Financial Services operating income increased in the first nine months of 2004 compared to the same period of 2003. The increase occurred because of the growth in Consumer Finance operating income, despite the impact of ILFC’s disposition of approximately $2 billion in aircraft through securitizations in the third quarter of 2003 and first quarter of 2004 and the reduced income from Capital Markets operations. Fluctuations in revenues and operating income from quarter to quarter are not unusual because of the transaction-oriented nature of Capital Markets operations.

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 50.3 percent in the first nine 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 September 30, 2004, AIG had total shareholders’ equity of $78.90 billion and total borrowings of $90.21 billion. At that date, $81.29 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable.

     During the period from January 1, 2004 through November 5, 2004, AIG repurchased in the open market 13,310,200 shares of its common stock.

Liquidity

At September 30, 2004, AIG’s consolidated invested assets included $16.74 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first nine months of 2004 amounted to $20.43 billion. AIG believes that its liquid assets, cash provided by operations and access to the capital markets will enable it to meet any foreseeable cash requirements.

Outlook

With respect to overall premium rates in the General Insurance business, industry pricing has eroded in some classes of business. Despite this, AIG believes it will still be able to identify profitable opportunities and build attractive new business as a result of AIG’s broad product line and extensive distribution reach. Both the Domestic Brokerage Group (DBG) and the Foreign General insurance group are benefitting from the flight to quality. AIG also continues to be able to modify and limit its contractual obligations by adding appropriate exclusions and policy restrictions. AIG expects total premiums to increase in 2004 resulting in positive growth in cash flow for investments. Thus, General Insurance net investment income is expected to rise in future quarters even in the current low interest rate environment.

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

     In the Life Insurance & Retirement Services segment, AIG expects overall continued growth through expansion in China, where AIG was the first foreign insurance organization to have wholly owned Life Insurance & Retirement Services operations in eight major cities. AIG expects continued growth in India, Korea and Vietnam as well as in the more established Japan market where retirement services operations have developed quickly.

     During the third quarter of 2004, AIG entered into an agreement with Sumitomo to market insurance products underwritten by ALICO in Japan. Sumitomo will initially market ALICO’s cancer insurance coverage through the Sumitomo sales channel of approximately 40,000 sales representatives. ALICO and Sumitomo have also agreed to consider expanding the relationship to include other insurance products in the future.

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

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

     In the airline industry, changes in market conditions are not immediately apparent in operating results. Lease rates have firmed considerably, as a result of strong demand spurred by the recovering global commercial aviation market, especially in Asia. Sales have begun to increase, and AIG expects them to be even stronger in future periods. Therefore, AIG believes that improvements in that market commencing in 2003 will be gradually reflected in ILFC’s results in 2004. In the Capital Markets operations, the integration of AIG

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Trading Group Inc. and its subsidiaries (AIGTG) into the operations of AIG Financial Products Corp. and its subsidiaries (AIGFP) created operating efficiencies that will continue to be realized and product synergies that should enhance 2004 results, although quarter to quarter variations are to be expected in this transaction-oriented business. AIG also expects increased contributions to Financial Services revenues and income from its consumer finance operations (Consumer Finance) both domestically, as a result of the improving economy, and overseas, as expansion of credit card operations continues and economic conditions improve.

     AIG expects its Asset Management operations to continue to benefit from the recovery in the equity markets and global economy. GICs, which are sold domestically and abroad to both institutions and individuals, are written on an opportunistic basis when market conditions are favorable.

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

Recent Developments

     As previously disclosed, in early October, AIG was advised by the Staff of the Securities and Exchange Commission that the Staff was considering recommending that the SEC bring a civil action against AIG and AIG Financial Products Corp. (AIGFP) alleging violations of the federal securities laws with respect to the marketing and sale by AIGFP to public companies of certain products involving structured financial transactions, as well as with respect to certain press releases issued by AIG which reported the Staff notification. AIG also reported that AIGFP had been informed by the U.S. Department of Justice that it was a target of an investigation involving possible violations of the federal securities laws with respect to such products. On October 21, 2004, AIG announced that it had been informed by the U.S. Attorney for the Southern District of Indiana that it was a target of a federal grand jury investigation arising out of a contract between AIG’s subsidiary, National Union Fire Insurance Company of Pittsburgh, Pa., and Brightpoint, Inc. that concerns “non-traditional insurance” or “income smoothing products” marketed to clients by AIG. On October 25, 2004, AIG announced that it intends to seek a resolution of these matters by reaching a prompt settlement on terms satisfactory to the Government and AIG. AIG is currently discussing proposed settlement terms with the Government, but a settlement has not yet been completed.

     As previously disclosed, on October 14, 2004, the New York State Attorney General 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 have pleaded guilty in connection with the Attorney General’s 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 are likely.

     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.

     AIG cannot at this time estimate its 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 quarterly reporting period.

     On October 11, 2004, Congress passed the American Jobs Creation Act of 2004 (Jobs Creation Act) and President Bush signed the bill into law on October 22, 2004. The Jobs Creation Act includes a number of provisions that are expected to affect current business practices. For example, the Jobs Creation Act creates a temporary incentive for U.S. multinationals to repatriate certain accumulated income earned abroad by providing a special 85 percent dividends received deduction, subject to specific reinvestment and repatriation guidelines and certain limitations. Companies may elect to take the temporary deduction in 2004 or 2005. AIG believes that the impact of the Jobs Creation Act on its results of operations and financial condition will not be significant.

Critical Accounting Estimates

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

     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

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establish each critical accounting estimate are highlighted below.

Reserves for Losses and Loss Expenses (General Insurance):

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

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

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

Deferred Policy Acquisition Costs (General Insurance):

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

Life Insurance & Retirement Services:

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

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

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

Operating Review

General Insurance Operations

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

     Domestic general insurance operations are comprised of DBG, which includes 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.

     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 2 of Notes to Financial Statements.)

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

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

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measurement is a useful and meaningful disclosure. (See also the discussion under “Liquidity” herein.)

