(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 reinsurance operations and realized capital gains. (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.
Net premiums written are initially deferred and earned based upon the terms of the underlying policies. The net unearned premium reserve constitutes the deferred earnings which are generally earned ratably over the policy period. Thus, the net unearned premium reserve is not fully recognized as net premiums earned until the end of the policy period.
Adjusted underwriting profit or loss (operating income less net investment income and realized capital gains) represents statutory underwriting profit or loss adjusted primarily for changes in the deferral of acquisition costs. (See also Note 4 of Notes to Financial Statements.) The adjusted underwriting profit in 1993 was $10.4 million compared to adjusted underwriting losses of $195.1 million recorded in 1992 and $4.8 million in 1991.
AIG's reinsurance recoverable results from its reinsurance arrangements. These arrangements do not relieve AIG from its direct obligation to its insureds. Thus, a contingent liability of approximately $12 billion existed at December 31, 1993 with respect to general reinsurance reserves for loss and loss expenses ceded (reinsurance recoverable) to the extent that reinsurers are unable to meet their obligations assumed under the reinsurance agreements. However, AIG holds substantial collateral as security under related reinsurance agreements in the form of funds, securities and/or irrevocable letters of credit which can be drawn on for amounts that remain unpaid beyond specified time periods. Although a provision is recorded for estimated unrecoverable reinsurance, AIG has been largely successful in prior recovery efforts. (See also Note 5 of Notes to Financial Statements.)
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. 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 the current reserves held. This emergence cannot now be reasonably estimated, but could have a material impact on AIG's future operating results and financial condition. The reserves carried for these claims as at December 31, 1993 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 those 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.)
The gross and net IBNR included in the reserve for loss and loss expenses at December 31, 1993 for environmental claims approximated $245 million and $85 million, respectively; for 1992, $225 million and $75 million, respectively; for 1991, $210 million and $60 million, respectively. Most of the claims included in the following table relate to policies written in 1984 and prior years.
General insurance realized capital gains were $65.3 million in 1993, $67.1 million in 1992 and $89.3 million in 1991. These realized gains resulted from the ongoing management of the general insurance investment portfolios within the overall objectives of the general insurance operations and arose primarily from the disposition of equity securities and fixed maturities, including redemptions of fixed maturities.
A year to year comparison of operating income is significantly influenced by the catastrophe losses in any one year as well as the volatility from one year to the next in realized capital gains. Adjusting each year to exclude the effects of both catastrophe losses and realized capital gains, operating income would have increased by 13.9 percent in 1993, 1.7 percent in 1992 and 5.1 percent in 1991. The increase in the growth rate of 1993 over 1992 after the aforementioned adjustments was a result of the increased net investment income as previously discussed and improvement in underwriting results. The decline in the growth rate in 1992 as compared to 1991 is primarily a result of the higher level of incurred losses and the general downward trend in interest rates, as discussed above.
percent increase from the prior year. This compares with increases of 19.6 percent and 16.7 percent in 1992 and 1991, respectively. The foreign ordinary life products were the major contributor to premium growth in all three years. In 1993, foreign life operations produced 95.3 percent of the life premium income and 94.4 percent of the operating income. (See also Notes 1, 4 and 6 of Notes to Financial Statements.)
Traditional life insurance products such as whole life and endowment continue to be significant in the overseas companies, especially in Southeast Asia, while a mixture of traditional, accident and health and financial products are being sold in Japan.
Underwriting risk represents the exposure to loss resulting from the actual policy experience adversely emerging in comparison to the assumptions made in the product pricing associated with mortality, morbidity, termination and expenses. AIG's life companies limit their maximum underwriting exposure on traditional life insurance of a single life to approximately $1 million of coverage by using yearly renewable term reinsurance. The life insurance operations have not entered into assumption reinsurance transactions or surplus relief transactions during the three year period ended December 31, 1993. (See also Note 5 of Notes to Financial Statements.)
The asset-liability relationship is appropriately managed in AIG's foreign operations, 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 such policy liabilities. Therefore, there is a risk that the reinvestment of the proceeds at the maturity of the investments may be at a yield below that of the interest required for the accretion of the policy liabilities. In Japan, the average duration of the investment portfolio is 5.3 years, while the related policy liabilities are estimated to be 7.4 years. To maintain an adequate yield to match the interest required over the duration of the liabilities, constant management focus is required to reinvest the proceeds of the maturing securities without sacrificing investment quality. To the extent permitted under local regulation, AIG may invest in qualified longer-term securities outside Japan to achieve a closer matching in both duration and the required yield. AIG is able to manage any asset-liability duration difference through maintenance of sufficient global liquidity and support of any operational shortfall through its international financial network. Domestically, the asset-liability matching process is appropriately functioning as there are investments available to match the duration and the required yield. (See also the discussion under "Liquidity" herein.)
