<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
FORM 10-Q
[ X ] QUARTERLY REPORT UNDER SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
FOR QUARTER ENDED SEPTEMBER 30, 1996 COMMISSION FILE NUMBER 1-8787
---------------------
AMERICAN INTERNATIONAL GROUP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 13-2592361
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
70 PINE STREET, NEW YORK, NEW YORK 10270
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (212) 770-7000
NONE
FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT.
</TABLE>
---------------------
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 [ X ] NO [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of September 30, 1996 469,437,132.
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<PAGE> 2
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investments and cash:
Fixed maturities:
Bonds held to maturity, at amortized cost (market value:
1996 -- $12,687,346; 1995 -- $11,822,190)............. $ 12,166,619 $ 11,086,025
Bonds available for sale, at market value (amortized
cost: 1996 -- $32,630,152; 1995 -- $29,417,475)....... 33,456,931 30,926,771
Bonds trading securities, at market value (cost:
1996 -- $406,080; 1995 -- $411,245)................... 416,071 428,296
Preferred stocks, at amortized cost (market value:
1996 -- $610,795; 1995 -- $620,217)................... 473,996 459,505
Equity securities:
Common stocks (cost: 1996 -- $4,929,368;
1995 -- $4,555,334)................................... 5,769,040 5,294,867
Non-redeemable preferred stocks (cost: 1996 -- $64,540;
1995 -- $73,497)...................................... 66,014 74,454
Mortgage loans on real estate, policy and collateral
loans -- net............................................. 10,077,088 7,860,532
Financial services assets:
Flight equipment primarily under operating leases, net of
accumulated depreciation (1996 -- $1,383,009;
1995 -- $1,182,128)................................... 13,435,666 12,442,010
Securities available for sale, at market value (cost:
1996 -- $5,670,354; 1995 -- $3,930,622)............... 5,676,581 3,931,100
Trading securities, at market value...................... 2,137,444 2,641,436
Spot commodities, at market value........................ 584,977 1,079,124
Unrealized gain on interest rate and currency swaps,
options and forward transactions...................... 6,241,161 7,250,954
Trade receivables........................................ 2,477,833 3,321,985
Securities purchased under agreements to resell,
at contract value..................................... 3,221,431 2,022,056
Other invested assets...................................... 2,973,057 2,808,158
Short-term investments, at cost which approximates market
value.................................................... 1,917,099 2,272,528
Cash....................................................... 150,004 88,371
------------ ------------
Total investments and cash.......................... 101,241,012 93,988,172
Investment income due and accrued............................. 1,387,738 1,212,948
Premiums and insurance balances receivable -- net............. 9,513,053 9,410,185
Reinsurance assets............................................ 17,874,989 16,878,155
Deferred policy acquisition costs............................. 6,360,725 5,767,573
Investments in partially-owned companies...................... 910,726 820,781
Real estate and other fixed assets, net of accumulated
depreciation (1996 -- $1,355,698; 1995 -- $1,303,693)...... 1,904,262 1,822,061
Separate and variable accounts................................ 3,152,704 2,506,791
Other assets.................................................. 2,304,075 1,729,732
------------ ------------
Total assets........................................ $144,649,284 $134,136,398
=========== ===========
</TABLE>
See Accompanying Notes to Financial Statements.
1
<PAGE> 3
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED BALANCE SHEET -- (CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1996 1995
------------- ------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES:
Reserve for losses and loss expenses.......................... $ 33,977,481 $ 33,046,717
Reserve for unearned premiums................................. 8,113,778 6,938,064
Future policy benefits for life and accident and health
insurance contracts........................................ 23,012,969 20,864,635
Policyholders' contract deposits.............................. 11,607,700 9,580,983
Other policyholders' funds.................................... 2,228,571 2,092,165
Reserve for commissions, expenses and taxes................... 1,529,054 1,257,246
Insurance balances payable.................................... 2,245,308 1,886,403
Funds held by companies under reinsurance treaties............ 418,733 344,692
Income taxes payable:
Current.................................................... 410,521 325,113
Deferred................................................... 385,805 552,144
Financial services liabilities:
Borrowings under obligations of guaranteed investment
agreements............................................... 5,843,145 5,423,555
Securities sold under agreements to repurchase, at contract
value.................................................... 2,029,156 1,379,872
Trade payables............................................. 2,245,322 2,810,947
Securities sold but not yet purchased, principally
obligations of the U.S. Government and Government
agencies, at market value................................ 720,498 1,204,386
Spot commodities sold but not yet purchased, at market
value.................................................... 747,889 783,302
Unrealized loss on interest rate and currency swaps,
options and forward transactions......................... 5,238,976 6,405,045
Deposits due to banks and other depositors................. 1,449,954 957,441
Commercial paper........................................... 2,565,013 1,834,882
Notes, bonds and loans payable............................. 10,251,221 8,932,743
Commercial paper.............................................. 1,516,834 1,331,753
Notes, bonds, loans and mortgages payable..................... 419,407 467,784
Separate and variable accounts................................ 3,152,704 2,506,791
Other liabilities............................................. 3,077,924 2,982,632
------------ ------------
Total liabilities................................... 123,187,963 113,909,295
------------ ------------
Preferred shareholders' equity in subsidiary company.......... 400,000 400,000
CAPITAL FUNDS:
Common stock, $2.50 par value: 1,000,000,000 shares
authorized; shares issued 1996 -- 506,084,172;
1995 -- 506,084,177........................................ 1,265,210 1,265,210
Additional paid-in capital.................................... 132,680 131,828
Unrealized appreciation of investments, net of taxes.......... 1,078,589 1,395,064
Cumulative translation adjustments, net of taxes.............. (463,723) (456,072)
Retained earnings............................................. 19,697,601 17,697,739
Treasury stock, at cost; 1996 -- 36,647,040;
1995 -- 31,899,951 shares of common stock.................. (649,036) (206,666)
------------ ------------
Total capital funds................................. 21,061,321 19,827,103
------------ ------------
Total liabilities and capital funds................. $144,649,284 $134,136,398
=========== ===========
</TABLE>
See Accompanying Notes to Financial Statements.
2
<PAGE> 4
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- -------------------------
1996 1995 1996 1995
----------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
General insurance operations:
Net premiums written................... $ 9,722,560 $9,070,598 $3,230,729 $3,046,371
Change in unearned premium reserve..... (958,655) (557,158) (194,142) (135,573)
---------- ---------- ---------- ----------
Net premiums earned.................... 8,763,905 8,513,440 3,036,587 2,910,798
Net investment income.................. 1,243,380 1,143,424 420,340 385,616
Realized capital gains................. 50,697 61,675 5,644 14,119
---------- ---------- ---------- ----------
10,057,982 9,718,539 3,462,571 3,310,533
---------- ---------- ---------- ----------
Losses and loss expenses incurred...... 6,665,489 6,486,607 2,271,984 2,178,092
Underwriting expenses.................. 1,798,608 1,745,817 650,672 617,418
---------- ---------- ---------- ----------
8,464,097 8,232,424 2,922,656 2,795,510
---------- ---------- ---------- ----------
Operating income....................... 1,593,885 1,486,115 539,915 515,023
---------- ---------- ---------- ----------
Life insurance operations:
Premium income......................... 6,508,465 5,863,977 2,213,481 2,026,826
Net investment income.................. 2,046,296 1,645,447 718,352 585,878
Realized capital gains................. 22,600 16,085 16,750 14,337
---------- ---------- ---------- ----------
8,577,361 7,525,509 2,948,583 2,627,041
---------- ---------- ---------- ----------
Death and other benefits............... 2,701,139 2,439,560 963,453 866,323
Increase in future policy benefits..... 3,209,509 2,689,991 1,053,878 936,605
Acquisition and insurance expenses..... 1,708,658 1,617,843 585,806 543,673
---------- ---------- ---------- ----------
7,619,306 6,747,394 2,603,137 2,346,601
---------- ---------- ---------- ----------
Operating income....................... 958,055 778,115 345,446 280,440
---------- ---------- ---------- ----------
Agency and service fee operating
income............................... 41,752 45,886 12,222 13,920
Financial services operating income.... 374,761 288,940 133,938 95,455
Equity in income of minority-owned
insurance operations................. 74,322 59,244 26,273 20,125
Other realized capital gains
(losses)............................. (1,072) (23,883) 649 (9,579)
Minority interest...................... (33,289) (27,723) (9,283) (10,215)
Other income (deductions) -- net....... (64,564) (62,738) (31,089) (26,302)
---------- ---------- ---------- ----------
Income before income taxes............. 2,943,850 2,543,956 1,018,071 878,867
---------- ---------- ---------- ----------
Income taxes (benefits) -- Current..... 803,291 694,185 289,579 218,229
-- Deferred... 13,536 13,144 (2,945) 29,952
---------- ---------- ---------- ----------
816,827 707,329 286,634 248,181
---------- ---------- ---------- ----------
Net income............................. $ 2,127,023 $1,836,627 $ 731,437 $ 630,686
========== ========== ========== ==========
Earnings per common share.............. $ 4.51 $ 3.87 $ 1.56 $ 1.33
========== ========== ========== ==========
Cash dividends per common share........ $ 0.27 $ 0.238 $ 0.10 $ 0.085
========== ========== ========== ==========
Average shares outstanding............. 471,515 473,986 469,436 474,130
---------- ---------- ---------- ----------
</TABLE>
See Accompanying Notes to Financial Statements.
3
<PAGE> 5
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER
30,
---------------------------
1996 1995
----------- -----------
<S> <C> <C>
Cash Flows From Operating Activities:
Net income...................................................... $ 2,127,023 $ 1,836,627
----------- -----------
Adjustments to reconcile net income to net cash provided by
operating activities:
Non-cash revenues, expenses, gains and losses included in
income:
Change in:
General and life insurance reserves........................ 4,336,394 4,749,997
Premiums and insurance balances receivable and payable --
net...................................................... 256,037 (537,801)
Reinsurance assets......................................... (996,834) (763,850)
Deferred policy acquisition costs.......................... (593,152) (509,020)
Investment income due and accrued.......................... (174,790) (262,199)
Funds held under reinsurance treaties...................... 74,041 (25,726)
Other policyholders' funds................................. 136,406 106,633
Current and deferred income taxes -- net................... 98,945 (244,481)
Reserve for commissions, expenses and taxes................ 271,808 147,223
Other assets and liabilities -- net........................ (479,051) 203,558
Trade receivables and payables -- net...................... 278,527 710,041
Trading securities, at market value........................ 503,992 (828,753)
Spot commodities, at market value.......................... 494,147 (150,969)
Net unrealized gain on interest rate and currency swaps,
options and forward transactions......................... (156,276) 37,684
Securities purchased under agreements to resell............ (1,199,375) (155,779)
Securities sold under agreements to repurchase............. 649,284 798,402
Securities sold but not yet purchased...................... (483,888) 303,074
Spot commodities sold but not yet purchased, at market
value.................................................... (35,413) 347,276
Realized capital gains........................................ (72,225) (53,877)
Equity in income of partially-owned companies and other
invested assets............................................ (119,331) (81,673)
Depreciation expenses, principally flight equipment........... 603,882 540,984
Change in cumulative translation adjustments.................. (30,049) (90,648)
Other -- net.................................................. 4,957 (48,529)
----------- -----------
Total Adjustments............................................. 3,368,036 4,191,567
----------- -----------
Net cash provided by operating activities....................... $ 5,495,059 $ 6,028,194
----------- -----------
</TABLE>
See Accompanying Notes to Financial Statements.