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 nine months ending September 30, 2004 and 2003 were as follows:

                     
(in millions, except ratios) 2004 2003

Net premiums written:
               
 
Domestic General
               
   
DBG
  $ 17,546     $ 14,734  
   
Transatlantic
    2,822       2,472  
   
Personal Lines
    3,288       2,704  
   
Mortgage Guaranty
    453       390  
 
Foreign General
    7,214       5,753  

Total
  $ 31,323     $ 26,053  

Net premiums earned:
               
 
Domestic General
               
   
DBG
  $ 16,247     $ 12,829  
   
Transatlantic
    2,729       2,319  
   
Personal Lines
    3,175       2,644  
   
Mortgage Guaranty
    398       365  
 
Foreign General
    6,500       5,175  

Total
  $ 29,049     $ 23,332  

Underwriting profit (loss):
               
 
Domestic General
               
   
DBG(a)
  $ 456     $ 721  
   
Transatlantic(a)
    (46 )     75  
   
Personal Lines(a)
    115       73  
   
Mortgage Guaranty
    207       208  
 
Foreign General(a)
    635       593  

Total
  $ 1,367     $ 1,670  

Net investment income:
               
 
Domestic General
               
   
DBG
  $ 1,689     $ 1,296  
   
Transatlantic
    220       202  
   
Personal Lines
    135       100  
   
Mortgage Guaranty
    89       111  
   
Intercompany adjustments and eliminations – net
          5  
 
Foreign General
    485       543  

Total
  $ 2,618     $ 2,257  

Realized capital gains (losses)
    19       (331 )

Operating income
  $ 4,004     $ 3,596  

Domestic General:
               
 
Loss Ratio
    79.87       77.55  
 
Expense Ratio
    17.25       16.69  

Combined Ratio
    97.12       94.24  

Foreign General:
               
 
Loss Ratio
    61.04       60.94  
 
Expense Ratio
    27.68       26.87  

Combined ratio
    88.72       87.81  

Consolidated:
               
 
Loss Ratio(b)
    75.65       73.87  
 
Expense Ratio
    19.65       18.94  

Combined Ratio
    95.30       92.81  

(a) Catastrophe losses for the first nine months of 2004 by segment were: DBG $406 million, Personal Lines $25 million, Transatlantic $165 million and Foreign General $140 million. Catastrophe losses for the first nine months of 2003 by segment were: DBG $48 million, Personal Lines $5 million, Transatlantic $4 million and Foreign General $16 million.
(b) The impact of catastrophe losses on the loss ratio was an increase of 2.53 in 2004 and 0.31 in 2003.

General Insurance Results

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

     DBG has maintained a disciplined approach to pricing and risk selection and chose not to renew approximately $207 million in premiums in the third quarter of 2004 where pricing, terms and conditions or loss experience did not meet underwriting standards. Like all AIG companies, DBG is benefiting from the flight to quality, a strong profit center focus and growing distribution channels. Overall, DBG’s net premiums written increased in the first nine months of 2004 over 2003. AIG believes that moderate premium rate increases will continue in 2004 particularly with respect to long tail lines of business where the insurer’s stability is critical to the insured. Based on historical patterns, AIG believes that overall growth in net premiums written will slow as competition for premiums increases in certain lines of business.

     Transatlantic net premiums written increased as a result of growth in its international business.

     Personal Lines net premiums written in the first nine months of 2004 include $301 million from the domestic insurance operations of GE that were acquired in August of 2003. The increase in net premiums written apart from this acquisition resulted from increased marketing efforts as well as rate increases in several states. The increase in underwriting profits in the first nine months of 2004 when compared to the same period of 2003 resulted from premium rate increases and growth in net premiums written and earned. Underwriting profits are expected to continue to increase through 2004 as a result of continued marketing efforts, loss cost stabilization and the full year impact of the acquisition.

     Mortgage Guaranty net premiums written increased 16.1 percent in the first nine months of 2004 when compared to the same period of 2003. Premiums grew and refinancings declined as interest rates rose. This growth was offset by a slight increase in the delinquency ratio, which is still below the industry average. UGC is moving forward with plans to enter new markets around the world.

     Foreign General insurance net premiums written growth was due to premium rate increases as well as flight to quality. Every major region of the worldwide network contributed to this performance. The Far East region had excellent growth. In Japan, corporate and personal accident business expanded. Commercial lines in Europe continue to exhibit strong growth, as did AIG’s personal lines operations in Brazil and

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Latin America. Additionally, AIG’s joint venture in India has expanded its commercial lines leadership among the private sector companies.

     In comparing the foreign currency exchange rates used to translate the results of AIG’s Foreign General operations during the first nine months of 2004 to those foreign currency exchange rates used to translate AIG’s Foreign General results during the same period of 2003, the U.S. dollar weakened slightly in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, when foreign net premiums written were translated into U.S. dollars for the purposes of the preparation of the consolidated financial statements, total General Insurance net premiums written were approximately 2.3 percentage points more than they would have been if translated utilizing those foreign currency exchange rates which prevailed during the same period of 2003.

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

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

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

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

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

     AIG’s General Insurance results reflect the impact of incurred losses from catastrophes of $736 million and $73 million, in the first nine months and third quarter of 2004 and 2003, respectively. The impact of losses caused by catastrophes can fluctuate widely from year to year, making comparisons of recurring type business more difficult. With respect to catastrophe losses, AIG believes that it has taken appropriate steps, such as careful exposure selection and obtaining reinsurance coverage, to reduce the impact of the magnitude of possible future losses. The occurrence of one or more catastrophic events of unanticipated frequency or severity, such as a terrorist attack, earthquake or hurricane, that causes insured losses, however, could have a material adverse effect on AIG’s results of operations, liquidity or financial condition.

     General Insurance net investment income grew in the first nine months of 2004 when compared to the same period of 2003. AIG is benefiting from the strong cash flow of the past two years, higher interest rates, dividend income and good private equity results. (See also the discussion under “Liquidity” herein.)

     Realized capital gains and losses resulted from the ongoing investment management of the General Insurance portfolios within the overall objectives of the General Insurance operations. The realized capital gains in the first nine months of 2004 reflect an improved economy, stronger corporate balance sheets and a significantly lower level of impairments. The realized capital losses in the first nine months of 2003 reflect primarily impairment loss provisions for both equity and fixed income holdings. (See the discussion on “Valuation of Invested Assets” herein.)

     The increase in General Insurance operating income in the first nine months of 2004 was primarily attributable to strong profitable growth in DBG operations, the improvement in net investment income and the capital gains realized in 2004 rather than the capital losses realized in 2003.

     The contribution of General Insurance operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change was 31.7 percent in the first nine months of 2004 compared to 36.5 percent in the same period of 2003. The decrease in contribution percentage in 2004 was influenced by the impact of the catastrophe losses.

