Net premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes deferred revenues which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period.
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 $490.2 million in 1997, $449.8 million in 1996 and $416.6 million in 1995. (See also Notes 4 and 17 of Notes to Financial Statements.)
AIG's results reflect the net impact of incurred losses from catastrophes approximating $16 million in 1997, $78 million in 1996 and $100 million in 1995. AIG's gross incurred losses from catastrophes approximated $22 million in 1997, $240 million in 1996 and $190 million in 1995. 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. 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 operating income in 1997 increased 12.1 percent when compared to 1996. The 1996 results reflect an increase of 8.5 percent from 1995. The contribution of general insurance operating income to income before income taxes was 52.6 percent in 1997 compared to 55.0 percent in 1996 and 58.6 percent in 1995.
AIG's general reinsurance assets amounted to $15.98 billion and resulted from AIG's reinsurance arrangements. Thus, a credit exposure existed at December 31, 1997 with respect to reinsurance recoverable to the extent that any reinsurer may not be able to reimburse AIG under the terms of these reinsurance arrangements. AIG manages its credit risk in its reinsurance relationships by transacting with reinsurers that it considers financially sound, and when necessary AIG holds substantial collateral in the form of funds, securities and/or irrevocable letters of credit. This collateral can be drawn on for amounts that remain unpaid beyond specified time periods on an individual reinsurer basis. At December 31, 1997, approximately 50 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, nearly all of these balances were collateralized. The remaining 50 percent of the general reinsurance assets were from authorized reinsurers and over 94 percent of such balances are from reinsurers rated A- (excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness.
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 seven 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.
In the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. At the current time, it is not possible to determine the future development of asbestos and environmental claims with the same degree of reliability as is the case for other types of claims. Such development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by changes in Superfund and waste dump site coverage issues. Although the estimated liabilities for these claims are subject to a significantly greater margin of error than for other claims, the reserves carried for these claims at December 31, 1997 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 asbestos and environmental claims count activity for the years ended December 31, 1997, 1996 and 1995 was as follows:
The developed survival ratios include both involuntary and voluntary indemnity payments. Involuntary payments include court judgments, court orders, covered claims with no coverage defenses, state mandated cleanup costs, claims where AIG's coverage defenses are minimal, and settlements made less than six months before the first trial setting. Also, AIG considers all legal and loss adjustment payments as involuntary.
AIG believes voluntary indemnity payments should be excluded from the survival ratio. The special asbestos and environmental claims unit actively manages AIG's asbestos and environmental claims and proactively pursues early settlement of environmental claims for all known and unknown sites. As a result, AIG reduces its exposure to future environmental loss contingencies.
Life insurance operations for the twelve month periods ending December 31, 1997, 1996 and 1995 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 1997 represented a 10.6 percent increase from the prior year. This compares with an increase of 11.7 percent in 1996 over 1995. Foreign life operations produced 94.4 percent, 94.0 percent and 94.2 percent of the life premium income in 1997, 1996 and 1995, respectively. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)
Life insurance realized capital gains were $21.2 million in 1997, $34.8 million in 1996 and $32.7 million in 1995. These realized gains resulted from the ongoing management of the life insurance investment portfolios within the overall objectives of the life insurance operations and arose primarily from the disposition of equity securities and available for sale fixed maturities as well as redemptions of fixed maturities.
Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately one million dollars of coverage by using yearly renewable term reinsurance. The life insurance operations have not entered into assumption reinsurance transactions or surplus relief transactions during the three year period ended December 31, 1997. (See also Note 5 of Notes to Financial Statements.)
AIG Trading Group Inc. and its subsidiaries (AIGTG) derive a substantial portion of their revenues from market making and trading activities, as principals, in foreign exchange, interest rates and precious and base metals. Revenues in 1997 increased 94.7 percent from 1996 compared to a 9.0 percent decrease during 1996 from 1995. During 1997, operating income increased 57.9 percent from 1996 and 16.6 percent during 1996 from 1995. A substantial portion of AIGTG's improvement during 1997 over 1996 was currency trading activity in volatile foreign exchange markets. As AIGTG is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein.)
In December 1997, AIGTG sold its energy operations. The sale of these operations will not have a significant impact on AIG's results of operations.
Net income amounted to $3.33 billion in 1997, $2.90 billion in 1996 and $2.51 billion in 1995. The increases in net income over the three year period resulted from those factors described above.
