<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, 1998 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 INCORPORATION (I.R.S. EMPLOYER IDENTIFICATION NUMBER)
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, 1998: 1,049,959,401.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS:
Investments and cash:
Fixed maturities:
Bonds available for sale, at market value (amortized
cost: 1998 -- $42,796,372; 1997 -- $36,568,360)... $ 44,477,805 $ 38,077,792
Bonds held to maturity, at amortized cost (market
value: 1998 -- $14,048,353;
1997 -- $13,365,703).............................. 13,021,715 12,530,315
Bonds trading securities, at market value (cost:
1998 -- $939,192; 1997 -- $699,614)............... 989,374 718,548
Preferred stocks, at amortized cost (market value:
1998 -- $2,718; 1997 -- $530,705)................. 2,963 239,331
Equity securities:
Common stocks (cost: 1998 -- $4,493,060;
1997 -- $4,625,433)............................... 4,236,211 5,209,274
Non-redeemable preferred stocks (cost:
1998 -- $283,687; 1997 -- $138,412)............... 271,180 138,745
Mortgage loans on real estate, policy and collateral
loans -- net......................................... 8,550,672 7,919,764
Financial services assets:
Flight equipment primarily under operating leases,
net of accumulated depreciation
(1998 -- $1,957,204; 1997 -- $1,657,313).......... 16,035,558 14,438,074
Securities available for sale, at market value (cost:
1998 -- $9,294,249; 1997 -- $9,145,244)........... 9,300,161 9,145,317
Trading securities, at market value.................. 6,378,719 3,974,561
Spot commodities, at market value.................... 459,304 459,517
Unrealized gain on interest rate and currency swaps,
options and forward transactions.................. 9,779,517 7,422,290
Trading assets....................................... 5,730,990 6,715,486
Securities purchased under agreements to resell,
at contract value................................. 4,969,860 4,551,191
Other invested assets.................................. 6,587,413 4,681,423
Short-term investments, at cost (approximates market
value)............................................... 3,257,420 3,332,542
Cash................................................... 209,959 86,917
------------ ------------
Total investments and cash...................... 134,258,821 119,641,087
Investment income due and accrued......................... 1,814,046 1,368,404
Premiums and insurance balances receivable -- net......... 11,837,467 10,282,987
Reinsurance assets........................................ 17,117,550 16,110,521
Deferred policy acquisition costs......................... 6,914,113 6,592,506
Investments in partially-owned companies.................. 440,560 1,121,173
Real estate and other fixed assets, net of accumulated
depreciation (1998 -- $1,690,106;
1997 -- $1,512,617).................................... 2,419,083 2,342,187
Separate and variable accounts............................ 5,578,226 3,993,971
Other assets.............................................. 3,542,955 2,517,851
------------ ------------
Total assets.................................... $183,922,821 $163,970,687
============ ============
</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,
1998 1997
------------- ------------
(UNAUDITED)
<S> <C> <C>
LIABILITIES:
Reserve for losses and loss expenses...................... $ 37,651,600 $ 33,400,160
Reserve for unearned premiums............................. 9,909,524 8,739,006
Future policy benefits for life and accident and health
insurance contracts.................................... 26,111,933 24,502,005
Policyholders' contract deposits.......................... 11,862,084 10,323,112
Other policyholders' funds................................ 2,408,809 2,352,514
Reserve for commissions, expenses and taxes............... 2,050,559 1,739,945
Insurance balances payable................................ 1,954,531 1,702,578
Funds held by companies under reinsurance treaties........ 437,384 336,585
Income taxes payable:
Current................................................ 701,063 585,375
Deferred............................................... 183,711 470,706
Financial services liabilities:
Borrowings under obligations of guaranteed investment
agreements........................................... 8,411,947 8,000,326
Securities sold under agreements to repurchase, at
contract value....................................... 3,758,854 2,706,310
Trading liabilities.................................... 5,077,895 5,366,421
Securities and spot commodities sold but not yet
purchased, at market value........................... 4,837,810 5,171,680
Unrealized loss on interest rate and currency swaps,
options and forward transactions..................... 7,135,097 5,979,571
Deposits due to banks and other depositors............. 1,038,864 972,423
Commercial paper....................................... 3,281,821 2,208,167
Notes, bonds and loans payable......................... 15,079,028 12,608,891
Commercial paper.......................................... 1,007,867 1,166,740
Notes, bonds, loans and mortgages payable................. 1,582,927 1,276,521
Separate and variable accounts............................ 5,578,226 3,993,971
Other liabilities......................................... 7,630,561 5,966,553
------------ ------------
Total liabilities............................... 157,692,095 139,569,560
------------ ------------
Preferred shareholders' equity in subsidiary company...... 400,000 400,000
------------ ------------
CAPITAL FUNDS:
Common stock, $2.50 par value: 2,000,000,000 shares
authorized; shares issued 1998 -- 1,138,658,328;
1997 -- 759,121,505.................................... 2,846,646 1,897,804
Additional paid-in capital................................ 87,416 105,689
Retained earnings......................................... 24,566,129 22,920,991
Accumulated other comprehensive income.................... (588,923) 172,141
Treasury stock, at cost; 1998 -- 88,698,927;
1997 -- 59,603,224 shares of common stock.............. (1,080,542) (1,095,498)
------------ ------------
Total capital funds............................. 25,830,726 24,001,127
------------ ------------
Total liabilities and capital funds............. $183,922,821 $163,970,687
============ ============
</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 THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
-------------------------- ------------------------
1998 1997 1998 1997
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
General insurance operations:
Net premiums written.................... $10,758,856 $10,286,766 $3,760,223 $3,429,877
Change in unearned premium reserve...... (439,628) (989,410) (61,108) (340,613)
----------- ----------- ---------- ----------
Net premiums earned..................... 10,319,228 9,297,356 3,699,115 3,089,264
Net investment income................... 1,587,337 1,366,275 584,588 463,324
Realized capital gains.................. 169,351 106,787 72,995 28,188
----------- ----------- ---------- ----------
12,075,916 10,770,418 4,356,698 3,580,776
----------- ----------- ---------- ----------
Losses and loss expenses incurred....... 7,841,503 7,042,283 2,801,556 2,300,428
Underwriting expenses................... 2,072,805 1,883,499 773,514 670,555
----------- ----------- ---------- ----------
9,914,308 8,925,782 3,575,070 2,970,983
----------- ----------- ---------- ----------
Operating income........................ 2,161,608 1,844,636 781,628 609,793
----------- ----------- ---------- ----------
Life insurance operations:
Premium income.......................... 7,389,556 7,329,233 2,407,129 2,480,443
Net investment income................... 2,335,041 2,147,593 774,978 742,483
Realized capital gains (losses)......... (29,412) 12,789 (14,917) 6,540
----------- ----------- ---------- ----------
9,695,185 9,489,615 3,167,190 3,229,466
----------- ----------- ---------- ----------
Death and other benefits................ 3,182,774 2,964,978 1,090,675 1,033,619
Increase in future policy benefits...... 3,308,805 3,521,732 985,058 1,153,378
Acquisition and insurance expenses...... 1,904,189 1,855,616 645,884 636,499
----------- ----------- ---------- ----------
8,395,768 8,342,326 2,721,617 2,823,496
----------- ----------- ---------- ----------
Operating income........................ 1,299,417 1,147,289 445,573 405,970
----------- ----------- ---------- ----------
Financial services operating income..... 640,065 487,434 234,229 180,485
Equity in income of minority-owned
insurance operations.................. 57,127 84,593 0 26,804
Other realized capital losses........... (10,731) (20,602) (7,636) (10,466)
Other income (deductions) -- net........ (109,476) (66,612) (39,265) (22,761)
----------- ----------- ---------- ----------
Income before income taxes and minority
interest.............................. 4,038,010 3,476,738 1,414,529 1,189,825
----------- ----------- ---------- ----------
Income taxes -- Current................. 908,178 923,154 276,734 314,746
-- Deferred............... 269,251 80,343 138,738 29,510
----------- ----------- ---------- ----------
1,177,429 1,003,497 415,472 344,256
----------- ----------- ---------- ----------
Income before minority interest......... 2,860,581 2,473,241 999,057 845,569
Minority interest....................... (100,968) (25,493) (67,987) (5,251)
----------- ----------- ---------- ----------
Net income............................ $ 2,759,613 $ 2,447,748 $ 931,070 $ 840,318
=========== =========== ========== ==========
Earnings per common share*
Basic................................. $ 2.63 $ 2.32 $ 0.89 $ 0.80
=========== =========== ========== ==========
Diluted............................... $ 2.62 $ 2.31 $ 0.89 $ 0.79
=========== =========== ========== ==========
Cash dividends per common share*........ $ 0.156 $ 0.139 $ 0.056 $ 0.050
=========== =========== ========== ==========
Average shares outstanding*
Basic................................. 1,049,678 1,053,860 1,049,992 1,052,078
----------- ----------- ---------- ----------
Diluted............................... 1,054,704 1,058,682 1,055,112 1,056,896
----------- ----------- ---------- ----------
</TABLE>
- ---------------
* Share information reflects a common stock split in the form of a 50 percent
common stock dividend paid July 31, 1998.
See Accompanying Notes to Financial Statements.
3
<PAGE> 5
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net income............................... $2,759,613 $2,447,748 $ 931,070 $ 840,318
Other comprehensive income:
Unrealized appreciation (depreciation)
of investments -- net of
reclassification
adjustments*...................... (980,785) 277,348 (1,118,462) 490,924
Deferred income tax (expense)
benefit on changes................ 366,136 (109,813) 389,576 (152,395)
Foreign currency translation
adjustments......................... (159,671) (458,174) (28,080) (310,430)
Applicable income tax (expense)
benefit on changes................ 13,256 54,182 (5,344) 18,179
---------- ---------- ----------- ---------
Other comprehensive income............... (761,064) (236,457) (762,310) 46,278
---------- ---------- ----------- ---------
Comprehensive Income..................... $1,998,549 $2,211,291 $ 168,760 $ 886,596
========== ========== =========== =========
</TABLE>
- ---------------
* A significant portion of the unrealized depreciation of investments for the
three months ended September 30, 1998 relates to American International Group,
Inc. (AIG) becoming a majority shareholder of 20th Century Industries (20th
Century). Previously, the appreciation of AIG's investment in 20th Century
over its cost basis was reflected as a component of unrealized appreciation
(depreciation) of investments. As a result of the consolidation of the results
of operations and the statement of condition of 20th Century for the third
quarter, such unrealized appreciation with respect to 20th Century was
eliminated.
See Accompanying Notes to Financial Statements.