Reinsurance

AIG is a major purchaser of reinsurance for its General Insurance operations. AIG is cognizant of the need to exercise good judgment in the selection and approval of both domestic and foreign companies participating in its reinsurance pro-

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

     AIG’s consolidated general reinsurance assets amounted to $25.44 billion at September 30, 2004 and resulted from AIG’s reinsurance arrangements. Thus, a credit exposure existed at September 30, 2004 with respect to reinsurance recoverable to the extent that any reinsurer may not be able to reimburse AIG under the terms of these reinsurance arrangements. AIG manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound, and when necessary AIG holds substantial collateral in the form of funds, securities and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. At December 31, 2003, approximately 47 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, the majority of these balances were collateralized. The remaining 53 percent of the general reinsurance assets were from authorized reinsurers. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness. Approximately 90 percent of the balances with respect to authorized reinsurers are from reinsurers rated A (excellent) or better, as rated by A.M. Best, or A (strong) or better, as rated by Standard & Poor’s. Through September 30, 2004, these distribution percentages have not changed significantly. This rating is a measure of financial strength.

     AIG maintains an allowance for estimated unrecoverable reinsurance and has been largely successful in its previous recovery efforts. AIG’s allowance for estimated unrecoverable reinsurance approximated $140 million as of September 30, 2004. At that date, AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction).

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

     AIG enters into certain intercompany reinsurance transactions for its general and life operations. AIG enters these transactions as a sound and prudent business practice in order to maintain underwriting control and spread insurance risk among various legal entities. These reinsurance agreements have been approved by the appropriate regulatory authorities. All material intercompany transactions have been eliminated in consolidation.

     At September 30, 2004, the consolidated general reinsurance assets of $25.44 billion include reinsurance recoverables for paid losses and loss expenses of $3.22 billion and $18.33 billion with respect to the ceded reserve for losses and loss expenses, including ceded losses incurred but not reported (IBNR) (ceded reserves). The ceded reserves represent the accumulation of estimates of ultimate ceded losses including provisions for ceded IBNR and loss expenses. The methods used to determine such estimates and to establish the resulting ceded reserves are continually reviewed and updated by management. Any adjustments thereto are reflected in income currently. It is AIG’s belief that the ceded reserves at September 30, 2004 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded.

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Reserve for Losses and Loss Expenses

The table below classifies as of September 30, 2004 the components of the General Insurance reserve for losses and loss expenses (loss reserves) with respect to major lines of business on a statutory basis*:

         
(in millions)

Other Liability Occurrence
  $ 15,602  
Other Liability Claims Made
    11,040  
Workers Compensation
    8,387  
Auto Liability
    5,516  
International
    3,216  
Property
    4,260  
Reinsurance
    2,542  
Medical Malpractice
    2,196  
Aircraft
    1,690  
Products Liability
    1,336  
Accident and Health
    1,120  
Fidelity/ Surety
    974  
Other
    4,271  

Total
  $ 62,150  

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

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

     At September 30, 2004, General Insurance net loss reserves increased $7.17 billion from the prior year end to $43.82 billion. In the first nine months of 2004, net adverse reported loss development for the prior accident years was estimated to be approximately $700 million. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated by management. Any adjustments resulting therefrom are reflected in operating income currently. It is management’s belief that the General Insurance net loss reserves are adequate to cover all General Insurance net losses and loss expenses as of September 30, 2004. While AIG annually reviews the adequacy of established loss reserves, there can be no assurance that AIG’s ultimate loss reserves will not adversely develop and materially exceed AIG’s loss reserves as of September 30, 2004. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on future results of operations.

     In a very broad sense, the General Insurance loss reserves can be categorized into two distinct groups, one group being long tail casualty lines of business. Such lines include excess and umbrella liability, directors and officers’ liability, professional liability, medical malpractice, general liability, products’ liability, and related classes. The other group is short tail lines of business consisting principally of property lines, personal lines and certain classes of casualty lines.

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

     Estimation of ultimate net losses and loss expenses (net losses) for long tail casualty lines of business is a complex process and depends on a number of factors, including the line and volume of the business involved. Experience in the more recent accident years of long tail casualty lines shows limited statistical credibility in reported net losses. That is, a relatively low proportion of net losses would be reported claims and expenses and an even smaller proportion would be net losses paid. A relatively high proportion of net losses would therefore be IBNR.

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

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

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

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

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Loss development factors which are used to project the reported losses for each accident year to an ultimate basis.

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

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

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

     With respect to the 2003 year-end actuarial loss reserve analysis for DBG, the actuaries continued to utilize the modified assumptions which gave additional weight to actual loss development from the more recent years, as identified during the 2002 analysis, with appropriate adjustments to account for the additional year of loss experience which emerged in 2003. Although the actuaries continued to use actuarial assumptions that rely on expected loss ratios based on the results of prior accident years, the expected loss ratio assumptions used gave far greater weight to the more recent accident year experience than was the case in the prior year-end assumptions. No weight was given to the more favorable experience of accident years prior to 1997. Additionally, the actuaries modified their loss cost trend assumptions to reflect the emerging experience from the recent accident years. For example, in setting the expected loss ratios for accident years 2001, 2002 and 2003 for the excess casualty lead umbrella class, the actuaries gave 100 percent weight to the results of the 1997 through 2000 accident years only, giving no weight to the more favorable development of accident years prior to 1997. In addition, they continued to utilize the 7.5 percent annual loss cost trend factor.

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

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assumptions and the point estimate of the required reserve from the modified assumptions described above in determining the actual loss reserve carried at year-end 2003.

     AIG does not believe disclosure of specific point estimates calculated by the actuaries would be meaningful. As described more fully below, considerable judgment is required in evaluating loss trends and developments for all classes of business, particularly long tailed lines. Any one actuarial point estimate is based on a particular series of judgments and assumptions of the actuary. Another actuary may give different weights or make different assumptions, and therefore reach a different point estimate. So long as the series of judgments and assumptions are reasonable, no one such point estimate is necessarily a better estimate than another point estimate. Point estimates are used to independently re-affirm the reasonableness of the overall carried reserves. Thus, provided the actuaries confirm the overall reasonableness of AIG’s loss and loss expense liabilities, AIG believes that disclosure of such point estimates would not be helpful and in fact could potentially be misleading. Nevertheless, in the interest of comprehensive disclosure, but taking into consideration the reservations AIG management has expressed with respect to the meaningfulness of disclosure of point estimates, the actual loss reserve carried at year-end 2003 for AIG’s overall General Insurance business was approximately 4 percent greater than the aggregate reserve indicated by the actuarial point estimates, including the historical assumptions as described above and was approximately 2 percent less than the aggregate reserve indicated by the actuarial point estimates utilizing the modified assumptions.

     AIG’s annual loss reserve does not calculate a range of loss reserve estimates. Because AIG’s General Insurance business is primarily in long tail casualty lines driven almost entirely by severity rather than frequency of claims, developing a range around loss reserve estimates would not be meaningful. An estimate is calculated which AIG’s actuaries believe provides a reasonable estimate of the required reserve. This amount is evaluated against actual carried reserves.