Life insurance realized capital gains were $54.6 million in 1993, $43.3 million in 1992 and $23.2 million in 1991. These realized gains resulted from the ongoing management of the life insurance investment portfolios within the overall objectives of the life insurance operations and arose primarily from the redemption of fixed maturities and, to a smaller extent, from the disposition of equity securities.
Life insurance operating income in 1993 increased 17.1 percent to $781.6 million compared to increases of 18.8 percent and 21.4 percent in 1992 and 1991, respectively. Excluding realized capital gains from life insurance operating income, the percent increases would be 16.5 percent, 15.9 percent and 14.8 percent in 1993, 1992 and 1991, respectively. The contribution of life insurance operating income to income before income taxes and the cumulative effect of accounting changes amounted to 30.0 percent in 1993 compared to 31.2 percent in 1992 and 27.8 percent in 1991.
Agency and service fee operating income in 1993 increased 14.6 percent to $60.2 million compared to an increase of 13.8 percent in 1992 and an increase of 26.0 percent in 1991. The increases in operating income in all three years resulted from the growth of risk management services. Agency and service fee operating income contributed 2.3 percent to AIG's income before income taxes and the cumulative effect of accounting changes in 1993 compared to 2.5 percent in 1992 and 2.3 percent in 1991.
Financial services operating income amounted to $390.0 million in 1993, an increase of 12.6 percent. This compares with operating income in 1992 and 1991 of $346.4 million and $222.2 million, respectively, or increases of 55.9 percent and 67.7 percent in 1992 and 1991, respectively. The financial services operating income in 1993 increased over that of 1992 as a result of increases in the operating income of International Lease Finance Corporation (ILFC) and AIG Trading Group Inc. and its subsidiaries (AIGTG). The financial services operating income in 1992 increased over that of 1991 as a result of increases in the operating income of AIG Financial Products Corp. and its subsidiaries (AIGFP), ILFC and AIGTG. The primary reason for the increase in financial services operating income in 1991 was the inclusion of twelve months results of operations of ILFC and AIGTG.
Although the notional amounts of derivatives are not recorded on the balance sheet, dealer or principal-related derivatives are carried at their estimated fair values. Substantially all of AIG's derivative positions at December 31, 1993 were dealer or principal-related and thus accounted for in that manner. The notional amounts used to express the extent of AIG's involvement in derivatives transactions do not represent a quantification of the market or credit risks of the positions. The notional amounts represent the amounts used to calculate contractual cash flows to be exchanged and are generally not actually paid or received, except for certain contracts such as currency swaps and foreign exchange forwards. Furthermore, other factors such as offsetting transactions, master netting agreements and collateral must all be thoroughly considered in any measurement of risk.
The market risk of derivatives arises principally from the potential for changes in volatility, interest rates, foreign exchange rates, and equity and commodity prices. The credit risk of derivatives arises from the potential for a counterparty to default on its contractual obligations. Credit risk exists at a particular point in time when a derivative has a positive market value. Derivatives, other than options, may be in an unrealized gain or unrealized loss position depending on market rates and contract terms. Purchased options contracts with positive market values have credit risk.
AIGFP conducts, primarily as principal, an interest rate, currency, equity and commodity derivative products business. AIGFP also enters into long dated forward foreign exchange, option, synthetic security, liquidity facility and investment contract transactions.
Revenues generated by AIGFP for 1993 were primarily comprised of interest rate swaps activity, which represented over 50 percent of total AIGFP revenues.
AIGTG engages as principal in trading activities in certain foreign exchange, precious and base metals, petroleum and petroleum products and natural gas markets. AIGTG is exposed to risk of loss through the potential non-performance of a counterparty on its contractual obligations (credit risk) and through the potential for changes in value due to fluctuations in interest and foreign exchange rates and in prices of commodities (market risk). Generally, AIGTG manages its credit risk through credit reviews, transaction limits and/or margin requirements. AIGTG manages the market risk of its various positions and transactions through offsetting transactions such as purchasing and selling options and forward and futures contracts.
Financial services operating income represented 15.0 percent of AIG's income before income taxes and the cumulative effect of accounting changes in 1993. This compares to 16.2 percent and 11.0 percent in 1992 and 1991, respectively.
Other realized capital losses amounted to $12.7 million, $11.3 million and $14.1 million in 1993, 1992 and 1991, respectively.
In 1993, AIG recorded a provision for income taxes of $683.0 million compared to the provisions of $512.0 million and $469.6 million in 1992 and 1991, respectively. These provisions represent effective tax rates of 26.3 percent, 24.0 percent and 23.2 percent in the same respective years. The most significant cause for the increase in the effective tax rate for 1993 was the Omnibus Budget Reconciliation Act of 1993 (the Act). Among other things, the Act increased the corporate tax rate to 35 percent from 34 percent, effective January 1, 1993. Additionally, the effective tax rate was influenced by higher state and local income taxes.
