(b) Includes net loss reserve charge of $2.8 billion in 2002 and WTC losses of $900 million in 2001.
(c) Per share amounts for all periods presented have been retroactively adjusted to reflect all stock dividends and splits and reflect the adoption of the Statement of Financial Accounting Standards No. 128 "Earnings per Share."
(d) Cash dividends have not been restated to reflect dividends paid by SunAmerica Inc., the Maryland corporation which was merged into AIG on January 1, 1999, nor AGC which was acquired by AIG on August 29, 2001.
Throughout this Management's Discussion and Analysis of Financial Condition and Results of Operations, AIG presents its operations in the way it believes will be most meaningful, as well as most transparent. Operating income is shown exclusive of realized capital gains (losses) because the determination to realize capital gains or losses is generally independent of the insurance underwriting process. Operating income and the related performance rates are also shown exclusive of one or more of the 2002 reserve charge discussed under "Loss Reserve Charge" herein, 2001 acquisition, restructuring and related charges, and 2001 World Trade Center and related losses (WTC losses) because AIG believes that these items are sufficiently unusual that they do not reflect the underlying basic performance of the business. Net income is presented exclusive of these items as well as the cumulative effect of accounting changes for the same reason. Premium income, gross premiums written, statutory underwriting profit (loss) and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance used in the insurance industry and thus allow more meaningful comparisons with AIG's insurance competitors. A reconciliation of these measurements to the most equivalent measurements presented in accordance with Generally Accepted Accounting Principles (GAAP) is presented on page 20.
INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE EFFECT OF ACCOUNTING CHANGES:
AIG's income before income taxes, minority interest and cumulative effect of accounting changes increased modestly in 2002 when compared to 2001. Factors influencing the growth were not only the increase in realized capital losses but also the impact of the $2.8 billion loss reserve charge in 2002. (See discussion under "Loss Reserve Charge" herein.) If the realized capital losses and such loss reserve charge were excluded from 2002 income and $836 million in realized capital losses, $900 million in WTC losses and $2.02 billion of acquisition, restructuring and related charges were excluded in 2001, AIG's growth in income before taxes, minority interest and cumulative effect of accounting changes would be 12.5 percent. AIG believes that the growth rates discussed above are more representative of the overall growth of its operations than the rates determined including the impact of events AIG views as unusual and unlikely to recur.
AIG's net income in 2002 increased 2.9 percent to $5.52 billion when compared to $5.36 billion in 2001. Excluding net of tax, realized capital gains (losses), the $1.8 billion loss reserve charge in 2002, the $1.38 billion of acquisition, restructuring and related charges, $533 million in WTC losses, and $136 million cumulative effect of accounting changes incurred in 2001, AIG's net income in 2002 increased 11.9 percent.
(d) Represents retirement savings & asset management commissions and other fees.
Life insurance operating income increased 5.4 percent in 2002 compared to 2001, impacted by an increase in realized capital losses of nearly $800 million. Excluding realized capital gains (losses) and WTC losses of $131 million in 2001, life insurance operating income increased 18.2 percent, reflecting operating income growth in each of AIG's principal life insurance businesses.
Retirement savings & asset management operating income decreased 6.6 percent in 2002 when compared to 2001. Results in the variable annuity business continue to be impacted by weak equity markets in the United States and around the world.
During 2002, AIG repurchased in the open market 10,858,000 shares of its common stock.
At December 31, 2002, consolidated invested assets were $432.36 billion including $8.16 billion in cash and short-term investments. Consolidated net cash provided from operating activities in 2002 amounted to $18.69 billion. AIG believes that its liquid assets, cash provided by operations and access to the capital markets will enable it to meet any forseeable cash requirements.
operations in Shanghai, Foshan, Guangzhou and Shenzhen. AIG also expects India and Vietnam to offer additional opportunities for growth.
AIG expects that ILFC will continue its growth and operating profitability even as the airline industry remains under stress. ILFC derives over 80 percent of its lease revenues from foreign carriers, thus limiting its exposure to the domestic commercial aviation market which is significantly more depressed than the rest of the industry. AIG is also optimistic about opportunities for growth in its consumer finance business through continued expansion of overseas credit card operations and alternative distribution systems such as the use of the Internet. During 2003, AIG also expects to expand its recently formed international retirement savings operations.
On August 29, 2001, American General Corporation (AGC), was acquired by AIG. In connection with the acquisition, AIG issued approximately 290 million shares of its common stock in exchange for all the outstanding common stock of AGC based on an exchange ratio of 0.5790 of a share of AIG common stock for each share of AGC common stock. The acquisition was accounted for as a pooling of interests and the accompanying financial statements have been prepared to retroactively combine AGC's financial statements with AIG's financial statements.
AIG's Foreign General insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance entities. The Foreign General insurance group also includes business written by AIG's foreign-based insurance subsidiaries for their own accounts. (See also Note 2 of Notes to Financial Statements.)
GENERAL INSURANCE OPERATIONS BY MAJOR OPERATING UNIT FOR 2002, 2001 AND 2000 WERE AS FOLLOWS:
(d) Includes 21st Century's loss adjustment expense pre-tax provision of $43 million for SB1899 Northridge earthquake claims.
Personal Lines' net premiums written increased 29.7 percent or $728 million in 2002 over 2001, reflecting auto insurance rate increases in many states, compared to a decrease of 2.2 percent or $56 million in 2001 from 2000.
THE STATUTORY GENERAL INSURANCE RATIOS, INCLUDING THE $2.8 BILLION LOSS RESERVE CHARGE IN 2002 AND $769 MILLION OF WTC LOSSES IN 2001, WERE AS FOLLOWS:
Statutory underwriting profit is arrived at by reducing net premiums earned by net losses and loss expenses incurred and net expenses incurred. Statutory accounting differs from GAAP, as statutory accounting, in general, requires immediate expense recognition and ignores the matching of revenues and expenses as required by GAAP. That is, for statutory purposes, expenses are recognized immediately, not over the same period that the revenues are earned.
In 2002, AIG's general insurance results reflect the net impact of the loss reserve charge of $2.8 billion with respect to accident years 1997 through 2001. Such charge was the result of AIG's annual year-end review of general insurance loss reserves. (See also the discussion under "Loss Reserve Charge" herein.) In addition, these results reflect the net impact of catastrophe losses approximating $57 million in 2002, $867 million in 2001 (which include $769 million in WTC losses and $50 million with respect to the Northridge earthquake, following the unprecedented decision by the State of California to require all insurers to reopen claims nearly eight years after the occurrence), and $44 million in 2000. On a gross basis, incurred losses included $3.5 billion attributable to the loss reserve charge and approximately $245 million from catastrophes in 2002, and catastrophe losses of $2.15 billion in 2001 (which include $2.0 billion in WTC losses), and $112 million in 2000.
AIG's historic ability to maintain its combined pro forma ratio below 100 is primarily attributable to the profitability of AIG's Foreign General insurance operations and AIG's emphasis on maintaining its disciplined underwriting, especially in the domestic specialty markets. In addition, AIG does not seek premium growth where rates do not adequately reflect its assessment of exposures.
AIG'S GENERAL REINSURANCE ASSETS amounted to $28.77 billion and resulted from AIG's reinsurance arrangements. Thus, a credit exposure existed at December 31, 2002 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, 2002, approximately 40 percent of the general reinsurance assets were from unauthorized reinsurers. In order to obtain statutory recognition, the majority of these balances were collateralized. The remaining 60 percent of the general reinsurance assets were from authorized reinsurers and over 90 percent of such balances are from reinsurers rated A-(excellent) or better, as rated by A.M. Best. This rating is a measure of financial strength. The terms authorized and unauthorized pertain to regulatory categories, not creditworthiness.
AIG maintains an allowance for estimated unrecoverable reinsurance and has been largely successful in its previous recovery efforts. At December 31, 2002, AIG had allowances for unrecoverable reinsurance approximating $120 million. At that date, AIG had no significant reinsurance recoverables from any individual reinsurer which is financially troubled (e.g., liquidated, insolvent, in receivership or otherwise subject to formal or informal regulatory restriction).
THE TABLE BELOW CLASSIFIES AS OF DECEMBER 31, 2002 THE COMPONENTS OF THE GENERAL INSURANCE RESERVE FOR LOSSES AND LOSS EXPENSES (LOSS RESERVES) WITH RESPECT TO MAJOR LINES OF BUSINESS ON A STATUTORY BASIS*:
* Presented pursuant to statutory reporting requirements as prescribed by the National Association of Insurance Commissioners.
At December 31, 2002, the loss reserves amounted to $51.54 billion. These loss reserves represent the accumulation of estimates of ultimate losses, including IBNR and loss expenses. Certain of these loss reserves are discounted. These discounted reserves relate primarily to certain workers' compensation claims. At December 31, 2002, general insurance net loss reserves increased $4.45 billion from prior year end to $30.35 billion. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments resulting therefrom are reflected in operating income currently. It is management's belief that the general insurance net loss reserves are adequate to cover all general insurance net losses and loss expenses as at December 31, 2002. While AIG annually reviews the adequacy of established loss reserves, there can be no assurance that AIG's ultimate loss reserves will not adversely develop and materially exceed AIG's loss reserves as of December 31, 2002. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on future results of operations. See "Loss Reserve Charge" below.
liability, and related classes. The other group is short tail lines of business consisting principally of property lines, personal lines and certain classes of casualty lines.
AIG's annual reserve review does not calculate a range of loss reserve estimates. Because AIG's general insurance business is primarily in volatile long tail casualty lines driven almost entirely by severity rather than frequency of claims, developing a range around loss reserve estimates would not be meaningful. An estimate is calculated which AIG's actuaries believe provides a reasonable estimate of the required reserve. This amount is evaluated against actual carried reserves.
It should also be noted that AIG's overall book of business consists of hundreds of segments or classes of business that are individually reviewed as part of the overall analysis of loss reserves. Most of these would fall into the category of longer tail lines of business. Due to the multitude of such classes and the volume of detail for each, it would not be possible to provide complete claim frequency, settlement, closure and other data for all such segments, nor does AIG believe that such disclosure by class of business would be meaningful or useful to the reader. It should be noted that none of the other segments or classes reflects the highly uncertain qualities that apply to the asbestos and environmental claims. For example, traditional actuarial methodologies can be applied to classes such as excess casualty, directors and officers liability, healthcare, and the other long tail coverages that AIG writes. These methodologies cannot be applied to asbestos and environmental exposures. Other than asbestos and environmental exposures, there is no area of significant exposure to AIG for which traditional actuarial methodologies cannot be applied.