     There is a potential for significant variation in the developing loss reserves, particularly for long tail classes of business such as excess casualty, when actual costs differ from the assumptions used to test the reserves. For the excess casualty class of business, a 5 percent change in the assumed loss cost trend from each accident year to the next would cause approximately a $400 million impact (either positively or negatively) to the net loss and loss expense reserve for this business. For the D&O and related management liability classes of business, a 5 percent change in the assumed loss cost trend would also cause approximately a $400 million impact (either positively or negatively) to the net loss and loss expense reserve for such business. For healthcare liability business, including hospitals and other healthcare exposures, the 5 percent change in the assumed loss cost trend would cause approximately a $100 million impact (either positively or negatively) to the loss and loss expense reserve for this business. Actual loss cost trends in the early 1990’s were negative for these classes, whereas in the late 1990’s loss costs trends ran well into the double digits for each of these three classes. The sharp increase in loss costs in the late 1990’s was thus much greater than the 5 percent changes cited above, and caused significant increases in the overall loss reserve needs for these classes. While changes in the loss cost trend assumptions can result in a significant impact on the reserve needs for other smaller classes of liability business, the potential impact of these changes on AIG’s overall carried reserves would be much less than for the classes noted above.

     For the excess casualty class, if future loss development factors differed by 5 percent from those utilized in the year-end 2003 loss reserve review, there would be approximately a $400 million impact on the overall AIG loss reserve position. The comparable impact on the D&O and related management liability classes would be approximately $200 million if future loss development factors differed by 5 percent from those utilized in the year-end 2003 loss reserve review. For healthcare liability classes, the impact would be approximately $100 million. For workers’ compensation reserves, the impact of a 5 percent deviation from the loss development factors utilized in the year-end 2003 reserve reviews would be approximately $600 million (either positively or negatively). Because loss development factors for this class have shown less volatility than higher severity classes such as excess casualty, however, actual changes in loss development factors are expected to be less than 5 percent. There is some degree of volatility in loss development patterns for other longer tail liability classes as well. However, the potential impact on AIG’s reserves would be much less than for the classes cited above.

     AIG management believes that using a 5 percent change in the assumptions for loss cost trends and loss development factors provides a reasonable estimate of the impact on the reserves of a common or normal potential deviation for AIG’s most significant lines of general insurance business. For excess casualty business, both the loss cost trend and the loss development factor assumptions are critical. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Moreover, as excess casualty is a long tail class of business, any deviation in loss cost trends or in loss development factors might not be discernible for an extended period of time subsequent to the recording of the initial loss reserve estimates for any accident year. Thus, there is the potential for the reserves with respect to a number of accident years to be significantly impacted by changes in the loss cost trends or loss development factors that were initially relied upon in setting the reserves. These changes in loss trends or loss development factors could be attributable to changes in inflation or in the judicial environment, or in other social or economic

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phenomena impacting claims. For example, during the lengthy periods during which losses develop for excess casualty, actual changes in loss costs from one accident year to the next have ranged from negative values to double-digit amounts. Thus the 5 percent sensitivity indicator is considered an appropriate estimate of a common or normal deviation for excess casualty. Likewise, in the judgment of AIG’s actuaries, an annual 5 percent potential deviation in loss development factors is reasonable based upon historical development.

     For D&O and related management liability classes of business, the loss cost trend assumption is critical. The loss development factor assumption is important but less critical than for excess casualty. As this coverage is written on a claims made basis, claims for a given accident year are all reported within that year. Therefore, the potential for significantly unusual loss development patterns generally exists only for several years. Actual changes in loss costs from one accident year to the next in the 1990s ranged from negative values to double-digit amounts. Thus the 5 percent sensitivity indicator is a reasonable estimate of a common or normal potential deviation. A 5 percent deviation in loss development factors is also considered reasonable for these classes. However, as noted above, the dollar impact of such a deviation is less than that of a similar deviation in loss cost trends.

     For healthcare liability classes, both the loss cost trend and the loss development factor assumptions are critical. The nature of the potential volatility would be analogous to that described above for the excess casualty business. However, AIG’s volume of business in the healthcare classes is much smaller than for excess casualty, hence the potential dollar impact on AIG’s overall reserves is smaller for these classes than for excess casualty. AIG’s healthcare liability business includes both primary and excess exposures.

     For workers’ compensation, the loss development factor assumptions are important. Generally, AIG’s actual historical workers’ compensation loss development would be expected to provide a reasonably accurate predictor of future loss development. A 5 percent sensitivity indicator for workers’ compensation would thus be considered to be toward the high end of potential deviations for this class of business. AIG’s workers’ compensation reserves include a small portion relating to excess workers’ compensation coverage. The analysis applicable to excess casualty would apply to these reserves. However, the volume of such business is de minimis compared to that for excess casualty. The loss cost trend assumption for workers’ compensation is not believed to be material with respect to AIG’s loss reserves other than for that portion representing excess workers’ compensation. This is primarily because AIG’s actuaries are generally able to use loss development projections for all but the most recent accident year’s reserves, so there is limited need to rely on loss cost trend assumptions for workers’ compensation business.

     For casualty business other than the classes noted above, there is generally some potential for deviation in both the loss cost trend and loss development factor selections. However, the impact of such deviations would not be material when compared to the impact cited above for excess casualty and directors and officers’ liability.

Asbestos and Environmental Reserves

AIG continues to receive claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites, referred to collectively as environmental claims, and indemnity claims asserting injuries from asbestos.

     The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage and an absolute asbestos exclusion was also implemented. However, AIG currently underwrites environmental impairment liability insurance on a claims made basis and has excluded such claims from the analysis herein.

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

     Estimation of asbestos and environmental claims loss reserves is a complex process. These asbestos and environmental claims cannot be estimated by AIG using conventional reserving techniques as previously described. Significant factors which affect the trends that influence the asbestos and environmental claims estimation process are the inconsistent court resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving and there is little likelihood that any firm direction will develop in the near future. Additionally, the exposure for cleanup costs of hazardous waste dump sites involve issues such as allocation of responsibility among potentially responsible parties and the government’s refusal to release parties.

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

     Although the estimated liabilities with respect to asbestos and environmental reserves are subject to a significantly

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greater margin of error than for other loss reserves, the asbestos and environmental reserves carried at the balance sheet date are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG’s net exposure retained relative to the gross exposure written was lower in 1984 and prior years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. However, if the asbestos and environmental reserves develop deficiently, such deficiency would have an adverse impact on future results of operations. (See the previous discussion on reinsurance collectibility herein.) AIG does not discount its asbestos and environmental reserves.

