General insurance operations for the twelve month periods ending December 31, 1996, 1995 and 1994 were as follows:
In AIG's general insurance operations, 1996 net premiums written and net premiums earned increased 6.7 percent and 3.9 percent, respectively, from those of 1995. In 1995, net premiums written increased 9.5 percent and net premiums earned increased 10.9 percent when compared to 1994.
The growth in net premiums written in 1996 and 1995 resulted from a combination of several factors. Domestically, AIG continued to achieve some general price increases in certain commercial property and specialty casualty markets, as well as volume growth in mortgage guaranty insurance and personal lines. Overseas, the primary reason for growth was volume increases. Foreign general insurance operations produced 34.1 percent of the general insurance net premiums written in 1996, 35.3 percent in 1995 and 34.4 percent in 1994.
In comparing the foreign exchange rates used to translate AIG's foreign general operations during 1996 to those foreign exchange rates used to translate AIG's foreign general operations during 1995, the U.S. dollar strengthened in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, when foreign net premiums written were translated into U.S. dollars for the purposes of consolidation, total general insurance net premiums written were approximately 2.9 percentage points less than they would have been if translated utilizing those exchange rates which prevailed during 1995.
AIG's results reflect the net impact with respect to incurred losses from catastrophes approximating $78 million in 1996, $100 million in 1995 and $55 million in 1994. AIG's gross incurred losses from catastrophes approximated $240 million in 1996, $190 million in 1995 and $174 million in 1994. The Kobe Japan earthquake which struck in early 1995 resulted in gross and net incurred losses to AIG of approximately $73 million and $30 million, respectively. A substantial portion of the remaining balances resulted from storms which struck portions of the United States and the Caribbean. The Northridge earthquake which struck the Los Angeles area of California in January, 1994, resulted in gross and net incurred losses of approximately $174 million and $55 million, respectively. If these catastrophes were excluded from the losses incurred in each period, the pro forma consolidated statutory general insurance ratios would be as follows:
General insurance net investment income in 1996 increased 9.3 percent when compared to 1995. In 1995, net investment income increased 7.7 percent over 1994. The growth in net investment income in each of the three years was primarily attributable to new cash flow for investment. The new cash flow was generated from net general insurance operating cash flow and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein and Note 8 of Notes to Financial Statements.)
General insurance realized capital gains were $65.0 million in 1996, $68.1 million in 1995 and $52.5 million in 1994. 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 1996 increased 9.0 percent when compared to 1995. The 1995 results reflect an increase of 20.8 percent from 1994. The contribution of general insurance operating income to income before income taxes was 53.7 percent in 1996 compared to 57.0 percent in 1995 and 55.4 percent in 1994.
A year to year comparison of operating income can be significantly influenced by the catastrophe losses in any one year as well as the volatility from one year to the next in realized capital gains. Adjusting each year to exclude the effects of both catastrophe losses and realized capital gains, operating income would have increased by 7.9 percent in 1996 and 22.6 percent in 1995. The decrease in the growth rate of 1996 over 1995 was caused in part by the effects of the strengthening U.S. dollar against major foreign currencies as previously described and the slightly increased domestic combined ratio. The increase in the growth rate of 1995 over 1994 after the aforementioned adjustments was a result of the increased net investment income and significant improvement in underwriting results.
AIG's general reinsurance assets amounted to $16.31 billion and resulted from AIG's reinsurance arrangements. Thus, a credit exposure existed at December 31, 1996 with respect to reinsurance recoverable to the extent that any reinsurer may not be able to reimburse AIG under the terms of these reinsurance arrangements. AIG manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound, and when necessary AIG holds substantial collateral in the form of funds, securities and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. This development includes losses incurred but not reported (IBNR). At December 31, 1996, approximately 50 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, nearly all of these balances are collateralized. The remaining 50 percent of the general reinsurance assets were from authorized reinsurers and over 97 percent of such balances are from reinsurers rated A- (excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness.
AIG maintains an allowance for estimated unrecoverable reinsurance and has been largely successful in its previous recovery efforts. At December 31, 1996, AIG had allowances for unrecoverable reinsurance approximating $125 million. At that date, and prior to this allowance, AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction). AIG has not entered into any material cessions that would provide surplus relief.
