AIG and its subsidiaries operate from approximately 250 offices in the United States, 5 offices in Canada and numerous offices in other foreign countries. The offices in Springfield, Illinois; Houston, Texas; Atlanta, Georgia; Baton Rouge, Louisiana; Wilmington, Delaware; Hato Rey, Puerto Rico; San Diego, California; Greensboro, North Carolina; Livingston, New Jersey; 70 Pine Street, 72 Wall Street and 175 Water Street in New York City; and offices in approximately 30 foreign countries including Bermuda, Hong Kong, the Philippines, Japan, England, Singapore, Taiwan and Thailand are located in buildings owned by AIG and its subsidiaries. The remainder of the office space utilized by AIG subsidiaries is leased.
(a) Represents the sum of general net premiums earned, life premium income, agency commissions, management and other fees, net investment income, financial services commissions, transaction and other fees, equity in income of minority-owned insurance operations and realized capital gains (losses). (See also tables under Item 1, "Business".)
(b) Including commercial paper and excluding that portion of long-term debt maturing in less than one year.
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Adjusted underwriting profit or loss (operating income less net investment income and realized capital gains) represents statutory underwriting profit or loss adjusted primarily for changes in deferred acquisition costs. The adjusted underwriting profits were $398.9 million in 1996, $361.6 million in 1995 and $147.5 million in 1994. (See also Notes 4 and 18 of Notes to Financial Statements.)
At December 31, 1996, general insurance reserves for losses and loss expenses (loss reserves) amounted to $33.43 billion, an increase of $383.1 million or 1.2 percent over the prior year end, and represent the accumulation of estimates of ultimate losses, including IBNR, and loss expenses and minor amounts of discounting related to certain workers' compensation claims. General insurance net loss reserves increased $714.5 million or 3.6 percent to $20.41 billion and represent loss reserves reduced by reinsurance recoverable, net of an allowance for unrecoverable reinsurance. The methods used to determine such estimates and to establish the resulting reserves are continually reviewed and updated. Any adjustments resulting therefrom are reflected in operating income currently. It is management's belief that the general insurance net loss reserves are adequate to cover all general insurance net losses and loss expenses as at December 31, 1996. In the future, if the general insurance net loss reserves develop deficiently, such deficiency would have an adverse impact on such future results of operations.
AIG continues to receive indemnity claims asserting injuries from toxic waste, hazardous substances, and other environmental pollutants and alleged damages to cover the cleanup costs of hazardous waste dump sites (hereinafter referred to collectively as environmental claims) and indemnity claims asserting injuries from asbestos. The vast majority of these asbestos and environmental claims emanate from policies written in 1984 and prior years. AIG has established a specialized claims unit which investigates and adjusts all such asbestos and environmental claims. Commencing in 1985, standard policies contained an absolute exclusion for pollution related damage. However, AIG currently underwrites pollution impairment liability insurance on a claims made basis and excluded such claims from the analyses included herein.
exposure may significantly change if the Congressional reauthorization of Superfund dramatically changes, thereby reducing or increasing litigation and cleanup costs.
In the interim, AIG and other industry members have and will continue to litigate the broadening judicial interpretation of the policy coverage and the liability issues. At the current time, it is not possible to determine the future development of asbestos and environmental claims. Such development will be affected by the extent to which courts continue to expand the intent of the policies and the scope of the coverage, as they have in the past, as well as by changes in Superfund and waste dump site coverage issues. Additional liabilities could emerge for amounts in excess of the current reserves held. Although this emergence cannot now be reasonably estimated, it could have a material adverse impact on AIG's future operating results. The reserves carried for these claims at December 31, 1996 are believed to be adequate as these reserves are based on the known facts and current law. Furthermore, as AIG's net exposure retained relative to the gross exposure written was lower in 1984 and prior years, the potential impact of these claims is much smaller on the net loss reserves than on the gross loss reserves. (See the previous discussion on reinsurance collectibility herein.)
A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined at December 31, 1996, 1995 and 1994 was as follows:
A summary of asbestos and environmental claims count activity for the years ended December 31, 1996, 1995 and 1994 was as follows:
An insurance rating agency has developed a survival ratio to measure the number of years it would take a company to exhaust both its asbestos and environmental reserves for losses and loss expenses based on that company's current level of asbestos and environmental claims payments. The higher the ratio, the more years the reserves for losses and loss expenses cover these claims payments. These ratios are computed based on the ending reserves for losses and loss expenses over the claims settlements during the fiscal year. Such payments include indemnity payments and legal and loss adjustment payments. It should be noted, however, that this is an extremely simplistic approach to measuring asbestos and environmental reserve levels. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have significant impact on the amount of asbestos and environmental losses and loss expense reserves, ultimate payments thereof and the resultant ratio.
