AMERICAN INTERNATIONAL GROUP, INC. quarterly report, Q1 FY2012

Business Context and Reporting Period

American International Group, Inc. (AIG) filed an unaudited Form 10-Q for the three months ended March 31, 2012. AIG reports through Chartis, SunAmerica, Aircraft Leasing and Other Operations. The filing reflects the continuing restructuring of AIG following the financial crisis, including asset sales, debt reduction, repayment of government-related preferred interests and capital management actions.

Key Financial Metrics

Metric	Q1 2012	Q1 2011	Change
Total revenues	$18.443 billion	$17.439 billion	6%
Pre-tax income from continuing operations	$4.584 billion	$(1.310) billion	Improved by $5.894 billion
Income from continuing operations	$3.436 billion	$(1.084) billion	Improved by $4.520 billion
Net income attributable to AIG	$3.208 billion	$1.297 billion	147%
Net income attributable to common shareholders	$3.208 billion	$485 million	Substantially higher
Diluted EPS from continuing operations	$1.70	$(1.34)	Improved
Comprehensive income attributable to AIG	$4.928 billion	$481 million	Substantially higher
Net cash used in operating activities	$(111) million	$(5.312) billion	Significantly improved
Total debt	$76.096 billion	$75.253 billion	Up $843 million
Total assets	$554.403 billion	$552.360 billion	Up $2.043 billion from year-end 2011
Total equity	$104.344 billion	$102.393 billion	Up $1.951 billion from year-end 2011

Approximate reported margins were 24.9% for pre-tax income from continuing operations and 17.4% for net income attributable to AIG, based on total revenues. These are derived measures and are not presented as AIG non-GAAP metrics.

Revenue and Earnings Drivers

Net investment income increased 28% to $7.105 billion, including a $1.795 billion gain related to AIA securities and a $1.252 billion increase in the fair value of AIG’s Maiden Lane III interest.
Net realized capital losses improved to $303 million from $648 million, primarily because of higher gains on securities sales, partly offset by higher other-than-temporary impairments and derivative losses.
Policyholder benefits and claims incurred declined 21% to $7.102 billion, largely because 2011 included substantially higher catastrophe losses.
Interest expense declined 10% to $953 million, while the 2011 period included a $3.313 billion loss on extinguishment of debt related primarily to the terminated Federal Reserve Bank of New York credit facility.
Chartis pre-tax income improved to $910 million from a $374 million loss. Its combined ratio improved to 102.1% from 118.6%, although the expense ratio increased to 34.1% from 28.9%.
SunAmerica pre-tax income declined 11% to $862 million, despite operating income increasing 12% to $1.311 billion, primarily because of higher realized losses and related items.
Aircraft Leasing pre-tax income was unchanged at $120 million.
Other Operations generated $2.736 billion of pre-tax income versus a $1.997 billion loss, driven primarily by gains on AIA securities and Maiden Lane III.

Financial Condition, Cash Flow, Debt and Liquidity

AIG had $406.961 billion of total investments and $1.315 billion of cash at March 31, 2012. Parent-level liquidity sources totaled $12.393 billion, consisting of $8.193 billion of cash and short-term investments, $3.2 billion of available syndicated credit facilities and $1.0 billion of contingent liquidity facilities.
Cash provided by investing activities was $10.186 billion, including approximately $6.0 billion of gross proceeds from the sale of AIA shares and approximately $1.6 billion distributed from the sale of Maiden Lane II assets.
Cash used in financing activities was $10.232 billion, including $8.6 billion to repay the Department of the Treasury’s AIA SPV preferred interests and $3.0 billion to repurchase AIG common shares.
AIG issued $2.0 billion of senior notes for the Matched Investment Program. ILFC raised approximately $2.4 billion through secured and unsecured financings.
Debt maturing during the four quarters following March 31, 2012 totaled $5.858 billion, including $2.894 billion of ILFC debt and $2.773 billion of borrowings supported by Direct Investment Book assets.
AIG reported $5.618 billion of off-balance-sheet commercial commitments, including $2.752 billion of investment commitments and $1.538 billion of guarantees, liquidity facilities and letters of credit.