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

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

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

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

     In order to test the overall reasonableness of the asbestos and environmental reserves established using the ground up approach, AIG uses primarily two methods, the market share method and the frequency/ severity method. The market share method produces indicated asbestos and environmental reserves needs by applying the appropriate AIG company market share to estimated potential industry ultimate loss and loss expenses based on the latest estimates from A.M. Best and Tillinghast.

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

     AIG’s net carried asbestos and environmental reserves are approximately $25 million greater than the mean indication of the reserves calculated using the market share method, and approximately $50 million less than the median indication of the reserves calculated using the frequency/ severity approach to test the reserves. Thus, based on these alternative tests, AIG deems its carried reserves to be reasonable as of December 31, 2003.

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

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A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined for the nine months ended September 30, 2004 and 2003 follows:

                                 
2004 2003


(in millions) Gross Net Gross Net

Asbestos:
                               
Reserve for losses and loss expenses at beginning of year
  $ 1,235     $ 386     $ 1,304     $ 400  
Losses and loss expenses incurred*
    222       75       163       54  
Losses and loss expenses paid*
    (228 )     (82 )     (224 )     (55 )

Reserve for losses and loss expenses at end of period
  $ 1,229     $ 379     $ 1,243     $ 399  

Environmental:
                               
Reserve for losses and loss expenses at beginning of year
  $ 789     $ 283     $ 832     $ 296  
Losses and loss expenses incurred*
    68       21       131       30  
Losses and loss expenses paid*
    (107 )     (48 )     (92 )     (35 )

Reserve for losses and loss expenses at end of period
  $ 750     $ 256     $ 871     $ 291  

Combined:
                               
Reserve for losses and loss expenses at beginning of year
  $ 2,024     $ 669     $ 2,136     $ 696  
Losses and loss expenses incurred*
    290       96       294       84  
Losses and loss expenses paid*
    (335 )     (130 )     (316 )     (90 )

Reserve for losses and loss expenses at end of period
  $ 1,979     $ 635     $ 2,114     $ 690  

All amounts pertain to policies underwritten in prior years.

The gross and net IBNR included in the reserve for losses and loss expenses at September 30, 2004 and December 31, 2003 were estimated as follows:

                                 
2004 2003


(in millions) Gross Net Gross Net

Combined
  $ 1,099     $ 298     $ 1,042     $ 280  

A summary of asbestos and environmental claims count activity for the nine months ended September 30, 2004 and 2003 was as follows:

                                                   
2004 2003


Asbestos Environmental Combined Asbestos Environmental Combined

Claims at beginning of year
    7,474       8,852       16,326       7,085       8,995       16,080  
Claims during year:
                                               
 
Opened
    681       2,146       2,827       335       944       1,279  
 
Settled
    (84 )     (226 )     (310 )     (62 )     (119 )     (181 )
 
Dismissed or otherwise resolved
    (461 )     (2,121 )     (2,582 )     (119 )     (1,146 )     (1,265 )

Claims at end of period
    7,610       8,651       16,261       7,239       8,674       15,913  

     A.M. Best, an insurance rating agency, has developed a survival ratio to measure the number of years it would take a company to exhaust both its asbestos and environmental reserves for losses and loss expenses based on that company’s current level of asbestos and environmental claims payments. This is a ratio derived by taking the current ending losses and loss expense reserves and dividing by the average annual payments for the prior three years. Therefore, the ratio derived is a simplistic measure of an estimate of the number of years it would be before the current ending losses and loss expense reserves would be paid off using recent average payments. The higher the ratio, the more years the reserves for losses and loss expenses cover these claims payments. These ratios are computed based on the ending reserves for losses and loss expenses over the respective claims settlement during the fiscal year. Such payments include indemnity payments and legal and loss adjustment payments. It should be noted, however, that this is an extremely simplistic approach to measuring asbestos and environmental reserve levels. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have a significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments made and the resultant ratio.

     AIG believes that voluntary payments with respect to environmental claims should be excluded from the calculation of the survival ratio for the environmental claims. That is, involuntary payments are primarily attributable to court judgments, court orders, covered claims with no coverage defenses, state mandated clean up costs, claims where AIG’s coverage defenses are minimal and settlements that are made less than six months before the first trial setting. Payments other than these are deemed voluntary because AIG can control the amount and timing of such payments, if any.

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AIG’s survival ratios for asbestos and environmental claims, separately and combined, excluding voluntary environmental claim payments, were based upon a three year average payment. These ratios at September 30, 2004 and 2003 were as follows:

                   
Gross Net

2004
               
Survival ratios:
               
 
Asbestos
    4.9       4.6  
 
Environmental
    17.5       12.3  
 
Combined
    8.6       7.6  

2003
               
Survival ratios:
               
 
Asbestos
    4.4       4.4  
 
Environmental
    16.4       11.8  
 
Combined
    7.7       7.1  

Life Insurance & Retirement Services Operations

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

     Domestically, AIG’s Life Insurance & Retirement Services operations offer a broad range of protection products, including life insurance, group life and health products and payout annuities which include single premium immediate annuities, structured settlements and terminal funding annuities. Home service operations include an array of traditional insurance and investment type products sold through agents. In addition, Home service includes a small block of run-off property and casualty coverage. Retirement services include group retirement products, individual fixed and variable annuity operations and annuity run-off operations which include fixed and variable annuities largely sold through merger related discontinued distribution relationships. AIG’s principal domestic Life Insurance & Retirement Services operations include AIG American General Life Companies, AIG Annuity Insurance Company (AIG Annuity), The Variable Annuity Life Insurance Company (VALIC) and SunAmerica Life Insurance Company.

     Overseas, AIG’s Life Insurance & Retirement Services operations include traditional products such as whole and term life and endowments, personal accident & health products, group products including pension, life and health, and fixed and variable annuities. AIG operates overseas principally through American Life Insurance Company (ALICO), American International Assurance Company, Limited (AIA), American International Assurance Company, (Bermuda) Limited (AIA(B)), Nan Shan Life Insurance Company, Ltd. (Nan Shan), The Philippine American Life and General Insurance Company (Philam Life), and AIG Star Life Insurance Co., Ltd. (AIG Star Life). AIG added significantly to its presence in Japan with the acquisition of GE Edison Life Insurance Company (now known as AIG Edison Life Insurance Company) (AIG Edison Life), consolidated beginning with the fourth quarter of 2003. ALICO is incorporated in Delaware and all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in Europe, Africa, Latin America, the Caribbean, the Middle East, South Asia, and the Far East, with Japan being the largest territory. AIA operates primarily in China (including Hong Kong), Singapore, Malaysia, Thailand, Korea and India. Nan Shan operates in Taiwan. AIG Star Life operates in Japan.