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AIG's operations are negatively impacted under guarantee fund assessment laws which exist in most states. As a result of operating in a state which has guarantee fund assessment laws, a solvent insurance company may be assessed for certain obligations arising from the insolvencies of other insurance companies which operated in that state. AIG generally records these assessments upon notice. Additionally, certain states permit at least a portion of the assessed amount to be used as a credit against a company's future premium tax liabilities. Therefore, the ultimate net assessment cannot reasonably be estimated. The guarantee fund assessments net of credits for 1996, 1995 and 1994 were $18.8 million, $23.5 million and $28.2 million, respectively.
AIG is also required to participate in various involuntary pools (principally workers' compensation business) which provide insurance coverage for those not able to obtain such coverage in the voluntary markets. This participation is also recorded upon notification, as these amounts cannot reasonably be estimated. (See also Note 18 of Notes to Financial Statements.)
Financial services operations for the twelve month periods ending December 31, 1996, 1995 and 1994 were as follows:
International Lease Finance Corporation (ILFC) generates its revenues primarily from leasing new and used commercial jet aircraft to domestic and foreign airlines. Revenues also result from the remarketing of commercial jets for its own account, for airlines and for financial institutions. Revenues in 1996 increased 13.2 percent from 1995 compared to a 25.6 percent increase during 1995 from 1994. The revenue growth in each year resulted primarily from the growth both in the size and relative cost of the fleet. During 1996, operating income increased 16.3 percent from 1995 and 6.3 percent during 1995 from 1994. The average borrowing cost during 1996 was 6.23 percent while the 1995 and 1994 costs were 6.47 percent and 6.41 percent, respectively. Declines in interest rates generally have a positive effect on leasing margins. (See also the discussions under "Capital Resources" and "Liquidity" herein.)
were not leased. Subsequently, two of these aircraft have been sold and two aircraft have been committed for lease. During 1996, slightly over 80 percent of the revenue derived from the rental of aircraft equipment was from foreign carriers. (See also the discussions under "Capital Resources" and "Liquidity" herein.)
AIG Trading Group Inc. and its subsidiaries (AIGTG) derive a substantial portion of their revenues from market making and trading activities, as principals, in foreign exchange, interest rates, precious and base metals and natural gas and other energy products. As a result of a decline in the volatility of AIGTG's major markets and fewer structured transactions, revenues in 1996 decreased 9.0 percent from 1995 compared to a 28.6 percent increase during 1995 from 1994. During 1996, operating income increased 16.6 percent from 1995 and 24.5 percent during 1995 from 1994. (See also the discussions under "Capital Resources," "Liquidity" and "Derivatives" herein.)
Financial services operating income represented 13.1 percent of AIG's income before income taxes in 1996. This compares to 12.1 percent and 13.7 percent in 1995 and 1994, respectively.
In 1996, AIG's equity in income of minority-owned insurance operations was $99.4 million compared to $81.7 million in 1995 and $56.0 million in 1994. In 1996, the equity interest in insurance companies represented 2.5 percent of income before income taxes compared to 2.4 percent in 1995 and 1.9 percent in 1994.
Other realized capital losses amounted to $11.8 million, $28.9 million and $52.3 million in 1996, 1995 and 1994, respectively.
Other income (deductions)-net includes AIG's equity in certain minor majority-owned subsidiaries and certain partially-owned companies, realized foreign exchange transaction gains and losses in substantially all currencies and unrealized gains and losses in hyperinflationary currencies, as well as the income and expenses of the parent holding company and other miscellaneous income and expenses. In 1996, net deductions amounted to $84.4 million. In 1995 and 1994, net deductions amounted to $91.2 million and $68.6 million, respectively.
Net income amounted to $2.90 billion in 1996, $2.51 billion in 1995 and $2.18 billion in 1994. The increases in net income over the three year period resulted from those factors described above.
Total borrowings at December 31, 1996 and 1995 were as follows:
AIG Funding, Inc. (Funding), through the issuance of commercial paper, fulfills the short-term cash requirements of AIG and its subsidiaries. Funding intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of Funding's commercial paper is subject to the approval of AIG's Board of Directors. ILFC and A.I. Credit Corp. (AICCO) issue commercial paper for the funding of their own operations. AIG does not guarantee AICCO's or ILFC's commercial paper. However, AIG has entered into an agreement in support of AICCO's commercial paper. From time to time, AIGFP may issue commercial paper, which AIG guarantees, to fund its operations. At December 31, 1996, AIGFP had no commercial paper outstanding. (See also the discussion under "Derivatives" herein and Note 9 of Notes to Financial Statements.)