Following completion of its annual year-end net loss reserve study, AIG increased general insurance loss and loss adjustment reserves, incurring a net, after-tax charge of $1.8 billion in the fourth quarter of 2002.
THE TABLE BELOW CLASSIFIES THE COMPONENTS OF THE NET LOSS RESERVE CHARGE BY ACCIDENT YEAR AND MAJOR LINE OF BUSINESS:
In conducting its 2002 year end loss reserve analysis, AIG considered all classes of business that could be volatile and directly incorporated that specific class analysis into its overall results.
resolutions and judicial interpretations which broaden the intent of the policies and scope of coverage. The current case law can be characterized as still evolving and there is little likelihood that any firm direction will develop in the near future. Additionally, the exposure for cleanup costs of hazardous waste dump sites involves issues such as allocation of responsibility among potentially responsible parties and the government's refusal to release parties.
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 the 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, 2002 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. In the future, if the environmental claims develop deficiently, such deficiency would have an adverse impact on future results of operations. (See the previous discussion on reinsurance collectibility herein.)
THE GROSS AND NET IBNR INCLUDED IN THE RESERVE FOR LOSSES AND LOSS EXPENSES AT DECEMBER 31, 2002, 2001 AND 2000 WERE ESTIMATED AS FOLLOWS:
A SUMMARY OF ASBESTOS AND ENVIRONMENTAL CLAIMS COUNT ACTIVITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WAS AS FOLLOWS:
THE AVERAGE COST PER CLAIM SETTLED, DISMISSED OR OTHERWISE RESOLVED FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 WAS AS FOLLOWS:
AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions. (See also Note 2 of Notes to Financial Statements.)
LIFE INSURANCE OPERATIONS PRESENTED ON A MAJOR PRODUCT BASIS FOR 2002, 2001 AND 2000 WERE AS FOLLOWS:
(c) Beginning 2001, certain Accident & Health operations are part of DBG.
(e) Premium income, deposits and other considerations represent aggregate business activity during the respective periods.
(f) The decline in life premiums is due primarily to lower private placement and corporate life market sales.
(h) Increase in 2001 reflects acquisition of AIG Star Life Insurance Co., Ltd. in April 2001.
AIG'S GAAP LIFE PREMIUM INCOME IN 2002 REPRESENTED A 6.6 PERCENT INCREASE FROM THE PRIOR YEAR. The slowing in growth in 2002 reflected lower demand and sales of annuities in connection with corporate pension restructuring activities in domestic operations. This compares with an increase of 11.1 percent in 2001 over 2000. Foreign life operations produced 77.3 percent, 74.0 percent and 72.0 percent of the GAAP life premium income in 2002, 2001 and 2000, respectively. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)
As previously discussed, the U.S. dollar strengthened slightly in relation to most major foreign currencies in which AIG transacts business. Accordingly for 2002, when foreign life premium income was translated into U.S. dollars for purposes of the preparation of the consolidated financial statements, total life premium income was approximately 1.6 percentage points less than it would have been if translated utilizing exchange rates prevailing in 2001.
LIFE INSURANCE REALIZED CAPITAL LOSSES were $1.05 billion in 2002, $254 million in 2001 and $162 million in 2000. These realized capital losses resulted from the ongoing investment management of the life insurance 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. (See also the discussion on "Valuation of Invested Assets" herein.)
The risks associated with the traditional life and accident and health products are underwriting risk and investment risk. The risk associated with the financial and investment contract products is primarily investment risk.
Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's foreign life companies limit their maximum underwriting exposure on traditional life insurance of
a single life to approximately $1.5 million dollars of coverage and AIG's domestic life companies, limit their maximum underwriting exposure on traditional life insurance of a single life to $2.5 million of coverage by using yearly renewable term reinsurance. (See also Note 5 of Notes to Financial Statements and the discussion under "Liquidity" herein.)
The asset-liability relationship is appropriately managed in AIG's foreign operations, as it has been throughout AIG's history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of the related policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the initial investments may be at a yield below that of the interest required for the accretion of the policy liabilities. Additionally, there exists a future investment risk associated with certain policies currently in force which will have premium receipts in the future. That is, the investment of these future premium receipts may be at a yield below that required to meet future policy liabilities.
For the ALICO operations in Japan, the variable life contract separate account fund performance has varied from the level assumed in the original pricing of the product. Thus, a general account liability has been established for the potential shortfall of future contract revenues. The ultimate liability is predominately dependent upon the fund performance in the future.
Deferred policy acquisition costs (DAC) for life insurance products arises from the deferral of those costs that vary with, and are directly related to, the acquisition of new or renewal business. Policy acquisition costs for traditional life insurance products are generally deferred and amortized over the premium paying period of the policy. Policy acquisition costs which relate to universal life and investment-type products (non-traditional life products) are deferred and amortized, with interest, in relation to the historical and future incidence of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits include investment income and gains and losses on investments less interest required as well as other charges in the contract less actual mortality and expenses. Current experience and changes in the expected future gross profits are analyzed to determine the impact on the amortization of DAC. The estimation of projected gross profits requires significant management judgment. The elements with respect to the current and projected gross profits are reviewed and analyzed quarterly and are appropriately adjusted.
AIG's financial services subsidiaries engage in diversified financial products and services including aircraft leasing, consumer and insurance premium financing, and capital markets structuring and market-making activities. (See also Note 2 of Notes to Financial Statements.)
(b) Revenues were primarily fees from proprietary positions entered into in connection with counterparty transactions.
ILFC generates its revenues primarily from leasing 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 2002 increased 8.9 percent from 2001 compared to an 7.0 percent increase during 2001 from 2000. The revenue growth in each year resulted primarily from the increase in flight equipment under operating lease and the increase in the relative cost of the leased fleet. ILFC has historically derived over 80 percent of its lease revenues with respect to flight equipment from airlines based outside the United States and is not significantly exposed to current domestic airline difficulties.
ILFC has historically re-leased aircraft returning at the end of a lease before the aircraft returns to ILFC. For aircraft returning before the end of their lease terms, ILFC has generally been able to re-lease aircraft returned from the prior lessee within two to three months of its return. As a lessor, ILFC considers an aircraft "idle" or "off lease" when the aircraft is not subject to a signed lease agreement or signed letter of intent. ILFC had one aircraft off lease at December 31, 2002 which had been off lease for less than three months. No impairments have been recognized related to these aircraft as ILFC believes that the existing service potential of the aircraft in ILFC's portfolio has not been diminished and ILFC has been able to re-lease the aircraft without diminution in lease rates from those previously obtained that would require an impairment write-down.
ILFC management is very active in the airline industry. Management formally reviews regularly, and no less frequently than quarterly, issues affecting ILFC's fleet, including events and circumstances that may cause impairment of aircraft values. Management evaluates aircraft in the fleet as necessary, based on these events and circumstances in accordance with Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (FAS 144). No impairments have been recognized related to these aircraft. (See also the discussions under "Liquidity" herein.)
AIGFP participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity and credit derivative products business. AIGFP also enters into structured transactions including long-dated
forward foreign exchange contracts, option transactions, liquidity facilities and investment agreements and invests in a diversified portfolio of securities. AIGFP derives substantially all its revenues from proprietary positions entered in connection with counterparty transactions rather than from speculative transactions.
As a dealer, AIGFP marks its transactions daily to fair value. Thus, a gain or loss on each transaction is recognized daily. AIGFP hedges the market risks arising from its transactions. Therefore, revenues and operating income are not significantly exposed to or affected by market fluctuations and volatility. Revenues of AIGFP and the percentage change in revenues for any given period are significantly affected by the number and size of transactions entered into by AIGFP during that period relative to those entered into during the prior period. Operating income and the percentage change in operating income for any period are determined by the number, size and profitability of the transactions attributable to that period relative to those attributable to the prior period. The realization of operating income as measured by the receipt of funds is not a significant event as the profit or loss on each of AIGFP's transactions has already been reflected in operating income. Revenues in 2002 increased 10.9 percent from 2001 compared to a 11.6 percent increase during 2001 from 2000. During 2002, operating income increased 6.6 percent from 2001 and increased 17.0 percent during 2001 from 2000. As AIGFP is a transaction-oriented operation, current and past revenues and operating results may not provide a basis for predicting future performance.
Financial market conditions in 2002 compared with 2001 were characterized by a continuing decline in interest rates across fixed income markets globally, a worldwide slump in credit prices with the concomitant widening of credit spreads, and a continuing decline in equity valuations. AIGFP's results in 2002 compared with 2001 reflected a shift in product segment activity to respond to these conditions. In particular, AIGFP experienced increases in demand for credit linked products that addressed the risk management needs of its counterparties (see also the discussion under "Derivatives" herein). The increase in spread income on investments and borrowings reflected the widening of credit spreads, as well as an increase in asset class diversification. Finally, the sharp decline in equity linked products reflected substantially reduced demand for products that hedge appreciated equity positions.
The most significant component of AIGFP's operating expenses is compensation, which approximated 36 percent, 31 percent and 31 percent of revenues in 2002, 2001 and 2000, respectively.
Other realized capital losses amounted to $530 million, $452 million and $190 million in 2002, 2001 and 2000, respectively.
In 2002, AIG recorded a provision for income taxes of $2.33 billion compared to the provisions of $2.34 billion and $2.97 billion in 2001 and 2000, respectively. These provisions represent effective tax rates of 28.6 percent in 2002, 28.7 percent in 2001 and 29.6 percent in 2000. (See Note 3 of Notes to Financial Statements.)
Minority interest represents minority shareholders' equity in income of certain majority-owned consolidated subsidiaries. Minority interest amounted to $295 million, $301 million and $413 million in 2002, 2001 and 2000, respectively.
Income before the cumulative effect of accounting changes amounted to $5.52 billion in 2002, $5.50 billion in 2001 and $6.64 billion in 2000.
Net income amounted to $5.52 billion in 2002, $5.36 billion in 2001 and $6.64 billion in 2000. The increase in 2002 and the decrease in 2001 in net income over the three year period resulted from those factors described above.
AT DECEMBER 31, 2002, THE COMMERCIAL PAPER ISSUED AND OUTSTANDING WAS AS FOLLOWS:
AIG Funding, Inc. (Funding), through the issuance of commercial paper, helps fulfill 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. The issuance of Funding's commercial paper is subject to the approval of AIG's Board of Directors.
