10-Q 1 y72212e10vq.htm FORM 10-Q FORM 10-Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
 
Form 10-Q
 
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended September 30, 2008
or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission File Number 1-8787
 
 
 
 
American International Group, Inc.
(Exact name of registrant as specified in its charter)
 
     
Delaware   13-2592361
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
70 Pine Street, New York, New York   10270
(Address of principal executive offices)   (Zip Code)
 
Registrant’s telephone number, including area code: (212) 770-7000
 
Former name, former address and former fiscal year, if changed since last report: None
 
 
 
 
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 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. (Check one):
 
Large accelerated filer  þ Accelerated filer  o Non-accelerated filer  o Smaller reporting company  o
                    (Do not check if a
                    smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of October 31, 2008, there were 2,689,938,313 shares outstanding of the registrant’s common stock.
 


 

 
TABLE OF CONTENTS
 
                 
        Page
Description   Number
       
          1  
          47  
          153  
          154  
       
          155  
          155  
          155  
    156  
 EX-10.1: RELEASE AGREEMENT WITH STEVEN J. BENSINGER
 EX-10.2: LETTER FROM ROBERT B. WILLUMSTAD
 EX-10.3: LETTER AGREEMENT
 EX-10.4: AMENDMENT NO.2 TO THE CREDIT AGREEMENT
 EX-12: COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES
 EX-31: CERTIFICATIONS
 EX-32: CERTIFICATIONS


Table of Contents

American International Group, Inc. and Subsidiaries

 
Part I – FINANCIAL INFORMATION
ITEM 1. Financial Statements (unaudited)
 
CONSOLIDATED BALANCE SHEET
 
(in millions) (unaudited)
                 
    September 30,
    December 31,
 
    2008     2007  
Assets:
               
Investments and Financial Services assets:
               
                 
Fixed maturity securities:
               
Bonds available for sale, at fair value (amortized cost: 2008 – $412,877; 2007 – $393,170)
  $ 394,494     $ 397,372  
Bonds held to maturity, at amortized cost (fair value: 2008 – $0; 2007 – $22,157)
          21,581  
Bond trading securities, at fair value
    7,552       9,982  
                 
Equity securities:
               
Common stocks available for sale, at fair value (cost: 2008 – $11,317; 2007 – $12,588)
    11,459       17,900  
Common and preferred stocks trading, at fair value
    20,674       21,376  
Preferred stocks available for sale, at fair value (cost: 2008 – $1,590; 2007 – $2,600)
    1,464       2,370  
Mortgage and other loans receivable, net of allowance (2008 – $90; 2007 – $77) (held for sale: 2008 – $26; 2007 – $377) (amount measured at fair value: 2008 – $328)
    33,724       33,727  
                 
Financial Services assets:
               
Flight equipment primarily under operating leases, net of accumulated depreciation (2008 – $11,812; 2007 – $10,499)
    43,561       41,984  
Securities available for sale, at fair value (cost: 2008 – $2,568; 2007 – $40,157)
    2,326       40,305  
Trading securities, at fair value
    36,136       4,197  
Spot commodities, at fair value
    34       238  
Unrealized gain on swaps, options and forward transactions, at fair value
    10,034       12,318  
Trade receivables
    4,617       672  
Securities purchased under agreements to resell, at fair value in 2008
    12,100       20,950  
Finance receivables, net of allowance (2008 – $1,290; 2007 – $878) (held for sale: 2008 – $26; 2007 – $233)
    32,590       31,234  
Securities lending invested collateral, at fair value (cost: 2008 – $41,336; 2007 – $80,641)
    41,511       75,662  
Other invested assets (amount measured at fair value: 2008 – $21,528; 2007 – $20,827)
    58,723       58,823  
Short-term investments (amount measured at fair value: 2008 – $22,590)
    52,484       51,351  
 
 
Total Investments and Financial Services assets
    763,483       842,042  
                 
Cash
    18,570       2,284  
Investment income due and accrued
    7,008       6,587  
Premiums and insurance balances receivable, net of allowance (2008 – $582; 2007 – $662)
    19,106       18,395  
Reinsurance assets, net of allowance (2008 – $471; 2007 – $520)
    23,943       23,103  
Current and deferred income taxes
    14,833        
Deferred policy acquisition costs
    48,182       43,914  
Investments in partially owned companies
    591       654  
Real estate and other fixed assets, net of accumulated depreciation (2008 – $5,814; 2007 – $5,446)
    5,730       5,518  
Separate and variable accounts, at fair value
    65,472       78,684  
Goodwill
    10,334       9,414  
Other assets, including prepaid commitment asset of $24,204 in 2008 (amount measured at fair value: 2008 – $1,623; 2007 – $4,152)
    44,985       17,766  
 
 
Total assets
  $ 1,022,237     $ 1,048,361  
See Accompanying Notes to Consolidated Financial Statements.


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American International Group, Inc. and Subsidiaries

 
 
 
 
CONSOLIDATED BALANCE SHEET (continued)
 
(in millions, except share data) (unaudited)
                 
    September 30,
    December 31,
 
    2008     2007  
Liabilities:
               
Reserve for losses and loss expenses
  $ 90,877     $ 85,500  
Unearned premiums
    28,448       27,703  
Future policy benefits for life and accident and health insurance contracts
    146,802       136,387  
Policyholders’ contract deposits (amount measured at fair value: 2008 – $4,282; 2007 – $295)
    259,792       258,459  
Other policyholders’ funds
    13,940       12,599  
Commissions, expenses and taxes payable
    5,577       6,310  
Insurance balances payable
    5,428       4,878  
Funds held by companies under reinsurance treaties
    2,462       2,501  
Current and deferred income taxes
          3,823  
Financial Services liabilities:
               
Securities sold under agreements to repurchase (amount measured at fair value: 2008 – $7,193)
    8,407       8,331  
Trade payables
    3,094       6,445  
Securities and spot commodities sold but not yet purchased, at fair value
    2,566       4,709  
Unrealized loss on swaps, options and forward transactions, at fair value
    6,325       14,817  
Trust deposits and deposits due to banks and other depositors (amount measured at fair value: 2008 – $215)
    5,946       4,903  
Commercial paper and extendible commercial notes
    5,600       13,114  
Federal Reserve Bank of New York credit facility
    62,960        
Other long-term borrowings (amount measured at fair value: 2008 – $39,149)
    155,990       162,935  
Separate and variable accounts
    65,472       78,684  
Securities lending payable
    42,800       81,965  
Minority interest
    11,713       10,422  
Other liabilities (amount measured at fair value: 2008 – $3,389; 2007 – $3,262)
    26,756       27,975  
 
 
Total liabilities
    950,955       952,460  
 
 
Preferred shareholders’ equity in subsidiary companies
    100       100  
 
 
Commitments, contingencies and guarantees (See Note 7)
               
Shareholders’ equity:
               
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2008 – 2,948,038,001; 2007 – 2,751,327,476
    7,370       6,878  
Additional paid-in capital
    32,501       2,848  
Payments advanced to purchase shares
          (912 )
Retained earnings
    49,291       89,029  
Accumulated other comprehensive income (loss)
    (9,480 )     4,643  
Treasury stock, at cost; 2008 – 258,123,304; 2007 – 221,743,421 shares of common stock
    (8,500 )     (6,685 )
 
 
Total shareholders’ equity
    71,182       95,801  
 
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 1,022,237     $ 1,048,361  
 
 
See Accompanying Notes to Consolidated Financial Statements.


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American International Group, Inc. and Subsidiaries

 
CONSOLIDATED STATEMENT OF INCOME (LOSS)
 
(in millions, except per share data) (unaudited)
                                 
    Three Months
    Nine Months
 
    Ended
    Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
Revenues:
                               
Premiums and other considerations
  $ 21,082     $ 19,733     $ 63,489     $ 58,908  
Net investment income
    2,946       6,172       14,628       21,149  
Net realized capital losses
    (18,312 )     (864 )     (30,482 )     (962 )
Unrealized market valuation losses on AIGFP super senior credit default swap portfolio
    (7,054 )     (352 )     (21,726 )     (352 )
Other income
    2,236       5,147       8,953       12,888  
 
 
Total revenues
    898       29,836       34,862       91,631  
 
 
Benefits and expenses:
                               
Incurred policy losses and benefits
    17,189       15,595       51,521       47,962  
Policy acquisition and other insurance expenses
    6,919       5,357       18,560       15,508  
Interest expense
    2,297       1,232       4,902       3,425  
Other expenses
    2,678       2,773       8,084       7,357  
 
 
Total benefits and expenses
    29,083       24,957       83,067       74,252  
 
 
Income (loss) before income taxes (benefits) and minority interest
    (28,185 )     4,879       (48,205 )     17,379  
Income taxes (benefits)
    (3,480 )     1,463       (10,374 )     4,868  
 
 
Income (loss) before minority interest
    (24,705 )     3,416       (37,831 )     12,511  
 
 
Minority interest
    237       (331 )     201       (1,019 )
 
 
Net income (loss)
  $ (24,468 )   $ 3,085     $ (37,630 )   $ 11,492  
Earnings (loss) per common share:
                               
Basic
  $ (9.05 )   $ 1.20     $ (14.40 )   $ 4.43  
Diluted
  $ (9.05 )   $ 1.19     $ (14.40 )   $ 4.40  
 
 
Dividends declared per common share
  $ --     $ 0.200     $ 0.420     $ 0.565  
Weighted average shares outstanding:
                               
Basic
    2,703       2,576       2,613       2,596  
Diluted
    2,703       2,589       2,613       2,609  
See Accompanying Notes to Consolidated Financial Statements.


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American International Group, Inc. and Subsidiaries

 
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
 
                 
    Nine Months Ended September 30, 2008  
(in millions, except share and per share data) (unaudited)   Amounts     Shares  
Common stock:
               
Balance, beginning of period
  $ 6,878       2,751,327,476  
Issuances
    492       196,710,525  
 
 
Balance, end of period
    7,370       2,948,038,001  
 
 
Additional paid-in capital:
               
Balance, beginning of period
    2,848          
Excess of proceeds over par value of common stock issued
    6,851          
Present value of future contract adjustment payments related to issuance of equity units
    (431 )        
Consideration received for preferred stock not yet issued
    23,000          
Excess of cost over proceeds of common stock issued under stock plans
    (80 )        
Other
    313          
         
         
Balance, end of period
    32,501          
         
         
Payments advanced to purchase shares:
               
Balance, beginning of period
    (912 )        
Payments advanced
    (1,000 )        
Shares purchased
    1,912          
         
         
Balance, end of period
             
         
         
Retained earnings:
               
Balance, beginning of period
    89,029          
Cumulative effect of accounting changes, net of tax
    (1,003 )        
         
         
Adjusted balance, beginning of period
    88,026          
Net loss
    (37,630 )        
Dividends to common shareholders ($0.42 per share)
    (1,105 )        
         
         
Balance, end of period
    49,291          
         
         
Accumulated other comprehensive income (loss):
               
Unrealized appreciation (depreciation) of investments, net of tax:
               
Balance, beginning of period
    4,375          
Cumulative effect of accounting changes, net of tax
    (105 )        
         
         
Adjusted balance, beginning of period
    4,270          
Unrealized appreciation (depreciation) on investments, net of reclassification adjustments
    (20,874 )        
Deferred income tax benefit
    7,491          
         
         
Balance, end of period
    (9,113 )        
         
         
Foreign currency translation adjustments, net of tax:
               
Balance, beginning of period
    880          
Translation adjustment
    (275 )        
Deferred income tax expense
    (304 )        
         
         
Balance, end of period
    301          
         
         
Net derivative gains (losses) arising from cash flow hedging activities, net of tax:
               
Balance, beginning of period
    (87 )        
Net deferred gains on cash flow hedges, net of reclassification adjustments
    2          
Deferred income tax expense
    (1 )        
         
         
Balance, end of period
    (86 )        
         
         
Retirement plan liabilities adjustment, net of tax:
               
Balance, beginning of period
    (525 )        
Net actuarial loss
    (47 )        
Prior service credit
    (9 )        
Deferred income tax expense
    (1 )        
         
         
Balance, end of period
    (582 )        
         
         
Accumulated other comprehensive income (loss), end of period
    (9,480 )        
         
         
Treasury stock, at cost:
               
Balance, beginning of period
    (6,685 )     (221,743,421 )
Shares acquired
    (1,912 )     (37,927,125 )
Issued under stock plans
    24       1,545,316  
Other
    73       1,926  
 
 
Balance, end of period
    (8,500 )     (258,123,304 )
 
 
Total shareholders’ equity, end of period
  $ 71,182          
       
See Accompanying Notes to Consolidated Financial Statements.


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American International Group, Inc. and Subsidiaries

 
CONSOLIDATED STATEMENT OF CASH FLOWS
 
(in millions) (unaudited)
                 
    Nine Months
 
    Ended September 30,  
    2008     2007  
Summary:
               
Net cash provided by (used in) operating activities
  $ 2,182     $ 27,549  
Net cash provided by (used in) investing activities
    (7,460 )     (65,862 )
Net cash provided by (used in) financing activities
    21,559       38,964  
Effect of exchange rate changes on cash
    5       8  
 
 
Change in cash
    16,286       659  
Cash at beginning of period
    2,284       1,590  
 
 
Cash at end of period
  $ 18,570     $ 2,249  
Cash flows from operating activities:
               
Net income (loss)
  $ (37,630 )   $ 11,492  
 
 
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Noncash revenues, expenses, gains and losses included in income (loss):
               
Unrealized market valuation losses on AIGFP super senior credit default swap portfolio
  $ 21,726     $ 352  
Net (gains) losses on sales of securities available for sale and other assets
    2       (1,110 )
Foreign exchange transaction (gains) losses
    (1,409 )     1,214  
Net unrealized (gains) losses on non-AIGFP derivatives and other assets and liabilities
    5,779       (103 )
Equity in (income) loss of partially owned companies and other invested assets
    2,000       (3,336 )
Amortization of deferred policy acquisition costs
    10,645       9,115  
Depreciation and other amortization
    2,727       2,984  
Provision for mortgage, other loans and finance receivables
    955       391  
Other-than-temporary impairments
    32,246       1,413  
Impairments of goodwill and other assets
    632        
Amortization of costs related to Federal Reserve Bank of New York credit facility
    802        
Changes in operating assets and liabilities:
               
General and life insurance reserves
    14,834       12,127  
Premiums and insurance balances receivable and payable – net
    (396 )     515  
Reinsurance assets
    (863 )     561  
Capitalization of deferred policy acquisition costs
    (12,710 )     (11,684 )
Investment income due and accrued
    (398 )     (538 )
Funds held under reinsurance treaties
    (49 )     (166 )
Other policyholders’ funds
    1,206       746  
Income taxes receivable and payable – net
    (10,935 )     707  
Commissions, expenses and taxes payable
    155       1,110  
Other assets and liabilities – net
    (1,084 )     1,674  
Trade receivables and payables – net
    (7,297 )     (2,546 )
Trading securities
    1,729       2,002  
Spot commodities
    204       105  
Net unrealized (gain) loss on swaps, options and forward transactions (net of collateral)
    (28,191 )     1,707  
Securities purchased under agreements to resell
    8,831       (6,898 )
Securities sold under agreements to repurchase
    41       3,686  
Securities and spot commodities sold but not yet purchased
    (2,154 )     660  
Finance receivables and other loans held for sale – originations and purchases
    (346 )     (4,735 )
Sales of finance receivables and other loans – held for sale
    545       5,119  
Other, net
    585       985  
 
 
Total adjustments
    39,812       16,057  
 
 
Net cash provided by operating activities
  $ 2,182     $ 27,549  
See Accompanying Notes to Consolidated Financial Statements.


