UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the fiscal year ended December 31, 2012 |
Commission file number 1-8787 |
American International Group, Inc.
(Exact name of registrant as specified in its charter)
Delaware (State or other jurisdiction of incorporation or organization) |
13-2592361 (I.R.S. Employer Identification No.) |
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180 Maiden Lane, New York, New York (Address of principal executive offices) |
10038 (Zip Code) |
Registrant's telephone number, including area code (212) 770-7000
Securities registered pursuant to Section 12(b) of the Act: See Exhibit 99.02
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) |
Smaller reporting company o |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No þ
The aggregate market value of the voting and nonvoting common equity held by nonaffiliates of the registrant (based on the closing price of the registrant's most recently completed second fiscal quarter) was approximately $21,463,000,000.
As of February 15, 2013, there were outstanding 1,476,322,473 shares of Common Stock, $2.50 par value per share, of the registrant.
DOCUMENTS INCORPORATED BY REFERENCE
Document of the Registrant
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Form 10-K Reference Locations
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Portions of the registrant's definitive proxy statement for the 2013 Annual Meeting of Shareholders | Part III, Items 10, 11, 12, 13 and 14 |
AMERICAN INTERNATIONAL GROUP, INC.
ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2012
TABLE OF CONTENTS
AIG 2012 Form 10-K
1
American International Group, Inc. (AIG) is a leading global insurance company. Founded in 1919, today we provide a wide range of property casualty insurance, life insurance, retirement products, mortgage insurance and other financial services to customers in more than 130 countries. Our diverse offerings include products and services that help businesses and individuals protect their assets, manage risks and provide for retirement security. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange. |
AIG's key strengths include:
World class insurance franchises that are leaders in their categories and are improving their operating performance;
A diverse mix of businesses with a presence in most international markets;
Effective capital management of the largest shareholders' equity of any insurance company in the world*, supported by enhanced risk management;
Execution of strategic objectives, such as the recent divestiture of non-core businesses and fulfillment of our commitment to repay the U.S. taxpayers; and
Improved profitability, as demonstrated by three consecutive years of full-year profit.
* At June 30, 2012, the latest date for which information was available for certain foreign insurance companies.
AIG 2012 Form 10-K
2
In this Annual Report on Form 10-K, unless otherwise mentioned or unless the context indicates otherwise, we use the terms "AIG," the "Company," "we," "us" and "our" to refer to AIG, a Delaware corporation, and its consolidated subsidiaries. We use the term "AIG Parent" to refer solely to American International Group, Inc., and not to any of its consolidated subsidiaries.
A reference summary of certain technical terms and acronyms used throughout this Annual Report on Form 10-K is available on pages 195-199.
AIG's Global Insurance Operations
HOW WE GENERATE REVENUES AND PROFITABILITY
We earn revenues primarily from insurance premiums, policy fees from universal life insurance and investment products, and income from investments.
Our operating expenses consist of policyholder benefits and claims incurred, interest credited to policyholders, commissions and other costs of selling and servicing our products, and general business expenses.
Our profitability is dependent on our ability to price and manage risk on insurance and annuity products, to manage our portfolio of investments effectively, and control costs through expense discipline.
Commencing in the third quarter of 2012, the Chartis segment was renamed AIG Property Casualty and the SunAmerica segment was renamed AIG Life and Retirement, although certain existing brands will continue to be used in certain geographies and market segments.
AIG Property Casualty | AIG Life and Retirement | |
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AIG Property Casualty is a leading provider of insurance products for commercial, institutional and individual customers through one of the world's most far-reaching property casualty networks. AIG Property Casualty offers one of the industry's most extensive ranges of products and services, through its diversified, multichannel distribution network, benefitting from its strong capital position. |
AIG Life and Retirement is a premier provider of life insurance and retirement services in the United States. It is among the largest life insurance and retirement services businesses in the United States. With one of the broadest distribution networks and most diverse product offerings in the industry, AIG Life and Retirement helps to ensure financial and retirement security for more than 18 million customers. |
Other Operations |
Mortgage Guaranty (United Guaranty Corporation or UGC), is a leading provider of private residential mortgage guaranty insurance (MI). MI covers mortgage lenders for the first loss from mortgage defaults on high loan-to-value conventional first-lien mortgages. By providing this coverage to lenders, UGC enables mortgage lenders to remain competitive, while generating a sound and responsible book of business, and enables individuals to purchase a house with a lower down payment. |
Other operations also include Global Capital Markets, Direct Investment book, Retained Interests and Corporate & Other operations. |
On December 9, 2012, AIG announced an agreement to sell 80.1 percent of International Lease Finance Corporation (ILFC) with an option for the purchaser to buy an additional 9.9 percent stake. As a result, ILFC operating results, which were previously presented in the Aircraft Leasing segment, have been classified as discontinued operations in all periods, and associated assets and liabilities have been classified as held-for-sale at December 31, 2012.
AIG 2012 Form 10-K
3
AIG 2012 Revenue Sources ($ millions)
For financial information concerning our reportable segments, including geographic areas of operation and changes made in 2012, see Note 3 to the Consolidated Financial Statements. Prior periods have been revised to conform to the current period presentation for segment changes and discontinued operations.
Restructuring and Rebuilding: AIG Moving Forward
We have taken significant steps to position our company for future growth and in 2012 fully repaid governmental financial support of AIG. These amounts are discussed below in 2011-2012 Accomplishments. Federal Reserve Bank of New York We repaid the governmental support that we received in September 2008 and thereafter during the global economic crisis. This support included a credit facility from the Federal Reserve Bank of New York (the FRBNY and such credit facility, the FRBNY Credit Facility) and funding from the Department of the Treasury through the Troubled Asset Relief Program (TARP). After receiving this support, our Board of Directors and management placed a strong focus on improving our businesses and pursued four main priorities: building AIG's value by
strengthening our international property and casualty and domestic life insurance and retirement businesses; repaying support from the U.S.
government, including through significant divestitures; decreasing our operating costs;
and reducing risk by winding down our exposure to certain financial products and derivatives trading activities. |
We have made substantial progress in each of these four main priority areas during the past few years. Our efforts have centered on protecting and enhancing the value of our key businesses, restoring AIG's financial strength, repaying U.S. taxpayers and reducing risk. |
AIG 2012 Form 10-K
4
Department of the Treasury
Through a series of transactions that closed on January 14, 2011 (the Recapitalization), we exchanged various forms of government support for AIG Common Stock, and the Department of the Treasury became AIG's majority shareholder, with approximately 92 percent of outstanding AIG Common Stock at that time.
The Department of the Treasury, as selling shareholder, sold all of its shares of AIG Common Stock through six registered public offerings completed in May 2011 and March, May, August, September and December 2012. We purchased approximately 421 million shares of AIG Common Stock in the first four of the 2012 offerings for approximately $13.0 billion. We did not purchase any shares in the May 2011 or December 2012 offerings.
See Item 7. MD&A Liquidity and Capital Resources and Notes 4, 17, 18, and 25 to the Consolidated Financial Statements for further discussion of the government support provided to AIG, the Recapitalization and significant asset dispositions.
These and other key accomplishments are described in the following table:
* AIG did not receive any proceeds from the sale of AIG Common Stock by the Department of the Treasury. The Department of the Treasury still owns ten-year warrants to purchase approximately 2.7 million shares of AIG Common Stock.
AIG 2012 Form 10-K
5
AIG Property Casualty
Business Strategy
Business Mix Shift: Grow in higher value lines of business and geographies.
Underwriting Excellence: Enhance pricing and risk-selection tools through investments in data mining, science and technology.
Claims Best Practices: Reduce loss costs through new claims technology, a more efficient and effective operating model and the use of data tools to better manage the economic drivers of losses.
Operating Expense Discipline: Decrease recurring operating expenses by leveraging AIG's scale and driving increased standardization.
Capital Management: Efficiently allocate capital through the use of risk adjusted profit metrics, optimization of reinsurance and legal entity restructuring.
AIG 2012 Form 10-K
6
AIG Property Casualty Operating Segments Products and Services
AIG Property Casualty operating segments are organized into Commercial Insurance and Consumer Insurance. Run-off lines of business and operations not attributable to these operating segments are included in an Other operations category.
Percent of 2012 Net premiums written by operating segment*
* The operations reported as part of Other do not have meaningful levels of Net premiums written.
Commercial Insurance |
Consumer Insurance |
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Commercial products: |
Consumer products: |
Casualty: Includes general liability, commercial automobile liability, workers' compensation, excess casualty and crisis management insurance. Casualty also includes risk management and other customized structured programs for large corporate customers and multinational companies. |
Accident & Health: Includes voluntary and sponsor-paid personal accidental and supplemental health products for individuals, employees, associations and other organizations. It also includes life products (outside of the U.S. market) as well as a broad range of travel insurance products and services for leisure and business travelers. |
AIG 2012 Form 10-K
7
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A Look at AIG Property Casualty
Global Footprint
AIG Property Casualty has a significant international presence in both developed markets and growth economy nations. It distributes its products through three major geographic regions:
In 2012, 6 percent and 5 percent of AIG Property Casualty direct premiums were written in the states of California and New York, respectively, and 19 percent and 7 percent were written in Japan and the United Kingdom, respectively. No other state or foreign jurisdiction accounted for more than 5 percent of such premiums.
On November 21, 2012, AIG, People's Insurance Company (Group) of China Limited (PICC Group) and PICC Life Insurance Company Limited (PICC Life) entered into a non-binding term sheet with respect to the proposed establishment of a joint venture insurance agency company between AIG and PICC Life (the Joint Venture) which plans to distribute life insurance and other insurance products through a specialized agency force on a nationwide basis with a focus on major cities in China and to engage in reinsurance and other related business cooperation. AIG
AIG 2012 Form 10-K
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Life and Retirement made an equity investment of approximately $0.5 billion in PICC Group. AIG's participation in the Joint Venture will be managed by AIG Property Casualty.
Total Net Premiums Written $34.4 bn |
Based on net premiums written in 2011, AIG Property Casualty is the largest U.S. commercial insurer in the U.S. and Canada, the largest U.S. based property casualty insurer in Europe, and the largest foreign property casualty insurer in Japan and China. In addition, AIG Property Casualty was first to market in many developing nations and is well positioned to enhance its businesses in countries such as China, India and Brazil. |
Competition
Operating in a highly competitive industry, AIG Property Casualty competes against approximately 3,300 stock companies, specialty insurance organizations, mutual companies and other underwriting organizations. In international markets, we compete for business with the foreign insurance operations of large U.S. insurers global insurance groups and local companies in specific market areas and product types.
Insurance companies compete through a combination of risk acceptance criteria, product pricing, service and terms and conditions. AIG Property Casualty distinguishes itself in the insurance industry primarily based on its well-established brand, financial strength and large capital base, innovative products, expertise in providing specialized coverages and customer service.
AIG 2012 Form 10-K
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AIG Property Casualty serves its business and individual customers on a global basis from the largest multinational corporations to local businesses and individuals. Our clients benefit from our substantial underwriting expertise and long-term commitment to the markets and clients we serve.
AIG Property Casualty Competitive Strengths and Challenges |
Diversification breadth of customers served, products underwritten and distribution channels |
Global franchise operating in more than 90 countries and jurisdictions |
Scale facilitates risk diversification to optimize returns on capital |
Service focused on customer needs, providing strong global claims, loss prevention and mitigation, engineering, underwriting and other related services |
Expertise experienced employees complemented with new talent |
Financial strength well capitalized, strong balance sheet |
Somewhat offsetting these strengths are the following challenges: |
Barriers to entry are high |
Regulatory changes in recent years created an increasingly complex environment that is affecting industry growth and profitability |
AIG 2012 Form 10-K
10
AIG Life and Retirement
Business Strategy
AIG Life and Retirement is focused on the following strategic initiatives:
Grow Assets Under Management: Fully leverage a unified distribution organization to increase sales of profitable products across all channels. Capitalize on the growing demand for income solutions and AIG Life and Retirement's capital base, risk controls, innovative product designs, expanded distribution initiatives and financial discipline to grow variable annuity business. Pursue selected institutional market opportunities where AIG Life and Retirement's scale and capital base provide a competitive advantage.
Increase Life Insurance In-Force: Develop innovative life offerings through consumer focused research that delivers superior, differentiated product solutions. Consolidate life insurance platforms, operations and systems to create a more efficient, cost-competitive and agile operating model.
Enhance Return on Equity: Build on simplified legal entity structure to enhance financial strength and durability, capital efficiency and ease of doing business. Improve operational efficiencies, expense control and service through investments in technology and more productive use of existing resources and lower-cost operations centers.
AIG 2012 Form 10-K
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Operating Segments
AIG Life and Retirement currently has two operating segments: Life Insurance focuses on life insurance and related protection products and Retirement Services focuses on investment, retirement savings and income solution products. On April 12, 2012, AIG Life and Retirement announced several key organizational structure and management changes intended to better serve the organization's distribution partners and customers. Key aspects of the new structure are distinct product divisions, shared annuity and life operations platforms and a unified all-channel distribution organization with access to all AIG Life and Retirement products.
AIG Life and Retirement expects to modify its presentation of results to reflect its new structure when the reporting changes are implemented in the first quarter of 2013 and conform all prior periods' presentations to reflect the new structure. The new structure will include two operating segments Retail and Institutional. Retail product lines will include life insurance and accident and health (A&H), fixed annuities, variable annuities and income solutions, brokerage services and retail mutual funds. Institutional product lines will include group retirement, group benefits and institutional markets. The institutional markets product line will consist of stable value wrap products, structured settlement and terminal funding annuities, private placement variable life and annuities, guaranteed investment contracts and corporate and bank-owned life insurance.
Additionally, AIG Life and Retirement completed the merger of six life insurance operating legal entities into American General Life Insurance Company effective December 31, 2012. This merger facilitates capital and dividend planning while creating operating efficiencies and making it easier for producers and customers to do business with AIG Life and Retirement. AIG Life and Retirement will continue to market products and services under its existing brands.
AIG Life and Retirement Operating Segments Products and Services
Percent of 2012 total revenue by operating segment (dollars in millions)
AIG 2012 Form 10-K
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Life Insurance
Percent of 2012 Premiums, Deposits and other considerations by line of business |
Retirement Services
Percent of 2012 Premiums, Deposits and other considerations by line of business |
* Other includes fixed, equity indexed and runoff annuities.
Products include a full line of life insurance, deferred and payout annuities, A&H products, worksite and group benefits. |
Products and services focus on investment, retirement savings and income solution products. |
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AIG Life and Retirement is one of the largest life insurance organizations in the United States and is a leader in today's financial services marketplace. |
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AIG Life and Retirement holds leadership positions in both retail and institutional markets: |
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Long-standing leadership position in fixed annuity sales through banks and other financial institutions |
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Innovator in guaranteed income solutions and a top provider of variable annuities |
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Industry-leading life and accident and health products |
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Broad range of retail mutual fund offerings |
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One of the largest independent broker-dealer networks in the country |
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Leading retirement plan provider in K-12 schools, higher education, healthcare, government and other nonprofit entities |
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Institutional Markets offerings, including leadership position in structured settlement annuities |
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Extensive lineup of group benefits offered in worksites and through affinity organizations |
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AIG 2012 Form 10-K
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Life Insurance |
Retirement Services |
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The Life Insurance operating segment offers a broad range of protection and mortality-based products. These products are marketed under four principal
brands American General, AGLA, AIG Direct and AIG Benefit Solutions. |
The Retirement Services operating segment provides investment, retirement and income solutions products and services. These products and
services are marketed through a variety of brands described below. |
AIG Life and Retirement conducts its business primarily through three major insurance operating companies: American General Life Insurance Company, The Variable Annuity Life Insurance Company and The United States Life Insurance Company in the City of New York. |
AIG 2012 Form 10-K
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AIG Life and Retirement 2012 Premiums and Premiums, Deposits and Other Considerations
Premiums represent amounts received on traditional life insurance policies, group benefit policies and deposits on life contingent payout annuities. Premiums, deposits and other considerations is a non-GAAP measure that includes life insurance premiums and deposits on annuity contracts and mutual funds.
See Item 7. MD&A Result of Operations AIG Life and Retirement Operations Premiums for a reconciliation of premiums, deposits and other considerations to premiums.
A Look at AIG Life and Retirement
AIG Life and Retirement 2012 Sales by Distribution Channel
(dollars in millions)
Represents life and group A&H premiums from new policies expected to be collected over a one-year period plus 10 percent of life unscheduled deposits, single premiums and annuity deposits from new and existing customers.
AIG 2012 Form 10-K
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AIG Life and Retirement's Diversified Distribution Network
Affiliated |
Nonaffiliated |
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VALIC career financial advisors
Over 1,200 financial advisors serving the worksites of educational, not-for-profit and governmental organizations |
Banks
Nearly 600 banks and 69,000 financial institution agents |
Competition and Customer Marketing Strengths
AIG Life and Retirement competes against approximately 1,800 providers of life insurance and retirement savings products, including other large, well-established life insurance companies and other financial services companies. Life insurance companies compete through a combination of risk-acceptance (underwriting) criteria, product pricing, service, and terms and conditions. Retirement services companies also compete through crediting rates and through offering guaranteed benefits features.
AIG Life and Retirement competes in the life insurance and retirement savings businesses primarily based on its well-established brands, innovative products, extensive distribution network, customer service and strong financial ratings. AIG Life and Retirement helps ensure financial and retirement security for more than 18 million customers.
AIG 2012 Form 10-K
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AIG Life and Retirement Competitive Strengths |
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Leading life insurance and retirement brands |
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Diversified product mix |
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Broad multi-channel distribution network |
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Financial strength |
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AIG Life and Retirement is an established leader with well-regarded brands in the markets it serves. AIG Life and Retirement has the scale and breadth of product knowledge to deliver effective solutions across a range of markets.
AIG Life and Retirement has an expansive product suite including life insurance, accident and health, annuity, mutual fund, group retirement, group benefit and institutional products as well as other solutions to help provide a secure future for our customers.
AIG Life and Retirement's distribution footprint covers a broad expanse of the U.S. market. AIG Life and Retirement products are sold by over 300,000 financial professionals across an extensive and growing multichannel network of financial advisors and insurance agents that spans both affiliated and non-affiliated partners.
AIG Life and Retirement's financial profile is strong and stable, giving customers confidence in AIG Life and Retirement's ability to meet financial obligations associated with its retirement and insurance products.
Somewhat offsetting these strengths are regulatory changes in recent years, which have created an increasingly complex environment that is affecting industry growth and profitability.
AIG 2012 Form 10-K
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Other Operations
Mortgage Guaranty (United Guaranty Corporation or UGC) offers private residential mortgage guaranty insurance, which protects mortgage lenders and investors from loss due to borrower default and loan foreclosure. With over 1,100 employees, United Guaranty currently insures over one million mortgage loans in the United States and has operations in nine other countries. In 2012, United Guaranty generated more than $37 billion in new insurance written, which represents the original principal balance of the insured mortgages, becoming the leading provider of private mortgage insurance in the United States and is the highest rated private mortgage insurance company in the U.S.
Mortgage Guaranty Business Strategy
Risk Selection: Ensure the high quality of our business through a continuous focus on risk selection and risk based pricing using a proprietary, multi-variant risk evaluation model and disciplined underwriting approach.
Innovation: Focus on innovation through the development and enhancement of products, technology, and processes, addressing the needs of stakeholders in the mortgage system.
Ease of Use: Eliminate complexity in the mortgage insurance system to create growth without sacrificing disciplined risk selection and management.
Expense Management: Streamline our processes through the use of technology and shared services to more quickly react to the changing dynamics of the mortgage industry.
Mortgage Guaranty Insurance
Products and Services: United Guaranty provides an array of products and services including first-lien mortgage guaranty insurance in a range of premium payment plans. United Guaranty's primary product is private mortgage insurance. The coverage we provide which is called mortgage guaranty insurance, mortgage insurance, or simply "MI" enables borrowers to purchase a house with a modest down payment. This is because MI protects lenders against the increased risk of borrower default related to high loan-to-value (LTV) mortgages those with less than 20 percent equity. In short, MI lets lenders provide more mortgage loans to more people.
Homeowner Support: United Guaranty also works with homeowners who are behind on their mortgage payments to identify ways to retain their home. As a liaison between the borrower and the mortgage servicer, United Guaranty provides the added support to qualified homeowners to help them avoid foreclosure.
AIG 2012 Form 10-K
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A Look at Mortgage Guaranty
Mortgage Guaranty Distribution Channels
National Mortgage Bankers |
Community Banks |
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Money Center Banks |
State Housing Finance Agencies |
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Regional Mortgage Lenders |
Builder-owned Mortgage Lenders |
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Credit Unions |
Internet-sourced lenders |
Mortgage Guaranty Competition and Competitive Strengths
United Guaranty competes with six private providers of mortgage insurance, both well-established and new entrants to the industry, and The Federal Housing Administration, which is the largest provider of mortgage insurance in the United States.