The increase in the effective tax rate for 1992 resulted from the adoption of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes" (FASB 109). That is, fresh start adjustments resulting from loss reserve discounting and salvage recoveries are no longer recognized periodically. The provision for income taxes in 1991 reflects a benefit of approximately $28 million relating to the fresh start adjustment. (See Note 3 of Notes to Financial Statements.)
Income before the cumulative effect of accounting changes amounted to $1.92 billion in 1993, $1.63 billion in 1992 and $1.55 billion in 1991. The increases in net income over the three year period resulted from those factors described above.
AIG had adopted FASB 106 and FASB 109 effective as at January 1, 1992 recording a cumulative effect net benefit of $31.9 million. The pretax cumulative charge of adopting FASB 106 was $83.1 million and the net of tax cumulative charge was $54.8 million. The cumulative effect of adopting FASB 109 was a benefit of $86.7 million.
Net income amounted to $1.94 billion in 1993, $1.66 billion in 1992 and $1.55 billion in 1991. The increases in net income over the three year period resulted from those factors described above.
Total borrowings at December 31, 1993 and 1992 were as follows:
AIG Funding, Inc. intends to continue to meet AIG's funding requirements through the issuance of commercial paper guaranteed by AIG. This issuance of commercial paper is subject to the approval of AIG's Board of Directors. ILFC, A.I. Credit Corp. (AICCO) and AIGFP 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. AIG guarantees AIGFP's commercial paper. (See Note 9 of Notes to Financial Statements.)
ILFC primarily uses the proceeds of its borrowings to acquire new and used commercial jet aircraft to lease and/or remarket to airlines around the world. During 1993, ILFC increased the aggregate principal amount outstanding of its medium term and term notes to $4.30 billion at December 31, 1993, a net increase of $1.08 billion from 1992. At December 31, 1993, ILFC had $1 billion in aggregate principal amount of debt securities registered for issuance from time to time. (See also the discussions under "Operational Review" and "Liquidity" herein and Notes 1, 9 and 16 of Notes to Financial Statements.)
During 1993, AIG issued $125.0 million in aggregate principal amount of medium term notes. The proceeds of these notes were used for general corporate purposes. During 1993, $67.0 million of previously issued notes matured. At December 31, 1993, AIG had $247.0 million in aggregate principal amount of debt securities registered for issuance from time to time. (See also Note 9 of Notes to Financial Statements.)
During 1993, preferred stock issued and outstanding decreased $7,500 and additional paid-in capital declined approximately $150 million due to the redemption of Series M-1 and M-2 Exchangeable Money Market Cumulative Serial Preferred Stock. Common stock increased by $281.2 million
The liquidity of the combined insurance operations is derived both domestically and abroad. The combined insurance pretax operating cash flow is derived from two sources, underwriting operations and investment operations. In the aggregate, AIG's insurance operations generated approximately $5.7 billion in pretax operating cash flow during 1993. The underwriting cash flow approximated $2.8 billion in 1993. Underwriting cash flow represents periodic premium collections and paid loss recoveries less reinsurance premiums, losses, benefits, and acquisition and operating expenses paid. Generally, there is a time lag from when premiums are collected and, when as a result of the occurrence of events specified in the policy, the losses and benefits are paid. AIG's insurance operations generated approximately $2.9 billion in investment income cash flow during 1993. Investment income cash flow is primarily derived from interest and dividends received and includes realized capital gains.
The combined insurance pretax operating cash flow coupled with the cash and short-term investments of $4.70 billion provided the insurance operations with a significant amount of liquidity. This liquidity is available to purchase high quality and diversified fixed income securities and to a lesser extent marketable equity securities and to provide mortgage loans on real estate, policy and collateral and guaranteed loans. With this liquidity coupled with proceeds of approximately $11 billion from the maturities, sales and redemptions of fixed income securities and from the sales of marketable equity securities, AIG purchased approximately $15 billion of fixed income securities and marketable equity securities.
With respect to bonds, AIG's strategy is to invest in high quality securities while maintaining diversification to avoid significant exposure to issuer, industry and/or country concentrations.
Approximately two-thirds of the fixed maturity investments are domestic securities. Approximately 43 percent of such domestic securities were rated AAA and approximately 2 percent were below investment grade.
Although AIG's fixed income insurance portfolios contain minor amounts of securities below investment grade, potentially any fixed income security is subject to downgrade for a variety of reasons subsequent to any balance sheet date.