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American International Group, Inc. and Subsidiaries

 
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
 
(in millions) (unaudited)
                 
    Nine Months
 
    Ended September 30,  
    2008     2007  
Cash flows from investing activities:
               
Proceeds from (payments for)
               
Sales and maturities of fixed maturity securities available for sale and hybrid investments
  $ 65,584     $ 96,737  
Sales of equity securities available for sale
    8,117       6,700  
Proceeds from fixed maturity securities held to maturity
    126       175  
Sales of trading securities
    19,348        
Sales of flight equipment
    430       95  
Sales or distributions of other invested assets
    11,840       9,298  
Payments received on mortgage and other loans receivable
    4,809       4,170  
Principal payments received on finance receivables held for investment
    9,731       9,554  
Purchases of fixed maturity securities available for sale and hybrid investments
    (75,938 )     (108,879 )
Purchases of equity securities available for sale
    (7,701 )     (8,438 )
Purchases of fixed maturity securities held to maturity
    (88 )     (154 )
Purchases of trading securities
    (20,488 )      
Purchases of flight equipment (including progress payments)
    (3,200 )     (3,925 )
Purchases of other invested assets
    (16,030 )     (20,677 )
Mortgage and other loans receivable issued
    (4,939 )     (7,354 )
Finance receivables held for investment – originations and purchases
    (11,697 )     (11,394 )
Change in securities lending invested collateral
    20,245       (18,723 )
Net additions to real estate, fixed assets, and other assets
    (1,034 )     (1,004 )
Net change in short-term investments
    (6,116 )     (11,764 )
Net change in non-AIGFP derivative assets and liabilities
    (459 )     (279 )
 
 
Net cash used in investing activities
  $ (7,460 )   $ (65,862 )
Cash flows from financing activities:
               
Proceeds from (payments for)
               
Policyholders’ contract deposits
  $ 46,446     $ 45,766  
Policyholders’ contract withdrawals
    (42,381 )     (43,574 )
Change in other deposits
    747       (446 )
Change in commercial paper and extendible commercial notes
    (7,540 )     2,526  
Other long-term borrowings issued
    111,558       72,039  
Federal Reserve Bank of New York credit facility borrowings
    61,000        
Repayments on other long-term borrowings
    (114,051 )     (49,643 )
Change in securities lending payable
    (39,127 )     18,156  
Proceeds from common stock issued
    7,343        
Issuance of treasury stock
    9       204  
Payments advanced to purchase shares
    (1,000 )     (5,000 )
Cash dividends paid to shareholders
    (1,629 )     (1,372 )
Acquisition of treasury stock
          (16 )
Other, net
    184       324  
 
 
Net cash provided by financing activities
  $ 21,559     $ 38,964  
Supplementary disclosure of cash flow information:
               
Cash paid (received) during the period for:
               
Interest
  $ 4,953     $ 6,190  
Taxes
  $ 562     $ 4,044  
Non-cash financing activities:
               
Consideration received for preferred stock not yet issued
  $ 23,000        
Interest credited to policyholder accounts included in financing activities
  $ 5,737     $ 7,553  
Treasury stock acquired using payments advanced to purchase shares
  $ 1,912     $ 3,725  
Present value of future contract adjustment payments related to issuance of equity units
  $ 431     $  
Non-cash investing activities:
               
Debt assumed on acquisitions and warehoused investments
  $ 153     $ 358  
Liability related to purchase of additional interest in 21st Century
  $     $ 759  
See Accompanying Notes to Consolidated Financial Statements.


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CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
 
(in millions) (unaudited)
                                 
    Three Months Ended
    Nine Months Ended
 
    September 30,     September 30,  
    2008     2007     2008     2007  
Net income (loss)
  $ (24,468 )   $ 3,085     $ (37,630 )   $ 11,492  
 
 
Other comprehensive income (loss):
                               
Cumulative effect of accounting changes
                (162 )      
Deferred income tax benefit on above changes
                57        
Unrealized (depreciation) appreciation of investments – net of reclassification adjustments
    (6,620 )     (3,394 )     (20,874 )     (4,246 )
Deferred income tax benefit on above changes
    2,678       941       7,491       1,081  
Foreign currency translation adjustments
    (1,383 )     619       (275 )     290  
Deferred income tax benefit (expense) on above changes
    (180 )     (109 )     (304 )     (74 )
Net derivative gains (losses) arising from cash flow hedging activities – net of reclassification adjustments
    (9 )     (93 )     2       (31 )
Deferred income tax benefit on above changes
    4       34       (1 )     39  
Change in pension and postretirement unrecognized periodic benefit
    (69 )     17       (56 )     35  
Deferred income tax benefit (expense) on above changes
    2       (8 )     (1 )     (10 )
 
 
Other comprehensive income (loss)
    (5,577 )     (1,993 )     (14,123 )     (2,916 )
 
 
Comprehensive income (loss)
  $ (30,045 )   $ 1,092     $ (51,753 )   $ 8,576  
See Accompanying Notes to Consolidated Financial Statements.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
 
 1.  Summary of Significant Accounting Policies
 
Basis of Presentation
 
These unaudited condensed consolidated financial statements do not include all disclosures required by accounting principles generally accepted in the United States (GAAP) for complete financial statements and should be read in conjunction with the audited consolidated financial statements and the related notes included in the Annual Report on Form 10-K of American International Group, Inc. (AIG) for the year ended December 31, 2007 (2007 Annual Report on Form 10-K).
 
In the opinion of management, these consolidated financial statements contain the normal recurring adjustments necessary for a fair statement of the results presented herein. All material intercompany accounts and transactions have been eliminated.
 
Going Concern Considerations
 
During the third quarter of 2008, requirements to post collateral in connection with AIGFP’s credit default swap (CDS) portfolio and other AIGFP transactions and to fund returns of securities lending collateral placed stress on AIG’s liquidity. AIG’s stock price declined from $22.76 on September 8, 2008 to $4.76 on September 15, 2008. On that date, AIG’s long-term debt ratings were downgraded by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. (S&P), Moody’s Investors Service (Moody’s) and Fitch Ratings (Fitch), which triggered additional requirements for liquidity. These and other events severely limited AIG’s access to debt and equity markets.
 
On September 22, 2008, AIG entered into an $85 billion revolving credit agreement (the Fed Credit Agreement) with the Federal Reserve Bank of New York (the NY Fed) and, pursuant to the Fed Credit Agreement, AIG agreed to issue 100,000 shares of Series C Perpetual, Convertible, Participating Preferred Stock (the Series C Preferred Stock) to a trust for the benefit of the United States Treasury (the Trust) (see Notes 4 and 5 to the Consolidated Financial Statements). At September 30, 2008, amounts owed under the facility created pursuant to the Fed Credit Agreement (the Fed Facility) totaled $63 billion, including accrued fees and interest.
 
Since September 30, 2008, AIG has borrowed additional amounts under the Fed Facility and has announced plans to sell assets and businesses to repay amounts owed in connection with the Fed Credit Agreement. In addition, subsequent to September 30, 2008, certain of AIG’s domestic life insurance subsidiaries entered into an agreement with the NY Fed pursuant to which the NY Fed has borrowed, in return for cash collateral, investment grade fixed maturity securities from the insurance subsidiaries. As described in Note 11 to the Consolidated Financial Statements, AIG announced on November 10, 2008 that it had entered into an agreement in principle as part of the Troubled Asset Relief Program (TARP) pursuant to which the United States Treasury will purchase from AIG $40 billion liquidation preference of newly issued perpetual preferred stock and a 10-year warrant exercisable for shares of AIG common stock equal to 2% of the outstanding shares of common stock, and that the NY Fed and AIG had agreed to amend the Fed Credit Agreement to reduce the interest rate on outstanding borrowings and undrawn amounts, extend the term from two years to five years, reduce the number of shares of common stock of AIG to be issued upon conversion of the Series C Preferred Stock held by the Trust so that the government’s overall interest will not exceed 79.9 percent and revise the total amount available under the Fed Facility. In addition, four AIG affiliates are participating in the NY Fed’s Commercial Paper Funding Facility (CPFF). AIG also has announced its intention to enter into other agreements with the NY Fed to limit AIG’s future liquidity exposures to the multi-sector credit default swap portfolio and securities lending programs.
 
In assessing AIG’s current financial position and developing operating plans for the future, management has made significant judgments and estimates with respect to the potential financial and liquidity effects of AIG’s risks and uncertainties, including but not limited to:
 
•  the potential adverse effects on AIG’s businesses that could result if there are further downgrades by rating agencies, including in particular, the uncertainty in estimating, for the super senior credit default swaps, both the number of counterparties who may elect to terminate under contractual termination provisions and the amount that would be required to be paid in the event of a downgrade;
 
•  the potential for continued declines in bond and equity markets; and
 
•  the potential effect on AIG if the capital levels of its regulated and unregulated subsidiaries prove inadequate to support current business plans; and
 
•  the effect on AIG’s businesses of continued compliance with the covenants of the Fed Credit Agreement.
 
Based on the agreement in principle, management’s plans to stabilize AIG’s businesses and dispose of its non-core assets, and after consideration of the risks and uncertainties to such plans, management believes that it will have adequate liquidity to finance and operate AIG’s businesses, execute its disposition plan and repay its obligations for at least the next twelve months.
 
It is possible that the actual outcome of one or more of management’s plans could be materially different, or that one


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
1.  Summary of Significant Accounting Policies (continued)
 
or more of management’s significant judgments or estimates about the potential effects of the risks and uncertainties could prove to be materially incorrect or that the agreements in principle disclosed in Note 11 to the Consolidated Financial Statements (and as discussed below) do not result in completed transactions. If one or more of these possible outcomes were realized, AIG may not have sufficient cash to meet its obligations. If AIG needs funds in excess of amounts available from the sources described below, AIG would need to find additional financing and, if such additional financing were to be unavailable, there could exist substantial doubt about AIG’s ability to continue as a going concern.
 
AIG’s consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded assets nor relating to the amounts and classification of liabilities that may be necessary should we be unable to continue as a going concern.
 
Investment Pricing
 
Certain of AIG’s foreign subsidiaries included in the consolidated financial statements report on a fiscal period ended August 31. The effect on AIG’s consolidated financial condition and results of operations of all material events occurring between August 31 and September 30 for all periods presented has been recorded. AIG determined the significant and rapid world-wide market decline in September 2008 to be an intervening event that had a material effect on its consolidated financial position and results of operations. AIG reflected this recent market decline throughout its investment portfolio. Accordingly, AIG recorded $1.3 billion ($845 million after tax) of hedge and mutual fund investment losses in net investment income, $1.1 billion ($910 million after tax) of other than temporary impairment charges, and $5.4 billion ($3.2 billion after tax) of unrealized depreciation on investments.
 
Revisions and Reclassifications
 
During the third quarter of 2008, AIG began reporting interest expense and other expenses separately on the consolidated statement of income (loss). Interest expense represents interest expense on short-term and long-term borrowings. Other expenses represent all other expenses not separately disclosed on the consolidated statement of income (loss). Prior period amounts were revised to conform to the current period presentation.
 
In the second quarter of 2008, AIG determined that certain accident and health contracts in its Foreign General Insurance reporting unit, which were previously accounted for as short duration contracts, should be treated as long duration insurance products. Accordingly, the December 31, 2007 consolidated balance sheet has been revised to reflect the reclassification of $763 million of deferred direct response advertising costs, previously reported in other assets, to deferred policy acquisition costs (DAC). Additionally, $320 million has been reclassified in the consolidated balance sheet as of December 31, 2007 from unearned premiums to future policy benefits for life and accident and health insurance contracts. These revisions did not have a material effect on AIG’s consolidated income before income taxes, net income, or shareholders’ equity for any period presented.
 
See Recent Accounting Standards — Accounting Changes below for a discussion of AIG’s adoption of the Financial Accounting Standards Board (FASB) Staff Position (FSP) FASB Interpretation No. (FIN) 39-1, “Amendment of FASB Interpretation No. 39” (FSP FIN 39-1).
 
Certain other reclassifications and format changes have been made to prior period amounts to conform to the current period presentation.
 
Fixed Maturity Securities, Held to Maturity — Change in Intent
 
During the third quarter of 2008, AIG transferred all securities previously classified as held to maturity to available for sale. As a result of the continuing disruption in the credit markets during the third quarter of 2008, AIG changed its intent to hold to maturity certain tax-exempt municipal securities held by its insurance subsidiaries, which comprised substantially all of AIG’s held to maturity securities. This change in intent resulted from a change in certain subsidiaries’ investment strategies to increase their allocations to taxable securities, reflecting AIG’s net operating loss position. As of September 30, 2008, the securities had a carrying value of $20.8 billion and a net unrealized loss of $752 million. No securities previously classified as held to maturity were sold during the third quarter.
 
Recent Accounting Standards
 
Accounting Changes
 
FAS 157
 
In September 2006, the FASB issued Statement of Financial Accounting Standards (FAS) No. 157, “Fair Value Measurements” (FAS 157). FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure requirements regarding fair value measurements but does not change existing guidance about whether an asset or liability is


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
1.  Summary of Significant Accounting Policies (continued)
 
carried at fair value. FAS 157 nullifies the guidance in Emerging Issues Task Force (EITF) Issue No. 02-3, “Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities,” (EITF 02-3) that precluded the recognition of a trading profit at the inception of a derivative contract unless the fair value of such contract was obtained from a quoted market price or other valuation technique incorporating observable market data. FAS 157 also clarifies that an issuer’s credit standing should be considered when measuring liabilities at fair value. The fair value measurement and related disclosure guidance in FAS 157 do not apply to fair value measurements associated with AIG’s share-based employee compensation awards accounted for in accordance with FAS 123(R), “Share-Based Payment.”
 
AIG adopted FAS 157 on January 1, 2008, its required effective date. FAS 157 must be applied prospectively, except for certain stand-alone derivatives and hybrid instruments initially measured using the guidance in EITF 02-3, which must be applied as a cumulative effect accounting change to retained earnings at January 1, 2008. The cumulative effect, net of taxes, of adopting FAS 157 on AIG’s consolidated balance sheet was an increase in retained earnings of $4 million.
 
The most significant effect of adopting FAS 157 on AIG’s consolidated results of operations for the three- and nine-month periods ended September 30, 2008 related to changes in fair value methodologies with respect to both liabilities already carried at fair value, primarily hybrid notes and derivatives, and newly elected liabilities measured at fair value (see FAS 159 discussion below). Specifically, the incorporation of AIG’s own credit spreads and the incorporation of explicit risk margins (embedded policy derivatives at transition only) resulted in a increase in pre-tax income of $2.4 billion ($1.5 billion after tax) and an increase in pre-tax income of $5.0 billion ($3.2 billion after tax) for the three- and nine-month periods ended September 30, 2008, respectively. The effects of the changes in AIG’s own credit spreads on pre-tax income for AIG Financial Products Corp. and AIG Trading Group Inc. and their respective subsidiaries (AIGFP) were increases of $1.3 billion and $3.8 billion for the three- and nine-month periods ended September 30, 2008, respectively. The effect of the changes in counterparty credit spreads for assets measured at fair value at AIGFP were decreases in pre-tax income of $2.3 billion and $5.3 billion for the three- and nine-month periods ended September 30, 2008, respectively.
 
See Note 3 to the Consolidated Financial Statements for additional FAS 157 disclosures.
 
FAS 159
 
In February 2007, the FASB issued FAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (FAS 159). FAS 159 permits entities to choose to measure at fair value many financial instruments and certain other items that are not required to be measured at fair value. Subsequent changes in fair value for designated items are required to be reported in income. FAS 159 also establishes presentation and disclosure requirements for similar types of assets and liabilities measured at fair value. FAS 159 permits the fair value option election on an instrument-by-instrument basis for eligible items existing at the adoption date and at initial recognition of an asset or liability, or upon most events that give rise to a new basis of accounting for that instrument.
 
AIG adopted FAS 159 on January 1, 2008, its required effective date. The adoption of FAS 159 with respect to elections made in the Life Insurance & Retirement Services segment resulted in an after-tax decrease to 2008 opening retained earnings of $559 million. The adoption of FAS 159 with respect to elections made by AIGFP resulted in an after-tax decrease to 2008 opening retained earnings of $448 million. Included in this amount are net unrealized gains of $105 million that were reclassified to retained earnings from accumulated other comprehensive income (loss) related to available for sale securities recorded in the consolidated balance sheet at January 1, 2008 for which the fair value option was elected.
 
See Note 3 to the Consolidated Financial Statements for additional FAS 159 disclosures.
 
FAS 157 and FAS 159
 
The following table summarizes the after-tax increase (decrease) from adopting FAS 157 and FAS 159 on the opening shareholders’ equity accounts at January 1, 2008:
 
                         
    At January 1, 2008  
    Accumulated
          Cumulative
 
    Other
          Effect of
 
    Comprehensive
    Retained
    Accounting
 
(in millions)   Income/(Loss)     Earnings     Changes  
FAS 157
  $     $ 4     $ 4  
FAS 159
    (105 )     (1,007 )     (1,112 )
 
 
Cumulative effect of accounting changes
  $ (105 )   $ (1,003 )   $ (1,108 )
 
FSP FIN 39-1
 
In April 2007, the FASB issued FSP FIN 39-1, which modifies FASB Interpretation (FIN) No. 39, “Offsetting of Amounts Related to Certain Contracts,” and permits companies to offset cash collateral receivables or payables against derivative instruments under certain circumstances. AIG adopted the provisions of FSP FIN 39-1 effective January 1, 2008, which


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
1.  Summary of Significant Accounting Policies (continued)
 
requires retrospective application to all prior periods presented. At September 30, 2008, the amounts of cash collateral received and posted that were offset against net derivative positions totaled $6.5 billion and $33.1 billion, respectively. The cash collateral received and paid related to AIGFP derivative instruments was previously recorded in both trade payables and trade receivables. Cash collateral received related to non-AIGFP derivative instruments was previously recorded in other liabilities. Accordingly, the derivative assets and liabilities at December 31, 2007 have been reduced by $6.3 billion and $5.8 billion, respectively, related to the netting of cash collateral.
 
FSP FAS 157-3
 
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active” (FSP FAS 157-3). FSP FAS 157-3 provides guidance clarifying certain aspects of FAS 157 with respect to the fair value measurements of a security when the market for that security is inactive. AIG adopted this guidance in the third quarter of 2008. The effects of adopting FSP FAS 157-3 on AIG’s consolidated financial condition and results of operations were not material.
 
