The growth in net premiums written in 1995 and 1994 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 personal lines. Overseas, the primary reasons for growth were price and volume increases. Foreign general insurance operations produced 35.3 percent of the general insurance net premiums written in 1995, 34.4 percent in 1994 and 30.4 percent in 1993.
In comparing the foreign exchange rates used to translate AIG's foreign general operations during 1995 to those foreign exchange rates used to translate AIG's foreign general operations during 1994, the U.S. dollar declined 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 2.3 percentage points greater than they would have been if translated utilizing those exchange rates which prevailed during 1994.
Adjusted underwriting profit or loss (operating income less net investment income and realized capital gains) represents statutory underwriting profit or loss adjusted primarily for changes in deferred acquisition costs. The adjusted underwriting profits were $361.6 million in 1995, $147.5 million in 1994 and $10.4 million in 1993. (See also Notes 4 and 18 of Notes to Financial Statements.)
General insurance operating income in 1995 increased 20.8 percent when compared to 1994. The 1994 results reflect an increase of 15.5 percent from 1993. The contribution of general insurance operating income to income before income taxes and the cumulative effect of accounting changes was 57.0 percent in 1995 compared to 55.4 percent in 1994 and 54.4 percent in 1993.
affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by changes in Superfund and waste dump site coverage issues. Additional liabilities could emerge for amounts in excess of the current reserves held. Although this emergence cannot now be reasonably estimated, it could have a material adverse impact on AIG's future operating results. The reserves carried for these claims at December 31, 1995 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.)
A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined at December 31, 1995, 1994 and 1993 was as follows:
The gross and net IBNR included in the aforementioned reserve for losses and loss expenses at December 31, 1995, 1994 and 1993 were estimated as follows:
The average cost per claim settled, dismissed or otherwise resolved for the years ended December 31, 1995, 1994 and 1993 was as follows:
Accordingly, AIG's survival ratios for involuntary asbestos and environmental claims, separately and combined, were estimated as follows for the years ended December 31, 1995, 1994 and 1993:
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 1995 represented an 19.5 percent increase from the prior year. This compares with an increase of 17.0 percent in 1994 over 1993. Foreign life operations produced 94.2 percent, 94.5 percent and 95.3 percent of the life premium income in 1995, 1994, and 1993, respectively. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)
Life insurance net investment income increased 29.5 percent in 1995 compared to an increase of 16.6 percent in 1994. The growth in net investment income was primarily attributable to foreign new cash flow for investment and, to a lesser degree, growth in interest income earned on policy loans related to domestic corporate-owned life insurance products (COLI). 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.)
Life insurance realized capital gains were $32.7 million in 1995, $86.7 million in 1994 and $54.6 million in 1993. 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 of fixed maturities.
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 rein-
Agency and service fee operating income in 1995 increased 5.1 percent to $56.9 million compared to $54.1 million in 1994 which was a decrease of 10.2 percent from 1993. The increase in operating income from 1993 resulted from the growth of risk management services. The decline in 1994 was due to reduced commission revenue in certain of AIG's managing general agencies. Agency and service fee operating income contributed 1.6 percent to AIG's income before income taxes and the cumulative effect of accounting changes in 1995 compared to 1.8 percent in 1994 and 2.3 percent in 1993.
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 1995 increased 25.6 percent from 1994 compared to a 24.8 percent increase during 1994 from 1993. The revenue increase in each year resulted primarily from the growth both in the size and relative cost of the fleet. During 1995, operating income increased 6.3 percent from 1994 and 12.8 percent during 1994 from 1993. The decline in the rate of increase of ILFC's 1995 operating income is due to the full effect of the lease margin compression resulting from the increases in interest rates that prevailed during 1994. The average borrowing cost during 1995 was 6.47 percent while 1994 was 6.41 percent. Further declines in interest rates would have a positive effect on leasing margins. (See also the discussions under "Capital Resources" and "Liquidity" herein.)
for sale. All other aircraft remain leased. Currently, 76 percent of rental revenue is from foreign carriers. (See also the discussions under "Capital Resources" and "Liquidity" herein.)