4
<PAGE> 6
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)
(DOLLARS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER
30,
---------------------------
1996 1995
----------- -----------
<S> <C> <C>
Cash Flows From Investing Activities:
Cost of fixed maturities, at amortized cost matured or
redeemed................................................... $ 1,346,988 $ 805,900
Cost of bonds, at market sold................................. 6,816,250 5,926,255
Cost of bonds, at market matured or redeemed.................. 1,960,194 2,229,751
Cost of equity securities sold................................ 2,136,119 1,949,312
Realized capital gains........................................ 72,225 53,877
Purchases of fixed maturities................................. (14,369,425) (13,138,722)
Purchases of equity securities................................ (2,507,784) (2,000,054)
Mortgage, policy and collateral loans granted................. (2,706,970) (2,471,324)
Repayments of mortgage, policy and collateral loans........... 490,414 646,268
Sales of securities available for sale........................ 1,628,718 1,579,593
Maturities of securities available for sale................... 105,473 347,652
Purchases of securities available for sale.................... (3,489,696) (2,524,482)
Sales of flight equipment..................................... 1,126,044 417,736
Purchases of flight equipment................................. (2,514,622) (2,795,462)
Net additions to real estate and other fixed assets........... (291,162) (239,863)
Sales or distributions of other invested assets............... 871,082 183,232
Investments in other invested assets.......................... (978,006) (418,550)
Change in short-term investments.............................. 358,630 352,881
Investments in partially-owned companies...................... (36,668) (32,664)
----------- -----------
Net cash used in investing activities........................... (9,982,196) (9,128,664)
----------- -----------
Cash Flows From Financing Activities:
Change in policyholders' contract deposits.................... 2,026,717 2,424,262
Change in deposits due to banks and other depositors.......... 492,513 (38,062)
Change in commercial paper.................................... 915,212 143,183
Proceeds from notes, bonds, loans and mortgages payable....... 3,190,940 3,964,311
Repayments on notes, bonds, loans and mortgages payable....... (1,927,525) (2,847,854)
Proceeds from guaranteed investment agreements................ 3,041,772 2,817,006
Maturities of guaranteed investment agreements................ (2,622,182) (3,338,742)
Proceeds from subsidiary company preferred stock issued....... (98) 98,476
Proceeds from common stock issued............................. 16,083 16,213
Cash dividends to shareholders................................ (127,161) (113,267)
Acquisition of treasury stock................................. (474,034) (17,201)
Other - net................................................... 16,533 4,649
----------- -----------
Net cash provided by financing activities....................... 4,548,770 3,112,974
----------- -----------
Change in cash.................................................. 61,633 12,504
Cash at beginning of period..................................... 88,371 76,237
----------- -----------
Cash at end of period........................................... $ 150,004 $ 88,741
========== ==========
</TABLE>
See Accompanying Notes to Financial Statements.
5
<PAGE> 7
AMERICAN INTERNATIONAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
a) These statements are unaudited. In the opinion of management, all
adjustments consisting of normal recurring accruals have been made for a
fair presentation of the results shown.
b) Earnings per share of American International Group, Inc. (AIG) are based on
the weighted average number of common shares outstanding during the period,
adjusted to reflect all stock splits. The effect of potentially dilutive
securities is not significant.
c) Supplemental cash flow information for the nine month periods ended
September 30, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
1996 1995
---------- --------
(IN THOUSANDS)
<S> <C> <C>
Income taxes paid............................ $ 699,500 $918,000
Interest paid................................ $1,123,000 $939,200
</TABLE>
d) For further information, refer to the Annual Report on Form 10-K of AIG for
the year ended December 31, 1995.
6
<PAGE> 8
AMERICAN INTERNATIONAL GROUP, INC.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OPERATIONAL REVIEW
General Insurance Operations
General insurance operations for the nine month periods ending September 30,
1996 and 1995 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
- ------------------------------------------------------
<S> <C> <C>
Net premiums written:
Domestic $6,386,214 $ 5,850,999
Foreign 3,336,346 3,219,599
- ------------------------------------------------------
Total $9,722,560 $ 9,070,598
- ------------------------------------------------------
Net premiums earned:
Domestic $5,763,020 $ 5,420,855
Foreign 3,000,885 3,092,585
- ------------------------------------------------------
Total $8,763,905 $ 8,513,440
- ------------------------------------------------------
Adjusted underwriting
profit (loss):
Domestic $ (13,518) $ 40,007
Foreign 313,326 241,009
- ------------------------------------------------------
Total $ 299,808 $ 281,016
- ------------------------------------------------------
Net investment income:
Domestic $ 987,280 $ 918,550
Foreign 256,100 224,874
- ------------------------------------------------------
Total $1,243,380 $ 1,143,424
- ------------------------------------------------------
Operating income before
realized capital gains:
Domestic $ 973,762 $ 958,557
Foreign 569,426 465,883
- ------------------------------------------------------
Total $1,543,188 $ 1,424,440
Realized capital gains 50,697 61,675
- ------------------------------------------------------
Operating income $1,593,885 $ 1,486,115
- ------------------------------------------------------
</TABLE>
During the first nine months of 1996, the net premiums written and net
premiums earned in AIG's general insurance operations increased 7.2 percent and
2.9 percent, respectively, from those of 1995.
The growth in net premiums written in the first nine months of 1996
resulted from a combination of several factors. Domestically, AIG continued to
achieve some general price increases in certain specialty markets and smaller
commercial markets as well as volume growth in mortgage guarantee insurance and
in personal lines. Overseas, the primary reasons for growth were price and
volume increases. Foreign general insurance operations produced 34.3 percent of
the general insurance net premiums written in the first nine months of 1996 and
35.5 percent in the same period of 1995.
In comparing the foreign exchange rates used to translate AIG's foreign
general operations during the first nine months of 1996 to those foreign
exchange rates used to translate AIG's foreign general operations during the
same period of 1995, the U.S. dollar strengthened 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 consolidation, total general insurance net premiums written were
approximately 3.1 percentage points less than they would have been if translated
utilizing those exchange rates which prevailed during that same period of 1995.
Net premiums written are initially deferred and earned based upon the terms
of the underlying policies. The net unearned premium reserve constitutes the
deferred revenues which are generally earned ratably over the policy period.
Thus, the net unearned premium reserve is not fully recognized as net premiums
earned until the end of the policy period.
The statutory general insurance ratios were as follows:
<TABLE>
<CAPTION>
1996 1995
- ------------------------------------------------------
<S> <C> <C>
Domestic:
Loss Ratio 85.54 85.51
Expense Ratio 15.24 14.60
- ------------------------------------------------------
Combined Ratio 100.78 100.11
- ------------------------------------------------------
Foreign:
Loss Ratio 57.83 59.87
Expense Ratio 31.10 31.89
- ------------------------------------------------------
Combined Ratio 88.93 91.76
- ------------------------------------------------------
Consolidated:
Loss Ratio 76.06 76.19
Expense Ratio 20.69 20.74
- ------------------------------------------------------
Combined Ratio 96.75 96.93
- ------------------------------------------------------
</TABLE>
Adjusted underwriting profit or loss (operating income less net investment
income and realized capital gains) represents statutory underwriting profit or
loss adjusted primarily for changes in deferred acquisition costs. The adjusted
underwriting profits were $299.8 million in the first nine months of 1996 and
$281.0 million in the same period of 1995.
7
<PAGE> 9
AIG's results reflect the net impact with respect to incurred losses of
catastrophes approximating $78 million in 1996 and $70 million in 1995. AIG's
gross incurred losses from catastrophes approximated $240 million and $150
million in 1996 and 1995, respectively. If these catastrophes were excluded from
the losses incurred in each period, the pro forma consolidated statutory general
insurance ratios would be as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------
1996 1995
- --------------------------------------------------------
<S> <C> <C>
Loss Ratio 75.17 75.37
Expense Ratio 20.69 20.74
- --------------------------------------------------------
Combined Ratio 95.86 96.11
- --------------------------------------------------------
</TABLE>
Excluding the effects of the aforementioned catastrophes, the results from
general insurance operations have improved in 1996. AIG's ability to maintain
the pro forma combined ratio below 100 is primarily attributable to the
profitability of AIG's foreign general insurance operations and AIG's emphasis
on maintaining its disciplined underwriting, especially in the domestic
specialty markets. In addition, AIG does not seek net premium growth where rates
do not adequately reflect its assessment of exposures.
General insurance net investment income in the first nine months of 1996
increased 8.7 percent when compared to the same period of 1995. The growth in
net investment income in 1996 was primarily attributable to new cash flow for
investment. The new cash flow was generated from net general insurance operating
cash flow and included the compounding of previously earned and reinvested net
investment income. (See also the discussion under "Liquidity" herein.)
General insurance realized capital gains were $50.7 million in the first
nine months of 1996 and $61.7 million in 1995. These realized gains resulted
from the ongoing management of the general insurance investment portfolios
within the overall objectives of the general insurance operations and arose
primarily from the disposition of equity securities and available for sale and
trading fixed maturities as well as redemptions of fixed maturities.
General insurance operating income in the first nine months of 1996
increased 7.3 percent when compared to the same period of 1995. The contribution
of general insurance operating income to income before income taxes was 54.1
percent in 1996 compared to 58.4 percent in 1995.
A period to period comparison of operating income is significantly
influenced by the catastrophe losses in any one period as well as the volatility
from one period to the next in realized capital gains. Adjusting each period to
exclude the effects of both catastrophe losses and realized capital gains,
operating income would have increased by 8.5 percent in the first nine months of
1996. The increase in the growth rate of 1996 over 1995 after the aforementioned
adjustments was a result of the increased net investment income and improvement
in underwriting results.
AIG is a major purchaser of reinsurance for its general insurance
operations. AIG is cognizant of the need to exercise good judgment in the
selection and approval of both domestic and foreign companies participating in
its reinsurance programs. AIG insures risks in over 100 countries and its
reinsurance programs must be coordinated in order to provide AIG the level of
reinsurance protection that it desires. These reinsurance arrangements do not
relieve AIG from its direct obligations to its insureds.
AIG's general reinsurance assets amounted to $17.65 billion and resulted
from AIG's reinsurance arrangements. Thus, a credit exposure existed at
September 30, 1996, 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. The
application of this collateral against balances due or any changes to the amount
of collateral are based on the development of losses recoverable on an
individual reinsurer basis. This development includes losses incurred but not
reported (IBNR). At December 31, 1995, approximately 50 percent of the general
reinsurance assets were from unauthorized reinsurers. In order to obtain
statutory recognition, nearly all of these balances were collateralized. The
remaining 50 percent of the general reinsurance assets were from authorized
reinsurers and over 96 percent of such balances were from reinsurers rated A-
(excellent) or better, as rated by A.M. Best. This rating is a measure of
financial strength. The terms authorized and unauthorized pertain to regulatory
categories, not creditworthiness. Through September 30, 1996, these
8
<PAGE> 10
distribution percentages have not changed significantly.
AIG's provision for estimated unrecoverable reinsurance has not changed
significantly from December 31, 1995, when AIG had allowances for unrecoverable
reinsurance approximating $125 million. At that date, and prior to this
allowance, AIG had no significant reinsurance recoverables from any individual
reinsurer which is financially troubled (e.g., liquidated, insolvent, in
receivership or otherwise subject to formal or informal regulatory restriction).
AIG's Reinsurance Security Department conducts ongoing detailed assessments
of the reinsurance markets and current and potential reinsurers, both foreign
and domestic. Such assessments include, but are not limited to, identifying if a
reinsurer is appropriately licensed and has sufficient financial capacity, and
the local economic environment in which a foreign reinsurer operates. This
department also reviews the nature of the risks ceded and the need for
collateral. In addition, AIG's Credit Risk Committee reviews the credit limits
for and concentrations with any one reinsurer.
AIG enters into certain intercompany reinsurance transactions for its
general and life operations. AIG enters into 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, 1996, the consolidated general reinsurance assets of
$17.65 billion include reinsurance recoverables for (i) paid losses and loss
expenses of $2.10 billion and (ii) $13.73 billion with respect to the ceded
reserve for losses and loss expenses, including ceded IBNR (ceded reserves). The
ceded reserves represent the accumulation of estimates of ultimate ceded losses
including provisions for ceded IBNR and loss expenses. The methods used to
determine such estimates and to establish the resulting ceded reserves are
continually reviewed and updated. Any adjustments therefrom are reflected in
income currently. It is AIG's belief that the ceded reserves at September 30,
1996 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.