ILFC and A.I. Credit Corp. (AICCO), AIG Credit Card Company (Taiwan) -- (AIGCCC-Taiwan) and AIG Finance (Taiwan) Limited -- (AIGF-Taiwan), both consumer finance subsidiaries in Taiwan, AGC and AGF have issued commercial paper for the funding of their own operations. At December 31, 2002, AIG did not guarantee the commercial paper of any of its subsidiaries other than Funding. On July 8, 2002, AGC ceased issuing commercial paper under its program. AGC's funding requirements are now being met through Funding's commercial paper program. (See also the discussion under "Derivatives" herein and Note 9 of Notes to Financial Statements.)
AIG and Funding are parties to unsecured syndicated revolving credit facilities (collectively, the Facility) aggregating $2.75 billion. The Facility consists of $1.375 billion in a short-term revolving credit facility and $1.375 billion in a five year revolving credit facility. The Facility can be used for general corporate purposes and also to provide backup for Funding's commercial paper programs. There are currently no borrowings outstanding under the Facility, nor were any borrowings outstanding as of December 31, 2002.
At December 31, 2002, ILFC had increased the aggregate principal amount outstanding of its medium term and long-term notes to $14.80 billion, a net increase of $2.91 billion, and recorded a net decline in its capital lease obligations of $104 million and a net increase in its commercial paper of $719 million. ILFC had $6.08 billion of debt securities registered for public sale at December 31, 2002. During the second quarter of 2002, ILFC expanded its Euro Medium Term Note Program from $2.0 billion to $4.0 billion, under which $2.31 billion in notes were sold through December 31, 2002. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings.
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.)
AIGFP has established a Euro Medium Term Note Program under which an aggregate principal amount of up to $4.0 billion of notes may be issued. As of December 31, 2002, $2.09 billion of notes had been issued under the program, all of which are currently outstanding. Notes issued under this program are included in Notes and Bonds Payable in the preceding table of borrowings.
AIG's capital funds increased $6.95 billion during 2002. Unrealized appreciation of investments, net of taxes increased $3.15 billion. During 2002, the cumulative translation adjustment loss, net of taxes, increased $381 million. The change for 2002 with respect to the unrealized appreciation of investments, net of taxes, was primarily impacted by the decrease in domestic interest rates. The 2001 transfer of bonds in the held to maturity at amortized cost to the bonds available for sale at market value in accordance with the transition provisions of Statement of Financial Accounting Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities," resulted in a gain of $339 million recorded in the statement of comprehensive income as a cumulative effect of an accounting change adjustment. The 2001 capital funds included a cumulative effect of an accounting change adjustment gain of $150 million. During 2002, there was a loss of $293 million, net of taxes relating to derivative contracts designated as cash flow hedging instruments. (See also the discussion under "Operational Review" and "Liquidity" herein, Notes 1(y) and 8(d) of Notes to Financial Statements and the Consolidated Statement of Comprehensive Income.) During 2002, retained earnings increased $5.05 billion, resulting from net income less dividends.
During 2002, AIG repurchased in the open market 10,858,000 shares of its common stock. During 2003 through March 20, 2003 AIG repurchased in the open market an additional 1,625,000 shares of its common stock. AIG intends to continue to buy its common shares in the open market for general corporate purposes, including to satisfy its obligations under various employee benefit plans.
AIG's insurance subsidiaries, in common with other insurers, are subject to regulation and supervision by the states and jurisdictions in which they do business. The National Association of Insurance Commissioners (NAIC) has developed Risk-Based Capital (RBC) requirements. RBC relates an individual insurance company's statutory surplus to the risk inherent in its overall operations. At December 31, 2002, the adjusted capital of each of AIG's domestic general companies and of each of AIG's domestic life companies exceeded each of their RBC standards. Federal, state or local legislation may affect AIG's ability to operate and expand its various financial services businesses and changes in the current laws, regulations or interpretations thereof may have a material adverse effect on these businesses.
THE MATURITY SCHEDULE OF AIG'S CONTRACTUAL OBLIGATIONS AT DECEMBER 31, 2002 WAS AS FOLLOWS:
THE MATURITY SCHEDULE OF AIG'S OTHER COMMERCIAL COMMITMENTS AT DECEMBER 31, 2002 WAS AS FOLLOWS:
AIG uses special purposes vehicles (SPVs) primarily in connection with certain guaranteed investment contract programs (GIC Programs) written by its life insurance subsidiaries, certain products provided by AIGFP, and certain invested asset and asset management activities.
AIG has established stringent guidelines with respect to the formation of and investment in SPVs. (See also the discussion under "Accounting Standards" herein.)
At December 31, 2002, AIG's consolidated invested assets included $8.16 billion of cash and short-term investments. Consolidated net cash provided from operating activities in 2002 amounted to $18.69 billion.
This liquidity is available, among other things, to purchase predominately high quality and diversified fixed income securities and, to a lesser extent, marketable equity securities, and to provide mortgage loans on real estate, policy loans and collateral loans. This cash flow coupled with proceeds of approximately $120 billion from the maturities, sales and redemptions of fixed income securities and from the sale of equity securities was used to purchase approximately $158 billion of fixed income securities and marketable equity securities during 2002.
(a) Includes $981 million of bond trading securities, at market value.
Generally, insurance regulations restrict the types of assets in which an insurance company may invest.
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, 2002, approximately 16 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 11 percent were below investment grade or not rated at that date. A large portion of the foreign insurance fixed income portfolio are sovereign fixed maturity securities supporting the policy liabilities in the country of issuance.
- The occurrence of a discrete credit event resulting in (i) the issuer defaulting on a material outstanding obligation; or (ii) the issuer seeking protection from creditors under the bankruptcy laws or any similar laws intended for the court supervised reorganization of insolvent enterprises; or (iii) the issuer proposing a voluntary reorganization pursuant to which creditors are asked to exchange their claims for cash or securities having a fair value substantially lower than par value of their claims; or
Once a security has been identified as potentially impaired, the amount of such impairment is determined by reference to that security's contemporaneous market price. However, the market price following a significant credit event of any issuer may be volatile after such an event. Factors such as market liquidity, hedge fund activity, sensitivity to "headline" risk, and the widening of bid/ask spreads contribute to price volatility. Because of such volatility, the market price may not be indicative of the fair value of such an investment; and consequently, not indicative of a reasonable estimate of realizable value.
As a result of these policies, AIG recorded in 2002 impairment losses net of taxes of approximately $795 million, of which $305 million was recognized in the three months ended December 31, 2002.
The most significant impairment charge for any single credit for 2002 was approximately $231 million net of tax with respect to AIG's holdings in WorldCom Inc. (WorldCom). This charge was recorded in the quarter ended June 30, 2002.
Excluding AIG's holdings in WorldCom for 2002, no impairment charge with respect to any one single credit was significant to AIG's consolidated financial condition or results of operations and no individual impairment loss exceeded approximately 1.4 percent of consolidated net income for 2002. At December 31, 2002, AIG believes that the circumstances which caused WorldCom's fair value to significantly decline were not characteristic of AIG's other holdings.
AIG measured the impairment charge with respect to WorldCom by reference to the market price of the WorldCom securities as of June 30, 2002.
Excluding the impairments noted above, the changes in market value for AIG's available for sale portfolio, which constitutes the vast majority of AIG's investments, were recorded in equity as unrealized gains or losses.
Note: At December 31, 2002, aggregate pre-tax unrealized gains were $14.7 billion.
For certain structured securities, the carrying value is based on an estimate of the security's future cash flows pursuant to the requirements of Emerging Issues Task Force Issue No. 99-20 "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." The change in carrying value is recognized in income.
With respect to hedge funds and limited partnerships in which AIG holds in the aggregate a five percent or greater interest, AIG's carrying value is the net asset value. The changes in such net asset values are recorded in income.
Other invested assets were primarily comprised of limited partnerships and outside managed funds.
AIG has performed a VaR analysis to estimate the maximum potential loss of fair value for each of AIG's insurance segments and for each market risk within each insurance segment. In this analysis, financial instrument assets include the domestic and foreign invested assets excluding real estate and investment income due and accrued. Financial instrument liabilities include reserve for losses and loss expenses, reserve for unearned premiums, future policy benefits for life and accident and health insurance contracts and policyholders' funds.
AIG calculated the VaR with respect to the net fair value of each of AIG's insurance segments as of December 31, 2002 and December 31, 2001. AIG uses the historical simulation methodology which entails re-pricing all assets and liabilities under explicit changes in market rates within a specific historical time period. In this case, the most recent three years of historical market information for interest rates, foreign exchange rates, and equity index prices were used to construct the historical scenarios. For each scenario, each transaction was re-priced. Portfolio, business unit and finally AIG-wide scenario values were then calculated by netting the values of all the underlying assets and liabilities. The final VaR number represents the maximum potential loss incurred by these scenarios with 95 percent confidence (i.e., only 5 percent of historical scenarios show losses greater than the VaR figure). A one month holding period was assumed in computing the VaR figure.
THE FOLLOWING TABLE PRESENTS THE VAR ON A COMBINED BASIS AND OF EACH COMPONENT OF MARKET RISK FOR EACH OF AIG'S INSURANCE SEGMENTS AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001. 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, 2002 AND 2001. (SEE ALSO THE DISCUSSIONS UNDER "OPERATIONAL REVIEW: FINANCIAL SERVICES OPERATIONS", "CAPITAL RESOURCES" AND "DERIVATIVES" HEREIN.)
At December 31, 2002, ILFC had committed to purchase 523 aircraft deliverable from 2003 through 2010 at an estimated aggregate purchase price of $29.8 billion and had options to purchase 18 aircraft deliverable from 2003 through 2008 at an estimated aggregate purchase price of $1.3 billion. Subsequent to December 31, 2002, ILFC cancelled delivery of four of the 523 aircraft. As of March 20, 2003, ILFC has entered into leases for 86 of 90 aircraft to be delivered in 2003 and 49 of 82 aircraft to be delivered in 2004 and 26 of 347 aircraft to be delivered subsequent to 2004. 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, but there can be no assurance that such success will continue in future environments.
ILFC is exposed to market risk and the risk of loss of fair value and possible liquidity strain resulting from adverse fluctuations in interest rates. As of December 31, 2002 and December 31, 2001, AIG statistically measured the loss of fair value through the application of a VaR model. In this analysis, the net fair value of ILFC was determined using the financial instrument assets which included the tax adjusted future flight equipment lease revenue and the financial instrument liabilities which included the future servicing of the current debt. The estimated impact of the current derivative positions was also taken into account.