AIG Financial Products Corp. and its subsidiaries (AIGFP) participate in the derivatives dealer market conducting, primarily as principal, an interest rate, currency and equity derivative products business. AIGFP also enters into long-dated forward foreign exchange contracts, option transactions, liquidity facilities, investment agreements and other structured transactions and invests in a diversified portfolio of securities. Thus, AIGFP derives substantially all its revenues from proprietary positions entered in connection with counterparty transactions rather than for speculative transactions. Revenues in 1995 increased 3.6 percent from 1994 compared to a 17.0 percent decline during 1994 from 1993. During 1995, operating income increased 7.0 percent from 1994 and declined 12.7 percent during 1994 from 1993. As AIGFP is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein.)
AIG Trading Group Inc. and its subsidiaries (AIGTG) derive a substantial portion of their revenues from market making and trading activities, as principals, in foreign exchange, interest rates, precious and base metals and natural gas and other energy products. Revenues in 1995 increased 28.6 percent from 1994 compared to an 8.5 percent increase during 1994 from 1993. During 1995, operating income increased 24.5 percent from 1994 and declined 20.9 percent during 1994 from 1993. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein.)
Financial services operating income represented 12.1 percent of AIG's income before income taxes and the cumulative effect of accounting changes in 1995. This compares to 13.7 percent and 15.0 percent in 1994 and 1993, respectively.
Income before income taxes amounted to $3.47 billion in 1995 and $2.95 billion in 1994. Income before income taxes and the cumulative effect of accounting changes was $2.60 billion in 1993.
Income before the cumulative effect of accounting changes amounted to $1.92 billion in 1993. At January 1, 1993, AIG's equity in income of minority-owned insurance operations was positively impacted by the cumulative effect of accounting changes on such operations from the adoption of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes"(FASB 109), which was partially offset by the adoption of Statement of Financial Accounting Standards No. 106 "Employer's Accounting for Postretirement Benefits Other than Pension Plans" (FASB 106). AIG's equity in the cumulative effect of such accounting changes was a net benefit of $20.7 million.
At December 31, 1995, AIG had total capital funds of $19.83 billion and total borrowings of $17.99 billion. At that date, $14.32 billion of such borrowings were either not guaranteed by AIG or were matched borrowings under obligations of guaranteed investment agreements (GIAs).
Total borrowings at December 31, 1995 and 1994 were as follows:
AIG Funding, Inc. (Funding), through the issuance of commercial paper, fulfills the short-term cash requirements of AIG and its subsidiaries. Funding intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of Funding's commercial paper is subject to the approval of AIG's Board of Directors. ILFC and A.I. Credit Corp. (AICCO) issue commercial paper for the funding of their own operations. AIG does not guarantee AICCO's or ILFC's commercial paper. However, AIG has entered into an agreement in support of AICCO's commercial paper. From time to time, AIGFP may issue commercial paper to fund its operations. AIG guarantees AIGFP's commercial paper. At December 31, 1995, AIGFP had no commercial paper outstanding. (See also the discussion under "Derivatives" herein and Note 9 of Notes to Financial Statements.)
ILFC increased the aggregate principal amount outstanding of its medium term and term notes to $5.94 billion at December 31, 1995, a net increase of $992.0 million, and incurred a net increase in its capital lease obligations of $783.0 million at that date. At December 31, 1995, ILFC had $1.80 billion in aggregate principal amount of debt securities registered for issuance from time to time. ILFC sold $200 million of Market Auction Preferred Stock in 1995. The cash used to purchase flight equipment, including progress payments during the construction phase, is primarily derived from the proceeds of ILFC's debt financings. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover of prior debt. (See also the discussions under "Operational Review" and "Liquidity" herein and Notes 1, 9 and 15 of Notes to Financial Statements.)
During 1995, AIG did not issue any medium term notes and $40.0 million of previously issued notes matured. At December 31, 1995, AIG had $247.0 million in aggregate principal amount of debt securities registered for issuance from time to time. An additional $500 million principal amount of debt securities was registered in February, 1996. (See also the discussion under "Derivatives" herein and Note 9 of Notes to Financial Statements.)
AIG's liquidity is primarily derived from the operating cash flows of its general and life insurance operations.
The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance pretax operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $9.6 billion in pretax cash flow during 1995. Cash flow includes periodic premium collections, including policyholders' contract deposits, paid loss recoveries less reinsurance premiums, losses, benefits, acquisition and operating expenses paid. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance investment operations generated approximately $3.5 billion in investment income cash flow during 1995. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains.