At September 30, 1996, general insurance reserves for losses and loss
expenses (loss reserves) amounted to $33.98 billion, an increase of $930.8
million or 2.8 percent over the prior year end, and represent the accumulation
of estimates of ultimate losses, including IBNR, and loss expenses and minor
amounts of discounting related to certain workers' compensation claims. General
insurance net loss reserves increased $554.7 million or 2.8 percent to $20.25
billion and represent loss reserves reduced by reinsurance recoverable, net of
an allowance for unrecoverable reinsurance. The methods used to determine such
estimates and to establish the resulting reserves are continually reviewed and
updated. Any adjustments resulting therefrom are reflected in operating income
currently. It is management's belief that the general insurance net loss
reserves are adequate to cover all general insurance net losses and loss
expenses as at September 30, 1996. In the future, if the general insurance net
loss reserves develop deficiently, such deficiency would have an adverse impact
on such future results of operations.
In a very broad sense, the general loss reserves can be categorized into
two distinct groups: one group being long tail casualty lines of business; the
other being short tail lines of business consisting principally of property
lines and including certain classes of casualty lines.
Estimation of ultimate net losses and loss expenses (net losses) for long
tail casualty lines of business is a complex process and depends on a number of
factors, including the line and volume of the business involved. In the more
recent accident years of long tail casualty lines there is limited statistical
credibility in reported net losses. That is, a relatively low proportion of net
losses would be reported claims and expenses and an even smaller proportion
would be net losses paid. A relatively high proportion of net losses would
therefore be IBNR.
A variety of actuarial methods and assumptions are normally employed to
estimate net losses for long tail casualty lines. These methods ordinarily
involve the use of loss trend factors intended to reflect the estimated annual
growth in loss costs from one accident year to the next. Loss trend factors
reflect many items including changes in claims handling, exposure and policy
forms and current and future estimates of monetary inflation
9
<PAGE> 11
and social inflation. Thus, many factors are implicitly considered in estimating
the year to year growth in loss costs. Therefore, AIG's carried net long tail
loss reserves are judgmentally set as well as tested for reasonableness using
the most appropriate loss trend factors for each class of business. In the
evaluation of AIG's net loss reserves, loss trend factors vary slightly,
depending on the particular class and nature of the business involved. For the
majority of long tail casualty lines, net loss trend factors approximating nine
percent were employed. These factors are periodically reviewed and subsequently
adjusted, as appropriate, to reflect emerging trends which are based upon past
loss experience.
Estimation of net losses for short tail business is less complex than for
long tail casualty lines. Loss cost trends for many property lines can generally
be assumed to be similar to the growth in exposure of such lines. For example,
if the fire insurance coverage remained proportional to the actual value of the
property, the growth in the property's exposure to fire loss can be approximated
by the amount of insurance purchased.
For other property and short tail casualty lines, the loss trend is
implicitly assumed to grow at the rate that reported net losses grow from one
year to the next. The concerns noted above for longer tail casualty lines with
respect to the limited statistical credibility of reported net losses generally
do not apply to shorter tail lines.
AIG continues to receive indemnity claims asserting injuries from toxic
waste, hazardous substances, and other environmental pollutants and alleged
damages to cover the cleanup costs of hazardous waste dump sites (hereinafter
collectively referred to as environmental claims) and indemnity claims asserting
injuries from asbestos. 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. However, AIG currently underwrites pollution impairment liability
insurance on a claims made basis and excluded such claims from the analyses
included herein. AIG has established a specialized claims unit which
investigates and adjusts all such asbestos and environmental claims.
Estimation of asbestos and environmental claims loss reserves is a
difficult process. These asbestos and environmental claims cannot be estimated
by conventional reserving techniques as previously described. Quantitative
techniques frequently have to be supplemented by subjective considerations
including managerial judgment. Significant factors which affect the trends which
influence the development of asbestos and environmental claims are the
inconsistent court resolutions, judicial interpretations which broaden the
intent of the policies and scope of coverage and the increasing number of new
claims. The case law that has emerged can be characterized as still being in its
infancy and the likelihood of any firm direction in the near future is very
small. Additionally, the exposure for cleanup costs of hazardous waste dump
sites involves issues such as allocation of responsibility among potentially
responsible parties and the government's refusal to release parties. The cleanup
cost exposure may significantly change if the Congressional reauthorization of
Superfund changes, thereby reducing or increasing litigation and cleanup costs.
In the interim, AIG and other industry members have and will continue to
litigate the broadening judicial interpretation of the policy coverage and the
liability issues. At the current time, it is not possible to determine the
future development of asbestos and environmental claims. Such development will
be affected by the extent to which courts continue to expand the intent of the
policies and the scope of the coverage, as they have in the past, as well as by
changes in Superfund and waste dump site coverage issues. Additional liabilities
could emerge for amounts in excess of the current reserves held. Although this
emergence cannot now be reasonably estimated, it could have a material adverse
impact on AIG's future operating results. The reserves carried for these claims
at September 30, 1996 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. (See the previous discussion on reinsurance
collectibility herein.)
The majority of AIG's exposures for asbestos and environmental claims are
excess casualty coverages, not primary coverages. Thus, the litigation costs are
treated in the same manner as indemnity reserves. That is, litigation expenses
are included within the limits of the liability AIG incurs. Individual
significant claim liabilities, where future litigation costs are reasonably
determinable, are established on a case basis.
10
<PAGE> 12
A summary of reserve activity, including estimates for applicable IBNR,
relating to asbestos and environmental claims separately and combined at
September 30, 1996 and 1995 was as follows:
(in millions)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
------------- -------------
GROSS NET Gross Net
<S> <C> <C> <C> <C>
- ------------------------------------------------------
Asbestos:
Reserve for losses and
loss expenses at
beginning of period $ 744.8 $127.9 $ 686.0 $130.2
Losses and loss
expenses incurred 144.7 77.6 62.3 (2.0)
Losses and loss
expenses paid (198.3) (45.6) (89.5) (16.3)
- ------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $ 691.2 $159.9 $ 658.8 $111.9
- ------------------------------------------------------
Environmental:
Reserve for losses and
loss expenses at
beginning of period $1,197.9 $379.3 $ 728.1 $200.1
Losses and loss
expenses incurred 197.9 125.8 478.6 147.8
Losses and loss
expenses paid (114.4) (37.7) (154.4) (43.3)
- ------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $1,281.4 $467.4 $1,052.3 $304.6
- ------------------------------------------------------
Combined:
Reserve for losses and
loss expenses at
beginning of period $1,942.7 $507.2 $1,414.1 $330.3
Losses and loss
expenses incurred 342.6 203.4 540.9 145.8
Losses and loss
expenses paid (312.7) (83.3) (243.9) (59.6)
- ------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $1,972.6 $627.3 $1,711.1 $416.5
- ------------------------------------------------------
</TABLE>
The gross and net IBNR included in the aforementioned reserve for losses
and loss expenses at September 30, 1996 and 1995 were estimated as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
---------------- ----------------
GROSS NET Gross Net
<S> <C> <C> <C> <C>
- ------------------------------------------------------
Combined $861,500 $306,200 $415,000 $125,000
- ------------------------------------------------------
</TABLE>
A summary of asbestos and environmental claims count activity for the nine
month periods ended September 30, 1996 and 1995 was as follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------------
1996 1995
---------------------------------- ----------------------------------
ASBESTOS ENVIRONMENTAL COMBINED Asbestos Environmental Combined
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Claims at beginning of period 5,244 17,858 23,102 5,947 16,223 22,170
Claims during period:
Opened 740 1,993 2,733 1,365 2,832 4,197
Settled (94) (395) (489) (111) (444) (555)
Dismissed or otherwise resolved (555) (2,485) (3,040) (556) (1,771) (2,327)
- ------------------------------------------------------------------------------------------------------------------
Claims at end of period 5,335 16,971 22,306 6,645 16,840 23,485
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The average cost per claim settled, dismissed or otherwise resolved for the
nine month periods ended September 30, 1996 and 1995 was as follows:
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
--------------- ---------------
GROSS NET Gross Net
<S> <C> <C> <C> <C>
- ------------------------------------------------------
Asbestos $305,500 $70,300 $134,200 $24,400
Environmental 39,700 13,100 69,700 19,500
Combined 88,600 23,600 84,600 20,700
- ------------------------------------------------------
</TABLE>
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. 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
11
<PAGE> 13
respective ending reserves for losses and loss expenses over the respective
claims settlements during the fiscal year. Such payments include indemnity
payments and legal and loss adjustment payments. It should be noted, however,
that this is an extremely simplistic approach to measuring asbestos and
environmental reserve levels. Many factors, such as aggressive settlement
procedures, mix of business and level of coverage provided, have significant
impact on the amount of asbestos and environmental losses and loss expense
reserves, ultimate payments thereof and the resultant ratio. The aforementioned
insurance rating agency has recently published the findings of its current
studies with respect to the ultimate aggregate costs for toxic waste cleanups
for the insurance industry. This agency has significantly lowered its ultimate
aggregate cost projections that were published in 1994. Other published studies
also project lower ultimate aggregate costs for toxic waste cleanups for the
insurance industry.
The developed survival ratios include both involuntary and voluntary
indemnity payments. Involuntary payments include court judgments, court orders,
covered claims with no coverage defenses, state mandated cleanup costs, claims
where AIG's coverage defenses are minimal, and settlements made less than six
months before trial. Also, AIG considers all legal and loss adjustment payments
as involuntary.
AIG believes voluntary indemnity payments should be excluded from the
survival ratio. The special asbestos and environmental claims unit actively
manages AIG's asbestos and environmental claims and proactively pursues early
settlement of environmental claims for all known and unknown sites. As a result,
AIG reduces its exposure to future environmental loss contingencies.
Accordingly, AIG's annualized survival ratios for involuntary asbestos and
environmental claims, separately and combined, were estimated as follows for the
nine month periods ended September 30, 1996 and 1995:
- -----------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
------------- -------------
GROSS NET Gross Net
<S> <C> <C> <C> <C>
- -----------------------------------------------------------
Involuntary survival
ratios:
Asbestos 2.6 2.6 5.5 5.1
Environmental 15.0 14.3 13.5 11.4
Combined 6.2 7.3 9.1 9.0
- -----------------------------------------------------------
</TABLE>
AIG's operations are negatively impacted under guarantee fund assessment
laws which exist in most states. As a result of operating in a state which has
guarantee fund assessment laws, a solvent insurance company may be assessed for
certain obligations arising from the insolvencies of other insurance companies
which operated in that state. AIG generally records these assessments upon
notice. Additionally, certain states permit at least a portion of the assessed
amount to be used as a credit against a company's future premium tax
liabilities. Therefore, the ultimate net assessment cannot reasonably be
estimated. The guarantee fund assessment net of credits for 1995 was $23.5
million. Based upon current information, AIG does not anticipate that its net
assessment will be significantly different in 1996.
AIG is also required to participate in various involuntary pools
(principally workers' compensation business) which provide insurance coverage
for those not able to obtain such coverage in the voluntary markets. This
participation is also recorded upon notification, as these amounts cannot
reasonably be estimated.
Life Insurance Operations
Life insurance operations for the nine month periods ending September 30, 1996
and 1995 were as follows:
(in thousands)
- ---------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
- ---------------------------------------------------------
Premium income:
Domestic $ 383,075 $ 354,939
Foreign 6,125,390 5,509,038
- ---------------------------------------------------------
Total $ 6,508,465 $ 5,863,977
- ---------------------------------------------------------
Net investment income:
Domestic $ 762,058 $ 613,331
Foreign 1,284,238 1,032,116
- ---------------------------------------------------------
Total $ 2,046,296 $ 1,645,447
- ---------------------------------------------------------
Operating income before
realized capital gains:
Domestic $ 76,341 $ 41,209
Foreign 859,114 720,821
- ---------------------------------------------------------
Total $ 935,455 $ 762,030
Realized capital gains 22,600 16,085
- ---------------------------------------------------------
Operating income $ 958,055 $ 778,115
- ---------------------------------------------------------
Life insurance in-force:*
Domestic $ 57,819,853 $ 54,272,118
Foreign 347,055,561 321,824,989
- ---------------------------------------------------------
Total $404,875,414 $376,097,107
- ---------------------------------------------------------
</TABLE>
* Amounts presented were as at September 30, 1996 and December 31, 1995,
respectively.