Approximately 6 percent of the fixed maturities portfolio are Collateralized Mortgage Obligations (CMOs). All the CMOs are investment grade and nearly all the CMOs are backed by various U.S. government agencies. Thus, credit risk is minimal. There are no interest only or principal only CMOs. CMOs are exposed to interest rate risk as the duration and ultimate realized yield would be affected by the accelerated prepayments of the underlying mortgages.
As previously discussed, the cash for the purchase of flight equipment is derived primarily from the proceeds of ILFC's debt financing. The primary sources for the repayment of this debt and the interest expense thereon are the lease receipts received and proceeds from the sale of flight equipment. During 1993, ILFC obtained net financing of $1.59 billion for the acquisition of flight equipment costing $2.41 billion. Additional funds were provided by the proceeds from the issuance of its preferred stock and the disposal of flight equipment.
Securities available for sale, and securities purchased under agreements to resell are primarily purchased with the proceeds of AIGFP's GIA financings. The securities purchased involve varying degrees of credit risk. The average credit rating of AIGFP's securities available for sale at December 31, 1993 was AA. Securities purchased under agreements to resell are treated as collateralized transactions. AIGFP generally takes possession of securities purchased under agreements to resell. AIGFP further minimizes its credit risk by monitoring customer credit exposure and requiring additional collateral to be deposited when deemed necessary.
Standards for the life RBC formula and a model act have been approved by regulators and were effective with the 1993 statutory financial statements. At December 31, 1993, the adjusted capital of each of AIG's four domestic life companies exceeded each of their RBC standards by multiples ranging from two to more than four.
o Where an enterprise purchases debt and equity securities principally for the purpose of selling them in the near term, those securities are deemed to be trading securities and are reported at fair value, with the unrealized gains and losses included in operating income.
This statement has significantly changed and narrowed the meaning of the held to maturity category from previous generally accepted accounting principles. (See also Notes 1(c) and 8 of Notes to Financial Statements.)
In November of 1992, FASB issued Statement of Financial Accounting Standards No. 112 "Employers' Accounting for Post-employment Benefits" (FASB 112). FASB 112 establishes accounting standards for employers who provide benefits to former or inactive employees after employment but before retirement. FASB 112 is effective for the 1994 financial statements and will have no material effect on AIG's results of operations or financial condition.
As discussed in Note 1(w) to the financial statements, the Company changed its method of accounting for investments in certain fixed maturity securities in 1993, and in 1992 for income taxes and postretirement benefits other than pensions.
(B) BASIS OF PRESENTATION: The accompanying financial statements have been prepared on the basis of generally accepted accounting principles. Certain accounts have been reclassified in the 1992 and 1991 financial statements to conform to their 1993 presentation.
General Insurance Operations: Premiums are earned primarily on a pro rata basis over the term of the related coverage. The reserve for unearned premiums represents the portion of net premiums written relating to the unexpired terms of coverage.
Financial Services Operations: AIG conducts, primarily as principal, an interest rate, currency, equity and commodity derivative products business. It also enters into long dated forward foreign exchange, option, synthetic security, liquidity facility and investment contract transactions. In the course of conducting its business, AIG also engages in a variety of other related transactions.
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 would be reflected in income for the difference between carrying value and estimated net realizable value.
(G) TRADING SECURITIES, AT MARKET VALUE: Trading securities are held to meet short term investment objectives, including hedging securities. These securities are carried at market value and are recorded on a trade date basis. The unrealized gains and losses are reflected in income currently.
(L) OTHER INVESTED ASSETS: Other invested assets consist primarily of investments in joint ventures and partnerships and other investments not classified elsewhere herein. The joint ventures and partnerships are carried at equity or cost depending on the nature of the invested asset and the ownership percentage thereof. Other investments are carried at cost or market depending upon the nature of the underlying assets. Unrealized gains and losses from the revaluation of those investments carried at market are reflected in capital funds, net of any related taxes.
(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 reinsurance 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, 1993, AIG's significant investments in partially-owned companies included its 45.4 percent interest in Transatlantic Holdings, Inc. (Transatlantic), which derives a substantial portion 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, 1993, the market value of AIG's investment in Transatlantic exceeded its carrying value by approximately $193.1 million.
(O) REAL ESTATE AND OTHER FIXED ASSETS: The costs of buildings and furniture and equipment are depreciated principally on a straight-line basis over their estimated useful lives (maximum of 40 years for buildings and 10 years for furniture and equipment). Expenditures for maintenance and repairs are charged to income as incurred; expenditures for betterments are capitalized and depreciated.