Material Changes Versus the Prior Comparable Period

AIG moved from a $1.084 billion loss from continuing operations in Q1 2011 to $3.436 billion of income in Q1 2012. The comparison is affected by the 2011 $3.3 billion debt-extinguishment charge and unusually high catastrophe losses.
Discontinued-operations income fell to $13 million from $2.585 billion because Q1 2011 included a $3.5 billion pre-tax gain from the sale of AIG Star and AIG Edison.
Chartis’s underwriting performance improved materially as catastrophe losses declined to $80 million from $1.727 billion. However, net prior-year adverse development increased to $66 million from $23 million.
Chartis net premiums written declined 4% to $8.820 billion as Commercial Insurance premiums fell 9%, partly offset by 5% growth in Consumer Insurance.
SunAmerica’s total premiums, deposits and other considerations decreased 13% to $5.560 billion. Individual fixed-annuity deposits declined 72%, while individual variable-annuity deposits increased 38%.
AIG retrospectively adopted revised insurance acquisition-cost accounting. The adoption reduced beginning retained earnings by $3.558 billion and reduced December 31, 2011 AIG shareholders’ equity by $3.413 billion; prior-period net income attributable to AIG was increased by $1.028 billion.
AIG sold approximately 1.72 billion AIA shares for approximately $6.0 billion, reducing its retained ownership from approximately 33% to 19%. It also repurchased approximately 103 million AIG shares for $3.0 billion.

Guidance, Outlook, Management Commentary and Risks

No formal consolidated earnings or revenue guidance is provided. AIG’s stated 2012 priorities were to strengthen core businesses, pursue a strategic alternative for ILFC, manage capital and interest expense, prepare for potential Federal Reserve regulation, improve systems and controls, and streamline operations.
Chartis expects 2012 to remain challenging but sees improving pricing, particularly in U.S. commercial insurance, and growth opportunities in Brazil, Turkey, India and Asia-Pacific markets. Management intends to emphasize higher-value, less capital-intensive business and stronger risk selection.
SunAmerica expects continued pressure from low interest rates and equity-market volatility. Approximately 51% of relevant annuity and universal-life account values were at contractual minimum crediting rates at March 31, 2012. Additional asset sales could create further loss recognition or reserve increases.
ILFC faced airline-credit and aircraft remarketing risks. Four lessees ceased operations or filed for bankruptcy during the first quarter, returning 42 aircraft. A strategic alternative, including an initial public offering or sale, remained under consideration.
Key market risks include interest-rate movements, equity-market declines, foreign-exchange changes, credit-spread volatility, European sovereign and financial-institution exposures, and valuation risk in Level 3 assets. A 100-basis-point parallel increase in yields was estimated to reduce value by approximately $15.5 billion; a 20% decline in equity and alternative investments was estimated to reduce value by approximately $6.9 billion.
AIG’s net notional super-senior credit-default-swap portfolio was $22.781 billion, with a $2.642 billion derivative liability before netting and collateral. AIG stated that it did not expect payments under regulatory-capital transactions based on current portfolio performance and structural protections, but actual outcomes could differ materially.
AIG was subject to significant litigation, regulatory inquiries and contingencies. Notable matters included securities litigation, workers’ compensation premium-reporting matters, insurance-conduct investigations, the Brookfield swap dispute with a stated maximum contractual loss of approximately $1.5 billion, and other claims for which AIG could not reasonably estimate potential losses.
AIG had accrued $450 million for a workers’ compensation class-action settlement pending appeal and up to $51 million for a proposed Chartis regulatory settlement. The filing also disclosed substantial aircraft purchase commitments of approximately $18.7 billion through 2019.
AIG stated that its disclosure controls and procedures were effective as of March 31, 2012, with no material change in internal control over financial reporting during the quarter.

Important Facts for Investors to Verify

Whether earnings improvements are sustainable without the large AIA and Maiden Lane III fair-value gains and other market-sensitive items.
Future development of Chartis casualty, environmental, asbestos and workers’ compensation reserves, including the $66 million of Q1 adverse prior-year development.
SunAmerica’s exposure to prolonged low interest rates, minimum crediting-rate guarantees, variable-annuity guarantees and additional loss recognition.
ILFC’s ability to refinance approximately $24.6 billion of debt, remarket returned aircraft and execute a strategic transaction.
Potential collateral calls, termination payments and liquidity requirements following credit-rating downgrades or adverse derivative valuations.
Valuation sensitivity of Maiden Lane III, AIA shares, Level 3 assets and the super-senior CDS portfolio.
Resolution, appeals and ultimate costs of disclosed litigation, regulatory settlements, indemnities and workers’ compensation matters.
The effect of the retrospective deferred-acquisition-cost accounting change when comparing 2012 results with previously issued 2011 financial statements.