With respect to fixed maturities, AIG's strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations. The growth in the percentage distribution of fixed maturities available for sale, at market value is primarily attributable to the decline in domestic interest rates and the redesignation of approximately $2.8 billion of fixed maturities held to maturity to fixed maturities available for sale. This change was permitted by the transition provision for a one-time transfer of securities from held to maturity, at amortized cost as included in the Financial Accounting Standards Board's "Special Report, a Guide to the Implementation of Statement No. 115 on Accounting for Certain Investments in Debt and Equity Securities."
At December 31, 1995, approximately 54 percent of the fixed maturity investments were domestic securities. Approximately 40 percent of such domestic securities were rated AAA, approximately two percent were below investment grade.
A significant portion of the foreign insurance fixed income portfolio is rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At December 31, 1995, approximately 46 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG's internal analysis were equivalent from a credit standpoint to securities so rated. Less than one percent of these investments were deemed below investment grade and approximately four percent were not rated at that date.
Although AIG's fixed income insurance portfolios contain only minor amounts of securities below investment grade, any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date. There have been no significant downgrades as at March 1, 1996.
of the underlying mortgages. There were no interest only or principal only CMOs.
Short-term investments represent amounts invested in various internal and external money market funds, time deposits and cash.
The following table is a summary of the composition of AIG's financial services invested assets at December 31, 1995 and 1994. (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 1995, ILFC acquired flight equipment costing $3.28 billion.
At December 31, 1995, ILFC had committed to purchase or had secured positions for 292 aircraft deliverable from 1996 through 2004 at an estimated aggregate purchase price of $15.9 billion and had options to purchase an additional 34 aircraft deliverable through 2005 at an estimated aggregate purchase price of $2.5 billion. As at March 15, 1996, ILFC has entered into leases, letters of intent to lease or is in various stages of negotiation for all of the aircraft to be delivered in 1996 and 44 of 228 aircraft to be delivered subsequent to 1996. ILFC will be required to find customers for any aircraft presently on order and any aircraft to be ordered, and it must arrange financing for portions of the purchase price of such equipment. In a rising interest rate environment, ILFC negotiates higher lease rates on any new contracts. ILFC has been successful to date both in placing its new aircraft on lease or under sales contract and obtaining adequate financing.
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.
AIGTG senior management has established positions and stop-loss limits for each line of business. AIGTG's traders are required to maintain positions within these limits. These positions are monitored during the day either manually or through on-line computer systems. In addition, these positions are reviewed by AIGTG management. Reports which present each trading book's position and the prior day's profit and loss are reviewed by traders, head traders and AIGTG's senior management. Based upon these and other reports, AIGTG's senior management may determine to adjust AIGTG's risk profile.
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG included in the financial services assets and liabilities at December 31, 1995 were as follows:
AIGTG conducts as principal, market making and trading activities in foreign exchange, interest rates, precious and base metals and natural gas and other energy products. AIGTG owns inventories in the commodities in which it trades. These inventories are carried at market and may be substantially hedged. AIGTG uses derivatives to manage the economic exposure of its various trading positions and transactions from adverse movements in interest rates, exchange rates and commodity prices. (See also the discussions under "Operational Review: Financial Services" and "Liquidity" herein.)
The following tables provide the notional and contractual amounts of AIGFP's derivatives portfolio at December 31, 1995. The notional amounts used to express the extent of AIGFP's involvement in swap transactions represent a standard of measurement of the volume of AIGFP's swaps business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps. The timing and the amount of cash flows relating to foreign exchange forwards and exchange traded futures and options contracts are determined by each of the respective contractual agreements.
The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss after the application of the aforementioned strategies, ISDA Master Agreements and collateral held.
The following table presents AIGFP's derivatives portfolio by maturity and type of derivative at December 31, 1995:
The following tables present AIGTG's derivatives portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1995:
(a) The net replacement value with respect to purchased options is presented as a component of spot commodities, at market value. (b) Options obligate AIGTG to buy or sell the underlying item if the option purchaser chooses to exercise. The amounts do not represent credit exposures.
At December 31, 1995, the counterparty breakdown by industry with respect to the net replacement value of AIGTG's derivatives portfolio was as follows:
As an end user, AIG and its subsidiaries, including its insurance subsidiaries, use derivatives to aid in managing AIG's foreign exchange translation exposure. Derivatives may also be used to minimize certain exposures with respect to AIG's debt financing and insurance investment operations; to date, such activities have been minor.
Over the counter derivatives dealers have drafted a code of conduct to provide standards for their industry. The alternative to self-regulation is federal regulation. AIG supports self-regulation and expects to adhere to promulgated standards.