The
United Guaranty brand has 50 years of history and is well regarded in the industry. We differentiate ourselves through our financial strength, our risk based pricing strategy, which
provides for lower premiums for lower risk mortgages, our innovative products and our rigorous approach to risk management. Despite these strengths there are potential challenges arising in the
mortgage market from increasingly complex regulations relating to mortgage originations as well as uncertainty in the government's involvement in the domestic residential housing finance system in the
future. These challenges may have an adverse impact on our business.
Other operations also include:
Global Capital Markets (GCM) consist of the operations of AIG Markets, Inc. (AIG Markets) and the remaining derivatives portfolio of AIG Financial Products Corp. and AIG Trading Group Inc. and their respective subsidiaries (collectively AIGFP). AIG Markets acts as the derivatives intermediary between AIG and its subsidiaries and third parties to provide hedging services. The AIGFP portfolio continues to be wound down and is managed consistent with AIG's risk management objectives. Although the portfolio may experience periodic fair value volatility, it consists predominantly of transactions that AIG believes are of low complexity, low risk or currently not economically appropriate to unwind based on a cost versus benefit analysis.
Direct Investment Book (DIB) consists of a portfolio of assets and liabilities held directly by AIG Parent in the Matched Investment Program (MIP) and certain subsidiaries not related to AIG's core insurance operations (including certain non-derivative assets and liabilities of AIGFP). The management of the DIB portfolio is focused on an orderly wind down to maximize returns consistent with AIG's risk management objectives. Certain non-derivative assets and liabilities of the DIB are accounted for under the fair value option and thus operating results are subject to periodic market volatility.
Retained Interests includes the fair value gains or losses, prior to their sale, of the AIA ordinary shares retained following the AIA initial public offering and the MetLife, Inc. (MetLife) securities that were received as consideration from the sale of American Life Insurance Company (ALICO) and the fair value gains or losses, prior to the FRBNY liquidation of ML III assets, on the retained interest in ML III.
AIG 2012 Form 10-K
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Corporate & Other Operations consist primarily of interest expense, intercompany interest income that is eliminated in consolidation, expenses of corporate staff not attributable to specific reportable segments, certain expenses related to internal controls and the financial and operating platforms, corporate initiatives, certain compensation plan expenses, corporate level net realized capital gains and losses, certain litigation-related charges and credits, the results of AIG's real estate investment operations and net gains and losses on sale of divested businesses and properties that did not meet the criteria for discontinued operations accounting treatment.
Divested Businesses We have divested a number of businesses since 2009 in connection with our strategies to focus on core businesses, repay governmental support, and improve our financial flexibility and risk management. Divested businesses include the historical results of divested entities that did not meet the criteria for discontinued operations accounting treatment.
Divested businesses include the historical results of AIA through October 29, 2010 and AIG's remaining consumer finance business, discussed below. In the third quarter of 2010, AIG completed an initial public offering of ordinary shares of AIA. Upon completion of this initial public offering, AIG owned approximately 33 percent of the outstanding shares of AIA. Because of this ownership position in AIA, as well as AIG's prior representation on the AIA board of directors, AIA was not presented as a discontinued operation.
Discontinued Operations consist of entities that were sold, or are being sold, that met specific accounting criteria discussed in Note 4 to the Consolidated Financial Statements. |
On December 9, 2012, AIG entered into an agreement to sell 80.1 percent of ILFC for approximately $4.2 billion in cash, with an option for the purchaser to buy an additional 9.9 percent stake. The sale is expected to be consummated in 2013. The operating results for ILFC are reflected as a discontinued operation in all periods presented and its assets and liabilities have been classified as held for sale at December 31, 2012.
On August 18, 2011, AIG closed the sale of Nan Shan Life Insurance Company, Ltd. (Nan Shan). On February 1, 2011, AIG closed the sale of AIG Star Life Insurance Co., Ltd. (AIG Star) and AIG Edison Life Insurance Company (AIG Edison). The operating results for Nan Shan, AIG Star and AIG Edison through the dates of their respective sales are reflected as discontinued operations in all periods prior to 2012.
In the fourth quarter of 2010, AIG closed the sales of ALICO and American General Finance, Inc. (AGF). Periods prior to 2011 reflect ALICO and AGF as discontinued operations.
Additionally, following the classification of AGF as a discontinued operation in the third quarter of 2010, AIG's remaining consumer finance business, which is primarily conducted through the AIG Federal Savings Bank and the Consumer Finance Group in Poland, is now reported in AIG's Other operations category as part of Corporate & Other.
A REVIEW OF LIABILITY FOR UNPAID CLAIMS AND CLAIMS ADJUSTMENT EXPENSE
The liability for unpaid claims and claims adjustment expenses represents the accumulation of estimates for unpaid reported claims and claims that have been incurred but not reported (IBNR) for our AIG Property Casualty subsidiaries and Mortgage Guaranty. Unpaid claims and claims adjustment expenses are also referred to as unpaid loss and loss adjustment expenses, or just loss reserves.
We recognized as assets the portion of this liability that will be recovered from reinsurers. Reserves are discounted for future expected investment income, where permitted, in accordance with U.S. GAAP.
AIG 2012 Form 10-K
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The Loss Reserve Development Process
The process of establishing the liability for unpaid losses and loss adjustment expenses is complex and imprecise because it must take into consideration many variables that are subject to the outcome of future events. As a result, informed subjective estimates and judgments about our ultimate exposure to losses are an integral component of our loss reserving process.
We use a number of techniques to analyze the adequacy of the established net liability for unpaid claims and claims adjustment expense (net loss reserves). Using these analytical techniques, we monitor the adequacy of
AIG's established reserves and determine appropriate assumptions for inflation and other factors influencing loss costs. Our analysis also takes into account emerging specific development patterns, such as case reserve redundancies or deficiencies
and IBNR emergence. We also consider specific factors that may impact losses, such as changing trends in medical costs, unemployment levels and other economic indicators, as well as changes in legislation and social attitudes that may affect
decisions to file claims or the magnitude of court awards. See Item 7. MD&A Critical Accounting Estimates for a description of our loss reserving process. A significant portion of AIG Property Casualty's business is in the U.S. commercial casualty class, which tends to involve longer periods of time for the reporting and settlement of claims and may increase the risk and uncertainty with respect to our loss reserve development. |
Because reserve estimates are subject to the outcome of future events, changes in prior year estimates are unavoidable in the insurance industry. These changes in estimates are sometimes referred to as "loss development" or "reserve development." |
Analysis of Consolidated Loss Reserve Development
The "Analysis of Consolidated Loss Reserve Development" table shown on page 22 presents the development of prior year net loss reserves for calendar years 2002 through 2012 for each balance sheet in that period. The information in the table is presented in accordance with reporting requirements of the Securities and Exchange Commission (SEC). This table should be interpreted with care by those not familiar with its format or those who are familiar with other loss development analyses arranged in an accident year or underwriting year basis rather than the balance sheet, as shown below. See Note 13 to the Consolidated Financial Statements.
The top row of the table shows Net Reserves Held (the net liability for unpaid claims and claims adjustment expenses) at each balance sheet date, net of discount. This liability represents the estimated amount of losses and loss adjustment expenses for claims arising in all years prior to the balance sheet date that were unpaid as of that balance sheet date, including estimates for IBNR claims. The amount of loss reserve discount included in the net reserves at each date is shown immediately below the net reserves held. The undiscounted reserve at each date is equal to the sum of the discount and the net reserves held.
For example, Net Reserves Held (Undiscounted) was $30.8 billion at December 31, 2002.
The next section of the table shows the original Net Undiscounted Reserves re-estimated over 10 years. This re-estimation takes into consideration a number of factors, including changes in the estimated frequency of reported claims, effects of significant judgments, the emergence of latent exposures, and changes in medical cost trends. For example, the original undiscounted reserve of $30.8 billion at December 31, 2002, was re-estimated to $58.0 billion at December 31, 2012. The amount of the development related to losses settled or re-estimated in 2012, but incurred in 2009, is included in the cumulative development amount for years 2009, 2010 and 2011. Any increase or decrease in the estimate is reflected in operating results in the period in which the estimate is changed.
AIG 2012 Form 10-K
21
The middle of the table shows Net Redundancy/(Deficiency). This is the aggregate change in estimates over the period of years covered by the table. For example, the net loss reserve deficiency of $27.1 billion for 2002 is the difference between the original undiscounted reserve of $30.8 billion at December 31, 2002 and the $58.0 billion of re-estimated reserves at December 31, 2012. The net redundancy/(deficiency) amounts are cumulative; in other words, the amount shown in the 2011 column includes the amount shown in the 2010 column, and so on. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it generally is not appropriate to extrapolate future development based on this table.
The bottom portion of the table shows the Paid (Cumulative) amounts during successive years related to the undiscounted loss reserves. For example, as of December 31, 2012, AIG had paid a total of $47.9 billion of the $58.0 billion in re-estimated reserves for 2002, resulting in Remaining Reserves (Undiscounted) of $10.1 billion for 2002. Also included in this section are the Remaining Reserves (Undiscounted) and the Remaining Discount for each year.
The following table presents loss reserves and the related loss development 2002 through 2012 and consolidated gross liability (before discount), reinsurance recoverable and net liability recorded for each calendar year, and the re-estimation of these amounts as of December 31, 2012.(a)
(in millions) |
2002 |
2003 |
2004 |
2005 |
2006 |
2007 |
2008 |
2009 |
2010 |
2011 |
2012 |
|||||||||||||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Net Reserves Held(b) |
$ | 29,347 | $ | 36,228 | $ | 47,253 | $ | 57,476 | $ | 62,630 | $ | 69,288 | $ | 72,455 | $ | 67,899 | $ | 71,507 | $ | 70,825 | $ | 68,782 | ||||||||||||
Discount (in Reserves Held) |
1,499 | 1,516 | 1,553 | 2,110 | 2,264 | 2,429 | 2,574 | 2,655 | 3,217 | 3,183 | 3,246 | |||||||||||||||||||||||
Net Reserves Held (Undiscounted) |
30,846 | 37,744 | 48,806 | 59,586 | 64,894 | 71,717 | 75,029 | 70,554 | 74,724 | 74,008 | $ | 72,028 | ||||||||||||||||||||||
Net undiscounted Reserve re-estimated as of: |
||||||||||||||||||||||||||||||||||
One year later |
32,913 | 40,931 | 53,486 | 59,533 | 64,238 | 71,836 | 77,800 | 74,736 | 74,919 | 74,429 | ||||||||||||||||||||||||
Two years later |
37,583 | 49,463 | 55,009 | 60,126 | 64,764 | 74,318 | 82,043 | 74,529 | 75,502 | |||||||||||||||||||||||||
Three years later |
46,179 | 51,497 | 56,047 | 61,242 | 67,303 | 78,275 | 81,719 | 75,187 | ||||||||||||||||||||||||||
Four years later |
48,427 | 52,964 | 57,618 | 63,872 | 70,733 | 78,245 | 82,422 | |||||||||||||||||||||||||||
Five years later |
49,855 | 54,870 | 60,231 | 67,102 | 70,876 | 79,098 | ||||||||||||||||||||||||||||
Six years later |
51,560 | 57,300 | 63,348 | 67,518 | 71,572 | |||||||||||||||||||||||||||||
Seven years later |
53,917 | 60,283 | 63,928 | 68,233 | ||||||||||||||||||||||||||||||
Eight years later |
56,827 | 60,879 | 64,532 | |||||||||||||||||||||||||||||||
Nine years later |
57,410 | 61,449 | ||||||||||||||||||||||||||||||||
Ten years later |
57,967 | |||||||||||||||||||||||||||||||||
Net Deficiency on net reserves held |
(27,121 |
) |
(23,705 |
) |
(15,726 |
) |
(8,647 |
) |
(6,678 |
) |
(7,381 |
) |
(7,393 |
) |
(4,633 |
) |
(778 |
) |
(421 |
) |
||||||||||||||
Net Deficiency related to A&E |
(4,042 | ) | (3,970 | ) | (2,965 | ) | (2,036 | ) | (1,827 | ) | (1,809 | ) | (1,759 | ) | (1,607 | ) | (106 | ) | (76 | ) | ||||||||||||||
Net Deficiency excluding A&E |
(23,079 | ) | (19,735 | ) | (12,761 | ) | (6,611 | ) | (4,851 | ) | (5,572 | ) | (5,634 | ) | (3,026 | ) | (672 | ) | (345 | ) | ||||||||||||||
Paid (Cumulative) as of: |
||||||||||||||||||||||||||||||||||
One year later |
10,775 | 12,163 | 14,910 | 15,326 | 14,862 | 16,531 | 24,267 | 15,919 | 17,661 | 19,235 | ||||||||||||||||||||||||
Two years later |
18,589 | 21,773 | 24,377 | 25,152 | 24,388 | 31,791 | 36,164 | 28,428 | 30,620 | |||||||||||||||||||||||||
Three years later |
25,513 | 28,763 | 31,296 | 32,295 | 34,647 | 40,401 | 46,856 | 38,183 | ||||||||||||||||||||||||||
Four years later |
30,757 | 33,825 | 36,804 | 40,380 | 40,447 | 48,520 | 53,616 | |||||||||||||||||||||||||||
Five years later |
34,627 | 38,087 | 43,162 | 44,473 | 46,474 | 53,593 | ||||||||||||||||||||||||||||
Six years later |
37,778 | 42,924 | 46,330 | 49,552 | 50,391 | |||||||||||||||||||||||||||||
Seven years later |
41,493 | 45,215 | 50,462 | 52,243 | ||||||||||||||||||||||||||||||
Eight years later |
43,312 | 48,866 | 52,214 | |||||||||||||||||||||||||||||||
Nine years later |
46,622 | 50,292 | ||||||||||||||||||||||||||||||||
Ten years later |
47,856 | |||||||||||||||||||||||||||||||||
Remaining Reserves (Undiscounted) |
10,111 |
11,157 |
12,318 |
15,990 |
21,181 |
25,505 |
28,806 |
37,004 |
44,882 |
55,194 |
||||||||||||||||||||||||
Remaining Discount |
876 | 993 | 1,087 | 1,203 | 1,362 | 1,589 | 1,869 | 2,203 | 2,535 | 2,899 | ||||||||||||||||||||||||
Remaining Reserves |
$ | 9,235 | $ | 10,164 | $ | 11,231 | $ | 14,787 | $ | 19,819 | $ | 23,916 | $ | 26,937 | $ | 34,801 | $ | 42,347 | $ | 52,295 | ||||||||||||||
Net Liability, End of Year |
$ | 30,846 | $ | 37,744 | $ | 48,806 | $ | 59,586 | $ | 64,894 | $ | 71,717 | $ | 75,030 | $ | 70,554 | $ | 74,724 | $ | 74,008 | $ | 72,028 | ||||||||||||
Reinsurance Recoverable, End of Year |
17,327 | 15,644 | 14,624 | 19,693 | 17,369 | 16,212 | 16,803 | 17,487 | 19,644 | 20,320 | 19,209 | |||||||||||||||||||||||
Gross Liability, End of Year |
48,173 | 53,388 | 63,430 | 79,279 | 82,263 | 87,929 | 91,833 | 88,041 | 94,368 | 94,328 | $ | 91,237 | ||||||||||||||||||||||
Re-estimated Net Liability |
57,967 | 61,449 | 64,532 | 68,233 | 71,572 | 79,098 | 82,422 | 75,187 | 75,502 | 74,429 | ||||||||||||||||||||||||
Re-estimated Reinsurance Recoverable |
25,535 | 23,131 | 21,249 | 24,093 | 20,528 | 19,135 | 18,480 | 18,371 | 16,861 | 20,395 | ||||||||||||||||||||||||
Re-estimated Gross Liability |
83,502 | 84,580 | 85,781 | 92,326 | 92,100 | 98,233 | 100,902 | 93,558 | 92,363 | 94,824 | ||||||||||||||||||||||||
Cumulative Gross |
$ | (35,329 | ) | $ | (31,192 | ) | $ | (22,351 | ) | $ | (13,047 | ) | $ | (9,837 | ) | $ | (10,304 | ) | $ | (9,069 | ) | $ | (5,517 | ) | $ | 2,005 | $ | (496 | ) | |||||
(a) During 2009, we deconsolidated Transatlantic Holdings, Inc. and sold 21st Century Insurance Group and HSB Group, Inc. The sales and deconsolidation are reflected in the table above as a reduction in December 31, 2009 net reserves of $9.7 billion and as an $8.6 billion increase in paid losses for the years 2000 through 2008 to remove the reserves for these divested entities from the ending balance.
(b) The increase in Net Reserves Held from 2009 to 2010 is partially due to the $1.7 billion in Net Reserves Held by Fuji, which was acquired in 2010. The decrease in 2011 is due to the cession of asbestos reserves described in Item 7. MD&A Results of Operations Segment Results AIG Property Casualty Operations Liability for Unpaid Claims and Claims Adjustment Expense Asbestos and Environmental Reserves.
AIG 2012 Form 10-K
22
The Liability for unpaid claims and claims adjustment expense as reported in AIG's Consolidated Balance Sheet at December 31, 2012 differs from the total reserve reported in the annual statements filed with state insurance departments and, where applicable, with foreign regulatory authorities primarily for the following reasons:
Gross loss reserves are calculated without reduction for reinsurance recoverables and represent the accumulation of estimates for reported losses and IBNR. We review the adequacy of established gross loss reserves in the manner previously described for net loss reserves. A reconciliation of activity in the Liability for unpaid claims and claims adjustment expense is included in Note 13 to the Consolidated Financial Statements.
AIG subsidiaries operate worldwide primarily by underwriting and accepting risks for their direct account on a gross basis and reinsuring a portion of the exposure on either an individual risk or an aggregate basis to the extent those risks exceed the desired retention level. In addition, as a condition of certain direct underwriting transactions, we are required by clients, agents or regulation to cede all or a portion of risks to specified reinsurance entities, such as captives, other insurers, local reinsurers and compulsory pools.
In 2012, AIG Property Casualty adopted a new ceded reinsurance framework and strategy to improve the efficiency of our legal entity capital management and support our global product line risk and profitability objectives. Reinsurance is also used to manage overall capital adequacy and mitigate the effects of certain events such as natural and man-made catastrophes. As a result of adopting the new framework and strategy, many individual reinsurance contracts were consolidated into more efficient global programs and reinsurance ceded to third parties in support of risk and capital management objectives has decreased in 2012. There are many different forms of reinsurance agreements and different markets that may be used to achieve our risk and profitability objectives. We continually evaluate the reinsurance markets and the relative attractiveness of various arrangements that may be used to achieve our risk and profitability objectives.
The form of reinsurance that we may choose from time to time will generally depend on whether we are seeking (i) proportional reinsurance, whereby we cede a specified percentage of premium and losses to reinsurers, or non-proportional or excess of loss reinsurance, whereby we cede all or a specified portion of losses in excess of a specified amount on a per risk, per occurrence (including catastrophe reinsurance) or aggregate basis and (ii) treaties that cover a defined book of policies, or facultative placements that cover an individual policy.
Reinsurance markets include:
Reinsurance arrangements do not relieve the AIG subsidiaries from their direct obligations to insureds. However, an effective reinsurance program substantially mitigates our exposure to potentially significant losses.
See Item 7. MD&A Enterprise Risk Management Insurance Operations Risks AIG Property Casualty Key Insurance Risks Reinsurance Recoverables for a summary of significant reinsurers.
AIG 2012 Form 10-K
23
GENERATING REVENUES: INVESTMENT ACTIVITIES OF OUR INSURANCE OPERATIONS
AIG Property Casualty and AIG Life and Retirement generally receive premiums and deposits well in advance of paying covered claims or benefits. In the intervening periods, we invest these premiums and deposits to generate
net investment income and fee income that is available to pay claims or benefits. As a result, we generate significant revenues from insurance investment activities. AIG's worldwide insurance investment policy places primary emphasis on investments in fixed maturity securities of corporations, municipal bonds and government issuances in all of its portfolios, and, to a lesser extent, investments in high-yield bonds, common stock, real estate, hedge funds and other alternative investments. |
We generate significant revenues in our AIG Property Casualty and AIG Life and Retirement operations from investment activities. |
The majority of assets backing insurance liabilities at AIG consist of intermediate and long duration fixed maturity securities.