12
<PAGE> 14
Demonstrating the strength of its franchise, AIG's life insurance
operations continued to show growth primarily as a result of overseas
operations, particularly in Asia. AIG's life premium income during the first
nine months of 1996 represented a 11.0 percent increase from the same period in
1995. Foreign life operations produced 94.1 percent and 93.9 percent of the life
premium income in 1996 and 1995, respectively.
As previously discussed, the U.S. dollar strengthened in value in relation
to most major foreign currencies in which AIG transacts business. Accordingly,
for the first nine months of 1996, when foreign life premium income was
translated into U.S. dollars for purposes of consolidation, total life premium
income was approximately 5.9 percentage points less than it would have been if
translated utilizing exchange rates prevailing in the same period of 1995.
Life insurance net investment income increased 24.4 percent during the
first nine months of 1996 from the same period in 1995. The growth in net
investment income was primarily attributable to foreign new cash flow for
investment and, to a lesser degree, growth in interest income earned on policy
loans related to domestic corporate-owned life insurance products. The new cash
flow was generated from life insurance operations and included the compounding
of previously earned and reinvested net investment income. (See also the
discussion under "Liquidity" herein.)
The traditional life products, such as whole and term life and endowments,
were the major contributors to the growth in foreign premium income and
investment income, particularly in Asia, and continue to be the primary source
of growth in the life segment. A mixture of traditional, accident and health and
financial products are being sold in Japan.
Life insurance realized capital gains were $22.6 million in 1996 and $16.1
million in 1995. These realized gains resulted from the ongoing management of
the life insurance investment portfolios within the overall objectives of the
life insurance operations and arose primarily from the disposition of equity
securities and available for sale fixed maturities as well as redemptions of
fixed maturities.
Life insurance operating income during the first nine months of 1996
increased 23.1 percent from the same period in 1995 to $958.1 million. Excluding
realized capital gains from life insurance operating income, the percent
increase would be 22.8 percent during the first nine months of 1996 from the
same period in 1995. The contribution of life insurance operating income to
income before income taxes amounted to 32.5 percent during the first nine months
of 1996 compared to 30.6 percent in the same period of 1995.
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 investment risk.
Underwriting risk represents the exposure to loss resulting from the actual
policy experience adversely emerging in comparison to the assumptions made in
the product pricing associated with mortality, morbidity, termination and
expenses. AIG's life companies limit their maximum underwriting exposure on
traditional life insurance of a single life to approximately one million dollars
of coverage by using yearly renewable term reinsurance. The life insurance
operations have not entered into assumption reinsurance transactions or surplus
relief transactions during the two year period ended September 30, 1996.
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.
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
13
<PAGE> 15
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 such policy liabilities. Therefore, there is a risk
that the reinvestment of the proceeds at the maturity of the investments may be
at a yield below that of the interest required for the accretion of the policy
liabilities. At December 31, 1995, the average duration of the investment
portfolio was 5.5 years, while the related policy liabilities were estimated to
be 11.8 years. These durations have not changed significantly during 1996. To
maintain an adequate yield to match the interest required over the duration of
the liabilities, constant management focus is required to reinvest the proceeds
of the maturing securities without sacrificing 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. Domestically,
the asset-liability matching process is appropriately functioning as there are
investments available to match the duration and the required yield. (See also
the discussion under "Liquidity" herein.)
AIG uses asset-liability matching as a management tool to determine the
composition of the invested assets and 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.
Agency and Service Fee Operations
Agency and service fee operating income during the first nine months of 1996
decreased 9.0 percent to $41.8 million compared to $45.9 million in 1995. Agency
and service fee operating income contributed 1.4 percent to AIG's income before
income taxes in the first nine months of 1996 compared to 1.8 percent in 1995.
Financial Services Operations
Financial services operations for the nine month periods ending September 30,
1996 and 1995 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
- ------------------------------------------------------
Revenues:
International Lease Finance
Corp. $1,148,310 $1,013,634
AIG Financial Products Corp.* 286,995 179,069
AIG Trading Group Inc.* 209,407 177,771
Other 230,412 164,873
- ------------------------------------------------------
Total $1,875,124 $1,535,347
- ------------------------------------------------------
Operating income:
International Lease Finance
Corp. $ 226,050 $ 199,683
AIG Financial Products Corp. 129,824 84,481
AIG Trading Group Inc. 53,903 40,292
Other, including intercompany
adjustments (35,016) (35,516)
- ------------------------------------------------------
Total $ 374,761 $ 288,940
- ------------------------------------------------------
</TABLE>
*Represents net trading revenues.
Financial services operating income increased 29.7 percent in the first
nine months of 1996 over 1995.
International Lease Finance Corporation (ILFC) generates its revenues
primarily from leasing new and used commercial jet aircraft to domestic and
foreign airlines. Revenues also result from the remarketing of commercial jets
for its own account, for airlines and for financial institutions. Revenues in
the first nine months of 1996 increased 13.3 percent from 1995. The revenue
increase resulted primarily from the growth both in the size and relative cost
of the fleet. During the first nine months of 1996, operating income increased
13.2 percent from 1995. The composite borrowing rates during the first nine
months of 1996 and 1995 were 6.28 percent and 6.50 percent, respectively. (See
also the discussions under "Capital Resources" and "Liquidity" herein.)
14
<PAGE> 16
ILFC is exposed to loss through non-performance of aircraft lessees,
through owning aircraft which it would be unable to lease or re-lease at
acceptable rates or sell at lease expiration and through committing to purchase
aircraft which it would be unable to lease. ILFC manages its lessee
non-performance exposure through credit reviews and security deposit
requirements. At September 30, 1996, only 6 of 314 aircraft owned were not
leased and of these, 4 aircraft have been committed for sale. At September 30,
1996, 75 percent of the fleet was leased to foreign airlines. (See also the
discussions under "Capital Resources" and "Liquidity" herein.)
AIG Financial Products Corp. and its subsidiaries (AIGFP) participate in
the derivatives dealer market conducting, primarily as principal, an interest
rate, currency and equity derivative products business. AIGFP also enters into
long-dated forward foreign exchange contracts, option transactions, liquidity
facilities, investment agreements and other structured transactions and invests
in a diversified portfolio of securities. Thus, AIGFP derives substantially all
its revenues from proprietary positions entered in connection with counterparty
transactions rather than for speculative transactions. Revenues in the first
nine months of 1996 increased 60.3 percent from the same period of 1995. During
the first nine months of 1996, operating income increased 53.7 percent from the
same period of 1995. As AIGFP is a transaction-oriented operation, current and
past revenues and operating results may not provide a basis for predicting
future performance. (See also the discussions under "Capital Resources,"
"Liquidity" and "Derivatives" herein.)
AIG Trading Group Inc. and its subsidiaries (AIGTG) derive a substantial
portion of their revenues from market making and trading activities, as
principals, in foreign exchange, interest rates, precious and base metals and
natural gas and other energy products. Revenues in the first nine months of 1996
increased 17.8 percent from the same period of 1995. During the first nine
months of 1996, operating income increased 33.8 percent from the same period of
1995 primarily due to certain structured transactions. (See also the discussions
under "Capital Resources," "Liquidity" and "Derivatives" herein.)
Financial services operating income represented 12.7 percent of AIG's
income before income taxes in the first nine months of 1996. This compares to
11.4 percent in the same period of 1995.
Other Operations
In the first nine months of 1996, AIG's equity in income of minority-owned
insurance operations was $74.3 million compared to $59.2 million in the same
period of 1995. In the first nine months of 1996, the equity interest in
insurance companies represented 2.5 percent of income before income taxes
compared to 2.3 percent in the same period of 1995.
Other realized capital losses amounted to $1.1 million and $23.9 million in
the first nine months of 1996 and 1995, respectively.
Minority interest represents minority shareholders' equity in income of
certain consolidated subsidiaries. In the first nine months of 1996, minority
interest amounted to $33.3 million. In the first nine months of 1995, minority
interest amounted to $27.7 million.
Other income (deductions)--net includes AIG's equity in certain minor
majority-owned subsidiaries and certain partially-owned companies, realized
foreign exchange transaction gains and losses in substantially all currencies
and unrealized gains and losses in hyperinflationary currencies, as well as the
income and expenses of the parent holding company and other miscellaneous income
and expenses. In the first nine months of 1996, net deductions amounted to $64.6
million. In the same period of 1995, net deductions amounted to $62.7 million.
Income before income taxes amounted to $2.94 billion in the first nine
months of 1996, and $2.54 billion in the same period of 1995.
In the first nine months of 1996, AIG recorded a provision for income taxes
of $816.8 million compared to the provision of $707.3 million in the same period
of 1995. These provisions represent effective tax rates of 27.7 percent in the
first nine months of 1996, and 27.8 percent in the same period of 1995.
Net income amounted to $2.13 billion in the first nine months of 1996 and
$1.84 billion in the same period of 1995. The increases in net income over the
periods resulted from those factors described above.
CAPITAL RESOURCES
At September 30, 1996, AIG had total capital funds of $21.06 billion and total
borrowings of $20.60 billion. At that date, $15.45 billion of such borrowings
were either not guaranteed by AIG or were matched
15
<PAGE> 17
borrowings under obligations of guaranteed investment agreements (GIAs).
Total borrowings at September 30, 1996 and December 31, 1995 were as
follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
<S> <C> <C>
- ------------------------------------------------------
GIAs -- AIGFP $ 5,843,145 $ 5,423,555
- ------------------------------------------------------
Commercial Paper:
Funding 792,265 687,182
ILFC(a) 2,565,013 1,834,882
AICCO 724,569 644,571
- ------------------------------------------------------
Total 4,081,847 3,166,635
- ------------------------------------------------------
Medium Term Notes:
ILFC(a) 2,449,585 2,391,535
AIG 90,000 115,000
- ------------------------------------------------------
Total 2,539,585 2,506,535
- ------------------------------------------------------
Notes and Bonds Payable:
ILFC(a) 3,550,000 3,550,000
AIGFP 3,213,959 1,868,943
AIG: Lire bonds 159,067 159,067
Zero coupon notes 79,568 73,348
- ------------------------------------------------------
Total 7,002,594 5,651,358
- ------------------------------------------------------
Loans and Mortgages Payable:
ILFC(a)(b) 1,037,677 1,122,265
AIG 90,772 120,369
- ------------------------------------------------------
Total 1,128,449 1,242,634
- ------------------------------------------------------
Total Borrowings 20,595,620 17,990,717
- ------------------------------------------------------
Borrowings not guaranteed by
AIG 9,602,275 8,898,682
Matched GIA borrowings 5,843,145 5,423,555
- ------------------------------------------------------
15,445,420 14,322,237
- ------------------------------------------------------
Remaining borrowings of AIG $ 5,150,200 $ 3,668,480
- ------------------------------------------------------
</TABLE>
(a)AIG does not guarantee or support these borrowings.
(b)Primarily capital lease obligations.
Financing was obtained mainly through GIAs and notes and bonds payable for
AIGFP's investments in a diversified portfolio of securities and derivative
transactions. (See also the discussions under "Operational Review", "Liquidity"
and "Derivatives" herein.)
AIG Funding, Inc. (Funding), through the issuance of commercial paper,
fulfills the short-term cash requirements of AIG and its subsidiaries. Funding
intends to continue to meet AIG's funding requirements through the issuance of
commercial paper guaranteed by AIG. This issuance of Funding's commercial paper
is subject to the approval of AIG's Board of Directors. ILFC and A.I. Credit
Corp. (AICCO) issue commercial paper for the funding of their own operations.
AIG does not guarantee AICCO's or ILFC's commercial paper. However, AIG has
entered into an agreement in support of AICCO's commercial paper. From time to
time, AIGFP may issue commercial paper, which AIG guarantees, to fund its
operations. At September 30, 1996, AIGFP had no commercial paper outstanding.
(See also the discussion under "Derivatives" herein.)