AIG and Funding have entered into two syndicated revolving credit facilities (the Facilities) aggregating $1 billion. The Facilities consist of a $500 million 364 day revolving credit facility and a $500 million five year revolving credit facility. The Facilities can be used for general corporate purposes and also provide backup for AIG's commercial paper programs administered by Funding. There are currently no borrowings outstanding under either of the Facilities, nor were any borrowings outstanding as of December 31, 1996.
At December 31, 1996, ILFC had increased the aggregate principal amount outstanding of its medium term and term notes to $6.05 billion, a net increase of $110.0 million, and recorded a net decline in its capital lease obligations of $92.6 million and a net increase in its commercial paper of $904.5 million. At December 31, 1996, ILFC had $636 million in aggregate principal amount of debt securities registered for issuance from time to time. In February 1997, ILFC reduced this registered amount through the sale of debt securities amounting to $546 million aggregate principal amount and registered for issuance from time to time $2.1 billion in aggregate principal amount of debt securities. The cash used to purchase flight equipment, including progress payments during the construction phase, is primarily derived from the proceeds of ILFC's debt financing. The primary sources for the repayment of this debt and the interest expense thereon are the cash flow from operations, proceeds from the sale of flight equipment and the rollover of prior debt. (See also the discussions under "Operational Review" and "Liquidity" herein.)
During 1996, AIG issued $100.0 million principal amount of medium term notes at rates ranging from 6.05 percent to 6.25 percent per annum for three year terms. During 1996, $75.0 million of previously issued medium term notes matured. At December 31, 1996 AIG had $647.0 million in aggregate principal amount of debt securities registered for issuance from time to time.
Payments of dividends to AIG by its insurance subsidiaries are subject to certain restrictions imposed by statutory authorities. AIG has in the past reinvested most of its unrestricted earnings in its operations and believes such continued reinvestment in the future will be adequate to meet any foreseeable capital needs. However, AIG may choose from time to time to raise additional funds through the issuance of additional securities. At December 31, 1996, there were no significant statutory or regulatory issues which would impair AIG's financial condition, results of operations or liquidity. (See also the discussion under "Liquidity" herein and Note 10 of Notes to Financial Statements.)
At December 31, 1996, AIG's consolidated invested assets included approximately $2.07 billion of cash and short-term investments. Consolidated net cash provided from operating activities in 1996 amounted to approximately $9.57 billion.
AIG received approximately $1.6 billion and $1.1 billion from redemptions of held to maturity municipal bonds during 1996 and 1995, respectively. Prior to redemption, the yield on these bonds approximated seven percent and eight percent in 1996 and 1995, respectively. The yield on the reinvestment of the proceeds in bonds with similar characteristics averaged approximately 5.6 percent and 6.0 percent in 1996 and 1995, respectively. AIG does not anticipate that these redemptions will have a significant effect on AIG's general investment income, operations, financial condition or liquidity.
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. At December 31, 1996, approximately 40 percent of the foreign fixed income investments were either rated AAA or, on the basis of AIG's internal analysis, were equivalent from a credit standpoint to securities so rated. Less than one percent of these investments were deemed below investment grade and approximately four percent were not rated at that date.
Although AIG's fixed income insurance portfolios contain only minor amounts of securities below investment grade, any fixed income security may be subject to downgrade for a variety of reasons subsequent to any balance sheet date. There have been no significant downgrades as at March 1, 1997.
AIG's real estate investment properties are primarily occupied by AIG's various operations. The current market value of these properties considerably exceeds their carrying value.
At December 31, 1996, ILFC had committed to purchase or had secured positions for 243 aircraft deliverable from 1997 through 2004 at an estimated aggregate purchase price of $13.3 billion and had options to purchase an additional 35 aircraft deliverable through 2005 at an estimated aggregate purchase price of $2.8 billion. As at March 11, 1997, ILFC has entered into leases, letters of intent to lease or is in various stages of negotiation for all of the aircraft to be delivered in 1997 and 44 of 179 aircraft to be delivered subsequent to 1997. 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.
Securities available for sale, at market value and securities purchased under agreements to resell are purchased with the proceeds of AIGFP's GIA financings and other long and short term borrowings. The proceeds from the disposal of securities available for sale and securities purchased under agreements to resell have been used to fund the maturing GIAs or other
AIGTG conducts, as principal, market making and trading activities in foreign exchange, interest rates, precious and base metals and natural gas and other energy products. AIGTG owns inventories in the commodities in which it trades and may reduce the exposure to market risk through the use of swaps, forwards, futures and option contracts. AIGTG uses derivatives to manage the economic exposure of its various trading positions and transactions from adverse movements of interest rates, exchange rates and commodity prices. AIGTG supports its trading activities largely through trading liabilities, unrealized losses on swaps, short-term borrowings and spot commodities sold but not yet purchased. (See also the discussions under "Capital Resources" and "Derivatives" herein.)