The consolidated general reinsurance assets of $16.31 billion at December 31, 1996 include reinsurance recoverables for (i) paid losses and loss expenses of $1.83 billion and (ii) $13.02 billion with respect to the ceded reserve for losses and loss expenses, including ceded IBNR (ceded reserves). The ceded reserves represent the accumulation of estimates of ultimate ceded losses including provisions for ceded IBNR and loss expenses. The methods used to determine such estimates and to establish the resulting ceded reserves are continually reviewed and updated. Any adjustments therefrom are reflected in income currently. It is AIG's belief that the ceded reserves at December 31, 1996 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded.
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 eight 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 property, the growth in property's exposure to fire loss can be approximated by the amount of insurance purchased.
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 and 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
The average cost per claim settled, dismissed or otherwise resolved for the years ended December 31, 1996, 1995 and 1994 was as follows:
* For 1996, paid losses for asbestos include certain unusual and non-recurring payments that satisfied historical settlement agreements.
AIG's survival ratios for involuntary asbestos and environmental claims, separately and combined, were based upon a three year average payment in order to present a more meaningful trend. These ratios for the years ended December 31, 1996, 1995 and 1994 were as follows:
Life insurance operations for the twelve month periods ending December 31, 1996, 1995 and 1994 were as follows:
AIG's life insurance operations, demonstrating the strength of its franchise, continued to show growth primarily as a result of overseas operations, particularly in Asia. AIG's life premium income in 1996 represented an 11.7 percent increase from the prior year. This compares with an increase of 19.5 percent in 1995 over 1994. Foreign life operations produced 94.0 percent, 94.2 percent and 94.5 percent of the life premium income in 1996, 1995 and 1994, respectively. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)
As previously discussed, the U.S. dollar strengthened in value in relation to most major foreign currencies in which AIG transacts business. Accordingly, when foreign life premium income was translated into U.S. dollars for purposes of consolidation, total life premium income was approximately 5.2 percentage points less than it would have been if translated utilizing exchange rates prevailing in 1995.
Life insurance net investment income increased 18.1 percent in 1996 compared to an increase of 29.5 percent in 1995. The slowing of the growth rate was impacted by the redemption of policy loans with respect to some large corporate life insurance policies (COLI products). The redemptions of the COLI products were a result of recently enacted unfavorable Federal Tax legislation. Such redemptions had an insignificant impact on operating income, financial condition and liquidity. The growth in net investment income in 1996 and 1995 was primarily attributable to foreign new cash flow for investment and, to a lesser degree in 1995, growth in interest income earned on policy loans related to domestic COLI products. The new cash flow was generated from life insurance operations and included the compounding of previously earned and reinvested net investment income. (See also the discussion under "Liquidity" herein.)
The growth in the premium income of the domestic life segment resulted primarily from the sales of individual and terminal funded pension plan annuities.
Life insurance realized capital gains were $34.8 million in 1996, $32.7 million in 1995 and $86.7 million in 1994. These realized gains resulted from the ongoing management of the life insurance investment portfolios within the overall objectives of the life insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities and redemptions.
Agency and service fee operating income in 1996 decreased 8.2 percent to $52.3 million compared to $56.9 million in 1995 which was an increase of 5.1 percent from 1994. The increase in operating income from 1994 resulted from the growth of risk management services. The decline in 1996 was due to reduced commission revenue in certain of AIG's managing general agencies. Agency and service fee operating income contributed 1.3 percent to AIG's income before income taxes in 1996 compared to 1.6 percent in 1995 and 1.8 percent in 1994.
Financial services operating income increased 25.4 percent in 1996 over 1995. This compares with an increase of 3.2 percent in 1995 over 1994.
ILFC is exposed to loss through non-performance of aircraft lessees, through owning aircraft which it would be unable to lease or re-lease at acceptable rates or sell at lease expiration and through committing to purchase aircraft which it would be unable to lease. ILFC manages its lessee non-performance exposure through credit reviews and security deposit requirements. At December 31, 1996, only four of 296 aircraft owned
Income before income taxes amounted to $4.01 billion in 1996, $3.47 billion in 1995 and $2.95 billion in 1994.
In 1996, AIG recorded a provision for income taxes of $1.12 billion compared to the provisions of $955.5 million and $776.5 million in 1995 and 1994, respectively. These provisions represent effective tax rates of 27.8 percent in 1996, 27.6 percent in 1995 and 26.3 percent in 1994. The increase in the effective tax rate in 1996 over prior years is primarily due to the profitability of domestic general adjusted underwriting relative to income before income taxes. (See Note 3 of Notes to Financial Statements.)
At December 31, 1996, AIG had total capital funds of $22.04 billion and total borrowings of $23.52 billion. At that date, $20.10 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.