AIG Property Casualty Fixed maturity securities held by the insurance companies included in AIG Property Casualty domestic operations historically have consisted primarily of laddered holdings of tax-exempt municipal bonds. These tax-exempt municipal bonds provided attractive after-tax returns and limited credit risk. To meet our domestic operations' current risk-return and tax objectives, our domestic property and casualty companies have begun to shift investment allocations away from tax-exempt municipal bonds towards taxable instruments. Any taxable instruments must meet our liquidity, duration and quality objectives as well as current risk-return and tax objectives. Fixed maturity securities held by AIG Property Casualty international operations consist primarily of intermediate duration high-grade securities, primarily in the markets being served. In addition, AIG Property Casualty has redeployed cash in excess of operating needs and short-term investments into longer-term, higher-yielding securities.
AIG Life and Retirement Our investment strategy is to generally match the duration of our liabilities with assets of comparable duration. AIG Life and Retirement also invests in a diversified portfolio of private equity funds, hedge funds and affordable housing partnerships. Although these types of investments are subject to periodic earnings volatility, through December 31, 2012, they have achieved total returns in excess of AIG Life and Retirement's base portfolio yield. AIG Life and Retirement expects that these alternative investments will continue to outperform the base portfolio yield over the long term.
The following table summarizes the investment results of AIG's insurance operations, excluding the results of discontinued operations
Years Ended December 31, (in millions) |
Annual Average Investments(a) |
Net Investment Income |
Pre-tax Return on Average Investments(b) |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
AIG Property Casualty: |
||||||||||
2012 |
$ 120,166 | $ 4,820 | 4.0% | |||||||
2011 |
113,405 | 4,348 | 3.8 | |||||||
2010 |
100,583 | 4,392 | 4.4 | |||||||
AIG Life and Retirement: |
||||||||||
2012 |
$ 190,983 | $ 10,718 | 5.6% | |||||||
2011 |
172,846 | 9,882 | 5.7 | |||||||
2010 |
154,167 | 10,768 | 7.0 | |||||||
(a) Includes real estate investments and excludes cash and short-term investments.
(b) Net investment income divided by the annual average investments.
Our operations around the world are subject to regulation by many different types of regulatory authorities, including banking, insurance, securities and investment advisory regulators in the United States and abroad. The insurance
AIG 2012 Form 10-K
24
and financial services industries generally have been subject to heightened regulatory scrutiny and supervision in recent years.
Federal Reserve Supervision
We are a savings and loan holding company (SLHC) within the meaning of the Home Owners' Loan Act (HOLA) and are regulated and subject to the examination, supervision and enforcement authority and reporting requirements of the Board of Governors of the Federal Reserve System (FRB). Because we were grandfathered as a unitary SLHC within the meaning of HOLA when we organized AIG Federal Savings Bank and became an SLHC in 1999, we generally are not restricted under existing laws as to the types of business activities in which we may engage, as long as AIG Federal Savings Bank continues to be a qualified thrift lender.
The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) has effected comprehensive changes to the regulation of financial services in the United States and subjects us to substantial additional federal regulation. The FRB supervises and regulates SLHCs, and the Office of the Comptroller of the Currency (OCC) supervises and regulates federal savings associations, such as AIG Federal Savings Bank. Dodd-Frank directs existing and newly-created government agencies and oversight bodies to promulgate regulations implementing the law, an ongoing process that has begun and is anticipated to continue over the next few years.
Changes mandated by Dodd-Frank include directing the FRB to promulgate minimum capital requirements for SLHCs. The FRB, OCC and Federal Deposit Insurance Corporation (FDIC) have proposed revised minimum leverage and risk-based capital requirements that would apply to all bank holding companies and SLHCs, as well as to insured depository institutions, such as AIG Federal Savings Bank. As required by Dodd-Frank, the FRB has also proposed enhanced prudential standards for large bank holding companies and non-bank systemically important financial institutions (SIFIs) and has stated its intention to propose enhanced prudential standards for SLHCs pursuant to HOLA. We cannot predict whether the capital regulations will be adopted as proposed or what enhanced prudential standards the FRB will promulgate for SLHCs, either generally or as applicable to insurance businesses. Further, we cannot predict how the FRB will exercise general supervisory authority over us, although the FRB could, as a prudential matter, for example, limit our ability to pay dividends, purchase shares of AIG Common Stock or acquire or enter into other businesses. We cannot predict with certainty the requirements of the regulations ultimately adopted or how or whether Dodd-Frank and such regulations will affect the financial markets generally, impact our businesses, results of operations, cash flows or financial condition, or require us to raise additional capital or result in a downgrade of our credit ratings.
Furthermore, Dodd-Frank requires SIFIs to be subject to regulation, examination and supervision by the FRB (including minimum leverage and risk-based capital requirements). Nonbank SIFIs will be designated by the Financial Stability Oversight Council (Council) created by Dodd-Frank. If we are designated as a SIFI, we will be regulated by the FRB both in that capacity and in our capacity as an SLHC. The regulations applicable to SIFIs and to SLHCs, when all have been adopted as final rules, may differ materially from each other. In October 2012, we received a notice that we are under consideration by the Council for a proposed determination that we are a SIFI. The notice stated that we will be reviewed in Stage 3 of the SIFI determination process described in the Council's interpretive guidance for nonbank financial company determinations. If we are designated as a SIFI, we would also be subject to additional regulatory requirements, including heightened prudential standards. For a description of those standards as currently proposed and a discussion of the potential effects on us if we are designated as a SIFI, see Item 1A. Risk Factors Regulation.
As part of its general prudential supervisory powers, the FRB has the authority to limit our ability to conduct activities that would otherwise be permissible for us to engage in if we do not satisfy certain requirements.
Directive 2002/87/EC (the Directive) issued by the European Parliament provides that certain financial conglomerates with regulated entities in the European Union, such as AIG, are subject to supplementary supervision. Pursuant to the Directive, the Commission Bancaire, the French banking regulator, was appointed as our supervisory coordinator. We have been in discussions with, and have provided information to, the Autorité de Contrôle Prudentiel (formerly, the Commission Bancaire) and the UK Financial Services Authority regarding the possibility of proposing another of our existing regulators as our equivalent supervisor.
AIG 2012 Form 10-K
25
Capital Requirements
Section 171 of Dodd-Frank (the Collins Amendment) subjects SLHCs to capital requirements that must be no less stringent than the requirements generally applicable to insured depository institutions or quantitatively lower than the requirements in effect for insured depository institutions as of July 21, 2010. The regulatory capital requirements currently applicable to insured depository institutions, such as AIG Federal Savings Bank, are computed in accordance with the U.S. federal banking agencies' generally applicable risk-based capital requirements, which are based on accords established by the Basel Committee on Banking Supervision (Basel Committee). These accords have evolved over time, and are referred to as Basel I, Basel II and Basel III.
In June 2012, the federal banking agencies issued proposed rules that would revise and replace current regulatory capital rules for banking organizations, including SLHCs.
We are still considering the full impact of the proposed capital rules and the FRB and the other federal banking agencies have not adopted final rules. In addition, the FRB has announced that the rules will not be effective as of January 1, 2013, as originally proposed, but has not provided a revised effective date.
Also in June 2012, the FRB and the other federal banking agencies issued revised final rules that modify their market risk regulatory capital requirements for banking institutions with significant trading activities. These modifications are designed to address the adjustments to the market risk regulatory capital framework that were announced by the Basel Committee in June 2010 (referred to as "Basel II.5") and the prohibition on the use of external credit ratings, as required by Dodd-Frank. These changes become effective for banking institutions in 2013 and will likely become effective for us when capital requirements for SLHCs are implemented. These changes will result in increased regulatory capital requirements for market risk. We are still considering the full impact of these capital requirements.
Volcker Rule
In July 2012, Section 619 of Dodd-Frank, referred to as the "Volcker Rule," became effective, although the final rule implementing Section 619 has not yet been released. Under the proposed rule released in October 2011, if we continue to be regulated as an SLHC due to our control of AIG Federal Savings Bank, or control another insured depository institution, we and our affiliates would be considered banking entities for purposes of the rule and, after the rule's conformance date of July 21, 2014, would be prohibited from "proprietary trading" and sponsoring or investing in "covered funds," subject to the rule's exceptions. Even if we are no longer regulated as an SLHC or no longer control an insured depository institution, we could be subject to restrictions on these activities if we are designated as a SIFI, as Dodd-Frank authorizes the FRB to subject SIFIs to capital requirements, quantitative limits or other restrictions if they engage in activities prohibited for banking entities under the Volcker Rule. The Volcker Rule, as proposed, contains an exemption for proprietary trading by insurance companies for their general account, but the final breadth and scope of this exemption is uncertain.
Other Effects of Dodd-Frank
In addition, Dodd-Frank will also have the following effects on us:
AIG 2012 Form 10-K
26
Dodd-Frank imposes various assessments on financial companies, including, as applicable to us, ex-post assessments to provide funds necessary to repay any borrowing and to cover the costs of any special resolution of a financial company conducted under Title II (although the regulatory authority would have to take account of the amounts paid by us into state guaranty funds).
We cannot predict whether these actions will become effective or the effect they may have on the financial markets or on our business, results of operations, cash flows, financial condition and credit ratings. However, it is possible that such effect could be materially adverse. See Item 1A. Risk Factors Regulation for additional information.
Other Regulatory Developments
In addition to the adoption of Dodd-Frank in the United States, regulators and lawmakers around the world are actively reviewing the causes of the financial crisis and taking steps to avoid similar problems in the future. The Financial Stability Board (FSB), consisting of representatives of national financial authorities of the G20 nations, has issued a series of frameworks and recommendations intended to produce significant changes in how financial companies, particularly SIFIs, should be regulated. These frameworks and recommendations address such issues as financial group supervision, capital and solvency standards, systemic economic risk, corporate governance including compensation, and a host of related issues associated with responses to the financial crisis. The FSB has directed the International Association of Insurance Supervisors (the IAIS, headquartered in Basel, Switzerland) to create
AIG 2012 Form 10-K
27
standards relative to these areas and incorporate them within that body's Insurance Core Principles. IAIS Insurance Core Principles form the baseline threshold for how countries' financial services regulatory efforts are measured relative to the insurance sector. That measurement is made by periodic Financial Sector Assessment Program (FSAP) reviews conducted by the World Bank and the International Monetary Fund and the reports thereon spur the development of country-specific additional or amended regulatory changes. Lawmakers and regulatory authorities in a number of jurisdictions in which our subsidiaries conduct business have already begun implementing legislative and regulatory changes consistent with these recommendations, including proposals governing consolidated regulation of insurance holdings companies by the Financial Services Agency in Japan, financial and banking regulation adopted in France and compensation regulations proposed or adopted by the financial regulators in Germany and the United Kingdom Financial Services Authority.
Legislation in the European Union could also affect our international insurance operations. The Solvency II Directive (2009/138/EEC) (Solvency II), which was adopted on November 25, 2009 and is expected to become effective in January 2014, reforms the insurance industry's solvency framework, including minimum capital and solvency requirements, governance requirements, risk management and public reporting standards. The impact on us will depend on whether the U.S. insurance regulatory regime is deemed "equivalent" to Solvency II; if the U.S. insurance regulatory regime is not equivalent, then we, along with other insurance companies, could be required to be supervised under Solvency II standards. Whether the U.S. insurance regulatory regime will be deemed "equivalent" is still under consideration by European authorities and remains uncertain, so we are not currently able to predict the impact of Solvency II.
We expect that the regulations applicable to us and our regulated entities will continue to evolve for the foreseeable future.
Regulation of Insurance Subsidiaries
Certain states require registration and periodic reporting by insurance companies that are licensed in such states and are controlled by other corporations. Applicable legislation typically requires periodic disclosure concerning the corporation that controls the registered insurer and the other companies in the holding company system and prior approval of intercompany services and transfers of assets, including in some instances payment of dividends by the insurance subsidiary, within the holding company system. Our subsidiaries are registered under such legislation in those states that have such requirements.
Our insurance subsidiaries are subject to regulation and supervision by the states and by other jurisdictions in which they do business. Within the United States, the method of such regulation varies but generally has its source in statutes that delegate regulatory and supervisory powers to an insurance official. The regulation and supervision relate primarily to the financial condition of the insurers and their corporate conduct and market conduct activities. This includes approval of policy forms and rates, the standards of solvency that must be met and maintained, including with respect to risk-based capital, the licensing of insurers and their agents, the nature of and limitations on investments, restrictions on the size of risks that may be insured under a single policy, deposits of securities for the benefit of policyholders, requirements for acceptability of reinsurers, periodic examinations of the affairs of insurance companies, the form and content of reports of financial condition required to be filed and reserves for unearned premiums, losses and other purposes. In general, such regulation is for the protection of policyholders rather than the equity owners of these companies.
In the U.S., the Risk-Based Capital (RBC) formula is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Virtually every state has adopted, in substantial part, the RBC Model Law promulgated by the National Association of Insurance Commissioners (NAIC), which allows states to act upon the results of RBC calculations, and provides for four incremental levels of regulatory action regarding insurers whose RBC calculations fall below specific thresholds. Those levels of action range from the requirement to submit a plan describing how an insurer would regain a calculated RBC ratio above the respective threshold through a mandatory regulatory takeover of the company. The action thresholds are based on RBC levels that are calculated so that a company subject to such actions is solvent but its future solvency is in doubt without some type of corrective action. The RBC formula computes a risk-adjusted surplus level by applying discrete factors to various asset, premium and reserve items. These factors are developed to be risk-sensitive so that higher factors are applied to items exposed to greater risk. The statutory surplus of each of our U.S.-based life and property and casualty insurance subsidiaries exceeded RBC minimum required levels as of December 31, 2012.
AIG 2012 Form 10-K
28
If any of our insurance entities fell below prescribed levels of statutory surplus, it would be our intention to provide appropriate capital or other types of support to that entity, under formal support agreements or capital maintenance agreements (CMAs) or otherwise. For additional details regarding CMAs that we have entered into with our insurance subsidiaries, see Item 7. MD&A Liquidity and Capital Resources Liquidity and Capital Resources of AIG Parent and Subsidiaries AIG Property Casualty and AIG Life and Retirement.
The National Association of Insurance Commissioners (NAIC) has undertaken the Solvency Modernization Initiative (SMI) which focuses on a review of insurance solvency regulations throughout the U.S. financial regulatory system and is expected to lead to a set of long-term solvency modernization goals. SMI is broad in scope, but the NAIC has stated that its focus will include the U.S. solvency framework, group solvency issues, capital requirements, international accounting and regulatory standards, reinsurance and corporate governance.
A substantial portion of AIG Property Casualty's business is conducted in foreign countries. The degree of regulation and supervision in foreign jurisdictions varies. Generally, we must satisfy local regulatory requirements, licenses issued by foreign authorities to our subsidiaries are subject to modification or revocation by such authorities, and therefore these subsidiaries could be prevented from conducting business in certain of the jurisdictions where they currently operate.
In addition to licensing requirements, our foreign operations are also regulated in various jurisdictions with respect to currency, policy language and terms, advertising, amount and type of security deposits, amount and type of reserves, amount and type of capital to be held, amount and type of local investment and the share of profits to be returned to policyholders on participating policies. Some foreign countries regulate rates on various types of policies. Certain countries have established reinsurance institutions, wholly or partially owned by the local government, to which admitted insurers are obligated to cede a portion of their business on terms that may not always allow foreign insurers, including our subsidiaries, full compensation. In some countries, regulations governing constitution of technical reserves and remittance balances may hinder remittance of profits and repatriation of assets.
See Item 7. MD&A Liquidity and Capital Resources Regulation and Supervision and Note 20 to the Consolidated Financial Statements.
AIG's businesses operate in a highly competitive global environment. Principal sources of competition are insurance companies, banks, and other non-bank financial institutions. AIG considers its principal competitors to be other large multinational insurance organizations. We describe our competitive strengths, our strategies to retain existing customers and attract new customers within each of our operating business segment descriptions.
At December 31, 2012, AIG and its subsidiaries had approximately 63,000 employees. We believe that our relations with our employees are satisfactory.
* Includes approximately 500 employees of ILFC, which was held for sale at December 31, 2012.
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DIRECTORS AND EXECUTIVE OFFICERS OF AIG
Information concerning the directors and executive officers of AIG as of February 21, 2013 is set forth below.
Name |
Title |
Age |
Served as Director or Officer Since |
|||
---|---|---|---|---|---|---|
Robert H. Benmosche |
Director, President and Chief Executive Officer |
68 | 2009 | |||
W. Don Cornwell |
Director |
65 | 2011 | |||
John H. Fitzpatrick |
Director |
56 | 2011 | |||
Christopher S. Lynch |
Director |
55 | 2009 | |||
Arthur C. Martinez |
Director |
73 | 2009 | |||
George L. Miles, Jr. |
Director |
71 | 2005 | |||
Henry S. Miller |
Director |
67 | 2010 | |||
Robert S. Miller |
Chairman |
71 | 2009 | |||
Suzanne Nora Johnson |
Director |
55 | 2008 | |||
Morris W. Offit |
Director |
76 | 2005 | |||
Ronald A. Rittenmeyer |
Director |
65 | 2010 | |||
Douglas M. Steenland |
Director |
61 | 2009 | |||
Michael R. Cowan |
Executive Vice President and Chief Administrative Officer |
59 | 2011 | |||
William N. Dooley |
Executive Vice President Investments |
59 | 1992 | |||
Peter D. Hancock |
Executive Vice President Property and Casualty Insurance |
54 | 2010 | |||
David L. Herzog |
Executive Vice President and Chief Financial Officer |
53 | 2005 | |||
Jeffrey J. Hurd |
Executive Vice President Human Resources and Communications |
46 | 2010 | |||
Thomas A. Russo |
Executive Vice President and General Counsel |
69 | 2010 | |||
Siddhartha Sankaran |
Executive Vice President and Chief Risk Officer |
35 | 2010 | |||
Brian T. Schreiber |
Executive Vice President and Treasurer |
47 | 2002 | |||
Jay S. Wintrob |
Executive Vice President Life and Retirement |
55 | 1999 | |||
Charles S. Shamieh |
Senior Vice President and Chief Corporate Actuary |
46 | 2011 | |||
All directors of AIG are elected for one-year terms at the annual meeting of shareholders.
All executive officers are elected to one-year terms, but serve at the pleasure of the Board of Directors. Except for the following individuals below, each of the executive officers has, for more than five years, occupied an executive position with AIG or companies that are now its subsidiaries. There are no arrangements or understandings between any executive officer and any other person pursuant to which the executive officer was elected to such position.
Robert Benmosche joined AIG as Chief Executive Officer in August 2009. Previously, he served as Chairman and Chief Executive Officer of MetLife, Inc. from September 1998 to February 2006 (Chairman until April 2006). He served as President of MetLife, Inc. from September 1999 to June 2004, President and Chief Operating Officer from November 1997 to June 1998, and Executive Vice President from September 1995 to October 1997. Mr. Benmosche has served as a member of the Board of Directors of Credit Suisse Group since 2002.
Michael R. Cowan joined AIG as Senior Vice President and Chief Administrative Officer in January 2010. Prior to joining AIG, he was at Merrill Lynch where he had served as Senior Vice President, Global Corporate Services, since 1998. Mr. Cowan began his career at Merrill Lynch in 1986 as a Financial Manager and later served as Chief Administrative Officer for Europe, the Middle East and Africa. He was also Chief Financial Officer and a member of the Executive Management Committee for the Global Private Client business, including Merrill Lynch Asset Management.
Thomas Russo joined AIG as Executive Vice President Legal, Compliance, Regulatory Affairs and Government Affairs and General Counsel in February 2010. Prior to joining AIG, Mr. Russo was with the law firm of Patton Boggs, LLP, where he served as Senior Counsel. Prior to that, he was Chief Legal Officer of Lehman Brothers Holdings, Inc. Before joining Lehman Brothers in 1993, he was a partner at the law firm of Cadwalader, Wickersham & Taft and a member of its Management Committee.
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Peter Hancock joined AIG in February 2010 as Executive Vice President of Finance and Risk. Prior to joining AIG, Mr. Hancock served as Vice Chairman of KeyCorp, responsible for Key National Banking. Prior to KeyCorp, he served as Managing Director of Trinsum Group, Inc. Prior to that position, Mr. Hancock was at JP Morgan for 20 years, eventually serving as head of its fixed income division and ultimately Chief Financial Officer.
Siddartha Sankaran joined AIG in December 2010 as Senior Vice President and Chief Risk Officer. Prior to that, he was a partner in the Finance and Risk practice of Oliver Wyman Financial Services and served as Canadian Market Manager since 2006.
Charles S. Shamieh joined AIG in 2007 as Executive Director of Enterprise Risk Management. In January 2011, Mr. Shamieh was elected to his current position of Senior Vice President and Corporate Chief Actuary. Prior to joining AIG, Mr. Shamieh was Group Chief Risk Officer for Munich Re Group and a Member of the Group Committee of Munich Re's Board of Management since 2006.