AIG and Funding have entered into two syndicated revolving credit
facilities (the Facilities) aggregating $1 billion. The Facilities consist of a
$500 million 364 day revolving credit facility and a $500 million five year
revolving credit facility. The Facilities can be used for general corporate
purposes and also provide backup for AIG's commercial paper programs
administered by Funding. There are currently no borrowings outstanding under
either of the Facilities, nor were any borrowings outstanding as of September
30, 1996.
At September 30, 1996, ILFC had increased the aggregate principal amount
outstanding of its medium term and term notes to $6.00 billion, a net increase
of $58.1 million, and recorded a net decline in its capital lease obligations of
$62.6 million and a net increase in its commercial paper of $730.1 million. At
September 30, 1996, ILFC had $1.01 billion in aggregate principal amount of debt
securities registered for issuance from time to time. The cash used to purchase
flight equipment, including progress payments during the construction phase, is
primarily derived from the proceeds of ILFC's debt financings. The primary
sources for the repayment of this debt and the interest expense thereon are the
cash flow from operations, proceeds from the sale of flight equipment and the
rollover of prior debt. (See also the discussions under "Operational Review" and
"Liquidity" herein.)
During the third quarter of 1996, AIG issued $50.0 million principal amount
of medium term notes at a rate of 6.25 percent per annum for a three year term.
During the first nine months of 1996, $75.0 million of previously issued medium
term notes matured. At September 30, 1996, AIG had $697.0 million in aggregate
principal amount of debt securities registered for issuance from time to time.
In addition, $50.0 million principal amount of medium term notes at a rate of
6.05 percent per annum for a three year term were issued on November 1, 1996.
(See also the discussion under "Derivatives" herein.)
AIG's capital funds have increased $1.23 billion in the first nine months
of 1996. Unrealized appreciation of investments, net of taxes declined $316.5
million, primarily as a result of the effect of rising domestic interest rates
impacting the
16
<PAGE> 18
market value of the bonds available for sale portfolio. As a result of AIG's
adoption of Financial Accounting Standards No. 115 "Accounting for Certain
Investments in Debt and Equity Securities", unrealized appreciation of
investments, net of taxes, is now subject to increased volatility resulting from
the changes in the market value of bonds available for sale. During the first
nine months of 1996, the cumulative translation adjustment loss, net of taxes,
increased $7.7 million and retained earnings increased $2.00 billion, resulting
from net income less dividends.
During the first nine months of 1996, AIG repurchased in the open market
5.2 million shares of its common stock at a cost of $473.3 million. AIG intends
to continue to buy its common shares in the open market from time to time and to
satisfy its obligations under various employee benefit plans through such
purchases.
Payments of dividends to AIG by its insurance subsidiaries are subject to
certain restrictions imposed by statutory authorities. AIG has in the past
reinvested most of its unrestricted earnings in its operations and believes such
continued reinvestment in the future will be adequate to meet any foreseeable
capital needs. However, AIG may choose from time to time to raise additional
funds through the issuance of additional securities. At September 30, 1996,
there were no significant statutory or regulatory issues which would impair
AIG's financial condition, results of operations or liquidity. (See also the
discussion under "Liquidity" herein.)
In 1989, the National Association of Insurance Commissioners (NAIC) adopted
the "NAIC Solvency Policing Agenda for 1990". Included in this agenda was the
development of Risk-Based Capital (RBC) requirements. RBC relates an individual
insurance company's statutory surplus to the risk inherent in its overall
operations.
At December 31, 1995, the adjusted capital of each of AIG's domestic
general companies and of each of AIG's domestic life companies exceeded each of
their RBC standards by considerable margins. There has been no significant
change through September 30, 1996.
A substantial portion of AIG's general insurance business and a majority of
its life insurance business is carried on in foreign countries. The degree of
regulation and supervision in foreign jurisdictions varies from minimal in some
to stringent in others. Generally, AIG, as well as the underwriting companies
operating in such jurisdictions, must satisfy local regulatory requirements.
To AIG's knowledge, no AIG company is on any regulatory or similar "watch
list".
LIQUIDITY
At September 30, 1996, AIG's consolidated invested assets included approximately
$2.07 billion of cash and short-term investments. Consolidated net cash provided
from operating activities in the first nine months of 1996 amounted to
approximately $5.50 billion.
Management believes that AIG's liquid assets, its net cash provided by
operations, and access to the capital markets will enable it to meet any
foreseeable cash requirements.
AIG's liquidity is primarily derived from the operating cash flows of its
general and life insurance operations.
The liquidity of the combined insurance operations is derived both
domestically and abroad. The combined insurance pretax operating cash flow is
derived from two sources, underwriting operations and investment operations. In
the aggregate, AIG's insurance operations generated approximately $7 billion in
pretax cash flow during the first nine months of 1996. Cash flow includes
periodic premium collections, including policyholders' contract deposits, paid
loss recoveries less reinsurance premiums, losses, benefits and acquisition and
operating expenses paid. Generally, there is a time lag from when premiums are
collected and, when as a result of the occurrence of events specified in the
policy, the losses and benefits are paid. AIG's insurance investment operations
generated over $3 billion in investment income cash flow during the first nine
months of 1996. Investment income cash flow is primarily derived from interest
and dividends received and includes realized capital gains.
The combined insurance pretax operating cash flow coupled with the cash and
short-term investments of $1.64 billion provided the insurance operations with a
significant amount of liquidity during the first nine months of 1996. This
liquidity is available to purchase high quality and diversified fixed income
securities and to a lesser extent marketable equity securities and to provide
mortgage loans on real estate, policy loans and collateral loans. With this
liquidity together with proceeds of approximately $12 billion from the
maturities, sales and redemptions of fixed income securities and from
17
<PAGE> 19
the sale of marketable equity securities, AIG purchased over $16 billion of
fixed income securities and marketable equity securities during the first nine
months of 1996.
During the first nine months of 1996, AIG received approximately $1.3
billion from redemptions of held to maturity municipal bonds. Prior to
redemption, the yield to maturity on these bonds approximated 7.3 percent. The
average yield to maturity on the reinvestment of the proceeds in bonds with
similar characteristics during this same period of time approximated 5.6
percent. AIG does not anticipate that these redemptions will have a significant
effect on AIG's general investment income, operations, financial condition or
liquidity.
The following table is a summary of AIG's invested assets by significant
segment, including investment income due and accrued and real estate, at
September 30, 1996 and December 31, 1995:
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
SEPTEMBER 30, 1996 December 31, 1995
------------------------ -----------------------
INVESTED PERCENT Invested Percent
ASSETS OF TOTAL Assets of Total
------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
General insurance $ 27,974,216 26.9% $26,550,431 27.5%
Life insurance 38,888,070 37.5 34,869,040 36.2
Financial services 36,566,802 35.2 34,468,961 35.8
Other 387,488 0.4 449,832 0.5
- ------------------------------------------------------------------------------------------------------------------
Total $103,816,576 100.0% $96,338,264 100.0%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
The following tables summarize the composition of AIG's insurance invested
assets by insurance segment, including investment income due and accrued and
real estate, at September 30, 1996 and December 31, 1995:
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT DISTRIBUTION
PERCENT ------------------
SEPTEMBER 30, 1996 GENERAL LIFE TOTAL OF TOTAL DOMESTIC FOREIGN
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Fixed Maturities:
Available for sale, at market value(a) $ 9,383,297 $24,378,455 $33,761,752 50.5% 35.2% 64.8%
Held to maturity, at amortized cost(b) 12,640,615 -- 12,640,615 18.9 100.0 --
Equity securities, at market value(c) 3,087,532 2,555,868 5,643,400 8.4 32.5 67.5
Mortgage loans on real estate, policy
and
collateral loans 52,818 8,371,866 8,424,684 12.6 59.1 40.9
Short-term investments, including time
deposits, and cash 701,269 937,480 1,638,749 2.5 18.9 81.1
Real estate 406,257 671,097 1,077,354 1.6 21.5 78.5
Investment income due and accrued 493,327 887,319 1,380,646 2.1 55.1 44.9
Other invested assets 1,209,101 1,085,985 2,295,086 3.4 47.0 53.0
- ------------------------------------------------------------------------------------------------------------------
Total $27,974,216 $38,888,070 $66,862,286 100.0% 50.4% 49.6%
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(a)Includes $416,071 of bonds trading securities, at market value.
(b)Includes $473,996 of preferred stock, at amortized cost.
(c)Includes $36,679 of preferred stock, at market value.
18
<PAGE> 20
<TABLE>
<CAPTION>
(dollars in thousands)
- ---------------------------------------------------------------------------------------------------------------------------
Percent Distribution
Percent -------------------
December 31, 1995 General Life Total of Total Domestic Foreign
<S> <C> <C> <C> <C> <C> <C>
- ---------------------------------------------------------------------------------------------------------------------------
Fixed Maturities:
Available for sale, at market value(a) $ 9,068,133 $22,168,672 $31,236,805 50.9% 37.5% 62.5%
Held to maturity, at amortized cost(b) 11,545,530 -- 11,545,530 18.8 100.0 --
Equity securities, at market value(c) 3,011,249 2,131,897 5,143,146 8.4 35.8 64.2
Mortgage loans on real estate, policy
and collateral loans 54,852 6,887,329 6,942,181 11.3 52.8 47.2
Short-term investments, including time
deposits, and cash 636,709 1,231,817 1,868,526 3.0 25.6 74.4
Real estate 345,336 660,954 1,006,290 1.6 17.3 82.7
Investment income due and accrued 466,744 732,380 1,199,124 2.0 55.3 44.7
Other invested assets 1,421,878 1,055,991 2,477,869 4.0 50.6 49.4
- ---------------------------------------------------------------------------------------------------------------------------
Total $26,550,431 $34,869,040 $61,419,471 100.0% 51.0% 49.0%
- ---------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a)Includes $428,296 of bonds trading securities, at market value.
(b)Includes $459,505 of preferred stock, at amortized cost.
(c)Includes $38,989 of preferred stock, at market value.
With respect to fixed maturities, AIG's strategy is to invest in high
quality securities while maintaining diversification to avoid significant
exposure to issuer, industry and/or country concentrations.
At September 30, 1996, approximately 53 percent of the fixed maturity
investments were domestic securities. Approximately 38 percent of such domestic
securities were rated AAA, and approximately two percent were below investment
grade.
A significant portion of the foreign insurance fixed income portfolio is
rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar
credit quality rating services are not available in all overseas locations. AIG
annually reviews the credit quality of the foreign portfolio nonrated fixed
income investments, including mortgages. At September 30, 1996, approximately 42
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. Less than one percent of these investments were deemed
below investment grade and approximately four percent were not rated at that
date.
Although AIG's fixed income insurance portfolios contain only minor amounts
of securities below investment grade, any fixed income security may be subject
to downgrade for a variety of reasons subsequent to any balance sheet date.
There have been no significant downgrades as at November 1, 1996.
At September 30, 1996, approximately 5 percent of the fixed maturities
portfolio was Collateralized Mortgage Obligations (CMOs). All of the CMOs were
investment grade and approximately 73 percent of the CMOs were backed by various
U.S. government agencies. The remaining 27 percent was rated at least A. Thus,
credit risk was minimal. CMOs are exposed to interest rate risk as the duration
and ultimate realized yield would be affected by the accelerated prepayments of
the underlying mortgages. There were no interest only or principal only CMOs.
When permitted by regulatory authorities and when deemed necessary to
protect insurance assets, including invested assets, from currency risk and
interest rate risk, AIG and its insurance subsidiaries enter into derivative
transactions as end users. To date, such activities have been minor. (See also
the discussion under "Derivatives" herein.)
Mortgage loans on real estate, policy and collateral loans comprised 12.6
percent of AIG's insurance invested assets at September 30, 1996. AIG's
insurance holdings of real estate mortgages amounted to $2.29 billion of which
33.8 percent was domestic. At September 30, 1996, no domestic mortgages and only
a nominal amount of foreign mortgages were in default. At September 30, 1996,
AIG's insurance holdings of collateral loans amounted to $856.4 million, all of
which were foreign. It is AIG's practice to maintain a maximum loan to value
ratio of 75 percent at loan origination. AIG's policy loans increased from $3.95
billion at December 31, 1995 to $5.28 billion at September 30, 1996, with most
of this increase relating to the domestic corporate-owned life insurance
product.