4
<PAGE> 6
AMERICAN INTERNATIONAL GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows From Operating Activities:
Net Income.................................................. $ 2,759,613 $ 2,447,748
------------ ------------
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..................... 3,055,362 3,504,897
Premiums and insurance balances receivable and
payable -- net........................................ (1,219,067) (421,135)
Reinsurance assets...................................... (345,301) (784,565)
Deferred policy acquisition costs....................... (244,793) (262,862)
Investment income due and accrued....................... (353,377) (166,218)
Funds held under reinsurance treaties................... (30,312) (44,793)
Other policyholders' funds.............................. 56,295 55,921
Current and deferred income taxes -- net................ 371,280 517,215
Reserve for commissions, expenses and taxes............. 280,533 363,824
Other assets and liabilities -- net..................... (682,833) 199,004
Trading assets and liabilities -- net................... 695,970 (677,204)
Trading securities, at market value..................... (2,404,158) 18,396
Spot commodities, at market value....................... 213 (266,448)
Net unrealized gain on interest rate and currency swaps,
options and forward transactions...................... (1,201,701) (1,215,474)
Securities purchased under agreements to resell......... (418,669) (422,806)
Securities sold under agreements to repurchase.......... 1,052,544 (2,431,765)
Securities and spot commodities sold but not yet
purchased, at market value............................ (333,870) 2,432,614
Realized capital gains.................................... (129,208) (98,974)
Equity in income of partially-owned companies and other
invested assets......................................... (152,190) (116,209)
Depreciation expenses, principally flight equipment....... 677,818 650,186
Change in cumulative translation adjustments.............. (159,671) (458,174)
Other -- net.............................................. 197,851 (82,523)
------------ ------------
Total adjustments......................................... (1,287,284) 292,907
------------ ------------
Net cash provided by operating activities................... $ 1,472,329 $ 2,740,655
------------ ------------
</TABLE>
See Accompanying Notes to Financial Statements.
5
<PAGE> 7
AMERICAN INTERNATIONAL GROUP, INC
CONSOLIDATED STATEMENT OF CASH FLOWS -- (CONTINUED)
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------
1998 1997
------------ ------------
<S> <C> <C>
Cash Flows From Investing Activities:
Cost of fixed maturities, at amortized cost matured or
redeemed................................................ $ 1,083,041 $ 993,917
Cost of bonds, at market sold............................. 7,740,764 7,360,382
Cost of bonds, at market matured or redeemed.............. 3,300,677 2,151,855
Cost of equity securities sold............................ 2,118,097 1,773,257
Realized capital gains.................................... 129,208 98,974
Purchases of fixed maturities............................. (14,448,893) (13,342,852)
Purchases of equity securities............................ (1,938,796) (1,735,493)
Acquisition of 20th Century Industries, net of cash
acquired................................................ (482,418) --
Mortgage, policy and collateral loans granted............. (1,781,309) (1,662,318)
Repayments of mortgage, policy and collateral loans....... 1,150,401 1,341,579
Sales of securities available for sale.................... 2,274,537 2,946,116
Maturities of securities available for sale............... 1,896,821 3,183,803
Purchases of securities available for sale................ (4,344,063) (4,116,709)
Sales of flight equipment................................. 523,031 974,249
Purchases of flight equipment............................. (2,549,130) (2,795,624)
Net additions to real estate and other fixed assets....... (289,798) (354,410)
Sales or distributions of other invested assets........... 1,038,734 5,653,523
Investments in other invested assets...................... (2,393,956) (6,113,935)
Change in short-term investments.......................... 262,047 (162,251)
Investments in partially-owned companies.................. (34,896) (28,654)
------------ ------------
Net cash used in investing activities....................... (6,745,901) (3,834,591)
------------ ------------
Cash Flows From Financing Activities:
Change in policyholders' contract deposits................ 1,538,972 627,363
Change in deposits due to banks and other depositors...... 66,441 (36,867)
Change in commercial paper................................ 914,781 (595,297)
Proceeds from notes, bonds, loans and mortgages payable... 5,974,967 5,461,763
Repayments on notes, bonds, loans and mortgages payable... (3,341,218) (5,403,645)
Liquidation of zero coupon notes payable.................. -- (12,235)
Proceeds from guaranteed investment agreements............ 3,860,098 3,407,703
Maturities of guaranteed investment agreements............ (3,448,477) (1,851,811)
Proceeds from common stock issued......................... 27,998 27,375
Cash dividends to shareholders............................ (165,633) (146,787)
Acquisition of treasury stock............................. (38,324) (274,448)
Other -- net.............................................. 7,009 5,305
------------ ------------
Net cash provided by financing activities................... 5,396,614 1,208,419
------------ ------------
Change in cash.............................................. 123,042 114,483
Cash at beginning of period................................. 86,917 58,740
------------ ------------
Cash at end of period....................................... $ 209,959 $ 173,223
============ ============
</TABLE>
See Accompanying Notes to Financial Statements.
6
<PAGE> 8
AMERICAN INTERNATIONAL GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
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,
retroactively adjusted to reflect all stock splits.
Cash dividends per common share reflect the adjustment for a common stock
split in the form of a 50 percent common stock dividend paid July 31, 1998.
The quarterly dividend rate per common share, commencing with the dividend
paid September 18, 1998 is $0.056.
c) Supplemental cash flow information for the nine month periods ended
September 30, 1998 and 1997 is as follows:
<TABLE>
<CAPTION>
1998 1997
---------- ----------
(i) (IN THOUSANDS)
<S> <C> <C>
Income taxes paid.................................. $ 764,300 $ 408,000
Interest paid...................................... $1,255,300 $1,256,000
</TABLE>
(ii) Preferred stock with a cost of $229,255,000 and warrants with a cost of
$16,000,000 were converted to common stock in connection with the
acquisition of 20th Century Industries.
d) Statement of Accounting Standards No. 130 "Comprehensive Income" (FASB 130)
was adopted by AIG effective January 1, 1998. FASB 130 establishes standards
for reporting comprehensive income and its components as part of capital
funds. Such statement is presented herein.
The reclassification adjustments with respect to available for sale
securities were $50.4 million and $129.2 million for the third quarter and
first nine months of 1998, respectively.
e) Derivatives Accounting Policy: AIG Financial Products Corp. and its
subsidiaries (AIGFP) and AIG Trading Group Inc. and its subsidiaries (AIGTG)
enter into future, forward, swap and option derivative transactions. These
transactions are marked to market. With the exception of the derivatives
used in market hedging activities with respect to securities available for
sale, at market, the marks to market on all such other derivative
transactions are recognized in income currently. The mark to market with
respect to derivatives which hedge the market movements of securities
available for sale, at market is recognized as a component of unrealized
appreciation of investments, net of taxes. When the underlying security is
sold, the loss or gain resulting from the hedging derivative transaction is
recognized as income in that same period.
f) In June 1998, FASB issued Statement of Financial Accounting Standards No.
133 "Accounting for Derivative Instruments and Hedging Activities" (FASB
133). This statement requires AIG to recognize all derivatives in the
consolidated balance sheet measuring these derivatives at fair value. The
recognition of the changes in the fair value of a derivative depends on a
number of factors, including the intended use of the derivative. AIGTG and
AIGFP account for derivatives as described above. AIG is evaluating the
impact of FASB 133 with respect to derivative transactions entered into by
other AIG operations. AIG believes that the impact of FASB 133 on its
results of operations, financial condition or liquidity will not be
significant. FASB 133 is effective for the year commencing January 1, 2000.
g) For further information, refer to the Annual Report on Form 10-K of AIG for
the year ended December 31, 1997.
7
<PAGE> 9
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,
1998, and 1997 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- --------------------------------------------------------
<S> <C> <C>
Net premiums written:
Domestic $ 7,223,956 $ 6,944,434
Foreign 3,534,900 3,342,332
- --------------------------------------------------------
Total $10,758,856 $10,286,766
- --------------------------------------------------------
Net premiums earned:
Domestic $ 6,984,066 $ 6,291,014
Foreign 3,335,162 3,006,342
- --------------------------------------------------------
Total $10,319,228 $ 9,297,356
- --------------------------------------------------------
Adjusted underwriting
profit:
Domestic $ 15,883 $ 3,085
Foreign 389,037 368,489
- --------------------------------------------------------
Total $ 404,920 $ 371,574
- --------------------------------------------------------
Net investment income:
Domestic $ 1,265,097 $ 1,095,993
Foreign 322,240 270,282
- --------------------------------------------------------
Total $ 1,587,337 $ 1,366,275
- --------------------------------------------------------
Operating income before
realized capital gains:
Domestic $ 1,280,980 $ 1,099,078
Foreign 711,277 638,771
- --------------------------------------------------------
Total 1,992,257 1,737,849
Realized capital gains 169,351 106,787
- --------------------------------------------------------
Operating income $ 2,161,608 $ 1,844,636
- --------------------------------------------------------
</TABLE>
Commencing with the third quarter 1998, the results of operations and the
statements of condition of Transatlantic Holdings, Inc. (Transatlantic) and 20th
Century Industries (20th Century) were consolidated into AIG's results of
operations and statement of condition as components of general insurance
operations.
During the first nine months of 1998, the net premiums written and net
premiums earned in AIG's general insurance operations increased 4.6 percent and
11.0 percent, respectively, from those of 1997.
Although the commercial insurance market remains highly competitive and
excessively capitalized, AIG has been able to sustain growth in various
specialty markets. Foreign general insurance operations produced 32.9 percent of
the general insurance net premiums written in the first nine months of 1998 and
32.5 percent in the same period of 1997.
In comparing the foreign currency exchange rates used to translate the
results of AIG's foreign general operations during the first nine months of 1998
to those foreign currency exchange rates used to translate AIG's foreign general
results during the same period of 1997, 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 the preparation of the consolidated financial statements,
total general insurance net premiums written were approximately 2.9 percentage
points less than they would have been if translated utilizing those foreign
currency exchange rates which prevailed during that same period of 1997.
Net premiums written are initially deferred and earned based upon the terms
of the underlying policies. The net unearned premium reserve constitutes
deferred revenues which are generally earned ratably over the policy period.
Thus, the net unearned premium reserve is not fully recognized as net premiums
earned until the end of the policy period.
The statutory general insurance ratios were as follows:
------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------
<S> <C> <C>
Domestic:
Loss Ratio 84.63 84.65
Expense Ratio 15.35 15.48
- -------------------------------------------------------
Combined Ratio 99.98 100.13
- -------------------------------------------------------
Foreign:
Loss Ratio 57.90 57.11
Expense Ratio 30.32 30.67
- -------------------------------------------------------
Combined Ratio 88.22 87.78
- -------------------------------------------------------
Consolidated:
Loss Ratio 75.99 75.75
Expense Ratio 20.27 20.42
- -------------------------------------------------------
Combined Ratio 96.26 96.17
- -------------------------------------------------------
</TABLE>
Adjusted underwriting profit (operating income less net investment income
and realized capital gains) represents statutory underwriting profit adjusted
primarily for changes in deferred acquisition costs. The adjusted underwriting
profits were $404.9 million in the first nine months of 1998 and $371.6 million
in the same period of 1997.
8
<PAGE> 10
AIG's results reflect the net impact of incurred losses from catastrophes
approximating $83 million and $16 million in 1998 and 1997, respectively. AIG's
gross incurred losses from catastrophes approximated $400 million and $22
million in 1998 and 1997, respectively.
If catastrophes were excluded from the losses incurred in each period, the
pro forma consolidated statutory general insurance ratios would be as follows:
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- -------------------------------------------------------
<S> <C> <C>
Loss Ratio 75.18 75.57
Expense Ratio 20.27 20.42
- -------------------------------------------------------
Combined Ratio 95.45 95.99
- -------------------------------------------------------
</TABLE>
AIG's ability to maintain its 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 1998
increased 16.2 percent when compared to the same period of 1997. The growth in
net investment income in 1998 was attributable to new cash flow for investment
and the compounding of previously earned and reinvested net investment income.
(See also the discussion under "Liquidity" herein.)