In 1994, the American Institute of Certified Public Accountants issued a Statement of Position (SOP) 94-6 "Disclosure of Certain Significant Risks and Uncertainties" (SOP 94-6). Pursuant to SOP 94-6, AIG has made certain disclosures as to risks and uncertainties and the nature of AIG's operations and AIG's use of estimates in the preparation of its 1995 financial statements.
- -------------------------------------------------------------------------------- Page - -------------------------------------------------------------------------------- Report of Independent Accountants 34 Consolidated Balance Sheet at December 31, 1995 and 1994 35 Consolidated Statement of Income for the years ended December 31, 1995, 1994 and 1993 37 Consolidated Statement of Capital Funds for the years ended December 31, 1995, 1994 and 1993 38 Consolidated Statement of Cash Flows for the years ended December 31, 1995, 1994 and 1993 39 Notes to Financial Statements 41
American International Group, Inc. NOTES TO FINANCIAL STATEMENTS and Subsidiaries - --------------------------------------------------------------------------------
(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 1994 and 1993 financial statements to conform to their 1995 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 very minor amounts related to certain workers' compensation claims.
Financial Services Operations: AIG participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency and equity derivative products business. AIG also enters into long-dated forward foreign exchange contracts, option transactions, liquidity facilities, investment agreements and other structured transactions and invests in a diversified portfolio of securities.
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 marketer of flight equipment and marketing revenues from such operations consist of net gains on sales of flight equipment, commissions and net gains on disposition of leased flight equipment.
(c) Investments in Fixed Maturities and Equity Securities: Bonds and preferred stocks held to maturity, both of which are principally owned by the insurance subsidiaries, are carried at amortized cost where AIG has the ability and positive intent to hold these securities until maturity. Where AIG may not have the positive intent to hold these securities until maturity, those bonds are considered to be available for sale and carried at market value. Included in the bonds available for sale are collateralized mortgage obligations (CMOs). Premiums and discounts arising from the purchase of CMOs are treated as yield adjustments over their estimated life. Bond trading securities are carried at market value, as it is AIG's intention to sell these securities in the near term. Common and non-redeemable preferred stocks are carried at market value.
Unrealized gains and losses from investments in equity securities and fixed maturities available for sale are reflected in capital funds, net of any related deferred income taxes. Unrealized gains
and losses from investments in trading securities are reflected in income currently.
(e) Flight Equipment: Flight equipment is stated at cost. Major additions and modifications are capitalized. Normal maintenance and repairs, airframe and engine overhauls and compliance with return conditions of flight equipment on lease are provided by and paid for by the lessee. Under the provisions of most leases for certain airframe and engine overhauls, the lessee is reimbursed for costs incurred up to but not exceeding contingent rentals paid to AIG by the lessee. AIG provides a charge to income for such reimbursements based upon the hours utilized during the period and the expected reimbursement during the life of the lease. Depreciation and amortization are computed on the straight-line basis to a residual value of approximately 15 percent over the estimated useful lives of the related assets but not exceeding 25 years. This caption also includes deposits for aircraft to be purchased.
(f) Securities Available for Sale, at market value: These securities are held to meet long term investment objectives and are accounted for as available for sale, carried at market value and recorded on a trade date basis. Unrealized gains and losses are reflected in capital funds, net of any related deferred income taxes.
(h) Spot Commodities, at market value: Spot commodities, which include commodities and options, are valued at market and are recorded on a trade date basis. The unrealized gains and losses are reflected in income currently. The exposure to market risk may be reduced through the use of forwards, futures and option contracts. These contracts are valued at market and are recorded as contractual commitments on a trade date basis. The unrealized gains and losses on open contracts are reflected in income currently.
(i) Unrealized Gain and Unrealized Loss on Interest Rate and Currency Swaps, Options and Forward Transactions: Swaps, options and forward transactions are accounted for as contractual commitments recorded on a trade date basis and are carried at market or estimated fair value when market values are not available. Estimated fair values are based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates with the resulting unrealized gains or losses reflected in income currently. These valuations represent an assessment of the present values of expected future cash flows of these transactions and may include reserves for market risk as deemed appropriate. The portfolio's discounted cash flows are evaluated with reference to current market conditions, maturities within the portfolio and other relevant factors. Based upon this evaluation, it is determined what, if any, offsetting transactions are necessary to reduce the market risk of the portfolio. The recorded values of these transactions may be different than the values that might be realized if AIG were to sell or close out the transactions prior to maturity. AIG manages its market risk with a variety of transactions, including swaps, trading securities, futures and forward contracts and other transactions, as appropriate.