Future Application of Accounting Standards
 
FAS 141(R)
 
In December 2007, the FASB issued FAS 141 (revised 2007), “Business Combinations” (FAS 141(R)). FAS 141(R) changes the accounting for business combinations in a number of ways, including broadening the transactions or events that are considered business combinations; requiring an acquirer to recognize 100 percent of the fair value of assets acquired, liabilities assumed, and noncontrolling (i.e., minority) interests; recognizing contingent consideration arrangements at their acquisition-date fair values with subsequent changes in fair value generally reflected in income; and recognizing preacquisition loss and gain contingencies at their acquisition-date fair values, among other changes.
 
AIG is required to adopt FAS 141(R) for business combinations for which the acquisition date is on or after January 1, 2009. Early adoption is prohibited.
 
FAS 160
 
In December 2007, the FASB issued FAS 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (FAS 160). FAS 160 requires noncontrolling (i.e., minority) interests in partially owned consolidated subsidiaries to be classified in the consolidated balance sheet as a separate component of consolidated shareholders’ equity. FAS 160 also establishes accounting rules for subsequent acquisitions and sales of noncontrolling interests and provides for how noncontrolling interests should be presented in the consolidated statement of income. The noncontrolling interests’ share of subsidiary income should be reported as a part of consolidated net income with disclosure of the attribution of consolidated net income to the controlling and noncontrolling interests on the face of the consolidated statement of income.
 
AIG is required to adopt FAS 160 on January 1, 2009 and early application is prohibited. FAS 160 must be adopted prospectively, except that noncontrolling interests should be reclassified from liabilities to a separate component of shareholders’ equity and consolidated net income should be recast to include net income attributable to both the controlling and noncontrolling interests retrospectively. AIG is currently assessing the effect that adopting FAS 160 will have on its consolidated financial statements.
 
FAS 161
 
In March 2008, the FASB issued FAS 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133” (FAS 161). FAS 161 requires enhanced disclosures about (a) how and why AIG uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS 133), and its related interpretations, and (c) how derivative instruments and related hedged items affect AIG’s consolidated financial condition, results of operations, and cash flows. FAS 161 is effective for AIG beginning with financial statements issued in the first quarter of 2009. Because FAS 161 only requires additional disclosures about derivatives, it will have no effect on AIG’s consolidated financial condition, results of operations or cash flows.
 
FAS 162
 
In May 2008, the FASB issued FAS 162, “The Hierarchy of Generally Accepted Accounting Principles” (FAS 162). FAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements presented in conformity with GAAP but does not change current practices. FAS 162 will become effective on the 60th day following Securities and Exchange Commission (SEC) approval of the Public Company Accounting Oversight Board amendments to remove GAAP hierarchy from the auditing standards. FAS 162 will have no effect on AIG’s consolidated financial condition, results of operations or cash flows.
 
FSP FAS 140-3
 
In February 2008, the FASB issued FSP No. FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
1.  Summary of Significant Accounting Policies (continued)
 
Financing Transactions” (FSP FAS 140-3). FSP FAS 140-3 requires an initial transfer of a financial asset and a repurchase financing that was entered into contemporaneously with or in contemplation of the initial transfer to be evaluated as a linked transaction unless certain criteria are met. FSP FAS 140-3 is effective for AIG beginning January 1, 2009 and will be applied to new transactions entered into from that date forward. Early adoption is prohibited. AIG is currently assessing the effect that adopting FSP FAS 140-3 will have on its consolidated financial statements but does not believe the effect will be material.
 
FSP FAS 133-1 and FIN 45-4
 
In September 2008, the FASB issued FASB Staff Position No. FAS 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An amendment of FASB Statement No. 133 and FASB Interpretation No. 45(FSP). The FSP amends FAS 133 to require additional disclosures by sellers of credit derivatives, including derivatives embedded in a hybrid instrument. The FSP also amends FIN No. 45, “Guarantor’s Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others”, to require an additional disclosure about the current status of the payment/performance risk of a guarantee. The FSP is effective for AIG beginning with the year-end 2008 financial statements. Because the FSP only requires additional disclosures about credit derivatives and guarantees, it will have no effect on AIG’s consolidated financial condition, results of operations or cash flows.
 
 2.  Segment Information
 
AIG identifies its operating segments by product line consistent with its management structure. These segments are General Insurance, Life Insurance & Retirement Services, Financial Services, and Asset Management.
 
AIG’s operations by operating segment were as follows:
 
                                 
 
    Three Months
    Nine Months
 
Operating Segments
  Ended September 30,     Ended September 30,  
(in millions)   2008     2007     2008     2007  
Total revenues(a):
                               
General Insurance
  $ 10,808     $ 12,758     $ 35,854     $ 38,589  
Life Insurance & Retirement Services
    (4,642 )     12,632       14,271       40,337  
Financial Services
    (5,851 )     2,785       (16,016 )     7,109  
Asset Management
    10       1,519       658       4,969  
Other
    451       13       531       407  
Consolidation and eliminations
    122       129       (436 )     220  
 
 
Total
  $ 898     $ 29,836     $ 34,862     $ 91,631  
 
 
Operating income (loss)(a):
                               
General Insurance
  $ (2,557 )   $ 2,439     $ (393 )   $ 8,511  
Life Insurance & Retirement Services
    (15,329 )     1,999       (19,561 )     6,900  
Financial Services
    (8,203 )     669       (22,880 )     1,008  
Asset Management
    (1,144 )     121       (2,709 )     1,806  
Other(b)
    (1,416 )     (627 )     (2,899 )     (1,557 )
Consolidation and eliminations
    464       278       237       711  
 
 
Total
  $ (28,185 )   $ 4,879     $ (48,205 )   $ 17,379  
(a) To better align financial reporting with the manner in which AIG’s chief operating decision maker manages the business, beginning in the third quarter of 2008, AIG’s own credit risk valuation adjustments on intercompany transactions are excluded from segment revenues and operating income.
(b) Includes AIG parent and other operations that are not required to be reported separately. The following table presents the operating loss for AIG’s Other category:
 


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
2.  Segment Information (continued)
 
                                 
 
    Three Months
    Nine Months
 
Other
  Ended September 30,     Ended September 30,  
(in millions)   2008     2007     2008     2007  
Operating income (loss):
                               
Equity earnings in partially owned companies
  $ (13 )   $ 37     $ 3     $ 128  
Interest expense on Fed Facility
    (802 )           (802 )      
Other interest expense
    (571 )     (315 )     (1,391 )     (869 )
Unallocated corporate expenses
    (154 )     (166 )     (529 )     (548 )
Net realized capital gains (losses)
    139       (199 )     (96 )     (226 )
Other miscellaneous, net
    (15 )     16       (84 )     (42 )
 
 
Total Other
  $ (1,416 )   $ (627 )   $ (2,899 )   $ (1,557 )
 
AIG’s General Insurance operations by major internal reporting unit were as follows:
 
                                 
 
    Three Months
    Nine Months
 
General Insurance
  Ended September 30,     Ended September 30,  
(in millions)   2008     2007     2008     2007  
Total revenues:
                               
Commercial Insurance
  $ 5,105     $ 6,736     $ 17,029     $ 20,731  
Transatlantic
    961       1,088       3,183       3,253  
Personal Lines
    1,207       1,252       3,718       3,688  
Mortgage Guaranty
    300       267       911       772  
Foreign General Insurance
    3,224       3,413       10,991       10,150  
Reclassifications and eliminations
    11       2       22       (5 )
 
 
Total
  $ 10,808     $ 12,758     $ 35,854     $ 38,589  
 
 
Operating income (loss):
                               
Commercial Insurance
  $ (1,109 )   $ 1,829     $ 57     $ 5,662  
Transatlantic
    (155 )     189       148       508  
Personal Lines
    23       28       47       252  
Mortgage Guaranty
    (1,118 )     (216 )     (1,990 )     (289 )
Foreign General Insurance
    (209 )     607       1,323       2,383  
Reclassifications and eliminations
    11       2       22       (5 )
 
 
Total
  $ (2,557 )   $ 2,439     $ (393 )   $ 8,511  
 
AIG’s Life Insurance & Retirement Services operations by major internal reporting unit were as follows:
 
                                 
 
    Three Months
    Nine Months
 
Life Insurance & Retirement Services
  Ended September 30,     Ended September 30,  
(in millions)   2008     2007     2008     2007  
Total revenues:
                               
Foreign:
                               
Japan and Other
  $ 2,566     $ 4,315     $ 11,831     $ 13,948  
Asia
    1,812       4,695       10,664       14,205  
Domestic:
                               
Domestic Life Insurance
    (1,704 )     2,185       813       7,065  
Domestic Retirement Services
    (7,316 )     1,437       (9,037 )     5,119  
 
 
Total
  $ (4,642 )   $ 12,632     $ 14,271     $ 40,337  
Operating income (loss):
                               
Foreign:
                               
Japan and Other
  $ (1,074 )   $ 1,030     $ (14 )   $ 2,753  
Asia
    (1,419 )     706       (971 )     1,921  
Domestic:
                               
Domestic Life Insurance
    (3,911 )     61       (5,786 )     774  
Domestic Retirement Services
    (8,925 )     202       (12,790 )     1,452  
 
 
Total
  $ (15,329 )   $ 1,999     $ (19,561 )   $ 6,900  

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
2.  Segment Information (continued)
 
AIG’s Financial Services operations by major internal reporting unit were as follows:
 
                                 
 
    Three Months
    Nine Months
 
Financial Services
  Ended September 30,     Ended September 30,  
(in millions)   2008     2007     2008     2007  
 
 
Total revenues:
                               
Aircraft Leasing
  $ 1,367     $ 1,237     $ 3,830     $ 3,468  
Capital Markets
    (8,337 )     540       (23,168 )     701  
Consumer Finance
    1,029       940       2,988       2,696  
Other, including intercompany adjustments
    90       68       334       244  
 
 
Total
  $ (5,851 )   $ 2,785     $ (16,016 )   $ 7,109  
Operating income (loss):
                               
Aircraft Leasing
  $ 366     $ 254     $ 921     $ 625  
Capital Markets
    (8,073 )     370       (23,284 )     183  
Consumer Finance
    (474 )     69       (559 )     180  
Other, including intercompany adjustments
    (22 )     (24 )     42       20  
 
 
Total
  $ (8,203 )   $ 669     $ (22,880 )   $ 1,008  
 
AIG’s Asset Management operations consist of a single internal reporting unit.
 
 3.  Fair Value Measurements
 
Effective January 1, 2008 AIG adopted FAS 157 and FAS 159, which specify measurement and disclosure standards related to assets and liabilities measured at fair value. See Note 1 to the Consolidated Financial Statements for additional information.
 
The most significant effect of adopting FAS 157 on AIG’s results of operations for the three- and nine-month periods ended September 30, 2008 related to changes in fair value methodologies with respect to both liabilities already carried at fair value, primarily hybrid notes and derivatives, and newly elected liabilities measured at fair value (see FAS 159 discussion below). Specifically, the incorporation of AIG’s own credit spreads and the incorporation of explicit risk margins (embedded policy derivatives at transition only) resulted in a increase of $2.4 billion to pre-tax income ($1.5 billion after tax) and an increase of $5.0 billion to pre-tax income ($3.2 billion after tax) for the three- and nine-month periods ended September 30, 2008, respectively, as follows:
                             
    Net Pre-Tax Increase (Decrease)            
    Three Months
      Nine Months
           
    Ended September 30,
      Ended September 30,
      Liabilities Carried
  Business Segment
(in millions)   2008       2008       at Fair Value   Affected
 
Income statement caption:
                           
Net realized capital losses
  $ 1,074       $ 1,325       Freestanding derivatives   All segments - excluding AIGFP
              (155 )     Embedded policy derivatives   Life Insurance & Retirement Services
Unrealized market valuation losses on AIGFP
                      Super senior credit default   AIGFP
super senior credit default swap portfolio
    98         207       swap portfolio    
Other income
  $ 1,194 *     $ 3,621 *     Notes, GIAs, derivatives,   AIGFP
                        other liabilities    
         
         
Net pre-tax increase
  $ 2,366       $ 4,998            
       
Liabilities already carried at fair value
  $ 2,550       $ 3,904            
Newly elected liabilities measured at fair value (FAS 159 elected)
    (184 )       1,094            
         
         
Net pre-tax increase
  $ 2,366       $ 4,998            
* The effect of changes in AIG’s own credit spreads on pre-tax income for AIGFP was an increase of $1.3 billion and $3.8 billion for the three- and nine-month periods ended September 30, 2008, respectively. The effect of the changes in counterparty credit spreads for assets measured at fair value at AIGFP was a decrease in pre-tax income of $2.3 billion and $5.3 billion for the three- and nine-month periods ended September 30, 2008, respectively.
 
Fair Value Measurements on a Recurring Basis
 
AIG measures at fair value on a recurring basis financial instruments in its trading and available for sale securities portfolios, certain mortgage and other loans receivable, certain spot commodities, derivative assets and liabilities, securities purchased (sold) under agreements to resell (repurchase), securities lending invested collateral, non-traded equity investments and certain private limited partnerships and certain hedge funds included in other invested assets, certain short-term investments, separate and variable account assets, certain policyholders’ contract deposits, securities and spot commodities sold but not yet purchased, certain trust deposits and deposits due to banks and other depositors, certain long-term borrowings, and certain hybrid financial instruments included in other liabilities. The fair value of a financial instrument is the amount that would be received on sale of an asset or paid to transfer a liability in an orderly


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
transaction between market participants at the measurement date.
 
The degree of judgment used in measuring the fair value of financial instruments generally correlates with the level of pricing observability. Financial instruments with quoted prices in active markets generally have more pricing observability and less judgment is used in measuring fair value. Conversely, financial instruments traded in other-than-active markets or that do not have quoted prices have less observability and are measured at fair value using valuation models or other pricing techniques that require more judgment. An active market is one in which transactions for the asset or liability being valued occur with sufficient frequency and volume to provide pricing information on an ongoing basis. An other-than-active market is one in which there are few transactions, the prices are not current, price quotations vary substantially either over time or among market makers, or in which little information is released publicly for the asset or liability being valued. Pricing observability is affected by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established, the characteristics specific to the transaction and general market conditions.
 
Incorporation of Credit Risk in Fair Value Measurements
 
•  AIG’s Own Credit Risk.  Fair value measurements for AIGFP’s debt, guaranteed investment agreements (GIAs), and structured note liabilities incorporate AIG’s own credit risk by discounting cash flows at rates that incorporate AIG’s currently observable credit default swap spreads and take into consideration collateral posted by AIG with counterparties at the balance sheet date.
 
Fair value measurements for freestanding derivatives incorporate AIG’s own credit risk by determining the explicit cost for each counterparty to protect against its net credit exposure to AIG at the balance sheet date by reference to observable AIG credit default swap spreads. A counterparty’s net credit exposure to AIG is determined based on master netting agreements, which take into consideration all derivative positions with AIG, as well as collateral posted by AIG with the counterparty at the balance sheet date.
 
Fair value measurements for embedded policy derivatives and policyholders’ contract deposits take into consideration that policyholder liabilities are senior in priority to general creditors of AIG and therefore are much less sensitive to changes in AIG credit default swap or cash issuance spreads.
 
•  Counterparty Credit Risk.  Fair value measurements for freestanding derivatives incorporate counterparty credit by determining the explicit cost for AIG to protect against its net credit exposure to each counterparty at the balance sheet date by reference to observable counterparty credit default swap spreads. AIG’s net credit exposure to a counterparty is determined based on master netting agreements, which take into consideration all derivative positions with the counterparty, as well as collateral posted by the counterparty at the balance sheet date.
 
Fair values for fixed maturity securities based on observable market prices for identical or similar instruments implicitly include the incorporation of counterparty credit risk. Fair values for fixed maturity securities based on internal models incorporate counterparty credit risk by using discount rates that take into consideration cash issuance spreads for similar instruments or other observable information.
 
Fixed Maturity Securities — Trading and Available for Sale
 
AIG maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Whenever available, AIG obtains quoted prices in active markets for identical assets at the balance sheet date to measure at fair value fixed maturity securities in its trading and available for sale portfolios. Market price data generally is obtained from exchange or dealer markets.
 
AIG estimates the fair value of fixed maturity securities not traded in active markets, including securities purchased (sold) under agreements to resell (repurchase), and mortgage and other loans receivable for which AIG elected the fair value option, by referring to traded securities with similar attributes, using dealer quotations, a matrix pricing methodology, discounted cash flow analyses or internal valuation models. This methodology considers such factors as the issuer’s industry, the security’s rating and tenor, its coupon rate, its position in the capital structure of the issuer, yield curves, credit curves, prepayment rates and other relevant factors. For fixed maturity instruments that are not traded in active markets or that are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability, and such adjustments generally are based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
Equity Securities Traded in Active Markets — Trading and Available for Sale
 
AIG maximizes the use of observable inputs and minimizes the use of unobservable inputs when measuring fair value. Whenever available, AIG obtains quoted prices in active markets for identical assets at the balance sheet date to measure at fair value marketable equity securities in its trading and available for sale portfolios. Market price data generally is obtained from exchange or dealer markets.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
Non-Traded Equity Investments — Other Invested Assets
 
AIG initially estimates the fair value of equity instruments not traded in active markets by reference to the transaction price. This valuation is adjusted only when changes to inputs and assumptions are corroborated by evidence such as transactions in similar instruments, completed or pending third-party transactions in the underlying investment or comparable entities, subsequent rounds of financing, recapitalizations and other transactions across the capital structure, offerings in the equity capital markets, and changes in financial ratios or cash flows. For equity securities that are not traded in active markets or that are subject to transfer restrictions, valuations are adjusted to reflect illiquidity and/or non-transferability and such adjustments generally are based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
Private Limited Partnership and Hedge Fund Investments — Other Invested Assets
 
AIG initially estimates the fair value of investments in certain private limited partnerships and certain hedge funds by reference to the transaction price. Subsequently, AIG obtains the fair value of these investments generally from net asset value information provided by the general partner or manager of the investments, the financial statements of which generally are audited annually.
 