(W) ACCOUNTING STANDARDS: (i) Standards Adopted in 1993: At January 1, 1993, AIG adopted Statement of Accounting Standards No. 113 "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" (FASB 113). This statement specifies the accounting for the reinsuring (ceding) of insurance contracts and, effective in the first quarter of 1993, eliminates the reporting of assets and liabilities net of the effects of reinsurance. As required by FASB 113, the reserve for losses and loss expenses, reserve for unearned premiums and future policy benefits for life and accident and health insurance contracts have been presented gross of ceded reinsurance. A reinsurance asset was established to include the aforementioned ceded reinsurance balances. The balance sheet at December 31, 1992 has been appropriately reclassified to reflect the new presentation.
FASB 113 also establishes the conditions required for a contract with a reinsurer to be accounted for as reinsurance ceded and prescribes accounting and reporting standards for the contract. There has been no material effect on AIG's general or life insurance operating income as a result of the adoption of FASB 113.
o Where debt and equity securities are not reported either as held to maturity securities or trading securities, those securities are deemed to be available for sale securities and reported at fair value, with unrealized gains and losses excluded from operating income and reported in a separate component of shareholders' equity.
(ii) Standards Adopted Prior to 1993: In 1990, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 106 "Employers' Accounting for Postretirement Benefits Other Than Pensions" (FASB 106). FASB 106 establishes accounting for postretirement benefits, principally postretirement health care and life insurance benefits. It requires accrual accounting for postretirement benefits during the years that an employee renders services. FASB 106 has been adopted effective January 1, 1992. The consolidated transition liability was approximately $83.1 million, including minor amounts for certain foreign plans. The transition liability was recognized immediately at adoption as a change in accounting principle. The cumulative effect of the adoption of FASB 106 was a charge of $54.8 million, net of a tax benefit of $28.3 million.
Although there will be no effect on AIG's operating income upon the adoption of the Interpretation, AIG will be required to present certain of its financial services assets and liabilities on a gross basis, thus increasing both assets and liabilities in the consolidated balance sheet. The effect of presenting these assets and liabilities on a gross basis on AIG's consolidated balance sheet will not be significant.
The Tax Reform Act of 1986 (the 1986 Act) required that, for tax purposes, AIG recalculate its property and casualty loss reserves to a discounted basis as of December 31, 1986. The discount of these loss reserves was the "Fresh Start" adjustment and any current tax benefit was deferred and amortizable over future periods. Effective January 1, 1992, the remaining future tax effect of this Fresh Start adjustment was recognized as a component of deferred taxes receivable. Prior to January 1, 1992, this adjustment was amortized into subsequent years' income, giving rise to a current tax benefit only. For 1991, this tax benefit approximated $16,000,000.
The Consolidated Omnibus Budget Reconciliation Act of 1990 (the 1990 Act) requires that life insurers capitalize and amortize policy acquisition expenses that relate to specified insurance contracts. This provision has no significant effect on current income taxes or future net income of AIG. The 1990 Act also requires that property and casualty insurers, for tax purposes, reduce the effects of the discounted loss and loss expenses reserve change by a discounted estimate of recoveries from the salvage and subrogation of claims. The tax effect applicable to 87 percent of the discounted December 31, 1989 anticipated recovery balance was a Fresh Start benefit to be amortized over four years. Thus, the provision for income taxes in 1991 reflects benefits of approximately $12,000,000. Effective January 1, 1992, a deferred tax receivable was recognized for the remainder of the discounted recoveries from salvage and subrogation.
The Omnibus Budget Reconciliation Act of 1993 (the 1993 Act) increased the highest tax rate on corporations to 35 percent for 1993. The 1993 Act requires securities dealers to recognize for tax purposes the mark-to-market gain or loss on certain securities. The adjustment from this change in accounting method must be phased into taxable income over five years beginning in 1993. The 1993 Act also disallows several items as expenses beginning in 1994. None of these items will have a significant effect on AIG's net income or financial condition. However, it is expected that income taxes paid will increase as a result of such changes.
(c) The components of the net deferred tax liability as of December 31, 1993 and December 31, 1992 were as follows:
(d) Under APB 11, deferred income tax expenses or benefits resulted from timing differences in the recognition of revenues and expenses for tax and financial statement purposes.
The sources of these differences and the tax effect of each are summarized as follows:
AIG life companies limit exposure to loss on any single life. For ordinary insurance, AIG retains a maximum of approximately $1,000,000 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.
AIG evaluates the financial condition of its reinsurers by an internal reinsurance security committee consisting of members of AIG's Senior Management. No single reinsurer is a material reinsurer to AIG nor is AIG's business substantially dependent upon any reinsurance contract.
A reconciliation of the Balance Sheet at December 31, 1992 reflecting the adoption of FASB 113 is as follows:
(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 9 percent.
(iii) The portion of net income and unrealized appreciation (depreciation) of investments that can inure to the benefit of AIG is limited in some cases by the insurance contracts and by the local insurance regulations of the countries in which the policies are in force. All net income and unrealized appreciation (depreciation) of investments in excess of these limits have been included in the reserve for future policy benefits in the consolidated balance sheet.