Short-term investments represent amounts invested in various internal and
external money market funds, time deposits and cash.
AIG's real estate investment properties are primarily occupied by AIG's
various operations. The current market value of these properties considerably
exceeds their carrying value.
19
<PAGE> 21
Other invested assets were primarily comprised of both foreign and domestic
private placements, limited partnerships and outside managed funds.
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.
The following table is a summary of the composition of AIG's financial
services invested assets at September 30, 1996 and December 31, 1995. (See also
the discussions under "Operational Review," "Capital Resources" and
"Derivatives" herein.)
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1996 1995
----------------------- -----------------------
INVESTED PERCENT Invested Percent
ASSETS OF TOTAL Assets of Total
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Flight equipment primarily under operating leases, net of
accumulated depreciation $13,435,666 36.7% $12,442,010 36.1%
Unrealized gain on interest rate and currency swaps,
options and forward transactions 6,241,161 17.1 7,250,954 21.0
Securities available for sale, at market value 5,676,581 15.5 3,931,100 11.4
Trading securities, at market value 2,137,444 5.9 2,641,436 7.7
Securities purchased under agreements to resell, at
contract value 3,221,431 8.8 2,022,056 5.9
Trade receivables 2,477,833 6.8 3,321,985 9.6
Spot commodities, at market value 584,977 1.6 1,079,124 3.1
Other, including short-term investments 2,791,709 7.6 1,780,296 5.2
- -----------------------------------------------------------------------------------------------------------------
Total $36,566,802 100.0% $34,468,961 100.0%
- -----------------------------------------------------------------------------------------------------------------
</TABLE>
As previously discussed, the cash used for the purchase of flight equipment
is derived primarily from the proceeds of ILFC's debt financing. The primary
sources for the repayment of this debt and the interest expense thereon are the
cash flow from operations, proceeds from the sale of flight equipment and the
rollover of prior debt. During the first nine months of 1996, ILFC acquired
flight equipment costing $2.51 billion.
AIGFP's derivative transactions are carried at market value or at estimated
fair value when market prices are not readily available. AIGFP reduces its
economic exposure through similarly valued offsetting transactions including
swaps, trading securities, options, forwards and futures. The estimated fair
values of these transactions represent assessments of the present value of
expected future cash flows. These transactions are exposed to liquidity risk if
AIGFP were to sell or close out the transactions prior to maturity. AIG believes
that the impact of any such limited liquidity would not be significant to AIG's
financial condition or its overall liquidity. (See also the discussion under
"Derivatives" herein.)
Securities available for sale, at market value and securities purchased
under agreements to resell are purchased with the proceeds of AIGFP's GIA
financings and other long and short-term borrowings. The proceeds from the
disposal of securities available for sale and securities purchased under
agreements to resell have been used to fund the maturing GIAs or other AIGFP
financing. (See also the discussion under "Capital Resources" herein.)
Securities available for sale is primarily a portfolio of debt securities,
where the individual securities have varying degrees of credit risk. At
September 30, 1996, the average credit rating of this portfolio was AA or the
equivalent thereto as determined through rating agencies or internal review. At
that date, AIGFP has also entered into credit derivative transactions to hedge
its credit risk associated with $1.8 billion of these securities. There were no
securities deemed below investment grade. There have been no significant
downgrades through November 1, 1996. Securities purchased under agreements to
resell are treated as collateralized transactions. AIGFP generally takes
possession of securities purchased under agreements to resell. AIGFP further
minimizes its credit risk by monitoring counterparty credit exposure and, when
AIGFP deems necessary, it requires additional collateral to be deposited.
Trading securities, at market value are marked to market daily and are held to
meet the short-term risk management objectives of AIGFP.
20
<PAGE> 22
AIGTG conducts, as principal, market making and trading activities in
foreign exchange, interest rates, precious and base metals and natural gas and
other energy products. AIGTG owns inventories in the commodities in which it
trades and may reduce the exposure to market risk through the use of swaps,
forwards, futures and option contracts. AIGTG uses derivatives to manage the
economic exposure of its various trading positions and transactions from adverse
movements of interest rates, exchange rates and commodity prices. AIGTG supports
its trading activities largely through trade payables, unrealized losses on
swaps, short-term borrowings and spot commodities sold but not yet purchased.
(See also the discussions under "Capital Resources" and "Derivatives" herein.)
DERIVATIVES
Derivatives are financial arrangements among two or more parties whose returns
are linked to or "derived" from some underlying equity, debt, commodity or other
asset, liability, or some index. Derivatives payments may be based on interest
rates and exchange rates and/or prices of certain securities, certain
commodities, or financial or commodity indices. The more significant types of
derivative arrangements in which AIG transacts are swaps, forwards, futures,
options and related instruments.
The most commonly used swaps are interest rate and currency swaps. An
interest rate swap is a contract between two parties to exchange interest rate
payments (typically a fixed interest rate versus a variable interest rate)
calculated on a notional principal amount for a specified period of time. The
notional amount is not exchanged. A currency swap is similar but the notional
amounts are different currencies which are typically exchanged at the
commencement and termination of the swap based upon negotiated exchange rates.
A futures or forward contract is a contract between two parties to purchase
or sell at a specified future date a specified quantity of a commodity,
security, currency, financial index or other instrument, at a specified price. A
futures contract is traded on an exchange, while a forward contract is executed
over the counter.
An option contract generally provides the option purchaser with the right
but not the obligation to buy or sell during a period of time or at a specified
date the underlying instrument at a set price. The option writer is obligated to
sell or buy the underlying item if the option purchaser chooses to exercise his
right. The option writer receives a nonrefundable fee or premium paid by the
option purchaser.
Derivatives are generally either negotiated over the counter contracts or
standardized contracts executed on an exchange. Standardized exchange traded
derivatives include futures and options which can be readily bought or sold over
recognized security exchanges and settled daily through such clearing houses.
Negotiated over the counter derivatives include forwards, swaps and options.
Over the counter derivatives are generally not traded like exchange traded
securities. However, in the normal course of business, with the agreement of the
original counterparty, these contracts may be terminated early or assigned to
another counterparty.
All significant derivatives activities are conducted through AIGFP and
AIGTG, permitting AIG to participate in the derivatives dealer market acting
primarily as principal. In these derivative operations, AIG structures
agreements which generally allow its counterparties to enter into transactions
with respect to changes in interest and exchange rates, securities' prices and
certain commodities and financial or commodity indices. Generally, derivatives
are used by AIG's customers such as corporations, financial institutions,
multinational organizations, sovereign entities, government agencies and
municipalities. For example, a futures, forward or option contract can be used
to protect the customers' assets or liabilities against price fluctuations.
The senior management of AIG, with review by the Board of Directors,
defines the policies and establishes general operating parameters for AIGFP and
AIGTG. AIG's senior management has established various oversight committees to
review the various financial market, operational and credit issues of AIGFP and
AIGTG. The senior managements of AIGFP and AIGTG report the results of their
respective operations to and review future strategies with AIG's senior
management.
AIG actively manages the exposures to limit potential losses, while
maximizing the rewards afforded by these business opportunities. In doing so,
AIG must manage a variety of exposures including credit, market, liquidity,
operational and legal risks.
Market risk principally arises from the uncertainty that future earnings
are exposed to potential
21
<PAGE> 23
changes in volatility, interest rates, foreign exchange rates, and equity and
commodity prices. AIG generally controls its exposure to market risk by taking
offsetting positions. AIG's philosophy with respect to its financial services
operations is to minimize or set limits for open or uncovered positions that are
to be carried. Credit risk exposure is separately managed. (See the discussion
on the management of credit risk below.)
AIGFP does not seek to manage the market risk of each of its transactions
through an individual offsetting transaction. Rather, AIGFP takes a portfolio
approach to the management of its market risk exposure. AIGFP values its
portfolio at market value or estimated fair value when market values are not
readily available. These valuations represent an assessment of the present
values of expected future cash flows of AIGFP's transactions and may include
reserves for such risks as are deemed appropriate by AIGFP's and AIG's
management. AIGFP evaluates the portfolio's discounted cash flows with reference
to current market conditions, maturities within the portfolio and other relevant
factors. Based upon this evaluation, AIGFP determines what, if any, offsetting
transactions are necessary to reduce the market risk exposure of the portfolio.
The aforementioned estimated fair values are based upon the use of
valuation models. These models utilize, among other things, current interest,
foreign exchange and volatility rates. These valuation models are integrated
into the evaluation of the portfolio, as described above, in order to provide
timely information for the market risk management of the portfolio.
Additionally, depending upon the nature of interest rates and market
movements during the day, the system will produce reports for management's
consideration for intra-day offsetting positions. Overnight, the system
generates reports which recommend the types of offsets management should
consider for the following day. Additionally, AIGFP operates in major business
centers overseas and is essentially open for business 24 hours a day. Thus, the
market exposure and offset strategies are monitored, reviewed and coordinated
around the clock. Therefore, offsetting adjustments can be made as and when
necessary from any AIGFP office in the world.
As part of its monitoring and controlling of its exposure to market risk,
AIGFP applies various testing techniques which reflect potential market
movements. These techniques vary by currency and are regularly changed to
reflect factors affecting the derivatives portfolio. In addition to the daily
monitoring, AIGFP's senior management and local risk managers conduct a weekly
review of the derivatives portfolio and existing hedges. This review includes an
examination of the portfolio's risk measures, such as aggregate option
sensitivity to movements in market variables. AIGFP's management may change
these measures to reflect their judgment and evaluation of the dynamics of the
markets. This management group will also determine whether additional or
alternative action is required in order to manage the portfolio. AIG utilizes an
outside consultant to provide the managements of AIG and AIGFP with comfort that
the system produces representative values.
AIGTG's approach to managing market risk is to establish an appropriate
offsetting position to a particular transaction or group of transactions
depending upon the extent of market risk AIGTG wishes to reduce.
AIGTG's senior management has established positions and stop-loss limits
for each line of business. AIGTG's traders are required to maintain positions
within these limits. These positions are monitored during the day either
manually or through on-line computer systems. In addition, these positions are
reviewed by AIGTG's management. Reports which present each trading book's
position and the prior day's profit and loss are reviewed by traders, head
traders and AIGTG's senior management. Based upon these and other reports,
AIGTG's senior management determines whether to adjust AIGTG's risk profile.
AIGTG attempts to secure reliable current market prices, such as published
prices or third party quotes, to value its derivatives. Where such prices are
not available, AIGTG uses an internal methodology which includes interpolation
or extrapolation from verifiable prices nearest to the dates of the
transactions. The methodology may reflect interest and exchange rates, commodity
prices, volatility rates and other relevant factors.
A significant portion of AIGTG's business is transacted in liquid markets.
Certain of AIGTG's derivative product exposures are evaluated using simulation
techniques which consider such factors as changes in currency and commodity
prices, interest rates, volatility levels and the effect of time. Though not
indicative of the future, past volatile
22
<PAGE> 24
market scenarios have represented profit opportunities for AIGTG.
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG
included in the financial services assets and liabilities at September 30, 1996
were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
GROSS GROSS BALANCE
UNREALIZED UNREALIZED SHEET
GAINS LOSSES AMOUNT
<S> <C> <C> <C>
- ------------------------------------------------------
Securities
available for
sale, at market
value $ 205,556 $ 199,329 $5,676,581
Unrealized
gain/loss on
interest rate
and currency
swaps, options
and forward
transactions(a)(b) 6,241,161 5,238,976 --
Trading
securities, at
market value -- -- 2,137,444
Securities sold
but not yet
purchased,
principally
obligations of
the U.S.
government and
government
agencies, at
market value -- -- 720,498
Trade
receivables(b) 4,822,019 2,987,022 2,477,833
Spot commodities,
at market
value(c) 149,152 270,869 584,977
Trade payables -- 1,905,980 2,245,322
Spot commodities
sold but not yet
purchased, at
market value 211,852 121,024 747,889
- ------------------------------------------------------
</TABLE>
(a)These amounts are also presented as the respective balance sheet amounts.