The most commonly used swaps are interest rate and currency swaps. An interest rate swap is a contract between two parties to exchange interest rate payments (typically a fixed interest rate versus a variable interest rate) calculated on a notional principal amount for a specified period of time. The notional amount is not exchanged. A currency swap is similar but the notional amounts are different currencies which are typically exchanged at the commencement and termination of the swap based upon negotiated exchange rates.
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 or through on-line computer systems. In addition, these positions are reviewed by AIGTG's management. Reports which present each trading book's position and the prior day's profit and loss are reviewed by traders, head traders and AIGTG's senior management. Based upon these and other reports, AIGTG's senior management may determine to adjust AIGTG's risk profile.
(a) See also Note 8 (e) of Notes to Financial Statements. (b) These amounts are also presented as the respective balance sheet amounts. (c) At December 31, 1996, AIGTG's replacement values with respect to interest rate and currency swaps were $514.0 million.
The following tables provide the notional and contractual amounts of AIGFP's and AIGTG's derivatives transactions at December 31, 1996.
to potential loss after the application of the aforementioned strategies, ISDA Master Agreements and collateral held.
The following tables provide the notional and contractual amounts of AIGTG's derivatives portfolio at December 31, 1996. In addition, the estimated positive fair values associated with the derivatives portfolio are also provided and include a maturity profile for the December 31, 1996 balances based upon the expected timing of the future cash flows.
The following tables present AIGTG's derivatives portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1996:
* Exchange traded futures and options are not deemed to have significant credit exposure as the exchanges guarantee that every contract will be properly settled on a daily basis.
FASB 128 is effective for year end 1997. Although earlier application is not permitted, all prior period information is required to be restated upon adoption.
(A) PRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of American International Group, Inc. and all significant subsidiaries (AIG). All material intercompany accounts and transactions have been eliminated.
The liabilities for future policy benefits and policyholders' contract deposits are established using assumptions described in Note 6.
Financial Services Operations: AIG participates in the derivatives dealer market conducting, primarily as principal, an interest rate, currency and equity derivative products business. AIG also enters into 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) INVESTMENTS IN FIXED MATURITIES AND EQUITY SECURITIES: Bonds and preferred stocks held to maturity, both of which are principally owned by the insurance subsidiaries, are carried at amortized cost where AIG has the ability and positive intent to hold these securities until maturity. Where AIG may not have the positive intent to hold these securities until maturity, those bonds are considered to be available for sale and carried at current market values. Included in the bonds available for sale are collateralized mortgage obligations (CMOs). Premiums and discounts arising from the purchase of CMOs are treated as yield adjustments over their estimated life. Bond trading securities are carried at current market values, as it is AIG's intention to sell these securities in the near term. Common and non-redeemable preferred stocks are carried at current market values.
Realized capital gains and losses are determined principally by specific identification. Where declines in values of securities below cost or amortized cost are considered to be other than temporary, a charge is reflected in income for the difference between amortized cost and estimated net realizable value.
(D) MORTGAGE LOANS ON REAL ESTATE, POLICY AND COLLATERAL LOANS--NET: Mortgage loans on real estate, policy loans and collateral loans are carried at unpaid principal balances. Impairment of mortgage loans on real estate and collateral loans is generally measured based on the present value of expected future cash flows discounted at the loan's effective interest rate subject to the fair value of underlying collateral. Interest income on such loans is recognized as cash is received.
(F) SECURITIES AVAILABLE FOR SALE, AT MARKET VALUE: These securities are held to meet long term investment objectives and are accounted for as available for sale, carried at current market values and recorded on a trade date basis. Unrealized gains and losses from valuing these securities and any related hedges are reflected in capital funds currently, net of any related deferred income taxes.
(G) 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.
(N) 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). Equity in income of minority-owned insurance operations is presented separately in the consolidated statement of income. Equity in realized capital gains of such companies is included in other realized capital gains (losses). Equity in net income of other unconsolidated companies is principally included in other income (deductions)-net. At December 31, 1996, AIG's significant investments in partially-owned companies included its 49.1 percent interest in Transatlantic Holdings, Inc. (Transatlantic), which derives approximately 20 percent of its assumed reinsurance from AIG subsidiaries; its 19.9 percent interest in Richmond Insurance Company; its 23.9 percent interest in SELIC Holdings, Ltd; and its 24.4 percent interest in IPC Holdings, Ltd. This balance sheet caption also includes investments in less significant partially-owned companies and in certain minor majority-owned subsidiaries. At December 31, 1996, the market value of AIG's investment in Transatlantic exceeded its carrying value by approximately $320.4 million.
and stock splits. The effect of all other common stock equivalents is not significant for any period presented.