Separate and Variable Account Assets
 
Separate and variable account assets are composed primarily of registered and unregistered open-end mutual funds that generally trade daily and are measured at fair value in the manner discussed above for equity securities traded in active markets.
 
Freestanding Derivatives
 
Derivative assets and liabilities can be exchange-traded or traded over the counter (OTC). AIG generally values exchange-traded derivatives using quoted prices in active markets for identical derivatives at the balance sheet date.
 
OTC derivatives are valued using market transactions and other market evidence whenever possible, including market-based inputs to models, model calibration to market clearing transactions, broker or dealer quotations or alternative pricing sources with reasonable levels of price transparency. When models are used, the selection of a particular model to value an OTC derivative depends on the contractual terms of, and specific risks inherent in, the instrument as well as the availability of pricing information in the market. AIG generally uses similar models to value similar instruments. Valuation models require a variety of inputs, including contractual terms, market prices and rates, yield curves, credit curves, measures of volatility, prepayment rates and correlations of such inputs. For OTC derivatives that trade in liquid markets, such as generic forwards, swaps and options, model inputs can generally be corroborated by observable market data by correlation or other means, and model selection does not involve significant management judgment.
 
Certain OTC derivatives trade in less liquid markets with limited pricing information, and the determination of fair value for these derivatives is inherently more difficult. When AIG does not have corroborating market evidence to support significant model inputs and cannot verify the model to market transactions, the transaction price is initially used as the best estimate of fair value. Accordingly, when a pricing model is used to value such an instrument, the model is adjusted so the model value at inception equals the transaction price. Subsequent to initial recognition, AIG updates valuation inputs when corroborated by evidence such as similar market transactions, third-party pricing services and/or broker or dealer quotations, or other empirical market data. When appropriate, valuations are adjusted for various factors such as liquidity, bid/offer spreads and credit considerations. Such adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used.
 
With the adoption of FAS 157 on January 1, 2008, AIG’s own credit risk has been considered and is incorporated into the fair value measurement of its freestanding derivative liabilities.
 
Embedded Policy Derivatives
 
The fair value of embedded policy derivatives contained in certain variable annuity and equity-indexed annuity and life contracts is measured based on actuarial and capital market assumptions related to projected cash flows over the expected lives of the contracts. These cash flow estimates primarily include benefits and related fees assessed, when applicable, and incorporate expectations about policyholder behavior. Estimates of future policyholder behavior are subjective and based primarily on AIG’s historical experience. With respect to embedded policy derivatives in AIG’s variable annuity contracts, because of the dynamic and complex nature of the expected cash flows, risk neutral valuations are used. Estimating the underlying cash flows for these products involves many estimates and judgments, including those regarding expected market rates of return, market volatility, correlations of market index returns to funds, fund performance, discount rates and policyholder behavior. With respect to embedded policy derivatives in AIG’s equity-indexed annuity and life contracts, option pricing models are used to estimate fair value, taking into account assumptions for future


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
equity index growth rates, volatility of the equity index, future interest rates, and determinations on adjusting the participation rate and the cap on equity indexed credited rates in light of market conditions and policyholder behavior assumptions. With the adoption of FAS 157, these methodologies were not changed, with the exception of incorporating an explicit risk margin to take into consideration market participant estimates of projected cash flows and policyholder behavior.
 
AIGFP’s Super Senior Credit Default Swap Portfolio
 
AIGFP values its credit default swaps written on the most senior (super senior) risk layers of designated pools of debt securities or loans using internal valuation models, third-party prices and market indices. The principal market was determined to be the market in which super senior credit default swaps of this type and size would be transacted, or have been transacted, with the greatest volume or level of activity. AIG has determined that the principal market participants, therefore, would consist of other large financial institutions who participate in sophisticated over-the-counter derivatives markets. The specific valuation methodologies vary based on the nature of the referenced obligations and availability of market prices.
 
The valuation of the super senior credit derivatives continues to be challenging given the limitation on the availability of market observable information due to the limited trading and lack of price transparency in the structured finance market, particularly during and since the fourth quarter of 2007. These market conditions have increased the reliance on management estimates and judgments in arriving at an estimate of fair value for financial reporting purposes. Further, disparities in the valuation methodologies employed by market participants when assessing illiquid markets have increased the likelihood that the various parties to these instruments may arrive at significantly different estimates as to their fair values.
 
AIGFP’s valuation methodologies for the super senior credit default swap portfolio have evolved in response to the deteriorating market conditions and the lack of sufficient market observable information. AIG has sought to calibrate the model to available market information and to review the assumptions of the model on a regular basis.
 
In the case of credit default swaps written to facilitate regulatory capital relief, AIGFP estimates the fair value of these derivatives by considering observable market transactions. The transactions with the most observability are the early terminations of these transactions by counterparties. AIG expects that the majority of these transactions will be terminated within the next 6 to 18 months by AIGFP’s counterparties. AIGFP also considers other market data, to the extent available.
 
AIGFP uses a modified version of the Binomial Expansion Technique (BET) model to value its credit default swap portfolio written on super senior tranches of multi-sector collateralized debt obligations (CDOs) of asset-backed securities (ABS), including maturity-shortening puts that allow the holders of the securities issued by certain CDOs to treat the securities as short-term eligible 2a-7 investments under the Investment Company Act of 1940 (2a-7 Puts).
 
The BET model uses the prices for the securities comprising the portfolio of a CDO as an input and converts those prices to credit spreads over current LIBOR-based interest rates. These credit spreads are used to determine implied probabilities of default and expected losses on the underlying securities. This data is then aggregated and used to estimate the expected cash flows of the super senior tranche of the CDO. The most significant assumption used in the BET model is the pricing of the individual securities within the CDO collateral pools. The BET model also uses diversity scores, weighted average lives, recovery rates and discount rates.
 
Prices for the individual securities held by a CDO are obtained in most cases from the CDO collateral managers, to the extent available. For the quarter ended September 30, 2008, CDO collateral managers provided market prices for approximately 70 percent of the underlying securities. When a price for an individual security is not provided by a CDO collateral manager, AIGFP derives the price through a pricing matrix using prices from CDO collateral managers for similar securities. Matrix pricing is a mathematical technique used principally to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the relationship of the security to other benchmark quoted securities. Substantially all of the CDO collateral managers who provided prices used dealer prices for all or part of the underlying securities, in some cases supplemented by third party pricing services.
 
AIGFP also employs a Monte Carlo simulation to assist in quantifying the effect on the valuation of the CDOs of the unique aspects of the CDOs’ structure such as triggers that divert cash flows to the most senior part of the capital structure. The Monte Carlo simulation is used to determine whether an underlying security defaults in a given simulation scenario and, if it does, the security’s implied random default time and expected loss. This information is used to project cash flow streams and to determine the expected losses of the portfolio.
 
In addition to calculating an estimate of the fair value of the super senior CDO security referenced in the credit default swaps using its internal model, AIGFP also considers the price estimates for the super senior CDO securities provided by


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
third parties, including counterparties to these transactions, to validate the results of the model and to determine the best available estimate of fair value. In determining the fair value of the super senior CDO security referenced in the credit default swaps, AIGFP uses a consistent process which considers all available pricing data points and eliminates the use of outlying data points. When pricing data points are within a reasonable range an averaging technique is applied.
 
In the case of credit default swaps written on portfolios of investment-grade corporate debt, AIGFP estimates the fair value of its obligations by comparing the contractual premium of each contract to the current market levels of the senior tranches of comparable credit indices, the iTraxx index for European corporate issuances and the CDX index for U.S. corporate issuances. These indices are considered to be reasonable proxies for the referenced portfolios. In addition, AIGFP compares these valuations to third party prices and makes adjustments as necessary to arrive at the best available estimate of fair value.
 
AIGFP estimates the fair value of its obligations resulting from credit default swaps written on collateralized loan obligations to be equivalent to the par value less the current market value of the referenced obligation. Accordingly, the value is determined by obtaining third-party quotes on the underlying super senior tranches referenced under the credit default swap contract.
 
Policyholders’ Contract Deposits
 
Policyholders’ contract deposits accounted for at fair value beginning January 1, 2008 are measured using an income approach by taking into consideration the following factors:
 
•  Current policyholder account values and related surrender charges;
 
•  The present value of estimated future cash inflows (policy fees) and outflows (benefits and maintenance expenses) associated with the product using risk neutral valuations, incorporating expectations about policyholder behavior, market returns and other factors; and
 
•  A risk margin that market participants would require for a market return and the uncertainty inherent in the model inputs.
 
The change in fair value of these policyholders’ contract deposits is recorded as incurred policy losses and benefits in the consolidated statement of income (loss).
 
Fair Value Measurements on a Non-Recurring Basis
 
AIG also measures the fair value of certain assets on a non-recurring basis, generally quarterly, annually, or when events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. These assets include held to maturity securities (in periods prior to the third quarter of 2008), cost and equity-method investments, life settlement contracts, flight equipment, collateral securing foreclosed loans and real estate and other fixed assets, goodwill, and other intangible assets. AIG uses a variety of techniques to measure the fair value of these assets when appropriate, as described below:
 
•  Held to Maturity Securities, Cost and Equity-Method Investments: When AIG determines that the carrying value of these assets may not be recoverable, AIG records the assets at fair value with the loss recognized in income. In such cases, AIG measures the fair value of these assets using the techniques discussed above for fixed maturities and equity securities. During the third quarter of 2008, AIG transferred all securities previously classified as held to maturity to the available for sale category (see Note 1 for further discussion).
 
•  Life Settlement Contracts:  AIG measures the fair value of individual life settlement contracts (which are included in other invested assets) whenever the carrying value plus the undiscounted future costs that are expected to be incurred to keep the life settlement contract in force exceed the expected proceeds from the contract. In those situations, the fair value is determined on a discounted cash flow basis, incorporating current life expectancy assumptions. The discount rate incorporates current information about market interest rates, the credit exposure to the insurance company that issued the life settlement contract and AIG’s estimate of the risk margin an investor in the contracts would require.
 
•  Flight Equipment Primarily Under Operating Leases:  When AIG determines the carrying value of its commercial aircraft may not be recoverable, AIG records the aircraft at fair value with the loss recognized in income. AIG measures the fair value of its commercial aircraft using an income approach based on the present value of all cash flows from existing and projected lease payments (based on historical experience and current expectations regarding market participants) including net contingent rentals for the period extending to the end of the aircraft’s economic life in its highest and best use configuration, plus its disposition value.
 
•  Collateral Securing Foreclosed Loans and Real Estate and Other Fixed Assets: When AIG takes collateral in connection with foreclosed loans, AIG generally bases its estimate


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
of fair value on the price that would be received in a current transaction to sell the asset by itself.
 
•  Goodwill:  AIG tests goodwill for impairment whenever events or changes in circumstances indicate the carrying amount of goodwill may not be recoverable, but at least annually. When AIG determines goodwill may be impaired, AIG uses techniques that consider market-based earnings multiples of the unit’s peer companies or discounted cash flow techniques based on the price that could be received in a current transaction to sell the asset assuming the asset would be used with other assets as a group (in-use premise). See Fair Value Measured on a Non-Recurring Basis below for additional information.
 
•  Intangible Assets:  AIG tests its intangible assets for impairment whenever events or changes in circumstances indicate the carrying amount of an intangible asset may not be recoverable. AIG measures the fair value of intangible assets based on an in-use premise that considers the same factors used to estimate the fair value of its real estate and other fixed assets under an in-use premise discussed above.
 
See Notes 1(c), (d), (e), (t), and (v) to Consolidated Financial Statements included in the 2007 Annual Report on Form 10-K for additional information about how AIG tests various asset classes for impairment.
 
Fair Value Hierarchy
 
Beginning January 1, 2008, assets and liabilities recorded at fair value in the consolidated balance sheet are measured and classified in a hierarchy for disclosure purposes consisting of three “levels” based on the observability of inputs available in the marketplace used to measure the fair values as discussed below:
 
•  Level 1:  Fair value measurements that are quoted prices (unadjusted) in active markets that AIG has the ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or dealer markets. AIG does not adjust the quoted price for such instruments. Assets and liabilities measured at fair value on a recurring basis and classified as Level 1 include certain government and agency securities, actively traded listed common stocks and derivative contracts, most separate account assets and most mutual funds.
 
•  Level 2:  Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals. Assets and liabilities measured at fair value on a recurring basis and classified as Level 2 generally include certain government securities, most investment-grade and high-yield corporate bonds, certain ABS, certain listed equities, state, municipal and provincial obligations, hybrid securities, mutual fund and hedge fund investments, derivative contracts, GIAs at AIGFP and physical commodities.
 
•  Level 3:  Fair value measurements based on valuation techniques that use significant inputs that are unobservable. These measurements include circumstances in which there is little, if any, market activity for the asset or liability. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety. AIG’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment. In making the assessment, AIG considers factors specific to the asset or liability. Assets and liabilities measured at fair value on a recurring basis and classified as Level 3 include certain distressed ABS, structured credit products, certain derivative contracts (including AIGFP’s super senior credit default swap portfolio), policyholders’ contract deposits carried at fair value, private equity and real estate fund investments, and direct private equity investments. AIG’s non-financial-instrument assets that are measured at fair value on a non-recurring basis generally are classified as Level 3.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis
 
The following table presents information about assets and liabilities measured at fair value on a recurring basis at September 30, 2008, and indicates the level of the fair value measurement based on the levels of the inputs used:
 
                                         
 
                            Total
 
                      Counterparty
    September 30,
 
(in millions)   Level 1     Level 2     Level 3     Netting(a)     2008  
 
 
Assets:
                                       
Bonds available for sale
  $ 891     $ 375,021     $ 18,582     $     $ 394,494  
Bond trading securities
          7,355       197             7,552  
Common stocks available for sale
    11,113       271       75             11,459  
Common and preferred stocks trading
    19,751       922       1             20,674  
Preferred stocks available for sale
    1       1,393       70             1,464  
Mortgage and other loans receivable
          324       4             328  
Financial Services assets:
                                       
Securities available for sale
    1       762       1,563             2,326  
Trading securities
    1,388       28,710       6,038             36,136  
Spot commodities
          34                   34  
Unrealized gain on swaps, options and forward transactions
          54,108       3,307       (47,381 )     10,034  
Securities purchased under agreements to resell
          12,100                   12,100  
Securities lending invested collateral(b)
          23,648       12,173             35,821  
Other invested assets(c)
    2,334       7,406       11,788             21,528  
Short-term investments
    4,320       18,201       69             22,590  
Separate and variable accounts
    61,405       2,953       1,114             65,472  
Other assets
    110       3,057       354       (1,898 )     1,623  
 
 
Total
  $ 101,314     $ 536,265     $ 55,335     $ (49,279 )   $ 643,635  
Liabilities:
                                       
Policyholders’ contract deposits
  $     $     $ 4,282     $     $ 4,282  
Other policyholders’ funds
                                       
Financial Services liabilities:
                                       
Securities sold under agreements to repurchase
          7,143       50             7,193  
Securities and spot commodities sold but not yet purchased
    715       1,851                   2,566  
Unrealized loss on swaps, options and forward transactions(d)
          47,066       34,949       (75,690 )     6,325  
Trust deposits and deposits due to banks and other depositors
          215                   215  
Other long-term borrowings
          38,347       802             39,149  
Other liabilities
    7       3,501       60       (179 )     3,389  
 
 
Total
  $ 722     $ 98,123     $ 40,143     $ (75,869 )   $ 63,119  
(a)  Represents netting of derivative exposures covered by a qualifying master netting agreement in accordance with FIN 39 of $42.8 billion, offset by cash collateral posted and received by AIG of $33.1 billion and $6.5 billion, respectively.
(b)  Amounts exclude short-term investments that are carried at cost, which approximates fair value of $5.7 billion.
(c)  Approximately 11 percent of the fair value of the assets recorded as Level 3 relates to various private equity, real estate, hedge fund and fund-of-funds investments. AIG’s ownership in these funds represented 27 percent, or $1.7 billion of the Level 3 amount.
(d)  Included in Level 3 is the fair value derivative liability of $32.3 billion on AIGFP super senior credit default swap portfolio.
 