(b)At September 30, 1996, AIGTG's net replacement values were $307.9 million
with respect to interest rate and currency swaps and $1.97 billion with
respect to futures and forward contracts which were included in trade
receivables.
(c)The net replacement value with respect to purchased option contracts of AIGTG
at September 30, 1996 was $420.0 million.
The interest rate risk on securities available for sale, at market, is
managed by taking offsetting positions on a security by security basis, thereby
offsetting a significant portion of the unrealized appreciation or depreciation.
At September 30, 1996, the unrealized gains and losses remaining after benefit
of the offsets were $10.5 million and $4.3 million, respectively.
AIGFP carries its derivatives at market or estimated fair value, whichever
is appropriate. Because of limited liquidity of certain of these instruments,
the recorded estimated fair values of these derivatives may be different than
the values that might be realized if AIGFP were to sell or close out the
transactions prior to maturity. (See also the discussions under "Operational
Review: Financial Services" and "Liquidity" herein.)
Trading securities, at market value, and securities sold but not yet
purchased are marked to market daily with the unrealized gain or loss being
recognized in income at that time. These securities are held to meet the
short-term risk management objectives of AIGFP.
AIGTG conducts, as principal, market making and trading activities in
foreign exchange, interest rates, precious and base metals and natural gas and
other energy products. AIGTG owns inventories in the commodities in which it
trades. These inventories are carried at market and may be substantially hedged.
AIGTG uses derivatives to manage the economic exposure of its various trading
positions and transactions from adverse movements in interest rates, exchange
rates and commodity prices. (See also the discussions under "Operational Review:
Financial Services" and "Liquidity" herein.)
A counterparty may default on any obligation to AIG, including a derivative
contract. Credit risk is a consequence of extending credit and/or carrying
trading and investment positions. Credit risk exists for a derivative contract
when that contract has an estimated positive fair value. To help manage this
risk, the credit departments of AIGFP and AIGTG operate within the guidelines of
the AIG Credit Risk Committee, which sets credit policy and limits for
counterparties and provides limits for derivative transactions with
counterparties having different credit ratings. In addition to credit ratings,
this committee takes into account other factors, including the industry and
country of the counterparty. Transactions which fall outside these
pre-established guidelines require the approval of the AIG Credit Risk
Committee. It is also AIG's policy to establish reserves for potential credit
impairment when necessary.
AIGFP and AIGTG determine the credit quality of each of their
counterparties taking into account credit ratings assigned by recognized
statistical rating organizations. If it is determined that a counterparty
requires credit enhancement, then one or more enhancement techniques will be
used. Examples of such enhancement techniques include
23
<PAGE> 25
letters of credit, guarantees, collateral credit triggers and credit derivatives
and margin agreements.
A significant majority of AIGFP's transactions are contracted and
documented under ISDA Master Agreements that provide for legally enforceable
set-off and close out netting of exposures in the event of default. Under such
agreements, in connection with the early termination of a transaction, AIGFP is
permitted to set-off its receivables from a counterparty against AIGFP's
payables to that same counterparty arising out of all included transactions.
Excluding regulated exchange transactions, AIGTG, whenever possible, enters into
netting agreements with its counterparties which are similar in effect to those
discussed above.
The following tables provide the notional and contractual amounts of
AIGFP's derivatives portfolio at September 30, 1996 and December 31, 1995. The
notional amounts used to express the extent of AIGFP's involvement in swap
transactions represent a standard of measurement of the volume of AIGFP's swaps
business. Notional amount is not a quantification of market risk or credit risk
and it may not necessarily be recorded on the balance sheet. Notional amounts
represent those amounts used to calculate contractual cash flows to be exchanged
and are not paid or received, except for certain contracts such as currency
swaps. The timing and the amount of cash flows relating to foreign exchange
forwards and exchange traded futures and options contracts are determined by
each of the respective contractual agreements.
The net replacement value most closely represents the net credit risk to
AIGFP or the maximum amount exposed to potential loss after the application of
the aforementioned strategies, ISDA Master Agreements and collateral held.
The following table presents AIGFP's derivatives portfolio by maturity and
type of derivative at September 30, 1996 and December 31, 1995:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REMAINING LIFE
------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL Total
YEAR FIVE YEARS TEN YEARS YEARS 1996 1995
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Interest rate, currency and
equity/commodity swaps and
swaptions:
Notional amount:
Interest rate swaps $31,689,800 $71,560,800 $37,635,300 $ 9,144,800 $150,030,700 $130,441,000
Currency swaps 10,001,900 15,475,400 7,147,900 3,530,600 36,155,800 28,829,000
Equity/commodity swaps 32,800 20,600 -- 50,000 103,400 320,000
Swaptions 360,200 1,196,000 2,577,000 949,800 5,083,000 4,374,000
- ------------------------------------------------------------------------------------------------------------------
Total $42,084,700 $88,252,800 $47,360,200 $13,675,200 $191,372,900 $163,964,000
- ------------------------------------------------------------------------------------------------------------------
Futures and forward contracts:
Exchange traded futures contracts
contractual amount $ 4,855,000 $ -- $ -- $ -- $ 4,855,000 $ 16,050,000
- ------------------------------------------------------------------------------------------------------------------
Over the counter forward contracts
contractual amount $ 7,478,000 $ -- $ -- $ -- $ 7,478,000 $ 2,238,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
24
<PAGE> 26
AIGFP determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At September 30, 1996 and
December 31, 1995, the counterparty credit quality by derivative product with
respect to the net replacement value of AIGFP's derivatives portfolio was as
follows:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NET REPLACEMENT VALUE
-----------------------------
SWAPS AND FUTURES AND TOTAL Total
SWAPTIONS FORWARD CONTRACTS 1996 1995
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Counterparty credit quality:
AAA $1,481,000 $ -- $1,481,000 $1,994,000
AA 2,018,000 14,000 2,032,000 2,146,000
A 1,316,000 4,000 1,320,000 1,443,000
BBB 1,028,000 -- 1,028,000 1,239,000
Below investment grade 20,000 -- 20,000 49,000
Not externally rated exchanges* -- -- -- 23,000
- ------------------------------------------------------------------------------------------------------------------
Total $5,863,000 $18,000 $5,881,000 $6,894,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
*Exchange traded futures and options are not deemed to have significant credit
exposure as the exchanges guarantee that every contract will be properly
settled on a daily basis.
At September 30, 1996 and December 31, 1995, the counterparty breakdown by
industry with respect to the net replacement value of AIGFP's derivatives
portfolio was as follows:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NET REPLACEMENT VALUE
-----------------------------
SWAPS AND FUTURES AND TOTAL Total
SWAPTIONS FORWARD CONTRACTS 1996 1995
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Non-U.S. banks $2,194,000 $17,000 $2,211,000 $2,443,000
Insured municipalities 579,000 -- 579,000 880,000
U.S. industrials 780,000 -- 780,000 1,025,000
Governmental 941,000 -- 941,000 845,000
Non-U.S. financial service companies 32,000 -- 32,000 40,000
Non-U.S. industrials 375,000 -- 375,000 531,000
Special purpose 105,000 -- 105,000 113,000
U.S. banks 211,000 1,000 212,000 319,000
U.S. financial service companies 460,000 -- 460,000 424,000
Supranationals 186,000 -- 186,000 251,000
Exchanges* -- -- -- 23,000
- ------------------------------------------------------------------------------------------------------------------
Total $5,863,000 $18,000 $5,881,000 $6,894,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
*Exchange traded futures and options are not deemed to have significant credit
exposure as the exchanges guarantee that every contract will be properly
settled on a daily basis.
The following tables provide the notional and contractual amounts of
AIGTG's derivatives portfolio at September 30, 1996 and December 31, 1995. In
addition, the estimated positive fair values associated with the derivatives
portfolio are also provided and include a maturity profile for the September 30,
1996 balances based upon the expected timing of the future cash flows.
The notional amounts used to express the extent of AIGTG's involvement in
derivatives transactions represent a standard of measurement of the volume of
AIGTG's derivatives business. Notional amount is not a quantification of the
market or credit risks of the positions and is not necessarily recorded on the
balance sheet. Notional amounts represent those amounts used to calculate
contractual cash flows to be exchanged and are not paid or received, except for
certain contracts such as currency swaps. The timing and the amount of cash
flows relating to foreign exchange forwards and exchange traded futures and
options contracts are determined by the contractual agreements.
The gross replacement values presented represent the sum of the estimated
positive fair values of all of AIGTG's derivatives contracts at September 30,
1996 and December 31, 1995. These values do not represent the credit risk to
AIGTG.
Net replacement values presented represent the net sum of estimated
positive fair values after
25
<PAGE> 27
the application of legally enforceable master closeout netting agreements and
collateral held. The net replacement values most closely represent the net
credit risk to AIGTG or the maximum amount exposed to potential loss.
The following tables present AIGTG's derivatives portfolio and the
associated credit exposure, if applicable, by maturity and type of derivative at
September 30, 1996 and December 31, 1995:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REMAINING LIFE
-------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 1996 1995
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Futures and forward contracts and
interest rate and currency swaps:
Exchange traded futures contracts
contractual amount $ 43,203,000 $6,790,000 $ 52,000 $ -- $ 50,045,000 $ 26,805,000
- ------------------------------------------------------------------------------------------------------------------
Over the counter forward contracts
contractual amount $236,812,000 $10,526,000 $1,126,000 $ 2,000 $248,466,000 $183,710,000
- ------------------------------------------------------------------------------------------------------------------
Interest rate and currency swaps:
Notional amount:
Interest rate swaps and forward
rate agreements $ 73,335,000 $8,024,000 $1,626,000 $ 189,000 $ 83,174,000 $ 29,936,000
Currency swaps -- 1,894,000 941,000 404,000 3,239,000 4,541,000
- ------------------------------------------------------------------------------------------------------------------
Total $ 73,335,000 $9,918,000 $2,567,000 $ 593,000 $ 86,413,000 $ 34,477,000
- ------------------------------------------------------------------------------------------------------------------
Futures and forward contracts and
interest rate and currency swaps:
Credit exposure:
Gross replacement value $ 4,204,000 $ 709,000 $ 280,000 $ 43,000 $ 5,236,000 $ 4,724,000
Master netting arrangements (2,357,000) (389,000 ) (85,000 ) (20,000) (2,851,000) (2,505,000)
Collateral (65,000) (43,000 ) (2,000 ) -- (110,000) (149,000)
- ------------------------------------------------------------------------------------------------------------------
Net replacement value* $ 1,782,000 $ 277,000 $ 193,000 $ 23,000 $ 2,275,000 $ 2,070,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
*The net replacement value of $307.9 million with respect to interest rate and
currency swaps is presented as a component of unrealized gain on interest rate
and currency swaps, options and forward transactions.
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REMAINING LIFE
----------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 1996 1995
<S> <C> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
Option contracts:
Contractual amounts for purchased options:
Exchange traded $ 1,693,000 $ 77,000 $ -- $ -- $ 1,770,000 $ 1,258,000
Over the counter 24,640,000 3,524,000 914,000 -- 29,078,000 25,279,000
- ------------------------------------------------------------------------------------------------------------------
Total $26,333,000 $3,601,000 $ 914,000 $ -- $30,848,000 $26,537,000
- ------------------------------------------------------------------------------------------------------------------
Credit exposure for purchased options:
Gross replacement value $ 416,000 $ 188,000 $ 66,000 $ -- $ 670,000 $ 706,000
Master netting arrangements (147,000) (71,000 ) (9,000 ) -- (227,000) (230,000)
Collateral (3,000) (20,000 ) -- -- (23,000) (17,000)
- ------------------------------------------------------------------------------------------------------------------
Net replacement value(a) $ 266,000 $ 97,000 $ 57,000 $ -- $ 420,000 $ 459,000
- ------------------------------------------------------------------------------------------------------------------
Contractual amounts for sold options(b) $28,951,000 $3,871,000 $ 858,000 $ -- $33,680,000 $28,080,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
(a)The net replacement value with respect to purchased options is presented as a
component of spot commodities, at market value.