(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 depending upon the nature of the underlying assets. Unrealized gains and losses from the revaluation of those investments carried at market are reflected in capital funds, net of any related taxes.
(r) Spot Commodities Sold but not yet Purchased, at market value: Spot commodities sold but not yet purchased represent sales of commodities not owned at the time of sale. These obligations are recorded on a trade date basis and are carried at market values based upon current commodity prices. The unrealized gains and losses are reflected in income currently.
(s) 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.
(v) 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 and stock splits. The effect of all other common stock equivalents is not significant for any period presented.
FASB 121 is effective for AIG commencing January 1, 1996. AIG believes that the adoption of this statement in 1996 will have an immaterial impact on the results of operations, financial condition and liquidity.
(ii) Standards Adopted Prior to 1995: In November 1992, FASB issued Statement of Financial Accounting Standards No. 112 "Employers' Accounting for Postemployment Benefits" (FASB 112). FASB 112 establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. FASB 112 was adopted by AIG effective January 1, 1994 and had no significant impact on AIG's results of operations, financial condition or liquidity.
Certain subsidiaries operate solely outside of the United States. Their assets and liabilities are located principally in the countries where the insurance risks are written and/or investment and non-insurance related operations are located. In addition, certain of AIG's domestic subsidiaries have branch and/or subsidiary operations and substantial assets and liabilities in foreign countries. Certain countries have restrictions on the conversions of funds which generally cause a delay in the outward remittance of such funds. Approximately 37 percent of consolidated assets at each of the years ended December 31, 1995 and 1994, and 53 percent, 53 percent and 51 percent of revenues for the years ended December 31, 1995, 1994 and 1993, respectively, were located in or derived from foreign countries (other than Canada). (See Note 18).
Foreign income not expected to be taxed in the United States has arisen because AIG's foreign subsidiaries were generally not subject to U.S. income taxes on income earned prior to January 1, 1987. Such income would become subject to U.S. income taxes at current tax rates if remitted to the United States or if other events occur which would make these amounts currently taxable. The cumulative amount of undistributed earnings of AIG's foreign subsidiaries currently not subject to U.S. income taxes was approximately $2.8 billion at December 31, 1995. Management presently has no intention of subjecting these accumulated earnings to material U.S. income taxes and no provision has been made in the accompanying financial statements for such taxes.
None of these changes had a material effect on AIG's results of operations or liquidity.
(b) The U.S. Federal income tax rate is 35 percent for 1995, 1994 and 1993. 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, 1995 and December 31, 1994 were as follows:
The following reflects the policy acquisition costs deferred for amortization against future income and the related amortization charged to income for general and life insurance operations, excluding certain amounts deferred and amortized in the same period:
For the years ended December 31, 1995, 1994 and 1993, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $5.14 billion, $4.84 billion and $4.45 billion, respectively.
AIG evaluates the financial condition of its reinsurers through an internal reinsurance security committee consisting of members of AIG's Senior Management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract.
Life insurance assumed represented 0.1 percent of gross life insurance in-force at December 31, 1995 and 1994 and 0.5 percent for 1993, and 0.1 percent of gross premium income for each of the periods ended December 31, 1995, 1994 and 1993.
Supplemental information for gross loss and benefit reserves net of ceded reinsurance at December 31, 1995 and 1994 follows:
(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 9.1 percent and maturities range from 2 to 7 years. Overseas, primarily in the United Kingdom, GIC type contracts are credited at rates ranging from 5.0 percent to 6.4 percent with maturities generally being one year. Contracts in other foreign locations have interest rates, maturities and withdrawal charges based upon local economic and regulatory conditions.
AIG's insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulatory authorities. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect deferred policy acquisition costs and deferred income taxes, all bonds are carried at amortized cost and reinsurance assets and liabilities are presented net of reinsurance. AIG's use of permitted statutory accounting practices does not have a significant impact on statutory surplus.
(c) Investment Gains and Losses:The realized capital gains (losses) and increase (decrease) in unrealized appreciation of investments for 1995, 1994 and 1993 were as follows:
(a) In 1995 and 1994, the realized gains (losses) resulted from the sale of available for sale fixed maturities. In 1993, a majority of the gains (losses) realized resulted from sales of bonds carried at market value.