At September 30, 2008, Level 3 assets were 5.4 percent of total assets, and Level 3 liabilities were 4.2 percent of total liabilities.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
The following tables present changes during the three- and nine-month periods ended September 30, 2008 in Level 3 assets and liabilities measured at fair value on a recurring basis, and the realized and unrealized gains (losses) recorded in income during the three- and nine-month periods ended September 30, 2008 related to the Level 3 assets and liabilities that remained in the consolidated balance sheet at September 30, 2008:
 
                                                         
 
                                        Changes in
 
          Net
                            Unrealized Gains
 
          Realized and
                            (Losses) on
 
          Unrealized
    Accumulated
    Purchases,
                Instruments
 
    Balance
    Gains (Losses)
    Other
    Sales,
          Balance at
    Held at
 
    Beginning of
    Included
    Comprehensive
    Issuances and
    Transfers
    September 30,
    September 30,
 
(in millions)   Period(a)     in Income(b)     Income (Loss)     Settlements-net     In (Out)     2008     2008  
 
 
Three Months Ended September 30, 2008:
                                                       
Assets:
                                                       
Bonds available for sale
  $ 18,480     $ (696 )   $ (255 )   $ (646 )   $ 1,699     $ 18,582     $  
Bond trading securities
    195       (11 )     (2 )     20       (5 )     197       (6 )
Common stocks available for sale
    227       1       1       (196 )     42       75        
Common and preferred stocks trading
    5             (3 )     5       (6 )     1        
Preferred stocks available for sale
    258       (7 )     (50 )     (9 )     (122 )     70        
Mortgage and other loans receivable
    4                               4        
Financial Services assets:
                                                       
Securities available for sale
    372       (3 )     (180 )     1,341       33       1,563        
Trading securities
    3,680       (1,510 )           3,865       3       6,038       (919 )
Securities lending invested collateral
    8,489       (2,091 )     829       (706 )     5,652       12,173        
Other invested assets
    11,868       77       (126 )     131       (162 )     11,788       293  
Short-term investments
                      69             69        
Separate and variable accounts
    1,178       (75 )           11             1,114       (75 )
Other assets
    334       (4 )           13             343       (4 )
 
 
Total
  $ 45,090     $ (4,319 )   $ 214     $ 3,898     $ 7,134     $ 52,017     $ (711 )
Liabilities:
                                                       
Policyholders’ contract deposits
  $ (4,179 )   $ 113     $ 43     $ (259 )   $     $ (4,282 )   $ 235  
Financial Services liabilities:
                                                       
Securities sold under agreements to repurchase
    (40 )     5             (15 )           (50 )     (5 )
Unrealized loss on swaps, options and forward transactions, net
    (26,674 )     (5,223 )           207       48       (31,642 )     (6,032 )
Other long-term borrowings
    (2,689 )     1,030             630       227       (802 )     (500 )
Other liabilities
    (25 )     (15 )     (2 )     2       (9 )     (49 )     4  
 
 
Total
  $ (33,607 )   $ (4,090 )   $ 41     $ 565     $ 266     $ (36,825 )   $ (6,298 )
Nine Months Ended September 30, 2008:
                                                       
Assets:
                                                       
Bonds available for sale
  $ 18,786     $ (2,140 )   $ (805 )   $ (870 )   $ 3,611     $ 18,582     $  
Bond trading securities
    141       (31 )           35       52       197       (16 )
Common stocks available for sale
    224       (4 )     1       (185 )     39       75        
Common and preferred stocks trading
    30       (1 )     (1 )     (14 )     (13 )     1        
Preferred stocks available for sale
    135       (9 )     (44 )     (76 )     64       70        
Mortgage and other loans receivable
                            4       4        
Financial Services assets:
                                                       
Securities available for sale
    285       (6 )     (172 )     1,423       33       1,563        
Trading securities
    4,422       (2,943 )           4,567       (8 )     6,038       (2,408 )
Securities lending invested collateral
    11,353       (5,229 )     1,916       (1,524 )     5,657       12,173        
Other invested assets
    10,373       269       11       1,279       (144 )     11,788       862  
Short-term investments
                      69             69        
Separate and variable accounts
    1,003       (48 )           159             1,114       (48 )
Other assets
    141       (4 )           206             343       (4 )
 
 
Total
  $ 46,893     $ (10,146 )   $ 906     $ 5,069     $ 9,295     $ 52,017     $ (1,614 )
Liabilities:
                                                       
Policyholders’ contract deposits
  $ (3,674 )   $ 56     $ (8 )   $ (656 )   $     $ (4,282 )   $ 398  
Financial Services liabilities:
                                                     
Securities sold under agreements to repurchase
    (208 )     (15 )           (49 )     222       (50 )     (5 )
Unrealized loss on swaps, options and forward transactions, net
    (11,718 )     (19,785 )           (222 )     83       (31,642 )     (20,631 )
Other long-term borrowings
    (3,578 )     1,120             1,268       388       (802 )     (522 )
Other liabilities
    (503 )     (70 )     (2 )     534       (8 )     (49 )     33  
 
 
Total
  $ (19,681 )   $ (18,694 )   $ (10 )   $ 875     $ 685     $ (36,825 )   $ (20,727 )
(a)  Total Level 3 derivative exposures have been netted on these tables for presentation purposes only.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
3. Fair Value Measurements (continued)
 
(b)  Net realized and unrealized gains and losses shown above are reported in the consolidated statement of income (loss) primarily as follows:
 
     
Major category of Assets/Liabilities   Consolidated Statement of Income (Loss) Line Items
 
Financial Services assets and liabilities
 
•   Other income
   
•   Unrealized market valuation losses on AIGFP super senior credit default swap portfolio
 
 
Securities lending invested collateral
 
•   Net realized capital gains (losses)
 
 
Other invested assets
 
•   Net realized capital gains (losses)
 
 
Policyholders’ contract deposits
 
•   Incurred policy losses and benefits
   
•   Net realized capital gains (losses)
 
 
 
Both observable and unobservable inputs may be used to determine the fair values of positions classified in Level 3 in the tables above. As a result, the unrealized gains (losses) on instruments held at September 30, 2008 may include changes in fair value that were attributable to both observable (e.g., changes in market interest rates) and unobservable inputs (e.g., changes in unobservable long-dated volatilities).
 
AIG uses various hedging techniques to manage risks associated with certain positions, including those classified within Level 3. Such techniques may include the purchase or sale of financial instruments that are classified within Level 1 and/or Level 2. As a result, the realized and unrealized gains (losses) for assets and liabilities classified within Level 3 presented in the table above do not reflect the related realized or unrealized gains (losses) on hedging instruments that are classified within Level 1 and/or Level 2.
 
Changes in the fair value of separate and variable account assets are completely offset in the consolidated statement of income (loss) by changes in separate and variable account liabilities, which are not carried at fair value and therefore not included in the tables above.
 
Fair Value Measured on a Non-Recurring Basis
 
AIG measures the fair value of certain assets on a non-recurring basis, generally quarterly, or when events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. These assets include goodwill, real estate owned, real estate loans held for sale, and other intangible assets.
 
Assets measured at fair value on a non-recurring basis on which impairment charges were recorded were as follows:
 
                                                 
 
                            Three Months Ended
    Nine Months Ended
 
                            September 30,
    September 30,
 
(in millions)   Level 1     Level 2     Level 3     Total     2008     2008  
 
 
Goodwill
  $     $     $     $     $ 432     $ 477  
Real estate owned
                1,358       1,358       100       102  
Other investments
                3,883       3,883       75       85  
Other assets
          7       190       197       2       53  
Total
  $     $ 7     $ 5,431     $ 5,438     $ 609     $ 717  
 
AIG recognized goodwill impairment charges of $432 million and $477 million for the three and nine months ended September 30, 2008, which were primarily related to the domestic Consumer Finance and the Capital Markets businesses.
 
AIG recognized an impairment charge on certain investment real estate and other real estate owned of $100 million and $102 million for the three and nine months ended September 30, 2008, respectively, which was included in other income. As required by FAS 157, the fair value disclosed in the table above is unadjusted for transaction costs. The amounts recorded on the consolidated balance sheet are net of transaction costs.
 
Fair Value Option
 
FAS 159 permits a company to choose to measure at fair value many financial instruments and certain other assets and liabilities that are not required to be measured at fair value. Subsequent changes in fair value for designated items are required to be reported in income. Unrealized gains and losses on financial instruments in AIG’s insurance businesses and in AIGFP for which the fair value option was elected under FAS 159 are classified in incurred policy losses and benefits and in other income, respectively, in the consolidated statement of income (loss).


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
The following table presents the gains or losses recorded during the three- and nine-month periods ended September 30, 2008 related to the eligible instruments for which AIG elected the fair value option and the related transition adjustment recorded as a decrease to opening shareholders’ equity at January 1, 2008:
 
                                         
   
                      Gain (Loss)
    Gain (Loss)
 
    January 1,
    Transition
    January 1,
    Three Months
    Nine Months
 
    2008
    Adjustment
    2008
    Ended
    Ended
 
    prior to
    upon
    after
    September 30,
    September 30,
 
(in millions)   Adoption     Adoption     Adoption     2008     2008  
 
 
Mortgage and other loans receivable
  $ 1,109     $     $ 1,109     $ (74 )   $ 5  
Financial Services assets(a):
                                       
Trading securities (formerly available for sale)
    39,278       5       39,283       (3,886 )     (5,037 )
Securities purchased under agreements to resell
    20,950       1       20,951       (180 )     395  
Other invested assets
    321       (1 )     320       (24 )     (12 )
Short-term investments
    6,969             6,969       (2 )     65  
Deferred policy acquisition costs
    1,147       (1,147 )                  
Other assets
    435       (435 )                  
 
 
Future policy benefits for life, accident and health insurance contracts
    299       299                    
Policyholders’ contract deposits(b)
    3,739       360       3,379       416       534  
Financial Services liabilities(a):
                                       
Securities sold under agreements to repurchase
    6,750       (10 )     6,760       339       (77 )
Securities and spot commodities sold but not yet purchased
    3,797       (10 )     3,807       157       144  
Trust deposits and deposits due to banks and other depositors
    216       (25 )     241       24       13  
Long-term borrowings
    57,968       (675 )     58,643       294       (97 )
Other liabilities
    1,792             1,792       1,266       947  
 
 
Total gain (loss) for the three- and nine-month periods ended September 30, 2008 (c)
                          $ (1,670 )   $ (3,120 )
Pre-tax cumulative effect of adopting the fair value option
            (1,638 )                        
Decrease in deferred tax liabilities
            526                          
 
 
Cumulative effect of adopting the fair value option
          $ (1,112 )                        
(a)  Effective January 1, 2008, AIGFP elected to apply the fair value option under FAS 159 to all eligible assets and liabilities (other than equity method investments, trade receivables and trade payables) because electing the fair value option allows AIGFP to more closely align its earnings with the economics of its transactions by recognizing concurrently through earnings the change in fair value of its derivatives and the offsetting change in fair value of the assets and liabilities being hedged as well as the manner in which the business is evaluated by management. Substantially all of the gain (loss) amounts shown above are reported in other income on the consolidated statement of income (loss). In August 2008, AIGFP modified prospectively this election as management believes it is appropriate to exclude from the automatic election securities purchased in connection with existing structured credit transactions and their related funding obligations. AIGFP will evaluate whether to elect the fair value option on a case-by-case basis for securities purchased in connection with existing structured credit transactions and their related funding obligations.
(b)  AIG elected to apply the fair value option to certain single premium variable life products in Japan and an investment-linked life insurance product sold principally in Asia, both classified within policyholders’ contract deposits in the consolidated balance sheet. AIG elected the fair value option for these liabilities to more closely align its accounting with the economics of its transactions. For the investment-linked product sold principally in Asia, the election more effectively aligns changes in the fair value of assets with a commensurate change in the fair value of policyholders’ liabilities. For the single premium life products in Japan, the fair value option election allows AIG to economically hedge the inherent market risks associated with this business in an efficient and effective manner through the use of derivative instruments. The hedging program, which was completed in the third quarter of 2008, results in an accounting presentation for this business that more closely reflects the underlying economics and the way the business is managed, with the change in the fair value of derivatives and underlying assets largely offsetting the change in fair value of the policy liabilities. AIG did not elect the fair value option for other liabilities classified in policyholders’ contract deposits because other contracts do not share the same contract features that created the disparity between the accounting presentation and the economic performance.
(c)  Not included in the table above were losses of $9.6 billion and $23.2 billion for the three- and nine-month periods ended September 30, 2008, respectively, that were primarily due to changes in the fair value of derivatives, trading securities and certain other invested assets for which the fair value option under FAS 159 was not elected. Included in these amounts were unrealized market valuation losses of $7.1 billion and $21.7 billion for the three- and nine-months periods ended September 30, 2008, respectively, related to AIGFP’s super senior credit default swap portfolio.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 3. Fair Value Measurements (continued)
 
Interest income and expense and dividend income on assets and liabilities elected under the fair value option are recognized and classified in the consolidated statement of income (loss) depending on the nature of the instrument and related market conventions. For AIGFP related activity, interest, dividend income, and interest expense are included in other income. Otherwise, interest and dividend income are included in net investment income in the consolidated statement of income (loss). See Note 1(a) to the Consolidated Financial Statements included in the 2007 Annual Report on Form 10-K for additional information about AIG’s policies for recognition, measurement, and disclosure of interest and dividend income and interest expense.
 
During the three- and nine-month periods ended September 30, 2008, AIG recognized a loss of $184 million and a gain of $1.1 billion, respectively, attributable to the observable effect of changes in credit spreads on AIG’s own liabilities for which the fair value option was elected. AIG calculates the effect of these credit spread changes using discounted cash flow techniques that incorporate current market interest rates, AIG’s observable credit spreads on these liabilities and other factors that mitigate the risk of nonperformance such as collateral posted.
 
The following table presents the difference between fair values and the aggregate contractual principal amounts of mortgage and other loans receivable and long-term borrowings, for which the fair value option was elected:
 
                         
   
          Principal
       
    Fair Value at
    Amount
       
    September 30,
    Due Upon
       
(in millions)   2008     Maturity     Difference  
 
 
Assets:
                       
Mortgage and other loans receivable
  $ 328     $ 378     $ (50 )
Liabilities:
                       
Long-term borrowings
  $ 36,464     $ 36,065     $ 399  
 
At September 30, 2008, there were no mortgage and other loans receivable for which the fair value option was elected, that were 90 days or more past due and in non-accrual status.
 
 4.   Revolving Credit Agreement and Guarantee and Pledge Agreement between AIG and the Federal Reserve Bank of New York
 
On September 22, 2008, AIG entered into the $85 billion Fed Credit Agreement and a Guarantee and Pledge Agreement (the Pledge Agreement) with the NY Fed.
 
The Fed Facility has a two-year term. Outstanding borrowings bear interest at 3-month LIBOR (not less than 3.5 percent per annum) plus 8.5 percent per annum. AIG incurred, in the form of an increase in the outstanding loan balance under the Fed Credit Agreement, a gross commitment fee of $1.7 billion, which was paid in kind and was recognized as a prepaid commitment asset. Pursuant to the Fed Credit Agreement, in consideration for the NY Fed’s extension of credit under the Fed Facility and the payment of $500,000, AIG agreed to issue 100,000 shares, liquidation preference $5.00 per share, of the Series C Preferred Stock to the Trust. The Series C Preferred Stock was not yet issued as of September 30, 2008. Accordingly, additional paid-in capital has been increased to reflect a prepaid commitment fee which represents AIG’s obligation to issue the Series C Preferred Stock in the fourth quarter of 2008. The value of the Series C Preferred Stock was also recognized as part of the prepaid commitment asset. The total prepaid commitment fee asset of $24.7 billion is being amortized as interest expense through the term of the facility. AIG also incurs a commitment fee on undrawn amounts at the rate of 8.5 percent per annum, which is recognized as interest expense when incurred.
 
Interest and the commitment fees are payable in kind and generally recognized through an increase in the outstanding balance under the Fed Facility.
 
AIG is required to repay the Fed Facility primarily from proceeds on sales of assets, including businesses. These mandatory repayments permanently reduce the maximum amount available to be borrowed under the Fed Facility. Additionally, AIG is permitted to repay any portion of the amounts borrowed at any time prior to the maturity of the Fed Facility, without penalty. Voluntary repayments do not reduce the maximum amount available to be borrowed.
 
The Fed Credit Agreement contains customary affirmative and negative covenants, including a requirement to maintain a minimum amount of liquidity and a requirement to use reasonable efforts to cause the composition of the Board of Directors of AIG to be satisfactory to the Trust within 10 days after the establishment of the Trust. Borrowings under the Fed Facility are conditioned, among other things, on the NY Fed being satisfied with AIG’s corporate governance and the value of the collateral.
 
The Fed Facility is secured by a pledge of the capital stock and assets of certain of AIG’s subsidiaries, subject to exclusions of certain property not permitted to be pledged under AIG debt agreements and its Restated Certificate of Incorporation, as well as exclusions of assets of regulated subsidiaries, assets of foreign subsidiaries and assets of special purpose vehicles. The exclusion of these assets from the pledge assures that AIG has not pledged all or substantially all of its assets to the NY Fed.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
4.   Revolving Credit Agreement and Guarantee and Pledge Agreement between AIG and the Federal Reserve Bank of New York (continued)
 
 
At September 30, 2008, the amount owed under the Fed Facility totaled $63 billion, which included accrued fees and interest of $2 billion added to the principal of cash borrowings. The amount available to be borrowed under the Fed Facility is not generally reduced for the amount of fees and interest added to cash borrowings.
 