In February 1997, the Securities and Exchange Commission (SEC) issued Financial Reporting Release No. 48 "Disclosure of Accounting Policies for Derivative Financial Instruments and Derivative Commodity Instruments and Disclosure of Quantitative and Qualitative Information about Market Risk Inherent in Derivative Financial Instruments, Other Financial Instruments, and Derivative Commodity Instruments"(FRR No. 48).
FRR No. 48 amends rules and forms for registrants and requires clarification and expansion of existing disclosures for derivative financial instruments, other financial instruments and derivative commodity instruments, as defined therein. The amendments require enhanced disclosure with respect to these derivative instruments in the footnotes to the financial statements. Additionally, the amendments expand existing disclosure requirements to include quantitative and qualitative discussions with respect to market risk inherent in market risk sensitive instruments such as equity and fixed maturity securities, as well as these derivative instruments. These amendments are designed to provide additional information about market risk sensitive instruments which investors can use to better understand and evaluate market risk exposures of registrants, including AIG. These disclosures will be effective with AIG's reporting during 1997.
(a) AIG and its domestic subsidiaries file a consolidated U.S. Federal income tax return. A Revenue Agent's Report assessing additional taxes for the years 1987 and 1988 has been issued and a Letter of Protest contesting the assessments has been filed with the Internal Revenue Service. It is management's belief that there are substantial arguments in support of the positions taken by AIG in its Letter of Protest. Management also believes that the final result of these examinations will be immaterial to the financial statements.
Foreign income not expected to be taxed in the United States has arisen because AIG's foreign subsidiaries were generally not subject to U.S. income taxes on income earned prior to January 1, 1987. Such income would become subject to U.S. income taxes at current tax rates if remitted to the United States or if other events occur which would make these amounts currently taxable. The cumulative amount of undistributed earnings of AIG's foreign subsidiaries currently not subject to U.S. income taxes was approximately $3.1 billion at December 31, 1996. Management presently has no intention of subjecting these accumulated earnings to material U.S. income taxes and no provision has been made in the accompanying financial statements for such taxes.
Income taxes paid in 1996, 1995 and 1994 amounted to $1,068,500,000, $1,065,700,000 and $741,900,000, respectively.
During 1994, the Internal Revenue Service issued Treasury Regulations that affect the tax accounting method for companies which enter into hedging transactions. The effect of these Regulations was to accelerate the timing of AIG's income tax payments.
AIG life companies limit exposure to loss on any single life. For ordinary insurance, AIG retains a maximum of approximately one million dollars of coverage per individual life. There are smaller retentions for other lines of business. Life reinsurance is effected principally under yearly renewable term treaties. Amounts recoverable from life reinsurers are estimated in a manner consistent with the assumptions used for the underlying policy benefits and are presented as a component of reinsurance assets.
In the normal course of their operations, certain AIG subsidiaries are provided reinsurance coverages from AIG's minority-owned reinsurance companies. During 1996, 1995 and 1994, the premiums written which were ceded to Transatlantic amounted to $232,000,000, $189,000,000 and $200,000,000, respectively.
For the years ended December 31, 1996, 1995 and 1994, reinsurance recoveries, which reduced loss and loss expenses incurred, amounted to $5.07 billion, $5.14 billion and $4.84 billion, respectively.
(ii) Mortality and surrender rates are based upon actual experience by geographical area modified to allow for variations in policy form. The weighted average lapse rate, including surrenders, for individual and group life approximated 8.1 percent.
(iv) The universal life funds have credited interest rates of 4.5 percent to 7.5 percent and guarantees ranging from 3.5 percent to 5.5 percent depending on the year of issue. Additionally, universal life funds are subject to surrender charges that amount to 10.0 percent of the fund balance grading to zero over a period not longer than 20 years.
(C) INVESTMENT GAINS AND LOSSES: The realized capital gains (losses) and increase (decrease) in unrealized appreciation of investments for 1996, 1995 and 1994 were as follows:
(b) Includes $51.2 million increase, $480.9 million increase and $440.5 million decrease in unrealized appreciation attributable to participating policyholders at December 31, 1996, 1995 and 1994, respectively.
The amortized cost and estimated market value of bonds available for sale and carried at market value at December 31, 1996 and 1995 were as follows:
(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 $2.40 billion of securities available for sale. At December 31, 1996, the cumulative increase in carrying value of the securities available for sale and related hedges as a result of marking to market such securities net of hedging transactions was $10.2 million.