Securities available for sale is mainly a portfolio of debt securities, where the individual securities have varying degrees of credit risk. At December 31, 2002, the average credit rating of this portfolio was AA or the equivalent thereto as determined through rating agencies or internal review. AIGFP has also entered into credit derivative transactions to hedge its credit risk associated with $66 million of these securities. Securities deemed below investment grade at December 31, 2002 amounted to approximately $100 million in fair value representing 0.6 of one percent of the total AIGFP securities available for sale. $30 million of this amount is hedged with a credit derivative. There have been no significant downgrades through March 1, 2003. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP takes possession of or obtains a security interest in securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring counterparty credit exposure and, when AIGFP deems necessary, it requires additional collateral to be deposited. Trading securities, at market value are marked to market daily and are held to meet the short-term risk management objectives of AIGFP.
THE GROSS UNREALIZED GAINS AND GROSS UNREALIZED LOSSES OF AIGFP AND AIGTG INCLUDED IN THE FINANCIAL SERVICES ASSETS AND LIABILITIES AT DECEMBER 31, 2002 WERE AS FOLLOWS:
AIGFP's interest rate and currency risks on securities available for sale, at market, are managed by taking offsetting positions on a security by security basis, thereby offsetting a significant portion of the unrealized appreciation or depreciation. At December 31, 2002, the unrealized gains and losses remaining after the benefit of the offsets were $62 million and $90 million, respectively.
As part of its monitoring and controlling of its exposure to market risk, AIGFP applies various testing techniques which reflect potential market movements. These techniques vary by currency and are regularly changed to reflect factors affecting the derivatives portfolio. In addition to the daily monitoring, AIGFP's senior management and local risk managers conduct a weekly review of the derivatives portfolio and existing hedges. This review includes an examination of the portfolio's risk measures, such as aggregate option sensitivity to movements in market variables. AIGFP's management may change these measures to reflect
AIGTG's senior management has established positions and stop-loss limits for each line of business. AIGTG's traders are required to maintain positions within these limits. These positions are monitored during the day either manually and/or through on-line computer systems. In addition, these positions are reviewed by AIGTG's management. Reports which present each trading books' position and the prior day's profit and loss are reviewed by traders, head traders and AIGTG's senior management. Based upon these and other reports, AIGTG's senior management may determine to adjust AIGTG's risk profile.
AIGTG attempts to secure reliable current market prices, such as published prices or third party quotes, to value its derivatives. Where such prices are not available, AIGTG uses an internal methodology which includes interpolation or extrapolation from verifiable prices nearest to the dates of the transactions. Historically, actual results have not materially deviated from these models. The methodology may reflect interest and exchange rates, commodity prices, volatility rates, market liquidity and other relevant factors. Unrealized gains and losses, with respect to AIGTG's positions are reflected in income currently.
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, market liquidity and the effect of time.
AIGFP's and AIGTG's asset and liability portfolios for which the VaR analyses were performed included over the counter and exchange traded investments, derivative instruments and commodities. Because 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 trading was not deemed necessary.
THE FOLLOWING TABLE PRESENTS THE VAR ON A COMBINED BASIS AND OF EACH COMPONENT OF AIGFP'S AND AIGTG'S MARKET RISK AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001. VAR WITH RESPECT TO COMBINED OPERATIONS CANNOT BE DERIVED BY AGGREGATING THE INDIVIDUAL RISK PRESENTED HEREIN.
(a) A one month holding period was used to measure the market exposures of AIGFP.
THE FOLLOWING TABLE PRESENTS THE AVERAGE, HIGH AND LOW VARS ON A COMBINED BASIS AND OF EACH COMPONENT OF AIGFP'S AND AIGTG'S MARKET RISK AS OF DECEMBER 31, 2002 AND 2001.
Derivatives are financial arrangements among two or more parties. The returns of the derivatives are linked to or "derived" from some underlying equity, debt, commodity or other asset, liability, or index. Derivatives payments may be based on interest rates and exchange rates and/or prices of certain securities, certain commodities, or financial or commodity indices. The more significant types of derivative arrangements in which AIG transacts are swaps, forwards, futures and options. In the normal course of business, with the agreement of the original counterparty, these contracts may be terminated early or assigned to another counter-party.
The overwhelming majority of AIG's derivatives activities are conducted through AIGFP and AIGTG, thus permitting AIG to participate in the derivatives dealer market acting primarily as principal. In these derivative operations, AIG structures agreements which generally allow its counterparties to enter into transactions with respect to changes in interest and exchange rates, securities' prices and certain commodities and financial or commodity indices. AIG's customers such as corporations, financial institutions, multinational organizations, sovereign entities, government agencies and municipalities use derivatives to hedge their own market exposures. For example, a futures, forward or option contract can be used to protect the customers' assets or liabilities against price fluctuations.
Discussions with respect to AIGFP's and AIGTG's counterpart credit quality, fair value source and notional amounts follow.
The following tables provide the counterparty credit quality amounts of AIGFP's and AIGTG's derivatives transactions at December 31, 2002 and December 31, 2001.
AIGFP determines counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, by internal analysis. At December 31, 2002 and December 31, 2001, the concentration of credit exposure with respect to counterparties judged A or higher by AIGFP was 92 percent and 93 percent, respectively.
AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGFP'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS:
Subsequent to the application of such credit enhancements, the net exposure to credit risk or the net replacement value of all futures, forwards, swaptions and purchased options contracts and interest rate and currency swaps was $2.29 billion and $3.05 billion at December 31, 2002 and December 31, 2001, respectively.
AIGTG'S NET REPLACEMENT VALUE AT DECEMBER 31, 2002 AND 2001 WAS AS FOLLOWS:
* The net replacement values with respect to exchange traded futures and options, forward contracts and purchased over the counter options are presented as a component of trading assets in the accompanying balance sheet. The net replacement values with respect to interest rate and currency swaps are presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions in the accompanying balance sheet.
AIGTG determines counterparty credit quality by reference to ratings from independent rating agencies or, where such ratings are not available, internal analysis. At December 31, 2002 and December 31, 2001, the concentration of credit exposure with respect to counterparties judged A or higher by AIGTG was 75 percent and 78 percent, respectively.
ALSO, AS OF DECEMBER 31, 2002 AND 2001, THE COUNTERPARTY CREDIT QUALITY AND COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WERE AS FOLLOWS:
AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE FAIR VALUE SOURCE OF THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WAS AS FOLLOWS:
THE FOLLOWING TABLE PRESENTS THE CONTRACTUAL AND NOTIONAL AMOUNTS BY MATURITY AND TYPE OF DERIVATIVE OF AIGFP'S DERIVATIVES PORTFOLIO AT DECEMBER 31, 2002 AND DECEMBER 31, 2001.
AIGFP enters into credit derivative transactions in the ordinary course of its business. The overwhelming majority of AIGFP's credit derivatives require AIGFP to provide credit protection on a designated portfolio of loans or debt securities. AIGFP provides such credit protection only on a "second loss" basis, under which AIGFP's payment obligations arise only after credit losses in the designated portfolio exceed a specified threshold amount or level of "first losses." The threshold amount of credit losses that must be realized before AIGFP has any payment obligation is negotiated by AIGFP for each transaction to provide that the likelihood of any payment obligation by AIGFP under each transaction is remote, even in severe recessionary market scenarios.
AIGFP continually monitors the underlying portfolios to determine whether the credit loss experience for any particular portfolio has caused the likelihood of AIGFP having a payment obligation under the transaction to be greater than super senior risk. AIGFP maintains the ability opportunistically to hedge specific securities in a portfolio thereby further limiting its exposure to loss and has hedged outstanding transactions in this manner on occasion. AIGFP has never had a payment obligation under these credit derivatives transactions. Furthermore, based on portfolio credit losses experienced to date under all outstanding transactions, no transaction has experienced credit losses in an amount that has made the likelihood of AIGFP having to make a payment, in AIGFP's view, to be greater than remote, even in severe recessionary market scenarios. At December 31, 2002 the notional amount with respect to AIGFP's credit derivative portfolio was $125.7 billion.
THE FOLLOWING TABLE PROVIDES THE CONTRACTUAL AND NOTIONAL AMOUNTS BY MATURITY AND TYPE OF DERIVATIVE OF AIGTG'S DERIVATIVES PORTFOLIO AT DECEMBER 31, 2002 AND DECEMBER 31, 2001.
In June 2001, FASB issued Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" (FAS 142). As of January 1, 2002, AIG adopted FAS 142. FAS 142 requires AIG to discontinue the amortization of goodwill in its consolidated income statement. Amortization
In November 2002, FASB issued Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" (FIN45). FIN45 requires that, for guarantees within its scope that are issued or amended after December 31, 2002, a liability for the fair value of the obligation undertaken in issuing the guarantee be established, and recognized through earnings. FIN45 also requires additional disclosures in financial statements starting with AIG's 2002 year-end financial statements.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN46). FIN46 changes the method of determining whether certain entities should be consolidated in AIG's consolidated financial statements. An entity is subject to FIN46 and is called a variable interest entity (VIE) if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) equity investors that cannot make significant decisions about the entity's operations, or that do not absorb the expected losses or receive the expected returns of the entity. All other entities are evaluated for consolidation under existing guidance. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both.
AIG is currently evaluating the impact of applying FIN46 to existing VIEs in which it has a variable interest, and believes that the impact on its results of operations and financial condition will not be significant. (See also the discussions under Note 20 of Notes to Financial Statements and "Special Purpose Vehicles" included herein.)
(b) Consists of derivative gains and losses qualifying for cash flow hedging arising from the adoption of Statement of Financial Accounting Standards No. 138 "Accounting for Derivative Instruments and Hedging Activities -- an amendment of FASB Statement No. 133" (collectively, FAS 133).
(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 2001 and 2000 financial statements to conform to their 2002 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 reviewed and updated. Adjustments resulting therefrom are reflected in income currently. AIG discounts certain of its loss reserves which are primarily related to certain workers' compensation claims. (See Note 6.)
The resulting DAC asset is reviewed for recoverability based on the profitability (both current and projected future) of the underlying insurance contracts.
Financial Services Operations: AIG participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency, equity and credit derivative products business. AIG also enters into structured transactions, including long-dated forward foreign exchange contracts, option transactions, liquidity facilities and investment agreements, and invests in a diversified portfolio of securities.
(C) NON-CASH TRANSACTIONS: During 2001 and 2000, AIG issued 291.6 million and 17.8 million common shares, respectively, in connection with acquisitions.
Fixed maturities held to maturity, at amortized cost, were transferred to bonds available for sale, at market value, as of January 1, 2001 as permitted and in accordance with the transition provisions of the Financial Accounting Standards No. 138 "Accounting for Derivative Instruments and Hedging Activities - -- an amendment of FASB Statement No. 133" (collectively, FAS 133). (See Notes 1(y) and 8(d)).