See Note 11 to the Consolidated Financial Statements, regarding borrowings under the Fed Facility and amendments to the Fed Credit Agreement subsequent to September 30, 2008.
 
 5.   Shareholders’ Equity and Earnings (Loss) Per Share
 
Shareholders’ Equity
 
Series C Perpetual, Convertible, Participating Preferred Stock
 
Pursuant to the Fed Credit Agreement, AIG agreed to issue 100,000 shares of Series C Preferred Stock to the Trust in the fourth quarter of 2008.
 
Under the terms of the Fed Credit Agreement prior to its amendment on November 9, 2008, the terms of the Series C Preferred Stock were as follows: The Series C Preferred Stock will have voting rights commensurate with an approximately 79.9 percent holding of all outstanding shares of common stock. Holders of the Series C Preferred Stock will be entitled to participate in dividends paid on the common stock, receiving up to 79.9 percent of the aggregate amount of dividends paid on the shares of common stock then outstanding. After the Series C Preferred Stock is issued, AIG will be required to hold a special shareholders’ meeting to amend its restated certificate of incorporation to increase the number of authorized shares of common stock to 19 billion and to reduce the par value per share. The holders of the common stock will be entitled to vote as a class separate from the holders of the Series C Preferred Stock on these changes to AIG’s Restated Certificate of Incorporation. If the increase in the number of authorized shares and change in par value is approved, the Series C Preferred Stock will become convertible into common stock. The number of shares into which the Series C Preferred Stock will be convertible is that which will result in a 79.9 percent holding, after conversion, based upon the number of common shares outstanding on the issue date of the Series C Preferred Stock, plus the number of common shares that are subsequently issued in settlement of Equity Units. Subject to certain exceptions, while the United States Treasury beneficially owns at least 50 percent of the Series C Preferred Stock (or the shares into which the Series C Preferred Stock is convertible), AIG will be prohibited from issuing any capital stock, or any securities or instruments convertible or exchangeable into, or exercisable for, capital stock, without the Trust’s consent. In addition, AIG is required to enter into a registration rights agreement that will provide demand registration rights for the Series C Preferred Stock and will require AIG to apply for the listing on the NYSE of the common stock underlying the Series C Preferred Stock. As described in Note 11 to the Consolidated Financial Statements, the November 9, 2008 agreement in principle provides that AIG will issue 10-year warrants to the United States Treasury, and the number of shares into which the Series C Preferred Stock will be convertible will be reduced so as not to exceed 77.9 percent of the outstanding shares of common stock.
 
AIG received the consideration in the form of the Fed Facility for the Series C Preferred Stock in the third quarter of 2008 and recorded the fair value of the Series C Preferred Stock, $23 billion, as an increase to additional paid-in capital. The value, net of the $500,000 cash portion of the consideration, was recognized as an addition to the prepaid commitment fee asset associated with the Fed Facility.
 
The valuation of the consideration received for the Series C Preferred Stock that AIG agreed to issue was determined by AIG and was primarily based on the implied value of 79.9 percent of AIG indicated by AIG’s common stock price after the terms of the Fed Credit Agreement were publicly announced. Other valuation techniques were employed to corroborate this value, taking into consideration both market observable inputs, such as AIG credit spreads, and other inputs. The following key assumptions were utilized in the valuation:
       
 
  •   The valuation date for the Series C Preferred Stock was the date at which consideration was received for the obligation to issue the Series C Preferred Stock, that is, the date borrowings were made available to AIG pursuant to the NY Fed’s agreement to enter into the Fed Credit Agreement.
       
 
  •   The Series C Preferred Stock will be economically equivalent to the common stock, will have voting rights commensurate with the common stock, and will be convertible into shares of common stock.
       
 
  •   The price of AIG common stock the day after the announcement of the terms of the NY Fed’s agreement to enter into the Fed Credit Agreement provided the most observable market evidence of the valuation of AIG.
 
Basic and diluted EPS will be affected in any period in which AIG has net income. The effect on basic EPS will be


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
computed using the two-class method, pursuant to which the earnings of the period will be allocated between the preferred shareholders and the common shareholders, determined on the same basis as if all the earnings were distributed. Prior to any partial conversion of the Series C Preferred Stock, this will result in 79.9 percent of the earnings for the period being allocated to the Series C Preferred Stock, directly reducing the net income available for common shareholders. Diluted EPS will be computed on the more dilutive of the if-converted method and the two-class method. Under the if-converted method, conversion of the Series C Preferred Stock is assumed to have occurred as of the beginning of the period, and the number of common shares that would be issued on conversion is assumed to be the number of additional shares outstanding for the period. Because AIG had losses for the three- and nine-month periods ended September 30, 2008, the Series C Preferred Stock was anti-dilutive to basic and diluted EPS.
 
Dividends
 
The quarterly dividend per common share declared in May 2008 and paid on September 19, 2008 was $0.22. Effective September 23, 2008, AIG’s Board of Directors suspended the declaration of dividends on AIG’s common stock. Pursuant to the Fed Credit Agreement, AIG is restricted from paying dividends on its common stock.
 
Share Issuance and Repurchase
 
In February 2007, AIG’s Board of Directors increased AIG’s share repurchase program by authorizing the purchase of shares with an aggregate purchase price of $8 billion. In November 2007, AIG’s Board of Directors authorized the purchase of an additional $8 billion in common stock. In 2007, AIG entered into structured share repurchase arrangements providing for the purchase of shares over time with an aggregate purchase price of $7 billion.
 
A total of 37,926,059 shares were purchased during the first six months of 2008 to meet commitments that existed at December 31, 2007. There were no repurchases during the third quarter of 2008. At October 31, 2008, $9 billion was available for purchases under the aggregate authorizations.
 
Pursuant to the Fed Credit Agreement, AIG is restricted from repurchasing shares of its common stock.
 
In May 2008, AIG sold 196,710,525 shares of common stock at a price per share of $38 for gross proceeds of $7.47 billion and 78,400,000 equity units (the Equity Units) at a price per unit of $75 for gross proceeds of $5.88 billion. The Equity Units, the key terms of which are summarized below, are recorded as long-term borrowings in the consolidated balance sheet.
 
Equity Units
 
Each Equity Unit has an initial stated amount of $75 and consists of a stock purchase contract issued by AIG and, initially, a 1/40th or 2.5 percent undivided beneficial ownership interest in three series of junior subordinated debentures (Series B-1, B-2 and B-3), each with a principal amount of $1,000.
 
Each stock purchase contract requires its holder to purchase, and requires AIG to sell, a variable number of shares of AIG common stock for $25 in cash on each of the following dates: February 15, 2011, May 1, 2011 and August 1, 2011. The number of shares that AIG is obligated to deliver on each stock purchase date is set forth in the chart below (where the “applicable market value” is an average of the trading prices of AIG’s common stock over the 20-trading-day period ending on the third business day prior to the relevant stock purchase date).
 
     
If the applicable market
   
value is:   then AIG is obligated to issue:
 
• Greater than or equal to
$45.60
 
 • 0.54823 shares per stock purchase contract
• Between $45.60 and $38.00
 
 • Shares equal to $25 divided by the applicable market value
• Less than or equal to
$38.00
 
 • 0.6579 shares per stock purchase contract
 
Basic earnings (loss) per share (EPS) will not be affected by outstanding stock purchase contracts. Diluted EPS will be determined considering the potential dilution from outstanding stock purchase contracts using the treasury stock method, and therefore diluted EPS will not be affected by outstanding stock purchase contracts until the applicable market value exceeds $45.60.
 
AIG is obligated to pay quarterly contract adjustment payments to the holders of the stock purchase contracts, at an initial annual rate of 2.7067 percent applied to the stated amount. The present value of the contract adjustment payments, $431 million, was recognized at inception as a liability (a component of other liabilities), and was recorded as a reduction to additional paid-in capital.
 
In addition to the stock purchase contracts, as part of the Equity Units, AIG issued $1.96 billion of each of the Series B-1, B-2 and B-3 junior subordinated debentures, which initially pay interest at rates of 5.67 percent, 5.82 percent and 5.89 percent, respectively. For accounting purposes, AIG allocated the proceeds of the Equity Units between the stock purchase contracts and the junior subordinated debentures on a relative fair value basis. AIG determined that the fair value of the stock purchase contract at issuance was zero, and therefore all of the proceeds were allocated to the junior subordinated debentures.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
Share-based Employee Compensation Plans
 
During the first quarter of 2008, AIG reviewed the vesting schedules of its share-based employee compensation plans, and on March 11, 2008, AIG’s management and the Compensation and Management Resources Committee of AIG’s Board of Directors determined that, to fulfill the objective of attracting and retaining high quality personnel, the vesting schedules of certain awards outstanding under these plans and all awards made in the future under these plans should be shortened.
 
For accounting purposes, a modification of the terms or conditions of an equity award is treated as an exchange of the original award for a new award. As a result of this modification, the incremental compensation cost related to the affected awards totaled $24 million and will, together with the unamortized originally-measured compensation cost, be amortized over shorter periods. AIG estimates the modifications will increase the amortization of this cost by $106 million and $46 million in 2008 and 2009, respectively, with a related reduction in amortization expense of $128 million in 2010 through 2013.
 
In the second quarter of 2008, reversals of previously accrued costs related to certain performance-based compensation plans were made, as performance to date was below the performance thresholds set forth in those plans.
 
Earnings (Loss) Per Share (EPS)
 
Basic EPS is based on the weighted average number of common shares outstanding. Diluted EPS is based on those shares used in basic EPS plus shares that would have been outstanding assuming issuance of common shares for all dilutive potential common shares outstanding.
 
The computation of basic and diluted EPS was as follows:
                                 
   
    Three Months
    Nine Months
 
    Ended September 30,     Ended September 30,  
(in millions, except per share data)   2008     2007     2008     2007  
Numerator for EPS:
                               
Net income (loss)
  $ (24,468 )   $ 3,085     $ (37,630 )   $ 11,492  
 
 
Denominator for EPS:
                               
Weighted average shares outstanding used in the computation of EPS:
                               
Common stock issued
    2,948       2,751       2,850       2,751  
Common stock in treasury
    (259 )     (189 )     (251 )     (168 )
Deferred shares
    14       14       14       13  
 
 
Weighted average shares outstanding – basic*
    2,703       2,576       2,613       2,596  
Incremental shares arising from awards outstanding under share-based employee compensation plans*
          13             13  
 
 
Weighted average shares outstanding – diluted*
    2,703       2,589       2,613       2,609  
EPS:
                               
Basic
  $ (9.05 )   $ 1.20     $ (14.40 )   $ 4.43  
Diluted
  $ (9.05 )   $ 1.19     $ (14.40 )   $ 4.40  
Calculated using the treasury stock method.  Certain potential common shares arising from share-based employee compensation plans were not included in the computation of diluted EPS because the effect would have been anti-dilutive. The number of potential shares excluded was 7 million for the nine-month period ended September 30, 2007. Additionally, the Preferred Stock to be issued was not included in the computation of basic or diluted EPS because the effect would have been anti-dilutive.
 
 6.  Ownership
 
According to the Schedule 13D/A filed on October 30, 2008, by C.V. Starr & Co., Inc. (Starr), Starr International Company, Inc. (SICO), Edward E. Matthews, Maurice R. Greenberg, the Maurice R. and Corinne P. Greenberg Family Foundation, Inc., the Universal Foundation, Inc., the Maurice R. and Corinne P. Greenberg Joint Tenancy Company, LLC and the C.V. Starr & Co., Inc. Trust, these reporting persons could be considered to beneficially own 278,430,935 shares or approximately 10 percent of AIG’s common stock at that date. Although these reporting persons may have made filings under Section 16 of the Exchange Act, reporting sales of shares of common stock, no amendment to the Schedule 13D has been filed to report a change in ownership subsequent to October 30, 2008.
 
 7.  Commitments, Contingencies and Guarantees
 
(a)   Litigation and Investigations
 
AIG and its subsidiaries, in common with the insurance and financial services industries in general, are subject to litigation, including claims for punitive damages, in the normal course of their business. At the current time, AIG cannot predict the outcome of the matters described below, or estimate any potential additional costs related to these matters, unless otherwise indicated. In AIG’s insurance operations,


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
litigation arising from claims settlement activities is generally considered in the establishment of AIG’s reserve for losses and loss expenses. However, the potential for increasing jury awards and settlements makes it difficult to assess the ultimate outcome of such litigation.
 
Various federal, state and foreign regulatory and governmental agencies are reviewing certain public disclosures, transactions and practices of AIG and its subsidiaries in connection with industry wide and other inquiries. These reviews include the inquiries by the SEC and U.S. Department of Justice (DOJ), previously confirmed by AIG, with respect to AIG’s valuation of and disclosures relating to the AIGFP super senior credit default swap portfolio. AIG has cooperated, and will continue to cooperate, in producing documents and other information in response to subpoenas and other requests.
 
In connection with some of the SEC investigations, AIG understands that some of its employees have received Wells notices and it is possible that additional current and former employees could receive similar notices in the future. Under SEC procedures, a Wells notice is an indication that the SEC staff has made a preliminary decision to recommend enforcement action that provides recipients with an opportunity to respond to the SEC staff before a formal recommendation is finalized.
 
Although AIG cannot currently quantify its ultimate liability for the unresolved litigation and investigation matters referred to below, it is possible that such liability could have a material adverse effect on AIG’s consolidated financial condition, or consolidated results of operations for an individual reporting period.
 
Litigation Relating to AIGFP’s Super Senior Credit Default Swap Portfolio
 
Securities Actions – Southern District of New York. On May 21, 2008, a purported securities fraud class action complaint was filed against AIG and certain of its current and former officers and directors in the United States District Court for the Southern District of New York (the Southern District of New York). The complaint alleges that defendants made statements during the period May 11, 2007 through May 9, 2008 in press releases, AIG’s quarterly and year-end filings and during conference calls with analysts which were materially false and misleading and which artificially inflated the price of AIG’s stock. The alleged false and misleading statements relate to, among other things, unrealized market valuation losses on AIGFP’s super senior credit default swap portfolio as a result of severe credit market disruption. The complaint alleges claims under Sections 10(b) and 20(a) of the Exchange Act. Three additional purported securities class action complaints were subsequently filed in the Southern District of New York, all containing similar allegations. One of the additional complaints filed on June 19, 2008, alleges a purported class period of November 10, 2006 through June 6, 2008. The Court has not yet appointed a lead plaintiff in these actions.
 
On October 9, 2008, a purported securities class action complaint was filed in the Southern District of New York on behalf of purchasers of 7.70 percent Series A-5 Junior Subordinated Debentures in connection with AIG’s public offering on December 11, 2007 against AIG, certain of its current and former officers and directors, and the offering underwriters. The complaint alleges that defendants made statements in AIG’s registration statement, prospectus and quarterly and year-end filings which were materially false and misleading, in violation of Sections 11, 12(a) and 15 of the Securities Act of 1933. The claims are based generally on the same allegations as the securities fraud class actions described above. One additional purported securities class action complaint was filed in the Southern District of New York on October 24, 2008, containing identical allegations.
 
ERISA Actions – Southern District of New York. On June 25, 2008, the Company, certain of its executive officers and directors, and unnamed members of the Company’s Retirement Board and Investment Committee were named as defendants in two separate, though nearly identical, actions filed in the Southern District of New York. The actions purport to be brought as class actions on behalf of all participants in or beneficiaries of certain pension plans sponsored by AIG or its subsidiaries (the Plans) during the period May 11, 2007 through the present and whose participant accounts included investments in the Company’s common stock. Plaintiffs allege, among other things, that the defendants breached their fiduciary responsibilities to Plan participants and their beneficiaries under the Employee Retirement Income Security Act of 1974, as amended (ERISA), by: (i) failing to prudently and loyally manage the Plans and the Plans’ assets; (ii) failing to provide complete and accurate information to participants and beneficiaries about the Company and the value of the Company’s stock; (iii) failing to monitor appointed Plan fiduciaries and to provide them with complete and accurate information; and (iv) breaching their duty to avoid conflicts of interest. The alleged ERISA violations relate to, among other things, the defendants’ purported failure to monitor and/or disclose unrealized market valuation losses on AIGFP’s super senior credit default swap portfolio as a result of severe credit market disruption. Six additional purported ERISA class action complaints were subsequently filed in the Southern District of New York, each containing similar allegations. It is anticipated that these actions will all be consolidated and that


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
the Court will then appoint a lead plaintiff in the consolidated action.
 
Derivative Actions – Southern District of New York. On November 20, 2007, two purported shareholder derivative actions were filed in the Southern District of New York naming as defendants the then current directors of AIG and certain senior officers of AIG and its subsidiaries. Plaintiffs assert claims for breach of fiduciary duty, waste of corporate assets and unjust enrichment, as well as violations of Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, and Section 20(a) of the Exchange Act, among other things, in connection with AIG’s public disclosures regarding its exposure to what the lawsuits describe as the subprime market crisis. The actions were consolidated as In re American International Group, Inc. 2007 Derivative Litigation (the Consolidated 2007 Derivative Litigation). On February 15, 2008, plaintiffs filed a consolidated amended complaint alleging the same causes of action. On April 15, 2008, motions to dismiss the action were filed on behalf of all defendants. The motions to dismiss are pending.
 