Life Insurance & Retirement Services operations presented on a major product basis for the nine months ending September 30, 2004 and 2003 were as follows:

                     
(in millions) 2004 2003 (a)

GAAP premiums:
               
 
Domestic Life:
               
   
Life insurance
  $ 1,407     $ 1,314  
   
Home service
    612       625  
   
Group life/health
    858       765  
   
Payout annuities (b)
    1,126       1,008  

   
Total
    4,003       3,712  

 
Domestic Retirement Services:
               
   
Group retirement products
    231       180  
   
Individual fixed annuities
    43       35  
   
Individual variable annuities
    300       240  
   
Individual annuities-runoff (c)
    59       61  

   
Total
    633       516  

 
Total Domestic
    4,636       4,228  

 
Foreign Life:
               
   
Life insurance
    11,135       9,437  
   
Personal accident & health
    3,171       2,186  
   
Group products (d)
    1,832       945  

   
Total
    16,138       12,568  

 
Foreign Retirement Services:
               
   
Individual fixed annuities
    282       174  
   
Individual variable annuities
    45       14  

   
Total
    327       188  

 
Total Foreign
    16,465       12,756  

Total GAAP premiums
  $ 21,101     $ 16,984  

Net investment income:
               
 
Domestic Life:
               
   
Life insurance
  $ 1,094     $ 966  
   
Home service
    528       511  
   
Group life/health
    92       87  
   
Payout annuities
    600       511  

   
Total
    2,314       2,075  

 
Domestic Retirement Services:
               
   
Group retirement products
    1,617       1,522  
   
Individual fixed annuities
    2,267       1,837  
   
Individual variable annuities
    180       172  
   
Individual annuities-runoff (c)
    807       971  

   
Total
    4,871       4,502  

 
Total Domestic
    7,185       6,577  

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(in millions) 2004 2003 (a)

 
Foreign Life:
               
   
Life insurance
    3,248       2,779  
   
Personal accident & health
    133       119  
   
Group products
    311       249  
   
Intercompany adjustments
    (13 )     (10 )

   
Total
    3,679       3,137  

 
Foreign Retirement Services:
               
   
Individual fixed annuities
    700       231  
   
Individual variable annuities
    78       1  

   
Total
    778       232  

 
Total Foreign
    4,457       3,369  

Total net investment income(e)
  $ 11,642     $ 9,946  

Realized capital gains (losses)(e)
    (106 )     (657 )

Total operating income(f)
  $ 6,302     $ 4,659  

Life insurance in-force (g):
               
 
Domestic
  $ 726,992     $ 645,606  
 
Foreign
    989,279       951,020  

Total
  $ 1,716,271     $ 1,596,626  

(a)   Restated to conform to 2004 presentation.
 
(b)   Includes structured settlements, single premium immediate annuities and terminal funding annuities.
 
(c)   Represents runoff annuity business sold through merger related discontinued distribution relationships.

(d)   2004 includes approximately $640 million of premium from a reinsurance transaction involving terminal funding business. This single premium amount is offset by a similar increase of benefit reserves.

(e)   For purposes of this presentation, investment income reflects certain amounts of realized capital gains where the gains are deemed to be an inherent element in pricing certain life products in some foreign countries.

(f)   2004 includes $5 million of catastrophe losses relating to minor Home service property and casualty subsidiaries currently in run-off.

(g)   Amounts presented were as at September 30, 2004 and December 31, 2003.

Life Insurance & Retirement Services Results

The increase in Life Insurance & Retirement Services operating income in the first nine months of 2004 when compared to the same period of 2003 was caused in part by strong growth, particularly overseas, and the decline in realized capital losses relative to the same period of 2003.

     The contribution of Life Insurance & Retirement Services operating income to AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change amounted to 49.9 percent in the first nine months of 2004 compared to 47.3 percent in the same period of 2003.

     Life GAAP premiums grew in the first nine months of 2004 when compared with the same period in 2003. AIG’s domestic life operations had strong universal and term life sales and good performance from the independent distribution segment. Payout annuities also had strong growth. The domestic group business is below AIG’s growth standards largely because several accounts where pricing was unacceptable were not renewed. AIG is reviewing growth strategies for this business. At American General Life and Accident Insurance Company (AGLA), the home services business, a number of the initiatives taken in recent months to accelerate growth, such as introducing new products, hiring new agents and retraining existing agents, will take some time before the results are evident. However, the business is solidly profitable with strong cash flow.

     Domestic Retirement Services had a solid quarter. The businesses most correlated to the equity markets performed well, with the strongest sales growth in the individual variable annuity segment. VALIC, the group retirement services business, which has approximately half of client assets in equities, also benefited from improved equity market performance. VALIC has had a successful start cross-selling individual variable annuities, fixed annuities and mutual funds. AIG Annuity, the individual fixed annuity business, had very good performance with stable spreads and growth in operating income, even as consumers shifted assets to equity-based products.

     With respect to Foreign Life, the majority of the growth in GAAP Life Insurance & Retirement Services premiums was attributable to the Life insurance, Personal accident & health, and Group products lines of business. This growth was most significant in Southeast Asia where AIG maintains significant market share established by its strong agency force, and in Japan, where AIG is benefiting from a flight to quality. Also in Japan, AIG Edison Life is being integrated successfully into AIG’s life operations. AIG Star Life is growing first year premiums as a result of new product introductions and an expanded agency force, and is benefiting from more successful conservation of in-force business. The annuity business in Japan is growing rapidly through product innovation and packaging skills and the confidence engendered by the financial strength of AIG companies. In China, Life Insurance first year premiums are growing significantly. Additionally, personal accident sales reflect the repricing of certain key products to improve profit margins and is included in the Personal accident & health line of business. In addition, AIG’s deep and diverse distribution, which includes bancassurance, worksite marketing, direct marketing and strong agency organizations, provides a powerful platform for growth. Foreign Life Insurance & Retirement Services operations produced 78.0 percent and 75.1 percent of GAAP Life Insurance & Retirement Services premiums in 2004 and 2003, respectively.

     As previously discussed, the U.S. dollar weakened in relation to most major foreign currencies in which AIG transacts business. Accordingly, for the first nine months of 2004, when foreign life GAAP premiums were translated into U.S. dollars for purposes of the preparation of the consolidated financial statements, total life GAAP premiums were approximately 4.5 percentage points more than they would have been if translated utilizing exchange rates prevailing in 2003.

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     Under U.S. GAAP, deposits and certain other considerations received under deferred annuity (variable and fixed) and universal life contracts are not included as GAAP premiums. If such amounts were to be included, the overall year to date growth from 2004 over 2003 would be more dramatic, due in part to large increases in foreign individual fixed annuities.