At December 31, 1997, ILFC had increased the aggregate principal amount outstanding of its medium term and term notes to $6.85 billion, a net increase of $795.4 million, and recorded a net decline in its capital lease obligations of $92.6 million and a net decrease in its commercial paper of $531.2 million. At December 31, 1997, ILFC had $610 million in aggregate principal amount of debt securities registered for issuance from time to time. In February 1998, ILFC reduced this registered amount to $230 million through the sale of debt securities amounting to $380 million aggregate principal amount. Also, in February 1998, ILFC registered $2.29 billion in aggregate principal amount of debt securities for issuance from time to time. At that time, the aggregate principal amount of registered debt available for issuance was $2.52 billion. The proceeds of ILFC's debt financing are primarily used to purchase flight equipment, including progress payments during the construction phase. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover and refinancing of the prior debt. (See also the discussions under "Operational Review" and "Liquidity" herein.)
AIG's capital funds increased $1.96 billion during 1997. Unrealized appreciation of investments, net of taxes decreased $28.1 million. During 1997, the cumulative translation adjustment loss, net of taxes, increased $684.8 million. The changes from year to year with respect to the unrealized appreciation of investments, net of taxes and the cumulative translation adjustment loss, net of taxes were primarily impacted by the economic situation in Japan and Southeast Asia and the general strength of the U.S. dollar against most currencies in which AIG conducts operations. (See also the discussion under "Operational Review" and "Liquidity" herein.) Retained earnings increased $2.50 billion, resulting from net income less dividends.
Sources of funds considered in meeting the objectives of AIG's financial services' operations include guaranteed investment agreements, issuance of long and short-term debt, maturities and sales of securities available for sale, securities sold under repurchase agreements, trading liabilities, securities and spot commodities sold but not yet purchased, issuance of equity, and cash provided from such operations. AIG's strong capital position is integral to managing this liquidity, as it enables AIG to raise funds in diverse markets worldwide. (See also the discussions under "Capital Resources" herein.)
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, 1997 and 1996:
(a) Includes $718,548 of bonds trading securities, at market value. (b) Includes $239,331 of preferred stock, at amortized cost. (c) Includes $111,609 of preferred stock, at market value.
(a) Includes $364,069 of bonds trading securities, at market value. (b) Includes $477,247 of preferred stock, at amortized cost. (c) Includes $46,732 of preferred stock, at market value.
At December 31, 1997, approximately 53.2 percent of the fixed maturities investments were domestic securities. Approximately 41 percent of such domestic securities were rated AAA. Approximately eight percent were below investment grade or not rated.
A significant portion of the foreign insurance fixed income portfolio is rated by Moody's, Standard & Poor's (S&P) or similar foreign services. Similar credit quality rating services are not available in all overseas locations. AIG annually reviews the credit quality of the foreign portfolio nonrated fixed income investments, including mortgages. At December 31, 1997, approximately 28 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG's internal analysis, were equivalent from a credit standpoint to securities so rated. Approximately 10 percent were below investment grade or not rated at that date.
Any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date. There have been no significant downgrades as of March 1, 1998.
Mortgage loans on real estate, policy and collateral loans comprised 8.5 percent of AIG's insurance invested assets at December 31, 1997. AIG's insurance operations' holdings of real estate mortgages amounted to $2.51 billion of which 36.1 percent was domestic. At December 31, 1997, no domestic mortgages and only a nominal amount of foreign mortgages were in default. It is AIG's practice to maintain a maximum loan to value ratio of 75 percent at loan origination. At December 31, 1997, AIG's insurance holdings of collateral loans amounted to $1.02 billion, all of which were foreign. It is AIG's strategy to enter into mortgage and collateral loans as an adjunct primarily to life insurance fixed maturity investments. AIG's policy loans decreased from $3.00 billion at December 31, 1996 to $2.67 billion at December 31, 1997. Nearly all of this decrease relates to the redemption of COLI products.
AIG's insurance operations are exposed to market risk. Market risk is the risk of loss of fair value resulting from adverse fluctuations in interest and foreign currency exchange rates and equity prices.
VaR with respect to combined operations cannot be derived by aggregating the individual risk or segment amounts presented herein.
The following table is a summary of the composition of AIG's financial services invested assets at December 31, 1997 and 1996. (See also the discussions under "Operational Review: Financial Services Operations", "Capital Resources" and "Derivatives" herein.)