In January 2001, the Emerging Issues Task Force (EITF) issued EITF 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets." EITF 99-20 provides guidance on the calculation of interest income and the recognition of impairments related to beneficial interests held in an investment portfolio. Beneficial interests are investments that represent rights to receive specified cash flows from a pool of underlying assets (e.g., collateralized debt obligations). In accordance with the transition provisions of EITF 99-20, AIG recorded in its consolidated income statement for 2001 a cumulative effect of an accounting change adjustment loss of $130 million ($200 million before tax).
(E) 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 based upon certain risk factors and when collection of all amounts due under the contractual term is not probable. This impairment 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.
(F) 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 expected reimbursements 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. AIG monitors the global aircraft market and the values of various types and models of aircraft within that market relative to the values of its own fleet. If events or circumstances were such that the carrying amount of AIG's aircraft might be impaired, AIG would determine if such impairment existed and recognize such impairment in accordance with Financial Accounting Standards Board (FASB) Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". This caption also includes deposits for aircraft to be purchased.
(H) FINANCE RECEIVABLES: Finance charges are recognized as revenue using the interest method. Revenue ceases to be accrued when contractual payments are not received for four consecutive months for loans and retail sales contracts, and for six months for revolving retail accounts and private label receivables. Extension fees, late charges, and prepayment penalties are recognized as revenue when received.
(I) TRADING SECURITIES, AT MARKET VALUE: Trading securities are held to meet short term investment objectives, including hedging securities. These securities are recorded on a trade date basis and carried at current market values. Unrealized gains and losses are reflected in income currently.
(L) TRADING ASSETS AND TRADING LIABILITIES: Trading assets and trading liabilities include option premiums paid and received and receivables from and payables to counterparties which relate to unrealized gains and losses on futures, forwards and options and balances due from and due to clearing brokers and exchanges.
AIG also enters into dollar roll agreements. These are agreements to sell mortgage-backed securities and to repurchase substantially the same securities at a specified price and date in the future. The dollar rolls are accounted for as collateralized financings and the repurchase obligation is a component of other liabilities. At December 31, 2002, 2001 and 2000, there were no dollar rolls outstanding.
(N) SECURITIES LENDING COLLATERAL AND SECURITIES LENDING PAYABLE: AIG's insurance operations lend their securities and primarily take cash as collateral with respect to the securities lent. Income earned on invested collateral, net of interest payable to the collateral provider is recorded in net investment income.
(P) REINSURANCE ASSETS: Reinsurance assets include the balances due from both reinsurance and insurance companies under the terms of AIG's reinsurance agreements 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. Amounts related to paid and unpaid losses and loss expenses with respect to these reinsurance agreements are substantially collateralized.
(Q) INVESTMENTS IN PARTIALLY-OWNED COMPANIES: The equity method of accounting is used for AIG's investment in companies in which AIG's ownership interest approximates twenty but is not greater than fifty percent (minority-owned companies). At December 31, 2002, AIG's significant investments in partially-owned companies included its 24.3 percent interest in IPC Holdings, Ltd., its 23.4 percent interest in Allied World Assurance Holdings, Ltd. and its 22.1 percent interest in The Fuji Fire and Marine Insurance Co., Ltd. This balance sheet caption also includes investments in less significant partially-owned companies and in certain minor majority-owned subsidiaries. The amounts of dividends received from unconsolidated entities owned less than 50 percent were $13 million, $3 million and $3 million in 2002, 2001 and 2000, respectively. The undistributed earnings of unconsolidated entities owned less than 50 percent was $155 million as of December 31, 2002.
From time to time, AIG assesses the carrying value of its real estate relative to the market values of real estate within the specific local area. At December 31, 2002, there were no impairments.
(V) 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" (FAS 52). Under FAS 52, functional currency assets and liabilities are translated into U.S. dollars generally using current rates of exchange prevailing at the balance sheet date of each respective subsidiary and the related translation adjustments are recorded as a separate component of comprehensive income, net of any related taxes in capital funds. 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 comprehensive income.
(X) 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.
AIG documents all relationships between hedging instruments and hedged items, as well as its risk-management objectives and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as hedges to specific assets or liabilities on the balance sheet, or specific firm commitments or forecasted transactions. AIG also assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items.
arising from recognizing the fair value of all derivative contracts designated as cash flow hedging instruments, and to a lesser extent, hedging instruments used to hedge net investments in foreign operations.
In addition to hedging activities, AIG also uses derivative instruments with respect to investment operations, which include, among other things, writing option contracts, and purchasing investments with embedded derivatives, such as equity linked notes and convertible bonds. All changes in the market value of these derivatives are recorded in earnings. AIG bifurcates an embedded derivative where: (i) the economic characteristics of the embedded instruments are not clearly and closely related to those of the remaining components of the financial instrument; and (ii) a separate instrument with the same terms as the embedded instrument meets the definition of a derivative under FAS 133.
FAS 142 requires goodwill to be subject to an assessment of impairment on an annual basis, or more frequently if circumstances indicate that a possible impairment has occurred. The assessment of impairment involves a two-step process prescribed in FAS 142, whereby an initial assessment for potential impairment is performed, followed by a measurement of the amount of impairment, if any. FAS 142 also requires the completion of a transitional impairment test in the year of adoption, with any identified impairments recognized as a cumulative effect of change in accounting principles. During the second quarter, AIG completed its transitional impairment test for 2002, resulting in no impairment.
Changes in the carrying amount of goodwill are primarily caused as a result of foreign currency translation adjustments.
AIG believes that the impact of FIN45 on its results of operations and financial condition will not be significant.
AIG guarantees the indebtedness of third parties principally in connection with AIG SunAmerica Inc.'s (AIG SunAmerica) investments in affordable housing properties. The guarantees are issued primarily to facilitate financing for the construction of the underlying properties, and range in duration of up to ten years. The loans are secured by the underlying real estate. Since the inception of this investment program over ten years ago, payments under these guarantees have been insignificant. This is due to the fact that the loans are first backed by the creditworthiness of the third party general partner, and secondly, are secured by the underlying properties. The maximum exposure under these guarantees as of December 31, 2002 is approximately $4.2 billion.
In January 2003, FASB issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN46). FIN46 changes the method of determining whether certain entities should be consolidated in AIG's consolidated financial statements. An entity is subject to FIN46 and is called a Variable Interest Entity (VIE) if it has (i) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) equity investors that cannot make significant decisions about the entity's operations, or do not absorb the expected losses or receive the expected returns of the entity. All other entities are evaluated for consolidation under existing guidance. A VIE is consolidated by its primary beneficiary, which is the party that has a majority of the expected losses or a majority of the expected residual returns of the VIE, or both.
The provisions of FIN46 are to be applied immediately to VIEs created after January 31, 2003, and to VIEs in which AIG obtains an interest after that date. For VIEs in which AIG holds a variable interest that it acquired before February 1, 2003, FIN46 applies to the fiscal quarter ended September 30, 2003. For any VIEs that must be consolidated under FIN46 that were created before February 1, 2003, the assets, liabilities and noncontrolling interest of the VIE would be initially measured at their carrying amounts with any difference between the net amount added to the balance sheet and any previously recognized interest being recognized as the cumulative effect of an accounting change.
The Domestic Brokerage Group (DBG) writes substantially all classes of business insurance accepting such business mainly from insurance brokers. This provides DBG the opportunity to select specialized markets and retain underwriting control. Any licensed broker is able to submit business to DBG without the traditional agent-company contractual relationship, but such broker usually has no authority to commit DBG to accept a risk. HSB's operations are included in this group.
Transatlantic Holdings, Inc. (Transatlantic) offers through its reinsurance company subsidiaries reinsurance capacity both domestically and overseas on treaty and facultative basis for a full range of property and casualty products.
Mortgage Guaranty provides guaranty insurance primarily on conventional first mortgage loans on single family dwellings and condominiums.
Life Insurance: AIG's life insurance subsidiaries offer a wide range of traditional insurance and financial and investment products. Traditional products consist of individual and group life, annuity, endowment and accident and health policies. Financial and investment products consist of fixed and variable annuities, guaranteed investment contracts and pensions.
AIG's three principal overseas life operations are American Life Insurance Company (ALICO), American International Assurance Company, Ltd. (AIA) and Nan Shan Life Insurance Company, Ltd. (Nan Shan). ALICO is
incorporated in Delaware and all of its business is written outside of the United States. ALICO has operations either directly or through subsidiaries in approximately 50 countries located in Europe, Africa, Latin America, the Caribbean, the Middle East, and the Far East, with Japan being the largest territory. In 2001, AIG added significantly to its presence in Japan with the acquisition of AIG Star Life Insurance Co, Ltd. (AIG Star Life) as a result of the reorganization of Chiyoda Mutual Life Insurance Company. AIA operates primarily in China, (including Hong Kong), Singapore, Malaysia and Thailand. Nan Shan operates in Taiwan. AIG's principal domestic life insurance subsidiaries include the AIG American General Life Companies, AIG Annuity Insurance Company and SunAmerica Life Insurance Company. These companies utilize multiple distribution channels including brokerage and career and general agents to offer traditional life products as well as financial investment products.
Financial Services: AIG's financial services subsidiaries engage in diversified financial products and services including aircraft leasing, consumer and insurance premium financing, and capital markets structuring and market-making activities.
AIG's Consumer Finance operations include American General Finance, Inc. as well as AIG Consumer Finance Group, Inc. (AIGCFG). AGF and AIGCFG provide a wide variety of consumer finance products, including real estate mortgages, consumer loans, retail sales finance and credit related insurance to customers both domestically and overseas, particularly emerging markets.
(B) THE FOLLOWING TABLE SUMMARIZES THE OPERATIONS BY MAJOR OPERATING SEGMENT FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000:
(b) Includes 21st Century's loss adjustment expense pre-tax provision of $43 million for SB 1899 Northridge earthquake claims.
(c) Includes 21st Century's pre-tax charge of $37 million to write off capitalized costs associated with a software development project.
(D) THE FOLLOWING TABLE SUMMARIZES AIG'S GENERAL INSURANCE OPERATIONS BY MAJOR INTERNAL REPORTING GROUP FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000:
(a) Adjusted underwriting profit (loss) is a GAAP measure that represents statutory underwriting profit or loss adjusted primarily for changes in deferred acquisition costs.
(d) Includes $769 million with respect to WTC losses: DBG: $544 million; Transatlantic: $200 million; Foreign General: $25 million.
(a) Increase in 2001 reflects acquisition of AIG Star Life Insurance Co. Ltd. in April 2001.