General insurance realized capital gains were $169.4 million in the first
nine months of 1998 and $106.8 million in 1997. 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 fixed
maturities as well as redemptions of fixed maturities.
General insurance operating income in the first nine months of 1998
increased 17.2 percent when compared to the same period of 1997. The
contribution of general insurance operating income to income before income taxes
and minority interest was 53.5 percent in 1998 compared to 53.1 percent in 1997.
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 AIG desires. These reinsurance arrangements do not
relieve AIG from its direct obligations to its insureds.
AIG's general reinsurance assets amounted to $17.00 billion and resulted
from AIG's reinsurance arrangements. Thus, a credit exposure existed at
September 30, 1998 with respect to reinsurance recoverable to the extent that
any reinsurer may not be able to reimburse AIG under the terms of these
reinsurance arrangements. AIG manages its credit risk in its reinsurance
relationships by transacting with reinsurers that it considers financially sound
and, when necessary, AIG holds substantial collateral in the form of funds,
securities and/or irrevocable letters of credit. This collateral can be drawn on
for amounts that remain unpaid beyond specified time periods on an individual
reinsurer basis. At December 31, 1997, 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 94 percent of such balances are from reinsurers rated A-
(excellent) or better, as rated by A.M. Best. This rating is a measure of
financial strength. The terms authorized and unauthorized pertain to regulatory
categories, not creditworthiness. Through September 30, 1998, these distribution
percentages have not significantly changed.
AIG's provision for estimated unrecoverable reinsurance has not changed
significantly from December 31, 1997 when AIG had allowances for unrecoverable
reinsurance approximating $120 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
9
<PAGE> 11
ceded and the need for collateral. In addition, AIG's Credit Risk Committee
reviews the credit limits for and concentrations with any one reinsurer.
AIG enters into certain intercompany reinsurance transactions for its
general and life operations. AIG enters these transactions as a sound and
prudent business practice in order to maintain underwriting control and spread
insurance risk among various legal entities. These reinsurance agreements have
been approved by the appropriate regulatory authorities. All material
intercompany transactions have been eliminated in consolidation.
At September 30, 1998, the consolidated general reinsurance assets of
$17.00 billion included reinsurance recoverables for paid losses and loss
expenses of $1.64 billion and $13.11 billion with respect to the ceded reserve
for losses and loss expenses, including ceded losses incurred but not reported
(IBNR) (ceded reserves). The ceded reserves represent the accumulation of
estimates of ultimate ceded losses including provisions for ceded IBNR and loss
expenses. The methods used to determine such estimates and to establish the
resulting ceded reserves are continually reviewed and updated. Any adjustments
therefrom are reflected in income currently. It is AIG's belief that the ceded
reserves at September 30, 1998 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, 1998, general insurance reserves for losses and loss
expenses (loss reserves) amounted to $37.65 billion. Excluding the consolidation
of the loss reserves of Transatlantic and 20th Century, the loss reserves
amounted to $34.09 billion, an increase of $688.9 million or 2.1 percent from
the prior year end. These loss reserves represent the accumulation of estimates
of ultimate losses, including IBNR, and loss expenses and minor amounts of
discounting related to certain workers' compensation claims. At September 30,
1998, general insurance net loss reserves increased $477.8 million to $24.55
billion. Excluding the consolidation of the net loss reserves of Transatlantic
and 20th Century, the net loss reserves amounted to $21.61 billion, an increase
of $436.7 million, or 2.1 percent from the prior year end. These loss reserves
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,
1998. 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. For the majority of
long tail casualty lines, net loss trend factors approximated six percent. Loss
trend factors reflect many items including changes in claims handling, exposure
and policy forms and current and future estimates of monetary inflation 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. 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
10
<PAGE> 12
property, the growth in 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 claims asserting injuries from toxic waste,
hazardous substances, and other environmental pollutants and alleged damages to
cover the cleanup costs of hazardous waste dump sites (hereinafter referred to
collectively as environmental claims) and indemnity claims asserting injuries
from asbestos. The vast majority of these asbestos and environmental claims
emanate from policies written in 1984 and prior years. AIG has established a
specialized claims unit which investigates and adjusts all such asbestos and
environmental claims. 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.
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 and judicial interpretations which broaden the
intent of the policies and scope of coverage. The current case law can be
characterized as still evolving and there is little likelihood that any firm
direction will develop in the near future. Additionally, the exposure for
cleanup costs of hazardous waste dump sites involves issues such as allocation
of responsibility among potentially responsible parties and the government's
refusal to release parties. The cleanup cost exposure may significantly change
if the Congressional reauthorization of Superfund dramatically 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 with the same degree of
reliability as is the case for other types of claims. Such development will be
affected by the extent to which courts continue to expand the intent of the
policies and the scope of the coverage, as they have in the past, as well as by
changes in Superfund and waste dump site coverage issues. Although the estimated
liabilities for these claims are subject to a significantly greater margin of
error than for other claims, the reserves carried for these claims at September
30, 1998 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.
A summary of reserve activity, including estimates for applicable IBNR,
relating to asbestos and
11
<PAGE> 13
environmental claims separately and combined at
September 30, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
(in millions)
- --------------------------------------------------------------
1998 1997
------------------ -----------------
GROSS Net Gross Net
- --------------------------------------------------------------
<S> <C> <C> <C> <C>
Asbestos:
Reserve for losses and
loss expenses at
beginning of year $ 842.1 $ 195.1 $ 875.9 $172.3
Losses and loss
expenses incurred 258.8 74.5 219.6 61.5
Losses and loss
expenses paid (193.6) (36.9) (244.7) (41.7)
- --------------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $ 907.3 $ 232.7 $ 850.8 $192.1
- --------------------------------------------------------------
Environmental:
Reserve for losses and
loss expenses at
beginning of year $1,467.1 $ 592.2 $1,427.4 $570.6
Losses and loss
expenses incurred 129.8 60.8 173.8 86.3
Losses and loss
expenses paid (170.6) (69.6) (117.6) (40.0)
- --------------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $1,426.3 $ 583.4 $1,483.6 $616.9
- --------------------------------------------------------------
Combined:
Reserve for losses and
loss expenses at
beginning of year $2,309.2 $ 787.3 $2,303.3 $742.9
Losses and loss
expenses incurred 388.6 135.3 393.4 147.8
Losses and loss
expenses paid (364.2) (106.5) (362.3) (81.7)
- --------------------------------------------------------------
Reserve for losses and
loss expenses at end
of period $2,333.6 $ 816.1 $2,334.4 $809.0
- --------------------------------------------------------------
</TABLE>
The gross and net IBNR included in the reserve for losses and loss expenses
at September 30, 1998 and December 31, 1997 were estimated as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------------- ---------------------
GROSS Net Gross Net
- ------------------------------------------------------------------
<S> <C> <C> <C> <C>
Combined $949,000 $362,990 $1,004,000 $393,900
- ------------------------------------------------------------------
</TABLE>
A summary of asbestos and environmental claims count activity for the nine
month periods ended September 30, 1998 and 1997 was as follows:
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------
1998 1997
----------------------------------- -----------------------------------
ASBESTOS ENVIRONMENTAL Combined Asbestos Environmental Combined
- ---------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Claims at beginning of year 6,150 17,422 23,572 5,668 17,395 23,063
Claims during period:
Opened 652 2,405 3,057 865 2,716 3,581
Settled (51) (460) (511) (105) (315) (420)
Dismissed or otherwise resolved (482) (2,780) (3,262) (303) (1,803) (2,106)
- ---------------------------------------------------------------------------------------------------------------------
Claims at end of period 6,269 16,587 22,856 6,125 17,993 24,118
- ---------------------------------------------------------------------------------------------------------------------
</TABLE>
The average cost per claim settled, dismissed or otherwise resolved for the
nine month periods ended September 30, 1998 and 1997 was as follows:
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------------ -------------------
GROSS Net Gross Net
- ----------------------------------------------------------------
<S> <C> <C> <C> <C>
Asbestos $363,200 $69,200 $599,800 $102,200
Environmental 52,700 21,500 55,500 18,900
Combined 96,500 28,200 143,400 32,300
- ----------------------------------------------------------------
</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 ending reserves for
losses and loss expenses over the respective claims settlements during the
fiscal year. Such payments include indemnity payments and legal and loss
adjustment payments. It should be noted, however, that this is an extremely
simplistic approach to measuring asbestos and environmental reserve levels.
Many factors, such as aggressive settlement procedures, mix of business and
level of coverage provided, have significant impact on the amount of asbestos
and environmental losses and loss expense reserves, ultimate payments thereof
and the resultant ratio.
The developed survival ratios include both involuntary and voluntary
indemnity payments. Involuntary payments include court judgments, court orders,
covered claims with no coverage de-
12
<PAGE> 14
fenses, state mandated cleanup costs, claims where
AIG's coverage defenses are minimal, and settlements made less than six months
before the first trial setting. Also, AIG considers all legal and loss
adjustment payments as involuntary.
AIG believes voluntary indemnity payments should be excluded from the
survival ratio. The special asbestos and environmental claims unit actively
manages AIG's asbestos and environmental claims and proactively pursues early
settlement of environmental claims for all known and unknown sites. As a result,
AIG reduces its exposure to future environmental loss contingencies.
AIG's survival ratios for involuntary asbestos and environmental claims,
separately and combined, were based upon a three year average payment. These
ratios at September 30, 1998 and 1997 were as follows:
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
-------------- --------------
GROSS Net Gross Net
- ---------------------------------------------------------
<S> <C> <C> <C> <C>
Involuntary survival
ratios:
Asbestos 3.2 4.2 3.6 4.2
Environmental 16.3 17.5 15.8 19.1
Combined 7.0 9.9 7.7 11.0
- ---------------------------------------------------------
</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 assessments net of credits for 1997 was $15.4
million. Based upon current information, AIG does not anticipate that its net
assessment will be significantly different in 1998.
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,
1998 and 1997 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------
<S> <C> <C>
Premium income:
Domestic $ 555,178 $ 403,507
Foreign 6,834,378 6,925,726
- ---------------------------------------------------------
Total $ 7,389,556 $ 7,329,233
- ---------------------------------------------------------
Net investment income:
Domestic $ 693,902 $ 620,219
Foreign 1,641,139 1,527,374
- ---------------------------------------------------------
Total $ 2,335,041 $ 2,147,593
- ---------------------------------------------------------
Operating income before
realized capital gains
(losses):
Domestic $ 111,522 $ 93,337
Foreign 1,217,307 1,041,163
- ---------------------------------------------------------
Total 1,328,829 1,134,500
Realized capital gains
(losses) (29,412) 12,789
- ---------------------------------------------------------
Operating income $ 1,299,417 $ 1,147,289
- ---------------------------------------------------------
Life insurance in-force:*
Domestic $ 62,869,221 $ 59,516,720
Foreign 396,203,509 377,056,403
- ---------------------------------------------------------
Total $459,072,730 $436,573,123
- ---------------------------------------------------------
</TABLE>
* Amounts presented were as at September 30, 1998 and December 31, 1997,
respectively.