The gross gains and gross losses realized on the disposition of available for sale securities for 1995 and 1994 follows:
(d) Market Value of Fixed Maturities and Unrealized Appreciation of Investments: At December 31, 1995 and 1994, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $1,286,600,000 and $1,320,000,000 and gross losses of approximately $546,100,000 and $914,500,000, respectively.
The amortized cost and estimated market values of fixed maturities held to maturity and fixed maturities available for sale at December 31, 1995, 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.
(e) Securities Available for Sale: AIGFP follows a policy of minimizing interest rate, equity and currency risks associated with securities available for sale by entering into swap or other transactions. In addition, to reduce its credit risk, AIGFP has entered into credit derivative transactions with respect to $1.10 billion of securities available for sale. At December 31, 1995, the cumulative increase in carrying value of the securities available for sale and related hedges as a result of marking to market such securities net of hedging transactions was $478,000.
The amortized cost and estimated market values of securities available for sale at December 31, 1995, 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, 1995, the gross weighted average coupon of this portfolio was 8.1 percent. The gross weighted average life of this portfolio was 6.7 years.
(a) Commercial Paper:At December 31, 1995, the commercial paper issued and outstanding was as follows:
(b) Borrowings under Obligations of Guaranteed Investment Agreements: Borrowings under obligations of guaranteed investment agreements, which are guaranteed by AIG, are recorded at the amount outstanding under each contract. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings are primarily fixed and range up to 10.6 percent.
At December 31, 1995, the market value of securities pledged as collateral with respect to these obligations approximated $1,081,000,000.
(i) Medium Term Notes Payable Issued by AIG: AIG's Medium Term Notes are unsecured obligations which may not be redeemed by AIG prior to maturity and bear interest at either fixed rates set by AIG at issuance or variable rates determined by reference to an interest rate or other formula.
At December 31, 1995, the maturity schedule for AIG's outstanding Medium Term Notes was as follows:
(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, 1995, notes in aggregate principal amount of $2,391,535,000 were outstanding with maturity dates varying from 1996 to 2005 at interest rates ranging from 4.5 percent to 9.88 percent. These notes provide for a single principal payment at the maturity of each note.
(ii) Italian Lire Bonds:In December, 1991, AIG issued unsecured bonds denominated in Italian Lire. The principal amount of 200 billion Italian Lire Bonds matures December 4, 2001 and accrues interest at a rate of 11.7 percent which is paid annually. These bonds are not redeemable prior to maturity, except in the event of certain changes involving taxation in the United States or the imposition of certain certification, identification or reporting requirements.
As of December 31, 1995, notes in aggregate principal amount of $3,550,000,000 were outstanding with maturity dates varying from 1996 to 2004 and interest rates ranging from 4.75 percent to 8.88 percent. $300,000,000 of such term notes are at floating interest rates and the remainder are at fixed rates. These notes provide for a single principal payment at maturity.
AIGFP has also issued various credit linked notes maturing from 1996 through 2000. These notes, which are primarily U.S. dollar denominated, have been issued to hedge certain credit risks in AIGFP's portfolio of securities available for sale. AIGFP's payment obligations under these notes are reduced or eliminated upon the occurrence of a payment default or bankruptcy event with respect to the reference third party credit that is being hedged. The notes bear interest at various interest rates. At December 31, 1995, these notes had a carrying value of $1.04 billion.
AIGFP is also obligated under various notes maturing from 1996 through 2015. The majority of these notes are U.S. dollar and Japanese yen denominated and bear interest at various interest rates. At December 31, 1995, these notes had a carrying value of $130.7 million.
(i) Capital Lease Obligations: At December 31, 1995, ILFC's capital lease obligations of $1.09 billion provide 10 year, fully amortizing debt with a portion of this debt at fixed rates varying from 6.18 percent to 6.89 percent and the remainder at a floating LIBOR base rate. The debt matures through 2005. The flight equipment associated with the obligations had a net book value of $1.22 billion. As of December 31, 1995, ILFC had the option to enter into an additional facility of $747 million for aircraft to be delivered in 1996 on the same terms as those for the existing facilities.
During 1993, dividends paid on the Exchangeable Money Market Cumulative Serial Preferred Stock then outstanding aggregated $1,043,000.
(c) The common stock activity for the three years ended December 31, 1995 was as follows:
As a result of common stock splits in the form of 50 percent stock dividends, common stock increased and additional paid-in capital decreased $421.7 million in 1995 and $281.2 million in 1993, respectively. Such stock splits effected as stock dividends were paid July 28, 1995 and July 30, 1993 to holders of record on June 30, 1995 and July 2, 1993, respectively.