(F) THE FOLLOWING TABLE SUMMARIZES AIG'S FINANCIAL SERVICES OPERATIONS BY MAJOR INTERNAL REPORTING GROUP FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000:
(a) AIGFP's interest revenue and interest expense are reported as net revenues in the caption "Commissions, transactions and other fees and loan fees".
(G) A SUBSTANTIAL PORTION OF AIG'S OPERATIONS IS CONDUCTED IN COUNTRIES OTHER THAN THE UNITED STATES AND CANADA. THE FOLLOWING TABLE SUMMARIZES AIG'S OPERATIONS BY MAJOR GEOGRAPHIC SEGMENT. ALLOCATIONS HAVE BEEN MADE ON THE BASIS OF THE LOCATION OF OPERATIONS AND ASSETS.
A component of life insurance surplus accumulated prior to 1984 is not taxable unless it exceeds certain statutory limitations or is distributed to shareholders. This surplus, accumulated in policyholder surplus accounts, totaled approximately $945 million at December 31, 2002. AIG has not made any provision in the accompanying financial statements for taxation of this amount as management has no intention of making any distributions from this surplus.
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 translated undistributed earnings of AIG's foreign subsidiaries currently not subject to U.S. income taxes was approximately $5.1 billion at December 31, 2002. Management presently has not subjected and 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.
(B) THE U.S. FEDERAL INCOME TAX RATE IS 35 PERCENT FOR 2002, 2001 AND 2000. ACTUAL TAX EXPENSE ON INCOME DIFFERS FROM THE "EXPECTED" AMOUNT COMPUTED BY APPLYING THE FEDERAL INCOME TAX RATE BECAUSE OF THE FOLLOWING:
* The components of domestic and foreign income and tax expense reflect the location in which the income and tax expense was generated and incurred, respectively.
(C) THE COMPONENTS OF THE NET DEFERRED TAX LIABILITY AS OF DECEMBER 31, 2002 AND DECEMBER 31, 2001 WERE AS FOLLOWS:
* Includes adjustments as a result of changes in the net unrealized gains or losses on debt and equity securities available for sale. Such adjustments were included with the change in net unrealized gains/losses on debt and equity securities available for sale that were credited or charged directly to comprehensive income.
GENERAL INSURANCE PREMIUMS WRITTEN AND EARNED WERE COMPRISED OF THE FOLLOWING:
For the years ended December 31, 2002, 2001 and 2000, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $10.28 billion, $8.80 billion and $6.00 billion, respectively.
Life insurance assumed represented 0.2 percent of gross life insurance in-force at December 31, 2002, 2001 and 2000 and life insurance premium income assumed represented 0.2 percent, 0.3 percent and 0.4 percent of gross premium income for the periods ended December 31, 2002, 2001 and 2000.
SUPPLEMENTAL INFORMATION FOR GROSS LOSS AND BENEFIT RESERVES NET OF CEDED REINSURANCE AT DECEMBER 31, 2002 AND 2001 FOLLOWS:
(C) Long duration contract liabilities included in future policy benefits, as presented in the table above, result from traditional life products. Short duration contract liabilities are primarily accident and health products. The liability for future life policy benefits has been established based upon the following assumptions:
(i) Interest rates (exclusive of immediate/terminal funding annuities), which vary by territory, year of issuance and products, range from 1.5 percent to 12.0 percent within the first 20 years. Interest rates on immediate/terminal funding annuities are at a maximum of 11.2 percent and grade to not greater than 6.2 percent.
(D) The liability for policyholders' contract deposits has been established based on the following assumptions:
(i) Interest rates credited on deferred annuities, which vary by territory and year of issuance, range from 1.5 percent to 9.3 percent. Current declared interest rates are generally guaranteed to remain in effect for a period of one year though
6. RESERVE FOR LOSSES AND LOSS EXPENSES AND FUTURE LIFE POLICY BENEFITS AND POLICYHOLDERS' CONTRACT DEPOSITS (continued)
some are guaranteed for longer periods. Withdrawal charges generally range from zero percent to 18.0 percent grading to zero over a period of zero to 15 years.
(iii) Interest rates on corporate life insurance products are guaranteed at 4.0 percent and the weighted average rate credited in 2002 was 5.8 percent.
(iv) The universal life funds have credited interest rates of 3.8 percent to 7.5 percent and guarantees ranging from 3.0 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 11.4 percent of the aggregate fund balance grading to zero over a period not longer than 20 years.
(E) Certain products, which are short duration contracts, are subject to experience adjustments. These include group life and group medical products, credit life contracts, accident & health insurance contracts/riders attached to life policies and, to a limited extent, reinsurance agreements with other direct insurers. Ultimate premiums from these contracts are estimated and recognized as revenue and the unearned portions of the premiums are held as reserves. Experience adjustments vary according to the type of contract and the territory in which the policy is in force and are subject to local regulatory guidance.
(a) Includes loss reserve charge, net of t ax of $1.8 billion.
(B) NET INVESTMENT INCOME: AN ANALYSIS OF THE NET INVESTMENT INCOME FROM THE GENERAL AND LIFE INSURANCE OPERATIONS FOLLOWS:
(C) INVESTMENT GAINS AND LOSSES: THE REALIZED CAPITAL GAINS (LOSSES) AND INCREASE (DECREASE) IN UNREALIZED APPRECIATION OF INVESTMENTS WERE AS FOLLOWS:
(b) Includes $758 million increase, $598 million increase and $51 million increase in unrealized appreciation attributable to participating policy-holders at December 31, 2002, 2001 and 2000, respectively.
THE GROSS GAINS AND GROSS LOSSES REALIZED ON THE DISPOSITION OF AVAILABLE FOR SALE SECURITIES WERE AS FOLLOWS:
THE AMORTIZED COST AND ESTIMATED MARKET VALUE OF BONDS AVAILABLE FOR SALE AND CARRIED AT MARKET VALUE AT DECEMBER 31, 2002 AND 2001 WERE AS FOLLOWS:
THE AMORTIZED COST AND ESTIMATED MARKET VALUES OF FIXED MATURITIES AVAILABLE FOR SALE AT DECEMBER 31, 2002, 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 $66 million of securities available for sale. At December 31, 2002, the cumulative decrease 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 $28 million.
(G) CMOS: At December 31, 2002, CMOs, held by AIG's life companies, were presented as a component of bonds available for sale, at market value. Substantially all of the CMOs were investment grade and approximately 24 percent of the CMOs were backed by various U.S. government agencies. The remaining 76 percent were corporate issuances.
At December 31, 2002 and 2001, the market value of the CMO portfolio was $35.61 billion and $32.62 billion, respectively; the amortized cost was approximately $34.30 billion in 2002 and $32.20 billion in 2001. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 2002 and 2001.
(H) FIXED MATURITIES BELOW INVESTMENT GRADE: At December 31, 2002, fixed maturities held by AIG that were below investment grade or not rated totaled $23.94 billion.
PAYMENTS DUE UNDER THESE INVESTMENT AGREEMENTS IN EACH OF THE NEXT FIVE YEARS ENDING DECEMBER 31, AND THE PERIODS THEREAFTER BASED ON THE EARLIEST CALL DATES, WERE AS FOLLOWS:
At December 31, 2002, the market value of securities pledged as collateral with respect to these obligations approximated $4.8 billion.
(B) COMMERCIAL PAPER: AT DECEMBER 31, 2002, THE COMMERCIAL PAPER ISSUED AND OUTSTANDING WAS AS FOLLOWS:
AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR ILFC'S OUTSTANDING MEDIUM TERM NOTES WAS AS FOLLOWS:
The interest rates on AIG's Medium Term Notes range from 0.50 percent to 4.52 percent. To the extent deemed appropriate, AIG may enter into swap transactions to reduce its effective borrowing rates with respect to these notes.
At December 31, 2002, AIG had $140 million of debt securities registered and available for issuance from time to time.
AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR AIGFP'S NOTES AND BONDS PAYABLE WAS AS FOLLOWS:
(ii) Notes Issued by ILFC: ILFC has issued unsecured obligations which may not be redeemed prior to maturity.
As of December 31, 2002, notes aggregating $7.48 billion were outstanding with maturity dates from 2003 to 2009 and interest rates ranging from 3.32 percent to 8.38 percent. Notes aggregating $1.38 billion are at floating interest rates and the remainder are at fixed rates. These notes provide for a single principal payment at maturity.
AT DECEMBER 31, 2002, THE MATURITY SCHEDULE FOR ILFC'S NOTES WAS AS FOLLOWS:
ILFC had $6.08 billion of debt securities registered for public sale at December 31, 2002. During the second quarter of 2002, ILFC expanded its Euro Medium Term Note Program from $2.0 billion to $4.0 billion, under which $2.31 billion in notes were sold through December 31, 2002. ILFC has eliminated the currency exposure arising from the notes by either hedging the notes through swaps, or through the offset provided by operating lease payments. ILFC translates the debt into U.S. dollars using current exchange rates. The foreign exchange adjustment for the euro denominated note was $265 million at December 31, 2002. Notes issued under this program are included in Notes and Bonds Payable in the accompanying table of borrowings.
AT DECEMBER 31, 2002, THE FUTURE MINIMUM PAYMENTS FOR ILFC'S BORROWINGS UNDER THE EXPORT CREDIT FACILITY WERE AS FOLLOWS:
(iii) Notes and Bonds Payable Issued by AGF: As of December 31, 2002, AGF notes aggregating $2.27 billion were outstanding with maturity dates ranging from 2003 to 2009 at interest rates ranging from 5.75 percent to 8.45 percent. These notes provide for a single principal payment at maturity.
As of November 2001, AIG guaranteed the notes and bonds of AGC. During 2002, AGC issued $200 million in notes which matured in March 2003. These notes are included in Notes and Bonds Payable in the accompanying table of borrowings.
(F) AS OF DECEMBER 31, 2002, THE COMBINED PAYMENTS DUE OF ALL SIGNIFICANT DEBT, EXCLUDING COMMERCIAL PAPER, IN EACH OF THE NEXT FIVE YEARS AND PERIODS THEREAFTER WERE AS FOLLOWS:
(H) INTEREST EXPENSE FOR ALL INDEBTEDNESS: Total interest expense for all indebtedness, net of capitalized interest, aggregated $3.57 billion in 2002, $3.97 billion in 2001 and $3.64 billion in 2000. Capitalized interest was $61 million in 2002, $71 million in 2001 and $69 million in 2000. Cash distributions on the preferred shareholders' equity in subsidiary companies of ILFC and certain AIG SunAmerica, AGC and HSB subsidiaries are accounted for as interest expense and included as minority interest in the consolidated statement of income. The cash distributions for ILFC were approximately $5 million, $15 million and $19 million for the years ended December 31, 2002, 2001 and 2000, respectively. The cash distributions for the AIG SunAmerica subsidiaries were approximately $8 million, $46 million and $62 million for the years ended December 31, 2002, 2001 and 2000, respectively. The cash distributions for AGC subsidiaries were approximately $129 million, $153 million and $158 million for the years ended December 31, 2002, 2001 and 2000, respectively.