On August 8, 2008, a purported shareholder derivative action was filed in the Southern District of New York asserting claims on behalf of AIG based generally on the same allegations as in the consolidated amended complaint in the Consolidated 2007 Derivative Litigation.
 
Derivative Action – Supreme Court of New York. On February 29, 2008, a purported shareholder derivative complaint was filed in the Supreme Court of Nassau County, asserting the same state law claims against the same defendants as in the consolidated amended complaint in the Consolidated 2007 Derivative Litigation. On May 19, 2008, defendants filed a motion to dismiss or to stay the proceedings in light of the pending Consolidated 2007 Derivative Litigation. The motion is pending.
 
Derivative Action – Delaware Court of Chancery. On September 17, 2008, a purported shareholder derivative complaint was filed in the Court of Chancery of Delaware naming as defendants certain directors and senior officers of AIG and its subsidiaries and asserting claims on behalf of AIG based generally on the same allegations as in the consolidated amended complaint in the Consolidated 2007 Derivative Litigation.
 
Action by the Starr Foundation – Supreme Court of New York. On May 7, 2008, the Starr Foundation filed a complaint in New York State Supreme Court against AIG, AIG’s former Chief Executive Officer, Martin Sullivan, and AIG’s then Chief Financial Officer, Steven Bensinger, asserting a claim for common law fraud. The complaint alleges that the defendants made materially misleading statements and omissions concerning alleged multi-billion dollar losses in AIG’s portfolio of credit default swaps. The complaint asserts that if the Starr Foundation had known the truth about the alleged losses, it would have sold its remaining shares of AIG stock. The complaint alleges that the Starr Foundation has suffered damages of at least $300 million. On May 30, 2008, a motion to dismiss the complaint was filed on behalf of defendants. The motion to dismiss, which has been converted by the court into a motion for summary judgment, is still pending.
 
Litigation Relating to the Credit Agreement with the NY Fed
 
On November 4, 2008, a purported class action was filed in the Delaware Court of Chancery naming as defendants AIG, Chairman and Chief Executive Officer, Edward M. Liddy, and current and past AIG directors. Plaintiff alleges violations of Delaware General Corporation Law Section 242(b)(2) and breaches of fiduciary duty in connection with the Series C Preferred Stock to be issued to the Trust created for the benefit of the United States Treasury pursuant to the Fed Credit Agreement. Plaintiff seeks an order declaring that the Series C Preferred Stock is not convertible into common stock absent a class vote by the holders of the common stock to amend the Restated Certificate of Incorporation to increase the number of authorized common shares and decrease the par value of the common shares, an order declaring that AIG’s directors are breaching their fiduciary duties in not seeking alternative or supplemental financing in advance of a stockholder vote on such an amendment to the Restated Certificate of Incorporation, and damages. During a conference with the Court on November 7, 2008, AIG’s counsel stated that any amendment to the Restated Certificate of Incorporation to increase the number of authorized common shares or to decrease the par value of the common shares would be the subject of a class vote by the holders of the common stock, and plaintiff’s counsel agreed that the plaintiff’s request for an order granting this relief is moot.
 
2006 Regulatory Settlements and Related Matters
 
2006 Regulatory Settlements. In February 2006, AIG reached a resolution of claims and matters under investigation with the DOJ, the SEC, the Office of the New York Attorney General (NYAG) and the New York State Department of Insurance (DOI). AIG recorded an after-tax charge of $1.15 billion relating to these settlements in the fourth quarter of 2005. The settlements resolved investigations conducted by the SEC, NYAG and DOI in connection with the accounting, financial reporting and insurance brokerage practices of AIG and its subsidiaries, as well as claims relating to the underpayment of certain workers compensation premium taxes and other assessments. These settlements did not, however, resolve


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
investigations by regulators from other states into insurance brokerage practices related to contingent commissions and other broker-related conduct, such as alleged bid rigging. Nor did the settlements resolve any obligations that AIG may have to state guarantee funds in connection with any of these matters.
 
As a result of these settlements, AIG made payments or placed amounts in escrow in 2006 totaling approximately $1.64 billion, $225 million of which represented fines and penalties. Amounts held in escrow totaling approximately $337 million, including interest thereon, are included in other assets at September 30, 2008. At that date, all of the funds were escrowed for settlement of claims resulting from the underpayment by AIG of its residual market assessments for workers’ compensation.
 
In addition to the escrowed funds, $800 million was deposited into a fund under the supervision of the SEC as part of the settlements to be available to resolve claims asserted against AIG by investors, including the securities class action shareholder lawsuits described below.
 
Also, as part of the settlements, AIG agreed to retain, for a period of three years, an independent consultant to conduct a review that will include, among other things, the adequacy of AIG’s internal control over financial reporting, the policies, procedures and effectiveness of AIG’s regulatory, compliance and legal functions and the remediation plan that AIG has implemented as a result of its own internal review.
 
Other Regulatory Settlements. AIG’s 2006 regulatory settlements with the SEC, DOJ, NYAG and DOI did not resolve investigations by regulators from other states into insurance brokerage practices. AIG entered into agreements effective January 29, 2008 with the Attorneys General of the States of Florida, Hawaii, Maryland, Michigan, Oregon, Texas and West Virginia; the Commonwealths of Massachusetts and Pennsylvania; and the District of Columbia; as well as the Florida Department of Financial Services and the Florida Office of Insurance Regulation, relating to their respective industry wide investigations into producer compensation and insurance placement practices. The settlements call for total payments of $12.5 million to be allocated among the ten jurisdictions representing restitution to state agencies and reimbursement of the costs of the investigation. During the term of the settlement agreements, AIG will continue to maintain certain producer compensation disclosure and ongoing compliance initiatives. AIG will also continue to cooperate with the industry wide investigations. The agreement with the Texas Attorney General also settles allegations of anticompetitive conduct relating to AIG’s relationship with Allied World Assurance Company and includes an additional settlement payment of $500,000 related thereto.
 
AIG entered into an agreement effective March 13, 2008 with the Pennsylvania Insurance Department relating to the Department’s investigation into the affairs of AIG and certain of its Pennsylvania-domiciled insurance company subsidiaries. The settlement calls for total payments of approximately $13.5 million, of which approximately $4.4 million was paid under previous settlement agreements. During the term of the settlement agreement, AIG will provide annual reinsurance reports, as well as maintain certain producer compensation disclosure and ongoing compliance initiatives.
 
NAIC Examination of Workers Compensation Premium Reporting. During 2006, the Settlement Review Working Group of the National Association of Insurance Commissioners (NAIC), under the direction of the states of Indiana, Minnesota and Rhode Island, began an investigation into AIG’s reporting of workers’ compensation premiums. In late 2007, the Settlement Review Working Group recommended that a multi-state targeted market conduct examination focusing on workers’ compensation insurance be commenced under the direction of the NAIC’s Market Analysis Working Group. AIG was informed of the multi-state targeted market conduct examination in January 2008. AIG has been advised that the lead states in the multi-state examination are Delaware, Florida, Indiana, Massachusetts, Minnesota, New York, Pennsylvania, and Rhode Island and that all other states (and the District of Columbia) have agreed to participate. AIG has also been advised that the examination will focus on both legacy issues and AIG’s current compliance with legal requirements applicable to AIG’s writing and reporting of workers’ compensation insurance, but as of October 31, 2008 no determinations had been made with respect to these issues.
 
Securities Action – Southern District of New York. Beginning in October 2004, a number of putative securities fraud class action suits were filed in the Southern District of New York against AIG and consolidated as In re American International Group, Inc. Securities Litigation. Subsequently, a separate, though similar, securities fraud action was also brought against AIG by certain Florida pension funds. The lead plaintiff in the class action is a group of public retirement systems and pension funds benefiting Ohio state employees, suing on behalf of themselves and all purchasers of AIG’s publicly traded securities between October 28, 1999 and April 1, 2005. The named defendants are AIG and a number of present and former AIG officers and directors, as well as Starr, SICO, General Reinsurance Corporation (General Re), and PricewaterhouseCoopers LLP (PwC), among others. The lead plaintiff alleges, among other things, that AIG: (1) concealed that it engaged in anti-competitive conduct through alleged payment of contingent commissions to brokers and participation in illegal bid-rigging; (2) concealed that it used


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
“income smoothing” products and other techniques to inflate its earnings; (3) concealed that it marketed and sold “income smoothing” insurance products to other companies; and (4) misled investors about the scope of government investigations. In addition, the lead plaintiff alleges that AIG’s former Chief Executive Officer, Maurice R. Greenberg, manipulated AIG’s stock price. The lead plaintiff asserts claims for violations of Sections 11 and 15 of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder, Section 20(a) of the Exchange Act, and Section 20A of the Exchange Act. In April 2006, the court denied the defendants’ motions to dismiss the second amended class action complaint and the Florida complaint. In December 2006, a third amended class action complaint was filed, which does not differ substantially from the prior complaint. Fact and class discovery is currently ongoing. On February 20, 2008, the lead plaintiff filed a motion for class certification. The class certification motion is pending.
 
ERISA Action – Southern District of New York. Between November 30, 2004 and July 1, 2005, several ERISA actions were filed in the Southern District of New York on behalf of purported class participants and beneficiaries of three pension plans sponsored by AIG or its subsidiaries. A consolidated complaint filed on September 26, 2005 alleges a class period between September 30, 2000 and May 31, 2005 and names as defendants AIG, the members of AIG’s Retirement Board and the Administrative Boards of the plans at issue, and present or former members of AIG’s Board of Directors. The factual allegations in the complaint are essentially identical to those in the securities actions described above. The parties have reached an agreement to settle this matter for an amount within AIG’s insurance coverage limits. On July 3, 2008, the Court granted preliminary approval of the settlement, and at a hearing on October 7, 2008 the Court issued an order finally approving the settlement, dismissing the action with prejudice. The deadline for filing an appeal from the approval order is November 7, 2008.
 
Derivative Action – Southern District of New York. Between October 25, 2004 and July 14, 2005, seven separate derivative actions were filed in the Southern District of New York, five of which were consolidated into a single action (the New York 2004/2005 Derivative Litigation). The complaint in this action contains nearly the same types of allegations made in the securities fraud action described above. The named defendants include current and former officers and directors of AIG, as well as Marsh & McLennan Companies, Inc. (Marsh), SICO, Starr, ACE Limited and subsidiaries (ACE), General Re, PwC, and certain employees or officers of these entity defendants. Plaintiffs assert claims for breach of fiduciary duty, gross mismanagement, waste of corporate assets, unjust enrichment, insider selling, auditor breach of contract, auditor professional negligence and disgorgement from AIG’s former Chief Executive Officer, Maurice R. Greenberg, and former Chief Financial Officer, Howard I. Smith, of incentive-based compensation and AIG share proceeds under Section 304 of the Sarbanes-Oxley Act, among others. Plaintiffs seek, among other things, compensatory damages, corporate governance reforms, and a voiding of the election of certain AIG directors. AIG’s Board of Directors has appointed a special committee of independent directors (Special Committee) to review the matters asserted in the operative consolidated derivative complaint. The court has entered an order staying this action pending resolution of the Delaware 2004/2005 Derivative Litigation discussed below. The court also has entered an order that termination of certain named defendants from the Delaware action applies to this action without further order of the court. On October 17, 2007, plaintiffs and those AIG officer and director defendants against whom the shareholder plaintiffs in the Delaware action are no longer pursuing claims filed a stipulation providing for all claims in this action against such defendants to be dismissed with prejudice. Former directors and officers Maurice R. Greenberg and Howard I. Smith have asked the court to refrain from so ordering this stipulation.
 
Derivative Actions – Delaware Chancery Court. From October 2004 to April 2005, AIG shareholders filed five derivative complaints in the Delaware Chancery Court. All of these derivative lawsuits were consolidated into a single action as In re American International Group, Inc. Consolidated Derivative Litigation (the Delaware 2004/2005 Derivative Litigation). The amended consolidated complaint named 43 defendants (not including nominal defendant AIG) who, as in the New York 2004/2005 Derivative Litigation, were current and former officers and directors of AIG, as well as other entities and certain of their current and former employees and directors. The factual allegations, legal claims and relief sought in this action are similar to those alleged in the New York 2004/2005 Derivative Litigation, except that the claims are only under state law. In early 2007, the court approved an agreement that AIG be realigned as plaintiff, and, on June 13, 2007, acting on the direction of the Special Committee, AIG filed an amended complaint against former directors and officers Maurice R. Greenberg and Howard I. Smith, alleging breach of fiduciary duty and indemnification. Also on June 13, 2007, the Special Committee filed a motion to terminate the litigation as to certain defendants, while taking no action as to others. Defendants Greenberg and Smith filed answers to AIG’s complaint and brought third-party complaints against certain current and former AIG directors and officers, PwC and Regulatory Insurance Services, Inc. On September 28, 2007, AIG and the shareholder plaintiffs filed a combined amended complaint in which AIG continued to assert claims


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
against defendants Greenberg and Smith and took no position as to the claims asserted by the shareholder plaintiffs in the remainder of the combined amended complaint. In that pleading, the shareholder plaintiffs are no longer pursuing claims against certain AIG officers and directors. On February 12, 2008, the court granted AIG’s motion to stay discovery pending the resolution of claims against AIG in the New York consolidated securities action. The court also directed the parties to coordinate a briefing schedule for the motions to dismiss. On April 11, 2008, the shareholder plaintiffs filed the First Amended Combined Complaint, which added claims against former AIG directors and officers Maurice Greenberg, Edward Matthews, and Thomas Tizzio for breach of fiduciary duty based on alleged bid-rigging in the municipal derivatives market. On June 13, 2008, certain defendants filed motions to dismiss the shareholder plaintiffs’ portions of the complaint. The motions to dismiss are pending.
 
AIG is also named as a defendant in a derivative action in the Delaware Chancery Court brought by shareholders of Marsh. On July 10, 2008, shareholder plaintiffs filed a second consolidated amended complaint, which contains claims against AIG for aiding and abetting a breach of fiduciary duty and contribution and indemnification in connection with alleged bid-rigging and steering practices in the commercial insurance market that are the subject of the Policyholder Antitrust and RICO Actions described below.
 
Policyholder Antitrust and RICO Actions. Commencing in 2004, policyholders brought multiple federal antitrust and Racketeer Influenced and Corrupt Organizations Act (RICO) class actions in jurisdictions across the nation against insurers and brokers, including AIG and a number of its subsidiaries, alleging that the insurers and brokers engaged in a broad conspiracy to allocate customers, steer business, and rig bids. These actions, including 24 complaints filed in different federal courts naming AIG or an AIG subsidiary as a defendant, were consolidated by the judicial panel on multi-district litigation and transferred to the United States District Court for the District of New Jersey (District of New Jersey) for coordinated pretrial proceedings. The consolidated actions have proceeded in that court in two parallel actions, In re Insurance Brokerage Antitrust Litigation (the Commercial Complaint) and In re Employee Benefit Insurance Brokerage Antitrust Litigation (the Employee Benefits Complaint, and, together with the Commercial Complaint, the Multi-district Litigation).
 
The plaintiffs in the Commercial Complaint are a group of corporations, individuals and public entities that contracted with the broker defendants for the provision of insurance brokerage services for a variety of insurance needs. The broker defendants are alleged to have placed insurance coverage on the plaintiffs’ behalf with a number of insurance companies named as defendants, including AIG subsidiaries. The Commercial Complaint also named various brokers and other insurers as defendants (three of which have since settled). The Commercial Complaint alleges, among other things, that defendants engaged in a widespread conspiracy to allocate customers through bid-rigging and steering practices. Plaintiffs assert that the defendants violated the Sherman Antitrust Act, RICO, and the antitrust laws of 48 states and the District of Columbia, and are liable under common law breach of fiduciary duty and unjust enrichment theories. Plaintiffs seek treble damages plus interest and attorneys’ fees as a result of the alleged RICO and Sherman Antitrust Act violations.
 
The plaintiffs in the Employee Benefits Complaint are a group of individual employees and corporate and municipal employers alleging claims on behalf of two separate nationwide purported classes: an employee class and an employer class that acquired insurance products from the defendants from August 26, 1994 to the date of any class certification. The Employee Benefits Complaint names AIG, as well as various other brokers and insurers, as defendants. The activities alleged in the Employee Benefits Complaint, with certain exceptions, track the allegations made in the Commercial Complaint.
 
The Court in connection with the Commercial Complaint granted (without leave to amend) defendants’ motions to dismiss the federal antitrust and RICO claims on August 31, 2007 and September 28, 2007, respectively. The court declined to exercise supplemental jurisdiction over the state law claims in the Commercial Complaint and therefore dismissed it in its entirety. On January 14, 2008, the court granted defendants’ motion for summary judgment on the ERISA claims in the Employee Benefits Complaint and subsequently dismissed the remaining state law claims without prejudice, thereby dismissing the Employee Benefits Complaint in its entirety. On February 12, 2008, plaintiffs filed a notice of appeal to the United States Court of Appeals for the Third Circuit with respect to the dismissal of the Employee Benefits Complaint. Plaintiffs previously appealed the dismissal of the Commercial Complaint to the United States Court of Appeals for the Third Circuit on October 10, 2007. Both appeals are pending.
 