AIGFP increased the aggregate principal amount outstanding of its notes and bonds payable to $5.24 billion, a net increase of $2.86 billion and increased its net GIA borrowings by $299.7 million. AIGFP uses the proceeds from the issuance of notes and bonds to invest in a segregated portfolio of securities available for sale. 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 and Notes 1, 8, 9 and 11 of Notes to Financial Statements.)
During 1996, AIG repurchased 5.4 million shares of its common stock in the open market at a cost of $492.5 million. During 1995, AIG repurchased 236,443 shares of its common stock in the open market at a cost of $17.6 million. AIG intends to continue to buy its common shares in the open market to satisfy its obligations under various employee benefit plans and for other purposes.
In 1989, the National Association of Insurance Commissioners (NAIC) adopted the "NAIC Solvency Policing Agenda for 1990". Included in this agenda was the development of Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company's statutory surplus to the risk inherent in its overall operations.
The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $7 billion in post-tax cash flow during 1996. Cash flow includes periodic premium collections, including policyholders' contract deposits, paid loss recoveries less reinsurance premiums, losses, benefits, acquisition and operating expenses and income taxes paid. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance investment operations generated approximately $4.4 billion in investment income cash flow during 1996. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains.
The combined insurance post-tax operating cash flow coupled with the cash and short-term investments of $1.6 billion provided the insurance operations with a significant amount of liquidity during 1996. This liquidity is available to purchase high quality and diversified fixed income securities and to a lesser extent marketable equity securities and to provide mortgage loans on real estate, policy and collateral and guaranteed loans. This liquidity coupled with proceeds of over $16 billion from the maturities, sales and redemptions of fixed income securities and from the sales of marketable equity securities, AIG purchased approximately $22.5 billion of fixed income securities and marketable equity securities during 1996.
The following table is a summary of AIG's invested assets by significant segment, including investment income due and accrued and real estate, at December 31, 1996 and 1995:
The following tables summarize the composition of AIG's insurance invested assets by insurance segment, including investment income due and accrued and real estate, at December 31, 1996 and 1995:
(a) Includes $428,296 of bonds trading securities, at market value. (b) Includes $459,505 of preferred stock, at amortized cost. (c) Includes $38,989 of preferred stock, at market value.
With respect to fixed maturities, AIG's general strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations.
At December 31, 1996, approximately 52 percent of the fixed maturity investments were domestic securities. Approximately 39 percent of such domestic securities were rated AAA. Approximately 5 percent were below investment grade or not rated.
At December 31, 1996, approximately 5 percent of the fixed maturities portfolio was Collateralized Mortgage Obligations (CMOs). All of the CMOs were investment grade and approximately 72 percent of the CMOs were backed by various U.S. government agencies. Thus, credit risk was minimal. CMOs are exposed to interest rate risk as the duration and ultimate realized yield would be affected by the accelerated prepayments of the underlying mortgages. There were no interest only or principal only CMOs.
Mortgage loans on real estate, policy and collateral loans comprised 9.3 percent of AIG's insurance invested assets at December 31, 1996. AIG's insurance operations holdings of real estate mortgages amounted to $2.38 billion of which 34.1 percent was domestic. At December 31, 1996, no domestic mortgages and only a nominal amount of foreign mortgages were in default. At December 31, 1996, AIG's insurance holdings of collateral loans amounted to $897.3 million, all of which were foreign. It is AIG's practice to maintain a maximum loan to value ratio of 75 percent at loan origination. AIG's policy loans decreased from $3.95 billion at December 31, 1995 to $3.00 billion at December 31, 1996. Nearly all of this decrease relates to the redemption of COLI products.
Short-term investments represent amounts invested in various internal and external money market funds, time deposits and cash held.
The following table is a summary of the composition of AIG's financial services invested assets at December 31, 1996 and 1995. (See also the discussions under "Operational Review," "Capital Resources" and "Derivatives" herein.)
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 of prior debt. During 1996, ILFC acquired flight equipment costing $3.25 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. Some of these transactions are exposed to liquidity risk if AIGFP were to sell or close out the transactions prior to maturity. AIG believes that the impact of any such limited liquidity would not be significant to AIG's financial condition or its overall liquidity. (See also the discussion under "Derivatives" herein.)
Derivatives are financial arrangements among two or more parties whose returns are linked to or "derived" from some underlying equity, debt, commodity or other asset, liability, or some index. Derivatives payments may be based on interest rates and exchange rates and/or prices of certain securities, certain commodities, or financial or commodity indices. The more significant types of derivative arrangements in which AIG transacts are swaps, forwards, futures, options and related instruments.