(F) CMOS: At December 31, 1996, CMOs, held by AIG's life companies, were presented as a component of bonds available for sale, at market value. All of the CMOs were investment grade and approximately 72 percent of the CMOs were backed by various U.S. government agencies. The remaining 28 percent were corporate issuances.
At December 31, 1996 and 1995, the market value of the CMO portfolio was $2.24 billion; the amortized cost was approximately $2.18 billion in 1996 and $2.12 billion in 1995. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 1996 and 1995.
The distribution of the CMOs at December 31, 1996 and 1995 was as follows:
(G) FIXED MATURITIES BELOW INVESTMENT GRADE: At December 31, 1996, the fixed maturities and securities available for sale held by AIG that were below investment grade were insignificant.
(H) At December 31, 1996, non-income producing invested assets were insignificant.
(B) BORROWINGS UNDER OBLIGATIONS OF GUARANTEED INVESTMENT AGREEMENTS: Borrowings under obligations of guaranteed investment agreements, which are guaranteed by AIG, are recorded at the amount outstanding under each contract. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings are primarily fixed and range up to 10.6 percent.
At December 31, 1996, the market value of securities pledged as collateral with respect to these obligations approximated $1.2 billion.
The interest rates on this debt range from 6.05 percent to 8.12 percent. To the extent deemed appropriate, AIG may enter into swap transactions to reduce its effective short-term borrowing rate.
At December 31, 1996, the maturity schedule for AIG's outstanding Medium Term Notes was as follows:
At December 31, 1996, the maturity schedule for ILFC's outstanding Medium Term Notes was as follows:
(i) Zero Coupon Notes:On October 1, 1984, AIG issued Eurodollar zero coupon notes in the aggregate principal amount at stated maturity of $750 million. The notes were offered at 12 percent of principal amount at stated maturity, bear no interest and are due August 15, 2004. The net proceeds to AIG from the issuance were $85.6 million. The notes are redeemable at any time in whole or in part at the option of AIG at 100 percent of their principal amount at stated maturity. The notes are also redeemable at the option of AIG or bearer notes may be redeemed at the option of the holder in the event of certain changes involving taxation in the United States at prices ranging from 42.59 percent currently, to 89.88 percent after August 15, 2003, of the principal amount at stated maturity together with accrued amortization of original issue discount from the preceding August 15. During 1996 and 1995, no notes were repurchased. At December 31, 1996, the notes outstanding had a face value of $189.2 million, an unamortized discount of $107.4 million and a net book value of $81.8 million. The amortization of the original issue discount was recorded as interest expense.
As of December 31, 1996, notes in aggregate principal amount of $3.5 billion were outstanding with maturity dates from 1997 to 2004 and interest rates ranging from 4.75 percent to 8.88 percent. $500 million of such term notes are at floating interest rates and the remainder are at fixed rates. These notes provide for a single principal payment at maturity.
At December 31, 1996, the maturity schedule for ILFC's Term Notes was as follows:
(iv) Notes and Bonds Payable Issued by AIGFP:At December 31, 1996, AIGFP's bonds outstanding, the proceeds of which are invested in a segregated portfolio of securities available for sale, were as follows:
(E) LOANS AND MORTGAGES PAYABLE: Loans and mortgages payable at December 31, 1996, consisted of the following:
(F) REVOLVING CREDIT FACILITIES: AIG and Funding have entered into two syndicated revolving credit facilities (the Facilities) aggregating $1 billion. The Facilities consist of a $500 million 364 day revolving credit facility and a $500 million five year revolving credit facility. The Facilities can be used for general corporate purposes and also provide backup for AIG's commercial paper programs administered by Funding. There are currently no borrowings outstanding under either of the Facilities, nor were any borrowings outstanding as of December 31, 1996.
(G) INTEREST EXPENSE FOR ALL INDEBTEDNESS: Total interest expense for all indebtedness, net of capitalized interest, aggregated $1,491,318,000 in 1996, $1,361,140,000 in 1995 and $1,289,277,000 in 1994. Interest expense paid approximated $1,594,733,000 in 1996, $1,318,736,000 in 1995 and $1,055,503,000 in 1994.
(a) At December 31, 1996, there were 6,000,000 shares of AIG's $5 par value serial preferred stock authorized, issuable in series.