AIG's life insurance operations, demonstrating the strength of its
franchise, continued to show growth in local currency. AIG's life premium income
during the first nine months of 1998 represented a 0.8 percent increase in U.S.
dollars from the same period in 1997. Foreign life operations produced 92.5
percent and 94.5 percent of the life premium income in 1998 and 1997,
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 1998, when foreign life premium income was
translated into U.S. dollars for purposes of the preparation of the consolidated
financial statements, total life premium income was approximately 15.6
percentage points less than it would have been if translated utilizing exchange
rates prevailing in 1997.
Life insurance net investment income increased 8.7 percent during the first
nine months of 1998. The growth in net investment income was primarily
attributable to foreign new cash flow for investment. The new cash flow was
generated from life insurance operations and included the com-
13
<PAGE> 15
pounding 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 investment income as well as local
currency premium income. A mixture of traditional, accident and health and
financial products are being sold in Japan.
Life insurance realized capital losses were $29.4 million in 1998 compared
to realized capital gains of $12.8 million in 1997. These realized capital gains
and losses 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 1998
increased 13.3 percent to $1.30 billion. Excluding realized capital gains and
losses from life insurance operating income, the increase would be 17.1 percent.
The contribution of life insurance operating income to income before income
taxes and minority interest amounted to 32.2 percent during the first nine
months of 1998 compared to 33.0 percent in the same period of 1997.
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, 1998.
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 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, 1997, the average duration
of the investment portfolio in Japan was 5.7 years, while the related policy
liabilities were estimated to be 13.7 years. These durations have not changed
significantly during 1998. 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, active monitoring assures appropriate
asset-liability matching 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
14
<PAGE> 16
unmatched position due to anticipated interest rate or other economic changes.
Financial Services Operations
Financial services operations for the nine month periods ending September
30, 1998 and 1997 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------
<S> <C> <C>
Revenues:
International Lease Finance
Corp. $1,474,242 $1,369,091
AIG Financial Products Corp.* 353,782 294,513
AIG Trading Group Inc.* 316,009 365,052
Other 269,384 299,020
- ---------------------------------------------------------
Total $2,413,417 $2,327,676
- ---------------------------------------------------------
Operating income:
International Lease Finance
Corp. $ 353,304 $ 287,151
AIG Financial Products Corp. 201,936 151,119
AIG Trading Group Inc. 104,542 83,431
Other, including intercompany
adjustments (19,717) (34,267)
- ---------------------------------------------------------
Total $ 640,065 $ 487,434
- ---------------------------------------------------------
</TABLE>
* Represents net trading revenues.
Financial services operating income increased 31.3 percent in the first
nine months of 1998 over 1997.
Financial services operating income represented 15.9 percent of AIG's
income before income taxes and minority interest in the first nine months of
1998. This compares to 14.0 percent in the same period of 1997.
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 1998 increased 7.7 percent from 1997. The revenue
growth resulted primarily from the growth in the relative cost of the fleet and
the increase in the number of aircraft sold. Approximately 20 percent of ILFC's
operating lease revenues are derived from U.S. and Canadian airlines. During the
first nine months of 1998, operating income increased 23.0 percent from 1997.
The composite borrowing rates at the end of the first nine months of 1998 and
1997 were 6.18 percent and 6.34 percent, respectively. (See also the discussions
under "Capital Resources" and "Liquidity" herein.)
ILFC is exposed to loss through non-performance of aircraft lessees,
through owning aircraft which it would be unable to sell or re-lease at
acceptable rates at lease expiration and through committing to purchase aircraft
which it would be unable to lease. ILFC manages its lessee non-performance
exposure through credit reviews and security deposit requirements. At September
30, 1998, there were 325 aircraft subject to operating leases and there were no
aircraft off lease. (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, equity and credit derivative products business. AIGFP also
enters into structured transactions including long-dated forward foreign
exchange contracts, option transactions, liquidity facilities and investment
agreements and invests in a diversified portfolio of securities. AIGFP derives
substantially all its revenues from proprietary positions entered in connection
with counterparty transactions rather than from speculative transactions.
Revenues in the first nine months of 1998 increased 20.1 percent from the same
period of 1997. During the first nine months of 1998, operating income increased
33.6 percent from the same period of 1997. 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 and precious and base metals.
Revenues in the first nine months of 1998 decreased 13.4 percent from the same
period of 1997. During the first nine months of 1998, operating income increased
25.3 percent from the same period of 1997. As AIGTG 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.)
OTHER OPERATIONS
In the first nine months of 1998, AIG's equity in income of minority-owned
insurance operations
15
<PAGE> 17
was $57.1 million compared to $84.6 million in the same period of 1997. In the
first nine months of 1998, the equity interest in insurance companies
represented 1.4 percent of income before income taxes and minority interest
compared to 2.4 percent in the same period of 1997.
As previously mentioned, Transatlantic was consolidated as a component of
general insurance operations for the first time this quarter. SELIC Holdings,
Ltd. was consolidated earlier this year. IPC Holdings, Ltd., the remaining
operation included in Equity in income of minority-owned insurance operations in
previous periods is now reported as a component of Other income
(deductions) -- net.
Other realized capital losses amounted to $10.7 million and $20.6 million
in the first nine months of 1998 and 1997, respectively.
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 1998, net deductions amounted to
$109.5 million. In the same period of 1997, net deductions amounted to $66.6
million.
Income before income taxes and minority interest amounted to $4.04 billion
in the first nine months of 1998, and $3.48 billion in the same period of 1997.
In the first nine months of 1998, AIG recorded a provision for income taxes
of $1.18 billion compared to the provision of $1.00 billion in the same period
of 1997. These provisions represent effective tax rates of 29.2 percent in the
first nine months of 1998, and 28.9 percent in the same period of 1997.
Minority interest represents minority shareholders' equity in operating
income and capital gains of certain consolidated subsidiaries. In the first nine
months of 1998, minority interest amounted to $101.0 million. In the first nine
months of 1997, minority interest amounted to $25.5 million.
Net income amounted to $2.76 billion in the first nine months of 1998, and
$2.45 billion in the same period of 1997. The increases in net income over the
periods resulted from those factors described above.
CAPITAL RESOURCES
At September 30, 1998, AIG had total capital funds of $25.83 billion and
total borrowings of $29.36 billion. At that date, $26.95 billion of such
borrowings were either not guaranteed by AIG or were matched borrowings under
obligations of guaranteed investment agreements (GIAs) or matched notes and
bonds payable.
Total borrowings and borrowings not guaranteed or matched at September 30,
1998 and December 31, 1997 were as follows:
(in thousands)
- ------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
- ---------------------------------------------------------
<S> <C> <C>
GIAs -- AIGFP $ 8,411,947 $ 8,000,326
- ---------------------------------------------------------
Commercial Paper:
Funding 196,764 307,997
ILFC(a) 3,281,821 2,208,167
AICCO 760,467 833,647
Universal Finance Company
(UFC)(a) 50,636 25,096
- ---------------------------------------------------------
Total 4,289,688 3,374,907
- ---------------------------------------------------------
Medium Term Notes:
ILFC(a) 3,216,750 2,896,865
AIG 230,565 248,225
- ---------------------------------------------------------
Total 3,447,315 3,145,090
- ---------------------------------------------------------
Notes and Bonds Payable:
ILFC(a) 4,025,000 3,950,000
AIGFP 6,996,510 4,858,706
AIG: Lire bonds 159,067 159,067
Zero coupon notes 98,972 91,179
- ---------------------------------------------------------
Total 11,279,549 9,058,952
- ---------------------------------------------------------
Loans and Mortgages Payable:
ILFC(a)(b) 840,768 903,320
SPC Credit Limited (SPC)(a) 528,660 538,988
Consumer Finance(a) 234,836 --
AIG 330,827 239,062
- ---------------------------------------------------------
Total 1,935,091 1,681,370
- ---------------------------------------------------------
Total Borrowings 29,363,590 25,260,645
- ---------------------------------------------------------
Borrowings not guaranteed by
AIG 12,178,471 10,522,436
Matched GIA borrowings 8,411,947 8,000,326
Matched notes and bonds
payable -- AIGFP 6,357,274 3,754,420
- ---------------------------------------------------------
26,947,692 22,277,182
- ---------------------------------------------------------
Remaining borrowings of AIG $ 2,415,898 $ 2,983,463
- ---------------------------------------------------------
</TABLE>
(a)AIG does not guarantee or support these borrowings.
(b)Capital lease obligations.
During the first nine months of 1998, AIGFP increased the aggregate
principal amount outstanding of its notes and bonds payable to $7.0 billion, a
net increase of $2.14 billion and increased its net GIA borrowings by $411.6
million. AIGFP uses the proceeds from the issuance of notes and bonds to invest
in a segregated portfolio of securities availa-
16
<PAGE> 18
ble for sale, although these funds may be temporarily invested in securities
purchased under agreements to resell. Funds received from GIA borrowings are
invested 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 non-insurance
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, A.I. Credit Corp. (AICCO) and UFC, a consumer finance
subsidiary in Taiwan, issue commercial paper for the funding of their own
operations. AIG does not guarantee AICCO's, ILFC's or UFC'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, 1998, 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, 1998.
At September 30, 1998, ILFC had increased the aggregate principal amount
outstanding of its medium term and term notes to $7.24 billion, a net increase
of $394.9 million, and recorded a net decline in its capital lease obligations
of $62.6 million and a net increase in its commercial paper of $1.07 billion. At
September 30, 1998, ILFC had $880 million in aggregate principal amount of debt
securities registered for issuance from time to time. The proceeds of ILFC's
debt financing are primarily used to purchase flight equipment, including
progress payments during the construction phase. The primary sources for the
repayment of this debt and the interest expense thereon are the cash flow from
operations, proceeds from the sale of flight equipment and the rollover and
refinancing of the prior debt. (See also the discussions under "Operational
Review" and "Liquidity" herein.)
During the first nine months of 1998, AIG issued $22.3 million principal
amount of Medium Term Notes and $40.0 million of previously issued notes
matured. At September 30, 1998 AIG had $516.5 million in aggregate principal
amount of debt securities registered for issuance from time to time.
AIG's capital funds increased $1.83 billion during the first nine months of
1998. Unrealized appreciation of investments, net of taxes decreased $614.6
million. During the first nine months of 1998, the cumulative translation
adjustment loss, net of taxes, increased $146.4 million. The changes from period
to period with respect to the unrealized appreciation of investments, net of
taxes and the cumulative translation adjustment loss, net of taxes were
primarily impacted by the economic situation in Japan and Southeast Asia and the
general strength of the U.S. dollar against most currencies in which AIG
conducts operations. Additionally, the unrealized appreciation of investments,
net of taxes declined as a result of the consolidation of 20th Century which was
previously carried as an investment presented at market value. (See also the
discussion under "Operational Review" and "Liquidity" herein.) Retained earnings
increased $1.65 billion, resulting from net income less dividends.
During the period from January 1, 1998 through October 30, 1998, AIG
repurchased 1,044,750 shares of its common stock in the open market at a cost of
$77.5 million. AIG intends to continue to buy its common shares in the open
market to satisfy its obligations under various employee benefit plans and,
depending on market conditions, for other corporate purposes.
Payments of dividends to AIG by its insurance subsidiaries are subject to
certain restrictions imposed by regulatory 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, 1998,
there were no significant statu-
17
<PAGE> 19
tory or regulatory issues which would impair AIG's financial condition, results
of operations or liquidity. To AIG's knowledge, no AIG company is on any
regulatory or similar "watch list." (See also the discussion under "Liquidity"
herein.)