AVAILABLE INFORMATION ABOUT AIG
Our corporate website is www.aig.com. We make available free of charge, through the Investor Information section of our corporate website, the following reports (and related amendments as filed with the SEC) as soon as reasonably practicable after such materials are electronically filed with, or furnished to, the SEC:
Also available on our corporate website:
Except for the documents specifically incorporated by reference into this Annual Report on Form 10-K, information contained on our website or that can be accessed through our website is not incorporated by reference into this Annual Report on Form 10-K. Reference to our website is made as an inactive textual reference.
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Investing in AIG involves risk. In deciding whether to invest in AIG, you should carefully consider the following risk factors. Any of these risk factors could have a significant or material adverse effect on our businesses, results of operations, financial condition or liquidity. They could also cause significant fluctuations and volatility in the trading price of our securities. Readers should not consider any descriptions of these factors to be a complete set of all potential risks that could affect AIG. These factors should be considered carefully together with the other information contained in this report and the other reports and materials filed by us with the Securities and Exchange Commission (SEC). Further, many of these risks are interrelated and could occur under similar business and economic conditions, and the occurrence of certain of them may in turn cause the emergence or exacerbate the effect of others. Such a combination could materially increase the severity of the impact of these risks on our results of operations, liquidity and financial condition.
MARKET CONDITIONS
Difficult conditions in the global capital markets and the economy may materially and adversely affect our businesses, results of operations, financial condition and liquidity. Our businesses are highly dependent on the economic environment, both in the U.S. and around the world. Concerns over continued high domestic unemployment, weakness in the U.S. housing and commercial real estate markets, the ability of the U.S. government to rein in the U.S. deficit, address the federal debt ceiling and reduce spending, and the European Union's ability to resolve its debt crisis, among other issues, have contributed to increased volatility and reduced expectations for the economy and the markets in the near term. Extreme prolonged market events, such as the global financial crisis during 2008 and 2009, have at times led, and could in the future lead, to a lack of liquidity, highly volatile markets, a steep depreciation in asset values across all classes, an erosion of investor and public confidence, and a widening of credit spreads. Difficult economic conditions could also result in increased unemployment and a severe decline in business across a wide range of industries and regions. These market and economic factors could have a material adverse effect on our businesses, results of operations, financial condition and liquidity.
Under difficult economic conditions, we could experience reduced demand for our financial and insurance products and an elevated incidence of claims and lapses or surrenders of policies. Contract holders may choose to defer or cease paying insurance premiums. Other ways in which we could be negatively affected by economic conditions, include, but are not limited to:
Sustained low interest rates may materially and adversely affect our profitability. Sustained low interest rates can negatively affect the performance of our investment securities and reduce the level of investment income earned on our investment portfolios. If a low interest rate environment persists, we may experience slower investment
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income growth and we may not be able to fully mitigate the interest rate risk of our assets relative to our liabilities. Continued low interest rates could impair our ability to earn the returns assumed in the pricing and the reserving for our products at the time they were sold and issued.
INVESTMENT PORTFOLIO, CONCENTRATION OF INVESTMENTS, INSURANCE AND OTHER EXPOSURES
The performance and value of our investment portfolio are subject to a number of risks and uncertainties, including changes in interest rates. Interest rates are highly sensitive to many factors, including monetary policies, domestic and international economic and political issues and other factors beyond our control. Changes in monetary policy or other factors may cause interest rates to rise, which would adversely affect the value of the fixed income securities that we hold and could adversely affect our ability to sell these securities. In addition, the evaluation of available-for-sale securities for other-than-temporary impairments, which may occur if interest rates rise, is a quantitative and qualitative process that is subject to significant management judgment.
Our investment portfolio is concentrated in certain segments of the economy. Our results of operations and financial condition have been adversely affected by the degree of concentration in our investment portfolio in the past, and this may occur again in the future. We have concentrations in residential mortgage-backed, commercial mortgage-backed and other asset-backed securities and commercial mortgage loans. We also have significant exposures to financial institutions and, in particular, to money center and global banks; U.S. state and local government issuers and authorities; and Eurozone financial institutions and governments and corporations. Events or developments that have a negative effect on any particular industry, asset class, group of related industries or geographic region may adversely affect our investments that are concentrated in such segments. Our ability to sell assets concentrated in such areas may be limited if other market participants are selling similar assets at the same time.
Concentration of our insurance and other risk exposures may have adverse effects. We may be exposed to risks as a result of concentrations in our insurance policies, derivatives and other obligations that we undertake for customers and counterparties. We manage these concentration risks by monitoring the accumulation of our exposures by factors such as exposure type, industry, geographic region, counterparty and other factors. We also use reinsurance, hedging and other arrangements to limit or offset exposures that exceed the limits we wish to retain. In certain circumstances, however, these risk management arrangements may not be available on acceptable terms or may prove to be ineffective for certain exposures. Also, our exposure may be so large that even a slightly adverse experience compared to our expectations may have a material adverse effect on our consolidated results of operations or financial condition, or result in additional statutory capital requirements for our subsidiaries.
RESERVES AND EXPOSURES
Our consolidated results of operations, liquidity and financial condition are subject to the effects of catastrophic events. Events such as hurricanes, windstorms, flooding, earthquakes, pandemic disease, acts of terrorism and other catastrophes have adversely affected our business in the past and could do so in the future. Such events could expose us to:
For a sensitivity analysis of our exposure to certain catastrophes, see Item 7. MD&A Enterprise Risk Management Insurance Operations Risks AIG Property Casualty Key Insurance Risks Catastrophe Exposures.
Insurance liabilities are difficult to predict and may exceed the related reserves for losses and loss expenses. We regularly review the adequacy of the established Liability for unpaid claims and claims adjustment
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expense and conduct extensive analyses of our reserves during the year. Our loss reserves, however, may develop adversely. Estimation of ultimate net losses, loss expenses and loss reserves is a complex process, particularly for long-tail casualty lines of business. These include, but are not limited to, general liability, commercial automobile liability, environmental, workers' compensation, excess casualty and crisis management coverages, insurance and risk management programs for large corporate customers and other customized structured insurance products, as well as excess and umbrella liability, D&O and products liability.
While we use a number of analytical reserve development techniques to project future loss development, reserves may be significantly affected by changes in loss cost trends or loss development factors that were relied upon in setting the reserves. These changes in loss cost trends or loss development factors could be due to difficulties in predicting changes, such as changes in inflation, the judicial environment, or other social or economic factors affecting claims. Any deviation in loss cost trends or in loss development factors might not be identified for an extended period of time after we record the initial loss reserve estimates for any accident year or number of years. For a further discussion of our loss reserves, see Item 7. MD&A Results of Operations Segment Results AIG Property Casualty Operations Liability for Unpaid Claims and Claims Adjustment Expense and Critical Accounting Estimates Liability for Unpaid Claims and Claims Adjustment Expense (AIG Property Casualty and Mortgage Guaranty).
Reinsurance may not be available or affordable and may not be adequate to protect us against losses. Our subsidiaries are major purchasers of reinsurance and we use reinsurance as part of our overall risk management strategy. While reinsurance does not discharge our subsidiaries from their obligation to pay claims for losses insured under our policies, it does make the reinsurer liable to them for the reinsured portion of the risk. For this reason, reinsurance is an important risk management tool to manage transaction and insurance line risk retention and to mitigate losses from catastrophes. Market conditions beyond our control determine the availability and cost of reinsurance. For example, reinsurance may be more difficult or costly to obtain after a year with a large number of major catastrophes. As a result, we may, at certain times, be forced to incur additional expenses for reinsurance or may be unable to obtain sufficient reinsurance on acceptable terms. In that case, we would have to accept an increase in exposure risk, reduce the amount of business written by our subsidiaries or seek alternatives. Additionally, we are exposed to credit risk with respect to our subsidiaries' reinsurers to the extent the reinsurance receivable is not secured by collateral or does not benefit from other credit enhancements. We also bear the risk that a reinsurer may be unwilling to pay amounts we have recorded as reinsurance recoverables for any reason, including that (i) the terms of the reinsurance contract do not reflect the intent of the parties of the contract, (ii) the terms of the contract cannot be legally enforced, (iii) the terms of the contract are interpreted by a court differently than intended, (iv) the reinsurance transaction performs differently than we anticipated due to a flawed design of the reinsurance structure, terms or conditions, or (v) a change in laws and regulations, or in the interpretation of the laws and regulations, materially impacts a reinsurance transaction. The insolvency of one or more of our reinsurers, or inability or unwillingness to make timely payments under the terms of our agreements, could have a material adverse effect on our results of operations and liquidity. For additional information on our reinsurance, see Item 7. MD&A Enterprise Risk Management Insurance Operations Risks AIG Property Casualty Key Insurance Risks Reinsurance Recoverables.
LIQUIDITY, CAPITAL AND CREDIT
Our internal sources of liquidity may be insufficient to meet our needs. We need liquidity to pay our operating expenses, interest on our debt, maturing debt obligations and to meet any statutory capital requirements of our subsidiaries. If our liquidity is insufficient to meet our needs, we may at the time need to have recourse to third-party financing, external capital markets or other sources of liquidity, which may not be available or could be prohibitively expensive. The availability and cost of any additional financing at any given time depends on a variety of factors, including general market conditions, the volume of trading activities, the overall availability of credit, regulatory actions and our credit ratings and credit capacity. It is also possible that, as a result of such recourse to external financing, customers, lenders or investors could develop a negative perception of our long- or short-term financial prospects. Disruptions, volatility and uncertainty in the financial markets, and downgrades in our credit ratings, may limit our ability to access external capital markets at times and on terms favorable to us to meet our capital and liquidity needs or prevent our accessing the external capital markets or other financing sources. For a further discussion of our liquidity, see Item 7. MD&A Liquidity and Capital Resources.
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A downgrade in our credit ratings could require us to post additional collateral and result in the termination of derivative transactions. Credit ratings estimate a company's ability to meet its obligations and may directly affect the cost and availability of financing. A downgrade of our long-term debt ratings by the major rating agencies would require us to post additional collateral payments related to derivative transactions to which we are a party, and could permit the termination of these derivative transactions. This could adversely affect our business, our consolidated results of operations in a reporting period or our liquidity. In the event of further downgrades of two notches to our long-term senior debt ratings, AIG would be required to post additional collateral of $226 million, and certain of our counterparties would be permitted to elect early termination of contracts.
AIG Parent's ability to access funds from our subsidiaries is limited. As a holding company, AIG Parent depends on dividends, distributions and other payments from its subsidiaries to fund payments due on its obligations, including its outstanding debt. The majority of our investments are held by our regulated subsidiaries. Our subsidiaries may be limited in their ability to make dividend payments or advance funds to AIG Parent in the future because of the need to support their own capital levels or because of regulatory limits.
AIG Parent's ability to support our subsidiaries is limited. AIG Parent has in the past and expects to continue to provide capital to our subsidiaries as necessary to maintain regulatory capital ratios, comply with rating agency requirements and meet unexpected cash flow obligations, in some cases under support or capital maintenance agreements. AIG Parent has entered into capital maintenance agreements with certain of our insurance subsidiaries that will require it to contribute capital if specific capital levels are breached. If AIG Parent is unable to satisfy a capital need of a subsidiary, the subsidiary could become insolvent or, in certain cases, could be seized by its regulator.
Our subsidiaries may not be able to generate cash to meet their needs due to the illiquidity of some of their investments. Our subsidiaries have investments in certain securities that may be illiquid, including certain fixed income securities and certain structured securities, private company securities, private equity funds and hedge funds, mortgage loans, finance receivables and real estate. Collectively, investments in these securities had a fair value of $49 billion at December 31, 2012. The decline in the U.S. real estate markets and tight credit markets have also materially adversely affected the liquidity of our other securities portfolios, including our residential and commercial mortgage-related securities and investment portfolios. In the event additional liquidity is required by one or more of our subsidiaries and AIG Parent is unable to provide it, it may be difficult for these subsidiaries to generate additional liquidity by selling, pledging or otherwise monetizing these less liquid investments.
A downgrade in the Insurer Financial Strength ratings of our insurance companies could prevent them from writing new business and retaining customers and business. Insurer Financial Strength (IFS) ratings are an important factor in establishing the competitive position of insurance companies. IFS ratings measure an insurance company's ability to meet its obligations to contract holders and policyholders. High ratings help maintain public confidence in a company's products, facilitate marketing of products and enhance its competitive position. Downgrades of the IFS ratings of our insurance companies could prevent these companies from selling, or make it more difficult for them to succeed in selling, products and services, or result in increased policy cancellations, termination of assumed reinsurance contracts, or return of premiums. Under credit rating agency policies concerning the relationship between parent and subsidiary ratings, a downgrade in AIG Parent's credit ratings could result in a downgrade of the IFS ratings of our insurance subsidiaries.
BUSINESS AND OPERATIONS
Interest rate fluctuations, increased surrenders, investment returns and other events may require our subsidiaries to accelerate the amortization of DAC, and record additional liabilities for future policy benefits. DAC represents deferred costs that are incremental and directly related to the successful acquisition of new business or renewal of existing business. The amortization of DAC associated with our Life and Retirement Services business is affected by factors that include current and expected interest rate fluctuations, surrender rates and investment returns. Changes in these factors may require our subsidiaries to accelerate the amortization of DAC and record additional liabilities for future policy benefits. For example, when interest rates rise, customers may buy a competitor's insurance products with higher anticipated returns. This can lead to an increase in policy loans, policy surrenders, withdrawals of life insurance policies, and withdrawals of annuity contracts, causing an acceleration of the amortization of DAC. If DAC amortization exceeds the fees we earn upon surrender or withdrawals, our results of operations could be negatively affected.
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We regularly review DAC for insurance-oriented, investment-oriented, and retirement services products to assess recoverability. This review involves estimating the future profitability of in-force business and requires significant management judgment. If future profitability is substantially lower than estimated, we could be required to accelerate DAC amortization.
Periodically, we evaluate the estimates used in establishing liabilities for future policy benefits for life and A&H insurance contracts, which include liabilities for certain payout annuities. We evaluate these estimates against actual experience and make adjustments based on judgments about mortality, morbidity, persistency, maintenance expenses, and investment returns, including the interest rate environment and net realized capital gains (losses). If actual experience or estimates result in changes to projected future losses on long duration insurance contracts, we may be required to record additional liabilities through a charge to policyholder benefit expense, which could negatively affect our results of operations. For further discussion of DAC and future policy benefits, see Item 7. MD&A Critical Accounting Estimates and Notes 2, 10 and 13 to the Consolidated Financial Statements.
Certain of our products offer guarantees that may decrease our earnings and increase the volatility of our results. We offer variable annuity products that guarantee a certain level of benefits, such as guaranteed minimum death benefits (GMDB), guaranteed minimum income benefits (GMIB), guaranteed minimum withdrawal benefits (GMWB) and guaranteed minimum account value benefits (GMAV). At December 31, 2012, our net liabilities associated with these guaranteed benefits were $1.4 billion. We use reinsurance combined with derivative instruments to mitigate our exposure to these liabilities. While we believe that our actions have mitigated the risks related to guaranteed benefits, our exposure is not fully hedged; in addition, we remain liable if reinsurers or counterparties are unable or unwilling to pay. Finally, downturns in equity markets, increased equity volatility or reduced interest rates could result in an increase in the liabilities associated with the guaranteed benefits, reducing our net income and shareholders' equity.
Indemnity claims could be made against us in connection with divested businesses. We have provided financial guarantees and indemnities in connection with the businesses we have sold, including ALICO, as described in greater detail in Note 16 to the Consolidated Financial Statements. While we do not currently believe the claims under these indemnities will be material, it is possible that significant indemnity claims could be made against us. If such a claim or claims were successful, it could have a material adverse effect on our results of operations, cash flows and liquidity. See Note 16 to the Consolidated Financial Statements for more information on these financial guarantees and indemnities.
Our foreign operations expose us to risks that may affect our operations. We provide insurance, investment and other financial products and services to both businesses and individuals in more than 130 countries. A substantial portion of our AIG Property Casualty business is conducted outside the United States, and we intend to continue to grow this business. Operations outside the United States, particularly in developing nations, may be affected by regional economic downturns, changes in foreign currency exchange rates, political upheaval, nationalization and other restrictive government actions, which could also affect our other operations.
The degree of regulation and supervision in foreign jurisdictions varies. Generally, AIG Parent, as well as its subsidiaries operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to our subsidiaries are subject to modification and revocation. Consequently, our insurance subsidiaries could be prevented from conducting future business in some of the jurisdictions where they currently operate. Adverse actions from any single country could adversely affect our results of operations depending on the magnitude of the event and our financial exposure at that time in that country.
Significant conditions precedent must be satisfied in order to complete the sale of the common stock of ILFC on the agreed terms. Under the terms of the share purchase agreement (Share Purchase Agreement) we entered into for the sale of up to 90% of the common stock of ILFC (the ILFC Transaction) to an entity (the Purchaser) formed on behalf of an investor group, consummation of the ILFC Transaction is subject to the satisfaction or waiver of a number of conditions precedent, such as certain customary conditions and other closing conditions, including the receipt of approvals or non-disapprovals from certain regulatory bodies, including, among others:
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in some cases, without the imposition on either party by such agencies of conditions that would qualify as burdensome.
Any relevant regulatory body may refuse its approval or may seek to make its approval subject to compliance by ILFC or the Purchaser with unanticipated or onerous conditions. Even if approval is not required, the regulator may impose requirements on ILFC subsequent to consummation of the ILFC Transaction. We or the Purchaser may not agree to such conditions or requirements and may have a contractual right to terminate the Share Purchase Agreement.
In addition to other customary termination events, the Share Purchase Agreement allows termination (i) by any party if the closing has not occurred on or before May 15, 2013, subject to an extension to June 17, 2013 if certain conditions are met or (ii) by us if Purchaser has not paid the required deposit into an escrow account upon the later of March 15, 2013 and ten days after approval of the transaction by CFIUS.
Because of the closing conditions and termination rights applicable to the ILFC Transaction, completion of the ILFC Transaction is not assured or may be delayed or, even if the transaction is completed, the terms of the sale may need to be significantly restructured.
Failure to complete the ILFC Transaction could negatively affect our businesses and financial results. If the ILFC Transaction is not completed, the ongoing businesses of ILFC and AIG may be adversely affected and we will be subject to several risks, including the following:
Significant legal proceedings may adversely affect our results of operations or financial condition. We are party to numerous legal proceedings, including securities class actions and regulatory and governmental investigations. Due to the nature of these proceedings, the lack of precise damage claims and the type of claims we are subject to, we cannot currently quantify our ultimate or maximum liability for these actions. Developments in these unresolved matters could have a material adverse effect on our consolidated financial condition or consolidated results of operations for an individual reporting period. For a discussion of these unresolved matters, see Note 16 to the Consolidated Financial Statements.
If we are unable to maintain the availability of our electronic data systems and safeguard the security of our data, our ability to conduct business may be compromised, which could adversely affect our consolidated financial condition or results of operations. We use computer systems to store, retrieve, evaluate and utilize customer, employee, and company data and information. Some of these systems in turn, rely upon third-party systems. Our business is highly dependent on our ability to access these systems to perform necessary business functions, including providing insurance quotes, processing premium payments, making changes to existing policies, filing and paying claims, administering variable annuity products and mutual funds, providing customer support and managing our investment portfolios. Systems failures or outages could compromise our ability to perform these functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with our business partners and customers. In the event of a natural disaster, a computer virus, a terrorist attack or other disruption inside or outside the U.S., our systems may be inaccessible to our employees, customers or business partners for an extended period of time, and our employees may be unable to perform their duties for an extended period of time if our data or systems are disabled or destroyed. Our systems could also be subject to unauthorized access, such as physical or electronic break-ins or unauthorized tampering. Like other global companies, we have, from time to time, experienced threats to our data and systems, including malware and computer virus attacks,
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unauthorized access, systems failures and disruptions. AIG maintains cyber risk insurance, but this insurance may not cover all costs associated with the consequences of personal, confidential or proprietary information being compromised. In some cases, such unauthorized access may not be immediately detected. This may impede or interrupt our business operations and could adversely affect our consolidated financial condition or results of operations.
In addition, we routinely transmit, receive and store personal, confidential and proprietary information by email and other electronic means. Although we attempt to keep such information confidential, we may be unable to do so in all events, especially with clients, vendors, service providers, counterparties and other third parties who may not have or use appropriate controls to protect confidential information. Furthermore, certain of our businesses are subject to compliance with laws and regulations enacted by U.S. federal and state governments, the European Union or other jurisdictions or enacted by various regulatory organizations or exchanges relating to the privacy and security of the information of clients, employees or others. The compromise of personal, confidential or proprietary information could result in remediation costs, legal liability, regulatory action and reputational harm.