At December 31, 1997, ILFC had committed to purchase or had secured positions for 328 aircraft deliverable from 1998 through 2006 at an estimated aggregate purchase price of $17.7 billion. As of March 9, 1998, 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 1998 and 84 of 268 aircraft to be delivered subsequent to 1998. 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.
Management's Discussion and Analysis of Financial Condition and Results of Operations (CONTINUED)
any such limited liquidity would not be significant to AIG's financial condition or its overall liquidity. (See also the discussion under "Operational Review: Financial Services Operations" and "Derivatives" herein.)
Securities available for sale, at market value and securities purchased under agreements to resell are purchased with the proceeds of AIGFP's GIA financings and other long and short term borrowings. The proceeds from the disposal of securities available for sale and securities purchased under agreements to resell have been used to fund the maturing GIAs or other AIGFP financing. (See also the discussion under "Capital Resources" herein.)
AIGTG conducts, as principal, market making and trading activities in foreign exchange, interest rates and precious and base metals. AIGTG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts. AIGTG uses derivatives to manage the economic exposure of its various trading positions and transactions from adverse movements of interest rates, foreign currency exchange rates and commodity prices. AIGTG supports its trading activities largely through trading liabilities, unrealized losses on swaps, short-term borrowings, securities sold under agreements to repurchase and securities and commodities sold but not yet purchased. (See also the discussions under "Capital Resources" and "Derivatives" herein.)
The gross unrealized gains and gross unrealized losses of AIGFP and AIGTG included in the financial services assets and liabilities at December 31, 1997 were as follows:
(a) See also Note 8 (e) of Notes to Financial Statements. (b) These amounts are also presented as the respective balance sheet amounts. (c) At December 31, 1997, AIGTG's replacement values with respect to interest rate and currency swaps were $610.4 million.
Market risk arises principally from the uncertainty that future earnings are exposed to potential changes in volatility, interest rates, foreign currency exchange rates, and equity and commodity prices. AIG generally controls its exposure to market risk by taking offsetting positions. AIG's philosophy with respect to its financial services operations is to minimize or set limits for open or uncovered positions that are to be carried. Credit risk exposure is separately managed. (See the discussion on the management of credit risk below).
department determines whether AIG's market risks, as well as those market risks of individual subsidiaries, are within the parameters established by AIG's senior management. Well established market risk management techniques such as sensitivity analysis are used. Additionally, this department verifies that specific market risks of each of certain subsidiaries are managed and hedged by that subsidiary.
AIGFP is exposed to market risk due to changes in and volatility of foreign currency exchange rates. AIGFP hedges its foreign currency exchange risk primarily through the use of currency swaps, options, forwards and futures.
A significant portion of AIGTG's business is transacted in liquid markets. Certain of AIGTG's derivative product exposures are evaluated using simulation techniques which consider such factors as changes in currency and commodity prices, interest rates, volatility levels and the effect of time. Though not indicative of the future, past volatile market scenarios have represented profit opportunities for AIGTG.
AIGFPand AIGTG used the sensitivity analysis model to measure the potential loss in fair value of market risk sensitive instruments of each of their respective portfolios. This potential loss in fair value results from selected hypothetical changes in interest and foreign currency exchange rates, equity prices and/or other market rates or prices over time.
The portfolios for which this analysis was performed included market risk sensitive transactions entered into by AIGFP and AIGTG. This includes over the counter and exchange traded investments, derivative transactions, borrowings and hedged securities and commodities. As the market risk with respect to securities available for sale, at market is substantially hedged, segregation of market sensitive instruments into trading and other than hedging was not done.
The following table presents the one day exposure to potential loss in fair value of each component of AIGTG's market risk as of December 31, 1997 under the most adverse scenario as discussed above:
The following tables provide the notional and contractual amounts of AIGFP's and AIGTG's derivatives transactions at December 31, 1997.
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.
AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or internal analysis. At December 31, 1997 and December 31, 1996, the counterparty credit quality and counterparty breakdown by industry with respect to the net replacement value of AIGTG's derivatives portfolio was as follows:
In 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 was effective January 1, 1997.
FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the footnotes to the financial statements. Additionally, the amendments expand existing disclosure requirements to include quantitative and qualitative discussions with respect to market risk inherent in market risk sensitive instruments such as equity and fixed maturity securities, as well as these derivative instruments. These amendments are designed to provide additional information about market risk sensitive instruments which investors can use to better understand and evaluate market risk exposures of registrants, including AIG. FRR No. 48 has been adopted herein.
AIG is subject to the Year 2000 computer program issue. That is, certain of AIG's computer systems, software products or other business systems may not accept, input, store, or output dates in the years 1999, 2000 and thereafter without error or interruption. If such a deficiency is not corrected, it is possible that some applications could fail or create erroneous results by or at the year 2000.
AIG has already reviewed and identified its business systems, including computer programs that are subject to such Year 2000 risk. Accordingly, AIG commenced the remediation of such systems and such remediation and testing thereof is anticipated to be complete in advance of the year 2000. The costs of such remediation are expensed as incurred and are not material to AIG's results of operations, financial condition or liquidity.
On January 1, 1999, certain of the member nations of the European Economic and Monetary Union (EMU) will adopt a common currency, the Euro. Once the national currencies are phased out, the Euro will be the sole legal tender of each of these nations. During the transition period, commerce of these nations will be transacted in the Euro or in the currently existing national currency.
(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 1996 and 1995 financial statements to conform to their 1997 presentation.
Life Insurance Operations: AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. One or more of these subsidiaries is licensed to write life insurance in all states of the United States and in over 70 foreign countries. Traditional products consist of individual and group life, annuity, and accident and health policies. Financial and investment products consist of single premium annuity, variable annuities, guaranteed investment contracts and universal life. Premiums for traditional life insurance products are generally recognized as revenues over the premium paying period of the related policies. Benefits and expenses are provided against such revenues to recognize profits over the estimated life of the policies. Revenues for universal life and investment-type products consist of policy charges for the cost of insurance, administration, and surrenders during the period. Expenses include interest credited to policy account balances and benefit payments made in excess of policy account balances. Investment income reflects certain minor amounts of realized capital gains where the gains are deemed to be an inherent element in pricing certain life products in some foreign countries.
(d) Mortgage Loans on Real Estate, Policy and Collateral Loans--net: Mortgage loans on real estate, policy loans and collateral loans are carried at unpaid principal balances. Interest income on such loans is accrued currently.
Impairment of mortgage loans on real estate and collateral loans is generally measured based on the present value of expected future cash flows discounted at the loan's effective interest rate subject to the fair value of underlying collateral. Interest income on such loans is recognized as cash is received.
the use of valuation models that utilize, among other things, current interest or commodity rates and foreign exchange and volatility rates, as applicable.
(m) Reinsurance Assets: Reinsurance assets include the balances due from both reinsurance and insurance companies under the terms of AIG's reinsurance arrangements for paid and unpaid losses and loss expenses, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. It also includes funds held under reinsurance treaties.
(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 and depreciated.
(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.
(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: Basic 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. Diluted earnings per share are based on those shares used in basic earnings per share plus shares that would have been outstanding assuming issuance of common shares for all dilutive potential common shares outstanding, retroactively adjusted to reflect all stock dividends and stock splits.
(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. FASB 125 was effective January 1, 1997.
In February 1997, the Securities and Exchange Commission (SEC) issued Financial Reporting Release No. 48 "Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments" (FRR No. 48).
FASB 130 establishes standards for reporting comprehensive income and its components in a full set of general purpose financial statements. FASB 130 is effective for AIG as of January 1, 1998. FASB 130 will have no impact on AIG's results of operations, financial condition or liquidity.
FASB 131 establishes standards for the way AIG is required to disclose information about its operating segments in its annual financial statements and selected information in its interim financial statements. FASB 131 establishes, where practicable, standards with respect to geographic areas, among other
(b) The U.S. Federal income tax rate is 35 percent for 1997, 1996 and 1995. Actual tax expense on income differs from the "expected" amount computed by applying the Federal income tax rate because of the following:
For the years ended December 31, 1997, 1996 and 1995, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $4.59 billion, $5.07 billion and $5.14 billion, respectively.
Supplemental information for gross loss and benefit reserves net of ceded reinsurance at December 31, 1997 and 1996 follows:
(b) The analysis of the future policy benefits and policyholders' contract deposits liabilities as at December 31, 1997 and 1996 follows:
(iii) The portions of current and prior net income and of current unrealized appreciation of investments that can inure to the benefit of AIG are restricted in some cases by the insurance contracts and by the local insurance regulations of the countries in which the policies are in force.