(a) Commitments to extend credit are agreements to lend subject to certain conditions. These commitments generally have fixed expiration dates or termination clauses and typically require payment of a fee. At December 31, 1995 and 1994, these commitments, made principally by AIG Capital Corp., approximated $96,300,000 and $133,000,000, respectively. AIG uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. AIG evaluates each counterparty's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by AIG upon extension of credit, is based on management's credit evaluation of the counterparty.
AIGFP, as principal and for its own account, enters into interest rate, currency and equity swaps, swaptions and forward commitments. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. AIGFP typically becomes a principal in the exchange of interest payments between the parties and, therefore, may be exposed to loss, if counterparties default. Currency and equity swaps are similar to interest rate swaps, but may involve the exchange of principal amounts at the beginning and end of the transaction. At December 31, 1995, the notional principal amount of the sum of the swap pays and receives approximated $164.0 billion, primarily related to interest rate swaps of approximately $130.4 billion.
The following table presents AIGFP's swaps and swaptions portfolio by maturity and type of derivative at December 31, 1995:
The following table presents AIGFP's futures and forward contracts portfolio by maturity and type of derivative at December 31, 1995:
These instruments involve, to varying degrees, elements of credit risk not explicitly recognized in the consolidated financial statements. AIGFP utilizes various credit enhancements, including collateral, credit triggers and credit derivatives to reduce the credit exposure relating to these off-balance sheet financial instruments. AIGFP requires credit enhancements in connection with specific transactions based on, among other things, the creditworthiness of the counterparties and the transaction's size and maturity. In addition, AIGFP's derivative transactions are generally documented under ISDA Master Agreements. Such agreements provide for legally enforceable set-off and close out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, AIGFP is permitted to set off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the net replacement value represents the net sum of estimated positive fair values after the application of such strategies, agreements and collateral held. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss. The net replacement value of all interest rate, currency, and equity swaps, swaptions and forward commitments at December 31, 1995, approximated $6.8 billion. The net replacement value for futures and forward contracts at December 31, 1995, approximated $50.0 million.
AIGFP monitors and controls its risk exposure on a daily basis through financial, credit and legal reporting systems and, accordingly, believes that it has in place effective procedures for evaluating and limiting the credit and market risks to which it is subject. Management is not aware of any potential counterparty defaults as of December 31, 1995.
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, 1995, the contractual amount of AIGTG's futures and forward contracts approximated $210.5 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, 1995:
As a writer of options, AIGTG generally receives an option premium and then manages the risk of any unfavorable change in the value of the underlying commodity, currency or index. At December 31, 1995, the contractual amount for sold options approximated $28.1 billion.
The following table presents AIGTG's options portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1995:
(a) The net replacement value with respect to purchased options is presented as a component of spot commodities, at market value.
AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At December 31, 1995, the counterparty credit quality by derivative product with respect to the net replacement value of AIGTG's derivatives portfolio was as follows:
AIGTG limits its risks by holding offsetting positions. In addition, AIGTG monitors and controls its risk exposures through various monitoring systems which evaluate AIGTG's market and credit risks, and through credit approvals and limits. At December 31, 1995, AIGTG did not have a significant concentration of credit risk from either an individual counterparty or group of counterparties.
Statement of Financial Accounting Standards No. 107 "Disclosures about Fair Value of Financial Instruments" (FASB 107) requires disclosure of fair value information about financial instruments for which it is practicable to estimate such fair value. These financial instruments may or may not be recognized in the consolidated balance sheet. In the measurement of the fair value of certain of the financial instruments, quoted market prices were not available and other valuation techniques were utilized. These derived fair value estimates are significantly affected by the assumptions used. FASB 107 excludes certain financial instruments, including those related to insurance contracts.
The carrying values and fair values of AIG's financial instruments at December 31, 1995 and December 31, 1994 and the average fair values with respect to derivative positions during 1995 and 1994 were as follows:
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, 1995, outstanding options granted with respect to 2,896,132 shares qualified for Incentive Stock Option treatment under the Economic Recovery Tax Act of 1981.
Information about fixed stock options outstanding at December 31, 1995, is summarized as follows:
The fair value of stock options granted during the year ended December 31, 1995 was $18,356,000. The fair value of each option is estimated on the date of the grant using the Black-Scholes option-pricing model.