(B) AIG SUNAMERICA: The preferred stock consists of $350 million liquidation amount of 7.5% Non-Voting Preferred Interests issued by Total Return LLC, a wholly owned subsidiary of AIG SunAmerica, in March 2000. The preferred stock was redeemed in March 2003.
(C) AGC: The preferred stock has been issued by five subsidiary trusts (the subsidiaries).
The sole assets of these subsidiaries are Junior Subordinated Debentures (Subordinated Debentures) issued by AGC. These subsidiaries have no independent operations. The Subordinated Debentures are eliminated in consolidation.
The interest terms and payment dates of the Subordinated Debentures held by the subsidiaries correspond to those of the subsidiaries' preferred securities. AGC's obligations under the Subordinated Debentures and related agreements, when taken together, constitute a full and unconditional guarantee by AGC of payments due on the preferred securities. The Subordinated Debentures are redeemable, under certain conditions, at the option of AGC on a proportionate basis.
On March 1, 2000, AGC redeemed 2.3 million shares or $85 million of its 7 percent convertible preferred stock by issuing 3.8 million shares of AGC common stock. On June 30, 2000, holders converted approximately 5 million shares or $250 million of 6 percent convertible preferred securities issued by American General Delaware, L.L.C. into 12.3 million shares of AGC common stock.
(D) HSB: The preferred stock consists of $95 million liquidation value of Exchange Capital Securities issued in July 1997 by HSB Capital I, a statutory business trust wholly owned by HSB. The sole assets of HSB Capital I are invested in debt securities of HSB. The capital securities accrue and pay quarterly cash distributions at a variable rate equal to 90 day LIBOR plus 0.91% of the stated liquidation amount of $1,000 per capital security, which rate was 2.29% at December 31, 2002. The capital securities are not redeemable prior to July 15, 2007 and are mandatorily redeemable upon the maturity of the debt securities on July 15, 2027 or the earlier redemption of the debt securities. AIG has issued a guarantee of the obligations of HSB, which together with the terms of the debt securities, the guarantee of HSB with respect to the capital securities, the indenture and the trust agreement with respect to the trust provide a full and unconditional guarantee of payments due on the capital securities. The trust is accounted for as a wholly owned subsidiary of AIG. The debt securities issued to the trust and the common securities issued by the trust to HSB are eliminated in the consolidated balance sheet.
(C) THE COMMON STOCK ACTIVITY FOR THE THREE YEARS ENDED DECEMBER 31, 2002 WAS AS FOLLOWS:
(a) Outstanding shares have been adjusted to reflect the conversion of all outstanding AGC shares by converting each outstanding share of AGC to 0.5790 shares of AIG.
Common stock increased and retained earnings decreased $2.04 billion in 2000 as a result of a common stock split in the form of 50 percent common stock dividend paid July 28, 2000.
(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. These commitments approximated $400 million and $300 million for December 31, 2002 and 2001, 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.
transactions include 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 counter-parties default. Currency and equity swaps are similar to interest rate swaps, but involves the exchange of specific currencies or the cashflows based on the underlying equity securities or indices. Also, they may involve the exchange of principal amounts at the beginning and end of the transaction. Swaptions are options where the holder has the right but not the obligation to enter into a swap transaction or cancel an existing swap transaction. At December 31, 2002, the notional principal amount of the sum of the swap pays and receives approximated $817.4 billion, primarily related to interest rate swaps of approximately $580.0 billion.
The notional amounts used to express the extent of involvement in swap transactions represent a standard of measurement of the volume of swaps business of AIGFP. 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 FOLLOWING TABLE PRESENTS AIGFP'S DERIVATIVES PORTFOLIO BY MATURITY AND TYPE OF DERIVATIVE AT DECEMBER 31, 2002 AND DECEMBER 31, 2001:
THE FOLLOWING TABLE PRESENTS AIGFP'S FUTURES AND FORWARD CONTRACTS PORTFOLIO BY MATURITY AND TYPE OF DERIVATIVE AT DECEMBER 31, 2002 AND DECEMBER 31, 2001:
AIGFP enters into credit derivative transactions in the ordinary course of its business. The overwhelming majority of AIGFP's credit derivatives require AIGFP to provide credit protection on a designated portfolio of loans or debt securities. AIGFP provides such credit protection only on a "second loss" basis, under which AIGFP's payment obligations arise only after credit losses in the designated portfolio exceed a specified threshold amount or level of "first losses." The threshold amount of credit losses that must be realized before AIGFP has any payment obligation is negotiated for each transaction by
AIGFP utilizes various credit enhancements, including letters of credit, guarantees, collateral, credit triggers, credit derivatives and margin agreements 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. Management believes that 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 counter-party 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 netting agreements excluding collateral held. The net exposure to credit risk or the net replacement value of all interest rate, currency, and equity swaps, swaptions and forward commitments approximated $14.98 billion at December 31, 2002 and $10.84 billion at December 31, 2001. The net replacement value for futures and forward contracts approximated $110 million at December 31, 2002 and $64 million at December 31, 2001. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss.
Revenues for the twelve months ended December 31, 2002, 2001 and 2000 from AIGFP's operations were $1.31 billion, $1.18 billion and $1.06 billion, respectively.
The following table provides the contractual and notional amounts and credit exposure, if applicable, by maturity and type of derivative of AIGTG's derivatives portfolio at December 31, 2002 and December 31, 2001. The gross replacement values presented represent the sum of the estimated positive fair values of all of AIGTG's derivatives contracts at December 31, 2002 and December 31, 2001. These values do not represent the credit risk to AIGTG.
(c) Notional amount is not representative of either market risk or credit risk.
AIGTG DETERMINES COUNTERPARTY CREDIT QUALITY BY REFERENCE TO RATINGS FROM INDEPENDENT RATING AGENCIES OR INTERNAL ANALYSIS. AT DECEMBER 31, 2002 AND DECEMBER 31, 2001, THE COUNTERPARTY CREDIT QUALITY AND COUNTERPARTY BREAKDOWN BY INDUSTRY WITH RESPECT TO THE NET REPLACEMENT VALUE OF AIGTG'S DERIVATIVES PORTFOLIO WERE AS FOLLOWS:
(e) At December 31, 2002, ILFC had committed to purchase 523 aircraft deliverable from 2003 through 2010 at an estimated aggregate purchase price of $29.8 billion and had options to purchase 18 aircraft deliverable from 2003 through 2008 at an estimated aggregate purchase price of $1.3 billion. ILFC will be required to find customers for any aircraft acquired, and it must arrange financing for portions of the purchase price of such equipment.
AIG continues to receive claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites (hereinafter collectively referred to as environmental claims) and indemnity claims asserting injuries from asbestos. Estimation of asbestos and environmental claims loss reserves is a difficult process, as these claims, which emanate from policies written in 1984 and prior years, cannot be estimated by conventional reserving techniques. Asbestos and environmental claims development is affected by factors such as inconsistent court resolutions, the broadening of the intent of policies and scope of coverage and increasing number of new claims. AIG and other industry members have and will continue to litigate the broadening judicial interpretation of policy coverage and the liability issues. If the courts continue in the future to expand the intent of the policies and the scope of the coverage, as they have in the past, additional liabilities would emerge for amounts in excess of reserves held. This emergence cannot now be reasonably estimated, but could have a material impact on AIG's future operating results. The reserves carried for these claims as at December 31, 2002 ($2.14 billion gross; $696 million net) are believed to be adequate as these reserves are based on known facts and current law.
AIG's general insurance companies have a special asbestos and environmental (A & E) claims unit actively managing A & E claims. AIG's experienced claims professionals evaluate case reserves for AIG losses at the earliest possible time, reserving to ultimate probable loss based upon known facts, current law, jurisdiction, policy language and other factors. AIG routinely reviews the adequacy of A & E case reserves. AIG does not discount A & E reserves.
(g) Risk Based Capital (RBC) is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Thus, inadequately capitalized general and life insurance companies may be identified.
The statutory surplus of each of AIG's domestic general and life insurance subsidiaries exceeded their RBC standards as of December 31, 2002.
(h) SAI Deferred Compensation Holdings, Inc., a wholly-owned subsidiary of AIG, has established a deferred compensation plan for registered representatives of certain AIG subsidiaries, pursuant to which participants have the opportunity to invest deferred commissions and fees on a notional basis. The value of the deferred compensation fluctuates with the value of the deferred investment alternatives chosen. AIG has provided a full and unconditional guarantee of the obligations of SAI Deferred Compensation Holdings, Inc. to pay the deferred compensation under the plan.
Finance receivables: the fair values of finance receivables were estimated using discounted cash flow calculations based upon the weighted average rates currently being offered for similar finance receivables.
Securities and spot commodities sold but not yet purchased: The carrying amounts for the financial instruments approximate fair values. Fair values for spot commodities sold short were based on current market prices.
(a) At December 31, 2002, AIG had three types of stock-based compensation plans: (i) a stock option plan; (ii) an incentive stock plan under which restricted stock units had been issued; and (iii) an employee stock purchase plan. AIG applied APB Opinion 25 "Accounting for Stock Issued to Employees" and related Interpretations (APB 25) in accounting for each plan. Accordingly, no compensation costs have been recognized for the plans.
FAS 148 provides transitioning guidance for a voluntary change of the application of FAS 123 and amends the disclosure requirements of FAS 123. Commencing January 1, 2003, AIG will be applying the "Prospective Method" in transitioning to the application of FAS 123. This method transitions the recognition with respect to stock based compensation to those awards granted or shares subscribed on or after January 1, 2003.
The fair values of stock options granted during the three years ended December 31, 2002, 2001, and 2000 were $140 million, $195 million, including $90 million in fair value with respect to shares granted in connection with the AGC acquisition, and $58 million, respectively. The fair value of those options granted in each of the three years was derived using the AIG model.