The National Association of Insurance Commissioners (NAIC) has developed
Risk-Based Capital (RBC) requirements. RBC relates an individual insurance
company's statutory surplus to the risk inherent in its overall operations. At
December 31, 1997, 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, 1998.
A substantial portion of AIG's general insurance business and a majority of
its life insurance business are conducted in foreign countries. The degree of
regulation and supervision in foreign jurisdictions varies from minimal in some
to stringent in others. Generally, AIG, as well as the underwriting companies
operating in such jurisdictions, must satisfy local regulatory requirements.
LIQUIDITY
AIG's liquidity is primarily derived from the operating cash flows of its
general and life insurance operations.
At September 30, 1998, AIG's consolidated invested assets included
approximately $3.47 billion of cash and short-term investments. Consolidated net
cash provided from operating activities in the first nine months of 1998
amounted to $1.47 billion.
Sources of funds considered in meeting the objectives of AIG's financial
services' operations include guaranteed investment agreements, issuance of long
and short-term debt, maturities and sales of securities available for sale,
securities sold under repurchase agreements, trading liabilities, securities and
spot commodities sold but not yet purchased, issuance of equity, and cash
provided from such operations. AIG's strong capital position is integral to
managing this liquidity, as it enables AIG to raise funds in diverse markets
worldwide. (See also the discussions under "Capital Resources" herein.)
Management believes that AIG's liquid assets, its net cash provided by
operations, and access to the capital markets will enable it to meet any
foreseeable cash requirements.
The liquidity of the combined insurance operations is derived both
domestically and abroad. The combined insurance operating cash flow is derived
from two sources, underwriting operations and investment operations. In the
aggregate, AIG's insurance operations generated over $5.5 billion in pre-tax
cash flow during the first nine months of 1998. Cash flow includes periodic
premium collections, including policyholders' contract deposits, paid loss
recoveries less reinsurance premiums, losses, benefits, acquisition and
operating expenses. Generally, there is a time lag from when premiums are
collected and, when as a result of the occurrence of events specified in the
policy, the losses and benefits are paid. AIG's insurance investment operations
generated approximately $3.7 billion in investment income cash flow during the
first nine months of 1998. Investment income cash flow is primarily derived from
interest and dividends received and includes realized capital gains.
The combined insurance pre-tax operating cash flow coupled with the cash
and short-term investments of $3.2 billion provided the insurance operations
with a significant amount of liquidity during the first nine months of 1998.
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. This
liquidity coupled with proceeds approximating $14 billion from the maturities,
sales and redemptions of fixed income securities and from the sale of equity
securities was used to purchase nearly $16 billion of fixed income securities
and marketable equity securities during the first nine months of 1998.
18
<PAGE> 20
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, 1998 and December 31, 1997:
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
September 30, 1998 December 31, 1997
--------------------------- ---------------------------
INVESTED Percent Invested Percent
ASSETS of Total Assets of Total
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
General insurance $ 37,936,805 27.6% $ 31,844,084 26.0%
Life insurance 43,624,514 31.7 41,046,969 33.5
Financial services 55,230,856 40.2 48,899,127 39.9
Other 673,609 0.5 661,701 0.6
- ------------------------------------------------------------------------------------------------------------------------
Total $137,465,784 100.0% $122,451,881 100.0%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
INSURANCE INVESTED ASSETS
The following tables summarize the composition of AIG's insurance invested
assets by insurance seg-
ment, including investment income due and accrued and real estate, at September
30, 1998 and December 31, 1997:
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
PERCENT DISTRIBUTION
PERCENT ---------------------
SEPTEMBER 30, 1998 GENERAL LIFE TOTAL OF TOTAL DOMESTIC FOREIGN
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities:
Available for sale, at market value(a) $15,544,237 $29,777,464 $45,321,701 55.5% 43.7% 56.3%
Held to maturity, at amortized cost(b) 13,024,678 -- 13,024,678 16.0 100.0 --
Equity securities, at market value(c) 3,050,931 1,230,325 4,281,256 5.2 49.3 50.7
Mortgage loans on real estate, policy
and
collateral loans 50,743 6,618,103 6,668,846 8.2 38.8 61.2
Short-term investments, including time
deposits, and cash 626,748 2,547,409 3,174,157 3.9 14.4 85.6
Real estate 385,955 931,375 1,317,330 1.6 17.3 82.7
Investment income due and accrued 642,132 1,051,457 1,693,589 2.1 43.1 56.9
Other invested assets 4,611,381 1,468,381 6,079,762 7.5 82.1 17.9
- ------------------------------------------------------------------------------------------------------------------------
Total $37,936,805 $43,624,514 $81,561,319 100.0% 53.8% 46.2%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a)Includes $989,374 of bonds trading securities, at market value.
(b)Includes $2,963 of preferred stock, at amortized cost.
(c)Includes $244,045 of preferred stock, at market value.
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Percent Distribution
Percent ---------------------
December 31, 1997 General Life Total of Total Domestic Foreign
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Fixed Maturities:
Available for sale, at market value(a) $11,326,246 $27,340,210 $38,666,456 53.0% 37.8% 62.2%
Held to maturity, at amortized cost(b) 12,769,646 -- 12,769,646 17.5 100.0 --
Equity securities, at market value(c) 3,314,603 1,815,849 5,130,452 7.0 43.5 56.5
Mortgage loans on real estate, policy
and collateral loans 50,297 6,147,606 6,197,903 8.5 39.0 61.0
Short-term investments, including time
deposits, and cash 616,683 2,409,353 3,026,036 4.2 33.1 66.9
Real estate 401,995 979,543 1,381,538 1.9 16.8 83.2
Investment income due and accrued 528,164 817,348 1,345,512 1.9 39.7 60.3
Other invested assets 2,836,450 1,537,060 4,373,510 6.0 76.7 23.3
- ------------------------------------------------------------------------------------------------------------------------
Total $31,844,084 $41,046,969 $72,891,053 100.0% 51.0% 49.0%
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(a)Includes $718,548 of bonds trading securities, at market value.
(b)Includes $239,331 of preferred stock, at amortized cost.
(c)Includes $111,609 of preferred stock, at market value.
Generally, insurance regulations restrict the types of assets in which an
insurance company may invest.
With respect to fixed maturities, AIG's general strategy is to invest in
high quality securities while maintaining diversification to avoid significant
exposure to issuer, industry and/or country concentra-
19
<PAGE> 21
tions. With respect to general insurance, AIG's strategy is to invest in longer
duration fixed maturities to maximize the yields at the date of purchase. With
respect to life insurance, AIG's strategy is to produce cash flows required to
meet maturing insurance liabilities (See also the discussion under "Operational
Review: Life Insurance Operations" herein.)
The fixed maturity available for sale portfolio is subject to decline in
fair value as interest rates rise. Such declines in fair value are presented as
a component of capital funds in unrealized appreciation of investments, net of
taxes.
The fixed maturities held to maturity portfolio is exposed to adverse
interest rate fluctuations. However, AIG has the ability and intent to hold such
securities to maturity. Therefore, there would be no detrimental impact to AIG's
results of operations or financial condition as a result of such fluctuations.
At September 30, 1998, approximately 56.2 percent of the fixed maturities
investments were domestic securities. Approximately 40 percent of such domestic
securities were rated AAA. Approximately 11 percent were below investment grade
or not rated.
A significant portion of the foreign insurance fixed income portfolio is
rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar
credit quality rating services are not available in all overseas locations. AIG
annually reviews the credit quality of the foreign portfolio nonrated fixed
income investments, including mortgages. At September 30, 1998, approximately 18
percent of the foreign fixed income investments were either rated AAA or, on the
basis of AIG's internal analysis, were equivalent from a credit standpoint to
securities so rated. Approximately 16 percent were below investment grade or not
rated at that date.
At September 30, 1998, approximately four percent of the fixed maturities
portfolio was Collateralized Mortgage Obligations (CMOs), including minor
amounts with respect to Commercial Mortgage Backed Securities. All of the CMOs
were investment grade and approximately 54 percent of the CMOs were backed by
various U.S. government agencies. 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 at September 30, 1998.
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 of November 1, 1998.
AIG invests in equities for reasons including diversifying its overall
exposure to interest rate risk. Equity securities are subject to declines in
fair value. Such declines in fair value are presented as components of capital
funds in unrealized appreciation of investments, net of taxes.
Mortgage loans on real estate, policy and collateral loans comprised 8.2
percent of AIG's insurance invested assets at September 30, 1998. AIG's
insurance operations' holdings of real estate mortgages amounted to $2.74
billion of which 37.9 percent was domestic. At September 30, 1998, no domestic
mortgages and only a nominal amount of foreign mortgages were in default. It is
AIG's practice to maintain a maximum loan to value ratio of 75 percent at loan
origination. At September 30, 1998, AIG's insurance holdings of collateral loans
amounted to $1.07 billion, all of which were foreign. It is AIG's strategy to
enter into mortgage and collateral loans as an adjunct primarily to life
insurance fixed maturity investments. AIG's policy loans increased from $2.67
billion at December 31, 1997 to $2.86 billion at September 30, 1998.
Short-term investments represent amounts invested in various internal and
external money market funds, time deposits and cash held.
AIG's real estate investment properties are primarily occupied by AIG's
various operations. The current market value of these properties considerably
exceeds their carrying value.
Other invested assets were primarily comprised of both foreign and domestic
private placements, limited partnerships and outside managed funds.
When permitted by regulatory authorities and when deemed necessary to
protect insurance assets, including invested assets, from adverse movements in
foreign currency exchange rates, interest rates and equity prices, AIG and its
insurance subsidiaries may enter into derivative transactions as end users. To
date, such activities have not been significant. (See also the discussion under
"Derivatives" herein.)
In certain jurisdictions, significant regulatory and/or foreign
governmental barriers exist which may not permit the immediate free flow of
funds
20
<PAGE> 22
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.
AIG's insurance operations are exposed to market risk. Market risk is the
risk of loss of fair value resulting from adverse fluctuations in interest and
foreign currency exchange rates and equity prices.
Measuring potential losses in fair values has recently become the focus of
risk management efforts by many companies. Such measurements are performed
through the application of various statistical techniques. One such technique is
Value at Risk (VaR). VaR is a summary statistical measure that uses historical
interest and foreign currency exchange rates and equity prices and estimates the
volatility and correlation of each of these rates and prices to calculate the
maximum loss that could occur over a defined period of time given a certain
probability.
AIG believes that statistical models alone do not provide a reliable method
of monitoring and controlling market risk. While VaR models are relatively
sophisticated, the quantitative market risk information generated is limited by
the assumptions and parameters established in creating the related models.
Therefore, such models are tools and do not substitute for the experience or
judgment of senior management.
AIG has performed a VaR analysis to estimate the maximum potential loss of
fair value for each of AIG's insurance segments and for each market risk within
each insurance segment. In this analysis, financial instrument assets include
the domestic and foreign invested assets excluding real estate and investment
income due and accrued. Financial instrument liabilities include reserve for
losses and loss expenses, reserve for unearned premiums, future policy benefits
for life and accident and health insurance contracts and policyholders' funds.
Due to the nature of each insurance segment, AIG manages the general and
life insurance operations separately. As a result, AIG manages separately the
invested assets of each. Accordingly, the VaR analysis was separately performed
for the general and the life insurance operations.