A number of complaints making allegations similar to those in the Multi-district Litigation have been filed against AIG and other defendants in state and federal courts around the country. The defendants have thus far been successful in having the federal actions transferred to the District of New Jersey and consolidated into the Multi-district Litigation. These additional consolidated actions are still pending in the District of New Jersey, but are currently stayed pending


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
a decision by the court on whether they will proceed during the appeal of the dismissal of the Multi-district Litigation. On August 20, 2008, the District Court, however, granted plaintiff’s motion to lift the stay in one tag-along matter and suggested that the case be remanded to the transferor court, and on September 17, 2008, the Judicial Panel on Multidistrict Litigation filed a Conditional Transfer Order with respect to this matter. The AIG defendants have also sought to have state court actions making similar allegations stayed pending resolution of the Multi-district Litigation proceeding. These efforts have generally been successful, although plaintiffs in one case pending in Texas state court have moved to re-open discovery; a hearing on that motion was held on April 9, 2008. The court subsequently issued an order deferring a ruling on the motion until the Court holds a hearing on defendants’ Special Exceptions. A hearing date has not yet been set. AIG has recently settled several of the various federal and state actions alleging claims similar to those in the Multi-district Litigation, including a state court action pending in Florida in which discovery had been allowed to proceed.
 
Ohio Attorney General Action – Ohio Court of Common Pleas. On August 24, 2007, the Ohio Attorney General filed a complaint in the Ohio Court of Common Pleas against AIG and a number of its subsidiaries, as well as several other broker and insurer defendants, asserting violation of Ohio’s antitrust laws. The complaint, which is similar to the Commercial Complaint, alleges that AIG and the other broker and insurer defendants conspired to allocate customers, divide markets, and restrain competition in commercial lines of casualty insurance sold through the broker defendant. The complaint seeks treble damages on behalf of Ohio public purchasers of commercial casualty insurance, disgorgement on behalf of both public and private purchasers of commercial casualty insurance, as well as a $500 per day penalty for each day of conspiratorial conduct. AIG, along with other co-defendants, moved to dismiss the complaint on November 16, 2007. On June 30, 2008, the Court denied defendants’ motion to dismiss. On August 18, 2008, defendants filed their answers to the complaint. Discovery is ongoing.
 
Action Relating to Workers Compensation Premium Reporting – Northern District of Illinois. On May 24, 2007, the National Workers Compensation Reinsurance Pool (the NWCRP), on behalf of its participant members, filed a lawsuit in the United States District Court for the Northern District of Illinois against AIG with respect to the underpayment by AIG of its residual market assessments for workers compensation. The complaint alleges claims for violations of RICO, breach of contract, fraud and related state law claims arising out of AIG’s alleged underpayment of these assessments between 1970 and the present and seeks damages purportedly in excess of $1 billion. On August 6, 2007, the court denied AIG’s motion seeking to dismiss or stay the complaint or, in the alternative, to transfer to the Southern District of New York. On December 26, 2007, the court denied AIG’s motion to dismiss the complaint. On March 17, 2008, AIG filed an amended answer, counterclaims and third-party claims against the National Council on Compensation Insurance (in its capacity as attorney-in-fact for the NWCRP), the NWCRP, its board members, and certain of the other insurance companies that are members of the NWCRP alleging violations of RICO, as well as claims for conspiracy, fraud, and other state law claims. The counterclaim-and third-party defendants filed motions to dismiss on June 9, 2008. The motions are scheduled for decision on November 20, 2008. Discovery is currently ongoing while the motions are pending.
 
Action Relating to Workers Compensation Premium Reporting – Minnesota. On February 16, 2006, the Attorney General of the State of Minnesota filed a complaint against AIG with respect to claims by the Minnesota Department of Revenue and the Minnesota Special Compensation Fund, alleging that AIG made false statements and reports to Minnesota agencies and regulators, unlawfully reducing AIG’s contributions and payments to Minnesota and certain state funds relating to its workers’ compensation premiums. While AIG settled that litigation in December 2007, a similar lawsuit was filed by the Minnesota Workers Compensation Reinsurance Association and the Minnesota Workers Compensation Insurers Association in the United States District Court for the District of Minnesota. On March 28, 2008, the court granted AIG’s motion to dismiss the case in its entirety. On April 25, 2008, plaintiffs appealed to the United States Court of Appeals for the Eighth Circuit and also filed a new complaint making similar allegations in Minnesota state court. On April 30, 2008, substantially identical claims were also filed in Minnesota state court by the Minnesota Insurance Guaranty Association and Minnesota Assigned Risk Plan. On September 11, 2008, the parties to both actions entered into a settlement, resulting in the dismissal of all claims against AIG. In exchange for the dismissal and a broad release of claims, the financial terms of the settlement provided for AIG’s payment of $21.5 million to plaintiffs and waiver of its right to collect $3.5 million in payments due from the plaintiffs.
 
Action Relating to Workers Compensation Premium Reporting – District of South Carolina. A purported class action was also filed in the United States District Court for the District of South Carolina on January 25, 2008 against AIG and certain of its subsidiaries, on behalf of a class of employers that obtained workers’ compensation insurance from AIG companies and allegedly paid inflated premiums as a result of AIG’s alleged underreporting of workers’


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
compensation premiums. An amended complaint was filed on March 24, 2008, and AIG filed a motion to dismiss the amended complaint on April 21, 2008. On July 8, 2008, the court granted AIG’s motion to dismiss all claims without prejudice and granted plaintiff leave to refile subject to certain conditions. Plaintiffs filed their second amended complaint on July 22, 2008. AIG moved to dismiss the second amended complaint on August 22, 2008. Discovery is stayed pending resolution of the motion to dismiss.
 
Litigation Relating to SICO and Starr
 
SICO Action. In July, 2005 SICO filed a complaint against AIG in the Southern District of New York, claiming that AIG had refused to provide SICO access to certain artwork, and asking the court to order AIG immediately to release the property to SICO. AIG filed an answer denying SICO’s allegations and setting forth defenses to SICO’s claims. In addition, AIG filed counterclaims asserting breach of contract, unjust enrichment, conversion, breach of fiduciary duty, a constructive trust and declaratory judgment, relating to SICO’s breach of its commitment to use its AIG shares only for the benefit of AIG and AIG employees. On June 23, 2008, the Court denied in part and granted in part SICO’s motion for summary judgment, and on July 31, 2008 the parties submitted a joint pre-trial order. Trial is scheduled to commence on March 2, 2009.
 
Derivative Action Relating to Starr and SICO. On December 31, 2002, a derivative lawsuit was filed in the Delaware Chancery Court against twenty directors and executives of AIG as well as against AIG as a nominal defendant that alleges, among other things, that the directors of AIG breached the fiduciary duties of loyalty and care by approving the payment of commissions to insurance managing general agencies owned by Starr and of rental and service fees to SICO and the executives breached their duty of loyalty by causing AIG to enter into contracts with Starr and SICO and their fiduciary duties by usurping AIG’s corporate opportunities. The complaint further alleges that the Starr agencies did not provide any services that AIG was not capable of providing itself, and that the diversion of commissions to these entities was solely for the benefit of Starr’s owners. The complaint also alleges that the service fees and rental payments made to SICO and its subsidiaries were improper. Under the terms of a stipulation approved by the Court on February 16, 2006, the claims against the outside independent directors were dismissed with prejudice, while the claims against the other directors were dismissed without prejudice. In an opinion dated June 21, 2006, the Court denied defendants’ motion to dismiss, except with respect to plaintiff’s challenge to payments made to Starr before January 1, 2000. On July 21, 2006, plaintiff filed its second amended complaint, which alleges that, between January 1, 2000 and May 31, 2005, individual defendants breached their duty of loyalty by causing AIG to enter into contracts with Starr and SICO and breached their fiduciary duties by usurping AIG’s corporate opportunity. Starr is charged with aiding and abetting breaches of fiduciary duty and unjust enrichment for its acceptance of the fees. SICO is no longer named as a defendant. On June 27, 2007, Starr filed a cross-claim against AIG, alleging one count that includes contribution, unjust enrichment and setoff. On November 15, 2007, the Court granted AIG’s motion to dismiss the cross-claim by Starr to the extent that it sought affirmative relief from AIG. On February 14, 2008, the Court granted a motion to add former AIG officer Thomas Tizzio as a defendant. As a result, the remaining defendants in the case are AIG (the nominal defendant), Starr and former directors and officers Maurice Greenberg, Howard Smith, Edward Matthews and Thomas Tizzio. On September 30, 2008, the parties filed a stipulation of settlement, and the court scheduled a settlement hearing for December 17, 2008. Pursuant to the settlement, defendants have agreed to payment of $115 million to AIG, net of attorneys’ fees and costs, in exchange for receipt of a broad release of claims relating to the allegations in the complaint.
 
Litigation Matters Relating to AIG’s General Insurance Operations
 
Caremark. AIG and certain of its subsidiaries have been named defendants in two putative class actions in state court in Alabama that arise out of the 1999 settlement of class and derivative litigation involving Caremark Rx, Inc. (Caremark). The plaintiffs in the second-filed action have intervened in the first-filed action, and the second-filed action has been dismissed. An excess policy issued by a subsidiary of AIG with respect to the 1999 litigation was expressly stated to be without limit of liability. In the current actions, plaintiffs allege that the judge approving the 1999 settlement was misled as to the extent of available insurance coverage and would not have approved the settlement had he known of the existence and/or unlimited nature of the excess policy. They further allege that AIG, its subsidiaries, and Caremark are liable for fraud and suppression for misrepresenting and/or concealing the nature and extent of coverage. In addition, the intervenor-plaintiffs allege that various lawyers and law firms who represented parties in the underlying class and derivative litigation (the Lawyer Defendants) are also liable for fraud and suppression, misrepresentation, and breach of fiduciary duty. The complaints filed by the plaintiffs and the intervenor-plaintiffs request compensatory damages for the 1999 class in the amount of $3.2 billion, plus punitive damages. AIG and its subsidiaries deny the allegations of fraud and suppression and have asserted that information concerning the excess policy was publicly disclosed months prior to the approval


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
of the settlement. AIG and its subsidiaries further assert that the current claims are barred by the statute of limitations and that plaintiffs’ assertions that the statute was tolled cannot stand against the public disclosure of the excess coverage. The plaintiffs and intervenor-plaintiffs, in turn, have asserted that the disclosure was insufficient to inform them of the nature of the coverage and did not start the running of the statute of limitations. On November 26, 2007, the trial court issued an order that dismissed the intervenors’ complaint against the Lawyer Defendants and entered a final judgment in favor of the Lawyer Defendants. The matter was stayed pending appeal to the Alabama Supreme Court. In September 2008 the Alabama Supreme Court affirmed the trial court’s dismissal of the Lawyer Defendants. It is anticipated that the next steps will be class discovery and a hearing on class certification. AIG cannot reasonably estimate either the likelihood of its prevailing in these actions or the potential damages in the event liability is determined.
 
(b)   Commitments
 
Flight Equipment
 
At September 30, 2008, International Lease Finance Corporation (ILFC) had committed to purchase 174 new aircraft deliverable from 2008 through 2019 at an estimated aggregate purchase price of $16.9 billion. ILFC will be required to find customers for any aircraft acquired, and it must arrange financing for portions of the purchase price of such equipment.
 
ILFC has ordered 74 Boeing 787 aircraft with the first aircraft now scheduled to be delivered in late 2011. Boeing has made several announcements concerning the delays in the deliveries of the 787s. Boeing has informed ILFC that its 787 deliveries will be delayed, on average, an excess of 27 months per aircraft. Such delays will span across ILFC’s entire order, with the original contracted deliveries running from 2010 through 2017. ILFC expects further delays on its future Boeing aircraft deliveries resulting from the recent labor strike.
 
Other Commitments
 
In the normal course of business, AIG enters into commitments to invest in limited partnerships, private equities, hedge funds and mutual funds and to purchase and develop real estate in the U.S. and abroad. These commitments totaled $8.4 billion at September 30, 2008.
 
On June 27, 2005, AIG entered into an agreement pursuant to which AIG agreed, subject to certain conditions, to make any payment that is not promptly paid with respect to the benefits accrued by certain employees of AIG and its subsidiaries under the SICO Plans (as discussed below under “Benefits Provided by Starr International Company, Inc. and C.V. Starr & Co., Inc.”).
 
(c)   Contingencies
 
Loss Reserves
 
Although AIG regularly reviews the adequacy of the established reserve for losses and loss expenses, there can be no assurance that AIG’s ultimate loss reserves will not develop adversely and materially exceed AIG’s current loss reserves. Estimation of ultimate net losses, loss expenses and loss reserves is a complex process for long-tail casualty lines of business, which include excess and umbrella liability, directors and officers liability, professional liability, medical malpractice, workers’ compensation, general liability, products liability and related classes, as well as for asbestos and environmental exposures. Generally, actual historical loss development factors are used to project future loss development. However, there can be no assurance that future loss development patterns will be the same as in the past. Moreover, any deviation in loss cost trends or in loss development factors might not be discernible for an extended period of time subsequent to the recording of the initial loss reserve estimates for any accident year. Thus, there is the potential for reserves with respect to a number of years to 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 attributable to changes in inflation, in labor and material costs or in the judicial environment, or in other social or economic phenomena affecting claims.
 
Deferred Tax Assets
 
AIG’s determination of the realizability of deferred tax assets requires estimates of future taxable income. Such estimates could change in the near term, perhaps materially, which may require AIG to adjust its valuation allowance. Such adjustment, either positive or negative, could be material to AIG’s consolidated financial condition or its results of operations. See Note 9 to the Consolidated Financial Statements.
 
Benefits Provided by Starr International Company, Inc. and C.V. Starr & Co., Inc.
 
SICO has provided a series of two-year Deferred Compensation Profit Participation Plans (SICO Plans) to certain AIG employees. The SICO Plans were created in 1975 when the voting shareholders and Board of Directors of SICO, a private holding company whose principal asset is AIG common stock, decided that a portion of the capital value of SICO should be used to provide an incentive plan for the current and


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 
7.  Commitments, Contingencies and Guarantees (continued)
 
succeeding managements of all American International companies, including AIG.
 
None of the costs of the various benefits provided under the SICO Plans has been paid by AIG, although AIG has recorded a charge to reported earnings for the deferred compensation amounts paid to AIG employees by SICO, with an offsetting amount credited to additional paid-in capital reflecting amounts considered to be contributed by SICO. The SICO Plans provide that shares currently owned by SICO are set aside by SICO for the benefit of the participant and distributed upon retirement. The SICO Board of Directors currently may permit an early payout of units under certain circumstances. Prior to payout, the participant is not entitled to vote, dispose of or receive dividends with respect to such shares, and shares are subject to forfeiture under certain conditions, including but not limited to the participant’s voluntary termination of employment with AIG prior to normal retirement age. Under the SICO Plans, SICO’s Board of Directors may elect to pay a participant cash in lieu of shares of AIG common stock. Following notification from SICO to participants in the SICO Plans that it will settle specific future awards under the SICO Plans with shares rather than cash, AIG modified its accounting for the SICO Plans from variable to fixed measurement accounting. AIG gave effect to this change in settlement method beginning on December 9, 2005, the date of SICO’s notice to participants in the SICO Plans.
 
(d)   Guarantees
 
AIG and certain of its subsidiaries are parties to derivative financial instruments with market risk resulting from both dealer and end-user activities to reduce currency, interest rate, equity and commodity exposures. These instruments are carried at their fair value in the consolidated balance sheet. The majority of AIG’s derivative activity is transacted by AIGFP. See Note 8 to the Consolidated Financial Statements included in the 2007 Annual Report on Form 10-K.
 
AIG has issued unconditional guarantees with respect to the prompt payment, when due, of all present and future payment obligations and liabilities of AIGFP arising from transactions entered into by AIGFP.
 
SAI Deferred Compensation Holdings, Inc., a wholly owned subsidiary of AIG, has established a deferred compensation plan for registered representatives of certain AIG subsidiaries, pursuant to which participants have the opportunity to invest deferred commissions and fees on a notional basis. The value of the deferred compensation fluctuates with the value of the deferred investment alternatives chosen. AIG has provided a full and unconditional guarantee of the obligations of SAI Deferred Compensation Holdings, Inc. to pay the deferred compensation under the plan.
 
See also Note 11 to the Consolidated Financial Statements for information on the termination of selected AIG voluntary non-qualified deferred compensation plans.


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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
 
 8.  Employee Benefits
 
The components of the net periodic benefit cost with respect to pensions and other postretirement benefits were as follows:
 
                                                 
 
    Pensions     Postretirement  
    Non-U.S.
    U.S.
          Non-U.S.
    U.S.
       
(in millions)   Plans     Plans     Total     Plans     Plans     Total  
 
 
Three Months Ended September 30, 2008
                                               
Components of net periodic benefit cost:
                                               
Service cost
  $ 34     $ 32     $ 66     $ 2     $ 2     $ 4