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 value at risk and scenario analysis are used. Additionally, this department verifies that specific market risks of each of certain subsidiaries are managed and hedged by that subsidiary.
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG included in the financial services assets and liabilities at December 31, 1996 were as follows:
The interest rate risk on securities available for sale, at market, is managed by taking offsetting positions on a security by security basis, thereby offsetting a significant portion of the unrealized appreciation or depreciation. At December 31, 1996, the unrealized gains and losses remaining after benefit of the offsets were $14.7 million and $4.5 million, respectively.
Trading securities, at market value, and securities sold but not yet purchased are marked to market daily with the unrealized gain or loss being recognized in income at that time. These securities are held to meet the short-term risk management objectives of AIGFP.
The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed
The following table presents AIGFP's derivatives portfolio by maturity and type of derivative at December 31, 1996:
At December 31, 1996, the counterparty breakdown by industry with respect to the net replacement value of AIGTG's derivatives portfolio was as follows:
Management of AIG's liquidity profile is designed to ensure that even under adverse conditions AIG is able to raise funds at the most economical cost to fund maturing liabilities and capital and liquidity requirements of its subsidiaries. Sources of funds considered in meeting these objectives include guaranteed investment agreements, 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, not yet purchased, issuance of equity, and cash provided from operations. AIG's strong capital position is integral to managing liquidity, as it enables AIG to raise funds in diverse markets worldwide. (See also the discussions under "Capital Resources" and "Liquidity" herein.)
Legal risk arises from the uncertainty of the enforceability, through legal or judicial processes, of the obligations of AIG's clients and counterparties, including contractual provisions intended to reduce credit exposure by providing for the netting of mutual obligations. (See also the discussion on master netting agreements above.) AIG seeks to eliminate or minimize such uncertainty through continuous consultation with internal and external legal advisors, both domestically and abroad, in order to understand the nature of legal risk, to improve documentation and to strengthen transaction structure.
In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FASB 125). This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This statement provides consistent standards for distinguishing transfer of financial assets that are sales from transfers that are secured borrowings.
FASB 125 is effective January 1, 1997 and is to be applied prospectively. AIG is currently assessing the impact of this statement and believes FASB 125 will not have a material impact on AIG's results of operations, financial condition and liquidity.
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.
We have audited the consolidated financial statements and the financial statement schedules of American International Group, Inc. and subsidiaries listed in the index on page 34 of this Form 10-K. These financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedules based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the account-ing principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American International Group, Inc. and subsidiaries as of December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
(B) BASIS OF PRESENTATION: The accompanying financial statements have been prepared on the basis of generally accepted accounting principles (GAAP). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Certain accounts have been reclassified in the 1995 and 1994 financial statements to conform to their 1996 presentation.
Losses and loss expenses are charged to income as incurred. The reserve for losses and loss expenses represents the accumulation of estimates for reported losses and includes provisions for losses incurred but not reported. The methods of determining such estimates and establishing resulting reserves, including amounts relating to reserves for estimated unrecoverable reinsurance, are continually reviewed and updated. Adjustments resulting therefrom are reflected in income currently. AIG does not discount its loss reserves, other than for minor amounts related to certain workers' compensation claims. (See Note 6.)
AIG engages in market making and trading activities, as principal, in foreign exchange, interest rates, precious and base metals and natural gas and other energy products. AIG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts.
AIG, as lessor, leases flight equipment principally under operating leases. Accordingly, income is reported over the life of the lease as rentals become receivable under the provisions of the lease or, in the case of leases with varying payments, under the straight-line method over the noncancelable term of the lease. In certain cases, leases provide for additional amounts contingent on usage. AIG is also a remarketer of flight equipment and revenues from such operations consist of net gains on sales of flight equipment, commissions and net gains on disposition of leased flight equipment.
(K) SECURITIES PURCHASED (SOLD) UNDER AGREEMENTS TO RESELL (REPURCHASE), AT CONTRACT VALUE: Purchases of securities under agreements to resell and sales of securities under agreements to repurchase are accounted for as collateralized transactions and are recorded at their contracted resale or repurchase amounts, plus accrued interest. Generally, it is AIG's policy to take possession of or obtain a security interest in securities purchased under agreements to resell.