AIG calculated the VaR with respect to the net fair value of each of AIG's
insurance segments as of December 31, 1997. Through September 30, 1998, the
economic facts and circumstances have not significantly changed. Therefore, the
VaR at December 31, 1997 was representative of a VaR at September 30, 1998. This
calculation used the variance-covariance (delta-normal) methodology. The
calculation also used daily historical interest and foreign currency exchange
rates and equity prices in the two years ending December 31, 1997. The VaR model
estimated the volatility of each of these rates and equity prices and the
correlation among them. For interest rates, each country's yield curve was
constructed using eleven separate points on this curve to model possible curve
movements. Inter-country correlations were also used. The redemption experience
of municipal and corporate fixed maturities and mortgage securities was taken
into account as well as the use of financial modeling. Thus, the VaR measured
the sensitivity of the asset and the liability portfolios to each of the
aforementioned market risk exposures. Each sensitivity was estimated separately
to capture the market exposures within each insurance segment. These
sensitivities were then applied to a data base which contained both historical
ranges of movements in all market factors and the correlations among them. The
results were aggregated to provide a single amount that depicts the maximum
potential loss in fair value at a confidence level of 95 percent for a time
period of one month. At December 31, 1997 the VaR of AIG's insurance segments
was approximately $520 million for general insurance and $799 million for life
insurance.
The following table presents the VaR of each component of market risk for
each of AIG's insurance segments as of December 31, 1997. VaR with respect to
combined operations cannot be derived by aggregating the individual risk or
segment amounts presented herein.
(in millions)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MARKET RISK GENERAL INSURANCE LIFE INSURANCE
- -------------------------------------------------------------------------------------------------
<S> <C> <C>
Interest rate $235.6 $779.3
Currency 25.9 84.9
Equity 354.5 120.1
- -------------------------------------------------------------------------------------------------
</TABLE>
21
<PAGE> 23
FINANCIAL SERVICES INVESTED ASSETS
The following table is a summary of the composition of AIG's financial
services invested assets at September 30, 1998 and December 31, 1997. (See also
the discussions under "Operational Review: Financial Services Operations,"
"Capital Resources" and "Derivatives" herein.)
(dollars in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
1998 1997
------------------------- -------------------------
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 $16,035,558 29.1% $14,438,074 29.5%
Unrealized gain on interest rate and currency swaps,
options and forward transactions 9,779,517 17.7 7,422,290 15.2
Securities available for sale, at market value 9,300,161 16.8 9,145,317 18.7
Trading securities, at market value 6,378,719 11.5 3,974,561 8.1
Securities purchased under agreements to resell, at
contract value 4,969,860 9.0 4,551,191 9.3
Trading assets 5,730,990 10.4 6,715,486 13.8
Spot commodities, at market value 459,304 0.8 459,517 0.9
Other, including short-term investments 2,576,747 4.7 2,192,691 4.5
- --------------------------------------------------------------------------------------------------------------------
Total $55,230,856 100.0% $48,899,127 100.0%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
As previously discussed, the cash used for the purchase of flight equipment
is derived primarily from the proceeds of ILFC's debt financings. The primary
sources for the repayment of this debt and the interest expense thereon are the
cash flow from operations, proceeds from the sale of flight equipment and the
rollover and refinancing of the prior debt. During the first nine months of
1998, ILFC acquired flight equipment costing $2.55 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 risk exposure through similarly valued offsetting transactions
including swaps, trading securities, options, forwards and futures. The
estimated fair values of these transactions represent assessments of the present
value of expected future cash flows. These transactions are exposed to liquidity
risk if AIGFP were 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 "Operational Review: Financial Services Operations" and "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 mainly a portfolio of debt securities,
where the individual securities have varying degrees of credit risk. At
September 30, 1998, the average credit rating of this portfolio was AA or the
equivalent thereto as determined through rating agencies or internal review.
AIGFP has also entered into credit derivative transactions to hedge its credit
risk associated with $397.3 million of these securities. There were no
securities deemed below investment grade at September 30, 1998. There have been
no significant downgrades through November 1, 1998. Securities purchased under
agreements to resell are treated as collateralized transactions. AIGFP takes
possession of or obtains a security interest in securities purchased under
agreements to resell. AIGFP further minimizes its credit risk by monitoring
counterparty credit exposure and, when AIGFP deems necessary, it requires
additional collateral to be deposited. Trading securities, at market value are
marked to market daily and are held to meet the short-term risk management
objectives of AIGFP.
AIGTG conducts, as principal, market making and trading activities in
foreign exchange, interest rates and precious and base metals. AIGTG owns
inventories in the commodities in which it trades and may reduce the exposure to
market risk through the use of swaps, forwards, futures and option contracts.
AIGTG uses derivatives to manage the economic exposure of its various trading
positions and transactions from adverse movements of interest
22
<PAGE> 24
rates, foreign currency exchange rates and commodity prices. AIGTG supports its
trading activities largely through trading liabilities, unrealized losses on
swaps, short-term borrowings, securities sold under agreements to repurchase and
securities and commodities sold but not yet purchased. (See also the discussions
under "Capital Resources" and "Derivatives" herein.)
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG
included in the financial services assets and liabilities at September 30, 1998
were as follows:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
GROSS GROSS
UNREALIZED UNREALIZED
GAINS LOSSES
- --------------------------------------------------------------------------------------
<S> <C> <C>
Securities available for sale, at market value $ 456,154 $ 450,242
Unrealized gain/loss on interest rate and currency swaps,
options and forward transactions(a)(b) 9,779,517 7,135,097
Trading assets 7,119,518 4,673,017
Spot commodities, at market value -- 81,788
Trading liabilities -- 3,157,557
Securities and spot commodities sold but not yet purchased,
at market value 397,381 --
- --------------------------------------------------------------------------------------
</TABLE>
(a)These amounts are also presented as the respective balance sheet amounts.
(b)At September 30, 1998, AIGTG's replacement values with respect to interest
rate and currency swaps were $856.1 million.
AIGFP's 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, 1998, the unrealized gains and losses remaining after the
benefit of the offsets were $11.6 million and $5.7 million, respectively.
Trading securities and spot commodities, at market value, and securities
and spot commodities sold but not yet purchased, at market value are marked to
market daily with the unrealized gain or loss being recognized in income at that
time. These securities and spot commodities are held to meet the short-term risk
management objectives of AIGFP and AIGTG.
The senior management of AIG defines the policies and establishes general
operating parameters for AIGFP and AIGTG. AIG's senior management has
established various oversight committees to review the various financial market,
operational and credit issues of AIGFP and AIGTG. The senior managements of
AIGFP and AIGTG report the results of their respective operations to and review
future strategies with AIG's senior management.
AIG actively manages the exposures to limit potential losses, while
maximizing the rewards afforded by these business opportunities. In doing so,
AIG must manage a variety of exposures including credit, market, liquidity,
operational and legal risks.
Market risk arises principally from the uncertainty that future earnings
are exposed to potential changes in volatility, interest rates, foreign currency
exchange rates, and equity and commodity prices. AIG generally controls its
exposure to market risk by taking offsetting positions. AIG's philosophy with
respect to its financial services operations is to minimize or set limits for
open or uncovered positions that are to be carried. Credit risk exposure is
separately managed. (See the discussion on the management of credit risk below.)
AIG's Market Risk Management Department provides detailed independent
review of AIG's market exposures, particularly those market exposures of AIGFP
and AIGTG. This department determines whether AIG's market risks, as well as
those market risks of individual subsidiaries, are within the parameters
established by AIG's senior management. Well established market risk management
techniques such as sensitivity analysis are used. Additionally, this department
verifies that specific market risks of each of certain subsidiaries are managed
and hedged by that subsidiary.
AIGFP is exposed to market risk due to changes in the level and volatility
of interest rates and the shape and slope of the yield curve. AIGFP hedges its
exposure to interest rate risk by entering into transactions such as interest
rate swaps and options and purchasing U.S. and foreign government obligations.
AIGFP is exposed to market risk due to changes in and volatility of foreign
currency exchange rates. AIGFP hedges its foreign currency
23
<PAGE> 25
exchange risk primarily through the use of currency swaps, options, forwards and
futures.
AIGFP is exposed to market risk due to changes in the level and volatility
of equity prices which affect the value of securities or instruments that derive
their value from a particular stock, a basket of stocks or a stock index. AIGFP
reduces the risk of loss inherent in its inventory in equity securities by
entering into hedging transactions, including equity swaps and options and
purchasing U.S. and foreign government obligations.
AIGFP does not seek to manage the market risk of each of its transactions
through an individual offsetting transaction. Rather, AIGFP takes a portfolio
approach to the management of its market risk exposure. AIGFP values its
portfolio 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 changes in interest rates and other 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.
All of AIGTG's market risk sensitive instruments are entered into for
trading purposes. The fair values of AIGTG's financial instruments are exposed
to market risk as a result of adverse market changes in interest rates, foreign
currency exchange rates, commodity prices and adverse changes in the liquidity
of the markets in which AIGTG trades.
AIGTG's approach to managing market risk is to establish an appropriate
offsetting position to a particular transaction or group of transactions
depending upon the extent of market risk AIGTG expects to reduce.
AIGTG's senior management has established positions and stop-loss limits
for each line of business. AIGTG's traders are required to maintain positions
within these limits. These positions are monitored during the day either
manually and/or through on-line computer systems. In addition, these positions
are reviewed by AIGTG's management. Reports which present each trading books
position and the prior day's profit and loss are reviewed by traders, head
traders and AIGTG's senior management. Based upon these and other reports,
AIGTG's senior management may determine to adjust AIGTG's risk profile.
AIGTG attempts to secure reliable current market prices, such as published
prices or third party quotes, to value its derivatives. Where such prices are
not available, AIGTG uses an internal methodology which includes interpolation
or extrapolation from verifiable prices nearest to the dates
24
<PAGE> 26
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 market scenarios have represented profit
opportunities for AIGTG.
AIGFP and AIGTG are both exposed to the risk of loss of fair value.
Sensitivity analysis is the statistical technique utilized to measure this
exposure. Such analysis is performed and presented separately for AIGFP and
AIGTG as AIG manages these operations separately.
AIGFP and AIGTG used the sensitivity analysis model to measure the
potential loss in fair value of market risk sensitive instruments of each of
their respective portfolios. This potential loss in fair value results from
selected hypothetical changes in interest and foreign currency exchange rates,
equity prices and/or other market rates or prices over time.
The portfolios for which this analysis was performed included market risk
sensitive transactions entered into by AIGFP and AIGTG. This includes over the
counter and exchange traded investments, derivative transactions, borrowings and
hedged securities and commodities. As the market risk with respect to securities
available for sale, at market is substantially hedged, segregation of market
sensitive instruments into trading and other than hedging was not done.
In each of these models, the market risks of AIGFP and AIGTG have been
classified as changes in the level of interest rates, foreign currency exchange
rates, equity prices or commodity prices and the respective volatility of each.
For each risk, four sensitivities were calculated under four scenarios with
respect to the fair values of the portfolios at September 30, 1998. The four
scenarios consisted of uniformly increasing or decreasing the relevant market
rates or prices by 10 percent; and uniformly increasing or decreasing the
relevant market volatility by 10 percent. For a given risk, the sensitivity
presented herein was the largest potential loss in fair value assuming trade
settlement under the most adverse of the four scenarios that could result in one
day.