(iv) The universal life funds have credited interest rates of 4.5 percent to 7.5 percent and guarantees ranging from 3.5 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 11.0 percent of the fund balance grading to zero over a period not longer than 20 years.
(d) Market Value of Fixed Maturities and Unrealized Appreciation of Investments: At December 31, 1997 and 1996, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $1,847,900,000 and $1,683,000,000 and gross losses of approximately $1,263,700,000 and $675,800,000, respectively.
The deferred tax payable related to the net unrealized appreciation of investments was $592,860,000 at December 31, 1997 and $681,705,000 at December 31, 1996.
(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 $444.0 million of securities available for sale. At December 31, 1997, 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 $73,000.
(f) CMOs: At December 31, 1997, CMOs, held by AIG's life companies, were presented as a component of bonds available for sale, at market value. All of the CMOs were investment grade and approximately 59 percent of the CMOs were backed by various U.S. government agencies. The remaining 41 percent were corporate issuances.
At December 31, 1997 and 1996, the market value of the CMO portfolio was $2.58 billion and $2.24 billion, respectively; the amortized cost was approximately $2.47 billion in 1997 and $2.18 billion in 1996. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 1997 and 1996.
At December 31, 1997, AIG's debt outstanding of $25.26 billion, shown below, included borrowings of $22.28 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) AIG does not guarantee or support these borrowings. (b) Capital lease obligations.
Commercial paper issued by Funding is guaranteed by AIG. AIG has entered into an agreement in support of AICCO's commercial paper. AIG does not guarantee ILFC's or UFC's commercial paper.
At December 31, 1997, the market value of securities pledged as collateral with respect to these obligations approximated $757.9 million.
An analysis of the Medium Term Notes for the year ended December 31, 1997 was as follows:
As of December 31, 1997, notes in aggregate principal amount of $3.95 billion were outstanding with maturity dates from 1998 to 2004 and interest rates ranging from 5.50 percent to 8.88 percent. Term notes in the aggregate principal amount of $500 million are at floating interest rates and the remainder are at fixed rates. These notes provide for a single principal payment at maturity.
(iv) Notes and Bonds Payable Issued by AIGFP: At December 31, 1997, AIGFP's bonds outstanding, the proceeds of which are invested in a segregated portfolio of securities available for sale, were as follows:
AIGFP has also issued various credit linked notes maturing from 1998 through 2000. These notes have been issued to hedge certain credit risks in AIGFP's portfolio of securities available for sale. The notes are primarily U.S. dollar denominated and have U.S. dollar interest rates ranging from 5.3 percent to 7.0 percent. AIGFP's payment obligations under these notes would be reduced or eliminated upon the occurrence of a payment default or a bankruptcy event with respect to certain third party credit that is being hedged. At December 31, 1997, these notes had a U.S. dollar carrying value of $503.4 million. No obligations under these notes were reduced or eliminated during 1997.
AIGFP is also obligated under various notes maturing from 1998 through 2026. The majority of these notes are denominated in U.S. dollars and bear interest at various interest rates. At December 31, 1997, these notes had a U.S. dollar carrying value of $467.9 million.
(e) Loans and Mortgages Payable: Loans and mortgages payable at December 31, 1997, consisted of the following:
(f) Revolving Credit Facilities: AIG and Funding have entered into two syndicated revolving credit facilities (the Facilities) aggregating $1 billion. The Facilities consist of a $500 million 364 day revolving credit facility and a $500 million five year revolving credit facility. The Facilities can be used for general corporate purposes and also provide backup for AIG's commercial paper programs administered by Funding. There are currently no borrowings outstanding under either of the Facilities, nor were any borrowings outstanding as of December 31, 1997.
(a) At December 31, 1997, there were 6,000,000 shares of AIG's $5 par value serial preferred stock authorized, issuable in series.
Common stock increased and additional paid-in capital decreased $421.7 million as a result of a common stock split in the form of a 50 percent common stock dividend paid July 28, 1995.
