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 22.6 percent in 1995 and 15.3 percent in 1994. The increase in the growth rate of 1995 over 1994 and 1994 over 1993 after the aforementioned adjustments was a result of the increased net investment income and improvement in underwriting results.
therefrom are reflected in income currently. It is AIG's belief that the ceded reserves at December 31, 1995 were representative of the ultimate losses recoverable. In the future, as the ceded reserves continue to develop to ultimate amounts, the ultimate loss recoverable may be greater or less than the reserves currently ceded.
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 respective ending reserves for losses and loss expenses over the respective 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. The aforementioned insurance rating agency has recently published the findings of its current studies with respect to the ultimate aggregate costs for toxic waste cleanups for the insurance industry. This agency has significantly lowered its ultimate aggregate cost projections that were published last year. Other published studies also project lower ultimate aggregate costs for toxic waste cleanups for the insurance industry.
The asset-liability relationship is appropriately managed in AIG's foreign operations, as it has been throughout AIG's history, even though certain territories lack qualified long-term investments or there are investment restrictions imposed by the local regulatory authorities. For example, in Japan and several Southeast Asia territories, the duration of the investments is often for a shorter period than the effective maturity of 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 5.5 years, while the related policy liabilities are estimated to be 11.8 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 to support 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.)
Financial services operating income increased 3.2 percent in 1995 over 1994. This compares with an increase of 3.8 percent in 1994 over 1993.
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 1995, net deductions amounted to $91.2 million. In 1994 and 1993, net deductions amounted to $68.6 million and $46.9 million, respectively.
AIG's capital funds have increased $3.41 billion in 1995. Unrealized appreciation of investments, net of taxes, increased $1.21 billion, primarily resulting from the rally of the domestic equity markets and the decline in domestic interest rates and its effect on the market values of bonds worldwide. As a result of AIG's adoption of Financial Accounting Standards No. 115 "Accounting for Certain Investments on Debt and Equity Securities", unrealized appreciation of investments, net of taxes, is now subject to increased volatility resulting from the changes in the market value of bonds available for sale. During 1995, the cumulative translation adjustment loss, net of taxes, increased $168.0 million and retained earnings increased $2.36 billion, resulting from net income less dividends.
* The net replacement value of $356.0 million with respect to interest rate and currency swaps is presented as a component of unrealized gain on interest rate and currency swaps, options and forward transactions.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of American International Group, Inc. and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
panies under the terms of AIG's reinsurance arrangements for paid and unpaid losses and loss expenses, ceded unearned premiums and ceded future policy benefits for life and accident and health insurance contracts and benefits paid and unpaid. It also includes funds held under reinsurance treaties.
(t) Translation of Foreign Currencies: Financial statement accounts expressed in foreign currencies are translated into U.S. dollars in accordance with Statement of Financial Accounting Standards No. 52 "Foreign Currency Translation" (FASB 52). Under FASB 52, functional currency assets and liabilities are translated into U.S. dollars generally using current rates of exchange and the related translation adjustments are recorded as a separate component of capital funds net of any related taxes. Functional currencies are generally the currencies of the local operating environment. Income statement accounts expressed in functional currencies are translated using average exchange rates. The adjustments resulting from translation of financial statements of foreign entities operating in highly inflationary economies are recorded in income. Exchange gains and losses resulting from foreign currency transactions are also recorded in income currently. The exchange gain or loss with respect to utilization of foreign exchange hedging instruments is recorded as a component of capital funds.
(iii) Interest rates on corporate-owned life insurance business are guaranteed at 4.0 percent and the weighted average rate credited in 1995 was 10.5 percent.
The distribution of the CMOs at December 31, 1995 and 1994 was as follows:
(h) During 1993, certain investments held by AIGFP experienced financial difficulties and suffered rating downgrades. The pretax impact on AIG of the estimated other than temporary impairment in value of these investments was $215 million. As is AIG's policy in such situations where credit ratings have deteriorated significantly, these impairments have been appropriately recognized by charges to income of $104 million in 1993 and $111 million prior to 1993.
The net trading revenues for the twelve months ended December 31, 1995 from AIGFP's operations were $289.0 million.
The net trading revenues for the twelve months ended December 31, 1995 from AIGTG's operations were $317.2 million.
At December 31, 1995, AIG had two types of stock-based compensation plans. One was a stock option plan; the other, an employee stock purchase plan. AIG applies APB Opinion 25 "Accounting for Stock Issued to Employees" and related Interpretations in accounting for its plans. Accordingly, no compensation costs have been recognized for either plan.
Additional information with respect to AIG's plans at December 31, 1995, and changes for the three years then ended, was as follows:
The following weighted average assumptions were used for grants in 1995: dividend yield of 0.32 percent, expected volatility of 20.4 percent, risk-free interest rate of 5.77 percent, and an expected life of 7 years.
AIG has adopted a Supplemental Executive Retirement Program (Supplemental Plan) to provide additional retirement benefits to designated executives and key employees. Under the Supplemental Plan, the annual benefit, not to exceed 60 percent of average final compensation, accrues at a percentage of average final pay multiplied for each year of credited service reduced by any benefits from the current and any predecessor retirement plans, Social Security, if any, and from any qualified pension plan of prior employers. The Supplemental Plan also provides a benefit equal to the reduction in benefits payable under the AIG retirement plan as a result of Federal limitations on benefits payable thereunder. Currently, the Supplemental Plan is unfunded.
Assumptions associated with the accrued postretirement benefit liability at December 31, 1995 were as follows:
(d) AIG has certain postemployment 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, 1995 was $6.4 million. The incremental expense was insignificant.