Not all market risk exposures that are managed by AIGFP and AIGTG are
quantified by this analysis. In almost all currencies, changes in the slope and
shape of the yield curve or changes in the relative value between certain types
of financial instruments or between the same type of instruments in different
currencies could affect the results of this analysis. Additionally, the
following quantitative information does not take into account anticipated
management reaction to breaches of counterparty credit limitations caused by the
shocks within a given risk category. The actual results could differ from the
results of this analysis because market movements could be different from the
scenarios that were considered or because the composition of the portfolio could
change substantially with time. AIGFP is also exposed to uncertainty on the
amount of dividends paid or the cost of borrowing certain equities.
The following table presents the one day exposure to the potential loss in
fair value of each component of AIGFP's market risk as of September 30, 1998
under the most adverse scenario as mentioned above:
(in millions)
- ------------------------------------------------------
<TABLE>
<CAPTION>
MARKET RISK
- ------------------------------------------------------
<S> <C>
Interest rate $ 25.1
Currency 25.1
Equity 12.8
- ------------------------------------------------------
</TABLE>
The following table presents the one day exposure to potential loss in fair
value of each component of AIGTG's market risk as of September 30, 1998 under
the most adverse scenario as discussed above:
(in millions)
- ------------------------------------------------------
<TABLE>
<CAPTION>
MARKET RISK
- ------------------------------------------------------
<S> <C>
Interest rate $5.7
Currency 5.2
Commodity 0
- ------------------------------------------------------
</TABLE>
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 index. Derivatives payments may be based on
interest rates and exchange rates and/or prices of certain securities,
25
<PAGE> 27
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 legal 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.
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.
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 or commodity 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.
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 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
26
<PAGE> 28
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 and AIGTG's derivatives transactions at September 30, 1998 and December
31, 1997.
The notional amounts used to express the extent of AIGFP's and AIGTG's
involvement in swap transactions represent a standard of measurement of the
volume of AIGFP's and AIGTG's swaps business. Notional amount is not a
quantification of market risk or credit risk and it may not necessarily be
recorded on the balance sheet. Notional amounts represent those amounts used to
calculate contractual cash flows to be exchanged and are not paid or received,
except for certain contracts such as currency swaps.
The timing and the amount of cash flows relating to AIGFP's and AIGTG's
foreign exchange forwards and exchange traded futures and options contracts are
determined by each of the respective contractual agreements.
The 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, 1998 and December 31, 1997:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REMAINING LIFE
----------------------------------------------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 1998 1997
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest rate, currency and
equity/commodity swaps and
swaptions:
Notional amount:
Interest rate swaps $ 77,684,000 $97,938,000 $46,869,000 $ 7,240,000 $229,731,000 $200,491,000
Currency swaps 22,239,000 21,569,000 15,088,000 3,494,000 62,390,000 54,748,000
Swaptions and equity swaps 7,644,000 5,755,000 5,629,000 1,245,000 20,273,000 11,217,000
- -----------------------------------------------------------------------------------------------------------------------
Total $107,567,000 $125,262,000 $67,586,000 $11,979,000 $312,394,000 $266,456,000
- -----------------------------------------------------------------------------------------------------------------------
Futures and forward
contracts:
Exchange traded futures
contracts contractual
amount $ 4,882,000 -- -- -- $ 4,882,000 $ 4,411,000
Over the counter forward
contracts contractual
amount $ 38,579,000 $ 85,000 -- -- $ 38,664,000 $ 13,271,000
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
AIGFP determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At September 30, 1998 and
December 31, 1997, 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 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Counterparty credit quality:
AAA $2,334,687 $ 4,076 $2,338,763 $2,326,502
AA 3,614,631 12,323 3,626,954 2,311,104
A 1,619,231 6,200 1,625,431 1,165,410
BBB 1,045,586 169 1,045,755 608,495
Below investment grade 258,663 -- 258,663 289,563
- ----------------------------------------------------------------------------------------------------------------------
Total $8,872,798 $22,768 $8,895,566 $6,701,074
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
27
<PAGE> 29
At September 30, 1998 and December 31, 1997, 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 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-U.S. banks $2,912,369 $16,725 $2,929,094 $2,263,305
Insured municipalities 946,438 -- 946,438 757,514
U.S. industrials 1,046,843 4,449 1,051,292 514,041
Governmental 666,539 -- 666,539 677,230
Non-U.S. financial service companies 233,865 -- 233,865 64,787
Non-U.S. industrials 1,200,108 -- 1,200,108 1,034,792
Special purpose 176,996 -- 176,996 163,109
U.S. banks 634,332 -- 634,332 584,915
U.S. financial service companies 862,490 1,594 864,084 433,710
Supranationals 192,818 -- 192,818 207,671
- ----------------------------------------------------------------------------------------------------------------------
Total $8,872,798 $22,768 $8,895,566 $6,701,074
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
The following tables provide the contractual and notional amounts of
AIGTG's derivatives portfolio at September 30, 1998 and December 31, 1997. In
addition, the estimated positive fair values associated with the derivatives
portfolio are also provided and include a maturity profile for the September 30,
1998 balances based upon the expected timing of the future cash flows.
The gross replacement values presented represent the sum of the estimated
positive fair values of
all of AIGTG's derivatives contracts at September 30, 1998 and December 31,
1997. These values do not represent the credit risk to AIGTG.
Net replacement values presented represent the net sum of estimated
positive fair values after the application of legally enforceable master
closeout netting agreements and collateral held. The net replacement values most
closely represent the net credit risk to AIGTG or the maximum amount exposed to
potential loss.
28
<PAGE> 30
The following tables present AIGTG's derivatives portfolio and the
associated credit exposure, if
applicable, by maturity and type of derivative at September 30, 1998 and
December 31, 1997:
(in thousands)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
REMAINING LIFE
-----------------------------------------------------
ONE TWO THROUGH SIX THROUGH AFTER TEN TOTAL TOTAL
YEAR FIVE YEARS TEN YEARS YEARS 1998 1997
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Contractual amount of futures,
forwards and options:
Exchange traded futures and
options $ 18,529,188 $1,230,515 $ 77,545 $ -- $ 19,837,248 $ 24,579,298
- ----------------------------------------------------------------------------------------------------------------------
Forwards $312,099,359 $17,939,515 $1,629,184 $ -- $331,668,058 $267,959,285
- ----------------------------------------------------------------------------------------------------------------------
Over the counter purchased
options $ 53,438,716 $18,646,124 $5,325,340 $1,240,695 $ 78,650,875 $ 60,273,754
- ----------------------------------------------------------------------------------------------------------------------
Over the counter sold
options(a) $ 53,266,013 $14,748,012 $5,033,565 $1,162,137 $ 74,209,727 $ 58,189,846
- ----------------------------------------------------------------------------------------------------------------------
Notional amount:
Interest rate swaps and forward
rate agreements $ 95,161,410 $23,614,760 $5,705,350 $ 668,133 $125,149,653 $ 77,502,650
Currency swaps 1,203,155 4,872,841 1,259,989 -- 7,335,985 6,489,333
Swaptions 172,838 1,528,401 1,130,980 1,358,815 4,191,034 1,633,988
- ----------------------------------------------------------------------------------------------------------------------
Total $ 96,537,403 $30,016,002 $8,096,319 $2,026,948 $136,676,672 $ 85,625,971
- ----------------------------------------------------------------------------------------------------------------------
Credit exposure:
Futures, forwards, swaptions
and purchased options
contracts and interest rate
and currency swaps:
Gross replacement value $ 7,654,891 $1,727,021 $ 625,607 $ 127,559 $ 10,135,078 $ 11,019,717
Master netting arrangements (4,799,011) (738,235) (329,803) (71,340) (5,938,389) (5,798,311)
Collateral (365,130) (37,020) (19,882) (8,143) (430,175) (224,678)
- ----------------------------------------------------------------------------------------------------------------------
Net replacement value(b) $ 2,490,750 $ 951,766 $ 275,922 $ 48,076 $ 3,766,514 $ 4,996,728
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
(a) Sold options obligate AIGTG to buy or sell the underlying item if the option
purchaser chooses to exercise. The amounts do not represent credit exposure.
(b) The net replacement values with respect to exchange traded futures and
options, forward contracts, swaptions and purchased over the counter options
are presented as a component of trading assets in the accompanying balance
sheet. The net replacement values with respect to interest rate and currency
swaps are presented as a component of unrealized gain on interest rate and
currency swaps, options and forward transactions in the accompanying balance
sheet.
29
<PAGE> 31
AIGTG determines counterparty credit quality by reference to ratings from
independent rating agencies or internal analysis. At September 30, 1998 and
December 31, 1997, the counterparty credit
quality and 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
----------------------------
1998 1997
- --------------------------------------------------------------------------------------------
<S> <C> <C>
Counterparty credit quality:
AAA $ 486,330 $ 752,741
AA 1,735,492 2,503,289
A 918,312 1,023,650
BBB 341,714 342,695
Below investment grade 71,873 98,425
Not externally rated, including exchange traded futures
and options* 212,793 275,928
- --------------------------------------------------------------------------------------------
Total $3,766,514 $4,996,728
- --------------------------------------------------------------------------------------------
Counterparty breakdown by industry:
Non-U.S. banks $1,370,884 $2,685,998
U.S. industrials 238,733 163,484
Governmental 166,693 135,269
Non-U.S. financial service companies 492,012 260,412
Non-U.S. industrials 125,339 167,835
U.S. banks 467,307 560,388
U.S. financial service companies 692,753 747,414
Exchanges* 212,793 275,928
- --------------------------------------------------------------------------------------------
Total $3,766,514 $4,996,728
- --------------------------------------------------------------------------------------------
</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 operations; to date, such
activities have not been significant.
AIG, through its Foreign Exchange Operating Committee, evaluates each of
its worldwide consolidated foreign currency 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.
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.
ACCOUNTING STANDARDS
In February 1997, FASB issued Statement of Financial Accounting Standards
No. 128 "Earnings per Share" (FASB 128). This statement simplifies the existing
computational guidelines, revises the disclosure requirements and increases
earnings per share comparability on an international basis.
AIG adopted all requirements of FASB 128 at December 31, 1997 and all prior
period information has been restated.
In June 1997, FASB issued Statement of Financial Accounting Standards No.
130 "Reporting Comprehensive Income" (FASB 130) and State-
30
<PAGE> 32
ment of Financial Accounting Standards No. 131
"Disclosure about Segments of an Enterprise and Related Information" (FASB 131).
FASB 130 establishes standards for reporting comprehensive income and its
components in a full set of general purpose financial statements. FASB 130 is
effective for AIG as of January 1, 1998 and has been adopted herein. FASB 130
had no impact on AIG's results of operations, financial condition or liquidity.
FASB 131 establishes standards for the way AIG is required to disclose
certain information about its operating segments in its annual financial
statements and certain selected information in its interim financial statements.
FASB 131 establishes, where practicable, standards with respect to geographic
areas, among other things. Certain descriptive information is also required.
FASB 131 is effective for the year ended December 31, 1998.
In February 1998, FASB issued Statement of Financial Accounting Standards
No. 132 "Employers' Disclosures about Pensions and Other Postretirement
Benefits" (FASB 132). This statement requires AIG to revise its disclosures
about pension and other postretirement benefit plans and does not change the
measurement or recognition of these plans. Also, FASB 132 requires additional
information on changes in the benefit obligations and fair values of plan
assets. FASB 132 is effective for the year ended December 31, 1998.