(iv) Participating life business represented approximately 29 percent of the gross insurance in-force at December 31, 1993 and 48 percent of gross premium income in 1993. The amount of dividends to be paid is determined annually by the Boards of Directors. Anticipated dividends are considered as a planned contractual benefit in computing the value of future policy benefits and are provided ratably over the premium-paying period of the contracts.
(c) The liability for policyholders' contract deposits has been established based on the following assumptions:
AIG's insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by domestic or foreign insurance regulators. The differences between statutory financial statements and financial statements prepared in accordance with generally accepted accounting principles (GAAP) vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect the change in the market value of the bonds available for sale, deferred policy acquisition costs and deferred income taxes.
(A) STATUTORY DEPOSITS: Cash in the amount of $165,111,000 and $84,763,000 and securities with a carrying value of $2,787,900,000 and $2,372,400,000 were deposited by AIG's subsidiaries under requirements of regulatory authorities as of December 31, 1993 and 1992 respectively.
(C) INVESTMENT GAINS AND LOSSES: The realized capital gains and change in unrealized appreciation of investments for 1993, 1992 and 1991 were as follows:
During 1993, 1992 and 1991, gross gains of $99,162,000, $87,776,000 and $79,315,000, respectively and gross losses of $43,094,000, $35,635,000 and $62,797,000, respectively were realized on dispositions of fixed maturities carried at amortized cost.
(D) MARKET VALUE OF FIXED MATURITIES AND UNREALIZED APPRECIATION OF INVESTMENTS: At December 31, 1993, the balance of the unrealized appreciation of investments in equity securities (before applicable taxes) included gross gains of approximately $906,400,000 and gross losses of approximately $246,400,000.
The deferred tax payable related to the net unrealized appreciation of investments was $404,264,000 at December 31, 1993 and $69,769,000 at December 31, 1992.
At December 31, 1993 and 1992, the market value of the CMO portfolio was $1.8 billion and $1.6 billion, respectively; the estimated amortized cost was approximately $1.7 billion in 1993 and $1.5 billion in 1992. AIG's CMO portfolio is readily marketable. There were no derivative (high risk) CMO securities contained in this portfolio at December 31, 1993.
The distribution of the CMOs at December 31, 1993 and 1992 was as follows:
At December 31, 1993, the gross weighted average coupon of this portfolio was 8.8 percent. The gross weighted average life of this portfolio was 6.5 years.
(F) FIXED MATURITIES BELOW INVESTMENT GRADE: At December 31, 1993, the fixed maturities held by AIG that were below investment grade were insignificant.
*Reflects the nominal Deutschemark rate available at December 31, 1993. Economically, this rate is reduced by various hedging transactions to an effective rate approximating those presented above.
Commercial paper issued by Funding and AIGFP is guaranteed by AIG. AIG has entered into an agreement in support of AICCO's commercial paper.
(B) BORROWINGS UNDER OBLIGATIONS OF GUARANTEED INVESTMENT AGREEMENTS: Borrowings under obligations of guaranteed investment agreements, which are guaranteed by AIG, are recorded on the basis of proceeds received. Obligations may be called at various times prior to maturity at the option of the counterparty. Interest rates on these borrowings range from 3.3 percent to 9.8 percent.
At December 31, 1993, the market value of securities pledged as collateral with respect to these obligations approximated $976 million.
The interest rates on this debt range from 3.13 percent to 8.45 percent. To the extent deemed appropriate, AIG enters into swap transactions to reduce its effective borrowing rate.
Simultaneous with the issuance of this debt, AIG entered into a swap transaction which effectively converted AIG's net interest expense to a U.S. dollar liability of approximately 7.9 percent, which requires the payment of proceeds at maturity of approximately $159 million in exchange for Italian Lire 200 billion and interest thereon.
(iii) Term Notes Issued by ILFC: ILFC has issued unsecured obligations which may not be redeemed prior to maturity. $200,000,000 of such term notes are at floating interest rates and the remainder are at fixed rates.
As of December 31, 1993, notes in aggregate principal amount of $2,550,000,000 were outstanding with maturity dates varying from 1994 to 2001 and interest rates ranging from 3.56 percent to 8.88 percent. These notes provide for a single principal payment at maturity.
(E) LOANS AND MORTGAGES PAYABLE: Loans and mortgages payable at December 31, 1993 consisted of the following:
(F) INTEREST EXPENSE FOR ALL INDEBTEDNESS: Total interest expense for all indebtedness, net of capitalized interest, aggregated $1,103,955,000 in 1993, $1,128,007,000 in 1992 and $871,036,000 in 1991. Interest expense paid approximated $1,017,066,000 in 1993, $1,051,976,000 in 1992 and $797,000,000 in 1991.