(b) AIG and certain of its subsidiaries become parties to financial instruments with market risk resulting from both dealer and end user activities and to reduce currency, interest rate, equity and commodity exposures. To the extent those instruments are carried at their estimated fair value, the elements of currency, interest rate, equity and commodity risks are reflected in the consolidated balance sheet. In addition, these instruments involve, to varying degrees, elements of credit risk not explicitly recognized in the consolidated balance sheet. Collateral is required, at the discretion of AIG, on certain transactions based on the creditworthiness 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, 1997, the notional principal amount of the sum of the swap pays and receives approximated $266.46 billion, primarily related to interest rate swaps of approximately $200.49 billion.
The following tables provide the contractual and notional amounts of AIGFP's, AIGTG's and ILFC's derivatives transactions at December 31, 1997.
The following table presents AIGFP's futures and forward contracts portfolio by maturity and type of derivative at December 31, 1997 and December 31, 1996:
At December 31, 1997 and December 31, 1996, the counterparty breakdown by industry with respect to the net replacement value of AIGFP's derivatives portfolio was as follows:
The following tables provide the contractual and notional amounts of AIGTG's derivatives portfolio at December 31, 1997 and December 31, 1996. In addition, the estimated positive fair values associated with the derivatives portfolio are also provided and include a maturity profile for the December 31, 1997 balances based upon the expected timing of the future cash flows.
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
The following tables present AIGTG's derivatives portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1997 and December 31, 1996:
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, 1997, AIGTG did not have a significant concentration of credit risk from either an individual counterparty or group of counterparties.
(e) At December 31, 1997, ILFC had committed to purchase or had secured positions for 328 aircraft deliverable from 1998 through 2006 at an estimated aggregate purchase price of $17.7 billion. 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.
The following table presents ILFC's notional amounts of its interest rate swaps, swaptions and interest rate floors by maturity at December 31, 1997 and 1996:
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, 1997, 1996 and 1995 was as follows:
Had compensation costs for these plans been determined consistent with the method of Statement of Financial Accounting Standards No. 123 "Accounting for Awards of Stock Based Compensation to Employees," AIG's net income and earnings per share for the years ended December 31, 1997, 1996 and 1995 would have been reduced to the pro forma amounts as follows:
(a) Stock Option Plan: On December 19, 1991, the AIG Board of Directors adopted a 1991 employee stock option plan (the 1991 Plan), which provided that options to purchase a maximum of 6,750,000 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 168,580 shares granted
Information about stock options outstanding at December 31, 1997, is summarized as follows:
There were 69,339 shares, 219,326 shares and 228,609 shares issued under the 1984 plan at weighted average prices of $52.76, $44.59 and $33.48 for the years ended December 31, 1997, 1996 and 1995, 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 147,085 shares issued under the 1996 plan at a weighted average price of $57.76 for the year ended December 31, 1997. 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.
The fair values of purchase privileges granted during the years ended December 31, 1997, 1996 and 1995 were $3,625,000, $3,039,000 and $2,005,000, respectively. The weighted average fair values per share of those purchase rights granted in 1997, 1996 and 1995 were $20.02, $13.14 and $9.93, respectively. The fair value of each purchase right is estimated on the date of the subscription using the Black-Scholes model.
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, 1997 and 1996:
* Net pension expense included $31,323, $34,584 and $30,978 related to non-U.S. plans for 1997, 1996 and 1995, respectively.
* The Medical trend rate grades downward from years 1 through 3 domestically and years 1 through 9 for the foreign benefits. The trend rates remain level thereafter.
(d) AIG has certain benefits provided to former or inactive employees who are not retirees. Certain of these benefits are insured and expensed currently; other expenses are provided for currently. Such uninsured expenses include long and short-term disability medical and life insurance continuation, short-term disability income continuation and COBRA medical subsidies. The provision for these benefits at December 31, 1997 was $5.6 million. The incremental expense was insignificant.
(a) AIG's operations are conducted principally through four business segments. These segments and their respective operations are as follows:
Life Insurance - AIG's life insurance operations offer a broad line of individual and group life, annuity and accident and health policies.
(c) AIG's individual life insurance and group life insurance portfolio accounted for 69 percent, 68 percent and 66 percent of AIG's consolidated life insurance operating income before realized capital gains or losses for the years ended December 31, 1997, 1996 and 1995, respectively. For those years, 92 percent, 92 percent and 94 percent, respectively, of consolidated life operating income before realized capital gains or losses was derived from foreign operations.
(a) Including general insurance operations in Canada. (b) Revenues are derived from revenues of the general, life and financial services operations, equity in income of minority-owned insurance operations and realized capital gains attributable to the segments.