(b)Options obligate AIGTG to buy or sell the underlying item if the option
purchaser chooses to exercise. The amounts do not represent credit exposures.
26
<PAGE> 28
AIGTG determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At September 30, 1996 and
December 31, 1995, the counterparty credit quality by derivative product with
respect to the net replacement value of AIGTG's derivatives portfolio was as
follows:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NET REPLACEMENT VALUE
-----------------------------------------------------
FUTURES AND FORWARD CONTRACTS AND OVER THE COUNTER TOTAL Total
INTEREST RATE AND CURRENCY SWAPS PURCHASED OPTIONS 1996 1995
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Counterparty credit quality:
AAA $ 282,000 $ 55,000 $ 337,000 $ 214,000
AA 694,000 193,000 887,000 906,000
A 704,000 91,000 795,000 530,000
BBB 240,000 18,000 258,000 72,000
Below investment grade 181,000 25,000 206,000 22,000
Not externally rated, including
exchange traded futures and
options* 174,000 38,000 212,000 785,000
- ------------------------------------------------------------------------------------------------------------------
Total $ 2,275,000 $ 420,000 $2,695,000 $2,529,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* Exchange traded futures and options are not deemed to have significant credit
exposure as the exchanges guarantee that every contract will be properly
settled on a daily basis.
At September 30, 1996 and December 31, 1995, the counterparty breakdown by
industry with respect to the net replacement value of AIGTG's derivatives
portfolio was as follows:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
NET REPLACEMENT VALUE
-----------------------------------------------------
FUTURES AND FORWARD CONTRACTS AND OVER THE COUNTER TOTAL Total
INTEREST RATE AND CURRENCY SWAPS PURCHASED OPTIONS 1996 1995
- ------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-U.S. banks $ 721,000 $ 176,000 $ 897,000 $ 834,000
U.S. industrials 527,000 13,000 540,000 340,000
Governmental 198,000 10,000 208,000 152,000
Non-U.S. financial service
companies 81,000 43,000 124,000 258,000
Non-U.S. industrials 127,000 13,000 140,000 116,000
U.S. banks 234,000 50,000 284,000 325,000
U.S. financial service companies 213,000 77,000 290,000 231,000
Exchanges* 174,000 38,000 212,000 273,000
- ------------------------------------------------------------------------------------------------------------------
Total $ 2,275,000 $ 420,000 $2,695,000 $2,529,000
- ------------------------------------------------------------------------------------------------------------------
</TABLE>
* Exchange traded futures and options are not deemed to have significant credit
exposure as the exchanges guarantee that every contract will be properly
settled on a daily basis.
Generally, AIG manages and operates its businesses in the currencies of the
local operating environment. Thus, exchange gains or losses occur when AIG's
foreign currency net investment is affected by changes in the foreign exchange
rates relative to the U.S. dollar from one reporting period to the next.
As an end user, AIG and its subsidiaries, including its insurance
subsidiaries, use derivatives to aid in managing AIG's foreign exchange
translation exposure. Derivatives may also be used to minimize certain exposures
with respect to AIG's debt financing and insurance investment operations; to
date, such activities have been minor.
AIG, through its Foreign Exchange Operating Committee, evaluates its
worldwide consolidated net asset or liability positions and manages AIG's
translation exposure to adverse movement in currency exchange rates. AIG may use
forward exchange contracts and purchase options where the cost of such is
reasonable and markets are liquid to reduce these exchange translation
exposures. The exchange gain or loss with respect to these hedging instruments
is recorded on an accrual basis as a component of the cumulative translation
adjustment account in capital funds. AIG's largest currency net investments have
had historically stable exchange rates with respect to the U.S. dollar.
Management of AIG's liquidity profile is designed to ensure that, even
under adverse conditions, AIG is able to raise funds at the most economical cost
to fund maturing liabilities and capital and liquidity requirements of its
subsidiaries. Sources of funds considered in meeting these objectives include
guaranteed investment agreements,
27
<PAGE> 29
issuance of long and short-term debt, maturities and sales of securities
available for sale, securities sold under repurchase agreements, trade payables,
securities and spot commodities sold but not yet purchased, issuance of equity,
and cash provided from operations. AIG's strong capital position is integral to
managing liquidity, as it enables AIG to raise funds in diverse markets
worldwide. (See also the discussions under "Capital Resources" and "Liquidity"
herein.)
Legal risk arises from the uncertainty of the enforceability, through legal
or judicial processes, of the obligations of AIG's clients and counterparties,
including contractual provisions intended to reduce credit exposure by providing
for the netting of mutual obligations. (See also the discussion on master
netting agreements above.) AIG seeks to eliminate or minimize such uncertainty
through continuous consultation with internal and external legal advisors, both
domestically and abroad, in order to understand the nature of legal risk, to
improve documentation and to strengthen transaction structure.
Over the counter derivatives are not transacted in an exchange traded
environment. The futures exchanges maintain considerable financial requirements
and surveillance to ensure the integrity of exchange traded futures and options.
Over the counter derivatives dealers have drafted a code of conduct to
provide standards for their industry. The alternative to self-regulation is
federal regulation. AIG supports self-regulation and expects to adhere to
promulgated standards.
ACCOUNTING STANDARDS
In March 1995, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standards No. 121 "Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed Of " (FASB 121). This
statement requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable and an impairment
loss must be recognized.
FASB 121 was effective for AIG commencing January 1, 1996. The adoption of
this statement at that date did not have a material impact on AIG's results of
operations, financial condition and liquidity.
In June 1996, FASB issued Statement of Financial Accounting Standards No.
125 "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities" (FASB 125). This statement provides accounting
and reporting standards for transfers and servicing of financial assets and
extinguishments of liabilities. This statement provides consistent standards for
distinguishing transfer of financial assets that are sales from transfers that
are secured borrowings.
FASB 125 is effective January 1, 1997 and is to be applied prospectively.
AIG is currently assessing the impact of this statement and believes FASB 125
will not have a material impact on AIG's results of operations, financial
condition and liquidity.
28
<PAGE> 30
PART II -- OTHER INFORMATION
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See accompanying Exhibit Index.
(b) There have been no reports on Form 8-K filed during the quarter ended
September 30, 1996.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
AMERICAN INTERNATIONAL GROUP, INC.
--------------------------------------
(Registrant)
s/s HOWARD I. SMITH
--------------------------------------
Howard I. Smith
Executive Vice President, Comptroller
and Chief Financial Officer
Dated: November 13, 1996
29
<PAGE> 31
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION LOCATION
- ------- ----------------------------------------------------------------- ------------------
<C> <S> <C>
2 Plan of acquisition, reorganization, arrangement, liquidation or
succession....................................................... None
4 Instruments defining the rights of security holders, including
indentures....................................................... Not required to be
filed.
10 Material contracts............................................... None
11 Statement re computation of per share earnings................... Filed herewith.
12 Statement re computation of ratios............................... Filed herewith.
15 Letter re unaudited interim financial information................ None
18 Letter re change in accounting principles........................ None
19 Report furnished to security holders............................. None
22 Published report regarding matters submitted to vote of security
holders.......................................................... None
23 Consents of experts and counsel.................................. None
24 Power of attorney................................................ None
27 Financial Data Schedule.......................................... Provided herewith.
99 Additional exhibits.............................................. None
</TABLE>
30
<PAGE> 1
EXHIBIT 11
AMERICAN INTERNATIONAL GROUP, INC.
COMPUTATION OF EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -------------------
1996 1995 1996 1995
---------- ---------- -------- --------
<S> <C> <C> <C> <C>
Average outstanding shares used in the
computation of per share earnings:
Common stock*.................................. 506,084 506,086 506,084 506,084
Common stock in treasury*...................... (34,569) (32,100) (36,648) (31,954)
---------- --------- -------- --------
471,515 473,986 469,436 474,130
========== ========== ======== ========
Net income (applicable to common stock).......... $2,127,023 $1,836,627 $731,437 $630,686
========== ========== ======== ========
Net income per share............................. $ 4.51 $ 3.87 $ 1.56 $ 1.33
========== ========== ======== ========
</TABLE>
- ---------------
* The effects of all other common stock equivalents are not significant.
31
<PAGE> 1
EXHIBIT 12
AMERICAN INTERNATIONAL GROUP, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ ------------------------
1996 1995 1996 1995
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income before income taxes.................. $2,943,850 $2,543,956 $1,018,071 $ 878,867
Less -- Equity income of less than 50% owned
persons................................... 88,402 64,123 31,715 23,081
Add -- Dividends from less than 50%
owned persons............................. 9,843 4,003 4,862 1,063
---------- ---------- ---------- ----------
2,865,291 2,483,836 991,218 856,849
Add --
Fixed charges............................. 1,165,706 1,168,552 396,548 387,832
Less --
Capitalized interest...................... 37,424 38,689 12,730 11,199
---------- ---------- ---------- ----------
Income before income taxes and fixed
charges................................... $3,993,573 $3,613,699 $1,375,036 $1,233,482
========= ========= ========= =========
Fixed charges:
Interest costs............................ $1,109,813 $1,108,792 $ 377,917 $ 367,912
Rent expense *............................ 55,893 59,760 18,631 19,920
---------- ---------- ---------- ----------
Total fixed charges.................... $1,165,706 $1,168,552 $ 396,548 $ 387,832
========= ========= ========= =========
Ratio of earnings to fixed charges.......... 3.43 3.09 3.47 3.18
</TABLE>
- ---------------
* The proportion deemed representative of the interest factor.
The ratio shown is significantly affected as a result of the inclusion of
the fixed charges and operating results of AIG Financial Products Corp. and its
subsidiaries (AIGFP). AIGFP structures borrowings through guaranteed investment
agreements and engages in other complex financial transactions, including
interest rate and currency swaps. In the course of its business, AIGFP enters
into borrowings that are primarily used to purchase assets that yield rates
greater than the rates on the borrowings with the intent of earning a profit on
the spread and to finance the acquisition of securities utilized to hedge
certain transactions. The pro forma ratios of earnings to fixed charges, which
exclude the effects of the operating results of AIGFP, are 5.21 and 4.67 for the
third quarter and 5.17 and 4.67 for the first nine months of 1996 and 1995,
respectively. As AIGFP will continue to be a subsidiary, AIG expects that these
ratios will continue to be lower than they would be if the fixed charges and
operating results of AIGFP were not included therein.
32
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-01-1996
<PERIOD-END> SEP-30-1996
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 33,456,931
<DEBT-CARRYING-VALUE> 12,166,619
<DEBT-MARKET-VALUE> 12,687,346
<EQUITIES> 5,835,054
<MORTGAGE> 2,714,488
<REAL-ESTATE> 1,187,826
<TOTAL-INVEST> 101,091,008
<CASH> 150,004
<RECOVER-REINSURE> 17,874,989
<DEFERRED-ACQUISITION> 6,360,725
<TOTAL-ASSETS> 144,649,284
<POLICY-LOSSES> 56,990,450
<UNEARNED-PREMIUMS> 8,113,778
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 13,836,271
<NOTES-PAYABLE> 14,752,475
0
0
<COMMON> 1,265,210
<OTHER-SE> 19,796,111
<TOTAL-LIABILITY-AND-EQUITY> 144,649,284
15,272,370
<INVESTMENT-INCOME> 3,289,676
<INVESTMENT-GAINS> 72,225
<OTHER-INCOME> (64,564)
<BENEFITS> 12,576,137
<UNDERWRITING-AMORTIZATION> 1,334,865
<UNDERWRITING-OTHER> 2,172,401
<INCOME-PRETAX> 2,943,850
<INCOME-TAX> 816,827
<INCOME-CONTINUING> 2,127,023
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,127,023
<EPS-PRIMARY> 4.51
<EPS-DILUTED> 4.51
<RESERVE-OPEN> 19,692,800
<PROVISION-CURRENT> 6,665,500
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 2,160,200
<PAYMENTS-PRIOR> 3,950,600
<RESERVE-CLOSE> 20,247,500
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