(b) AIG parent depends on its subsidiaries for cash flow in the form of loans, advances and dividends. Some AIG subsidiaries, namely those in the insurance business, 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 53 percent of consolidated capital funds were restricted from immediate transfer to AIG parent at December 31, 1993.
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, 1993 and 1992, these commitments, made principally by AIG Capital Corp., approximated $140,700,000 and $167,300,000 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.
As a writer of options, AIGFP generally receives a premium at the outset and then follows a policy of minimizing interest rate, commodity, equity and currency risks underlying the option. At December 31, 1993, the notional principal amount of interest rate, commodity, equity and currency options written, expressed in five-year equivalent amounts, approximated $813 million.
AIGFP, for its own account, enters into interest rate, currency, equity and commodity swaps and forward commitments. Interest rate swap and swaption 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, equity and commodity 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, 1993, the notional principal amount of the sum of the swap pays and receives expressed in five-year equivalent amounts, approximated $118 billion, primarily related to interest rate swaps ($90 billion). Assuming simultaneous nonperformance by all counterparties on all contracts potentially subject to a loss, the maximum potential loss, based on the cost of replacement at market rates prevailing at December 31, 1993, approximated $5.4 billion.
At December 31, 1993, the breakdown by industry of maximum potential loss was as follows:
AIGFP has entered into commitments to provide liquidity for certain insured variable rate bonds issued by municipal entities. The bond agreements allow the holder, in certain circumstances, to tender the bonds to the issuer at par value. In the event a remarketing agent of the issuer is unable to resell such bonds, AIGFP would be obligated to purchase the bonds at par value. AIGFP would receive interest on any bonds purchased at rates above the then prevailing market rates. These liquidity facilities aggregated $685 million at December 31, 1993 and extend through December 31, 1997. In management's opinion, it is unlikely that AIGFP will become obligated to purchase any bonds pursuant to the liquidity facilities.
AIG has issued an unconditional guarantee with respect to the prompt payment, when due, of all present and future obligations and liabilities of AIGFP arising from transactions entered into by AIGFP.
AIG Trading Group Inc. and its subsidiaries (AIGTG) becomes party to off-balance sheet financial instruments in the normal course of its business and to reduce its currency, interest rate and commodity exposures.
As a writer of foreign exchange options, AIGTG generally receives a premium at the outset and then follows a policy of minimizing the currency risk underlying the option. At December 31, 1993, the notional principal amount of foreign currency options written approximated $15 billion.
AIGTG limits its risks by holding offsetting positions. In addition, AIGTG monitors and controls its risk exposures through various monitoring systems which evaluate AIGTG's market and credit risks, and through credit approvals and limits. At December 31, 1993, AIGTG did not have a significant concentration of credit risk from either an individual counterparty or group of counterparties.
AIG continues to receive indemnity claims asserting injuries from toxic waste, hazardous substances, asbestos and other environmental pollutants and alleged damages to cover the clean-up costs of hazardous waste dump sites (environmental claims). Estimation of 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. Environmental claims development is affected by factors such as inconsistent court resolutions, the broadening of the intent of policies and scope
Financial Accounting Standards Board Statement No. 107 "Disclosures about Fair Value of Financial Instruments" (FASB 107) requires disclosure of fair value information about financial instruments for which it is practicable to estimate such fair value. These financial instruments may or may not be recognized in the consolidated balance sheet. In the measurement of the fair value of certain of the financial instruments, quoted market prices were not available and other valuation techniques were utilized. These derived fair value estimates are significantly affected by the assumptions used. FASB 107 excludes certain financial instruments, including those related to insurance contracts.
Receivables from and payables to securities brokers and dealers: Fair values for receivables from and payables to securities brokers and dealers approximate the carrying values presented in the consolidated balance sheet.
Spot commodities: Fair values for spot commodities, which include options, were based on current market prices.
Net unrealized gains on interest rate and currency swaps, options and forward transactions: Fair values for swaps, options and forward transactions were based on the use of valuation models that utilize, among other things, current interest, foreign exchange and volatility rates, as applicable.
Other invested assets: For assets for which market prices were not readily available, fair valuation techniques were not applied as AIG believes it would have to expend excessive costs for the benefits derived.
GIAs: Fair values of AIG's obligations under investment type agreements were estimated using discounted cash flow calculations based on interest rates currently being offered for similar agreements with maturities consistent with those remaining for the agreements being valued. Additionally, AIG follows a policy of minimizing interest rate risks associated with GIAs by entering into swap transactions. The unrealized gains for transactions related to GIAs were $526.3 million at December 31, 1993.