(L) OTHER INVESTED ASSETS: Other invested assets consist primarily of investments in joint ventures and partnerships and other investments not classified elsewhere herein. The joint ventures and partnerships are carried at equity or cost depending on the nature of the invested asset and the ownership percentage thereof. Other investments are carried at cost or market values depending upon the nature of the underlying assets. Unrealized gains and losses from the revaluation of those investments carried at market values are reflected in capital funds, net of any related deferred income taxes.
(O) REAL ESTATE AND OTHER FIXED ASSETS: The costs of buildings and furniture and equipment are depreciated principally on a straight-line basis over their estimated useful lives (maximum of 40 years for buildings and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterments are capitalized anddepreciated.
(Q) SECURITIES AND SPOT COMMODITIES SOLD BUT NOT YET PURCHASED, AT MARKET VALUE: Securities and spot commodities sold but not yet purchased represent sales of securities and spot commodities not owned at the time of sale. Securities are recorded on a trade date basis and are carried at current market values. Spot commodities are carried at current market values based upon current commodity prices. Unrealized gains and losses are reflected in income currently.
(R) PREFERRED SHAREHOLDERS' EQUITY IN SUBSIDIARY COMPANY: Preferred shareholders' equity in subsidiary company relates to outstanding market auction preferred stock of International Lease Finance Corporation (ILFC), a wholly owned subsidiary of AIG.
(S) TRANSLATION OF FOREIGN CURRENCIES: Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 "Foreign Currency Translation" (FASB 52). Under FASB 52, functional currency assets and liabilities are translated into U.S. dollars generally using current rates of exchange and the related translation adjustments are recorded as a separate component of capital funds net of any related taxes. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates. The adjustments resulting from translation of financial statements of foreign entities operating in highly inflationary economies are recorded in income. Exchange gains and losses resulting from foreign currency transactions are also recorded in income currently. The exchange gain or loss with respect to utilization of foreign exchange hedging instruments is recorded as a component of capital funds.
(T) INCOME TAXES: Deferred federal and foreign income taxes are provided for temporary differences for the expected future tax consequences of events that have been recognized in AIG's financial statements or tax returns.
(U) EARNINGS PER SHARE: Earnings per common share are based on the weighted average number of common shares outstanding, retroactively adjusted to reflect all stock dividends
(V) ACCOUNTING STANDARDS: In June 1996, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 125 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FASB 125). This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This statement provides consistent standards for distinguishing transfer of financial assets that are sales from transfers that are secured borrowings.
(b) The U.S. Federal income tax rate is 35 percent for 1996, 1995 and 1994. Actual tax expense on income differs from the "expected" amount computed by applying the Federal income tax rate because of the following:
(c) The components of the net deferred tax liability as of December 31, 1996 and December 31, 1995 were as follows:
Life insurance recoveries, which reduced death and other benefits, approximated $113.5 million, $111.4 million and $96.0 million, respectively, for the years ended December 31, 1996, 1995 and 1994.
Life insurance assumed represented 0.2 percent of gross life insurance in-force at December 31, 1996 and 0.1 percent for 1995 and 1994, and life insurance premium income assumed represented 0.1 percent of gross premium income for each of the periods ended December 31, 1996, 1995 and 1994.
(b) The analysis of the future policy benefits and policyholders' contract deposits liabilities as at December 31, 1996 and 1995 follows:
(c) Long duration contract liabilities included in future policy benefits, as presented in the table above, result from traditional life products. Short duration contract liabilities are primarily accident and health products. The liability for future life policy benefits has been established based upon the following assumptions:
(iv) Participating life business represented approximately 31 percent of the gross insurance in-force at December 31, 1996 and 49 percent of gross premium income in 1996. The amount of dividends to be paid is determined annually by the Boards of Directors. Anticipated dividends are considered as a planned contractual benefit in computing the value of future policy benefits and are provided ratably over the premium-paying period of the contracts.
(i) Interest rates credited on deferred annuities vary by year of issuance and range from 3.0 percent to 8.0 percent. Credited interest rate guarantees are generally for a period of one year. Withdrawal charges generally range from 6.0 percent to 10.0 percent grading to zero over a period of 6 to 10 years.
(ii) Domestically, GICs have market value withdrawal provisions for any funds withdrawn other than benefit responsive payments. Interest rates credited generally range from 4.7 percent to 8.1 percent and maturities range from 2 to 7 years. Overseas, primarily in the United Kingdom, GIC type contracts are credited at rates ranging from 4.4 percent to 6.2 percent with guarantees generally being one year. Contracts in other foreign locations have interest rates, maturities and withdrawal charges based upon local economic and regulatory conditions.