(b) AIG parent depends on its subsidiaries for cash flow in the form of loans, advances and dividends. AIG's insurance subsidiaries are subject to regulatory restrictions on the amount of dividends which can be remitted to AIG parent. These restrictions vary by state. For example, unless permitted by the New York Superintendent of Insurance, general insurance companies domiciled in New York may not pay dividends to shareholders which in any twelve month period exceed the lesser of 10 percent of the company's statutory policyholders' surplus or 100 percent of its "adjusted net investment income", as defined. Generally, less severe restrictions applicable to both general and life insurance companies exist in most of the other states in which AIG's insurance subsidiaries are domiciled. Certain foreign jurisdictions have restrictions which generally cause only a temporary delay in the remittance of dividends. There are also various local restrictions limiting cash loans and advances to AIG by its subsidiaries. Largely as a result of the restrictions, approximately 60 percent of consolidated capital funds were restricted from immediate transfer to AIG parent at December 31, 1996.
(a) Commitments to extend credit are agreements to lend subject to certain conditions. These commitments generally have fixed expiration dates or termination clauses and typically require payment of a fee. At December 31, 1996 and 1995, these commitments, made principally by AIG Capital Corp., approximated $95,200,000 and $96,300,000, respectively. AIG uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. AIG evaluates each counterparty's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by AIG upon extension of credit, is based on management's credit evaluation of the counterparty.
AIGFP, as principal and for its own account, enters into interest rate, currency and equity swaps, swaptions and forward commitments. Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. AIGFP typically becomes a principal in the exchange of interest payments between the parties and, therefore, may be exposed to loss, if counterparties default. Currency and equity swaps are similar to interest rate swaps, but may involve the exchange of principal amounts at the beginning and end of the transaction. At December 31, 1996, the notional principal amount of the sum of the swap pays and receives approximated $210.7 billion, primarily related to interest rate swaps of approximately $165.8 billion.
The notional amounts used to express the extent of AIGFP's, AIGTG's and ILFC's involvement in swap transactions represent a standard of measurement of the volume of AIGFP's, AIGTG's and ILFC's swaps business. Notional amount is not a quantification of market risk or credit risk and it may not necessarily be recorded on the balance sheet. Notional amounts represent those amounts used to calculate contractual cash flows to be exchanged and are not paid or received, except for certain contracts such as currency swaps.
These instruments involve, to varying degrees, elements of credit risk not explicitly recognized in the consolidated financial statements. AIGFP utilizes various credit enhancements, including collateral, credit triggers and credit derivatives to reduce the credit exposure relating to these off-balance sheet financial instruments. AIGFP requires credit enhancements in connection with specific transactions based on, among other things, the creditworthiness of the counterparties and the transaction's size and maturity. In addition, AIGFP's derivative transactions are generally documented under ISDA Master Agreements. Such agreements provide for legally enforceable set-off and close out netting of exposures to specific counterparties. Under such agreements, in connection with an early termination of a transaction, AIGFP is permitted to set off its receivables from a counterparty against its payables to the same counterparty arising out of all included transactions. As a result, the net replacement value represents the net sum of estimated positive fair values after the application of such strategies, agreements and collateral held. The net replacement value most closely represents the net credit risk to AIGFP or the maximum amount exposed to potential loss. The net replacement value of all interest rate, currency, and equity swaps, swaptions and forward commitments at December 31, 1996, approximated $6.4 billion. The net replacement value for futures and forward contracts at December 31, 1996, approximated $34.3 million.
AIGFP has entered into commitments to provide liquidity for certain tax-exempt variable rate demand notes issued by municipal entities. The agreements allow the holders, in certain circumstances, to tender the notes to the issuer at par value. In the event a remarketing agent of an issuer is unable to resell such tendered notes, AIGFP would be obligated to purchase the notes at par value. With respect to certain notes that have been issued, AIGFP has fulfilled its liquidity commitments by arranging bank liquidity facilities. These banks agree to purchase the notes that AIGFP is otherwise obligated to purchase in connection with a failed remarketing. It is the intention of AIGFP to arrange similar liquidity with respect to the $603.3 million aggregate amount of notes that are expected to be issued through 1999. In connection with one transaction that has a bank liquidity facility, AIGFP has committed through December 31, 1997 to purchase up to $278.0 million of notes in the event the bank is required to purchase notes under the liquidity facility. Any notes so purchased by AIGFP would be insured as to both principal and interest and, while held by AIGFP, would bear interest at an above-market tax-exempt rate. It is AIGFP's intention, as with existing obligations, to remove itself from this risk through bank participations before the issuance of the underlying notes.
(d) AIG Trading Group Inc. and its subsidiaries (AIGTG) becomes a party to off-balance sheet financial instruments in the normal course of its business and to reduce its currency, interest rate and commodity exposures.
The gross replacement values presented represent the sum of the estimated positive fair values of all of AIGTG's derivatives contracts at December 31, 1996. These values do not represent the credit risk to AIGTG.