     The growth in net investment income in the first nine months of 2004 when compared to the same period of 2003 was attributable to both foreign and domestic invested new cash flow for investment. Additionally, net investment income was positively impacted by the compounding of previously earned and reinvested net investment income. (See also the discussion under “Liquidity” herein.)

     Life Insurance & Retirement Services investment portfolios are managed within the overall objectives of the Life Insurance & Retirement Services operations. The decline in the realized capital losses in the first nine months of 2004 reflect an improved economy, stronger corporate balance sheets and a significantly lower level of impairments. The realized capital losses in the first nine months of 2003 reflect impairment loss provisions for certain equity and fixed income holdings. (See also the discussion on “Valuation of Invested Assets” herein.)

Underwriting and Investment Risk

The risks associated with the traditional life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is primarily investment risk.

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

     AIG’s foreign life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately $1.5 million of coverage and AIG’s domestic life companies generally limit their maximum underwriting exposure on traditional life insurance of a single life to $2.5 million of coverage by using yearly renewable term reinsurance. (See also the discussion under “Liquidity” herein.)

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

     To minimize its exposure to investment risk, AIG tests the cash flows from the invested assets and the policy and contract liabilities using various interest rate scenarios to assess whether there is a liquidity excess or deficit. If a rebalancing of the invested assets to the policy and contract claims became necessary and did not occur, a demand could be placed upon liquidity. (See also the discussion under “Liquidity” herein.)

     The asset-liability relationship is appropriately managed in AIG’s foreign operations, as it has been throughout AIG’s history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of the related policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the initial investments may be at a yield below that of the interest required for the accretion of the policy liabilities. Additionally, there exists a future investment risk associated with certain policies currently in force which will have premium receipts in the future. That is, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities.

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

     To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and to support any operational shortfall through its international financial network. (See also the discussion under “Liquidity” herein.)

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

     The asset-liability relationship is appropriately managed in AIG’s domestic operations, as there is ample supply of qualified long-term investments.

     AIG uses asset-liability matching as a management tool worldwide to determine the composition of the invested assets and appropriate marketing strategies. As a part of these strategies, AIG may determine that it is economically advantageous to be temporarily in an unmatched position due to anticipated interest rate or other economic changes.

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     A number of guaranteed benefits are offered on certain variable life products. (For further discussion see Note 7 of Notes to Financial Statements.)

     DAC for life insurance products arises from the deferral of those costs that vary with, and are directly related to, the acquisition of new or renewal business. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs which relate to universal life and investment-type products, including fixed annuities, (nontraditional life products) are deferred and amortized, with interest, as appropriate, in relation to the historical and future incidence of estimated gross profits to be realized over the estimated lives of the contracts. With respect to variable annuities, AIG’s policy, as appropriate, has been to adjust amortization assumptions for DAC when estimates of current or future gross profits to be realized from these contracts are revised. With respect to variable annuities sold domestically (representing the vast majority of AIG’s variable annuity business), the assumption for the long-term annual net growth rate of the equity markets used in the determination of DAC amortization is approximately 10 percent. A methodology referred to as “reversion to the mean” is used to maintain this long-term net growth rate assumption, while giving consideration to short-term variations in equity markets. Estimated gross profits include investment income and gains and losses on investments less interest required as well as other charges in the contract less actual mortality and expenses. Current experience and changes in the expected future gross profits are analyzed to determine the impact on the amortization of DAC. The estimation of projected gross profits requires significant management judgment. The elements with respect to the current and projected gross profits are reviewed and analyzed quarterly and are appropriately adjusted.

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

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

Insurance and Asset Management Invested Assets

AIG’s general strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations. With respect to General Insurance, AIG’s strategy is to invest in longer duration fixed maturities to maximize the yields at the date of purchase. With respect to Life Insurance & Retirement Services, AIG’s strategy is to produce cash flows required to meet maturing insurance liabilities. (See also the discussion under “Operating Review: Life Insurance & Retirement Services Operations” herein.) AIG invests in equities for various reasons, including diversifying its overall exposure to interest rate risk. Equity securities are subject to declines in fair value. Such declines in fair value are presented in unrealized appreciation or depreciation of investments, net of taxes as a component of other comprehensive income. Generally, insurance regulations restrict the types of assets in which an insurance company may invest. When permitted by regulatory authorities and when deemed necessary to protect insurance assets, including invested assets, from adverse movements in foreign currency exchange rates, interest rates and equity prices, AIG and its insurance subsidiaries may enter into derivative transactions as end users. (See also the discussion under “Derivatives” herein.)

     In certain jurisdictions, significant regulatory and/or foreign governmental barriers exist which may not permit the immediate free flow of funds between insurance subsidiaries or from the insurance subsidiaries to AIG parent. These barriers generally cause only minor delays in the outward remittance of the funds.

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The following tables summarize the composition of AIG’s insurance and asset management invested assets by segment, at September 30, 2004 and December 31, 2003:

                                                           
Life
Insurance & Percent Distribution
September 30, 2004 General Retirement Asset Percent
(dollars in millions) Insurance Services Management Total of Total Domestic Foreign

Fixed Maturities:
                                                       
 
Available for sale, at market value(a)
  $ 42,600     $ 243,190     $ 46,013     $ 331,803       69.0 %     62.2 %     37.8%  
 
Held to maturity, at amortized cost
    15,415                   15,415       3.2       100.0        
Equity securities, at market value(b)
    5,346       10,495       119       15,960       3.3       31.6       68.4  
Mortgage loans on real estate, policy and collateral loans
    23       16,170       5,156       21,349       4.5       69.4       30.6  
Short-term investments, including time deposits, and cash
    2,106       11,662       2,239       16,007       3.3       40.7       59.3  
Real estate
    557       2,851       324       3,732       0.8       28.9       71.1  
Investment income due and accrued
    1,006       4,317       508       5,831       1.2       60.2       39.8  
Securities lending collateral
    4,819       37,478       11,506       53,803       11.2       86.9       13.1  
Other invested assets
    6,670       5,702       4,549       16,921       3.5       84.9       15.1  

Total
  $ 78,542     $ 331,865     $ 70,414     $ 480,821       100.0 %     65.3 %     34.7%  

(a) Includes $2.40 billion of bond trading securities, at market value.
(b) Includes $1.91 billion of preferred stocks, at market value.
                                                           
Life
Insurance & Percent Distribution
December 31, 2003 General Retirement Asset Percent
(dollars in millions) Insurance Services Management Total of Total Domestic Foreign

Fixed Maturities:
                                                       
 
Available for sale, at market value(a)
  $ 41,610     $ 225,686     $ 32,453     $ 299,749       75.2 %     64.1 %     35.9%  
 