(iii) Interest rates on corporate-owned life insurance business are guaranteed at 4.0 percent and the weighted average rate credited in 1996 was 9.4 percent.
(a) The realized gains (losses) resulted from the sale of available for sale fixed maturities.
(D) MARKET VALUE OF FIXED MATURITIES AND UNREALIZED APPRECIATION OF INVESTMENTS: At December 31, 1996 and 1995, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $1,683,000,000 and $1,286,600,000 and gross losses of approximately $675,800,000 and $546,100,000, respectively.
The deferred tax payable related to the net unrealized appreciation of investments was $681,705,000 at December 31, 1996 and $656,572,000 at December 31, 1995.
The amortized cost and estimated market value of investments in fixed maturities carried at amortized cost at December 31, 1996 and December 31, 1995 were as follows:
The amortized cost and estimated market values of fixed maturities held to maturity and fixed maturities available for sale at December 31, 1996, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
The amortized cost, related hedges and estimated market value of securities available for sale and carried at market value at December 31, 1996 and 1995 were as follows:
The amortized cost and estimated market values of securities available for sale at December 31, 1996, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.
At December 31, 1996, the gross weighted average coupon of this portfolio was 7.4 percent. The gross weighted average life of this portfolio was 6.3 years.
At December 31, 1996, AIG's debt outstanding of $23.52 billion, shown below, included borrowings of $20.10 billion which were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs) or matched notes and bonds payable.
(A) COMMERCIAL PAPER: At December 31, 1996, the commercial paper issued and outstanding was as follows:
An analysis of the Medium Term Notes for the year ended December 31, 1996 was as follows:
At December 31, 1996, AIG had $647 million principal amount of Series E Medium Term Notes registered and available for issuance from time to time.
(ii) Medium Term Notes Payable Issued by ILFC: ILFC's Medium Term Notes are unsecured obligations which may not be redeemed by ILFC prior to maturity and bear interest at fixed rates set by ILFC at issuance.
As of December 31, 1996, notes in aggregate principal amount of $2.55 billion were outstanding with maturity dates from 1997 to 2005 at interest rates ranging from 4.9 percent to 9.88 percent. These notes provide for a single principal payment at the maturity of each note.
AIGFP is also obligated under various notes maturing from 1997 through 2026. The majority of these notes are denominated in U.S. dollar, Japanese yen, and Danish kroner and bear interest at various interest rates. At December 31, 1996, these notes had a U.S. dollar carrying value of $666.1 million.
At December 31, 1996, ILFC's capital lease obligations were $995.9 million. Fixed interest rates with respect to these obligations range from 6.18 percent to 6.89 percent; variable rates are referenced to LIBOR. These obligations mature through 2005. The flight equipment associated with the capital lease obligations had a net book value of $1.17 billion.
(c) The common stock activity for the three years ended December 31, 1996 was as follows:
The following tables provide the notional and contractual amounts of AIGFP's, AIGTG's and ILFC's derivatives transactions at December 31, 1996.
Futures and forward contracts are contracts for delivery of foreign currencies or financial indices in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise as a result of movements in current market prices from contracted prices and the potential inability of counterparties to meet their obligations under the contracts. At December 31, 1996, the contractual amount of AIGFP's futures and forward contracts approximated $12.8 billion.
The following table presents AIGFP's futures and forward contracts portfolio by maturity and type of derivative at December 31, 1996:
AIGFP determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At December 31, 1996, the counterparty credit quality by derivative product with respect to the net replacement value of AIGFP's derivatives portfolio was as follows:
At December 31, 1996, the counterparty breakdown by industry with respect to the net replacement value of AIGFP's derivatives portfolio was as follows:
The net trading revenues for the twelve months ended December 31, 1996 from AIGFP's operations were $369.2 million.
Futures and forward contracts are contracts for delivery of foreign currencies, commodities or financial indices in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise as a result of movements in current market prices from contracted prices and the potential inability of counterparties to meet their obligations under the contracts. At December 31, 1996, the contractual amount of AIGTG's futures and forward contracts approximated $230.9 billion.
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. At December 31, 1996, the net replacement value of AIGTG's futures and forward contracts and interest rate and currency swaps approximated $2.97 billion.
The following table presents AIGTG's derivatives portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1996:
* Options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposures.
AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At December 31, 1996, the counterparty credit quality by derivative product with respect to the net replacement value of AIGTG's derivatives portfolio was as follows:
In the normal course of business, ILFC employs a variety of off-balance sheet derivative transactions with the objective to lower its overall borrowing cost and to maintain its optimal mix of variable and fixed rate interest obligations. These derivative products include interest rate swaps, swaptions and interest rate floors (off-balance sheet derivative transactions).