As of December 31, 1993, there were 84,055 shares of common stock subscribed to at a weighted average price of $75.97 per share pursuant to grants of privileges under the 1984 plan. There were 93,447 shares, 92,220 shares and 122,072 shares issued under the 1984 plan at weighted average prices of $54.46, $49.66 and $41.33 for the years ended December 31, 1993, 1992 and 1991, respectively. The excess of the proceeds over the par value or cost of the common stock issued was credited to additional paid-in capital. There were 352,040 shares available for the grant of future purchase privileges under the 1984 plan at December 31, 1993.
On December 19, 1991, the AIG Board of Directors adopted a 1991 employee stock option plan, which provides that options to purchase a maximum of 3,000,000 shares of common stock could be granted to officers and other key employees at prices not less than fair market value at the date of grant. Both the 1991 plan, and the options with respect to 74,925 shares granted thereunder on December 19, 1991, were approved by shareholders at the 1992 Annual Meeting. At December 31, 1993, 2,108,950 shares were reserved for future grants under the 1991 plan. As of March 18, 1992, no further options could be granted under the 1987 plan, but outstanding options granted under the 1987 plan and the previously superceded 1982 plan continue in force until exercise or expiration. At December 31, 1993, there were 2,622,259 shares reserved for issuance under the 1991, 1987 and 1982 plans.
Under each plan, 25 percent of the options granted become exercisable on the anniversary of the date of grant in each of the four years following that grant and all options expire 10 years from the date of the grant. As of December 31, 1993, outstanding options granted with respect to 1,981,273shares qualified for Incentive Stock Option treatment under the Economic Recovery Tax Act of 1981.
normal retirement at age 65. Benefits are based upon a percentage of average final compensation multiplied by years of credited service commencing April 1, 1985 and limited to 44 years of credited service. The average final compensation is subject to certain limitations. Annual funding requirements are determined based on the "projected unit credit" cost method which attributes a pro rata portion of the total projected benefit payable at normal retirement to each year of credited service.
Assumptions associated with the projected benefit obligation and expected long-term rate of return on plan assets at December 31, 1993 were as follows:
* The ranges for the non-U.S. plans reflect the local socioeconomic environments in which AIG operates.
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, 1993 and 1992:
Effective January 1, 1993, both plans' provisions were amended. Employees who retire on or after January 1, 1993 will be required to pay the actual cost of the medical benefits reduced by a credit which is based upon age and years of serv- ice at retirement. The life insurance benefit will vary by age at retirement from $5,000 for retirement at ages 55 through 59 to $15,000 for retirement at ages 65 and over.
* The Medical trend rate grades downward from years 1 through 8 domestically and years 1 through 9 for the foreign benefits. The trend rates remain level thereafter.
The following table sets forth the liability for the accrued postretirement benefits of the various plans, and amounts recognized in the accompanying consolidated balance sheet as of December 31, 1993 and 1992. These plans are not funded currently.
The medical trend rate assumptions have a significant effect on the amounts reported. Increasing each trend rate by 1 percent in each year would increase the accumulated post-retirement benefit obligations as of December 31, 1993 by $5.0 million and the aggregate service and interest cost components of the periodic postretirement benefit costs for 1993 by $468,000.
During 1991, AIG recognized the cost of providing current medical and life insurance benefits by recording the annual insurance premiums as an expense. During 1991 these costs approximated $32,000,000. The cost of providing these benefits for retirees was not separable from the cost of providing benefits for active employees prior to 1992.
Rent expense approximated $200,500,000, $199,200,000, and $199,400,000 for the years ended December 31, 1993, 1992 and 1991, respectively.
(b) Minimum future rental income on noncancelable operating leases of flight equipment which have been delivered at December 31, 1993 was as follows:
The following quarterly financial information for each of the three months ended March 31, June 30, September 30 and December 31, 1993 and 1992 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.
(a) Represents a net benefit for the cumulative effect of the adoption of accounting pronouncements related to postretirement benefits (FASB 106) and income taxes (FASB 109) by minority-owned reinsurance operations in 1993 and by AIG in 1992.
(a) Including other operations and other income (deductions) -net, which are not deemed to be reportable segments. (b) Including realized capital gains attributable to the segments. (c) Substantially dividend income from subsidiaries. (d) Relating primarily to ILFC. (e) Assets as at December 31, 1993 and 1992 have been adjusted to conform to the requirements of FASB 113.
(a) Including workers' compensation and retrospectively rated risks. (b) Including involuntary pools. (c) Including mass marketing and specialty programs.
(c) AIG's individual life insurance and group life insurance portfolio accounted for 64 percent, 67 percent and 71 percent of AIG's consolidated life insurance operating income before realized capital gains or losses for the years ended December 31, 1993, 1992 and 1991, respectively. For those years, 97 percent, 98 percent and 99 percent, respectively, of consolidated life operating income before realized capital gains or losses was derived from foreign operations.