Held to maturity, at amortized cost
    8,037                   8,037       2.0       100.0        
Equity securities, at market value(b)
    5,130       4,174       60       9,364       2.4       53.7       46.3  
Mortgage loans on real estate, policy and collateral loans
    25       15,513       5,228       20,766       5.2       68.4       31.6  
Short-term investments, including time deposits, and cash
    1,918       4,662       2,343       8,923       2.2       53.1       46.9  
Real estate
    569       2,903       302       3,774       0.9       28.9       71.1  
Investment income due and accrued
    881       3,597       420       4,898       1.2       62.9       37.1  
Securities lending collateral
    5,225       20,537       4,433       30,195       7.6       76.0       24.0  
Other invested assets
    5,121       4,404       3,415       12,940       3.3       85.3       14.7  

Total
  $ 68,516     $ 281,476     $ 48,654     $ 398,646       100.0 %     65.8 %     34.2%  

(a) Includes $282 million of bond trading securities, at market value.
(b) Includes $1.90 billion of preferred stocks, at market value.

Credit Quality

At September 30, 2004, approximately 64 percent of the fixed maturities investments were domestic securities. Approximately 32 percent of such domestic securities were rated AAA by one or more of the principal rating agencies. Approximately 7 percent were below investment grade or not rated.

     A significant portion of the foreign fixed income portfolio is rated by Moody’s, Standard & Poor’s (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At September 30, 2004, approximately 20 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG’s internal analysis, were equivalent from a credit standpoint to securities so rated. Approximately 5 percent were below investment grade or not rated at that date. A large portion of the foreign fixed income portfolio are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance.

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

Valuation of Invested Assets

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

     Another aspect of valuation is an assessment of impairment. As a matter of policy, the determination that a security has incurred an other-than-temporary decline in value and

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the amount of any loss recognition requires the judgment of AIG’s management and a continual review of its investments.

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

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

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

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

     As a result of these policies, AIG recorded impairment losses, net of taxes, of $361 million and $798 million in the first nine months of 2004 and 2003, respectively. The recovery in global equity markets and reasonably steady domestic interest rates were the primary reasons for the decline in impairment loss recognition from 2003 to 2004.

     No impairment charge with respect to any one single credit was significant to AIG’s consolidated financial condition or results of operations, and no individual impairment loss exceeded 1.0 percent of consolidated net income for the first nine months of 2004.

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

     At September 30, 2004, the aggregate unrealized losses after taxes of the fixed maturity securities were approximately $1.4 billion. At September 30, 2004, the aggregate unrealized losses after taxes of the equity securities portfolio were approximately $168 million.

     At September 30, 2004, aggregate unrealized gains after taxes were $10.8 billion and aggregate unrealized losses after taxes were $1.5 billion. At September 30, 2004, the fair value of AIG’s fixed maturities and equity securities aggregated to $365.1 billion.

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

At September 30, 2004, unrealized losses for fixed maturity securities and equity securities did not reflect any significant industry concentrations.

The amortized cost of fixed maturities available for sale in an unrealized loss position at September 30, 2004, by contractual maturity, is shown below:

         
Amortized
(in millions) Cost

Due in one year or less
  $ 2,045  
Due after one year through five years
    12,272  
Due after five years through ten years
    21,315  
Due after ten years
    31,737  

Total
  $ 67,369  

     In the nine months ended September 30, 2004, the pretax realized losses incurred with respect to the sale of fixed maturities and equity securities were $1.2 billion. The aggregate fair value of securities sold was $28.6 billion, which was approximately 98 percent of amortized cost. The average period of time that securities sold at a loss during the nine months ended September 30, 2004 were trading continuously at a price below book value was approximately four months.

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At September 30, 2004, aggregate pretax unrealized gains were $16.6 billion, while the pretax unrealized losses with respect to investment grade bonds, below investment grade bonds and equity securities were $1.61 billion, $500 million and $258 million, respectively. Aging of the pretax unrealized losses with respect to these securities, distributed as a percentage of cost relative to unrealized loss (the extent by which the market value is less than amortized cost or cost), including the number of respective items, was as follows:

                                                                                                   

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




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

Investment grade bonds
                                                                                               
 
0-6 months
  $ 43,891     $ 737       2,771     $ 32     $ 10       15     $     $           $ 43,923     $ 747       2,786  
 
7-12 months
    6,999       233       579       69       15       20                         7,068       248       599  
 
>12 months
    10,395       526       787       340       85       12                         10,735       611       799  

Total
  $ 61,285     $ 1,496       4,137     $ 441     $ 110       47     $     $           $ 61,726     $ 1,606       4,184  

Below investment grade bonds
                                                                                               
 
0-6 months
  $ 3,081     $ 97       425     $ 55     $ 14       28     $ 36     $ 21       20     $ 3,172     $ 132       473  
 
7-12 months
    830       71       128       92       26       51       13       10       11       935       107       190  
 
>12 months
    974       85       115       531       159       99       31       17       14       1,536       261       228  

Total
  $ 4,885     $ 253       668     $ 678     $ 199       178     $ 80     $ 48       45     $ 5,643     $ 500       891  

Total bonds
                                                                                               
 
0-6 months
  $ 46,972     $ 834       3,196     $ 87     $ 24       43     $ 36     $ 21       20     $ 47,095     $ 879       3,259  
 
7-12 months
    7,829       304       707       161       41       71       13       10       11       8,003       355       789  
 
>12 months
    11,369       611       902       871       244       111       31       17       14       12,271       872       1,027  

Total
  $ 66,170     $ 1,749       4,805     $ 1,119     $ 309       225     $ 80     $ 48       45     $ 67,369     $ 2,106       5,075  

Equity securities
                                                                                               
 
0-6 months
  $ 2,151     $ 146       765     $ 193     $ 52       142     $ 23     $ 18       40     $ 2,367     $ 216       947  
 
7-12 months
    359       9       73       57       17       266       17       14       25       433       40       364  
 
>12 months
                      3       1       3       1       1       3       4       2       6  

Total
  $ 2,510     $ 155       838     $ 253     $ 70       411     $ 41     $ 33       68     $ 2,804     $ 258       1,317  

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

     As stated previously, the valuation for AIG’s investment portfolio comes from market exchanges or dealer quotations, with the exception of nontraded securities. AIG considers nontraded securities to mean certain fixed income investments, certain structured securities, direct private equities, limited partnerships and hedge funds. The aggregate carrying value of these securities at September 30, 2004 was approximately $65.5 billion.

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

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

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

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

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

     Each of these investment categories is regularly tested to determine if impairment in value exists. Various valuation te