ILFC accounts for its off-balance sheet derivative transactions on an accrual basis. Accrued future payments or receipts are reflected in operating income in the period incurred or earned. Credit risk exposure arises from the potential that the counterparty may not perform under these agreements with respect to the off-balance sheet derivative transactions. ILFC minimizes such exposure through transacting with recognized U.S. derivative dealers rated at least A by a recognized statistical rating organization. The counterparties to the majority of the off-balance sheet derivative transactions are rated AAA. ILFC monitors each counterparty's assigned credit rating throughout the life of each of the off-balance sheet derivative transactions. ILFC currently does not require security nor is security required by its counterparties for its positions. ILFC has the right to require security under certain circumstances.
The following table provides the notional and contractual amounts of ILFC's off-balance sheet derivative transactions at December 31, 1996. The timing and the amount of the cash flows relating to swaption and other interest rate option contracts are determined by each of the respective contractual agreements.
(f) AIG and its subsidiaries, in common with the insurance industry in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. AIG does not believe that such litigation will have a material effect on its operating results and financial condition.
A summary of reserve activity, including estimates for applicable incurred but not reported losses and loss expenses, relating to asbestos and environmental claims separately and combined at December 31, 1996, 1995 and 1994 was as follows:
(a) At December 31, 1996 and 1995, incurred losses for asbestos and environmental claims reflect reserve strengthening in the IBNR carried.
The carrying values and fair values of AIG's financial instruments at December 31, 1996 and December 31, 1995 and the average fair values with respect to derivative positions during 1996 and 1995 were as follows:
At December 31, 1996, AIG had two types of stock-based compensation plans. One was a stock option plan; the other, an employee stock purchase plan. AIG applies APB Opinion 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans. Accordingly, no compensation costs have been recognized for either plan.
Had compensation costs for these plans been determined consistent with the method of FASB 123, AIG's net income and earnings per share for the years ended December 31, 1996 and 1995 would have been reduced to the pro forma amounts as follows:
The fair value of stock grants included in the pro forma amounts is not necessarily indicative of future effects on net income and earnings per share.
(A) STOCK OPTION PLAN: On December 19, 1991, the AIG Board of Directors adopted a 1991 employee stock option plan, which provides that options to purchase a maximum of 4,500,000 shares of common stock could be granted to officers and other key employees at prices not less than fair market value at the date of grant. Both the 1991 plan, and the options with respect to 112,387 shares granted thereunder on December 19, 1991, were approved by shareholders at the 1992 Annual Meeting. At December 31, 1996, 1,513,764 shares were reserved for future grants under the 1991 plan. As of March 18, 1992, no further options could be granted under the 1987 plan, but outstanding options granted under the 1987 plan continue in force until exercise or expiration. At December 31, 1996, there were 4,313,771 shares reserved for issuance under the 1991 and 1987 plans.
Under each plan, 25 percent of the options granted become exercisable on the anniversary of the date of grant in each of the four years following that grant and all options expire 10 years from the date of the grant. As of December 31, 1996, outstanding options granted with respect to 2,918,092 shares qualified for Incentive Stock Option treatment under the Economic Recovery Tax Act of 1981.
The fair values of stock options granted during the years ended December 31, 1996 and 1995 were $25,566,000 and $18,356,000, respectively. The fair value of each option is estimated on the date of the grant using the Black-Scholes option-pricing model.
The following weighted average assumptions were used for grants in 1996 and 1995, respectively: dividend yields of 0.33 percent and 0.32 percent, expected volatilities of 20.0 percent and 20.4 percent, risk-free interest rates of 6.29 percent and 5.77 percent, and expected terms of 7 years.
(B) EMPLOYEE STOCK PURCHASE PLAN: AIG's 1984 employee stock purchase plan was adopted at its 1984 shareholders' meeting and became effective as of July 1, 1984. Eligible employees could receive privileges to purchase up to an aggregate of 1,968,750 shares of AIG common stock, at a price equal to 85 percent of the fair market value on the date of grant of the purchase privilege. Purchase privileges were granted annually and were limited to the number of whole shares that could be purchased by an amount equal to 5 percent of an employee's annual salary or $3,750, whichever was less. Beginning with the January 1, 1996 subscription, the maximum allowable purchase limitation increased to $5,500.
There were 146,217 shares, 152,406 shares and 135,992 shares issued under the 1984 plan at weighted average prices of $66.88, $50.22 and $50.37 for the years ended December 31, 1996, 1995 and 1994, respectively. The excess or deficit of the proceeds over the par value or cost of the common stock issued was credited or charged to additional paid-in capital.
AIG's 1996 employee stock purchase plan was adopted at its 1996 shareholders' meeting and became effective as of July 1, 1996, replacing the 1984 plan. Eligible employees may receive privileges to purchase up to an aggregate of 1,000,000 shares of AIG common stock, at a price equal to 85 percent of the fair market value on the date of the grant of the purchase privilege. Purchase privileges are granted annually and are limited to the number of whole shares that can be purchased by an amount equal to 5 percent of an employee's annual salary or $5,500, whichever is less. In all other respects, the 1996 plan is identical to the 1984 plan.
As of December 31, 1996, there were 129,453 shares of common stock subscribed to at a weighted average price of $82.70 per share pursuant to grants of privileges under both plans. There were 919,334 shares available for the grant of future purchase privileges under the 1996 plan at December 31, 1996.
AIG's U.S. postretirement medical and life insurance benefits are based upon the employee reaching age 55 with 10 years of service to be eligible for an immediate benefit from the U.S. retirement plan. Retirees and their dependents who were age 65 by May 1, 1989 participate in the medical plan at no cost. Employees who retired after May 1, 1989 and on or prior to January 1, 1993 pay the active employee premium if under age 65 and 50 percent of the active employee premium if over age 65. Retiree contributions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance and Medicare coordination and a lifetime maximum benefit of $1,000,000. The maximum life insurance benefit prior to age 70 is $32,500, with a maximum of $25,000 thereafter.
Assumptions associated with the accrued postretirement benefit liability at December 31, 1996 were as follows:
The medical trend rate assumptions have a significant effect on the amounts reported. Increasing each trend rate by 1 percent in each year would increase the accumulated postretirement benefit obligations as of December 31, 1996 by $6.9 million and the aggregate service and interest cost components of the periodic postretirement benefit costs for 1996 by $640,000.
At December 31, 1996, the future minimum lease payments under operating leases were as follows:
Rent expense approximated $219,100,000, $215,600,000, and $208,000,000 for the years ended December 31, 1996, 1995 and 1994, respectively.
(b) Minimum future rental income on noncancelable operating leases of flight equipment which have been delivered at December 31, 1996 was as follows:
Flight equipment is leased, under operating leases, for periods ranging from one to ten years.
(B) TRANSACTIONS WITH RELATED PARTIES: During the ordinary course of business, AIG and its subsidiaries pay commissions to Starr and its subsidiaries for the production and management of insurance business. Net commission payments to Starr aggregated approximately $48,400,000 in 1996, $42,600,000 in 1995 and $31,200,000 in 1994, from which Starr is required to pay commissions due originating brokers and its operating expenses. AIG also received approximately $15,300,000 in 1996, $14,100,000 in 1995 and $12,900,000 in 1994 from Starr and paid approximately $34,000 in both 1996 and 1995 and $42,000 in 1994 to Starr as reimbursement for services provided at cost. AIG also received approximately $1,000,000 in 1996, $1,500,000 in 1995 and $900,000 in 1994 from SICO and paid approximately $1,200,000 in each of the years 1996, 1995 and 1994 to SICO as reimbursement for services rendered at cost. AIG also paid to SICO $4,400,000 in 1996, $5,000,000 in 1995 and $3,000,000 in 1994 in rental fees.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1996 and 1995 is unaudited. However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary to present fairly the results of operations for such periods, have been made for a fair presentation of the results shown.
General Insurance - AIG's general insurance operations are multiple line property and casualty companies writing substantially all lines of insurance other than title insurance. The general insurance operations also include mortgage guaranty insurance operations.
(c) AIG's individual life insurance and group life insurance portfolio accounted for 68 percent, 66 percent and 62 percent of AIG's consolidated life insurance operating income before realized capital gains or losses for the years ended December 31, 1996, 1995 and 1994, respectively. For those years, 92 percent, 94 percent and 96 percent, respectively, of consolidated life operating income before realized capital gains or losses was derived from foreign operations.
(d) A substantial portion of AIG's business is conducted in countries other than the United States and Canada. The following table is a summary of AIG's business by geographic segments. Allocations have been made on the basis of location of operations and assets.
(b) Revenues are derived from revenues of the general, life, agency and service fee and financial services operations, equity in income of minority-owned insurance operations and realized capital gains attributable to the segments.