AMERICAN INTERNATIONAL GROUP, INC. quarterly report, Q2 FY2012

Business Context and Reporting Period

American International Group, Inc. filed an unaudited Form 10-Q for the quarter and six months ended June 30, 2012. AIG reported through Chartis property and casualty insurance, SunAmerica life and retirement services, Aircraft Leasing through ILFC, and Other Operations, including mortgage guaranty, Global Capital Markets, the Direct Investment Book, retained interests and corporate activities.

The filing reflects retrospective adoption of revised insurance acquisition-cost accounting and related revisions to prior-period amounts. Chartis was expected to be renamed AIG and SunAmerica to be renamed AIG Life and Retirement beginning in the fall of 2012.

Financial Performance and Position

Metric	Three months ended June 30, 2012	Three months ended June 30, 2011	Six months ended June 30, 2012	Six months ended June 30, 2011
Total revenues	$17.1 billion	$16.7 billion	$35.6 billion	$34.1 billion
Income before tax from continuing operations	$1.8 billion	$1.8 billion	$6.3 billion	$0.5 billion
Income from continuing operations	$2.3 billion	$2.1 billion	$5.8 billion	$1.0 billion
Net income attributable to AIG	$2.3 billion	$1.8 billion	$5.5 billion	$3.1 billion
Diluted EPS from continuing operations	$1.33	$1.03	$3.05	$(0.12)
Net cash from operating activities	Not separately presented for the quarter	$1.6 billion	$(3.5) billion

Six-month revenue increased 4 percent, while premiums declined 2 percent and net investment income increased 15 percent.
Six-month policyholder benefits and claims declined 13 percent, primarily because 2011 included substantially higher catastrophe losses.
Net realized capital gains were $397 million in the quarter and $147 million for the six months, compared with $75 million and a $660 million loss, respectively, in the prior-year periods.
Effective tax rates on continuing operations were negative 33.8 percent for the quarter and 8.8 percent for the six months. AIG released approximately $1.3 billion of life-insurance capital-loss deferred-tax valuation allowance in the quarter and $1.5 billion for the six months.
At June 30, 2012, total assets were $555.4 billion, total liabilities were $449.7 billion and total equity was $105.5 billion. AIG shareholders’ equity was $104.7 billion.
Long-term debt was $73.9 billion, down from $75.3 billion at December 31, 2011. Total debt, including debt not guaranteed by AIG, was $73.9 billion at June 30, 2012.
Cash was $1.2 billion, compared with $1.5 billion at year-end 2011. Total investments were $412.5 billion.

Segment Results and Material Changes

Chartis: Pre-tax income increased to $961 million from $826 million in the quarter and to $1.9 billion from $452 million for the six months. The improvement reflected lower catastrophe losses, rate increases, enhanced risk selection and business-mix changes. The six-month combined ratio improved to 102.3 percent from 111.1 percent, although the adjusted accident-year combined ratio increased to 99.3 percent from 98.1 percent.
Chartis catastrophe losses were $328 million in the quarter and $408 million for the six months, compared with $539 million and $2.3 billion in the prior-year periods. Chartis recorded adverse prior-year development of $137 million in the quarter and $184 million for the six months.
SunAmerica: Pre-tax income was $777 million in the quarter, broadly comparable with $766 million, and $1.6 billion for the six months, down from $1.7 billion. Operating income increased, but results were affected by realized gains and losses, variable-annuity embedded derivatives and related reserve and acquisition-cost adjustments. Individual fixed-annuity deposits declined 77 percent in the quarter and 74 percent for the six months because of low interest rates, while individual variable-annuity deposits increased 51 percent and 45 percent, respectively.
Aircraft Leasing: Pre-tax income was $86 million in the quarter and $206 million for the six months, essentially unchanged from the prior-year periods. Early aircraft returns from bankrupt lessees and higher depreciation and impairment charges pressured results.
Other Operations: Pre-tax income was a loss of $116 million in the quarter versus income of $87 million, but income was $2.6 billion for the six months versus a $1.9 billion loss. Six-month results included gains on the AIG interest in Maiden Lane III and the AIA share sale, while the quarter included a $493 million decline in the fair value of the retained AIA interest.
AIG sold approximately 1.72 billion AIA shares for approximately $6.0 billion, reducing its retained ownership from approximately 33 percent to 19 percent. The retained AIA interest was valued at approximately $7.7 billion at June 30, 2012, compared with $12.4 billion at year-end 2011.
The Department of the Treasury’s ownership of AIG common stock declined from approximately 77 percent to approximately 61 percent after March and May offerings. AIG repurchased approximately 169 million shares for approximately $5.0 billion.
AIG paid down the remaining $8.6 billion liquidation preference of the Department of the Treasury’s AIA SPV preferred interests in full.