BUSINESS AND OPERATIONS OF ILFC PRIOR TO COMPLETION OF THE ILFC TRANSACTION
We will be subject to the following risks until we complete the ILFC Transaction:
Our aircraft leasing business depends on lease revenues and exposes us to the risk of lessee nonperformance. A decrease in ILFC's customers' ability to meet their obligations to ILFC under their leases may negatively affect our business, results of operations and cash flows.
ILFC's aircraft may become obsolete over time. Aircraft are long-lived assets requiring long lead times to develop and manufacture. Particular models and types of aircraft may become obsolete and less in demand over time, when newer, more advanced and efficient aircraft or aircraft engines are manufactured. This life cycle, however, can be shortened by world events, government regulation or customer preferences. As aircraft in ILFC's fleet approach obsolescence, demand for particular models and types may decrease. This may result in declining lease rates, losses on sales, impairment charges or fair value adjustments and may adversely affect ILFC's business and our consolidated financial condition, results of operations and cash flows.
The residual value of ILFC's aircraft is subject to a number of risks and uncertainties. Technological developments, macro-economic conditions, availability and cost of funding for aviation, and the overall health of the airline industry impact the residual values of ILFC's aircraft. If challenging economic conditions persist for extended periods, the residual values of ILFC's aircraft could be negatively impacted, which could result in future impairments.
COMPETITION AND EMPLOYEES
We face intense competition in each of our businesses. Our businesses operate in highly competitive environments, both domestically and overseas. Our principal competitors are other large multinational insurance organizations, as well as banks, investment banks and other non-bank financial institutions. The insurance industry in particular is highly competitive. Within the U.S., AIG Property Casualty subsidiaries compete with approximately 3,300 other stock companies, specialty insurance organizations, mutual insurance companies and other underwriting organizations. AIG Life and Retirement subsidiaries compete in the U.S. with approximately 1,800 life insurance companies and other participants in related financial services fields. Overseas, our subsidiaries compete for business with the foreign insurance operations of large U.S. insurers and with global insurance groups and local companies.
The past reduction of our credit ratings and the lingering effects of AIG's negative publicity have made, and may continue to make, it more difficult to compete to retain existing customers and to maintain our historical levels of business with existing customers and counterparties. General insurance and life insurance companies compete through a combination of risk acceptance criteria, product pricing, and terms and conditions. Retirement services companies compete through crediting rates and the issuance of guaranteed benefits. A decline in our position as to any one or more of these factors could adversely affect our profitability.
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Competition for employees in our industry is intense, and we may not be able to attract and retain the highly skilled people we need to support our business. Our success depends, in large part, on our ability to attract and retain key people. Due to the intense competition in our industry for key employees with demonstrated ability, we may be unable to hire or retain such employees. Losing any of our key people also could have a material adverse effect on our operations given their skills, knowledge of our business, years of industry experience and the potential difficulty of promptly finding qualified replacement employees. Our results of operations and financial condition could be materially adversely affected if we are unsuccessful in attracting and retaining key employees.
Mr. Benmosche may be unable to continue to provide services to AIG due to his health. Robert Benmosche, our President and Chief Executive Officer, was diagnosed with cancer and has been undergoing treatment for his disease. He continues to fulfill all of his responsibilities and has stated his desire to continue in such roles beyond 2013. However, his condition may change and prevent him from continuing to perform these roles.
Employee error and misconduct may be difficult to detect and prevent and may result in significant losses. There have been a number of cases involving fraud or other misconduct by employees in the financial services industry in recent years and we run the risk that employee misconduct could occur. Instances of fraud, illegal acts, errors, failure to document transactions properly or to obtain proper internal authorization, or failure to comply with regulatory requirements or our internal policies may result in losses. It is not always possible to deter or prevent employee misconduct, and the controls that we have in place to prevent and detect this activity may not be effective in all cases.
REGULATION
Our businesses are heavily regulated and changes in regulation may affect our operations, increase our insurance subsidiary capital requirements or reduce our profitability. Our operations generally, and our insurance subsidiaries, in particular, are subject to extensive supervision and regulation by national authorities and by the various jurisdictions in which we do business. Supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of insurance regulation is the protection of our insurance contract holders, and not our investors. The extent of domestic regulation varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to state insurance departments.
We strive to maintain all required licenses and approvals. However, our businesses may not fully comply with the wide variety of applicable laws and regulations. The relevant authority's interpretation of the laws and regulations also may change from time to time. Regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the required licenses and approvals or do not comply with applicable regulatory requirements, these authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit them to supervise the business and operations of an insurance company.
In the U.S., the risk based capital (RBC) formula is designed to measure the adequacy of an insurer's statutory surplus in relation to the risks inherent in its business. Virtually every state has adopted, in substantial part, the RBC Model Law promulgated by the National Association of Insurance Commissioners (NAIC), which specifies the regulatory actions the insurance regulator may take if an insurer's RBC calculations fall below specific thresholds. Those actions range from requiring an insurer to submit a plan describing how it would regain a specified RBC ratio, to a mandatory regulatory takeover of the company.
The degree of regulation and supervision in foreign jurisdictions varies. Generally, AIG Parent, as well as its subsidiaries operating in such jurisdictions, must satisfy local regulatory requirements. Licenses issued by foreign authorities to our subsidiaries are subject to modification and revocation. Thus, our insurance subsidiaries could be prevented from conducting future business in certain of the jurisdictions where they currently operate. Adverse actions from any single country could adversely affect our results of operations, liquidity and financial condition, depending on the magnitude of the event and our financial exposure at that time in that country.
Our status as a savings and loan holding company and the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) will subject us to substantial additional federal regulation, either or both of which may materially and adversely affect our businesses, results of operations and cash flows. On July 21, 2010, Dodd-Frank, which effects comprehensive changes to the regulation of financial services in the United States, was signed into law. Dodd-Frank directs existing and newly created government agencies and bodies
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to promulgate regulations implementing the law, an ongoing process anticipated to continue over the next few years. We cannot predict with certainty the requirements of the regulations ultimately adopted or how or whether Dodd-Frank and such regulations will affect our businesses, results of operations or cash flows, or require us to raise additional capital.
We are regulated by the Board of Governors of the Federal Reserve System (FRB) and subject to its examination, supervision and enforcement authority and reporting requirements as a savings and loan holding company (SLHC). The FRB, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation have proposed revised minimum leverage and risk-based capital requirements that would apply to all bank holding companies and SLHCs, as well as to insured depository institutions, such as AIG Federal Savings Bank. As a result of our regulation by the FRB as an SLHC:
In addition, under Dodd-Frank we may separately become subject to the examination, enforcement and supervisory authority of the FRB as a nonbank systemically important financial institution (SIFI). In October 2012, we received a notice that we are under consideration by the Financial Stability Oversight Council (Council) for a proposed determination that we are a SIFI. The notice stated that we will be reviewed in Stage 3 of the SIFI determination process described in the Council's interpretive guidance for nonbank financial company determinations. If we are designated as a SIFI:
In addition, the regulations applicable to SIFIs and to SLHCs, when all have been adopted as final rules, may differ materially from each other.
See Item 1. Business Regulation for further discussion of this potential regulation.
Further, if we continue to control AIG Federal Savings Bank or another insured depository institution, as of July 21, 2014, we will be required to conform to the "Volcker Rule", which prohibits "proprietary trading" and the sponsoring or investing in "covered funds". The term "covered funds" includes hedge, private equity or similar funds and, in certain cases, issuers of asset backed securities if such securities have equity-like characteristics. These prohibitions could have a substantial impact on our investment portfolios as they are currently managed. The Volcker Rule, as
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proposed, contains an exemption for proprietary trading by insurance companies for their general account, but the final breadth and scope of this exemption cannot be predicted. Even if we no longer controlled an insured depository institution, Dodd-Frank authorizes the FRB to subject SIFIs to additional capital and quantitative limitations if they engage in activities prohibited for depository institutions by the Volcker Rule.
In addition, Dodd-Frank establishes a new framework for regulation of over-the-counter (OTC) derivatives under which we may have to provide or increase collateral under the terms of bilateral agreements with derivatives counterparties. These additional obligations to post collateral or the costs of assignment, termination or obtaining alternative credit could have a material adverse effect on us. This new framework may also increase the cost of conducting a hedging program or have other effects materially adverse to us.
We cannot predict the requirements of the regulations ultimately adopted, the level and magnitude of supervision we may become subject to, or how Dodd-Frank and such regulations will affect the financial markets generally or our businesses, results of operations or cash flows. It is possible that the regulations adopted under Dodd-Frank and our regulation by the FRB as an SLHC could significantly alter our business practices, require us to raise additional capital, impose burdensome and costly requirements and additional costs. Some of the regulations may also affect the perceptions of regulators, customers, counterparties, creditors or investors about our financial strength and could potentially affect our financing costs.
The USA PATRIOT Act, the Office of Foreign Assets Control and similar laws that apply to us may expose us to significant penalties. The operations of our subsidiaries are subject to laws and regulations, including, in some cases, the USA PATRIOT Act of 2001, which require companies to know certain information about their clients and to monitor their transactions for suspicious activities. Also, the Department of the Treasury's Office of Foreign Assets Control administers regulations requiring U.S. persons to refrain from doing business, or allowing their clients to do business through them, with certain organizations or individuals on a prohibited list maintained by the U.S. government or with certain countries. The United Kingdom, the European Union and other jurisdictions maintain similar laws and regulations. Although we have instituted compliance programs to address these requirements, there are inherent risks in global transactions.
Attempts to mitigate the impact of Regulation XXX and Actuarial Guideline AXXX may fail in whole or in part resulting in an adverse effect on our financial condition and results of operations. The NAIC Model Regulation "Valuation of Life Insurance Policies" ("Regulation XXX") requires insurers to establish additional statutory reserves for term life insurance policies with long-term premium guarantees and universal life policies with secondary guarantees. In addition, NAIC Actuarial Guideline 38 (AXXX) (Guideline AXXX) clarifies the application of Regulation XXX as to certain universal life insurance policies with secondary guarantees. The application of Regulation XXX and Guideline AXXX involves numerous interpretations. At times, there may be differences of opinion between management and state insurance departments about the application of these and other actuarial guidelines. Consequently, a state insurance regulator may require greater reserves to support insurance liabilities than management has estimated.
We have implemented intercompany reinsurance and capital management actions to mitigate the capital impact of Regulation XXX and Guideline AXXX. In so doing, we focus on identifying cost-effective opportunities to manage our intercompany reinsurance transactions, particularly with respect to certain redundant statutory reserve requirements on Regulation XXX and Guideline AXXX reserves. Our efforts have included the use of an intercompany reinsurance arrangement for Regulation XXX and Guideline AXXX reserves and the use of letters of credit to support the reinsurance provided by our affiliated reinsurance subsidiary. All of these letters of credit are due to mature on December 31, 2015. The reinsurance and capital management actions we have taken may not be sufficient to offset regulatory, rating agency or other requirements. In that case, we could be required to increase statutory reserves or incur higher operating and/or tax costs. If we are unable to implement actions to mitigate the impact of Regulation XXX or Guideline AXXX on future sales of term and universal life insurance products, we may reduce the sales of these products or incur higher operating costs or it may impact our sales of these products.
New regulations promulgated from time to time may affect our businesses, results of operations, financial condition and ability to compete effectively. Legislators and regulators may periodically consider various proposals that may affect the profitability of certain of our businesses. New regulations may even affect our ability to conduct certain businesses at all, including proposals relating to restrictions on the type of activities in which financial institutions are permitted to engage and the size of financial institutions. These proposals could also impose additional taxes on a limited subset of financial institutions and insurance companies (either based on size, activities,
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geography, government support or other criteria). It is uncertain whether and how these and other such proposals would apply to us or our competitors or how they could impact our consolidated results of operations, financial condition and ability to compete effectively.
An "ownership change" could limit our ability to utilize tax losses and credits carryforwards to offset future taxable income. As of December 31, 2012, we had a U.S. federal net operating loss carryforward of approximately $40.9 billion, $17.3 billion in capital loss carryforwards and $5.5 billion in foreign tax credits (tax losses and credits carryforwards). Our ability to use such tax attributes to offset future taxable income may be significantly limited if we experience an "ownership change" as defined in Section 382 of the Internal Revenue Code of 1986, as amended (the Code). In general, an ownership change will occur when the percentage of AIG Parent's ownership (by value) of one or more "5-percent shareholders" (as defined in the Code) has increased by more than 50 percent over the lowest percentage owned by such shareholders at any time during the prior three years (calculated on a rolling basis). An entity that experiences an ownership change generally will be subject to an annual limitation on its pre-ownership change tax losses and credits carryforwards equal to the equity value of the corporation immediately before the ownership change, multiplied by the long-term, tax-exempt rate posted monthly by the IRS (subject to certain adjustments). The annual limitation would be increased each year to the extent that there is an unused limitation in a prior year. The limitation on our ability to utilize tax losses and credits carryforwards arising from an ownership change under Section 382 would depend on the value of our equity at the time of any ownership change. If we were to experience an "ownership change", it is possible that a significant portion of our tax losses and credits carryforwards could expire before we would be able to use them to offset future taxable income.
On March 9, 2011, our Board of Directors adopted a Tax Asset Protection Plan (the Plan) to help protect these tax losses and credits carryforwards. At our 2011 Annual Meeting of Shareholders, shareholders ratified the Plan. At the same time, shareholders adopted a protective amendment to our Restated Certificate of Incorporation, which is designed to prevent certain transfers of AIG Common Stock that could result in an "ownership change". The Plan is designed to reduce the likelihood of an "ownership change" by (i) discouraging any person or group from becoming a 4.99 percent shareholder and (ii) discouraging any existing 4.99 percent shareholder from acquiring additional shares of AIG Common Stock. The Protective Amendment generally restricts any transfer of AIG Common Stock that would (i) increase the ownership by any person to 4.99 percent or more of AIG stock then outstanding or (ii) increase the percentage of AIG stock owned by a Five Percent Stockholder (as defined in the Plan). Despite the intentions of the Plan and the Protective Amendment to deter and prevent an "ownership change", such an event may still occur. In addition, the Plan and the Protective Amendment may make it more difficult and more expensive to acquire us, and may discourage open market purchases of AIG Common Stock or a non-negotiated tender or exchange offer for AIG Common Stock. Accordingly, the Plan and the Protective Amendment may limit a shareholder's ability to realize a premium over the market price of AIG Common Stock in connection with any stock transaction.
Changes in tax laws could increase our corporate taxes, reduce our deferred tax assets or make some of our products less attractive to consumers. Changes in tax laws or their interpretation could negatively impact our business or results. Some proposed changes could have the effect of increasing our effective tax rate by reducing deductions or increasing income inclusions, such as by limiting rules that allow for deferral of tax on certain foreign insurance income. Conversely, other changes, such as lowering the U.S. federal corporate tax rate discussed recently in the context of tax reform, could reduce the value of our deferred tax assets. In addition, changes in the way foreign taxes can be credited against U.S. taxes, methods for allocating interest expense, the ways insurance companies calculate and deduct reserves for tax purposes, and impositions of new or changed premium, value added and other indirect taxes could increase our tax expense, thereby reducing earnings.
In addition to proposing to change the taxation of corporations in general and insurance companies in particular, the Executive Branch of the Federal Government and Congress have recently considered proposals that could increase taxes on owners of insurance products. For example, there are proposals that would limit the deferral of tax on income from life and annuity contracts relative to other investment products. These changes could reduce demand in the U.S. for life insurance and annuity contracts, or cause consumers to shift from these contracts to other investments, which would reduce our income due to lower sales of these products or potential increased surrenders of in-force business.
Governments' need for additional revenue makes it likely that there will be continued proposals to change tax rules in ways that would reduce our earnings. However, it remains difficult to predict whether or when there will be any tax law changes having a material adverse effect on our financial condition or results of operations.
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ESTIMATES AND ASSUMPTIONS
Actual experience may differ from management's estimates used in the preparation of financial statements. Our financial statements are prepared in conformity with U.S. Generally Accepted Accounting Principles, which requires the application of accounting policies that often involve a significant degree of judgment. The accounting policies that we consider most dependent on the application of estimates and assumptions, and therefore may be viewed as critical accounting estimates, are described in Item 7. MD&A Critical Accounting Estimates. These accounting estimates require the use of assumptions, some of which are highly uncertain at the time of estimation. These estimates are based on judgment, current facts and circumstances, and, when applicable, internally developed models. Therefore, actual results could differ from these estimates, possibly in the near term, and could have a material effect on our consolidated financial statements.
Our ability to achieve our long-term goals, including return on equity (ROE) and earnings per share (EPS), is based on significant assumptions, and our actual results may differ, possibly materially, from these goals. In setting our long-term goals for ROE and EPS, described in Part I, Item 2. MD&A Long-Term Aspirational Goals in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2011, we made significant assumptions that include, among other things:
These assumptions are not historical facts but instead represent our expectations about future events. Many of these events, by their nature, are inherently subject to significant uncertainties and contingencies and are outside our control. It is very likely that actual events and results will differ from some or all of the assumptions we made. While we remain committed to our long-term aspirational goals, our actual results are likely to differ from these aspirational goals and the difference may be material and adverse.
The aspirational goals and their underlying assumptions are forward-looking statements. Shareholders and other investors should not place undue reliance on any of these assumptions or aspirational goals. We are not under any obligation (and expressly disclaim any obligation) to update or alter any assumptions, goals, projections or other related statements, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise. See Cautionary Statement Regarding Forward-Looking Information for additional information about forward-looking statements.
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ITEM 1B / UNRESOLVED STAFF COMMENTS
There are no material unresolved written comments that were received from the SEC staff 180 days or more before the end of AIG's fiscal year relating to AIG's periodic or current reports under the Exchange Act.
AIG and its subsidiaries operate from over 400 offices in the United States and approximately 600 offices in over 75 foreign countries. The following offices are located in buildings in the United States owned by AIG and its subsidiaries:
AIG Property Casualty: | AIG Life and Retirement: | |
175 Water Street in New York, New York |
Amarillo, Ft. Worth and Houston, Texas |
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Wilmington, Delaware |
Nashville, Tennessee |
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Stevens Point, Wisconsin |
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San Juan, Puerto Rico |
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Other Operations: |
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Greensboro and Winston-Salem, North Carolina |
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Livingston, New Jersey |
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Stowe, Vermont |
In addition, AIG Property Casualty owns offices in approximately 20 foreign countries and jurisdictions including Argentina, Bermuda, Colombia, Ecuador, Japan, Mexico, the U.K., Taiwan, and Venezuela. The remainder of the office space utilized by AIG and its subsidiaries is leased. AIG believes that its leases and properties are sufficient for its current purposes.
LOCATIONS OF CERTAIN ASSETS
As of December 31, 2012, approximately 11 percent of the consolidated assets of AIG were located outside the U.S. and Canada, including $260 million of cash and securities on deposit with regulatory authorities in those locations. See Note 3 to the Consolidated Financial Statements for additional geographic information. See Note 7 to the Consolidated Financial Statements for total carrying values of cash and securities deposited by our insurance subsidiaries under requirements of regulatory authorities.
Operations outside the U.S. and Canada and assets held abroad may be adversely affected by political developments in foreign countries, including tax changes, nationalization and changes in regulatory policy, as well as by consequence of hostilities and unrest. The risks of such occurrences and their overall effect upon AIG vary from country to country and cannot easily be predicted. If expropriation or nationalization does occur, AIG's policy is to take all appropriate measures to seek recovery of any affected assets. Certain of the countries in which AIG's business is conducted have currency restrictions that generally cause a delay in a company's ability to repatriate assets and profits. See also Item 1A. Risk Factors Business and Operations for additional information.
For a discussion of legal proceedings, see Note 16 Legal Contingencies to the Consolidated Financial Statements, which is incorporated herein by reference.
ITEM 4 / MINE SAFETY DISCLOSURES
Not applicable.
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ITEM 5 / MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
AIG's common stock, par value $2.50 per share (AIG Common Stock), is listed on the New York Stock Exchange (NYSE: AIG), as well as on the Tokyo Stock Exchange. There were approximately 37,550 stockholders of record of AIG Common Stock as of January 31, 2013.