(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 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 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 $3,750, whichever is less. Beginning with the January 1, 1996 subscription, the maximum allowable purchase limitation increased to $5,500.
As of December 31, 1995, there were 110,641 shares of common stock subscribed to at a weighted average price of $65.20 per share pursuant to grants of privileges under the 1984 plan. There were 152,406 shares, 135,992 shares and 140,171 shares issued under the 1984 plan at weighted average prices of $50.22, $50.37 and $36.31 for the years ended December 31, 1995, 1994 and 1993, 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. There were 255,104 shares available for the grant of future purchase privileges under the 1984 plan at December 31, 1995.
(a) Employees of AIG, its subsidiaries and certain affiliated companies, including employees in foreign countries, are generally covered under various funded and insured pension plans. Eligibility for participation in the various plans is based on either completion of a specified period of continuous service or date of hire, subject to age limitation. While benefits vary, they are usually based on the employees' years of credited service and average compensation in the three years preceding retirement.
AIG's U.S. retirement plan is a qualified, noncontributory, defined benefit plan. All qualified employees who have attained age 21 and completed twelve months of continuous service are eligible to participate in this plan. An employee with 5 or more years of service is entitled to pension benefits beginning at normal retirement at age 65. Benefits are based upon a percentage of average final compensation multiplied by years of credited service limited to 44 years of credited service. Prior to January 1, 1996, average final compensation was subject to certain limitations. Annual funding requirements are determined based on the "projected unit credit" cost method which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service.
Assumptions associated with the projected benefit obligation and expected long-term rate of return on plan assets at December 31, 1995 were as follows:
The following table sets forth the funded status of the various pension plans and the amounts recognized in the accompanying consolidated balance sheet as of December 31, 1995 and 1994:
Net pension cost for the years ended December 31, 1995, 1994 and 1993 included the following components:
Effective January 1, 1993, both plans' provisions were amended. Employees who retire on or after January 1, 1993 are required to pay the actual cost of the medical benefits reduced by a credit which is based upon age and years of serv ice at retirement. The life insurance benefit varies by age at retirement from $5,000 for retirement at ages 55 through 59 to $15,000 for retirement at ages 65 and over.
* The Medical trend rate grades downward from years 1 through 6 domestically and years 1 through 9 for the foreign benefits. The trend rates remain level thereafter.
The net periodic postretirement costs for the years ended December 31, 1995, 1994 and 1993 included the following components:
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, 1995 by $5.6 million and the aggregate service and interest cost components of the periodic postretirement benefit costs for 1995 by $502,000.
Rent expense approximated $215,600,000, $208,000,000, and $200,500,000 for the years ended December 31, 1995, 1994 and 1993, respectively.
(b) Minimum future rental income on noncancelable operating leases of flight equipment which have been delivered at December 31, 1995 was as follows:
(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 $42,600,000 in 1995, $31,200,000 in 1994 and $25,800,000 in 1993, from which Starr is required to pay commissions due originating brokers and its operating expenses. AIG also received approximately $14,100,000 in 1995, $12,900,000 in 1994 and $11,800,000 in 1993 from Starr and paid approximately $34,000 in 1995, $42,000 in 1994 and $60,000 in 1993 to Starr as reimbursement for services provided at cost. AIG also received approximately $1,500,000 in 1995, $900,000 in 1994 and $600,000 in 1993 from SICO and paid approximately $1,200,000 in 1995, $1,200,000 in 1994 and $1,100,000 in 1993 to SICO as reimbursement for services rendered at cost. AIG also paid to SICO $5,000,000 in 1995, $3,000,000 in 1994 and $3,400,000 in 1993 in rental fees.
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1995 and 1994 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.
The following table is a summary of the operations by major operating segments for the years ended December 31, 1995, 1994 and 1993:
NOTES TO FINANCIAL STATEMENTS (CONTINUED) - -------------------------------------------------------------------------------- 18. Segment Information (continued)
(b) The following table is a summary of AIG's general insurance operations by major operating category for the years ended December 31, 1995, 1994 and 1993:
(c) AIG's individual life insurance and group life insurance portfolio accounted for 66 percent, 62 percent and 64 percent of AIG's consolidated life insurance operating income before realized capital gains or losses for the years ended December 31, 1995, 1994 and 1993, respectively. For those years, 94 percent, 96 percent and 97 percent, respectively, of consolidated life operating income before realized capital gains or losses was derived from foreign operations.