Cash Flow, Liquidity and Capital

Six-month operating cash flow was $1.6 billion, compared with cash used of $3.5 billion in 2011. Investing activities provided $10.9 billion, while financing activities used $12.7 billion.
Financing uses included the $8.6 billion AIA SPV preferred-interest repayment and $5.0 billion of common-stock purchases. AIG issued $6.8 billion of long-term debt and repaid $8.2 billion.
At June 30, 2012, AIG Parent reported liquidity sources of $11.5 billion, consisting of $7.3 billion of cash and short-term investments, $3.2 billion of available syndicated credit facilities and $1.0 billion of contingent liquidity facilities.
AIG reported $4.8 billion of debt maturities through the second quarter of 2013, including $3.0 billion of ILFC maturities and $1.5 billion of Direct Investment Book maturities.
Parent liquidity, subsidiary dividends, credit-market access and asset sales remain important to meeting obligations. The filing states that regulatory restrictions, collateral calls, reserve strengthening, higher policy surrenders, credit downgrades or catastrophic losses could materially increase liquidity needs.

Guidance, Outlook, Risks and Unusual Items

AIG’s 2012 priorities included strengthening core businesses, pursuing an IPO or sale of ILFC, managing capital and interest expense, preparing for potential Federal Reserve regulation, improving systems and controls, and restructuring operations.
Chartis expected low interest rates and uncertain global conditions to pressure results, while relying on improving pricing, underwriting discipline, expense initiatives and a shift toward higher-value, less capital-intensive business.
SunAmerica expected continued pressure on fixed-annuity sales, spreads and investment returns from low interest rates. Management indicated that, if rates remained near prevailing levels through 2013, full-year 2012 and 2013 pre-tax operating income would not be materially affected, although effects could increase in 2014.
ILFC faced airline-credit, European sovereign-debt and aircraft remarketing risks. Six lessees ceased operations or filed for bankruptcy during the first six months, returning 45 aircraft.
AIG recorded an approximately $719 million increase in estimated litigation liability in the second quarter, contributing to higher Corporate and Other expenses.
Material contingencies included the $450 million workers’ compensation class-action settlement held in escrow, a $75 million Transatlantic securities-lending settlement for which AIG was fully reserved, unresolved securities and regulatory litigation, and a potential maximum contractual loss of approximately $1.5 billion in the Brookfield interest-rate-swap dispute.
ILFC had commitments to purchase aircraft with aggregate remaining payments of approximately $18.5 billion. Other investment commitments totaled approximately $2.5 billion.
At June 30, 2012, AIG’s super-senior credit-default-swap portfolio had net notional exposure of approximately $19.8 billion and a fair-value derivative liability of approximately $2.5 billion before netting and collateral. A one-notch or further downgrade could require additional collateral or termination payments; estimates in the filing range from negligible amounts to approximately $230 million for specified downgrade scenarios.
AIG reported $95.3 billion of credit exposure to global financial institutions, including $32.6 billion to U.K. and European financial institutions. The filing also highlights exposure to U.S. municipalities, Japan, European sovereigns, structured securities and commercial real estate.
Management identified significant estimation risk in insurance reserves, deferred tax assets, deferred acquisition costs, aircraft values, impairments, legal contingencies and Level 3 fair values.

Most Important Facts to Verify

Whether Chartis’s underwriting improvement is sustainable despite adverse prior-year reserve development and combined ratios above 100 percent.
The recoverability of AIG’s deferred tax assets and the extent to which tax-valuation-allowance releases contributed to reported earnings.
Fair values, liquidity requirements and potential losses associated with AIA, Maiden Lane III, Level 3 assets and the remaining credit-default-swap portfolio.
The adequacy of insurance reserves, particularly environmental, asbestos, excess casualty and mortgage-guaranty reserves.
ILFC’s aircraft purchase commitments, lessee credit quality, aircraft impairments and ability to refinance upcoming maturities.
The ultimate cost and timing of pending litigation, regulatory matters, settlements and indemnification obligations.
Whether AIG Parent can maintain sufficient liquidity after debt maturities, share repurchases, subsidiary funding needs and potential collateral calls.
The effect of continued low interest rates on SunAmerica spreads, fixed-annuity sales, policyholder behavior, reserves and deferred acquisition costs.