The following table presents high and low closing sale prices on the New York Stock Exchange Composite Tape and the dividends paid per share of AIG Common Stock for each quarter of 2012 and 2011:
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2012 | 2011 | |||||||||||||||||
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High |
Low |
Dividends Paid |
High |
Low |
Dividends Paid |
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First quarter |
$ | 30.83 | $ | 23.54 | $ | | $ | 61.18 | * | $ | 34.95 | $ | | ||||||
Second quarter |
34.76 | 27.21 | | 35.00 | 27.23 | | |||||||||||||
Third quarter |
35.02 | 30.15 | | 30.21 | 21.61 | | |||||||||||||
Fourth quarter |
37.21 | 30.68 | | 26.34 | 20.07 | | |||||||||||||
* Includes the effect of the AIG Common Stock trading with due bills for the dividend paid in the form of warrants.
From November 2008 through January 14, 2011, AIG was unable to pay dividends under the terms of certain series of AIG preferred stock that were then outstanding. From January 14, 2011 to May 2011, we were unable to pay dividends on AIG Common Stock, due to restrictions relating to the AIG Series G Cumulative Mandatory Convertible Preferred Stock, par value $5.00 per share (the Series G Preferred Stock). The Series G Preferred Stock was cancelled in connection with AIG's public offering of AIG Common Stock in May 2011. Our ability to pay dividends has not been subject to any contractual restrictions since the cancellation of the Series G Preferred Stock.
Any payment of dividends must be approved by AIG's Board of Directors. In determining whether to pay any dividend, our Board of Directors may consider AIG's financial position, the performance of our businesses, our consolidated financial condition, results of operations and liquidity, available capital, the existence of investment opportunities, and other factors. AIG is subject to restrictions on the payment of dividends and purchases of AIG Common Stock as a result of being regulated as a savings and loan holding company. AIG may become subject to other restrictions on the payment of dividends and purchases of AIG Common Stock if it is designated a SIFI. See Item 1A. Risk Factors Regulation for further discussion of this regulation.
For a discussion of certain restrictions on the payment of dividends to AIG by some of its insurance subsidiaries, see Item 1A. Risk Factors Liquidity, Capital and Credit AIG Parent's ability to access funds from our subsidiaries is limited, and Note 17 to the Consolidated Financial Statements.
EQUITY COMPENSATION PLANS
Our table of equity compensation plans will be included in the definitive proxy statement for AIG's 2013 Annual Meeting of Shareholders. The definitive proxy statement will be filed with the SEC no later than 120 days after the end of AIG's fiscal year pursuant to Regulation 14A.
PURCHASES OF EQUITY SECURITIES
We purchased a total of 421,228,855 shares of AIG Common Stock for approximately $13.0 billion in four offerings of AIG Common Stock by the Department of the Treasury during 2012. All purchases were authorized by our Board of
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Directors. At December 31, 2012, our Board had not authorized any additional purchases. See Note 17 to the Consolidated Financial Statements for additional information on AIG share purchases.
COMMON STOCK PERFORMANCE GRAPH
The following Performance Graph compares the cumulative total shareholder return on AIG Common Stock for a five-year period (December 31, 2007 to December 31, 2012) with the cumulative total return of the S&P's 500 stock index (which includes AIG) and a peer group of companies (the New Peer Group) consisting of fifteen insurance companies to which we compare our business and operations:
ACE Limited |
Lincoln National Corporation |
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AEGON, N.V. |
MetLife, Inc. |
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Aflac Incorporated |
Principal Financial Group, Inc. |
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Allianz Group |
Prudential Financial, Inc. |
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AXA Group |
The Travelers Companies, Inc. |
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The Chubb Corporation |
XL Capital Ltd. |
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CNA Financial Corporation |
Zurich Insurance Group |
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Hartford Financial Services Group, Inc. |
The Performance Graph also compares the cumulative total shareholder return on AIG Common Stock to the return of a group of companies (the Old Peer Group) consisting of ten insurance companies to which we compared our business and operations in our Annual Report on Form 10-K for the year ended December 31, 2011:
ACE Limited |
MetLife, Inc. |
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Allianz Group |
Prudential Financial, Inc. |
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The Chubb Corporation |
The Travelers Companies, Inc. |
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Hartford Financial Services Group, Inc. |
XL Capital Ltd. |
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Lincoln National Corporation |
Zurich Insurance Group |
AEGON, N.V., Aflac Incorporated, AXA Group, CNA Financial Corporation and Principal Financial Group, Inc. were added to the New Peer Group because we believe the changes result in a peer group that is more comparable to our overall business and operations. Dividend reinvestment has been assumed and returns have been weighted to reflect relative stock market capitalization.
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Five-Year Cumulative Total Shareholder Returns
Value of $100 Invested on December 31, 2007
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As of December 31, | ||||||||||||||||||
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2007 | 2008 | 2009 | 2010 | 2011 | 2012 | |||||||||||||
AIG |
$ | 100.00 | $ | 2.91 | $ | 2.77 | $ | 5.33 | $ | 2.62 | $ | 3.98 | |||||||
S&P 500 |
100.00 | 63.00 | 79.67 | 91.68 | 93.61 | 108.59 | |||||||||||||
New Peer Group |
100.00 | 55.09 | 64.18 | 69.34 | 60.13 | 77.21 | |||||||||||||
Old Peer Group |
100.00 | 55.12 | 65.95 | 76.00 | 68.06 | 85.32 |
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ITEM 6 / SELECTED FINANCIAL DATA
The Selected Consolidated Financial Data should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying notes included elsewhere herein.
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Years Ended December 31, | |||||||||||||||
(in millions, except per share data) |
2012 |
2011 |
2010(a) |
2009(a) |
2008 |
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Revenues: |
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Premiums |
$ | 38,011 | $ | 38,990 | $ | 45,319 | $ | 48,583 | $ | 60,147 | ||||||
Policy fees |
2,791 | 2,705 | 2,710 | 2,656 | 2,990 | |||||||||||
Net investment income |
20,343 | 14,755 | 20,934 | 18,992 | 10,453 | |||||||||||
Net realized capital gains (losses) |
929 | 701 | (716 | ) | (3,787 | ) | (50,426 | ) | ||||||||
Other income |
3,582 | 2,661 | 4,582 | 3,729 | (34,941 | ) | ||||||||||
Total revenues |
65,656 | 59,812 | 72,829 | 70,173 | (11,777 | ) | ||||||||||
Benefits, claims and expenses: |
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Policyholder benefits and claims incurred |
31,977 | 33,450 | 41,392 | 45,314 | 45,447 | |||||||||||
Interest credited to policyholder account balances |
4,362 | 4,467 | 4,487 | 4,611 | 5,582 | |||||||||||
Amortization of deferred acquisition costs |
5,709 | 5,486 | 5,821 | 6,670 | 6,425 | |||||||||||
Other acquisition and insurance expenses |
9,235 | 8,458 | 10,163 | 9,815 | 14,783 | |||||||||||
Interest expense |
2,319 | 2,444 | 6,742 | 13,237 | 14,440 | |||||||||||
Net loss on extinguishment of debt |
9 | 2,847 | 104 | | | |||||||||||
Net (gain) loss on sale of properties and divested businesses |
2 | 74 | (19,566 | ) | 1,271 | | ||||||||||
Other expenses |
2,721 | 2,470 | 3,439 | 5,282 | 5,842 | |||||||||||
Total benefits, claims and expenses |
56,334 | 59,696 | 52,582 | 86,200 | 92,519 | |||||||||||
Income (loss) from continuing operations before income taxes(b) |
9,322 | 116 | 20,247 | (16,027 | ) | (104,296 | ) | |||||||||
Income taxes expense (benefit) |
1,570 | (19,424 | ) | 6,993 | (2,551 | ) | (8,097 | ) | ||||||||
Income (loss) from continuing operations |
7,752 | 19,540 | 13,254 | (13,476 | ) | (96,199 | ) | |||||||||
Income (loss) from discontinued operations, net of taxes |
(4,052 | ) | 1,790 | (969 | ) | 3,750 | (6,683 | ) | ||||||||
Net income (loss) |
3,700 | 21,330 | 12,285 | (9,726 | ) | (102,882 | ) | |||||||||
Net income (loss) attributable to AIG |
3,438 | 20,622 | 10,058 | (8,362 | ) | (101,784 | ) | |||||||||
Income (loss) per common share attributable to AIG common shareholders |
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Basic and diluted |
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Income (loss) from continuing operations |
4.44 | 10.03 | 16.50 | (98.52 | ) | (725.89 | ) | |||||||||
Income (loss) from discontinued operations |
(2.40 | ) | 0.98 | (1.52 | ) | 27.15 | (49.91 | ) | ||||||||
Net income (loss) attributable to AIG |
2.04 | 11.01 | 14.98 | (71.37 | ) | (775.80 | ) | |||||||||
Dividends declared per common share |
| | | | 8.40 | |||||||||||
Year-end balance sheet data: |
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Total investments |
375,824 | 410,438 | 410,412 | 601,165 | 636,912 | |||||||||||
Total assets |
548,633 | 553,054 | 675,573 | 838,346 | 848,552 | |||||||||||
Long-term debt |
48,500 | 75,253 | 106,461 | 136,733 | 177,485 | |||||||||||
Total liabilities |
449,630 | 442,138 | 568,363 | 748,550 | 797,692 | |||||||||||
Total AIG shareholders' equity |
98,002 | 101,538 | 78,856 | 60,585 | 40,844 | |||||||||||
Total equity |
98,669 | 102,393 | 106,776 | 88,837 | 48,939 | |||||||||||
Book value per share(a) |
66.38 | 53.53 | 561.40 | 448.54 | 303.71 | |||||||||||
Book value per share, excluding Accumulated other comprehensive income (loss)(a)(c) |
57.87 | 50.11 | 498.25 | 400.90 | 353.97 | |||||||||||
AIG Property Casualty combined ratio(d) |
108.6 | 108.8 | 116.8 | 108.4 | 102.1 | |||||||||||
Other data (from continuing operations): |
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Other-than-temporary impairments |
1,167 | 1,280 | 3,039 | 6,696 | 41,867 | |||||||||||
Adjustment to federal and foreign deferred tax valuation allowance |
(1,907 | ) | (18,307 | ) | 1,361 | 2,986 | 22,172 | |||||||||
Amortization of prepaid commitment fee |
| 49 | 3,471 | 8,359 | 9,279 | |||||||||||
Catastrophe-related losses |
$ | 2,652 | $ | 3,307 | $ | 1,076 | $ | 53 | $ | 1,840 | ||||||
(a) Comparability between 2010 and 2009 data is affected by the deconsolidation of AIA in the fourth quarter of 2010. Book value per share, excluding Accumulated other comprehensive income (loss) is a non-GAAP measure. See Item 7. MD&A Use of Non-GAAP Measures for additional information. Comparability of 2010, 2009 and 2008 is affected by a one for twenty reverse stock split.
(b) Reduced by fourth quarter reserve strengthening charges of $4.2 billion and $2.2 billion in 2010 and 2009, respectively, related to the annual review of AIG Property Casualty loss and loss adjustment reserves.
(c) Amounts for periods after December 31, 2008 have been revised to reflect reclassification of income taxes from AOCI to additional paid in capital to correct the presentation of components of AIG Shareholders' Equity. See Note 1 to the Consolidated Financial Statements for additional information on the reclass.
(d) See Item 7. MD&A Results of Operations AIG Property Casualty Operations for a reconciliation of the adjusted combined ratio.
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Changes In Accounting For Acquisition Costs
Reflects changes from the adoption of the new accounting standard related to deferred acquisition costs for 2009 and 2008, as set out in further detail below. See Note 2 to the Consolidated Financial Statements for a description of the effect of the adoption of the new accounting standards on 2011 and 2010 periods, which is also reflected in the data presented above.
Year Ended December 31, 2009 (dollars in millions, except per share data) |
As Previously Reported(a) |
Effect of Change |
As Currently Reported |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Income (loss) from continuing operations |
$ | (13,907 | ) | $ | 431 | $ | (13,476 | ) | ||
Income (loss) from discontinued operations, net of income tax(b) |
1,594 | 2,156 | 3,750 | |||||||
Net income (loss) |
(12,313 | ) | 2,587 | (9,726 | ) | |||||
Net income (loss) attributable to AIG |
$ | (10,949 | ) | $ | 2,587 | $ | (8,362 | ) | ||
Net income (loss) attributable to AIG common shareholders |
$ | (12,244 | ) | $ | 2,587 | $ | (9,657 | ) | ||
Income (loss) per share attributable to AIG common shareholders: |
||||||||||
Basic and diluted: |
||||||||||
Income (loss) from continuing operations |
$ | (100.70 | ) | $ | 3.18 | $ | (98.52 | ) | ||
Income from discontinued operations |
$ | 11.22 | $ | 15.93 | $ | 27.15 | ||||
Income (loss) attributable to AIG |
$ | (90.48 | ) | $ | 19.11 | $ | (71.37 | ) | ||
December 31, 2009 balance sheet data: |
||||||||||
Total assets |
$ | 847,585 | $ | (9,239 | ) | $ | 838,346 | |||
Total liabilities |
748,550 | | 748,550 | |||||||
Total AIG shareholders' equity |
69,824 | (9,239 | ) | 60,585 | ||||||
Total equity |
98,076 | (9,239 | ) | 88,837 | ||||||
Other data (from continuing operations): |
||||||||||
Adjustment to federal and foreign deferred tax valuation allowance |
$ | 3,137 | $ | (151 | ) | $ | 2,986 | |||
Year Ended December 31, 2008 (in millions, except per share data) |
As Previously Reported(a) |
Effect of Change |
As Currently Reported |
|||||||
---|---|---|---|---|---|---|---|---|---|---|
Loss from continuing operations |
$ | (94,022 | ) | $ | (2,177 | ) | $ | (96,199 | ) | |
Loss from discontinued operations, net of tax |
(6,365 | ) | (318 | ) | (6,683 | ) | ||||
Net loss |
(100,387 | ) | (2,495 | ) | (102,882 | ) | ||||
Net loss attributable to AIG |
$ | (99,289 | ) | $ | (2,495 | ) | $ | (101,784 | ) | |
Net loss attributable to AIG common shareholders |
$ | (99,689 | ) | $ | (2,495 | ) | $ | (102,184 | ) | |
Loss per common share attributable to AIG common shareholders: |
||||||||||
Basic and diluted: |
||||||||||
Loss from continuing operations |
$ | (709.35 | ) | $ | (16.54 | ) | $ | (725.89 | ) | |
Loss from discontinued operations |
$ | (47.50 | ) | $ | (2.41 | ) | $ | (49.91 | ) | |
Net loss attributable to AIG |
$ | (756.85 | ) | $ | (18.95 | ) | $ | (775.80 | ) | |
December 31, 2008 balance sheet data: |
||||||||||
Total assets |
$ | 860,418 | $ | (11,866 | ) | $ | 848,552 | |||
Total liabilities |
797,692 | | 797,692 | |||||||
Total AIG shareholders' equity |
52,710 | (11,866 | ) | 40,844 | ||||||
Total equity |
60,805 | (11,866 | ) | 48,939 | ||||||
Other data (from continuing operations): |
||||||||||
Adjustment to federal and foreign deferred tax valuation allowance |
$ | 20,121 | $ | 2,051 | $ | 22,172 | ||||
(a) Includes the effect of the reclassification of ILFC as discontinued operations.
(b) Includes an adjustment to the loss accrual related to the sale of Nan Shan of $2.3 billion.
AIG 2012 Form 10-K
49
Items Affecting Comparability Between Periods
The following are significant developments that affected multiple periods and financial statement captions. Other items that affected comparability are included in the footnotes to the table presented immediately above.
Market Events in 2008 and 2009
AIG was significantly affected by the market turmoil in late 2008 and early 2009 and recognized other-than-temporary impairment charges in 2008 related primarily to collateralized mortgage-backed securities, other structured securities and securities of financial institutions; losses related to the change in AIG's intent and ability to hold to recovery certain securities; and losses related to AIG's securities lending program.
In 2008, AIG also recognized unrealized market valuation losses representing the change in fair value of its super senior credit default swap portfolio, established a deferred tax valuation allowance and experienced an unprecedented strain on liquidity. This strain led to several transactions with the FRBNY and the Department of the Treasury. See Note 25 to the Consolidated Financial Statements for further discussion of these transactions and relationships.
FRBNY Activity and Effect on Interest Expense in 2008, 2009 and 2010
The decline in interest expense in 2010 was due primarily to a reduced weighted-average interest rate on borrowings, a lower average outstanding balance and a decline in amortization of the prepaid commitment fee asset related to the partial repayment of the FRBNY Credit Facility. On January 14, 2011, AIG repaid the remaining $20.7 billion and terminated this facility, resulting in a net $3.3 billion pretax charge in the first quarter of 2011, representing primarily the accelerated amortization of the remaining prepaid commitment fee asset included in Net loss on extinguishment of debt. See Note 25 to the Consolidated Financial Statements for further discussion of the Recapitalization.
As a result of the closing of the Recapitalization on January 14, 2011, the preferred interests (the SPV Preferred Interests) in the special purpose vehicles that held remaining AIA shares and the proceeds of the AIA initial public offering and the ALICO sale (the SPVs) were transferred to the Department of the Treasury. After such closing, the SPV Preferred Interests were not considered permanent equity on AIG's Consolidated Balance Sheet and were classified as redeemable non-controlling interests.
Asset Dispositions in 2010, 2011 and 2012
On December 9, 2012, we announced the agreement to sell up to 90% of ILFC and executed multiple asset dispositions in 2010 and 2011, as further discussed in Note 4 to the Consolidated Financial Statements, including the completion of an initial public offering of AIA in 2010 for which AIG recognized an $18.1 billion gain.
Adjustment to Federal Deferred Tax Valuation Allowance in 2008, 2009, 2010, 2011 and 2012
As further discussed in Note 24 to the Consolidated Financial Statements, AIG concluded that $18.4 billion of the deferred tax asset valuation allowance for the U.S. consolidated income tax group should be released through the Consolidated Statement of Operations in 2011. The valuation allowance resulted primarily from losses subject to U.S. income taxes recorded from 2008 through 2010.
Capitalization and Book Value Per Share
As a result of the closing of the Recapitalization on January 14, 2011, the remaining SPV Preferred Interests held by the FRBNY of approximately $26.4 billion were purchased by AIG and transferred to the Department of the Treasury. The SPV Preferred Interests were no longer considered permanent equity on AIG's Consolidated Balance Sheet, and were classified as redeemable non-controlling interests. See Note 18 to the Consolidated Financial Statements for further discussion.
AIG 2012 Form 10-K
50
The following table presents pro forma ratios as if the Recapitalization had been consummated in 2008 and a reconciliation of book value per share to book value per share, excluding Accumulated other comprehensive income (loss), which is a non-GAAP measure. See Item 7. MD&A Use of Non-GAAP Measures for additional information.*
|
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|
|
|
|
|||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Years Ended December 31, | |||||||||||||||
(in millions, except per share data) |
2012 |
2011 |
2010 |
2009 |
2008 |
|||||||||||
Total AIG shareholders' equity |
$ | 98,002 | $ | 101,538 | $ | 78,856 | $ | 60,585 | $ | 40,844 | ||||||
Recapitalization |
| | (3,328 | ) | | | ||||||||||
Value on conversion of equity units |
| | 2,169 | 5,880 | 5,880 | |||||||||||
Pro forma shareholders' equity |
98,002 | 101,538 | 77,697 | 66,465 | 46,724 | |||||||||||
Accumulated other comprehensive income (loss) |
12,574 | 6,481 | 8,871 | 6,435 | (6,759 | ) | ||||||||||
Total AIG shareholders' equity, excluding |
||||||||||||||||
Accumulated other comprehensive income (loss) |
$ | 85,428 | $ | 95,057 | $ | 69,985 | $ | 54,150 | $ | 47,603 | ||||||
Total common shares outstanding |
1,476,321,935 | 1,896,821,482 | 140,463,159 | 135,070,907 | 134,483,454 | |||||||||||
Issuable for equity units |
| | 2,854,069 | 7,736,904 | 7,736,904 | |||||||||||
Shares assumed converted |
| | 1,655,037,962 | 1,655,037,962 | 1,655,037,962 | |||||||||||
Pro forma common shares outstanding |
1,476,321,935 | 1,896,821,482 | 1,798,355,190 | 1,797,845,773 | 1,797,258,320 | |||||||||||
Pro forma book value per share |
N/A | N/A | $ | 43.20 | $ | 36.97 | $ | 26.00 | ||||||||
Pro forma book value per share, excluding |
||||||||||||||||
Accumulated other comprehensive income (loss) |
N/A | N/A | $ | 38.27 | $ | 33.39 | $ | 29.76 | ||||||||
* Amounts for periods after December 31, 2008 have been revised to reflect reclassification of income taxes from AOCI to additional paid in capital to correct the presentation of components of AIG Shareholders' Equity. See Note 1 to the Consolidated Financial Statements for additional information on the reclass.
AIG 2012 Form 10-K
51
ITEM 7 / MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K and other publicly available documents may include, and officers and representatives of American International Group, Inc. (AIG) may from time to time make, projections, goals, assumptions and statements that may constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These projections, goals, assumptions and statements are not historical facts but instead represent only AIG's belief regarding future events, many of which, by their nature, are inherently uncertain and outside AIG's control. These projections, goals, assumptions and statements include statements preceded by, followed by or including words such as "believe," "anticipate," "expect," "intend," "plan," "view," "target" or "estimate." These projections, goals, assumptions and statements may address, among other things:
the monetization of AIG's interests in International Lease Finance Corporation (ILFC), including whether AIG's proposed sale of up to 90 percent of ILFC will be completed and if completed, the timing and final terms of such sale; AIG's exposures to subprime mortgages, monoline insurers, the residential and commercial real estate markets, state and municipal bond issuers and sovereign bond issuers; AIG's exposure to European governments and European financial institutions; |
AIG's strategy for risk management; AIG's generation of deployable capital; AIG's return on equity and earnings per share long-term aspirational goals; AIG's strategies to grow net investment income, efficiently manage capital and reduce expenses; AIG's strategies for customer retention, growth, product development, market position, financial results and reserves; and the revenues and combined ratios of AIG's subsidiaries. |
It is possible that AIG's actual results and financial condition will differ, possibly materially, from the results and financial condition indicated in these projections, goals, assumptions and statements. Factors that could cause AIG's actual results to differ, possibly materially, from those in the specific projections, goals, assumptions and statements include:
changes in market conditions; the occurrence of catastrophic events, both natural and man-made; significant legal proceedings; the timing and applicable requirements of any new regulatory framework to which AIG is subject as a savings and loan holding company (SLHC), and if such a determination is made, as a systemically important financial institution (SIFI); concentrations in AIG's investment portfolios; actions by credit rating agencies; |
judgments concerning casualty insurance underwriting and insurance liabilities; judgments concerning the recognition of deferred tax assets; judgments concerning deferred policy acquisition costs (DAC) recoverability; and such other factors discussed in: this Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A); and Part I, Item 1A. Risk Factors of this Annual Report on Form 10-K. |
AIG is not under any obligation (and expressly disclaims any obligation) to update or alter any projections, goals, assumptions or other statements, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.
AIG 2012 Form 10-K
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The MD&A is organized as follows:
INDEX TO ITEM 7
Throughout the MD&A, we use certain terms and abbreviations which are summarized in the Glossary and Acronyms on pages 195 and 199, respectively.
AIG has incorporated into this discussion a number of cross-references to additional information included throughout this Annual Report on Form 10-K to assist readers seeking additional information related to a particular subject.
AIG 2012 Form 10-K
53
Use of Non-GAAP Measures
In Item 6. Selected Financial Data and throughout this MD&A, we present AIG's financial condition and results of operations in the way we believe will be most meaningful, representative and most transparent. Some of the measurements we use are "non-GAAP financial measures" under SEC rules and regulations. GAAP is the acronym for "accounting principles generally accepted in the United States." The non-GAAP financial measures we present may not be comparable to similarly-named measures reported by other companies.
Book Value Per Share Excluding Accumulated Other Comprehensive Income (Loss) (AOCI) is presented in Item 6. Selected Financial Data and is used to show the amount of our net worth on a per-share basis. We believe Book Value Per Share Excluding AOCI is useful to investors because it eliminates the effect of non-cash items that can fluctuate significantly from period to period, including changes in fair value of our available for sale portfolio and foreign currency translation adjustments. Book Value Per Share Excluding AOCI is derived by dividing Total AIG shareholders' equity, excluding AOCI, by Total common shares outstanding. The reconciliation to book value per share, the most comparable GAAP measure, is presented in Item 6. Selected Financial Data.
We use the following operating performance measures because we believe they enhance understanding of the underlying profitability of continuing operations and trends of AIG and our business segments. We believe they also allow for more meaningful comparisons with our insurance competitors. When we use these measures, reconciliations to the most comparable GAAP measure are provided in the Results of Operations section of this MD&A.
AIG 2012 Form 10-K
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Catastrophe losses are generally weather or seismic events having a net impact on AIG Property Casualty in excess of $10 million each.
Results from discontinued operations are excluded from all of these measures.
AIG 2012 Form 10-K
55
Executive Summary
AIG made solid progress toward many of its strategic objectives in 2012.
We fully repaid governmental support as a result of the Department of the Treasury's sale of its remaining shares of AIG common stock, par value $2.50 per share (AIG Common Stock).*
We improved our financial and operational performance, leading to a third consecutive year of profitability:
Our financial flexibility was enhanced by $5.2 billion in cash distributions from subsidiaries.
We announced an agreement to sell ILFC, received final distributions on our interests in Maiden Lane II LLC (ML II) and ML III, and sold our remaining interest in AIA Group Limited (AIA), which will support our capital management initiatives, sharpen our business focus, and enable us to redeploy assets in a more productive manner.
We completed $13.0 billion in share purchases using a portion of the proceeds of our asset sales.
AIG 2012 Form 10-K
56
Our Performance Selected Indicators
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|||||||
---|---|---|---|---|---|---|---|---|---|---|
Years Ended December 31, (in millions, except per share data) |
2012 |
2011 |
2010 |
|||||||
Results of operations data: |
||||||||||
Total revenues |
$ | 65,656 | $ | 59,812 | $ | 72,829 | ||||
Income from continuing operations |
7,752 | 19,540 | 13,254 | |||||||
Net income attributable to AIG |
3,438 | 20,622 | 10,058 | |||||||
Income per common share attributable to AIG (diluted) |
2.04 | 11.01 | 14.98 | |||||||
Balance sheet data: |
||||||||||
Total assets |
$ | 548,633 | $ | 553,054 | $ | 675,573 | ||||
Long-term debt |
48,500 | 75,253 | 106,461 | |||||||
Total AIG shareholders' equity |
98,002 | 101,538 | 78,856 | |||||||
Book value per common share |
66.38 | 53.53 | 561.40 | |||||||
AIG 2012 Form 10-K
57
TOTAL REVENUES ($ millions)
* Comparability between 2011 and 2010 data is affected by the deconsolidation of AIA in the fourth quarter of 2010.
AIG 2012 Form 10-K
58
The following table presents a reconciliation of pre-tax income (loss) to operating income (loss) by operating segment and after-tax operating income (loss), which are non-GAAP measures. See Use of Non-GAAP Measures for additional information.
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|||||||
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Years Ended December 31, (in millions) |
2012 |
2011 |
2010 |
|||||||
AIG Property Casualty |
||||||||||
Pre-tax income (loss) |
$ | 1,837 | $ | 1,820 | $ | (93 | ) | |||
Net realized capital (gains) losses |
2 | (607 | ) | 38 | ||||||
Legal settlements* |
(17 | ) | | | ||||||
Bargain purchase gain |
| | (332 | ) | ||||||
Other (income) expense net |
(2 | ) | 5 | (669 | ) | |||||
Operating income (loss) |
$ | 1,820 | $ | 1,218 | $ | (1,056 | ) | |||
AIG Life and Retirement |
||||||||||
Pre-tax income |
$ | 3,780 | $ | 2,956 | $ | 2,701 | ||||
Legal settlements* |
(154 | ) | | | ||||||
Changes in fair value of fixed maturity securities designated to hedge living benefit liabilities |
(37 | ) | | | ||||||
Net realized capital (gains) losses |
(630 | ) | (6 | ) | 1,251 | |||||
Change in benefit reserves and DAC, VOBA and SIA related to net realized capital (gains) losses |
1,201 | 327 | 104 | |||||||
Operating income |
$ | 4,160 | $ | 3,277 | $ | 4,056 | ||||
Other Operations |
||||||||||
Pre-tax income (loss) |
$ | 3,899 | $ | (4,703 | ) | $ | 17,611 | |||
Net realized capital gains |
(501 | ) | (12 | ) | (908 | ) | ||||
Net (gains) losses on sale of divested businesses |
2 | 74 | (18,897 | ) | ||||||
Amortization of prepaid commitment fee asset |
| | 3,471 | |||||||
Legal reserves |
754 | 20 | 3 | |||||||
Legal settlements* |
(39 | ) | | | ||||||
Deferred gain on FRBNY credit facility |
| (296 | ) | | ||||||
Loss on extinguishment of debt |
9 | 3,143 | 104 | |||||||
Divested businesses |
| | (1,875 | ) | ||||||
Operating income (loss) |
$ | 4,124 | $ | (1,774 | ) | $ | (491 | ) | ||
Total |
||||||||||
Operating income of reportable segments and other operations |
$ | 10,104 | $ | 2,721 | $ | 2,509 | ||||
Consolidations, eliminations and other adjustments |
(20 | ) | (190 | ) | (301 | ) | ||||
Income tax benefits (expenses) |
(3,187 | ) | 243 | (1,585 | ) | |||||
Non-controlling interest |
(262 | ) | (688 | ) | (2,172 | ) | ||||
After-tax operating income (loss) |
$ | 6,635 | $ | 2,086 | $ | (1,549 | ) | |||
* Reflects litigation settlement income recorded in 2012 from settlements with three financial institutions that participated in the creation, offering and sale of RMBS as to which AIG and its subsidiaries suffered losses either for their own accounts or in connection with their participation in AIG's securities lending program.
AIG 2012 Form 10-K
59
PRE-TAX INCOME (LOSS) ($ millions)
OPERATING INCOME (LOSS) ($ millions)
Prior Period Revisions
Prior period amounts have been revised to reflect the following:
Accounting for Deferred Acquisition Costs
As discussed in Note 2 to the Consolidated Financial Statements, AIG retrospectively adopted an accounting standard on January 1, 2012 that amended the accounting for costs incurred by insurance companies that can be capitalized in connection with acquiring or renewing insurance contracts.
AIG Property Casualty Operating Segment Changes
To align financial reporting with changes made during 2012 to the manner in which AIG's chief operating decision makers review the businesses to assess performance and make decisions about resources to be allocated, certain products previously reported in Commercial Insurance were reclassified to Consumer Insurance. These revisions did not affect the total AIG Property Casualty reportable segment results previously reported.
In the fourth quarter of 2012, to increase the focus on the drivers of the losses and proactively mitigate reserve development and legal costs, the management of certain environmental liability businesses written prior to 2004 was moved from Commercial Insurance to a separate claims organization. To align financial reporting with the internal management changes, this environmental (1987-2004) business is reported in the Other category. These revisions did not affect our total reportable segment results previously reported.
Sale of ILFC and Discontinued Operations Presentation
On December 9, 2012, AIG entered into an agreement to sell 80.1 percent of ILFC for approximately $4.2 billion in cash, with an option for the purchaser to buy an additional 9.9 percent stake (the ILFC Transaction). The sale is expected to close in 2013. At the closing of the transaction, in connection with the termination of intercompany arrangements between AIG and ILFC, AIG will return $1.1 billion to ILFC. As a result, ILFC operating results, which were previously presented in the Aircraft Leasing segment, have been classified as discontinued operations in all periods, and associated assets and liabilities have been classified as held-for-sale at December 31, 2012. See Note 4 to the Consolidated Financial Statements for further discussion.
AIG 2012 Form 10-K
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Changes in Fair Value of Derivatives
To align the presentation of changes in the fair value of derivatives with changes in the administration of AIG's derivatives portfolio, changes were made to the presentation within the Consolidated Statement of Operations and Consolidated Statement of Cash Flows. Specifically, amounts attributable to derivative activity where AIG Financial Products Corp. and AIG Trading Group Inc. and their respective subsidiaries (collectively AIGFP) is an intermediary for AIG subsidiaries have been reclassified from Other income to Net realized capital gains (losses).
Liquidity and Capital Resources Highlights
In March 2012, AIG paid down in full the $8.6 billion remaining preferred interests (the AIA SPV Preferred Interests) in the special purpose vehicle holding the proceeds of the AIA initial public offering (the AIA SPV) held by the Department of the Treasury.
In addition, in 2012, the Department of the Treasury, as selling shareholder, sold its remaining shares of AIG common stock by completing five registered public offerings in March, May, August, September and December (collectively, the 2012 Offerings). The Department of the Treasury sold approximately 1.5 billion shares of AIG Common Stock for aggregate proceeds of approximately $45.8 billion in the 2012 Offerings. We purchased approximately 421 million shares of AIG Common Stock at an average price of $30.86 per share for an aggregate purchase amount of approximately $13.0 billion in the first four of the 2012 Offerings. We did not purchase any shares in the December 2012 offering.
In 2012, AIG received $10.1 billion in distributions from the FRBNY's final disposition of ML II and ML III assets. Also in 2012, we sold our entire remaining interest in AIA ordinary shares for gross proceeds of approximately $14.5 billion.
Additional discussion and other liquidity and capital resources developments are included in Note 17 to the Consolidated Financial Statements and Liquidity and Capital Resources herein.
Investment Highlights
Net investment income increased 38 percent to $20.3 billion in 2012 compared to 2011, primarily through our previous investments in ML III and AIA. The overall credit rating of our fixed maturity portfolio was largely unchanged, and other-than- temporary impairments declined compared to prior year levels.
AIG 2012 Form 10-K
61
Risk Management Highlights
Our Risk Management Process
Risk management is an integral part of managing our businesses. It is a key element of our approach to corporate governance. We have an integrated process for managing risks throughout the organization. The framework of our Enterprise Risk Management (ERM) system provides senior management with a consolidated view of our major risk positions. Our risk management process includes: An enhanced risk governance structure that supports consistent and transparent decision making. We have recently revised our corporate policies to ensure that accountability for the implementation and oversight of each policy is better aligned with individual corporate executives while specialized risk governance committees already in operation receive regular reporting regarding policy compliance. Risk committees at our corporate level as well as in each business unit that manage the development and maintenance of a risk and control culture encompassing all significant risk categories. Our Board of Directors oversees the management of risk through the complementary functioning of the Finance and Risk Management Committee (the FRMC) and the Audit Committee, as well as through its regular interaction with other committees of the Board. A capital and liquidity stress testing framework to assess our aggregate exposure to our most significant risks. We conduct enterprise-wide stress tests under a range of scenarios to better understand the resources needed to support our subsidiaries and consolidated company. |
We remain committed to adhering to the highest standards of risk management and corporate governance. We continue to promote awareness and accountability for key risk and business decisions, and performance than in the past. We manage risks better by applying performance metrics that enable us to assess
risk more clearly and address evolving market conditions. |
Strategic Outlook
Industry Trends
Our business is affected by industry and economic factors such as interest rates, credit and equity market conditions, regulation, tax policy, competition, and general economic, market and political conditions. In 2012, and continuing into 2013, we operated under difficult market conditions, characterized by factors such as low interest rates, instability in the global markets due to the European debt crisis, and slow growth in the U.S. economy.
The prevailing interest rate climate has a particularly significant effect on our industry. Investment returns have declined as the U.S. fixed income market remains in a low interest rate environment. In addition, current market conditions may not necessarily permit insurance companies to increase pricing across all our product lines.
AIG 2012 Form 10-K
62
AIG Priorities for 2013 |
|
AIG is focused on the following priorities for 2013: |
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Strengthen and improve the operating performance of our core businesses; |
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Consummate the sale of up to 90 percent of our interest in ILFC; |
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Enhance the yield on our investments while maintaining focus on credit quality; |
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Manage AIG's capital and interest expense more efficiently by redeploying excess capital in areas that promote profitable growth; |
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Work with the Board of Governors of the Federal Reserve System (the FRB) in its capacity as AIG's principal regulator; and |
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Reduce recurring operating expenses by leveraging AIG's scale and driving increased standardization through investments in infrastructure. |
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Strategic Outlook for Our Operating Businesses
The strategic outlook for each of our businesses and management initiatives to improve growth and performance in 2013 and over the longer term are described below.
AIG PROPERTY CASUALTY STRATEGIC OUTLOOK
We expect that the current low interest rate environment and ongoing uncertainty in global economic conditions will continue to challenge the growth of net investment income and limit growth in some markets through at least 2013. These conditions, coupled with overcapacity in the property casualty insurance industry business, are leading carriers to tighten terms and conditions, shed unprofitable business and develop advanced data analytics in order to improve profitability.
We have observed improving trends in certain key indicators that may offset the effect of current economic challenges. Commencing in the second quarter of 2011, and continuing since, we have benefited from favorable pricing trends, particularly in our U.S. commercial business. The property casualty insurance industry is beginning to experience modest growth as a result of this positive rate trend and an increase in overall exposures in some markets. We expect that expansion in certain growth economies will occur at a faster pace than in developed countries, although at levels lower than those previously expected due to revised economic assumptions.
AIG 2012 Form 10-K
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AIG Property Casualty is focused on the following strategic initiatives:
Business Mix Shift We expect that shifting our mix of business to higher value lines and geographies of opportunity will generate business with more favorable underwriting results. However, as a result of the business mix shift to consumer products, higher value commercial products, and the investment in growth economy nations, policy acquisition expenses, including direct marketing costs, are expected to continue to increase.
Underwriting Excellence We anticipate that refining technical pricing account management tools and marketing analytics will further enhance our risk selection process. We believe that accident year loss ratios will continue to improve due to these actions.
Claims Best Practices We expect to reduce loss costs by realizing greater efficiencies in servicing customer claims, introducing fraud detection tools and developing knowledge of the economic drivers of losses, which will proactively mitigate reserve development and legal costs, and establish effective pricing strategies.
Operating Expense Discipline We continue to make strategic investments in systems, processes and talent worldwide, which will result in elevated operating expense in the short-term, but is expected to create additional value and greater efficiency beginning in 2014. |
Continue shifting toward higher value business to increase profitability. Expand in attractive growth economies, specifically in Asia Pacific, the Middle East and Latin America. Enhance risk selection and pricing to earn returns commensurate to the risk assumed. Implement improved claims practices and advanced technology to lower the loss ratio. Apply operating expense discipline and drive efficiencies by leveraging our global footprint.
Optimize the investment portfolio by aligning it with our risk appetite and tax objectives. |
Capital Efficiency
We plan to continue to execute capital management initiatives by enhancing broad-based risk tolerance guidelines for our operating units, implementing underwriting strategies to increase return on equity by line of business and reducing exposure to businesses with inadequate pricing and increased loss trends. In addition, we remain focused on enhancing our global reinsurance strategy to improve capital efficiency.
We continue to streamline our legal entity structure, to enhance transparency with regulators and optimize capital and tax efficiency. For the year ended December 31, 2012, we completed 41 legal entity and branch restructuring transactions. We completed the integration of our European operations into a single pan-European insurance company, AIG Europe Limited, and continued the restructuring activities in the Asia Pacific region, including focusing on the strategy to consolidate the Japan operations under one holding company. During 2012, our restructuring and capital management initiatives enabled certain subsidiaries in Europe and the Asia Pacific region to return $575 million of capital to be used for general corporate purposes. We continue to implement restructuring plans in each region and the overall end state structure is expected to be mostly completed by the end of 2014.
Our Investment Strategy for AIG Property Casualty
Consistent with AIG's worldwide insurance investment policy, we place primary emphasis on investments in fixed maturity securities issued by corporations, municipalities and other governmental agencies, and to a lesser extent, common stocks, private equity, hedge funds and other alternative investments. We also attempt to enhance returns through investments in a diversified portfolio of private equity funds, hedge funds, and partnerships. Although these
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investments are subject to periodic volatility, they have historically achieved yields in excess of the base portfolio yields. Our expectation is that these alternative investments will continue to outperform the base portfolio yields over the long-term.
Opportunistic investments in structured securities and other yield-enhancement opportunities continue to be made with the objective of increasing net investment income. Overall base yields increased in 2012 due to the portfolio mix shift away from tax-exempt municipal bonds toward taxable instruments; overall investment purchases were made at expected yields higher than the weighted average yields of the existing portfolio.
In 2013, we expect to continue to refine our investment strategy, which includes asset diversification and yield-enhancement opportunities that meet our liquidity, duration and credit quality objectives as well as current risk-return and tax objectives.
See Segment Results AIG Property Casualty Operations AIG Property Casualty Results - AIG Property Casualty Investing and Other Results and Note 7 to the Consolidated Financial Statements for additional information.
AIG LIFE AND RETIREMENT STRATEGIC OUTLOOK
AIG Life and Retirement's businesses and the life and annuity industry continue to be affected by the current economic environment of low interest rates and volatile equity markets. Continued low interest rates put pressure on long-term investment returns, negatively affect future sales of interest rate-sensitive products and reduce future profits on certain existing business. Also, products such as payout annuities and traditional life insurance that are not rate-adjustable may require increases in reserves if future investment yields are insufficient to support current valuation interest rates. Equity market volatility may result in higher reserves for variable annuity guarantee features, and both equity market volatility and low interest rates can affect the recoverability and amortization rate of DAC assets. During 2012, AIG Life and Retirement implemented a number of management actions to proactively address the impact of low interest rates. These actions include a continued disciplined approach to new business pricing of interest sensitive products (e.g. fixed annuities), active management of renewal crediting rates, increased pricing in certain life insurance products and re-filing of products to continue lowering minimum rate guarantees. |
Grow assets under management Increase life insurance in force Enhance return on equity |
AIG Life and Retirement is focused on the following strategic initiatives:
Growth of Assets Under Management
AIG Life and Retirement plans to fully leverage its unified all-channel distribution organization to increase sales of profitable products across all channels. In addition, management will pursue select institutional market opportunities where AIG Life and Retirement's scale and capacity provides a competitive market advantage. AIG Life and Retirement is well positioned to capitalize on the growing demand for income solutions while certain competitors are scaling back in this market. AIG Life and Retirement will continue to manage the risks associated with variable annuity living benefits through innovative product designs and hedging strategies. Given the size and diversity of AIG Life and Retirement's overall product portfolio, variable annuity reserves are a relatively small portion of its total reserves compared to others in this market. As a result of a broad distribution network and a more favorable competitive environment, AIG Life and Retirement expects variable annuity sales to remain strong for 2013.
Increase Life Insurance In force
AIG Life and Retirement's strategic focus related to life insurance and other mortality-based products includes disciplined underwriting, active expense management and product innovation. AIG Life and Retirement's distribution
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strategy is to grow new sales by strengthening the core retail independent and career agent distributor channels and expanding its market presence through the development of innovative life insurance offerings based on consumer focused research to drive superior, differentiated product solutions. In addition, AIG Life and Retirement is enhancing its service and technology platform through the consolidation of its life operations and administrative systems, which is expected to result in a more efficient, cost-competitive and agile operating model.
Enhance Return on Equity
AIG Life and Retirement expects to leverage its streamlined legal entity structure to enhance financial strength and durability capital efficiency and ease of doing business. AIG Life and Retirement completed the merger of six life insurance operating legal entities into American General Life Insurance Company effective December 31, 2012. This merger will allow for more effective capital and dividend planning while creating operating efficiencies and making it easier for producers and customers to do business with AIG Life and Retirement. AIG Life and Retirement also plans to improve operational efficiencies and service through investments in technology, more productive use of existing resources and further use of lower-cost operations centers.
Our Investment Strategy for AIG Life and Retirement
AIG Life and Retirement places primary emphasis on investments in fixed maturity securities issued by corporations, municipalities and other governmental agencies, structured securities collateralized by, among others, residential and commercial real estate, and to a lesser extent, commercial mortgage loans, private equity, hedge funds, other alternative investments, and common and preferred stock.
Our fundamental investment strategy is to maintain primarily a diversified, high quality portfolio of fixed maturity securities and, as nearly as is practicable, to match the duration characteristics of our liabilities with assets of comparable duration. In addition, AIG Life and Retirement enhances its returns through investments in a diversified portfolio of private equity funds, hedge funds and affordable housing partnerships. Although returns on these investments are more volatile than our base fixed maturity securities portfolio, they have historically achieved higher total returns and yields than the base portfolio yields. AIG Life and Retirement's expectation is that these alternative investments will continue to outperform the base portfolio yields over the long-term.
Opportunistic investments in structured securities and other yield enhancement opportunities continue to be made with the objective of increasing net investment income. Overall base yields increased in 2012 due to the reinvestment of significant amounts of cash and short term investments during 2011. However, base yields have been declining in the latter half of 2012 as investment purchases were made at yields lower than the weighted average yield of the existing portfolio. During prolonged periods of low or declining interest rates, AIG Life and Retirement has to invest net flows and reinvest interest and principal payments from its investment portfolio in lower yielding securities.
See Segment Results AIG Life and Retirement Operations and Note 7 to the Consolidated Financial Statements for additional information.
Other Operations
Mortgage Guaranty
The following are expected to continue to affect results for 2013: Market developments UGC is a market leader in the mortgage insurance industry with a differentiated risk-based pricing model that is designed to produce high quality new business. The withdrawal of certain competitors from the market during 2011 combined with UGC's investment grade rating and risk-based pricing has positioned UGC to take advantage of market opportunities. UGC plans to continue to execute this strategy during 2013 and to further enhance its market position. UGC will continue to review its new business pricing relative to changes in the market to ensure that the price of coverage is commensurate with the level of risk being underwritten. |
Increase market share through competitor differentiation. Improve the risk profile of new insurance written. Build our market leadership position. |
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Global Capital Markets (GCM)
AIG Markets acts as the derivatives intermediary between AIG and its subsidiaries and third parties to provide hedging services. The derivative portfolio of AIG Markets consists primarily of interest rate and currency derivatives.
The remaining derivatives portfolio of AIGFP consists primarily of hedges of the assets and liabilities of the DIB and a portion of the legacy hedges for AIG and its subsidiaries. Future hedging needs for AIG and its subsidiaries will be executed through AIG Markets. AIGFP's derivative portfolio consists primarily of interest rate, currency, credit, commodity and equity derivatives. Additionally, AIGFP has a credit default swap portfolio being managed for economic benefit and with limited risk. The AIGFP portfolio continues to be wound down and is managed consistent with our risk management objectives. Although the portfolio may experience periodic fair value volatility, it consists predominantly of transactions that we believe are of low complexity, low risk or currently not economically appropriate to unwind based on a cost versus benefit analysis.
Direct Investment Book (DIB)
The DIB portfolio is being wound down and is managed with the objective of ensuring that at all times it maintains the liquidity we believe is necessary to meet all its liabilities, as they come due, even under stress scenarios and to maximize return consistent with our risk management objectives. We are focused on meeting the DIB's liquidity needs, including the need for contingent liquidity arising from collateral posting for debt positions of the DIB without relying on resources beyond the DIB. As part of this program management, we may from time to time access the capital markets, subject to market conditions. In addition, we may seek to buy back debt or sell assets on an opportunistic basis, subject to market conditions.
From time to time, we may utilize cash allocated to the DIB that is not required to meet the risk target for general corporate purposes unrelated to the DIB.
Certain non-derivative assets and liabilities of the DIB are accounted for under the fair value option and thus operating results are subject to periodic market volatility. The overall hedging activity for the assets and liabilities of the DIB is executed by GCM. The value of hedges related to the non-derivative assets and liabilities of AIGFP in the DIB are included within the assets and liabilities and operating results of GCM and are not included within the DIB operating results, assets or liabilities.
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Results of Operations |
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The following section provides a comparative discussion of our Results of Operations on a reported basis for the three-year period ended December 31, 2012. Factors that relate primarily to a specific business segment are discussed in more detail within that business segment. For a discussion of the Critical Accounting Estimates that affect the Results of Operations, see the Critical Accounting Estimates section of Item 7. MD&A, in this Annual Report on Form 10-K. |
The following table presents AIG's condensed consolidated results of operations:
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Percentage Change | ||||||||||||
Years Ended December 31, (in millions) |
2012 |
2011 |
2010 |
2012 vs. 2011 |
2011 vs. 2010 |
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Revenues: |
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Premiums |
$ | 38,011 | $ | 38,990 | $ | 45,319 | (3 | )% | (14 | )% | ||||||
Policy fees |
2,791 | 2,705 | 2,710 | 3 | | |||||||||||
Net investment income |
20,343 | 14,755 | 20,934 | 38 | (30 | ) | ||||||||||
Net realized capital gains (losses) |
929 | 701 | (716 | ) | 33 | NM | ||||||||||
Other income |
3,582 | 2,661 | 4,582 | 35 | (42 | ) | ||||||||||
Total revenues |
65,656 | 59,812 | 72,829 | 10 | (18 | ) | ||||||||||
Benefits, claims and expenses: |
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Policyholder benefits and claims incurred |
31,977 | 33,450 | 41,392 | (4 | ) | (19 | ) | |||||||||
Interest credited to policyholder account balances |
4,362 | 4,467 | 4,487 | (2 | ) | | ||||||||||
Amortization of deferred acquisition costs |
5,709 | 5,486 | 5,821 | 4 | (6 | ) | ||||||||||
Other acquisition and insurance expenses |
9,235 | 8,458 | 10,163 | 9 | (17 | ) | ||||||||||
Interest expense |
2,319 | 2,444 | 6,742 | (5 | ) | (64 | ) | |||||||||
Net loss on extinguishment of debt |
9 | 2,847 | 104 | (100 | ) | NM | ||||||||||
Net (gain) loss on sale of properties and divested businesses |
2 | 74 | (19,566 | ) | (97 | ) | NM | |||||||||
Other expenses |
2,721 | 2,470 | 3,439 | 10 | (28 | ) | ||||||||||
Total benefits, claims and expenses |
56,334 | 59,696 | 52,582 | (6 | ) | 14 | ||||||||||
Income from continuing operations before income tax expense (benefit) |
9,322 | 116 | 20,247 | NM | (99 | ) | ||||||||||
Income tax expense (benefit) |
1,570 | (19,424 | ) | 6,993 | NM | NM | ||||||||||
Income from continuing operations |
7,752 | 19,540 | 13,254 | (60 | ) | 47 | ||||||||||
Income (loss) from discontinued operations, net of income tax expense (benefit) |
(4,052 | ) | 1,790 | (969 | ) | NM | NM | |||||||||
Net income |
3,700 | 21,330 | 12,285 | (83 | ) | 74 | ||||||||||
Less: Net income attributable to noncontrolling interests |
262 | 708 | 2,227 | (63 | ) | (68 | ) | |||||||||
Net income attributable to AIG |
$ | 3,438 | $ | 20,622 | $ | 10,058 | (83 | )% | 105 | % | ||||||
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AIG 2012 and 2011 Comparison
Income from continuing operations before income taxes for 2012 and 2011 reflected the following:
pre-tax income from insurance operations of $5.6 billion in 2012, which included catastrophe losses of $2.7 billion, largely arising from Storm Sandy, and severe losses of $326 million, compared to pre-tax income from insurance operations of $4.8 billion in 2011, which included catastrophe losses of $3.3 billion, largely arising from Hurricane Irene, U.S. tornadoes and the Great Tohoku Earthquake & Tsunami in Japan (the Tohoku Catastrophe) and severe losses of $296 million; increases in fair value of AIG's interest in AIA ordinary shares of $2.1 billion and $1.3 billion in 2012 and 2011, respectively. The increase in fair value in 2012 included a gain on sale of AIA ordinary shares of approximately $0.8 billion; an increase in fair value of AIG's interest in ML III of $2.9 billion in 2012, compared to a decrease in fair value of $646 million in the same period of 2011; an increase in estimated litigation liability of approximately $783 million for the year ended December 31, 2012 based on developments in several actions; litigation settlement income of $210 million in 2012 from settlements with three financial institutions who participated in the creation, offering and sale of RMBS from which AIG and its subsidiaries suffered losses either for their own accounts or in connection with their participation in AIG's securities lending program; and a $3.3 billion net loss, primarily consisting of the accelerated amortization of the remaining prepaid commitment fee asset resulting from the termination of the credit facility provided by the FRBNY (the FRBNY Credit Facility) in 2011. This was partially offset by a $484 million gain on extinguishment of debt in the fourth quarter of 2011 due to the exchange of subordinated debt. |
For the third consecutive year we posted a full year profit. Our total AIG Property Casualty accident year loss ratio, as adjusted, improved each year during the past three years. We enhanced spread income and actively managed through the low interest rate environment. Our investment portfolio performance improved due to the completion of the cash
deployment in 2011. |
For the year ended December 31, 2012, the effective tax rate on pre-tax income from continuing operations was 16.8 percent. This rate differs from the statutory rate primarily due to tax benefits of $1.9 billion related to a decrease in the life-insurance-business capital loss carryforward valuation allowance and $302 million associated with tax exempt interest income. These items were partially offset by charges in uncertain tax positions of $586 million and $172 million associated with the effect of foreign operations.
For the year ended December 31, 2011, the effective tax rate on pre-tax income from continuing operations was not meaningful, due to the significant effect of releasing approximately $18.4 billion of the deferred tax asset valuation allowance. Other factors that contributed to the difference from the statutory rate included tax benefits of $454 million associated with tax exempt interest income, $386 million associated with the effect of foreign operations, and $224 million related to our investment in subsidiaries and partnerships.
In 2012, AIG recorded a loss from discontinued operations, net of income taxes, of $4.1 billion, which included a pre-tax loss of $6.7 billion on the announced sale of ILFC.
After-tax operating income for 2012 was $6.6 billion compared to $2.1 billion for 2011.
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AIG 2011 and 2010 Comparison
Income from continuing operations before income taxes for 2011 and 2010 reflected the following:
Partially offsetting these declines were:
As discussed above, AIG released $18.4 billion of the deferred tax asset valuation allowance for the U.S. consolidated income tax group in 2011.
For the year ended December 31, 2010, the effective tax rate on pre-tax income from continuing operations was 34.5 percent. This rate differs from the statutory rate primarily due to tax benefits of $1.3 billion associated with our investment in subsidiaries and partnerships, principally the AIA SPV which is treated as a partnership for U.S. tax purposes, and $587 million associated with tax exempt interest, partially offset by an increase in the deferred tax asset valuation allowance attributable to continuing operations of $1.4 billion.
In 2011, AIG recorded income from discontinued operations net of taxes of $1.8 billion, which included a pre-tax gain of $3.5 billion recorded in the first quarter of 2011 on the sale of AIG Star Life Insurance Co., Ltd. (AIG Star) and AIG Edison Life Insurance Company (AIG Edison). This compared to a net loss of $969 million in 2010, which included goodwill impairment charges of $4.6 billion associated with the sale of American Life Insurance Company (ALICO), AIG Star and AIG Edison.
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The following table presents a reconciliation of income attributable to AIG from continuing operations to after-tax operating income (loss):
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Years Ended December 31, (in millions) |
2012 |
2011 |
2010 |
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Net income |
$ | 3,700 | $ | 21,330 | $ | 12,285 | ||||
Income (loss) from discontinued operations, net of income tax expense (benefit) |
(4,052 | ) | 1,790 | (969 | ) | |||||
Income from continuing operations |
7,752 | 19,540 | 13,254 | |||||||
Net (gains) losses on sale of divested businesses |
1 | 48 | (15,326 | ) | ||||||
Income from divested businesses |
| (16 | ) | (1,552 | ) | |||||
Legacy FIN 48 and other tax adjustments |
543 | | | |||||||
Legal reserves (settlements) related to legacy crisis matters |
353 | 13 | 2 | |||||||
Deferred income tax valuation allowance (releases) charges |
(1,911 | ) | (18,307 | ) | 1,392 | |||||
Amortization of FRBNY prepaid commitment fee asset |
| 2,358 | 2,255 | |||||||
Changes in fair value of AIG Life and Retirement fixed income securities designated to hedge living benefit liabilities |
(24 | ) | | | ||||||
Change in benefit reserves and DAC, VOBA and SIA related to net realized capital (gains) losses |
781 | 202 | 74 | |||||||
(Gain) loss on extinguishment of debt |
6 | (520 | ) | 104 | ||||||
Net realized capital (gains) losses |
(586 | ) | (460 | ) | 1,104 | |||||
Non-qualifying derivative hedging gains, excluding net realized capital (gains) losses |
(18 | ) | (84 | ) | (352 | ) | ||||
Bargain purchase gain |
| | (332 | ) | ||||||
After-tax operating income |
6,897 | 2,774 | 623 | |||||||
Net income from continuing operations attributable to noncontrolling interests |
262 | 688 | 2,172 | |||||||
After-tax operating income (loss) |
$ | 6,635 | $ | 2,086 | $ | (1,549 | ) | |||
After-tax operating income increased in 2012 compared to 2011 primarily due to increases in income from insurance operations and in the fair value gains on AIG's interest in AIA ordinary shares and AIG's interest in ML III, discussed above. This was partially offset by an increase in income tax expenses in 2012 compared to an income tax benefit in 2011.
For the year ended December 31, 2012, the effective tax rate on pre-tax operating income was 31.6 percent. The effective tax rate for the year ended December 31, 2012, attributable to pre-tax operating income differs from the statutory rate primarily due to tax exempt interest income and other permanent tax items.
For the year ended December 31, 2011, the effective tax rate on pre-tax operating income was (9.6) percent. The significant factors that contributed to the difference from the statutory rate included tax benefits resulting from tax exempt interest income, tax benefits associated with non-controlling interests, as well as discrete tax benefits recorded during the year.
We reported after-tax operating income in 2011 compared to after-tax operating losses in 2010 primarily due to a net charge to strengthen AIG Property Casualty's loss reserves in 2010, partially offset by higher catastrophe losses in 2011.
For the year ended December 31, 2010, the effective tax rate on pre-tax operating income was 70.2 percent. The effective tax rate attributable to pre-tax operating income for the year ended December 31, 2010 differs from the statutory rate primarily due to tax benefits associated with divested businesses, which are excluded from after-tax operating income.
AIG reports the results of its operations through two reportable segments: AIG Property Casualty and AIG Life and Retirement. The Other operations category consists of businesses and items not allocated to our reportable segments.
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The following table summarizes the operations of each reportable segment. See also Note 3 to the Consolidated Financial Statements.
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Percentage Change | ||||||||||||
Years Ended December 31, (in millions) |
2012 |
2011 |
2010 |
2012 vs. 2011 |
2011 vs. 2010 |
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Total revenues: |
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AIG Property Casualty |
$ | 39,781 | $ | 40,722 | $ | 37,207 | (2 | )% | 9 | % | ||||||
AIG Life and Retirement |
16,767 | 15,315 | 14,747 | 9 | 4 | |||||||||||
Total reportable segments |
56,548 | 56,037 | 51,954 | 1 | 8 | |||||||||||
Other Operations |
9,974 | 4,079 | 21,405 | 145 | (81 | ) | ||||||||||
Consolidation and eliminations |
(866 | ) | (304 | ) | (530 | ) | (185 | ) | 43 | |||||||
Total |
65,656 | 59,812 | 72,829 | 10 | (18 | ) | ||||||||||
Pre-tax income (loss): |
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AIG Property Casualty |
1,837 | 1,820 | (93 | ) | 1 | NM | ||||||||||
AIG Life and Retirement |
3,780 | 2,956 | 2,701 | 28 | 9 | |||||||||||
Total reportable segments |
5,617 | 4,776 | 2,608 | 18 | 83 | |||||||||||
Other Operations |
3,899 | (4,703 | ) | 17,611 | NM | NM | ||||||||||
Consolidation and eliminations |
(194 | ) | 43 | 28 | NM | 54 | ||||||||||
Total |
9,322 | 116 | 20,247 | NM | (99 | ) | ||||||||||
A discussion of significant items affecting pre-tax segment income follows. Factors that affect operating income for a specific business segment are discussed in the detailed business segment analysis.
2012 and 2011 Pre-tax Income Comparison
AIG Property Casualty Pre-tax income increased slightly in 2012 compared to 2011. The increase in pre-tax income was the result of lower underwriting losses due to the impact of lower catastrophe losses, underwriting improvements related to rate increases and enhanced risk selection, higher net investment income due to asset diversification by reducing the concentration in tax-exempt municipal instruments and increasing investments in private placement debt and structured securities. These increases were partially offset by higher acquisition costs as a result of the change in business mix from Commercial Insurance to Consumer Insurance and higher general operating expenses and lower net realized capital gains.
AIG Life and Retirement Pre-tax income increased in 2012 compared to 2011, principally due to efforts to actively manage net investment spreads. Results benefited from higher net investment income, lower interest credited, lower reserves for death claims and the impact of more favorable separate account performance on DAC amortization and policyholder benefit reserves. These items were partially offset by significant proceeds from a legal settlement in 2011, higher mortality costs and an increase in GIC reserves.
Other Operations Other Operations recorded pre-tax income in 2012 compared to a pre-tax loss in 2011 due to fair value and realized gains in our interest in AIA ordinary shares, and in our interest in ML III, partially offset by an increase in estimated litigation liability, and a loss on extinguishment of debt of $3.3 billion in 2011 in connection with the termination of the FRBNY Credit Facility.
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2011 and 2010 Pre-tax Income Comparison
AIG Property Casualty AIG Property Casualty generated pre-tax income in 2011 compared to a pre-tax loss in 2010. The increase in pre-tax income was the result of lower underwriting losses primarily due to an increase in premium revenues, resulting from the consolidation of Fuji commencing in the third quarter of 2010 and lower prior year adverse development in 2011. These increases in pre-tax income were partially offset by higher catastrophe losses, and higher acquisition and general operating expenses due to a change in business mix.
Pre-t