The following weighted average assumptions were used for purchase privileges granted in 2002, 2001 and 2000, respectively: dividend yields of 0.26 percent, 0.19 percent and 0.17 percent; expected volatilities of 34.0 percent, 32.0 percent and 31.0 percent; risk-free interest rates of 1.26 percent, 3.17 percent and 5.92 percent; and expected terms of 1 year.
to which stock options may be granted to any employee in any one year to 375,000 shares. Options granted under this Plan expire not more than 10 years from the date of the grant. Options with respect to 27,500 shares, 25,000 shares and 12,000 shares were granted to non-employee members of the Board of Directors on May 15, 2002, May 16, 2001 and May 17, 2000, respectively. These options become exercisable on the first anniversary of the date of grant, expire 10 years from the date of grant and do not qualify for Incentive Stock Option Treatment under the Section 422 of the Internal Revenue Code (ISO Treatment). The Plan, and the options previously granted thereunder, were approved by the shareholders at the 2000 Annual Meeting of Shareholders. At December 31, 2002, 4,140,235 shares were reserved for future grants under the 1999 Plan. The 1999 Plan superseded the 1991 employee stock option plan (the 1991 Plan) and the previously superseded 1987 employee stock option plan (the 1987 Plan), although outstanding options granted under the 1991 Plan continue in force until exercise or expiration. At December 31, 2002, there were 20,537,641 shares reserved for issuance under the 1999 and 1991 Plans.
During 2002 and 2001, AIG granted options with respect to 356,034 shares and 837,275 shares, respectively, which become exercisable on the fifth anniversary of the date of grant and expire 10 years from the date of grant. These options do not qualify for ISO Treatment. The agreements with respect to all other options granted to employees under these plans provide that 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 expire 10 years from the date of the grant. As of December 31, 2002, outstanding options granted with respect to 10,234,385 shares qualified for ISO Treatment.
During 1999, AIG issued 1,009,968 shares of AIG common stock which vested on the effectiveness of the merger with SunAmerica Inc., and an additional 993,031 shares were issued pursuant to deferred share and share unit obligations. During 2000, deferred share and share unit obligations with respect to an additional 1,224,214 shares of AIG common stock vested, 142,105 shares were issued pursuant to deferred share and share unit obligations and an additional 1,082,109 shares were delivered into a trust in connection with a deferred compensation plan. During 2002 and 2001, deferred share and share unit obligations with respect to an additional 1,895 shares and 19,930 shares, respectively, of AIG common stock vested and were issued. No additional deferred share or share unit obligations may be granted under the SunAmerica plans. As of December 31, 2002, deferred share and share unit obligations with respect to 65,657 shares remained outstanding under the SunAmerica plans.
As a result of the acquisition of HSB in November 2000, HSB options outstanding at the acquisition date were fully vested and were converted into options to purchase AIG common stock at the exchange ratio of 0.4178 shares of AIG common stock for each share of HSB common stock. No further options can be granted under the HSB option plans, but outstanding options so converted continue in force until exercise or expiration. At December 31, 2002, there were 1,413,268 shares of AIG common stock reserved for issuance under the HSB option plans, none of which qualified for ISO Treatment.
At August 29, 2001, AGC had stock-based compensation plans pursuant to which options and restricted share units had been issued and remained outstanding. Options granted under these plans had an exercise price equal to the market price on the date of the grant, had a maximum term of ten years and generally became exercisable ratably over a three-year period. All of the AGC options outstanding at the acquisition date became fully vested on that date and were converted into options to purchase AIG common stock at an exchange ratio of 0.5790 shares of AIG common stock for each share of AGC common stock. No further options can be granted under the AGC plans, but outstanding options so converted continue in force until exercise or expiration. At December 31, 2002, there were 13,862,087 shares of AIG common stock reserved for issuance on exercise of options under these plans. Options with respect to 1,898,266 of these shares qualified for ISO Treatment as of December 31, 2002.
ADDITIONAL INFORMATION WITH RESPECT TO AIG'S PLANS AT DECEMBER 31, 2002, AND CHANGES FOR THE THREE YEARS THEN ENDED, WERE AS FOLLOWS:
INFORMATION ABOUT STOCK OPTIONS OUTSTANDING AT DECEMBER 31, 2002, IS SUMMARIZED AS FOLLOWS:
(II) 2002 STOCK INCENTIVE PLAN: AIG's 2002 Stock Incentive Plan was adopted at its 2002 shareholders' meeting and amended and restated by the AIG Board of Directors on September 18, 2002. This plan provides that equity-based or equity-related awards with respect to up to a maximum of 16,000,000 shares of common stock can be issued to officers, employees or members of the Board of Directors of AIG. Under the Plan, no grantee may receive awards covering more than 250,000 shares of common stock. During 2002, AIG granted restricted stock units (RSUs) relating to 171,215 shares of common stock to employees. These RSUs will vest on the fourth anniversary of the date of grant assuming continued employment through such date. AIG reserves the right to make payment for the RSUs in shares of common stock or the cash equivalent on the date of vesting. At December 31, 2002, there were 15,828,785 shares of common stock reserved for issuance in connection with future grants of awards under the Plan.
subscription, the maximum allowable purchase limitation increased to 10 percent of an employee's annual salary or $10,000 per year, whichever is less, and the eligibility requirement was reduced from two years to one year.
AIG's U.S. postretirement medical and life insurance benefits are based upon the employee electing immediate retirement and having a minimum of ten years of service. Retirees who were age 65 by May 1, 1989 and their dependents participate in the medical plan at no cost. Employees who retired after May 1, 1989 and on or prior to January 1, 1993 pay the active employee premium if under age 65 and 50 percent of the active employee premium if over age 65. Retiree contributions are subject to adjustment annually. Other cost sharing features of the medical plan include deductibles, coinsurance and Medicare coordination and a lifetime maximum benefit of $2.0 million. The maximum life insurance benefit prior to age 70 is $32,500, with a maximum of $25,000 thereafter.
(b) AIG sponsors a voluntary savings plan for domestic employees (a 401(k) plan), which, during the three years ended December 31, 2002, provided for salary reduction contributions by employees and matching contributions by AIG of up to 6 percent of annual salary depending on the employees' years of service.
(e) HSB sponsored a voluntary savings plan for its employees (the HSB 401(k) plan), which provided for salary reduction contributions by employees and matching contributions by HSB of up to 6 percent of annual salary. The HSB voluntary savings plan merged into the AIG voluntary savings plan on January 1, 2002.
(f) AIG has certain benefits provided to 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 medical and life insurance continuation, and COBRA medical subsidies.
THE NET BENEFIT COST FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000 INCLUDED THE FOLLOWING COMPONENTS:
Participation in the SICO Plan by any person, and the amount of such participation, is at the sole discretion of SICO's Board of Directors, and none of the costs of the various benefits provided under such plan is paid by or charged to AIG. The SICO Plan provides that shares currently owned by SICO may be set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors may permit an early pay-out of units under certain circumstances. Prior to pay-out, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant's voluntary termination of employment with AIG prior to normal retirement age. In addition, SICO's Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. If the expenses of the SICO Plan had been reflected by AIG, the pre-tax amounts accrued would have been $49.4 million, $55.7 million and $76.8 million for 2002, 2001 and 2000, respectively.
Rent expense approximated $503 million, $472 million and $412 million for the years ended December 31, 2002, 2001 and 2000 respectively.
(B) MINIMUM FUTURE RENTAL INCOME ON NONCANCELABLE OPERATING LEASES OF FLIGHT EQUIPMENT WHICH HAVE BEEN DELIVERED AT DECEMBER 31, 2002 WAS AS FOLLOWS:
Flight equipment is leased, under operating leases, with remaining terms ranging from one to 15 years.
With respect to the charges of $1.36 billion incurred in the third quarter of 2001, approximately $512 million was related to direct costs of the acquisition. Of the $512 million, $85 million was attributable to investment banking, legal and accounting fees. The remaining direct costs of $427 million were related to employee severance and other termination benefits, and other compensation costs related to change in control agreements with AGC executives. The costs were also based in part on a projected elimination of positions, in accordance with AIG's post-business combination plans, which were intended to enhance the effectiveness and efficiency of the combined operations.
With respect to the elimination of positions, 2,287 terminations were included in AIG's original post-business combination plans. As of December 31, 2002, terminations totaled 1,714, including 609 made during 2001. The remaining 573 terminations are scheduled to occur in 2003, in accordance with AGC's employee termination program.
The indirect costs of $851 million represented charges resulting from post-business combination plans, recognizing that certain assets will have no future economic benefit or ability to generate future revenues. Such charges include asset impairments charges related to software, leasehold improvements and certain goodwill. Also included were certain adjustments associated with conforming AGC's balances to AIG's existing accounting policies and methodologies. Of the $851 million, $782 million had been applied as of December 31, 2002, including $669 million in 2001. The balance, $69 million, remains outstanding and is reflected as a component of "Other Liabilities" as of December 31, 2002.
AIG is a party to numerous entities that may be considered to be Variable Interest Entities (VIEs) under FIN46. Principally, such entities include special purpose vehicles (SPVs). AIG uses SPVs primarily in connection with certain guaranteed investment contract programs (GIC Programs) written by its life insurance subsidiaries, certain products provided by AIGFP, and certain invested asset and asset management activities.
In the GIC Programs, AIG's life insurance subsidiaries (principally SunAmerica Life Insurance Company) provide guaranteed investment contracts (GICs) to SPVs which are not controlled by AIG. The SPVs issue notes or bonds which are sold to third party institutional investors. Neither AIG nor the insurance company issuing the GICs has any obligation to the investors in the notes or bonds. The proceeds from the SPVs issuance of securities are used to invest in the GICs. The insurance company subsidiaries use these proceeds to invest in a diversified portfolio of securities, primarily investment grade bonds. Both the assets and the liabilities of the insurance companies arising from these GIC Programs are presented in AIG's consolidated balance sheet. Thus, at December 31, 2002, approximately $29 billion of policyholders' contract deposits represented liabilities from issuances of GICs included in these GIC Programs, offset by the proceeds from the issuances included as insurance invested assets.
AIGFP uses SPVs as an integral part of its ongoing operations with respect to specific structured transactions with independent third parties. In most instances, AIGFP controls and manages the assets and liabilities with respect to these SPVs, subject to certain transaction specific limitations. These SPVs are fully consolidated by AIG. AIGFP also sponsors an SPV that issues commercial paper and secured liquidity notes to third-party institutional investors. This SPV uses the proceeds of these offerings to obtain beneficial interests in certain financial assets (total assets of approximately $900 million), which serve as collateral for the securities issued by the SPV. AIGFP provides credit and liquidity support to this SPV, which is not consolidated by AIG.
THE FOLLOWING QUARTERLY FINANCIAL INFORMATION FOR EACH OF THE THREE MONTHS ENDED MARCH 31, JUNE 30, SEPTEMBER 30 AND DECEMBER 31, 2002 AND 2001 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.