In June 1998, FASB issued Statement of Financial Accounting Standards No.
133 "Accounting for Derivative Instruments and Hedging Activities" (FASB 133).
This statement requires AIG to recognize all derivatives in the consolidated
balance sheet measuring these derivatives at fair value. The recognition of the
change in the fair value of a derivative depends on a number of factors,
including the intended use of the derivative. Currently, AIGTG and AIGFP
present, in all material respects, the changes in fair value of their derivative
transactions as a component of AIG's operating income. AIG is evaluating the
impact of FASB 133 with respect to derivative transactions entered into by other
AIG operations. AIG believes that the impact of FASB 133 on its results of
operations, financial condition or liquidity will not be significant. FASB 133
is effective for the year commencing January 1, 2000.
RECENT DEVELOPMENTS
The Year 2000 issue arises from computer programs being written using two
digits rather than four digits to define the applicable year. This could result
in a failure of the information technology systems (IT systems) and other
equipment containing imbedded technology (non-IT systems) in the year 2000,
causing disruption of operations of AIG, its lessees, vendors, or business
partners.
AIG has developed a plan to address the Year 2000 issue as it affects AIG's
internal IT and non-IT systems, and to assess Year 2000 issues relating to third
parties with whom AIG has critical relationships.
The plan for addressing internal systems includes an assessment of internal
IT and non-IT systems and equipment affected by the Year 2000 issue; definition
of strategies to address affected systems and equipment; remediation of
identified affected systems and equipment; and internal certification that each
internal system is Year 2000 compliant. AIG has remediated, tested and returned
to production substantially all of its internal IT systems. AIG continues to
remediate and test internal non-IT systems and expects to complete remediation
by mid-1999.
AIG has also initiated formal communications with respect to the Year 2000
issue to those third parties which have significant interaction with AIG.
Currently, AIG is unable to ascertain whether all such third parties will
successfully address the Year 2000 issue, particularly those third parties
outside the United States where it is believed that remediation efforts relating
to the Year 2000 issue may be less advanced. While AIG expects to have no
interruption of operations as a result of internal IT and non-IT systems,
significant uncertainties remain about the effect on AIG of third parties who
are not Year 2000 compliant. AIG will continue to monitor third party Year 2000
issue readiness to determine whether additional or alternative measures may be
necessary. Such measures may include the selection of alternate third parties or
other actions designed to mitigate the effects of a third party's lack of
preparedness. There can be no assurance that unresolved Year 2000 issues of
third parties will not have a material adverse impact on AIG's results of
operations, financial condition or liquidity. AIG is considering the effects of
Year 2000 related failures on its business and, as the most reasonably likely
31
<PAGE> 33
worst case scenarios become more clearly identified, AIG will develop
appropriate contingency plans.
The costs associated with addressing the Year 2000 issue, including
developing and implementing the above stated plans and remediating affected
systems and equipment, has approximated $80 million and has been expensed as
incurred.
On January 1, 1999, certain of the member nations of the European Economic
and Monetary Union (EMU) will adopt a common currency, the Euro. Once the
national currencies are phased out, the Euro will be the sole legal tender of
each of these nations. During the transition period, commerce of these nations
will be transacted in the Euro or in the currently existing national currency.
AIG has identified the significant issues and will be prepared with respect
to the phase in of and ultimate redenomination to the Euro. Any costs associated
with the adoption of the Euro are expensed as incurred and are not material to
AIG's results of operations, financial condition or liquidity.
Any statements contained in this section that are not historical facts, or
that might be considered an opinion or projection, whether expressed or implied,
is meant as, and should be considered, a forward-looking statement as that term
is defined in the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are based on assumptions and opinions concerning a
variety of known and unknown risks, including those risks related to the Year
2000 issue. If any assumptions or opinions prove incorrect, any forward-looking
statements made on that basis may also prove materially incorrect.
On August 20, 1998, AIG and SunAmerica Inc. (SunAmerica) announced that
they have entered into a definitive agreement whereby AIG will acquire 100
percent of the outstanding common stock of SunAmerica. The merger transaction
has been approved by the Board of Directors of both companies, and is subject to
various regulatory approvals and other customary conditions, as well as the
approval of AIG and SunAmerica shareholders at special meetings scheduled to be
held November 18, 1998.
32
<PAGE> 34
PART II -- OTHER INFORMATION
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
See accompanying Exhibit Index.
(b) Reports on Form 8-K.
During the three months ended September 30, 1998, there were three
current reports filed on Form 8-K:
(1) Current Report on Form 8-K, August 20, 1998: Press Release dated
August 20, 1998 announcing that SunAmerica Inc. will merge into AIG
(2) Current Report on Form 8-K, August 24, 1998 to report the definitive
Agreement and Plan of Merger between SunAmerica Inc. and American
International Group, Inc., dated as of August 19, 1998
(3) Current Report on Form 8-K, October 22, 1998: Press Release dated
October 22, 1998 reporting the earnings of AIG for the quarter and
the nine months ended September 30, 1998
33
<PAGE> 35
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/ HOWARD I. SMITH
--------------------------------------
Howard I. Smith
Executive Vice President, Chief
Financial Officer and Comptroller
Dated: November 13, 1998
34
<PAGE> 36
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION LOCATION
- ------- ----------- --------
<S> <C> <C>
2 Plan of acquisition, reorganization, arrangement,
liquidation or succession
(a) Agreement and Plan of Merger between SunAmerica Inc.
and American International Group, Inc., dated as of August
19, 1998............................................... Filed as an Exhibit
to AIG's Current
Report on Form 8-K,
August 24, 1998
(File No. 1-8787)
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>
35
<PAGE> 1
EXHIBIT 11
AMERICAN INTERNATIONAL GROUP, INC.
COMPUTATION OF EARNINGS PER SHARE
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1998(a) 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
SHARE INFORMATION REFLECTS AN ADJUSTMENT
FOR A COMMON STOCK SPLIT IN THE FORM OF
A 50 PERCENT COMMON STOCK DIVIDEND PAID
JULY 31, 1998.
Numerator:
Net income (applicable to common stock)... $2,759,613 $2,447,748 $ 931,070 $ 840,318
========== ========== ========== ==========
Denominator:
Average outstanding shares used in the
computation of per share earnings:
Common Stock............................ 1,138,675 1,138,687 1,138,664 1,138,684
Common stock in treasury................ (88,997) (84,827) (88,672) (86,606)
---------- ---------- ---------- ----------
Average outstanding shares -- basic....... 1,049,678 1,053,860 1,049,992 1,052,078
---------- ---------- ---------- ----------
Stock options (treasury stock method)..... 4,957 4,761 5,037 4,749
Stock purchase plan....................... 69 61 83 69
---------- ---------- ---------- ----------
Average outstanding shares -- diluted..... 1,054,704 1,058,682 1,055,112 1,056,896
---------- ---------- ---------- ----------
Net income per share:
Basic................................... $ 2.63 $ 2.32 $ 0.89 $ 0.80
---------- ---------- ---------- ----------
Diluted................................. $ 2.62 $ 2.31 $ 0.89 $ 0.79
---------- ---------- ---------- ----------
</TABLE>
- ---------------
(a) The number of common shares outstanding as of September 30, 1998 was
1,049,959,401.
The number of common shares that would have been outstanding as of September
30, 1998 assuming the exercise or issuance of all potentially dilutive
common shares is 1,054,754,786.
<PAGE> 1
EXHIBIT 12
AMERICAN INTERNATIONAL GROUP, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(IN THOUSANDS, EXCEPT RATIOS)
<TABLE>
<CAPTION>
NINE MONTHS THREE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------------ ------------------------
1998 1997 1998 1997
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Income before income taxes and minority
interest................................ $4,038,010 $3,476,738 $1,414,529 $1,189,825
Less -- Equity income of less than 50%
owned persons........................... 83,193 89,193 10,132 23,046
Add -- Dividend from less than 50% owned
persons................................. 19,225 20,247 1,937 3,682
---------- ---------- ---------- ----------
3,974,042 3,407,792 1,406,334 1,170,461
Add --
Fixed charges........................... 1,476,387 1,340,101 468,542 446,820
Less --
Capitalized interest.................... 47,062 35,586 15,175 11,808
---------- ---------- ---------- ----------
Income before income taxes, minority
interest and fixed charges.............. $5,403,367 $4,712,307 $1,859,701 $1,605,473
========== ========== ========== ==========
Fixed charges:
Interest costs.......................... $1,410,336 $1,284,448 $ 446,525 $ 428,269
Rent expense*........................... 66,051 55,653 22,017 18,551
---------- ---------- ---------- ----------
Total fixed charges............. $1,476,387 $1,340,101 $ 468,542 $ 446,820
========== ========== ========== ==========
Ratio of earnings to fixed charges........ 3.66 3.52 3.97 3.59
</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 5.95 and 5.56 for the
third quarter and 5.86 and 5.46 for the first nine months of 1998 and 1997,
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.
<TABLE> <S> <C>
<ARTICLE> 7
<MULTIPLIER> 1,000
<CURRENCY> US DOLLARS
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<DEBT-HELD-FOR-SALE> 44,477,805
<DEBT-CARRYING-VALUE> 13,021,715
<DEBT-MARKET-VALUE> 14,048,353
<EQUITIES> 4,507,391
<MORTGAGE> 3,260,127
<REAL-ESTATE> 1,392,917
<TOTAL-INVEST> 134,048,862
<CASH> 209,959
<RECOVER-REINSURE> 17,117,550
<DEFERRED-ACQUISITION> 6,914,113
<TOTAL-ASSETS> 183,922,821
<POLICY-LOSSES> 63,763,533
<UNEARNED-PREMIUMS> 9,909,524
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 14,270,893
<NOTES-PAYABLE> 20,951,643
0
0
<COMMON> 2,846,646
<OTHER-SE> 22,984,080
<TOTAL-LIABILITY-AND-EQUITY> 183,922,821
17,708,784
<INVESTMENT-INCOME> 3,922,378
<INVESTMENT-GAINS> 129,208
<OTHER-INCOME> (109,476)
<BENEFITS> 14,333,082
<UNDERWRITING-AMORTIZATION> 1,459,159
<UNDERWRITING-OTHER> 2,517,835
<INCOME-PRETAX> 4,038,010
<INCOME-TAX> 1,177,429
<INCOME-CONTINUING> 2,759,613
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,759,613
<EPS-PRIMARY> 2.63<F1>
<EPS-DILUTED> 2.62<F1>
<RESERVE-OPEN> 21,171,500
<PROVISION-CURRENT> 7,841,500
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 2,550,800
<PAYMENTS-PRIOR> 4,813,000
<RESERVE-CLOSE> 24,545,100
<CUMULATIVE-DEFICIENCY> 0
<FN>
<F1>EARNINGS PER SHARE INFORMATION REFLECTS A COMMON STOCK SPLIT IN THE FORM OF A
50 PERCENT COMMON STOCK DIVIDEND PAID JULY 31, 1998. PRIOR PERIOD FINANCIAL
DATA SCHEDULES HAVE NOT BEEN RESTATED FOR THIS STOCK SPLIT.
</FN>
</TABLE>