Options are contracts that allow the holder of the option to purchase or sell the underlying commodity, currency or index at a specified price and within, or at, a specified period of time. Risks arise as a result of movements in current market prices from contracted prices, and the potential inability of the counterparties to meet their obligations under the contracts. At December 31, 1996, the contractual amount of AIGTG's purchased options approximated $28.9 billion.
As a writer of options, AIGTG generally receives an option premium and then manages the risk of any unfavorable change in the value of the underlying commodity, currency or index. At December 31, 1996, the contractual amount for sold options approximated $32.4 billion.
The following table presents AIGTG's options portfolio and the associated credit exposure, if applicable, by maturity and type of derivative at December 31, 1996:
At December 31, 1996, AIGTG had issued and outstanding $230.6 million principal amount of letters of credit. These letters of credit were issued primarily to various exchanges.
(e) At December 31, 1996, ILFC had committed to purchase or had secured positions for 243 aircraft deliverable from 1997 through 2004 at an estimated aggregate purchase price of $13.3 billion and had options to purchase an additional 35 aircraft deliverable through 2005 at an estimated aggregate purchase price of $2.8 billion. ILFC will be required to find customers for any aircraft presently on order and any aircraft to be ordered, and it must arrange financing for portions of the purchase price of such equipment.
AIG continues to receive indemnity 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, 1996 ($2.30 billion gross; $742.9 million net) are believed to be adequate as these reserves are based on known facts and current law.
(b) For 1996, paid losses for asbestos include certain unusual and non-recurring payments that satisfied historical settlement agreements.
Fixed maturity securities: Fair values for fixed maturity securities carried at amortized cost or at market value were generally based upon quoted market prices. For certain fixed maturity securities for which market prices were not readily available, fair values were estimated using values obtained from independent pricing services. No other fair valuation techniques were applied to these bonds as AIG believes it would have to expend excessive costs for the benefits derived.
Mortgage loans on real estate, policy and collateral loans: Where practical, the fair values of loans on real estate and collateral loans were estimated using discounted cash flow calculations based upon AIG's current incremental lending rates for similar type loans. The fair values of the policy loans were not calculated as AIG believes it would have to expend excessive costs for the benefits derived.
Deposits due to banks and other depositors: To the extent certain amounts are not demand deposits or certificates of deposit which mature in more than one year, fair values were not calculated as AIG believes it would have to expend excessive costs for the benefits derived.
Additional information with respect to AIG's plans at December 31, 1996, and changes for the three years then ended, was as follows:
were $19.71 and $14.90, respectively. The fair value of each purchase right is estimated on the date of the subscription using the Black-Scholes model.
The following weighted average assumptions were used for grants in 1996 and 1995, respectively: dividend yields of 0.37 percent and 0.32 percent, expected volatilities of 21.9 percent and 16.9 percent, risk-free interest rates of 5.54 percent and 5.64 percent, and expected terms of 1 year.
The following table sets forth the funded status of the various pension plans and the amounts recognized in the accompanying consolidated balance sheet as of December 31, 1996 and 1995:
Net pension cost for the years ended December 31, 1996, 1995 and 1994 included the following components:
* Net pension expense included $34,584, $30,978 and $26,727 related to non-U.S. plans for 1996, 1995 and 1994, respectively.
(b) AIG sponsors a voluntary savings plan for domestic employees (a 401(k) plan), which, during the year ended December 31, 1994, provided for salary reduction contributions by employees and matching contributions by AIG of up to 2 percent of annual salary. Commencing January 1, 1995, the 401(k) plan provided for matching contributions by AIG of up to 6 percent of annual salary depending on the employees' years of service.
* The Medical trend rate grades downward from years 1 through 4 domestically and years 1 through 9 for the foreign benefits. The trend rates remain level thereafter.
The net periodic postretirement costs for the years ended December 31, 1996, 1995 and 1994 included the following components:
(d) AIG has certain benefits provided to former or inactive employees who are not retirees. Certain of these benefits are insured and expensed currently; other expenses are provided for currently. Such uninsured expenses include long and short-term disability medical and life insurance continuation, short-term disability income continuation and COBRA medical subsidies. The provision for these benefits at December 31, 1996 was $6.0 million. The incremental expense was insignificant.
Agency and Service Fee - AIG's agency operations are engaged in the production and management of various types of insurance for affiliated and non-affiliated companies.
The following table is a summary of the operations by major operating segments for the years ended December 31, 1996, 1995 and 1994:
(b) The following table is a summary of AIG's general insurance operations by major operating category for the years ended December 31, 1996, 1995 and 1994: