10-Q 1 y35350e10vq.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 UNDER SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 
    For the quarterly period ended June 30, 2007
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, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer    þ                       Accelerated filer    o                       Non-accelerated filer    o
     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 July 31, 2007, there were 2,564,389,291 shares outstanding of the registrant’s common stock.
 
 


 

TABLE OF CONTENTS
                 
    Page
Description   Number
 
 PART I — FINANCIAL INFORMATION        
     Item 1.       1  
     Item 2.       28  
     Item 3.       86  
     Item 4.       86  
 PART II — OTHER INFORMATION        
     Item 2.       87  
     Item 4.       87  
     Item 6.       87  
 SIGNATURES     88  
 EX-10.1: FORM OF OPTION AWARD AGREEMENT
 EX-10.2: FORM OF PERFORMANCE RSU AWARD AGREEMENT
 EX-10.3: FORM OF TIME-VESTED RSU AWARD AGREEMENT
 EX-10.4: FORM OF TIME-VESTED RSU AWARD AGREEMENT WITH EARLY RETIREMENT PROVISIONS
 EX-10.5: FORM OF NON-EMPLOYEE DIRECTOR DEFERRED STOCK UNITS AWARD AGREEMENT
 EX-10.6: SUMMARY OF DIRECTOR COMPENSATION
 EX-12: STATEMENT RE COMPUTATION OF RATIOS
 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)
 
                       
    June 30,   December 31,
    2007   2006
 
Assets:
               
 
Investments and financial services assets:
               
   
Fixed maturities:
               
     
Bonds available for sale, at fair value (amortized cost: 2007 – $383,451; 2006 – $377,698) (includes hybrid financial instruments: 2007 – $767; 2006 – $522)
  $ 388,717     $ 387,391  
     
Bonds held to maturity, at amortized cost (fair value: 2007 – $21,614; 2006 – $22,154)
    21,389       21,437  
     
Bond trading securities, at fair value (cost: 2007 – $9,264; 2006 – $9,016)
    9,261       9,037  
   
Equity securities:
               
     
Common stocks available for sale, at fair value (cost: 2007 – $12,320; 2006 – $10,662)
    17,372       13,262  
     
Common and preferred stocks trading, at fair value (cost: 2007 – $15,101; 2006 – $12,734)
    17,479       14,421  
     
Preferred stocks available for sale, at fair value (cost: 2007 – $2,574; 2006 – $2,485)
    2,609       2,539  
   
Mortgage loans on real estate, net of allowance (2007 – $57; 2006 – $55)
    18,701       17,067  
   
Policy loans
    7,607       7,501  
   
Collateral and guaranteed loans, net of allowance (2007 – $3; 2006 – $9)
    5,054       3,850  
   
Financial services assets:
               
     
Flight equipment primarily under operating leases, net of accumulated depreciation
(2007 – $9,670; 2006 – $8,835)
    42,232       39,875  
     
Securities available for sale, at fair value (cost: 2007 – $46,508; 2006 – $45,912)
    48,166       47,205  
     
Trading securities, at fair value
    4,567       5,031  
     
Spot commodities
    93       220  
     
Unrealized gain on swaps, options and forward transactions
    18,120       19,252  
     
Trade receivables
    7,138       4,317  
     
Securities purchased under agreements to resell, at contract value
    31,595       31,853  
     
Finance receivables, net of allowance (2007 – $736; 2006 – $737) (includes finance receivables held for sale: 2007 – $608; 2006 – $1,124)
    30,027       29,573  
   
Securities lending collateral, at fair value (which approximates cost)
    81,079       69,306  
   
Other invested assets
    49,887       42,114  
   
Short-term investments, at cost (approximates fair value)
    27,736       25,249  
 
     
Total investments and financial services assets
    828,829       790,500  
 
Cash
    1,635       1,590  
 
Investment income due and accrued
    6,118       6,077  
 
Premiums and insurance balances receivable, net of allowance (2007 – $776; 2006 – $756)
    20,147       17,789  
 
Reinsurance assets, net of allowance (2007 – $521; 2006 – $536)
    23,541       23,355  
 
Deferred policy acquisition costs
    39,694       37,235  
 
Investments in partially owned companies
    1,176       1,101  
 
Real estate and other fixed assets, net of accumulated depreciation (2007 – $5,616; 2006 – $5,525)
    5,060       4,381  
 
Separate and variable accounts
    78,618       72,655  
 
Goodwill
    8,590       8,628  
 
Other assets
    20,458       16,103  
 
Total assets
  $ 1,033,866     $ 979,414  
 
See Accompanying Notes to Consolidated Financial Statements.

1


Table of Contents

American International Group, Inc. and Subsidiaries
CONSOLIDATED BALANCE SHEET (continued)
(in millions, except share data) (unaudited)
 
                     
    June 30,   December 31,
    2007   2006
 
Liabilities:
               
 
Reserve for losses and loss expenses
  $ 82,079     $ 79,999  
 
Unearned premiums
    28,019       26,271  
 
Future policy benefits for life and accident and health insurance contracts
    126,584       122,230  
 
Policyholders’ contract deposits
    247,526       246,615  
 
Other policyholders’ funds
    8,562       8,281  
 
Commissions, expenses and taxes payable
    6,144       5,305  
 
Insurance balances payable
    5,765       3,789  
 
Funds held by companies under reinsurance treaties
    2,407       2,602  
 
Income taxes payable
    8,996       9,546  
 
Financial services liabilities:
               
   
Borrowings under obligations of guaranteed investment agreements
    19,451       20,664  
   
Securities sold under agreements to repurchase, at contract value
    19,459       19,677  
   
Trade payables
    8,324       6,174  
   
Hybrid financial instrument liabilities, at fair value
    8,155       8,856  
   
Securities and spot commodities sold but not yet purchased, at market value
    4,297       4,076  
   
Unrealized loss on swaps, options and forward transactions
    12,841       11,401  
   
Trust deposits and deposits due to banks and other depositors
    4,290       5,249  
   
Commercial paper
    10,057       8,208  
   
Notes, bonds, loans and mortgages payable
    93,998       87,602  
 
Commercial paper
    4,468       4,821  
 
Notes, bonds, loans and mortgages payable
    23,156       17,088  
 
Junior subordinated debt
    4,585        
 
Liabilities connected to trust preferred stock
    1,440       1,440  
 
Separate and variable accounts
    78,618       72,655  
 
Securities lending payable
    82,219       70,198  
 
Minority interest
    9,290       7,778  
 
Other liabilities (includes hybrid financial instruments: 2007 – $208; 2006 – $111)
    28,706       27,021  
 
Total liabilities
    929,436       877,546  
 
Preferred shareholders’ equity in subsidiary companies
    100       191  
 
 
Commitments and Contingent Liabilities (See Note 6)
               
Shareholders’ equity:
               
 
Common stock, $2.50 par value; 5,000,000,000 shares authorized; shares issued 2007 and 2006 – 2,751,327,476
    6,878       6,878  
 
Additional paid-in capital
    2,708       2,590  
 
Payments advanced to purchase shares
    (2,336 )      
 
Retained earnings
    92,251       84,996  
 
Accumulated other comprehensive income (loss)
    8,187       9,110  
 
Treasury stock, at cost; 2007 – 171,309,237; 2006 – 150,131,273 shares of common stock
    (3,358 )     (1,897 )
 
Total shareholders’ equity
    104,330       101,677  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 1,033,866     $ 979,414  
 
See Accompanying Notes to Consolidated Financial Statements.

2


Table of Contents

American International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF INCOME
                                     
(in millions, except per share data) (unaudited)
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
    2007   2006   2007   2006
 
Revenues:
                               
 
Premiums and other considerations
  $ 19,533     $ 18,326     $ 39,175     $ 36,596  
 
Net investment income
    7,853       6,145       14,977       12,116  
 
Net realized capital gains (losses)
    (28 )     (214 )     (98 )     (45 )
 
Other income
    3,792       2,597       7,741       5,465  
 
 
Total revenues
    31,150       26,854       61,795       54,132  
 
Benefits and expenses:
                               
 
Incurred policy losses and benefits
    16,221       14,066       32,367       29,155  
 
Insurance acquisition and other operating expenses
    8,601       7,547       16,928       14,943  
 
 
Total benefits and expenses
    24,822       21,613       49,295       44,098  
 
Income before income taxes, minority interest and cumulative effect of an accounting change
    6,328       5,241       12,500       10,034  
 
Income taxes
    1,679       1,688       3,405       3,123  
 
Income before minority interest and cumulative effect of an accounting change
    4,649       3,553       9,095       6,911  
 
Minority interest
    (372 )     (363 )     (688 )     (560 )
 
Income before cumulative effect of an accounting change
    4,277       3,190       8,407       6,351  
 
Cumulative effect of an accounting change, net of tax
                      34  
 
Net income
  $ 4,277     $ 3,190     $ 8,407     $ 6,385  
 
Earnings per common share:
                               
 
Basic
                               
   
Income before cumulative effect of an accounting change
  $ 1.64     $ 1.23     $ 3.22     $ 2.44  
   
Cumulative effect of an accounting change, net of tax
                      0.01  
 
   
Net income
  $ 1.64     $ 1.23     $ 3.22     $ 2.45  
 
 
Diluted
                               
   
Income before cumulative effect of an accounting change
  $ 1.64     $ 1.21     $ 3.21     $ 2.42  
   
Cumulative effect of an accounting change, net of tax
                      0.01  
 
   
Net income
  $ 1.64     $ 1.21     $ 3.21     $ 2.43  
 
Dividends declared per common share
  $ 0.200     $ 0.165     $ 0.365     $ 0.315  
 
Average shares outstanding:
                               
 
Basic
    2,602       2,606       2,607       2,606  
 
Diluted
    2,613       2,625       2,621       2,624  
 
See Accompanying Notes to Consolidated Financial Statements.

3


Table of Contents

American International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS
                     
(in millions) (unaudited)
 
    Six Months
    Ended June 30,
     
    2007   2006
 
Summary:
               
 
Net cash provided by operating activities
  $ 15,071     $ 5,265  
 
Net cash used in investing activities
    (37,873 )     (33,930 )
 
Net cash provided by financing activities
    22,866       28,861  
 
Effect of exchange rate changes on cash
    (19 )     47  
 
 
Change in cash
    45       243  
 
Cash at beginning of period
    1,590       1,897  
 
 
Cash at end of period
  $ 1,635     $ 2,140  
 
Cash flows from operating activities:
               
 
Net income
  $ 8,407     $ 6,385  
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
 
Noncash revenues, expenses, gains and losses included in income:
               
   
Net gains on sales of securities available for sale and other assets
    (732 )     (226 )
   
Foreign exchange transaction (gains) losses
    639       915  
   
Net unrealized (gains) losses on non-AIGFP derivative assets and liabilities
    (123 )     (770 )
   
Equity in income of partially owned companies and other invested assets
    (2,747 )     (1,410 )
   
Amortization of deferred policy acquisition costs
    5,976       5,607  
   
Amortization of premium and discount on securities
    41       39  
   
Depreciation expenses, principally flight equipment
    1,337       1,137  
   
Provision for finance receivable losses
    229       245  
   
Impairment losses
    884       596  
 
Changes in operating assets and liabilities:
               
   
General and life insurance reserves
    8,202       7,290  
   
Premiums and insurance balances receivable and payable – net
    (941 )     (1,229 )
   
Reinsurance assets
    434       707  
   
Capitalization of deferred policy acquisition costs
    (7,678 )     (8,346 )
   
Investment income due and accrued
    (46 )     (5 )
   
Funds held under reinsurance treaties
    (210 )     (953 )
   
Other policyholders’ funds
    339       (233 )
   
Income taxes payable
    (225 )     885  
   
Commissions, expenses and taxes payable
    724       291  
   
Other assets and liabilities – net
    832       (1,475 )
   
Bonds, common and preferred stocks trading, at fair value
    (2,962 )     (2,921 )
   
Trade receivables and payables – net
    (925 )     20  
   
Trading securities, at fair value
    465       1,334  
   
Spot commodities
    127       (705 )
   
Net unrealized (gain) loss on swaps, options and forward transactions
    1,317       (425 )
   
Securities purchased under agreements to resell
    258       1,174  
   
Securities sold under agreements to repurchase
    (226 )     (4,390 )
   
Securities and spot commodities sold but not yet purchased, at market value
    221       (248 )
   
Finance receivables held for sale – originations and purchases
    (3,652 )     (4,911 )
   
Sales of finance receivables – held for sale
    4,168       5,250  
   
Other, net
    938       1,637  
 
   
Total adjustments
    6,664       (1,120 )
 
Net cash provided by operating activities
  $ 15,071     $ 5,265  
 
See Accompanying Notes to Consolidated Financial Statements.

4


Table of Contents

American International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF CASH FLOWS (continued)
                   
(in millions) (unaudited)
 
    Six Months
    Ended June 30,
     
    2007   2006
 
Cash flows from investing activities:
               
Proceeds from (payments for)
               
 
Sales and maturities of fixed maturity securities available for sale
  $ 64,754     $ 60,229  
 
Sales of equity securities available for sale
    4,187       7,231  
 
Proceeds from fixed maturity securities held to maturity
    133       313  
 
Sales of flight equipment
    28       256  
 
Sales or distributions of other invested assets
    6,185       8,021  
 
Payments received on mortgage, policy, collateral and guaranteed loans
    2,047       1,876  
 
Principal payments received on finance receivables held for investment
    6,430       6,297  
 
Purchases of fixed maturity securities available for sale
    (73,274 )     (69,849 )
 
Purchases of equity securities available for sale
    (5,852 )     (8,178 )
 
Purchases of fixed maturity securities held to maturity
    (129 )     (323 )
 
Purchases of flight equipment
    (3,883 )     (4,171 )
 
Purchases of other invested assets
    (10,688 )     (8,118 )
 
Acquisitions of new businesses, net of cash acquired
    (655 )      
 
Mortgage, policy, collateral and guaranteed loans issued
    (4,408 )     (4,420 )
 
Finance receivables held for investment – originations and purchases
    (7,387 )     (7,053 )
 
Change in securities lending collateral
    (11,772 )     (9,261 )
 
Net additions to real estate, fixed assets, and other assets
    (466 )     (388 )
 
Net change in short-term investments
    (3,023 )     (6,529 )
 
Net change in non-AIGFP derivative assets and liabilities
    (100 )     137  
 
Net cash used in investing activities
  $ (37,873 )   $ (33,930 )
 
Cash flows from financing activities:
               
Proceeds from (payments for)
               
 
Policyholders’ contract deposits
  $ 28,774     $ 25,119  
 
Policyholders’ contract withdrawals
    (28,189 )     (20,440 )
 
Change in other deposits
    (1,271 )     313  
 
Change in commercial paper
    1,424       2,971  
 
Notes, bonds, loans and mortgages payable, and hybrid financial instrument liabilities issued
    40,931       22,333  
 
Repayments on notes, bonds, loans and mortgages payable, and hybrid financial instrument liabilities
    (30,282 )     (10,481 )
 
Issuance of junior subordinated debt
    4,490        
 
Issuance of guaranteed investment agreements
    4,186       6,841  
 
Maturities of guaranteed investment agreements
    (4,655 )     (6,469 )
 
Change in securities lending payable
    12,021       9,345  
 
Issuance of treasury stock
    180       63  
 
Payments advanced to purchase shares
    (4,000 )      
 
Acquisition of treasury stock
    (16 )     (4 )
 
Cash dividends paid to shareholders
    (859 )     (780 )
 
Other, net
    132       50  
 
Net cash provided by financing activities
  $ 22,866     $ 28,861  
 
Supplementary disclosure of cash flow information:
               
Cash paid during the period for:
               
 
Interest
  $ 3,744     $ 2,805  
 
Taxes
  $ 3,524     $ 2,100  
Non-cash financing activities:
               
 
Interest credited to policyholder accounts
  $ 5,932     $ 4,653  
 
Treasury stock acquired using payments advanced to purchase shares
  $ 1,664        
Non-cash investing activities:
               
 
Debt assumed on acquisitions
  $ 1,654     $  
 
See Accompanying Notes to Consolidated Financial Statements.

5


Table of Contents

American International Group, Inc. and Subsidiaries
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS)
                                     
(in millions) (unaudited)
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
    2007   2006   2007   2006
 
Net income
  $ 4,277     $ 3,190     $ 8,407     $ 6,385  
 
Other comprehensive income (loss):
                               
 
Unrealized (depreciation) appreciation of investments –
net of reclassification adjustments
    (2,161 )     (5,734 )     (852 )     (8,333 )
   
Deferred income tax benefit (expense) on above changes
    598       1,743       140       2,843  
 
Foreign currency translation adjustments
    (164 )     520       (329 )     1,070  
   
Deferred income tax benefit (expense) on above changes
    7       (59 )     35       (349 )
 
Net derivative gains arising from cash flow hedging activities –
net of reclassification adjustments
    61       4       62       8  
   
Deferred income tax benefit (expense) on above changes
    (22 )     (16 )     5       (3 )
 
Change in pension and postretirement unrecognized periodic benefit (cost)
    15             18       (3 )
   
Deferred income tax benefit (expense) on above changes
    (1 )     34       (2 )     1  
 
Other comprehensive income (loss)
    (1,667 )     (3,508 )     (923 )     (4,766 )
 
Comprehensive income (loss)
  $ 2,610     $ (318 )   $ 7,484     $ 1,619  
 
See Accompanying Notes to Consolidated Financial Statements.

6


Table of Contents

American International Group, Inc. and Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
  1.  Summary of Significant Accounting Policies
Basis of Presentation
These unaudited condensed consolidated financial statements do not include certain financial information required by U.S. generally accepted accounting principles (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, 2006 (2006 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.
     Certain reclassifications and format changes have been made to prior period amounts to conform to the current period presentation.
Out of period adjustments
During the three and six-month periods ended June 30, 2007, AIG recorded the effects of certain out of period adjustments which reduced net income by $139 million and $373 million, respectively, and diluted earnings per share by $0.05 per share and $0.14 per share, respectively.
     During the three and six-month periods ended June 30, 2006, AIG recorded the effects of certain out of period adjustments which increased (decreased) net income by $279 million and $(67) million, respectively, and diluted earnings per share by $0.11 per share and $(0.03) per share, respectively.
Recent Accounting Standards
Accounting Changes
SOP 05-1
On September 19, 2005, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 05-1, “Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts” (SOP 05-1). SOP 05-1 provides guidance on accounting for internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards (FAS) No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” (FAS 97). SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverage that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. Internal replacements that result in a substantially changed contract are accounted for as a termination and a replacement contract.
     The provisions of SOP 05-1 became effective as of January 1, 2007. On the date of adoption, AIG recorded a cumulative effect reduction of $82 million, net of tax, to the opening balance of retained earnings to reflect changes in unamortized deferred policy acquisition costs (DAC), value of business acquired, deferred sales inducement assets, unearned revenue liabilities and future policy benefits for life and accident and health insurance contracts. This adjustment primarily reflects a shorter expected life related to certain group life and health insurance contracts and the effect on the gross profits of investment-oriented products related to previously anticipated future internal replacements. This cumulative effect adjustment affected only the Life Insurance & Retirement Services segment.
FIN 48
On July 13, 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48), which clarifies the accounting for uncertainty in income tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of an income tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, and additional disclosures. AIG adopted the provisions of FIN 48 on January 1, 2007. As a result of the adoption of FIN 48, AIG recognized a $71 million increase in the liability for unrecognized tax benefits, which was accounted for as a decrease to opening retained earnings as of January 1, 2007.
     As of the date of adoption and after recognizing the effect of the increase in the liability noted above, the total amount of AIG’s unrecognized tax benefit, excluding interest and penalties, was $1.138 billion. Included in this balance are $407 million related to tax positions the disallowance of which would not affect the annual effective income tax rate. Accordingly, the amount of unrecognized tax benefit that, if recognized, would favorably affect the effective tax rate is $731 million.
     At June 30, 2007, AIG’s unrecognized tax benefit, excluding interest and penalties, was $1.274 billion which includes $577 million related to tax positions the disallowance of which would not affect the annual effective income tax rate. Accordingly, the amount of unrecognized tax benefit

7


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  1.  Summary of Significant Accounting Policies (continued)
that, if recognized, would favorably affect the effective tax rate was $697 million.
     Interest and penalties related to unrecognized tax benefits are recognized in income tax expense. At January 1, 2007 and June 30, 2007, AIG had accrued $176 million and $203 million, respectively, for the payment of interest (net of the federal benefit) and penalties.
     Neither reserves for uncertain tax positions attributable to prior restatements (including various other remediation-related adjustments) nor the corresponding interest income have been recognized because such amounts are not currently estimable. In addition, certain tax benefits from compensation deductions have not been recognized because of existing uncertainty with respect to the documentation supporting these tax benefits.
     AIG continually evaluates proposed adjustments by taxing authorities. At June 30, 2007, such proposed adjustments would not result in a material change to AIG’s consolidated financial condition. However, AIG believes that it is reasonably possible that the balance of the unrecognized tax benefits could decrease by $0 to $150 million by the end of 2007 due to settlements or expiration of statutes.
Listed below are the tax years that remain subject to examination by major tax jurisdiction:
         
Major Tax Jurisdictions   Open Tax Years
 
United States
    1991-2006  
Hong Kong
    1997-2006  
Malaysia
    1999-2006  
Singapore
    1993-2006  
Thailand
    2001-2006  
Taiwan
    2000-2006  
Japan
    2000-2006  
United Kingdom
    2003-2006  
France
    2003-2006  
Korea
    2001-2006  
 
FSP 13-2
On July 13, 2006, the FASB issued FASB Staff Position (FSP) No. 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction” (FSP 13-2). FSP 13-2 addresses how a change or projected change in the timing of cash flows relating to income taxes generated by a leveraged lease transaction affects the accounting for the lease by the lessor, and directs that the tax assumptions be consistent with any FIN 48 uncertain tax position related to the lease. FSP 13-2 is effective for fiscal years beginning after December 15, 2006. Upon adoption, AIG recorded at January 1, 2007, a $50 million decrease in the opening balance of retained earnings, net of tax, as of January 1, 2007 to reflect the cumulative effect of this change in accounting. The adoption of this guidance is not expected to have a material effect on the Company’s results of operations in 2007.
     As a result of the adoptions of SOP 05-1, FIN 48 and FSP 13-2, AIG recorded a total decrease to opening retained earnings of $203 million as of January 1, 2007.
Future Application of Accounting Standards
FAS 157
In September 2006, the FASB issued 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. FAS 157 will be effective January 1, 2008. AIG is currently assessing the effect of implementing this guidance.
FAS 159
In February 2007, the FASB issued FAS No. 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 currently required to be measured at fair value. Subsequent changes in fair value for designated items will be required to be reported in earnings in the current period. FAS 159 also establishes presentation and disclosure requirements for similar types of assets and liabilities measured at fair value. FAS 159 will be effective January 1, 2008. AIG is currently assessing the effect of implementing this guidance, which depends on the nature and extent of items elected to be measured at fair value upon initial application of the standard on January 1, 2008.
SOP 07-1
In June 2007, the AICPA issued Statement of Position No. 07-1 (SOP 07-1), “Clarification of the Scope of the Audit and Accounting Guide ‘Audits of Investment Companies’ and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies.” SOP 07-1 amends the guidance for whether an entity may apply the provisions of the Audit and Accounting Guide, “Audits of Investment Companies” (the Guide). Investment companies that are subject to the Guide must report all investments at fair value regardless of the nature of the investment or the level of ownership. SOP 07-1 also establishes new requirements for whether a parent company can retain specialized investment company accounting in its consolidated financial statements for subsidiaries and equity method investees that are covered by the Guide. SOP 07-1 will be effective on January 1, 2008. AIG is currently assessing the effect of implementing this guidance.

8


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  2.  Segment Information
AIG identifies its reportable segments by product line consistent with its management structure. These segments are General Insurance, Life Insurance & Retirement Services, Financial Services and Asset Management.
     In order to better align financial reporting with the manner in which AIG’s chief operating decision makers have managed their businesses, commencing in the first quarter of 2007, AIG realigned certain products among reportable segments and major internal reporting units. AIG also began reporting net realized capital gains and losses for the Financial Services and Asset Management segments in the results of these segments. Historically, net realized capital gains and losses were included in the Other category. There has been no change in AIG’s management structure or in its reportable segments. All prior period amounts presented in the tables below have been revised to conform to the current year’s presentation of these items.
The following table summarizes AIG’s operations by major operating segment:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Operating Segments        
(in millions)   2007   2006   2007   2006
 
Revenues(a):
                               
 
General Insurance(b)(c)
  $ 12,928     $ 12,167     $ 25,831     $ 23,823  
 
Life Insurance & Retirement Services(c)(d)
    14,023       11,911       27,705       24,761  
 
Financial Services(e)(f)
    2,123       1,246       4,324       2,912  
 
Asset Management(g)
    1,989       1,515       3,897       2,654  
 
Other
    263       138       394       228  
 
Consolidation and eliminations
    (176 )     (123 )     (356 )     (246 )
 
Consolidated
  $ 31,150     $ 26,854     $ 61,795     $ 54,132  
 
Operating income (loss)(a)(h):
                               
 
General Insurance(c)
  $ 2,976     $ 2,863     $ 6,072     $ 5,194  
 
Life Insurance & Retirement Services(c)
    2,620       2,381       4,901       5,011  
 
Financial Services(f)
    47       (530 )     339       (638 )
 
Asset Management
    1,128       785       2,122       1,234  
 
Other(i)
    (460 )     (258 )     (930 )     (767 )
 
Consolidation and eliminations
    17             (4 )      
 
Consolidated
  $ 6,328     $ 5,241     $ 12,500     $ 10,034  
 
(a) Includes gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS 133), including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, respectively, the effect was $(430) million and $(1.08) billion in both revenues and operating income. For the six-month periods ended June 30, 2007 and 2006, respectively, the effect was $(882) million and $(1.30) billion in both revenues and operating income. These amounts result primarily from interest rate and foreign currency derivatives that are hedging investments and borrowings. These gains (losses) for the three and six months ended June 30, 2007 include out of period charges of $431 million and $326 million, respectively, including a $380 million charge in both periods to reverse net gains recognized on transfers of available for sale securities among legal entities consolidated within AIG Financial Products Corp. and AIG Trading Group Inc. and their respective subsidiaries (collectively, AIGFP). The first six months of 2006 include an out of period charge of $300 million related to the remediation of the material weakness in accounting for certain derivative transactions under FAS 133.
(b) Represents the sum of General Insurance net premiums earned, net investment income and net realized capital gains (losses).
(c) Includes the effect of an out of period adjustment in the second quarter of 2006 related to the accounting for certain interests in unit investment trusts (UCITS). For the three and six-month periods ended June 30, 2006, the effect was an increase of $432 million and $405 million, respectively, in both revenues and operating income for General Insurance and an increase of $221 million and $203 million, respectively, in revenues and $144 million and $132 million, respectively, in operating income for Life Insurance & Retirement Services.
(d) Represents the sum of Life Insurance & Retirement Services premiums and other considerations, net investment income and net realized capital gains (losses). Included in net realized capital gains (losses) and operating income are gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, which were $41 million and $73 million for the three-month periods ended June 30, 2007 and 2006, respectively, and $(82) million and $425 million for the six-month periods ended June 30, 2007 and 2006, respectively. Also included in net realized capital gains (losses) was the application of FAS No. 52 “Foreign Currency Translation” (FAS 52), the effects of which were $(24) million and $(94) million for the three-month periods ended June 30, 2007 and 2006, respectively, and $99 million and $(90) million for the six-month periods ended June 30, 2007 and 2006, respectively.
(e) Primarily represents interest, lease and finance charges.
(f) Includes gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, respectively, the effect was $(443) million, and $(1.1) billion in both revenues and operating income. For the six-month periods ended June 30, 2007 and 2006, respectively, the effect was $(603) million and $(1.8) billion in both revenues and operating income. These amounts result primarily from interest rate and foreign currency derivatives that are effective economic hedges of investments and borrowings. The second quarter and the first six months of 2007 include the out of period charges of $431 million and $326 million, respectively, as discussed above. The first six months of 2006 include an out of period charge of $300 million as discussed above. In the first quarter of 2007, AIG began applying hedge accounting for certain transactions, primarily in its Capital Markets operations. In the second quarter of 2007, American General Finance, Inc. (AGF) and International Lease Finance Corporation (ILFC) began applying hedge accounting to most of their derivatives hedging interest rate and foreign exchange risks associated with their floating rate and foreign currency denominated borrowings.
(g) Represents net investment income with respect to spread-based products and management and advisory fees.
(h) Represents income before income taxes, minority interest and cumulative effect of an accounting change.

9


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  2.  Segment Information (continued)
(i) Includes AIG parent and other operations which are not required to be reported separately. The following table presents the operating loss for AIG’s Other category:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2007   2006   2007   2006
 
Other operating income (loss):
                               
 
Equity earnings in unconsolidated entities
  $ 50     $ 111     $ 91     $ 130  
 
Interest expense
    (302 )     (223 )     (554 )     (406 )
 
Unallocated corporate expenses
    (200 )     (64 )     (362 )     (248 )
 
Compensation expense — SICO Plans
    (10 )     (14 )     (20 )     (90 )
 
Compensation expense — Starr tender offer
                      (54 )
 
Net realized capital gains (losses)
    22       (49 )     (27 )     (54 )
 
Other miscellaneous, net
    (20 )     (19 )     (58 )     (45 )
 
Total Other
  $ (460 )   $ (258 )   $ (930 )   $ (767 )
 
The following table summarizes AIG’s General Insurance operations by major internal reporting unit:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
General Insurance        
(in millions)   2007   2006   2007   2006
 
Revenues:
                               
 
Domestic Brokerage Group
  $ 6,904     $ 6,587     $ 13,995     $ 13,148  
 
Transatlantic
    1,069       1,015       2,165       2,031  
 
Personal Lines
    1,223       1,223       2,436       2,438  
 
Mortgage Guaranty
    257       212       505       410  
 
Foreign General(a)
    3,475       3,130       6,737       5,794  
 
Reclassifications and eliminations
                (7 )     2  
 
Total General Insurance
  $ 12,928     $ 12,167     $ 25,831     $ 23,823  
 
Operating Income (loss)(b):
                               
 
Domestic Brokerage Group
  $ 1,904     $ 1,474     $ 3,833     $ 2,779  
 
Transatlantic
    168       143       319       284  
 
Personal Lines
    118       118       224       219  
 
Mortgage Guaranty
    (81 )     107       (73 )     216  
 
Foreign General(a)(c)
    867       1,021       1,776       1,694  
 
Reclassifications and eliminations
                (7 )     2  
 
Total General Insurance
  $ 2,976     $ 2,863     $ 6,072     $ 5,194  
 
(a) The three and six-month periods ended June 30, 2006, include the effect of an out of period UCITS adjustment in the second quarter of 2006 which was an increase of $412 million and $386 million, respectively, in both revenues and operating income.
(b) Includes additional losses incurred and net reinstatement premiums related to prior year catastrophes of $18 million and $(51) million for the three-month periods ended June 30, 2007 and 2006, respectively. Such losses and premiums were $53 million and $48 million for the six-month periods ended June 30, 2007 and 2006, respectively.
(c) Includes losses incurred and net reinstatement premiums related to current year catastrophes of $68 million in both the three and six-month periods ended June 30, 2007.
The following table summarizes AIG’s Life Insurance & Retirement Services operations by major internal reporting unit:
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Life Insurance & Retirement Services        
(in millions)   2007   2006   2007   2006
 
Revenues:
                               
 
Foreign:
                               
   
Japan and Other
  $ 4,863     $ 3,812     $ 9,633     $ 8,076  
   
Asia*
    5,019       4,303       9,510       8,763  
 
Domestic:
                               
   
Domestic Life Insurance
    2,359       2,222       4,880       4,589  
   
Domestic Retirement Services
    1,782       1,574       3,682       3,333  
 
Total Life Insurance & Retirement Services
  $ 14,023     $ 11,911     $ 27,705     $ 24,761  
 
Operating Income:
                               
 
Foreign:
                               
   
Japan and Other
  $ 810     $ 975     $ 1,723     $ 1,953  
   
Asia*
    844       764       1,215       1,472  
 
Domestic:
                               
   
Domestic Life Insurance
    368       235       713       601  
   
Domestic Retirement Services
    598       407       1,250       985  
 
Total Life Insurance & Retirement Services
  $ 2,620     $ 2,381     $ 4,901     $ 5,011  
 
* Includes the effect of an out of period UCITS adjustment in the second quarter of 2006. For the three and six-month periods ended June 30, 2006, the effect was an increase of $221 million and $203 million, respectively, in revenues and $144 million and $132 million, respectively, in operating income.

10


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  2.  Segment Information (continued)
The following table summarizes AIG’s Financial Services operations by major internal reporting unit:
                                   
    Three Months   Six Months
    Ended June 30,   Ended June 30,
Financial Services        
(in millions)   2007   2006   2007   2006
 
Revenues:
                               
 
Aircraft Leasing(a)
  $ 1,173     $ 1,051     $ 2,231     $ 2,063  
 
Capital Markets(b)(c)
    (67 )     (788 )     161       (1,088 )
 
Consumer Finance(d)(e)
    949       942       1,832       1,867  
 
Other, including intercompany adjustments
    68       41       100       70  
 
Total Financial Services
  $ 2,123     $ 1,246     $ 4,324     $ 2,912  
 
Operating income (loss):
                               
 
Aircraft Leasing(a)
  $ 207     $ 198     $ 371     $ 374  
 
Capital Markets(b)(c)
    (255 )     (952 )     (187 )     (1,422 )
 
Consumer Finance(d)(e)
    75       202       111       378  
 
Other, including intercompany adjustments
    20       22       44       32  
 
Total Financial Services
  $ 47     $ (530 )   $ 339     $ (638 )
 
(a) Revenues are primarily aircraft lease rentals from ILFC. Both revenues and operating income include gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, the effect was $24 million and $10 million, respectively. For the six-month periods ended June 30, 2007 and 2006, the effect was $(13) million and $55 million, respectively. These amounts result primarily from interest rate and foreign currency derivatives that are effective economic hedges of borrowings. In the second quarter of 2007, ILFC began applying hedge accounting to most of its derivatives hedging interest rate and foreign exchange risks associated with its floating rate and foreign currency denominated borrowings.
(b) Revenues, shown net of interest expense of $805 million and $633 million for the three-month periods ended June 30, 2007 and 2006, respectively, and $1.9 billion and $1.3 billion for the six-month periods ended June 30, 2007 and 2006, respectively, were primarily from hedged financial positions entered into in connection with counterparty transactions. Both revenues and operating income include gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, the effect was $(528) million and $(1.2) billion, respectively. For the six-month periods ended June 30, 2007 and 2006, the effect was $(613) million and $(1.8) billion, respectively. The second quarter and the first six months of 2007 include out of period charges of $431 million and $326 million, respectively, including a $380 million charge in both periods to reverse net gains recognized on transfers of available for sale securities among legal entities consolidated within AIGFP. The first six months of 2006 include an out of period charge of $300 million related to the remediation of the material weakness in accounting for certain derivative transactions under FAS 133. In the first quarter of 2007, AIGFP began applying hedge accounting for certain transactions.
(c) Certain transactions entered into by AIGFP generate tax credits and benefits which are included in income taxes in the consolidated statement of income. The amounts of such tax credits and benefits for the three-month periods ended June 30, 2007 and 2006 were $18 million and $8 million, respectively. The amounts of such tax credits and benefits for the six-month periods ended June 30, 2007 and 2006 were $35 million and $26 million, respectively.
(d) Revenues are primarily finance charges. Both revenues and operating income include gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, the effect was $20 million and $5 million, respectively. For the six-month periods ended June 30, 2007 and 2006, the effect was $(15) million and $8 million, respectively. These amounts result primarily from interest rate and foreign currency derivatives that are effective economic hedges of borrowings. In the second quarter of 2007, AGF began applying hedge accounting to most of its derivatives hedging interest rate and foreign exchange risks associated with its floating rate and foreign currency denominated borrowings.
(e) The three-month and six-month periods ended June 30, 2007 included pre-tax charges of $50 million and $178 million, respectively, in connection with domestic consumer finance’s mortgage banking activities.

11


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  3.  Shareholders’ Equity and Earnings Per Share
Earnings Per Share (EPS)
Basic EPS of AIG is calculated using 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 potentially dilutive common shares outstanding.
The following table presents the computation of basic and diluted EPS:
                                     
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions, except per share data)   2007   2006   2007   2006
 
Numerator for earnings per share:
                               
Income before cumulative effect of an accounting change
  $ 4,277     $ 3,190     $ 8,407     $ 6,351  
Cumulative effect of an accounting change, net of tax
                      34  
 
Net income applicable to common stock for basic EPS
  $ 4,277     $ 3,190     $ 8,407     $ 6,385  
Interest on contingently convertible bonds, net of tax (a)
          3             6  
 
Net income applicable to common stock for diluted EPS
  $ 4,277     $ 3,193     $ 8,407     $ 6,391  
Cumulative effect of an accounting change, net of tax
                      (34 )
 
Income before cumulative effect of an accounting change applicable to common stock for diluted EPS
  $ 4,277     $ 3,193     $ 8,407     $ 6,357  
 
Denominator for earnings per share:
                               
 
Weighted average shares outstanding used in the computation of EPS:
                               
   
Common stock issued
    2,751       2,751       2,751       2,751  
   
Common stock in treasury
    (161 )     (153 )     (156 )     (153 )
   
Deferred shares
    12       8       12       8  
 
Weighted average shares outstanding – basic
    2,602       2,606       2,607       2,606  
Incremental shares from potential common stock:
                               
 
Weighted average number of shares arising from outstanding employee stock plans (treasury stock method) (b)
    11       10       14       9  
 
Contingently convertible bonds(a)
          9             9  
 
Weighted average shares outstanding – diluted(b)
    2,613       2,625       2,621       2,624  
 
Earnings per share:
                               
Basic:
                               
 
Income before cumulative effect of an accounting change
  $ 1.64     $ 1.23     $ 3.22     $ 2.44  
 
Cumulative effect of an accounting change, net of tax
                      0.01  
 
Net income
  $ 1.64     $ 1.23     $ 3.22     $ 2.45  
 
Diluted:
                               
 
Income before cumulative effect of an accounting change
  $ 1.64     $ 1.21     $ 3.21     $ 2.42  
 
Cumulative effect of an accounting change, net of tax
                      0.01  
 
Net income
  $ 1.64     $ 1.21     $ 3.21     $ 2.43  
 
(a) Assumes conversion of contingently convertible bonds due to the adoption of Emerging Issues Task Force Issue No. 04-8 “Accounting Issues Related to Certain Features of Contingently Convertible Debt and the Effect on Diluted Earnings per Share.”
(b) Certain shares arising from employee stock plans were not included in the computation of diluted earnings per share where the exercise price of the options exceeded the average market price for the period and would have been antidilutive. The number of shares excluded was 7 million and 15 million for the six-month periods ended June 30, 2007 and 2006, respectively.
Shareholders’ Equity
From time to time, AIG may buy shares of its common stock for general corporate purposes, including to satisfy its obligations under various employee benefit plans. In February 2007, AIG’s Board of Directors increased AIG’s share repurchase program by authorizing the repurchase of shares with an aggregate purchase price of $8 billion. During March 2007, AIG entered into a $3 billion structured share repurchase arrangement, and in May 2007 AIG entered into an additional $1 billion structured share repurchase arrangement. A total of 24,491,961 shares were repurchased during the first six months of 2007. The portion of the payments advanced by AIG under the structured share repurchase arrangements that had not yet been utilized to repurchase shares at June 30, 2007, amounting to $2.34 billion, has been recorded as a component of shareholders’ equity under the caption Payments advanced to purchase shares. Purchases have continued subsequent to June 30, 2007, with an additional 24,501,510 shares purchased from July 1 through August 6, 2007. All shares repurchased are recorded as treasury stock at cost.

12


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  3.  Shareholders’ Equity and Earnings Per Share (EPS) (continued)
The quarterly dividend per common share, commencing with the dividend declared in May 2007 and payable on September 21, 2007, was $0.20.
The following table summarizes the changes in retained earnings during the first six months of 2007:
             
(in millions)   June 30, 2007
 
Retained earnings:
       
 
Balance at beginning of year
  $ 84,996  
   
Cumulative effect of accounting changes, net of tax
    (203 )
 
 
Adjusted balance, beginning of year
    84,793  
   
Net income
    8,407  
   
Dividends to shareholders
    (949 )
 
Balance, end of period
  $ 92,251  
 
  4.  Benefits Provided by Starr
International Company, Inc.
and C.V. Starr & Co., Inc.
Starr International Company, Inc. (SICO) has provided a series of two-year Deferred Compensation Profit Participation Plans (SICO Plans) to certain AIG employees. The SICO Plans came into being 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 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 deemed 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. See also Note 6(b) “Commitments” herein.
     In January 2006, C.V. Starr & Co., Inc. (Starr) completed its tender offer to purchase Starr interests from AIG employees. In conjunction with AIG’s adoption of FAS No. 123R “Share-Based Payments” (FAS 123R), Starr is considered to be an “economic interest holder” in AIG. As a result, compensation expense of $54 million was included in the first six months of 2006 with respect to the Starr tender offer.
     Compensation expense with respect to the SICO Plans aggregated $10  million and $14 million for the three-month periods ended June 30, 2007 and 2006, respectively, and $20 million and $90 million for the six-month periods ended June 30, 2007 and 2006, respectively. Compensation expense for the first six months of 2006 included various out of period adjustments totaling $61 million, primarily relating to stock splits and other miscellaneous items for the SICO plans.
  5.  Ownership
According to the Schedule 13D filed on March 20, 2007 by Starr, 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 deemed to beneficially own 354,987,261 shares of AIG’s common stock at that date. Based on the shares of AIG’s common stock outstanding as of July 31, 2007, this ownership would represent approximately 14 percent of the voting stock of AIG. Although these reporting persons have made filings under Section 16 of the Securities Exchange Act of 1934 (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 March 20, 2007.
  6.  Commitments, Contingencies and Guarantees
In the normal course of business, various commitments and contingent liabilities are entered into by AIG and certain of its

13


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  6.  Commitments, Contingencies and Guarantees (continued)
subsidiaries. In addition, AIG guarantees various obligations of certain subsidiaries.
(a) Litigation and Investigations
Litigation Arising from Operations. 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. In AIG’s insurance operations, litigation arising from claims settlement activities is generally considered in the establishment of AIG’s reserve for losses and loss expenses. However, in certain circumstances, AIG provides disclosure because of the size or nature of the potential liability to AIG. The potential for increasing jury awards and settlements makes it difficult to assess the ultimate outcome of such litigation.
     Litigation Arising from 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 their complaint, 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, inter alia, that information concerning the excess policy was publicly disclosed months prior to the approval 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. 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. The trial court is currently considering, under standards mandated by the Alabama Supreme Court, whether a class action can be certified and whether the defendants in the case brought by the intervenors should be dismissed. AIG cannot reasonably estimate either the likelihood of its prevailing in these actions or the potential damages in the event liability is determined.
     Litigation Arising from Insurance Operations — Gunderson. A subsidiary of AIG has been named as a defendant in a putative class action lawsuit in the 14th Judicial District Court for the State of Louisiana. The Gunderson complaint alleges failure to comply with certain provisions of the Louisiana Any Willing Provider Act (the Act) relating to discounts taken by defendants on bills submitted by Louisiana medical providers and hospitals that provided treatment or services to workers compensation claimants and seeks monetary penalties and injunctive relief. On July 20, 2006, the court denied defendants’ motion for summary judgment and granted plaintiffs’ partial motion for summary judgment, holding that the AIG subsidiary was a “group purchaser” and, therefore, potentially subject to liability under the Act. On November 28, 2006, the court issued an order certifying a class of providers and hospitals. In an unrelated action also arising under the Act, a Louisiana appellate court ruled that the district court lacked jurisdiction to adjudicate the claims at issue. In response, defendants in Gunderson filed an exception for lack of subject matter jurisdiction. On January 19, 2007, the court denied the motion, holding that it has jurisdiction over the putative class claims. The AIG subsidiary is appealing the class certification ruling and is seeking an appeal from the jurisdictional ruling. While AIG believes that it has meritorious defenses to plaintiffs’ claims, it cannot currently estimate the likelihood of prevailing in this action or reasonably estimate the likely damages, if any.
     2006 Regulatory Settlements. In February 2006, AIG reached a resolution of claims and matters under investigation with the United States Department of Justice (DOJ), the Securities and Exchange Commission (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 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

14


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  6.  Commitments, Contingencies and Guarantees (continued)
$1.64 billion, $225 million of which represented fines and penalties. Amounts held in escrow totaling $341 million, including interest thereon, are included in other assets at June 30, 2007. At that date, approximately $322 million of the funds were escrowed for settlement of claims resulting from the underpayment by AIG of its residual market assessments for workers compensation. The National Workers Compensation Reinsurance Pool, on behalf of its participant members, has filed a lawsuit against AIG with respect to the underpayment of such assessments. The National Association of Insurance Commissioners has formed a Settlement Review Working Group directed by the State of Indiana, which has commenced its own investigation into the underreporting of workers compensation premium. In addition, similar lawsuits filed by the Attorney General of the State of Minnesota, the Minnesota Workers Compensation Reinsurance Association and the Minnesota Workers Compensation Insurers Association are pending. AIG cannot currently estimate whether the amount ultimately required to settle these claims will exceed the funds escrowed or otherwise accrued for this purpose.
     The remaining escrowed funds, which amounted to $19 million at June 30, 2007, are set aside for settlements for certain specified AIG policyholders. During the first six months of 2007, approximately $366 million was paid out from escrow in exchange for releasing AIG and its subsidiaries from any alleged liability relating to, among other things, brokerage practices alleged in the NYAG settlement. Any funds remaining at the end of the escrow period can be used to resolve claims asserted by policyholders relating to such insurance brokerage practices, including those described in Private Litigation below.
     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 shareholder lawsuits described herein.
     At the current time, AIG cannot predict the outcome of the matters described above, or estimate any potential additional cost related to these matters.
     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.
Private Litigation
Securities Actions. Beginning in October 2004, a number of putative securities fraud class action suits were filed 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, 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 “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 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.
     ERISA Action. Between November 30, 2004 and July 1, 2005, several Employee Retirement Income Security Act of 1974 (ERISA) actions were filed on behalf of purported class of 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 four 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. Plaintiffs allege that defendants violated duties under ERISA by allowing the plans to offer AIG stock as a permitted investment, when defendants allegedly knew it was not a prudent investment, and by failing to provide participants with accurate information about AIG stock. AIG’s motion to dismiss was denied by

15


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  6.  Commitments, Contingencies and Guarantees (continued)
order dated December 12, 2006. AIG filed an answer on February 12, 2007, denying plaintiffs’ allegations of wrongdoing and asserting affirmative defenses to plaintiffs’ claims. Discovery was consolidated with proceedings in the securities actions and is ongoing.
     Derivative Actions — 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 derivative complaint contains nearly the same types of allegations made in the securities fraud and ERISA actions 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 Reinsurance Corporation, 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 and Chief Financial Officer 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 approved an agreement staying the derivative case pending in the Southern District of New York. The current stay extends until September 14, 2007.
     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 have been consolidated into a single action. The amended consolidated complaint names 43 defendants (not including nominal defendant AIG) who, like the New York consolidated derivative litigation, are 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 Delaware action are similar to those alleged in the New York derivative actions, except that plaintiffs in the Delaware derivative action assert claims only under state law. Earlier in 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. Certain defendants have subsequently filed motions to dismiss plaintiff’s complaint, as well as defendants Greenberg and Smith’s third-party complaints. Both plaintiff and defendant Smith have served initial discovery requests; however, certain defendants have sought to stay discovery pending the resolution of the motions to dismiss. Such motions are currently before the Court.
     In December 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 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 opportunity. 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 alleged 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. On October 31, 2005, Messrs. Greenberg, Matthews and Smith, SICO and Starr filed motions to dismiss the amended complaint. 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 April 20, 2007, the individual defendants and Starr filed a motion seeking leave of the Court to assert a cross-claim against AIG and a third-party complaint against PwC and the directors previously dismissed from the action, as well as certain other AIG officers and employees. On June 13, 2007, the Court denied the individual defendants’ motion to file a third-party complaint, but granted the proposed cross-claim against AIG. On June 27,

16


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
 6. Commitments, Contingencies and Guarantees (continued)
2007, Starr filed its cross-claim against AIG, alleging one count that includes contribution, unjust enrichment and set-off. On July 16, 2007, AIG filed its answer and motion to dismiss Starr’s cross-claim to the extent it seeks contribution by Starr and/or the individual defendants. That motion is currently before the Court. Document discovery and depositions are currently ongoing.
     Policyholder Actions. After the NYAG filed its complaint against insurance broker Marsh, 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 23 complaints filed in different federal courts naming AIG or an AIG subsidiary as a defendant, were consolidated or will be consolidated by the judicial panel on multi-district litigation and transferred to the United States District Court for the 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 First Commercial Complaint) and In re Employee Benefit Insurance Brokerage Antitrust Litigation (the First Employee Benefits Complaint, and together with the First Commercial Complaint, the multi-district litigation).
     The plaintiffs in the First Commercial Complaint are nineteen 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 First Commercial Complaint also named ten brokers and fourteen other insurers as defendants (two of which have since settled). The First Commercial Complaint alleges that defendants engaged in a widespread conspiracy to allocate customers through “bid-rigging” and “steering” practices. The First Commercial Complaint also alleges that the insurer defendants permitted brokers to place business with AIG subsidiaries through wholesale intermediaries affiliated with or owned by those same brokers rather than placing the business with AIG subsidiaries directly. Finally, the First Commercial Complaint alleges that the insurer defendants entered into agreements with broker defendants that tied insurance placements to reinsurance placements in order to provide additional compensation to each broker. Plaintiffs assert that the defendants violated the Sherman Antitrust Act, RICO, 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 First Employee Benefits Complaint are nine 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 First Employee Benefits Complaint names AIG, as well as eleven brokers and five other insurers, as defendants. The activities alleged in the First Employee Benefits Complaint, with certain exceptions, track the allegations of contingent commissions, bid-rigging and tying made in the First Commercial Complaint.
     On October 3, 2006, Judge Hochberg of the District of New Jersey reserved in part and denied in part motions filed by the insurer defendants and broker defendants to dismiss the multi-district litigation. The Court also ordered the plaintiffs in both actions to file supplemental statements of particularity to elaborate on the allegations in their complaints. Plaintiffs filed their supplemental statements on October 25, 2006, and the AIG defendants, along with other insurer and broker defendants in the two consolidated actions, filed renewed motions to dismiss on November 30, 2006. On February 16, 2007, the case was transferred to Judge Garrett E. Brown, Chief Judge of the District of New Jersey. On April 5, 2007, Chief Judge Brown granted the defendants’ renewed motions to dismiss the First Commercial Complaint and First Employee Benefits Complaint with respect to the antitrust and RICO claims. The claims were dismissed without prejudice and the plaintiffs were given 30 days, later extended to 45 days, to file amended complaints. On April 11, 2007, the Court stayed all proceedings, including all discovery, that are part of the multi-district litigation until any renewed motions to dismiss the amended complaints are resolved.
     A number of complaints making allegations similar to those in the First Commercial Complaint 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. The AIG defendants have also sought to have state court actions making similar allegations stayed pending resolution of the multi-district litigation proceeding. In one state court action pending in Florida, the trial court recently decided not to grant an additional stay, but instead to allow the case to proceed. The parties in that case are currently awaiting the trial court’s ruling on the defendants’ motions to dismiss the complaint.

17


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  6.  Commitments, Contingencies and Guarantees (continued)
     Plaintiffs filed amended complaints in both In re Insurance Brokerage Antitrust Litigation (the Second Commercial Complaint) and In re Employee Benefit Insurance Brokerage Antitrust Litigation (the Second Employee Benefits Complaint) along with revised particularized statements in both actions on May 22, 2007. The allegations in the Second Commercial Complaint and the Second Employee Benefits Complaint are substantially similar to the allegations in the First Commercial Complaint and First Employee Benefits Complaint, respectively. The complaints also attempt to add several new parties and delete others; the Second Commercial Complaint adds two new plaintiffs and twenty seven new defendants (including three new AIG defendants), and the Second Employee Benefits Complaint adds eight new plaintiffs and nine new defendants (including two new AIG defendants). The defendants filed motions to dismiss the amended complaints and to strike the newly added parties, and the parties are currently awaiting the court’s ruling on the motions.
     Litigation Relating to 21st Century. Shortly after the announcement in late January 2007 of AIG’s offer to acquire the outstanding shares of 21st Century Insurance Group (21st Century) not already owned by AIG and its subsidiaries, two related class actions were filed in the Superior Court of California, Los Angeles County, against AIG, 21st Century, and the individual members of 21st Century’s Board of Directors, two of whom are current executive officers of AIG. The actions were filed purportedly on behalf of the minority shareholders of 21st Century and assert breaches of fiduciary duty in connection with the AIG proposal. The complaints allege that the proposed per share price is unfair and seek preliminary and permanent injunctive relief to enjoin the consummation of the proposed transaction. On May 23, 2007, a third action was filed alleging breaches of fiduciary duty by the same defendants based upon their entering into the merger agreement and taking steps to complete the contemplated merger, and seeking injunctive relief comparable to that sought in the first two complaints. All three actions have been consolidated under the caption In re 21st Century Shareholder Litigation. Plaintiffs have stated an intention to file a consolidated amended complaint.
     SICO. 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 asked 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. Fact and expert discovery has been substantially concluded and SICO’s motion for summary judgment is pending.
     Regulatory Investigations. Regulators from several states have commenced investigations into insurance brokerage practices related to contingent commissions and other industry-wide practices as well as other broker-related conduct, such as alleged bid-rigging. In addition, various federal and state regulatory agencies are reviewing certain transactions and practices of AIG and its subsidiaries in connection with industry-wide and other inquiries. AIG has cooperated, and will continue to cooperate, in producing documents and other information in response to subpoenas and other requests.
     Wells Notices. AIG understands that some of its employees have received Wells notices in connection with previously disclosed SEC investigations of certain of AIG’s transactions or accounting practices. 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. It is possible that additional current and former employees could receive similar notices in the future as the regulatory investigations proceed.
Effect on AIG
In the opinion of AIG management, AIG’s ultimate liability for the unresolved litigation and investigation matters referred to above is not likely to have a material adverse effect on AIG’s consolidated financial condition, although it is possible that the effect would be material to AIG’s consolidated results of operations for an individual reporting period.
(b) Commitments
Flight Equipment
At June 30, 2007, ILFC had committed to purchase 246 new aircraft deliverable from 2007 through 2017 at an estimated aggregate purchase price of $20.9 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.
Other Commitments
In the normal course of business, AIG enters into commitments to invest in limited partnerships, private equities and hedge funds and to purchase and develop real estate in the U.S. and abroad. These commitments totaled $6.73 billion at June 30, 2007.
     On June 27, 2005, AIG entered into an agreement pursuant to which AIG agrees, subject to certain conditions, to

18


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  6.  Commitments, Contingencies and Guarantees (continued)
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 in Note 4 herein).
(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 (D&O), 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.
     Synthetic Fuel Tax Credits. AIG generates income tax credits as a result of investing in synthetic fuel production. Tax credits generated from the production and sale of synthetic fuel under the Internal Revenue Code are subject to an annual phase-out provision that is based on the average wellhead price of domestic crude oil. The price range within which the tax credits are phased-out was originally established in 1980 and is adjusted annually for inflation. Depending on the price of domestic crude oil for a particular year, all or a portion of the tax credits generated in that year might be eliminated. AIG evaluates the production levels of its synthetic fuel production facilities in light of the risk of phase-out of the associated tax credits. As a result of fluctuating domestic crude oil prices, AIG evaluates and adjusts production levels when appropriate in light of this risk. Under current legislation, the opportunity to generate additional tax credits from the production and sale of synthetic fuel expires on December 31, 2007.
     Lease Transactions. On June 27, 2007, field agents at the Internal Revenue Service issued three Notices of Proposed Adjustment (NOPAs) relating to a series of lease transactions by an AIG subsidiary. In the NOPAs, the field agents asserted that the leasing transactions were “lease-in lease-out” transactions described in Revenue Ruling 2002-69 and proposed adjustments to taxable income of approximately $81 million in the aggregate for the years 1998 and 1999. AIG cannot currently estimate the effect, if any, of the resolution of these matters.
(d) Guarantees
AIG and certain of its subsidiaries become parties to derivative financial instruments with market risk resulting from both dealer and end-user activities and to reduce currency, interest rate, equity and commodity exposures. These instruments are carried at their estimated fair values in the consolidated balance sheet. The vast majority of AIG’s derivative activity is transacted by AIGFP. See Note 9 below and see Note 19 to the consolidated financial statements in the 2006 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.

19


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  7.  Employee Benefits
The following table presents the components of the net periodic benefit costs with respect to pensions and other postretirement benefits:
                                                   
    Pensions   Postretirement
         
    Non-U.S.   U.S.       Non-U.S.   U.S.    
(in millions)   Plans   Plans   Total   Plans   Plans   Total
 
Three Months Ended June 30, 2007
                                               
 
Components of net periodic benefit cost:
                                               
 
Service cost
  $ 21     $ 30     $ 51     $ 2     $ 3     $ 5  
 
Interest cost
    12       44       56             4       4  
 
Expected return on assets
    (9 )     (54 )     (63 )                  
 
Amortization of prior service cost
    (3 )           (3 )           (1 )     (1 )
 
Amortization of net loss
    3       9       12                    
 
Settlement loss
    1             1                    
 
Net periodic benefit cost
  $ 25     $ 29     $ 54     $ 2     $ 6     $ 8  
 
Three Months Ended June 30, 2006
                                               
 
Components of net periodic benefit cost:
                                               
 
Service cost
  $ 18     $ 31     $ 49     $ 1     $ 2     $ 3  
 
Interest cost
    8       41       49             2       2  
 
Expected return on assets
    (7 )     (49 )     (56 )                  
 
Amortization of prior service cost
    (2 )           (2 )           (1 )     (1 )
 
Recognized actuarial loss
    4       19       23                    
 
Net periodic benefit cost
  $ 21     $ 42     $ 63     $ 1     $ 3     $ 4  
 
Six Months Ended June 30, 2007
                                               
 
Components of net periodic benefit cost:
                                               
 
Service cost
  $ 44     $ 60     $ 104     $ 3     $ 5     $ 8  
 
Interest cost
    24       89       113       1       8       9  
 
Expected return on assets
    (18 )     (107 )     (125 )                  
 
Amortization of prior service cost
    (5 )     (1 )     (6 )           (1 )     (1 )
 
Amortization of net loss
    5       18       23                    
 
Settlement loss
    1             1                    
 
Net periodic benefit cost
  $ 51     $ 59     $ 110     $ 4     $ 12     $ 16  
 
Six Months Ended June 30, 2006
                                               
 
Components of net periodic benefit cost:
                                               
 
Service cost
  $ 37     $ 62     $ 99     $ 2     $ 3     $ 5  
 
Interest cost
    17       81       98       1       5       6  
 
Expected return on assets
    (14 )     (97 )     (111 )                  
 
Amortization of prior service cost
    (4 )     (1 )     (5 )           (3 )     (3 )
 
Recognized actuarial loss
    8       38       46                    
 
Net periodic benefit cost
  $ 44     $ 83     $ 127     $ 3     $ 5     $ 8  
 

20


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  8.  Information Provided in Connection with Outstanding Debt
The following condensed consolidating financial statements are provided in compliance with Regulation S-X of the Securities and Exchange Commission.
•  American General Corporation (AGC) is a holding company and a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all outstanding debt of AGC.
 
•  AIG Liquidity Corp. is a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all obligations of AIG Liquidity Corp.
 
•  AIG Program Funding, Inc. is a wholly owned subsidiary of AIG. AIG provides a full and unconditional guarantee of all obligations of AIG Program Funding, Inc., which was established in 2007.
Condensed Consolidating Balance Sheet
                                                           
 
    American    
    International       AIG   AIG    
    Group, Inc.       Liquidity   Program   Other       Consolidated
(in millions)   (As Guarantor)   AGC   Corp.   Funding, Inc.   Subsidiaries   Eliminations   AIG
 
June 30, 2007
                                                       
Assets:
                                                       
 
Investments and financial services assets
  $ 14,368     $     $     $     $ 832,421     $ (17,960 )   $ 828,829  
 
Cash
    36                         1,599             1,635  
 
Carrying value of subsidiaries and partially owned companies, at equity
    116,412       27,670                   11,896       (154,802 )     1,176  
 
Other assets
    5,201       2,673                   194,403       (51 )     202,226  
 
Total assets
  $ 136,017     $ 30,343     $     $     $ 1,040,319     $ (172,813 )   $ 1,033,866  
 
Liabilities:
                                                       
 
Insurance liabilities
  $ 23     $     $     $     $ 507,129     $ (66 )     507,086  
 
Debt
    26,454       2,136                   154,213       (17,493 )     165,310  
 
Other liabilities
    5,210       3,143                   248,725       (38 )     257,040  
 
Total liabilities
    31,687       5,279                   910,067       (17,597 )     929,436  
 
Preferred shareholders’ equity in subsidiary companies
                            100             100  
Total shareholders’ equity
    104,330       25,064                   130,152       (155,216 )     104,330  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 136,017     $ 30,343     $     $     $ 1,040,319     $ (172,813 )   $ 1,033,866  
 
December 31, 2006
                                                       
Assets:
                                                       
 
Investments and financial services assets
  $ 7,346     $     $ *     $     $ 797,976     $ (14,822 )   $ 790,500  
 
Cash
    76             *             1,514             1,590  
 
Carrying value of subsidiaries and partially owned companies, at equity
    109,125       27,967                   8,436       (144,427 )     1,101  
 
Other assets
    3,989       2,622       *             181,561       (1,949 )     186,223  
 
Total assets
  $ 120,536     $ 30,589     $ *     $     $ 989,487     $ (161,198 )   $ 979,414  
 

21


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
                                                           
 
    American    
    International       AIG   AIG    
    Group, Inc.       Liquidity   Program   Other       Consolidated
(in millions)   (As Guarantor)   AGC   Corp.   Funding, Inc.   Subsidiaries   Eliminations   AIG
 
Liabilities:
                                                       
 
Insurance liabilities
  $ 21     $     $     $     $ 495,135     $ (64 )   $ 495,092  
 
Debt
    15,157       2,136       *             146,206       (14,820 )     148,679  
 
Other liabilities
    3,681       3,508       *             228,068       (1,482 )     233,775  
 
Total liabilities
    18,859       5,644       *     $       869,409       (16,366 )     877,546  
 
Preferred shareholders’ equity in subsidiary companies
                            191             191  
Total shareholders’ equity
    101,677       24,945       *             119,887       (144,832 )     101,677  
 
Total liabilities, preferred shareholders’ equity in subsidiary companies and shareholders’ equity
  $ 120,536     $ 30,589     $ *     $     $ 989,487     $ (161,198 )   $ 979,414  
 
*Less than $1 million.

22


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  8.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statement of Income
                                                         
 
    American    
    International       AIG   AIG    
    Group, Inc.       Liquidity   Program   Other       Consolidated
(in millions)   (As Guarantor)   AGC   Corp.   Funding, Inc.   Subsidiaries   Eliminations   AIG
 
Three Months Ended June 30, 2007
                                                       
Operating income (loss)
  $ (282 )   $ (13 )   $ *     $     $ 6,623     $     $ 6,328  
Equity in undistributed net income of consolidated subsidiaries
    3,605       340                         (3,945 )      
Dividend income from consolidated subsidiaries
    879       218                         (1,097 )      
Income taxes
    (75 )     (15 )     *             1,769             1,679  
Minority interest
                            (372 )           (372 )
 
Net income (loss)
  $ 4,277     $ 560     $ *     $     $ 4,482     $ (5,042 )   $ 4,277  
 
Three Months Ended June 30, 2006
                                                       
Operating income (loss)
  $ (436 )   $ (48 )   $ *     $     $ 5,725     $     $ 5,241  
Equity in undistributed net income of consolidated subsidiaries
    3,507       309                         (3,816 )      
Dividend income from consolidated subsidiaries
    380       154                         (534 )      
Income taxes (benefits)
    261       (17 )     *             1,444             1,688  
Minority interest
                            (363 )           (363 )
 
Net income (loss)
  $ 3,190     $ 432     $ *     $     $ 3,918     $ (4,350 )   $ 3,190  
 
Six Months Ended June 30, 2007
                                                       
Operating income (loss)
  $ (543 )   $ (86 )   $ *     $     $ 13,129     $     $ 12,500  
Equity in undistributed net income of consolidated subsidiaries
    6,849       491                         (7,340 )      
Dividend income from consolidated subsidiaries
    2,165       658                         (2,823 )      
Income taxes
    64       (7 )     *             3,348             3,405  
Minority interest
                            (688 )           (688 )
 
Net income (loss)
  $ 8,407     $ 1,070     $ *     $     $ 9,093     $ (10,163 )   $ 8,407  
 
Six Months Ended June 30, 2006
                                                       
Operating income (loss)
  $ (722 )   $ (86 )   $ *     $     $ 10,842     $     $ 10,034  
Equity in undistributed net income of consolidated subsidiaries
    6,767       668                         (7,435 )      
Dividend income from consolidated subsidiaries
    567       458                         (1,025 )      
Income taxes (benefits)
    261       (30 )     *             2,892             3,123  
Minority interest
                            (560 )           (560 )
Cumulative effect of an accounting change, net of tax
    34                                     34  
 
Net income (loss)
  $ 6,385     $ 1,070     $ *     $     $ 7,390     $ (8,460 )   $ 6,385  
 
*Less than $1 million.

23


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  8.  Information Provided in Connection with Outstanding Debt (continued)
Condensed Consolidating Statement of Cash Flow
                                                   
 
    American    
    International       AIG   AIG    
    Group, Inc.       Liquidity   Program   Other   Consolidated
(in millions)   (As Guarantor)   AGC   Corp.   Funding, Inc.   Subsidiaries   AIG
 
Six Months Ended June 30, 2007
                                               
Net cash provided by operating activities
  $ 743     $ 172     $ *     $     $ 14,156     $ 15,071  
 
Cash flows from investing:
                                               
 
Invested assets disposed
                            83,764       83,764  
 
Invested assets acquired
    (6,973 )                       (114,198 )     (121,171 )
 
Other
    (242 )     (76 )     *             (148 )     (466 )
 
Net cash used in investing activities
    (7,215 )     (76 )     *             (30,582 )     (37,873 )
 
Cash flows from financing activities:
                                               
 
Issuance of debt
    11,931                         39,100       51,031  
 
Repayments of debt
    (793 )                       (34,144 )     (34,937 )
 
Payments advanced to purchase shares
    (4,000 )                             (4,000 )
 
Cash dividends paid to shareholders
    (859 )                             (859 )
 
Other
    153       (96 )     *             11,574       11,631  
 
Net cash provided by (used in) financing activities
    6,432       (96 )     *             16,530       22,866  
 
Effect of exchange rate changes on cash
                            (19 )     (19 )
 
Change in cash
    (40 )           *             85       45  
Cash at beginning of period
    76                         1,514       1,590  
 
Cash at end of period
  $ 36     $     $ *     $     $ 1,599     $ 1,635  
 
Six Months Ended June 30, 2006
                                               
Net cash (used in) provided by operating activities
  $ (3,465 )   $ 112     $ *     $     $ 8,618     $ 5,265  
 
Cash flows from investing:
                                               
 
Invested assets disposed
                            84,360       84,360  
 
Invested assets acquired
    (905 )                       (116,997 )     (117,902 )
 
Other
    (718 )     (17 )     *             347       (388 )
 
Net cash used in investing activities
    (1,623 )     (17 )     *             (32,290 )     (33,930 )
 
Cash flows from financing activities:
                                               
 
Issuance of debt
    5,816                         26,329       32,145  
 
Repayments of debt
    (145 )                       (16,805 )     (16,950 )
 
Cash dividends paid to shareholders
    (780 )                             (780 )
 
Other
    60       (95 )     *             14,481       14,446  
 
Net cash provided by (used in) financing activities
    4,951       (95 )     *             24,005       28,861  
 
Effect of exchange rate changes on cash
                            47       47  
 
Change in cash
    (137 )           *             380       243  
Cash at beginning of period
    190                         1,707       1,897  
 
Cash at end of period
  $ 53     $     $ *     $     $ 2,087     $ 2,140  
 
*Less than $1 million.

24


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  9.  Derivatives and Hedge Accounting
AIG uses derivatives and other instruments as part of its financial risk management programs and as part of its investment operations. AIGFP also transacts in derivatives as a dealer.
     Derivatives, as defined in FAS 133, are financial arrangements among two or more parties with returns linked to or “derived” from some underlying equity, debt, commodity or other asset, liability, or foreign exchange rate or other index or the occurrence of a specified payment event. Derivative payments may be based on interest rates, exchange rates, prices of certain securities, commodities, or financial or commodity indices or other variables. Collateral is required on certain transactions based on the creditworthiness of the counterparty.
     Unless subject to a scope exclusion, AIG carries all derivatives on the consolidated balance sheet at fair value. The changes in fair value of the derivative transactions of AIGFP are presented as a component of AIG’s operating income.
AIGFP
AIGFP, in the ordinary course of operations and as principal, structures and enters into derivative transactions to meet the needs of counterparties who may be seeking to hedge certain aspects of such counterparties’ operations or obtain a desired financial exposure. AIGFP also enters into derivative transactions to mitigate risk in its exposures (interest rates, currencies, commodities and equities) arising from such transactions. Such instruments are carried at market or fair value, whichever is appropriate, and are reflected on the balance sheet in “Unrealized gain on swaps, options and forward transactions” and “Unrealized loss on swaps, options and forward contracts.”
     Beginning in the first quarter of 2007, AIGFP designated certain interest rate swaps as fair value hedges of the benchmark interest rate risk on certain of its interest bearing financial assets and liabilities. In these hedging relationships, AIG is hedging its fixed rate available for sale securities and fixed rate borrowings. AIGFP also designated foreign currency forward contracts as fair value hedges for changes in spot foreign exchange rates of the non-U.S. dollar denominated available for sale debt securities. Under these strategies, all or portions of individual or multiple derivatives may be designated against a single hedged item.
     At inception of each hedging relationship, AIGFP performs and documents its prospective assessments of hedge effectiveness to demonstrate that the hedge is expected to be highly effective. For hedges of interest rate risk, AIGFP uses regression to demonstrate the hedge is highly effective, while it uses the periodic dollar offset method for its foreign currency hedges. AIGFP uses the periodic dollar offset method to assess whether its hedging relationships were highly effective on a retrospective basis. The prospective and retrospective assessments are updated on a daily basis. The passage of time component of the hedging instruments is excluded from the assessment of hedge effectiveness and measurement of hedge ineffectiveness. AIGFP does not utilize the shortcut, match terms or equivalent methods.
     The change in fair value of the derivative that qualifies under the requirements of FAS 133 as a fair value hedge is recorded in current period earnings along with the gain or loss on the hedged item for the hedged risk. For interest rate hedges, the adjustments to the carrying value of the hedged items are amortized into income using the effective yield method over the remaining life of the hedged item. Amounts excluded from the assessment of hedge effectiveness are recognized in current period earnings.
     For the three and six months ended June 30, 2007, AIGFP recognized a net loss of less than $1 million and a net gain of $2 million in earnings, respectively, representing hedge ineffectiveness, and also recognized a net loss of $157 million and $211 million, respectively, related to the portion of the hedging instruments excluded from the assessment of hedge effectiveness. All these amounts are reflected in Other income. AIGFP did not apply hedge accounting in 2006.
Other Derivative Users
AIG and its subsidiaries (other than AIGFP) also use derivatives and other instruments as part of their financial risk management programs. Interest rate derivatives (such as interest rate swaps) are used to manage interest rate risk associated with investments in fixed income securities, commercial paper issuances, medium- and long-term note offerings, and other interest rate sensitive assets and liabilities. In addition, foreign exchange derivatives (principally cross currency swaps, forwards and options) are used to economically mitigate risk associated with non-U.S. dollar denominated debt, net capital exposures and foreign exchange transactions. The derivatives are effective economic hedges of the exposures they are meant to offset.

25


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
  9.  Derivatives and Hedge Accounting (continued)
     In 2007, AIG and its subsidiaries other than AIGFP designated certain derivatives as either fair value or cash flow hedges of their debt. The fair value hedges included (i) interest rate swaps that were designated as hedges of the change in the fair value of fixed rate debt attributable to changes in the benchmark interest rate and (ii) foreign currency swaps designated as hedges of the change in fair value of foreign currency denominated debt attributable to changes in foreign exchange rates and/or the benchmark interest rate. With respect to the cash flow hedges, (i) interest rate swaps were designated as hedges of the changes in cash flows on floating rate debt attributable to changes in the benchmark interest rate, and (ii) foreign currency swaps were designated as hedges of changes in cash flows on foreign currency denominated debt attributable to changes in the benchmark interest rate and foreign exchange rates.
     AIG assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. Regression analysis is employed to assess the effectiveness of these hedges both on a prospective and retrospective basis. AIG does not utilize the shortcut, match terms or equivalent methods.
     The change in fair value of derivatives designated and effective as fair value hedges along with the gain or loss on the hedged item are recorded in net realized capital gains (losses). Upon discontinuation of hedge accounting, the cumulative adjustment to the carrying value of the hedged item resulting from changes in the benchmark interest rate is amortized into income using the effective yield method over the remaining life of the hedged item. Amounts excluded from the assessment of hedge effectiveness are recognized in current period earnings. During both the three and six months ended June 30, 2007, AIG recognized a gain of less than $1 million in earnings related to the ineffective portion of the hedging instruments. AIG also recognized a loss of $8 million related to the change in the hedging instruments forward points excluded from the assessment of hedge effectiveness.
     The effective portion of the change in fair value of a derivative qualifying as a cash flow hedge is recorded in Accumulated other comprehensive income (loss), until earnings are affected by the variability of cash flows in the hedged item. The ineffective portion of these hedges is recorded in net realized capital gains (losses). During the three and six months ended June 30, 2007, AIG recognized a loss of less than $1 million and a gain of less than $1 million, respectively, in earnings representing hedge ineffectiveness. At June 30, 2007, $10 million of the deferred net gain in Accumulated other comprehensive income is expected to be recognized in earnings during the next 12 months. All components of the derivatives’ gains and losses were included in the assessment of hedge effectiveness. There were no instances of the discontinuation of hedge accounting in 2007.

26


Table of Contents

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
American International Group, Inc. and Subsidiaries
10.  Cash Flows 
As part of its remediation activities during 2006, AIG determined that certain non-cash activities and adjustments, including the effects of changes in foreign exchange translation on assets and liabilities, previously were misclassified within the operating, investing and financing sections of the Consolidated Statement of Cash flows. The more significant line items revised include the change in General and life insurance reserves and DAC within operating activities; Purchases of fixed maturity securities within investing activities; and Proceeds from notes, bonds, loans and mortgages payable, and hybrid financial instrument liabilities within financing activities. After evaluating the effect of these items during the third quarter of 2006, AIG revised the previous periods presented in its September 30, 2006 consolidated financial statements included in that quarter’s Quarterly Report on Form 10-Q to conform to the revised presentation.
     Subsequent to that revision, additional revisions were made in 2006, primarily relating to certain elements of net realized capital gains and the effect of reclassifying certain policyholders’ account balances from Other policyholder funds to Policyholders’ contract deposits.
The effect of these revisions on the Consolidated Statement of Cash flows for the six months ended June 30, 2006 is presented below:
                                         
    Originally   Revisions   As Revised        
    Reported   Third Quarter   Third Quarter   Additional    
(in millions)   June 30, 2006   2006   2006   Revisions   As Revised
 
Cash flows from operating activities
  $ 6,978     $ (355 )   $ 6,623     $ (1,358 )   $ 5,265  
 
Cash flows from investing activities
    (40,048 )     5,682       (34,366 )     436       (33,930 )
 
Cash flows from financing activities
    32,243       (4,304 )     27,939       922       28,861  
 
Effect of exchange rate changes on cash
    1,070       (1,023 )     47             47  
 

27


Table of Contents

American International Group, Inc. and Subsidiaries
ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations is designed to provide the reader a narrative with respect to AIG’s operations, financial condition and liquidity and certain other significant matters.
INDEX
             
    Page
 
    28  
    29  
      29  
      30  
      32  
      33  
      33  
    33  
    35  
      35  
        36  
        42  
      46  
        47  
        61  
      63  
        63  
      68  
        69  
      70  
    71  
      71  
      78  
      78  
    78  
    82  
      82  
      83  
Cautionary Statement Regarding Projections and Other Information About Future Events
This Quarterly Report on Form 10-Q and other publicly available documents may include, and AIG’s officers and representatives may from time to time make, projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. These projections and statements are not historical facts but instead represent only AIG’s belief regarding future events, many of which, by their nature, are inherently uncertain and outside AIG’s control. These projections and statements may address, among other things, the status and potential future outcome of the current regulatory and civil proceedings against AIG and their potential effect on AIG’s businesses, financial position, results of operations, cash flows and liquidity, the effect of credit rating changes on AIG’s businesses and competitive position, the unwinding and resolving of various relationships between AIG and SICO and AIG’s strategy for growth, product development, market position, financial results and reserves. It is possible that AIG’s actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these projections and statements. Factors that could cause AIG’s actual results to differ, possibly materially, from those in the specific projections and statements are discussed throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Item 1A. Risk Factors of AIG’s Annual Report on Form 10-K for the year ended December 31, 2006 (2006 Annual Report on Form 10-K). AIG is not under any obligation (and expressly disclaims any such obligations) to update or alter any projection or other statement, whether written or oral, that may be made from time to time, whether as a result of new information, future events or otherwise.

28


Table of Contents

American International Group, Inc. and Subsidiaries
In addition to reviewing AIG’s results for the first six months of 2007, this Management’s Discussion and Analysis of Financial Condition and Results of Operations supplements and updates the information and discussion included in the 2006 Annual Report on Form 10-K. Throughout this Management’s Discussion and Analysis, AIG presents its operations in the way it believes will be most meaningful. Statutory loss ratios and combined ratios are presented in accordance with accounting principles prescribed by insurance regulatory authorities because these are standard measures of performance filed with insurance regulatory authorities and used for analysis in the insurance industry and thus allow more meaningful comparisons with AIG’s insurance competitors. AIG has also incorporated into this discussion cross-references to additional information included in this Quarterly Report on Form 10-Q and in the 2006 Annual Report on Form 10-K to assist readers seeking related information on a particular subject.
Overview of Operations
and Business Results
AIG identifies its reportable segments by product or service line, consistent with its management structure. AIG’s segments are General Insurance, Life Insurance & Retirement Services, Financial Services and Asset Management. AIG’s operations in 2007 and 2006 were conducted by its subsidiaries through these segments. Through these segments, AIG provides insurance, financial and investment products and services to both businesses and individuals in more than 130 countries and jurisdictions. This geographic, product and service diversification is one of AIG’s major strengths and sets it apart from its competitors. AIG’s Other category consists of items not allocated to AIG’s operating segments.
     AIG’s subsidiaries serve commercial, institutional and individual customers through an extensive property-casualty and life insurance and retirement services network. In the United States, AIG companies are the largest underwriters of commercial and industrial insurance and are among the largest life insurance and retirement services operations as well. AIG’s Financial Services businesses include commercial aircraft and equipment leasing, capital markets operations and consumer finance, both in the United States and abroad. AIG also provides asset management services to institutions and individuals. As part of its spread-based business activities, AIG issues various debt instruments in the public and private markets.
Outlook
The following paragraphs supplement and update the information and discussion included in Management’s Discussion and Analysis of Financial Condition and Results of Operations — Outlook, in the 2006 Annual Report on Form 10-K to reflect developments in or affecting AIG’s business during 2007.
     The commercial property and casualty insurance industry has historically experienced cycles of price erosion followed by rate strengthening as a result of catastrophes or other significant losses that affect the overall capacity of the industry to provide coverage. Despite industry price erosion in commercial lines, AIG expects to continue to identify profitable opportunities and build attractive new general insurance businesses as a result of AIG’s broad product line and extensive distribution networks in the U.S. and abroad.
     Workers compensation remains under considerable pricing pressure, as statutory rates continue to decline. Rates for excess casualty, D&O and certain other lines of insurance also continue to decline due to competitive pressures. There can be no assurance that price erosion will not become more widespread or that AIG’s profitability will not deteriorate from current levels in major commercial lines; however, AIG seeks to mitigate this risk by constantly seeking out profitable opportunities across its diverse product lines and distribution networks.
     In AIG’s Foreign Retirement Services business, the continued weak yen has resulted in higher than normal surrenders and that trend, if prolonged, could further accelerate the amortization of deferred acquisition costs (DAC). Similarly, in the Domestic Retirement Services business, the flat yield curve and the age of the in-force blocks of individual fixed annuities could result in an acceleration of surrender activity as early as 2008.
     In Japan, the National Tax Authority in cooperation with the Life Insurance Association of Japan is reviewing the tax treatment for increasing term life insurance, which may affect the amount of premiums that qualify as tax deductions for business owners. As a result of this review, AIG’s life insurance companies in Japan suspended the sale of increasing term life insurance from early April 2007. This action will have an adverse effect on life insurance sales in the second half of 2007. AIG companies in Japan have taken several measures aimed at increasing sales of other products in the Japanese market, in particular sales of U.S. dollar life insurance products.
     In March 2007, the U.S. Treasury Department published proposed new regulations that, if adopted in their current form, would limit the ability of U.S. taxpayers to claim foreign tax credits in certain circumstances under the Internal Revenue Code. Should the proposed regulations be adopted in their current form, they would limit AIG’s ability to claim foreign tax credits in connection with certain structured transactions entered into by AIG Financial Products Corp. and AIG Trading Group Inc. and their respective subsidiaries (collectively, AIGFP), resulting in a material adverse effect on AIGFP’s operating results.
     The U.S. residential mortgage market is experiencing serious disruption due to deterioration in the credit quality of loans originated to non-prime and subprime borrowers,

29


Table of Contents

American International Group, Inc. and Subsidiaries
evolving changes in the regulatory environment and a slower residential housing market. AIG participates in the U.S. residential mortgage market in several ways: American General Finance, Inc. (AGF) extends first and second-lien mortgage loans to buyers and owners of residential housing; United Guaranty Corporation (UGC) provides mortgage guaranty insurance for first and second-lien residential mortgages; AIG insurance and financial services subsidiaries invest in mortgage-backed securities and collateralized debt obligations (CDOs) in which the underlying collateral is composed in whole or in part of residential mortgage loans; and AIGFP provides credit protection through credit default swaps on certain senior tranches of such CDOs. The operating results of AIG’s consumer finance and mortgage guaranty operations in the United States have been and are likely to continue to be adversely affected by the factors referred to above. The downward cycle in the U.S. housing market is not expected to improve until residential inventories return to a more normal level and the mortgage credit market stabilizes. AIG expects that this downward cycle will continue to adversely affect UGC’s operating results for the foreseeable future, although UGC is beginning to experience improved credit quality trends on new production. The effect of the downward cycle in the U.S. housing market on AIG’s other operations, investment portfolio and overall consolidated financial position, is not expected to be material due to AIG’s disciplined underwriting and active risk management, as well as the high credit ratings for assets collateralized by subprime and non-prime mortgages and the structural protections against loss afforded AIG by its senior position in the investments and exposures that it holds.
     In recent quarters, AIG’s returns from partnerships and other alternative investments have been particularly strong, driven by favorable equity market performance and credit conditions. These returns may vary significantly from period to period. AIG believes that the particularly strong performance in recent periods is not indicative of the returns to be expected from this asset class in future periods.
Consolidated Results
The following table summarizes AIG’s consolidated revenues, income before income taxes, minority interest and cumulative effect of an accounting change and net income:
                                                 
 
    Three Months       Six Months    
    Ended June 30,   Percentage   Ended June 30,   Percentage
        Increase/       Increase/
(in millions)   2007   2006   (Decrease)   2007   2006   (Decrease)
 
Total revenues
  $ 31,150     $ 26,854       16 %   $ 61,795     $ 54,132       14 %
 
Income before income taxes, minority interest and cumulative effect of an accounting change
    6,328       5,241       21       12,500       10,034       25  
 
Net income
  $ 4,277     $ 3,190       34 %   $ 8,407     $ 6,385       32 %
 
     AIG’s consolidated revenues for the three and six-month periods ended June 30, 2007 increased compared to the same periods in 2006 as revenues increased in each of AIG’s operating segments.
     AIG’s consolidated income before income taxes, minority interest and cumulative effect of an accounting change increased in the three and six-month periods ended June 30, 2007 compared to the same periods in 2006. During the three months ended June 30, 2007, growth was experienced in all operating segments compared to the same period in 2006. For the six months ended June 30, 2007 operating income grew in all operating segments with the exception of Life Insurance & Retirement Services, which declined marginally due to higher net realized capital losses. Operating income for the three and six-month periods ended June 30, 2007 reflects significant increases from the comparable periods in 2006 related to differences in the accounting treatment for hedging activities. In the first six months of 2007, AIGFP applied hedge accounting to certain of its interest rate swaps and foreign currency forward contracts hedging its investments and borrowings. As a result, AIGFP was able to recognize in earnings the change in the fair value on the hedged items attributable to the hedged risks, offsetting the gains and losses on the derivatives designated as hedges. In 2006, AIGFP did not apply hedge accounting under FAS 133 to any of its derivatives or related assets and liabilities.
     During the three months ended June 30, 2007, AIG recorded certain out of period adjustments. These adjustments collectively decreased pre-tax operating income in that quarter by $334 million and net income by $139 million. The adjustments were comprised of a charge of $431 million ($280 million after tax) in Capital Markets, including $380 million ($247 million after tax) to reverse net gains on transfers of investment securities among legal entities consolidated within AIGFP into Accumulated other comprehensive income; a $78 million decrease in income tax expense related to the remediation of the material weakness in controls over income tax accounting; $27 million ($18 million after tax) of net realized capital gains relating to foreign exchange; and $70 million of additional income primarily relating to other remediation activities ($45 million after tax).
     For the six months ended June 30, 2007, out of period adjustments collectively decreased pre-tax operating income by $495 million ($373 million after tax). The adjustments were comprised of a charge of $380 million ($247 million after tax) discussed above; $51 million of additional income tax expense related to the aforementioned remediation

30


Table of Contents

American International Group, Inc. and Subsidiaries
activities; $74 million ($48 million after tax) of net realized capital gains related to foreign exchange; and $189 million ($123 million after tax) of additional expense, primarily relating to other remediation activities.
     During the second quarter of 2006, as part of its remediation efforts, AIG identified and recorded an out of period adjustment related to the accounting for UCITS in accordance with FIN 46(R), “Consolidation of Variable Interest Entities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” These investments had previously been accounted for as available for sale securities, with changes in market values being reflected in Accumulated other comprehensive income, net of deferred income taxes. Beginning with the second quarter of 2006, the changes in market values are included in Net investment income. For the three and six-month periods ended June 30, 2006, the effect on the Consolidated Statement of Comprehensive Income (Loss) was decreases of $576 million and $537 million, respectively, in Unrealized appreciation (depreciation) of investments — net of reclassification adjustments, and increases of $202 million and $188 million, respectively, in the related Deferred income tax benefit (expense). For the three and six-month periods ended June 30, 2006, the effect on the Consolidated Statement of Income was increases of $653 million and $608 million, respectively, in Net investment income, increases of $77 million and $71 million, respectively, in Incurred policy losses and benefits, related to certain participating policyholder funds, and increases in Income taxes of $202 and $188 million, respectively. There was no effect on Total shareholders’ equity at June 30, 2006.
     In the second quarter of 2006, AIG recorded other out of period adjustments of $85 million ($55 million after tax) of interest income related to interest earned on deposit contracts and $199 million ($150 million after tax) of expenses related to the remediation of a material weakness in controls over certain balance sheet reconciliations and other remediation-related activities.
     For the six months ended June 30, 2006, out of period adjustments collectively increased pre-tax operating income by $23 million and reduced net income by $67 million. The adjustments were comprised of $537 million ($349 million after tax) of additional investment income related to the accounting for UCITS; $300 million ($145 million after tax) of charges related to the remediation of a material weakness in accounting for certain derivative transactions under FAS 133; $126 million of additional income tax expense related to the aforementioned remediation activities; $85 million ($55 million after tax) of interest income related interest earned on deposit contracts; $61 million (before and after tax) of expenses related to the Starr International Company, Inc. (SICO) Deferred Compensation Profit Participation Plans (SICO Plans); $59 million ($38 million after tax) of expenses related to deferred advertising costs; and $179 million ($101 million after tax) of additional expense, primarily related to other remediation activities.
     Results for the first six months of 2006 were also negatively affected by a one-time charge relating to the C.V. Starr & Co., Inc. (Starr) tender offer ($54 million before and after tax) and an additional allowance for losses in AIG Credit Card Company (Taiwan) ($88 million before and after tax), both of which were recorded in first quarter of 2006.
     Since March 31, 2006, through its continued remediation efforts, AIG identified additional out of period adjustments relating to the three and six months ended June 30, 2006 that increased (decreased) net income by $(45) million and $76 million, respectively. These items primarily relate to AIG’s ongoing remediation of internal controls over accounting for UCITS and reconciliation of balance sheet accounts.
     The effective income tax rate decreased from 30.1 percent for the full year of 2006 to 26.5 percent and 27.2 percent for the three and six-month periods ended June 30, 2007, respectively, primarily due to the benefits from remediation adjustments and the recognition of tax benefits associated with the SICO Plans for which the compensation expense had been recognized in prior years. Such tax benefits amounted to $97 million and $143 million, respectively, for the three and six-month periods ended June 30, 2007.

31


Table of Contents

American International Group, Inc. and Subsidiaries
Segment Results
The following table summarizes AIG’s operations by major operating segment. (See also Note 2 of Notes to Consolidated Financial Statements.)
                                                   
 
    Three Months       Six Months    
    Ended June 30,   Percentage   Ended June 30,   Percentage
        Increase/       Increase/
(in millions)   2007   2006   (Decrease)   2007   2006   (Decrease)
 
Revenues(a):
                                               
 
General Insurance(b)(c)
  $ 12,928     $ 12,167       6 %   $ 25,831     $ 23,823       8 %
 
Life Insurance & Retirement Services(c)(d)
    14,023       11,911       18       27,705       24,761       12  
 
Financial Services(e)(f)
    2,123       1,246       70       4,324       2,912       48  
 
Asset Management(g)
    1,989       1,515       31       3,897       2,654       47  
 
Other
    263       138       91       394       228       73  
 
Consolidation and eliminations
    (176 )     (123 )           (356 )     (246 )      
 
Consolidated
  $ 31,150     $ 26,854       16 %   $ 61,795     $ 54,132       14 %
 
Operating income (loss)(a)(h):
                                               
 
General Insurance(c)
  $ 2,976     $ 2,863       4 %   $ 6,072     $ 5,194       17 %
 
Life Insurance & Retirement Services(c)
    2,620       2,381       10       4,901       5,011       (2)  
 
Financial Services(f)
    47       (530 )           339       (638 )      
 
Asset Management
    1,128       785       44       2,122       1,234       72  
 
Other
    (460 )     (258 )           (930 )     (767 )      
 
Consolidation and eliminations
    17                   (4 )            
 
Consolidated
  $ 6,328     $ 5,241       21 %   $ 12,500     $ 10,034       25 %
 
(a) Includes gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS 133), including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, respectively, the effect was $(430) million and $(1.08) billion in both revenues and operating income. For the six-month periods ended June 30, 2007 and 2006, respectively, the effect was $(882) million and $(1.30) billion in both revenues and operating income. These amounts result primarily from interest rate and foreign currency derivatives that are hedging investments and borrowings. These gains (losses) for the three and six months ended June 30, 2007 include out of period charges of $431 million and $326 million, respectively, including a $380 million charge in both periods to reverse net gains recognized on transfers of available for sale securities among legal entities consolidated within AIGFP. The first six months of 2006 include an out of period charge of $300 million related to the remediation of the material weakness in accounting for certain derivative transactions under FAS 133.
(b) Represents the sum of General Insurance net premiums earned, net investment income and net realized capital gains (losses).
(c) Includes the effect of an out of period UCITS adjustment in the second quarter of 2006. For the three and six-month periods ended June 30, 2006, the effect was an increase of $432 million and $405 million, respectively, in both revenues and operating income for General Insurance and an increase of $221 million and $203 million, respectively, in revenues and $144 million and $132 million, respectively, in operating income for Life Insurance & Retirement Services.
(d) Represents the sum of Life Insurance & Retirement Services premiums and other considerations, net investment income and net realized capital gains (losses). Included in net realized capital gains (losses) and operating income are gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, which were $41 million and $73 million for the three-month periods ended June 30, 2007 and 2006, respectively, and $(82) million and $425 million for the six-month periods ended June 30, 2007 and 2006, respectively. Also included in net realized capital gains (losses) was the application of FAS 52, the effects of which were $(24) million and $(94) million for the three-month periods ended June 30, 2007 and 2006, respectively, and $99 million and $(90) million for the six-month periods ended June 30, 2007 and 2006, respectively.
(e) Primarily represents interest, lease and finance charges.
(f) Includes gains (losses) from hedging activities that did not qualify for hedge accounting treatment under FAS 133, including the related foreign exchange gains and losses. For the three-month periods ended June 30, 2007 and 2006, respectively, the effect was $(443) million, and $(1.1) billion in both revenues and operating income. For the six-month periods ended June 30, 2007 and 2006, respectively, the effect was $(603) million and $(1.8) billion in both revenues and operating income. These amounts result primarily from interest rate and foreign currency derivatives that are effective economic hedges of investments and borrowings. The second quarter and the first six months of 2007 include the out of period charges of $431 million and $326 million, respectively, as discussed above. The first six months of 2006 include an out of period charge of $300 million as discussed above. In the first quarter of 2007, AIG began applying hedge accounting for certain transactions, primarily in its Capital Markets operations. In the second quarter of 2007, AGF and ILFC began applying hedge accounting to most of their derivatives hedging interest rate and foreign exchange risks associated with their floating rate and foreign currency denominated borrowings.
(g) Represents net investment income with respect to spread-based products and management and advisory fees.
(h) Represents income before income taxes, minority interest and cumulative effect of an accounting change.
General Insurance
AIG’s General Insurance operations provide property and casualty products and services throughout the world. Foreign operations provided approximately 29 percent and 36 percent of General Insurance operating income for the three months ended June 30, 2007 and 2006, respectively, and approximately 29 percent and 33 percent for the six months ended June 30, 2007 and 2006, respectively. The increase in General Insurance operating income in the three and six-month periods ended June 30, 2007 compared to the same periods in 2006 was primarily attributable to improved underwriting results for the Domestic Brokerage Group (DBG) and higher net investment income, partially offset by losses from the Mortgage Guaranty business.
Life Insurance & Retirement Services
AIG’s Life Insurance & Retirement Services operations provide insurance, financial and investment products throughout the world. Foreign operations provided approximately 63 percent and 73 percent of Life Insurance & Retirement Services operating income for the three months ended June 30, 2007 and 2006, respectively, and approximately 60 percent and 68 percent for the six months ended June 30, 2007 and 2006, respectively. Operating income for the three months ended June 30, 2007 grew compared to the same period in 2006 primarily due to higher income from partnerships, credit-linked notes and call and

32


Table of Contents

American International Group, Inc. and Subsidiaries
tender activity (other yield enhancement income) and growth in the underlying business. For the six months ended June 30, 2007, operating income declined 2 percent compared to the same period in 2006 due to charges related to balance sheet reconciliation remediation, an industry-wide claims review in Japan, the effect of SOP 05-1 and realized capital losses.
Financial Services
AIG’s Financial Services subsidiaries engage in diversified activities including aircraft and equipment leasing, capital markets, consumer finance and insurance premium finance.
     Financial Services operating income increased in the three and six-month periods ended June 30, 2007 compared to the same periods of 2006 primarily due to differences in the accounting treatment for hedging activities. In the first quarter of 2007, AIGFP applied hedge accounting to certain of its interest rate swaps and foreign currency forward contracts hedging its investments and borrowings. In the second quarter of 2007, AGF and International Lease Finance Corporation (ILFC) began applying hedge accounting to most of their derivatives hedging interest rate and foreign currency denominated borrowings. Prior to 2007, hedge accounting under FAS 133 was not being applied to any of AIG’s derivatives and related assets and liabilities. Accordingly, revenues and operating income were exposed to volatility resulting from differences in the timing of revenue recognition between the derivatives and the hedged assets and liabilities.
     In the second quarter and first six months of 2007, the domestic consumer finance operations recorded pre-tax charges of $50 million and $178 million, respectively, representing the estimated cost of implementing the Supervisory Agreement entered into with the Office of Thrift Supervision (OTS), which are discussed in the Consumer Finance results of operations section.
Asset Management
AIG’s Asset Management operations include institutional and retail asset management, broker-dealer services and institutional spread-based investment businesses. The Matched Investment Program (MIP) has replaced the GIC program as AIG’s principal institutional spread-based investment activity.
     Asset Management operating income increased for the three-month period ended June 30, 2007 compared to the same period in 2006 primarily due to higher investment gains, including a realized capital gain of $398 million on the sale of a portion of AIG’s investment in Blackstone Group, LP in connection with its initial public offering. Asset Management operating income increased for the six-month period ended June 30, 2007 compared to the same period in 2006 due to the aforementioned investment gains as well as growth in both the Spread-Based Investment business and the Institutional Asset Management business. Gains and losses arising from the consolidation of certain partnerships, private equity investments and real estate funds are included in Operating income, but are offset in Minority interest expense, which is not a component of operating income.
Capital Resources
In the first six months of 2007, AIG issued $4.49 billion of junior subordinated debentures in four series of securities. Substantially all of the proceeds from these sales, net of expenses, are being used to repurchase shares of AIG’s common stock.
     At June 30, 2007, AIG had total consolidated shareholders’ equity of $104.3 billion and total consolidated borrowings of $165.3 billion. At that date, $148.1 billion of such borrowings were not guaranteed by AIG, were matched borrowings by AIG Parent or AIGFP, or represented junior subordinated debt or liabilities connected to trust preferred stock.
     In February 2007, AIG’s Board of Directors increased AIG’s share repurchase program by authorizing the repurchase of shares with an aggregate purchase price of $8 billion. Share repurchases during 2007 are described under Capital Resources and Liquidity — Share Repurchases and in Item 2. of Part II of this Quarterly Report on Form 10-Q.
Liquidity
AIG manages liquidity at both the subsidiary and parent company levels. At June 30, 2007, AIG’s consolidated invested assets, primarily held by its subsidiaries, included $29.4 billion in cash and short-term investments. Consolidated net cash provided from operating activities in the first six months of 2007 amounted to $15.1 billion. Management believes that AIG’s liquid assets, cash provided by operations and access to the capital markets will enable it to meet its anticipated cash requirements, including the funding of increased dividends under AIG’s new dividend policy and repurchases of common stock.
Critical Accounting Estimates
AIG considers its most critical accounting estimates to be those relating to reserves for losses and loss expenses, future policy benefits for life and accident and health contracts, recoverability of DAC, estimated gross profits for investment-oriented products, fair value determinations for certain Capital Markets assets and liabilities, other-than-temporary declines in the value of investments and flight equipment recoverability. These accounting estimates require the use of assumptions about matters, some of which are highly uncertain at the time of estimation. To the extent actual experience differs from the assumptions used, AIG’s results of operations would be directly affected.
     Throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations, AIG’s

33


Table of Contents

American International Group, Inc. and Subsidiaries
critical accounting estimates are discussed in detail. The major categories for which assumptions are developed and used to establish each critical accounting estimate are highlighted below.
Reserves for Losses and Loss Expenses
(General Insurance):
Loss trend factors: used to establish expected loss ratios for subsequent accident years based on premium rate adequacy and the projected loss ratio with respect to prior accident years.
 
Expected loss ratios for the latest accident year: in this case, accident year 2007 for the loss reserve analyses updated through June 30, 2007. For low-frequency, high-severity classes such as excess casualty, expected loss ratios generally are utilized for at least the three most recent accident years.
 
Loss development factors: used to project the reported losses for each accident year to an ultimate amount.
 
Reinsurance recoverable on unpaid losses: the expected recoveries from reinsurers on losses that have not yet been reported and/or settled.
Future Policy Benefits for Life and Accident and Health Contracts (Life Insurance & Retirement Services):
Interest rates: which vary by geographical region, year of issuance and products.
 
Mortality, morbidity and surrender rates: based upon actual experience by geographical region modified to allow for variation in policy form, risk classification and distribution channel.
Estimated Gross Profits (Life Insurance & Retirement Services):
Estimated gross profits: to be realized over the estimated duration of the contracts (investment-oriented products) affect the carrying value of DAC, unearned revenue liability and associated amortization patterns under FAS 97 and Sales Inducement Assets under Statement of Position 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (SOP 03-1). Estimated gross profits include investment income and gains and losses on investments less required interest, actual mortality and other expenses.
Deferred Policy Acquisition Costs (Life Insurance & Retirement Services):
Recoverability: based on current and future expected profitability, which is affected by interest rates, foreign exchange rates, mortality experience, and policy persistency.
Deferred Policy Acquisition Costs (General Insurance):
Recoverability and eligibility: based upon the current terms and profitability of the underlying insurance contracts.
Fair Value Determinations Of Certain Assets And Liabilities (Financial Services):
Valuation models: utilizing factors, such as market liquidity and current interest, foreign exchange and volatility rates.
 
Market price data: AIG attempts to secure reliable and independent current market price data, such as published exchange rates from external subscription services such as Bloomberg or Reuters or third-party broker quotes for use in its models. When such data is not available, AIG uses an internal methodology, which includes interpolation and extrapolation from verifiable recent prices.
Other-Than-Temporary Declines In The Value Of Investments:
A security is considered a candidate for other-than-temporary impairment if it meets any of the following criteria:
Trading at a significant (25 percent or more) discount to par or amortized cost (if lower) for an extended period of time (nine months or longer);
 
The occurrence of a discrete credit event resulting in the debtor defaulting or seeking bankruptcy or insolvency protection or voluntary reorganization; or
 
The probability of non-realization of a full recovery on its investment, irrespective of the occurrence of one of the foregoing events.
     At each balance sheet date, AIG evaluates its securities holdings in an unrealized loss position. Where AIG does not intend to hold such securities until they have fully recovered their carrying value, based on the circumstances present at the date of evaluation, AIG records the unrealized loss in income. If events or circumstances change, such as unexpected changes in the creditworthiness of the obligor, unanticipated changes in interest rates, tax laws, statutory capital positions and unforeseen liquidity events, among others, AIG revisits its intent. Further, if a loss is recognized from a sale subsequent to a balance sheet date pursuant to these unexpected changes in circumstances, the loss is recognized in the period in which the intent to hold the securities to recovery no longer exists.
     In periods subsequent to the recognition of an other-than-temporary impairment loss for debt securities, AIG amortizes the discount or reduced premium over the remaining life of the security in a prospective manner based on the amount and timing of estimated future cash flows.
Flight Equipment — Recoverability (Financial Services):
Expected undiscounted future net cash flows: based upon current lease rates, projected future lease rates and estimated terminal values of each aircraft based on third party information.

34


Table of Contents

American International Group, Inc. and Subsidiaries
Operating Review
General Insurance Operations
AIG’s General Insurance subsidiaries are multiple line companies writing substantially all lines of property and casualty insurance and various personal lines both domestically and abroad.
     Domestic General Insurance operations are comprised of DBG, Reinsurance, Personal Lines and Mortgage Guaranty businesses.
     DBG writes substantially all classes of business insurance, accepting such business mainly from insurance brokers. This provides DBG the opportunity to select specialized markets and retain underwriting control. Any licensed broker is able to submit business to DBG without the traditional agent-company contractual relationship, but such broker usually has no authority to commit DBG to accept a risk.
     Transatlantic Holdings, Inc. (Transatlantic) subsidiaries offer reinsurance capacity on both a treaty and facultative basis both in the U.S. and abroad. Transatlantic structures programs for a full range of property and casualty products with an emphasis on specialty risk.
     AIG’s Personal Lines operations provide automobile insurance through AIG Direct, a mass marketing operation, the Agency Auto Division and 21st Century, as well as a broad range of coverages for high net worth individuals through the AIG Private Client Group.
     The main business of the UGC subsidiaries is the issuance of residential mortgage guaranty insurance on conventional first-lien mortgages for the purchase or refinance of one to four family residences. UGC subsidiaries also write second-lien and private student loan guaranty insurance.
     AIG’s Foreign General Insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance companies. The Foreign General Insurance group also includes business written by AIG’s foreign-based insurance subsidiaries.

35


Table of Contents

American International Group, Inc. and Subsidiaries
General Insurance Results
General Insurance operating income is comprised of statutory underwriting results, changes in DAC, net investment income and net realized capital gains and losses.
Operating income, as well as net premiums written, net premiums earned, net investment income and net realized capital gains (losses) and statutory ratios were as follows:
________________________________________________________________________________
                                                     
    Three Months       Six Months    
    Ended June 30,   Percentage   Ended June 30,   Percentage
        Increase/       Increase/
(in millions, except ratios)   2007   2006   (Decrease)   2007   2006   (Decrease)
 
Net premiums written:
                                               
 
Domestic General
                                               
   
DBG
  $ 6,439     $ 6,476       (1 )%   $ 12,448     $ 12,336       1 %
   
Transatlantic(a)
    983       914       8       1,967       1,828       8  
   
Personal Lines
    1,203       1,180       2       2,432       2,378       2  
   
Mortgage Guaranty
    272       193       41       538       390       38  
 
Foreign General(a)
    3,242       2,871       13       6,860       5,957       15  
 
Total
  $ 12,139     $ 11,634       4 %   $ 24,245     $ 22,889       6 %
 
Net premiums earned:
                                               
 
Domestic General
                                               
   
DBG
  $ 5,996     $ 5,818       3 %   $ 11,977     $ 11,587       3 %
   
Transatlantic(a)
    948       909       4       1,913       1,817       5  
   
Personal Lines
    1,168       1,167             2,323       2,326        
   
Mortgage Guaranty
    221       179       23       431       345       25  
 
Foreign General(a)
    3,030       2,605       16       5,938       5,073       17  
 
Total
  $ 11,363     $ 10,678       6 %   $ 22,582     $ 21,148       7  
 
Net investment income:
                                               
 
Domestic General
                                               
   
DBG
  $ 984     $ 813       21 %   $ 2,017     $ 1,558       29  
   
Transatlantic
    119       108       10       235       210       12  
   
Personal Lines
    57       55       4       114       112       2  
   
Mortgage Guaranty
    39       36       8       76       68       12  
 
Foreign General(b)
    427       602       (29 )     746       784       (5 )
Reclassifications and Eliminations
    2                   3              
 
Total
  $ 1,628     $ 1,614       1 %   $ 3,191     $ 2,732       17 %
 
Net realized capital gains (losses)
  $ (63 )   $ (125 )     (50 )%   $ 58     $ (57 )     %
 
Operating Income (loss)(c):
                                               
 
Domestic General
                                               
   
DBG
  $ 1,904     $ 1,474       29 %   $ 3,833     $ 2,779       38 %
   
Transatlantic
    168       143       17       319       284       12  
   
Personal Lines
    118       118             224       219       2  
   
Mortgage Guaranty
    (81 )     107             (73 )     216        
 
Foreign General(b)(d)(e)
    867       1,021       (15 )     1,776       1,694       5  
Reclassifications and Eliminations
                      (7 )     2        
 
Total
  $ 2,976     $ 2,863       4 %   $ 6,072     $ 5,194       17 %
 
Statutory underwriting profit (loss)(c)(f) :
                                               
 
Domestic General
                                               
   
DBG
  $ 946     $ 641       48 %   $ 1,730     $ 1,125       54 %
   
Transatlantic
    37       33       12       53       63       (16 )
   
Personal Lines
    56       53       6       89       93       (4 )
   
Mortgage Guaranty
    (126 )     73             (168 )     143        
 
Foreign General(d)(e)
    371       423       (12 )     773       756       2  
 
Total
  $ 1,284     $ 1,223       5 %   $ 2,477     $ 2,180       14 %
 
Domestic General(c):
                                               
 
Loss Ratio
    68.2       68.6               68.5       70.1          
 
Expense Ratio
    19.6       19.8               20.3       20.0          
       
Combined Ratio
    87.8       88.4               88.8       90.1          
       
Foreign General(c):
                                               
 
Loss Ratio(a)(e)
    52.1       47.1               51.4       48.9          
 
Expense Ratio(d)
    33.3       33.3               30.8       30.8          
       
Combined ratio
    85.4       80.4               82.2       79.7          
       
Consolidated(d):
                                               
 
Loss Ratio
    63.9       63.4               64.0       65.0          
 
Expense Ratio
    23.2       23.1               23.3       22.8          
       
Combined Ratio
    87.1       86.5               87.3       87.8          
       
(a)  Income statement accounts expressed in non-functional currencies are translated into U.S. dollars using average exchange rates.
(b)  The three and six-month periods ended June 30, 2006 include increases of $412 million and $386 million, respectively, relating to an out of period UCITS adjustment recorded in the second quarter of 2006.
(c)  Includes additional losses incurred and net reinstatement premiums related to prior year catastrophes of $18 million and $(51) million in the three-month periods ended June 30, 2007 and 2006, respectively, and $53 million and $48 million in the six-month periods ended June 30, 2007 and 2006, respectively.
(d)  Includes the results of wholly owned Foreign General agencies.
(e)  Includes losses incurred and net reinstatement premiums related to current year catastrophes of $68 million in both the three and six-month periods ended June 30, 2007.

36


Table of Contents

American International Group, Inc. and Subsidiaries
(f)  Statutory underwriting profit (loss) is a measure that U.S. domiciled insurance companies are required to report to their regulatory authorities. The following table reconciles statutory underwriting profit (loss) to operating income for General Insurance:
                                                           
 
    Domestic    
    Brokerage       Personal   Mortgage   Foreign   Reclassifications    
(in millions)   Group   Transatlantic   Lines   Guaranty   General   and Eliminations   Total
 
Three Months Ended June 30, 2007:
                                                       
 
Statutory underwriting profit (loss)
  $ 946     $ 37     $ 56     $ (126 )   $ 371     $     $ 1,284  
 
Increase (decrease) in DAC
    50       10       7       9       51             127  
 
Net investment income
    984       119       57       39       427       2       1,628  
 
Net realized capital gains (losses)
    (76 )     2       (2 )     (3 )     18       (2 )     (63 )
 
Operating income (loss)
  $ 1,904     $ 168     $ 118     $ (81 )   $ 867     $     $ 2,976  
 
Three Months Ended June 30, 2006:
                                                       
 
Statutory underwriting profit (loss)
  $ 641     $ 33     $ 53     $ 73     $ 423     $     $ 1,223  
 
Increase (decrease) in DAC
    64       4       9       1       73             151  
 
Net investment income
    813       108       55       36       602             1,614  
 
Net realized capital gains (losses)
    (44 )     (2 )     1       (3 )     (77 )           (125 )
 
Operating income (loss)
  $ 1,474     $ 143     $ 118     $ 107     $ 1,021     $     $ 2,863  
 
Six Months Ended June 30, 2007:
                                                       
 
Statutory underwriting profit (loss)
  $ 1,730     $ 53     $ 89     $ (168 )   $ 773     $     $ 2,477  
 
Increase (decrease) in DAC
    85       14       22       21       204             346  
 
Net investment income
    2,017       235       114       76       746       3       3,191  
 
Net realized capital gains (losses)
    1       17       (1 )     (2 )     53       (10 )     58  
 
Operating income (loss)
  $ 3,833     $ 319     $ 224     $ (73 )   $ 1,776     $ (7 )   $ 6,072  
 
Six Months Ended June 30, 2006:
                                                       
 
Statutory underwriting profit (loss)
  $ 1,125     $ 63     $ 93     $ 143     $ 756     $     $ 2,180  
 
Increase (decrease) in DAC
    93       7       14       8       217             339  
 
Net investment income
    1,558       210       112       68       784             2,732  
 
Net realized capital gains (losses)
    3       4             (3 )     (63 )     2       (57 )
 
Operating income (loss)
  $ 2,779     $ 284     $ 219     $ 216     $ 1,694     $ 2     $ 5,194  
 
AIG transacts business in most major foreign currencies. The following table summarizes the effect of changes in foreign currency exchange rates on the growth of General Insurance net premiums written:
                                 
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
    2007   2006   2007   2006
 
Growth in original currency*
    3.3 %     9.7 %     4.7 %     7.9 %
Foreign exchange effect
    1.0       (0.4 )     1.2       (1.1 )
 
Growth as reported in U.S. dollars
    4.3 %     9.3 %     5.9 %     6.8 %
 
Computed using a constant exchange rate throughout each period.
Quarterly General Insurance Results
General Insurance operating income increased in the three months ended June 30, 2007 compared to the same period in 2006. The 2007 combined ratio increased to 87.1, an increase of 0.6 points over 2006, including an increase in the loss ratio of 0.5 points. Prior year development and increases in the loss reserve discount reduced incurred losses by $212 million and $248 million for the three months ended June 30, 2007 and 2006, respectively, accounting for 0.5 points of the increase. The loss ratio for accident year 2007 recorded in the three months ended June 30, 2007 was substantially the same as the loss ratio recorded in the three months ended June 30, 2006 for accident year 2006, despite a $68 million loss from the June 2007 U.K. floods and an increase in Mortgage Guaranty losses in the 2007 period. The downward cycle in the U.S. housing market is not expected to improve until residential inventories return to a more normal level, and AIG expects that this downward cycle will continue to adversely affect UGC’s loss ratios for the foreseeable future. Net premiums written increased for the three months ended June 30, 2007 compared to the same period in 2006, driven by Foreign General growth from both established and new distribution channels and the effect of changes in foreign currency exchange rates.
     General Insurance net investment income was essentially unchanged for the three months ended June 30, 2007 compared to the same period in 2006. Interest and dividend income increased $138 million for the second quarter of 2007 compared to the same period in 2006 as investment in fixed maturities and equity securities increased by $11.9 billion and the yield on interest earning investments remained consistent at 4.6 percent. Income from partnership investments increased $120 million for the three months ended June 30, 2007 compared to the same period in 2006, primarily due to improved returns on underlying investments. Other investment income decreased $250 million, primarily

37


Table of Contents

American International Group, Inc. and Subsidiaries
due to the effect of the $432 million out of period adjustment related to the accounting for UCITS recorded in 2006.
Year-to-Date General Insurance Results
General Insurance operating income increased for the first six months of 2007 compared to the same period in 2006 due to growth in net investment income and an increase in underwriting profit, which is reflected in the combined ratio. The combined ratio improved to 87.3, a reduction of 0.5 points from 2006, including an improvement in the loss ratio of 1.0 point. Prior year development and increases in the loss reserve discount reduced incurred losses by $343 million and $213 million for the first six months of 2007 and 2006, respectively, accounting for 0.5 points of the improvement in the loss ratio. The loss ratio for accident year 2007 recorded in the first six months of 2007 was 0.5 points lower than the loss ratio recorded in the first six months of 2006 for accident year 2006, despite the loss from the June 2007 U.K. floods and an increase in Mortgage Guaranty losses in the 2007 period.
     General Insurance net premiums written increased in the first six months of 2007 compared to the same period in 2006, reflecting growth in Foreign General from both established and new distribution channels, the effect of changes in foreign currency exchange rates, and growth in Mortgage Guaranty, primarily from international business.
     General Insurance net investment income increased in the first six months of 2007 to $3.2 billion. Interest and dividend income increased $333 million for the first six months of 2007 compared to the same period of 2006 as fixed maturities and equity securities increased by $11.9 billion and the yield remained consistent at 4.6 percent. Income from partnership investments increased $302 million for the first six months of 2007 compared to the same period in 2006, primarily due to improved returns on underlying investments and higher levels of invested assets, which increased by $1.3 billion. Other investment income decreased by $154 million, which reflects the effect of the $405 million out of period UCITS adjustment recorded in 2006. See also Capital Resources and Liquidity — Liquidity and Invested Assets herein.
     In order to better align financial reporting with the manner in which AIG’s chief operating decision makers have managed their businesses, commencing in the first quarter of 2007, the foreign aviation business, which was historically reported in DBG, is now being reported as part of Foreign General, and the oil rig and marine businesses, which were historically reported in Foreign General, are now being reported as part of DBG. Prior period amounts have been revised to conform to the current presentation.
Quarterly DBG Results
DBG’s operating income increased in the three months ended June 30, 2007 compared to the same period of 2006. The improvement is also reflected in the combined ratio, which declined 3.9 points in the three months ended June 30, 2007 compared to the same period of 2006 primarily due to an improvement in the loss ratio of 3.8 points. The loss ratio for accident year 2007 recorded in the three months ended June 30, 2007 was 2.4 points lower than the loss ratio recorded in the same period of 2006 for accident year 2006. Prior year development and increases in the loss reserve discount reduced incurred losses by $190 million and $106 million for the three months ended June 30, 2007 and 2006, respectively, accounting for 1.4 points of the improvement.
     DBG’s net premiums written declined for the three months ended June 30, 2007 compared to the same period in 2006 due to an increase in ceded premiums and declines in premium rates in casualty lines of business. These declines were partially offset by the renewal of a property reinsurance treaty in 2007 at rates lower than the expiring treaty, resulting in a $52 million increase in net premiums written. Ceded premiums as a percentage of gross written premiums increased to 26 percent for the three months ended June 30, 2007 compared to 24 percent in the same period in 2006, primarily due to additional reinsurance for property risks to manage catastrophe exposures.
     DBG’s expense ratio decreased to 17.5 for the three months ended June 30, 2007 compared to 17.7 in the same period in 2006, primarily due to a decrease in charges related to remediation of the material weakness in balance sheet reconciliations which included a $32 million out of period charge in the second quarter of 2006. This decline was partially offset by increases in expenses for marketing initiatives in 2007.
     DBG’s net investment income increased for the three months ended June 30, 2007 compared to the same period in 2006, as interest income increased $95 million for the three months ended June 30, 2007, on growth in the bond portfolio resulting from investment of operating cash flows and capital contributions. Income from partnership investments increased $44 million for the three months ended June 30, 2007 compared to the same period in 2006, primarily due to improved returns on the underlying investments.
Year-to-date DBG Results
DBG’s operating income increased for the first six months of 2007 compared to the same period in 2006. The improvement is also reflected in the combined ratio, which declined 4.3 points in the first six months of 2007 compared to the same period in 2006, primarily due to an improvement

38


Table of Contents

American International Group, Inc. and Subsidiaries
in the loss ratio of 4.5 points. The loss ratio for accident year 2007 recorded for the first six months of 2007 was 2.5 points lower than the loss ratio recorded in the same period of 2006 for accident year 2006. Prior year development and increases in the loss reserve discount reduced incurred losses by $277 million and $32 million for the three months ended June 30, 2007 and 2006, respectively, accounting for 2.0 points of the improvement.
     DBG’s net premiums written increased in the first six months of 2007 compared to the same period of 2006 due to the strength of AIG’s capacity, commitment during challenging market conditions, diverse product offerings and the acquisition of TravelGuard, which markets accident and health products. Ceded premiums as a percentage of gross written premiums increased to 25 percent in the first six months of 2007 compared to 23 percent for the same period in 2006, primarily due to additional reinsurance for property risks to manage catastrophe exposures.
     DBG’s expense ratio increased to 18.3 for the first six months in 2007 compared to 18.1 in the same period of 2006, due to increases in operating expenses for marketing initiatives and operations as well as changes in the mix of business towards products with lower loss ratios and higher expense ratios.
     DBG’s net investment income increased for the first six months of 2007 compared to the same period in 2006, as interest income increased $225 million for the six months ended June 30, 2007, on growth in the bond portfolio resulting from investment of operating cash flows and capital contributions. Income from partnership investments increased $199 million for the first six months of 2007 compared to the same period in 2006, primarily due to improved returns on the underlying investments.
Quarterly Transatlantic Results
Transatlantic’s net premiums written and net premiums earned increased for the three months ended June 30, 2007 compared to the same period in 2006 due primarily to increased writings in domestic and international operations. Statutory underwriting profit increased due to improved underwriting results from European operations for the three months ended June 30, 2007 compared to the same period in 2006. Operating income increased for the three months ended June 30, 2007 compared to the same period in 2006 due to increased net investment income and improved underwriting results.
Year-to-date Transatlantic Results
Transatlantic’s net premiums written and net premiums earned increased for the first six months of 2007 compared to the same period in 2006 due primarily to increased writings in domestic operations. Statutory underwriting profit was adversely affected by European windstorm and flood losses and storms in Australia, partially offset by lower net adverse development for the six months ended June 30, 2007 compared to the same period in 2006, resulting in an overall decline in statutory underwriting profit for the 2007 period. Operating income increased for the first six months of 2007 compared to the same period in 2006 as increased net investment income and net realized capital gains more than offset the decline in underwriting results.
Quarterly Personal Lines Results
Personal Lines operating income in the three months ended June 30, 2007 compared to the same period of 2006 was unchanged, and reflected a reduction in the loss ratio of 0.5 points. The loss ratio for accident year 2007 recorded for the three months ended June 30, 2007 was 1.5 points lower than the loss ratio recorded for the same period in 2006 for accident year 2006. Prior year development reduced incurred losses by $32 million and $43 million for the three months ended June 30, 2007 and 2006, respectively, increasing the 2007 loss ratio by 1.0 point relative to the 2006 loss ratio. The improvement in the accident year loss ratio is primarily due to favorable loss trends and growth in the Private Client Group. The improvement in the loss ratio along with a decrease in the expense ratio of 0.26 points resulted in an overall improvement of the combined ratio of 0.73 points.
     Net premiums written increased 1.9 percent for the three months ended June 30, 2007 compared to the same period in 2006 due to continued growth in the Private Client Group, partially offset by an 11 percent reduction in Agency Auto.
     On May 15, 2007, AIG and 21st Century Insurance Group entered into a definitive merger agreement providing that AIG will acquire the 21st Century shares it does not currently own at a price of $22.00 per share in cash, for a total purchase price of approximately $813 million. AIG already owns, through its subsidiaries, approximately 60.8 percent of the outstanding shares of 21st Century. Upon completion of the transaction, 21st Century will become a wholly owned subsidiary of AIG.
     The merger is expected to be completed in the third quarter of 2007, subject to customary conditions and approvals. The exact time is dependent on the review and clearance of necessary filings with the SEC, which are in process. The transaction is subject to the affirmative vote of the holders of the majority of the outstanding shares of 21st Century. AIG has agreed to vote or cause to be voted all of its and its subsidiaries’ 21st Century shares in favor of the merger.
Year-to-date Personal Lines Results
The modest increase in Personal Lines operating income in the first six months of 2007 compared to the same period of 2006 reflects a reduction in the loss ratio of 1.0 point. The loss ratio for accident year 2007 recorded for the first six

39


Table of Contents

American International Group, Inc. and Subsidiaries
months of 2007 was 1.0 point lower than the loss ratio recorded in the same period of 2006 for accident year 2006. Prior year development reduced incurred losses by $61 million and $62 million for the six months ended June 30, 2007 and 2006, respectively, resulting in a negligible change in the loss ratio between the periods. The improvement in the accident year loss ratio was primarily due to favorable loss trends and growth in the Private Client Group, partially offset by increased losses in 21st Century. The improvement in the loss ratio was partially offset by an increase in the expense ratio of 0.6 points, primarily due to increased acquisition expenses in connection with the 21st Century merger, growth in the Private Client Group, and reduced premium writings in Agency Auto.
     Net premiums written increased 2.3 percent for the first six months of 2007 compared to the same period in 2006 due to continued growth in the Private Client Group and a modest increase in the Direct business, partially offset by a 10 percent reduction in Agency Auto.
Quarterly Mortgage Guaranty Results
The significant decline in Mortgage Guaranty operating income for the three months ended June 30, 2007 compared to the same period in 2006 was due primarily to unfavorable loss experience in both the domestic first and second-lien businesses as a result of the continued softening in the U.S. housing market. Losses incurred were up significantly across all lines of the domestic Mortgage Guaranty business. UGC’s consolidated loss ratio for the three months ended June 30, 2007 was 129.9 compared to a loss ratio of 33.1 for the same period in 2006. Prior year development reduced incurred losses by $4 million and $52 million for the three months ended June 30, 2007 and 2006, respectively, increasing the 2007 loss ratio by 27.6 points relative to the 2006 loss ratio.
     Net premiums written increased 41 percent in the three months ended June 30, 2007 compared to the same period in 2006 as international premiums were up $50 million, accounting for 26 points of the increase in net premiums written. In addition, first-lien premiums increased by $23 million due to increased use of mortgage insurance for credit enhancement and improved persistency. Although UGC discontinued accepting new business for the poorly performing third-party originated second-lien product in the fourth quarter of 2006, UGC will continue to receive renewal premiums on the existing portfolio for the life of the loans, estimated to be three to five years. The expense ratio of 22.4 in the three months ended June 30, 2007 declined from 24.7 in the same period of 2006 as premium growth offset expenses related to UGC’s international expansion and additional operational resources in the second-lien and private education loan businesses.
     UGC’s domestic mortgage net risk in force totaled $25.9 billion as of June 30, 2007 with a 60-day delinquency ratio of 2.5 percent (based on number of policies, consistent with mortgage insurance industry practice). A significant portion of the mortgage risk is secured by first liens on single family, owner-occupied properties.
Year-to-date Mortgage Guaranty Results
The significant decline in Mortgage Guaranty operating income in the first six months of 2007 compared to the same period in 2006 was due primarily to the unfavorable loss experience in both the domestic first and second-lien businesses. The third-party originated second-lien product continued to perform poorly. UGC’s consolidated loss ratio for the first six months was 111.5 compared to a loss ratio of 31.8 for the same period in 2006. Prior year development increased incurred losses by $27 million in the first six months of 2007 compared to a reduction of $65 million for the same period in 2006, accounting for 25 points of the increase in the loss ratio.
     Net premiums written increased 38 percent in the first six months of 2007 compared to the same period in 2006 as international premiums grew $85 million, accounting for 22 points of the increase in net premiums written. In addition, domestic first-lien premiums increased $36 million for the six months ended June 30, 2007 compared to the same period in 2006 due to the increased use of mortgage insurance for credit enhancement as well as improved persistency. The expense ratio of 22.1 in the first six months of 2007 declined from 23.7 for the same period in 2006 as premium growth offset expenses related to UGC’s international expansion and additional operational resources in the second-lien and private education loan businesses.
Quarterly Foreign General Insurance Results
Foreign General’s operating income decreased in the three months ended June 30, 2007 compared to the same period in 2006 due to decreases in statutory underwriting profit and net investment income, partially offset by increases due to the effect of changes in the currency exchange rates of the Euro and the British Pound. Statutory underwriting profit decreased due to a $68 million loss from the June 2007 U.K. floods. Net investment income in the prior year quarter included the $412 million out of period UCITS adjustment.
     Net premiums written increased 13 percent (9 percent in original currency) for the three months ended June 30, 2007 compared to the same period in 2006, reflecting growth in commercial and consumer lines driven by new business from both established and new distribution channels, including Central Insurance Co. Ltd. in Taiwan, and by greater retention of commercial lines accounts on renewal. Growth in consumer lines in Latin America and Europe and commercial lines in Europe and the U.K. also contributed to

40


Table of Contents

American International Group, Inc. and Subsidiaries
the increase. Net premiums written also increased by one percent compared to the same period in 2006 due to decreases in the use of reinsurance. Net premiums written by the Lloyd’s syndicate Ascot increased for the three months ended June 30, 2007 compared to the same period in 2006. Net premiums written for Aviation declined due to rate decreases resulting from increased market competition.
     The loss ratio increased 5 points for the three months ended June 30, 2007 compared to the same period in 2006. The 2007 loss ratio increased 2.2 points due to the losses from the U.K. floods and increased 0.6 points due to higher asbestos and environmental reserves relating to one case. The 2007 and 2006 loss ratios benefited from favorable loss development on prior accident years, by 0.8 points and 2.7 points, respectively.
     The expense ratio was unchanged for the three months ended June 30, 2007 compared to the same period in 2006. The 2006 expense ratio reflected a profit commission adjustment in Ascot which increased the second quarter 2006 expense ratio by 1.2 points. The comparable increase in the expense ratio in 2007 resulted from higher commission costs and higher operating expenses due to new business initiatives and the cost of realigning certain legal entities through which Foreign General operates. AIG expects the expense ratio to increase during the remainder of 2007 due to the underlying seasonality of renewals and as the consumer lines of business, which have higher acquisition costs, increase in significance as a component of net premiums written.
     Net investment income decreased for the three months ended June 30, 2007 compared to the same period in 2006, as the 2006 period included the out of period UCITS adjustment, which more than offset underlying growth of $237 million in net investment income. Net investment income for the second quarter of 2007 reflected higher interest rates, strong cash flows and increased equity mutual fund and partnership income. Equity mutual fund income was $130 million higher than the same quarter last year reflecting the strong performance in the equity markets, and partnership income was $69 million higher than prior year quarter due to strong infrastructure fund performance in Africa, Europe and Latin America.
Year-to-date Foreign General Insurance Results
Foreign General’s operating income increased in the first six months of 2007 compared to the same period in 2006, due to the effect of changes in the currency exchange rates of the Euro and the British Pound and increased net realized capital gains.
     Net premiums written increased 15 percent (11 percent in original currency) for the six months ended June 30, 2007 compared to the same period in 2006, reflecting growth in commercial and consumer lines driven by new business from both established and new distribution channels, including a wholly owned insurance company in Vietnam and Central Insurance Co., Ltd. in Taiwan, and by greater retention of commercial lines accounts on renewal. Growth in consumer lines in Latin America and commercial lines in Europe and the U.K. also contributed to the increase. Net premiums written also increased by one percent from the same period in 2006 due to decreases in the use of reinsurance.
     The loss ratio increased 2.5 points for the six months ended June 30, 2007 compared to the same period in 2006. The 2007 loss ratio increased 1.1 points due to the losses from the U.K. floods and increased 0.7 points due to severe but non-catastrophic losses. The 2007 and 2006 loss ratios benefited from favorable loss development on prior accident years by 1.5 points and 2.1 points, respectively.
     The expense ratio was unchanged in the six months ended June 30, 2007 compared to the same period in 2006. The expense ratio for 2006 increased by 1.5 points due to a profit commission charge in Ascot and an out of period charge for amortization of deferred advertising costs. This increase in the 2006 expense ratio was offset by higher commission costs and higher operating expenses due to new business initiatives and the realignment costs mentioned above.
     Net investment income decreased for the six months ended June 30, 2007 compared to the same period in 2006, as the 2006 period reflected the out of period UCITS adjustment, which more than offset underlying growth of $348 million in net investment income. Net investment income for the first six months of 2007 reflected higher interest rates, strong cash flows and increased equity mutual fund and partnership income. Equity mutual fund income increased $156 million for the six months ended June 30, 2007 compared to the same period in 2006 reflecting strong performance in the equity markets and partnership income increased $94 million for the six months ended June 30, 2007 compared to the same period in 2006 due to strong infrastructure fund performance in Africa, Europe and Latin America.

41


Table of Contents

American International Group, Inc. and Subsidiaries
Reserve for Losses and Loss Expenses
The following table presents the components of the General Insurance gross reserve for losses and loss expenses (loss reserves) as of June 30, 2007 and December 31, 2006 by major line of business on a statutory Annual Statement basis(a):
                 
 
    June 30,   December 31,
(in millions)   2007   2006(b)
 
Other liability occurrence
  $ 19,961     $ 19,327  
Workers compensation
    14,502       13,612  
Other liability claims made
    13,470       12,513  
Auto liability
    6,137       6,070  
International
    6,100       6,006  
Property
    4,629       5,499  
Reinsurance
    3,152       2,979  
Medical malpractice
    2,330       2,347  
Products liability
    2,181       2,239  
Accident and health
    1,851       1,693  
Commercial multiple peril
    1,744       1,651  
Aircraft
    1,698       1,629  
Fidelity/surety
    1,248       1,148  
Other
    3,076       3,286  
 
Total
  $ 82,079     $ 79,999  
 
(a) Presented by lines of business pursuant to statutory reporting requirements as prescribed by the National Association of Insurance Commissioners.
(b) Allocations among various lines were revised from the previous presentation.
     AIG’s gross reserve for losses and loss expenses represents the accumulation of estimates of ultimate losses, including provisions for losses incurred but not reported (IBNR) and loss expenses. The methods used to determine loss reserve estimates and to establish the resulting reserves are continually reviewed and updated by management. Any adjustments resulting therefrom are reflected in operating income currently. Because loss reserve estimates are subject to the outcome of future events, changes in estimates are unavoidable given that loss trends vary and time is often required for changes in trends to be recognized and confirmed. Reserve changes that increase previous estimates of ultimate cost are referred to as unfavorable or adverse development or reserve strengthening. Reserve changes that decrease previous estimates of ultimate cost are referred to as favorable development.
     At June 30, 2007, General Insurance net loss reserves were $65.20 billion, an increase of $2.57 billion from the prior year-end. The net loss reserves represent loss reserves reduced by reinsurance recoverables, net of an allowance for unrecoverable reinsurance and applicable discount for future investment income.
The following table classifies the components of the General Insurance net loss reserves by business unit:
                 
 
    June 30,   December 31,
(in millions)   2007   2006
 
DBG(a)
  $ 45,650     $ 44,119  
Transatlantic
    6,451       6,207  
Personal Lines(b)
    2,304       2,440  
Mortgage Guaranty
    718       460  
Foreign General(c)
    10,074       9,404  
 
Total Net Loss Reserve
  $ 65,197     $ 62,630  
 
(a) At June 30, 2007 and December 31, 2006, respectively, DBG loss reserves include approximately $3.23 billion and $3.33 billion ($3.50 billion and $3.66 billion, respectively, before discount), related to business written by DBG but ceded to American International Reinsurance Company Limited (AIRCO) and reported in AIRCO’s statutory filings. DBG loss reserves also include approximately $601 million and $535 million related to business included in American International Underwriters Overseas, Ltd.’s (AIUO) statutory filings at June 30, 2007 and December 31, 2006, respectively.
(b) At June 30, 2007 and December 31, 2006, respectively, Personal Lines loss reserves include $826 million and $861 million related to business ceded to DBG and reported in DBG’s statutory filings.
(c) At June 30, 2007 and December 31, 2006, respectively, Foreign General loss reserves include approximately $2.90 billion and $2.75 billion related to business reported in DBG’s statutory filings.
     The DBG net loss reserve of $45.7 billion is comprised principally of the business of AIG subsidiaries participating in the American Home Assurance Company (American Home)/ National Union Fire Insurance Company of Pittsburgh, Pa. (National Union) pool (11 companies) and the surplus lines pool (Lexington, Starr Excess Liability Insurance Company and Landmark Insurance Company).
     DBG cedes a quota share percentage of its other liability occurrence and products liability occurrence business to AIRCO. The quota share percentage ceded was 15 percent for the six months ended June 30, 2007 and 20 percent for the year 2006 and covered all business written in these years for these lines by participants in the American Home/ National Union pool. AIRCO’s loss reserves relating to these quota share cessions from DBG are recorded on a discounted basis. As of June 30, 2007, AIRCO carried a discount of approximately $270 million applicable to the $3.50 billion in undiscounted reserves it assumed from the American Home/ National Union pool via this quota share cession. AIRCO also carries approximately $503 million in net loss reserves relating to Foreign General insurance business. These reserves are carried on an undiscounted basis.
     The companies participating in the American Home/ National Union pool have maintained a participation in the business written by AIU for decades. As of June 30, 2007, these AIU reserves carried by participants in the American Home/ National Union pool totaled approximately $2.90 billion. The remaining Foreign General reserves are carried by AIUO, AIRCO, and other smaller AIG subsidiaries domiciled outside the United States. Statutory filings in the U.S. by AIG companies reflect all the business written by

42


Table of Contents

American International Group, Inc. and Subsidiaries
U.S. domiciled entities only, and therefore exclude business written by AIUO, AIRCO, and all other internationally domiciled subsidiaries. The total reserves carried at June 30, 2007 by AIUO and AIRCO were approximately $4.57 billion and $3.73 billion, respectively. AIRCO’s $3.73 billion in total general insurance reserves consist of approximately $3.23 billion from business assumed from the American Home/ National Union pool and an additional $503 million relating to Foreign General Insurance business.
Discounting of Reserves
At June 30, 2007, AIG’s overall General Insurance net loss reserves reflect a loss reserve discount of $2.39 billion, including tabular and non-tabular calculations. The tabular workers compensation discount is calculated using a 3.5 percent interest rate and the 1979-81 Decennial Mortality Table. The non-tabular workers compensation discount is calculated separately for companies domiciled in New York and Pennsylvania, and follows the statutory regulations for each state. For New York companies, the discount is based on a five percent interest rate and the companies’ own payout patterns. For Pennsylvania companies, the statute has specified discount factors for accident years 2001 and prior, which are based on a six percent interest rate and an industry payout pattern. For accident years 2002 and subsequent, the discount is based on the yield of U.S. Treasury securities ranging from one to twenty years and the company’s own payout pattern, with the future expected payment for each year using the interest rate associated with the corresponding Treasury security yield for that time period. The discount is comprised of the following: $726 million – tabular discount for workers compensation in DBG; $1.39 billion – non-tabular discount for workers compensation in DBG; and, $270 million – non-tabular discount for other liability occurrence and products liability occurrence in AIRCO. The total undiscounted workers compensation loss reserve carried by DBG is approximately $12.2 billion as of June 30, 2007. The other liability occurrence and products liability occurrence business in AIRCO that is assumed from DBG is discounted based on the yield of U.S. Treasury securities ranging from one to twenty years and the DBG payout pattern for this business. The undiscounted reserves assumed by AIRCO from DBG totaled approximately $3.50 billion at June 30, 2007.
Quarterly Reserving Process
Management believes that the General Insurance net loss reserves are adequate to cover General Insurance net losses and loss expenses as of June 30, 2007. While AIG regularly reviews the adequacy of established loss reserves, there can be no assurance that AIG’s ultimate loss reserves will not develop adversely and materially exceed AIG’s loss reserves as of June 30, 2007. In the opinion of management, such adverse development and resulting increase in reserves is not likely to have a material adverse effect on AIG’s consolidated financial condition, although it could have a material adverse effect on AIG’s consolidated results of operations for an individual reporting period.
The following table presents the reconciliation of net loss reserves:
                                   
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2007   2006   2007   2006
 
Net reserve for losses and loss expenses at beginning of period
  $ 64,034     $ 58,892     $ 62,630     $ 57,476  
Foreign exchange effect
    252       370       214       487  
 
Losses and loss expenses incurred:
                               
 
Current year
    7,334       6,911       14,549       13,752  
 
Prior years, other than accretion of discount
    (120 )     (248 )     (268 )     (213 )
 
Prior years, accretion of discount
    12       101       128       202  
 
Losses and loss expenses incurred
    7,226       6,764       14,409       13,741  
 
Losses and loss expenses paid
    6,315       5,812       12,056       11,490  
 
Net reserve for losses and loss expenses at end of period
  $ 65,197     $ 60,214     $ 65,197     $ 60,214  
 
The following tables summarize development, (favorable) or unfavorable, of incurred losses and loss expenses for prior years (other than accretion of discount):
                                   
 
    Three Months   Six Months
    Ended June 30,   Ended June 30,
         
(in millions)   2007   2006   2007   2006
 
Prior Accident Year Development by Reporting Unit:
                               
  DBG   $ (65 )   $ (106 )   $ (152 )   $ (32 )
  Personal Lines     (32 )     (43 )     (61 )     (62 )
 
Mortgage Guaranty
    (4 )     (52 )     27       (64 )
  Foreign General     (4 )     (77 )     (68 )     (120 )
 
Subtotal
    (105 )     (278 )     (254 )     (278 )
 
Transatlantic
    18       30       36       65  
 
Asbestos settlements*
    (33 )           (50 )      
 
Prior years, other than accretion of discount
  $ (120 )   $ (248 )   $ (268 )   $ (213 )
 
Represents the effect of settlements of certain asbestos liabilities.

43


Table of Contents

American International Group, Inc. and Subsidiaries
                   
 
    Calendar Year
     
(in millions)   2007   2006
 
Prior Accident Year Development by
Accident Year:
               
 
2006
  $ (454 )        
 
2005
    (165 )   $ (302 )
 
2004
    (136 )     (259 )
 
2003
    15       (214 )
 
2002
    112       61  
 
2001 & prior
    360       501  
 
Prior years, other than accretion of discount
  $ (268 )   $ (213 )
 
     In determining the quarterly loss development from prior accident years, AIG conducts analyses to determine the change in estimated ultimate loss for each accident year for each profit center. For example, if loss emergence for a profit center is different than expected for certain accident years, the actuaries examine the indicated effect such emergence would have on the reserves of that profit center. In some cases, the higher or lower than expected emergence may result in no clear change in the ultimate loss estimate for the accident years in question, and no adjustment would be made to the profit center’s reserves for prior accident years. In other cases, the higher or lower than expected emergence may result in a larger change, either favorable or unfavorable, than the difference between the actual and expected loss emergence. Such additional analyses were conducted for each profit center, as appropriate, in the second quarter of 2007 to determine the loss development from prior accident years for the second quarter of 2007. As part of its quarterly reserving process, AIG also considers notices of claims received with respect to emerging issues, such as those related to stock option backdating. Also as part of the quarterly reserving process, beginning with the second quarter of 2007, AIG updated its analysis of the loss reserve discount pertaining to workers compensation reserves. Historically, this review was only performed at year end. As a result of the updated analysis in the second quarter of 2007, AIG increased its loss reserve discount for workers compensation by approximately $155 million in the second quarter of 2007, bringing the total increase in loss reserve discount for workers compensation for the first six months of 2007 to approximately $185 million.
2007 Net Loss Development
In the three months ended June 30, 2007, net loss development from prior accident years was favorable by approximately $120 million, including approximately $18 million of adverse development from the general reinsurance operations of Transatlantic; and excluding approximately $12 million from accretion of loss reserve discount. Excluding Transatlantic, as well as accretion of discount, net loss development in the three months ended June 30, 2007 from prior accident years was favorable by approximately $138 million. The overall favorable development of $120 million consisted of approximately $475 million of favorable development from accident years 2003 through 2006, partially offset by approximately $355 million of adverse development from accident years 2002 and prior. For the three months ended June 30, 2007, most classes of AIG’s business continued to experience favorable development for accident years 2003 through 2006. The majority of the adverse development from accident years 2002 and prior was related to developments from excess casualty business within DBG and from Transatlantic.
     In the first six months of 2007, net loss development from prior accident years was favorable by approximately $268 million, including approximately $36 million of adverse development from the general reinsurance operations of Transatlantic; and excluding approximately $128 million from accretion of loss reserve discount. Excluding Transatlantic, as well as accretion of discount, net loss development in the first six months of 2007 from prior accident years was favorable by approximately $304 million. The overall favorable development of $268 million consisted of approximately $740 million of favorable development from accident years 2003 through 2006, partially offset by approximately $472 million of adverse development from accident years 2002 and prior. For the first six months of 2007, most classes of AIG’s business continued to experience favorable development for accident years 2003 through 2006. The majority of the adverse development from accident years 2002 and prior was related to development from excess casualty business within DBG and from Transatlantic.
2006 Net Loss Development
In the second quarter of 2006, net loss development from prior accident years was favorable by approximately $248 million. This reflects approximately $63 million of favorable development pertaining to catastrophes in 2005, partially offset by adverse development of approximately $30 million from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $101 million, net loss development from prior accident years in the second quarter of 2006 was favorable by approximately $215 million. The overall favorable development of $248 million consisted of approximately $490 million of favorable development from accident years 2003 through 2005, partially offset by approximately $242 million of adverse development from accident years 2002 and prior. For the three months ended June 30, 2006, most classes of AIG’s business experienced favorable development for accident years 2003 through 2005. The adverse development from accident years 2002 and prior reflected development from excess casualty business within DBG, and to a much lesser extent from excess workers compensation business within DBG, as well as development from Transatlantic.
     In the first six months of 2006, net loss development from prior accident years was favorable by approximately $213 million. This reflects approximately $35 million of

44


Table of Contents

American International Group, Inc. and Subsidiaries
adverse development pertaining to catastrophes in 2004 and 2005 and approximately $65 million of adverse development from Transatlantic. Excluding catastrophes and Transatlantic, as well as accretion of discount of approximately $202 million, net loss development from prior accident years in the first six months of 2006 was favorable by approximately $313 million. The $213 million of overall net favorable development was comprised of approximately $775 million of favorable development from accident years 2003 through 2005, partially offset by approximately $562 million of adverse development from accident years 2002 and prior. For the first six months of 2006, most classes of AIG’s business experienced favorable development for accident years 2003 through 2005. The adverse development from accident years 2002 and prior reflected development from excess casualty business within DBG, and to a lesser extent from excess workers compensation business within DBG, as well as development from Transatlantic.
Asbestos and Environmental Reserves
The estimation of loss reserves relating to asbestos and environmental claims on insurance policies written many years ago is subject to greater uncertainty than other types of claims due to inconsistent court decisions as well as judicial interpretations and legislative actions that in some cases have tended to broaden coverage beyond the original intent of such policies and in others have expanded theories of liability.
     As described more fully in the 2006 Annual Report on Form 10-K, AIG’s reserves relating to asbestos and environmental claims reflect a comprehensive ground up analysis. In the first six months of 2007, one large asbestos settlement resulted in a minor amount of adverse incurred loss development, which was more than offset, on a net basis, by the favorable $50 million effect of several other settlements.
A summary of reserve activity, including estimates for applicable IBNR, relating to asbestos and environmental claims separately and combined:
                                   
 
    Six Months
    Ended June 30,
     
    2007   2006
         
(in millions)   Gross   Net   Gross   Net
 
Asbestos:
                               
 
Reserve for losses and loss expenses at beginning of year
  $ 4,464     $ 1,889     $ 4,441     $ 1,840  
 
Losses and loss expenses incurred*
    10       (25 )     (1 )     4  
 
Losses and loss expenses paid*
    (454 )     (268 )     (277 )     (96 )
 
Reserve for losses and loss expenses at end of period
  $ 4,020     $ 1,596     $ 4,163     $ 1,748  
 
Environmental:
                               
 
Reserve for losses and loss expenses at beginning of year
  $ 588     $ 290     $ 926     $ 410  
 
Losses and loss expenses incurred*
          (1 )     1        
 
Losses and loss expenses paid*
    (54 )     (31 )     (55 )     (33 )
 
Reserve for losses and loss expenses at end of period
  $ 534     $ 258     $ 872     $ 377  
 
Combined:
                               
 
Reserve for losses and loss expenses at beginning of year
  $ 5,052     $ 2,179     $ 5,367     $ 2,250  
 
Losses and loss expenses incurred*
    10       (26 )           4  
 
Losses and loss expenses paid*
    (508 )     (299 )     (332 )     (129 )
 
Reserve for losses and loss expenses at end of period
  $ 4,554     $ 1,854     $ 5,035     $ 2,125  
 
All amounts pertain to policies underwritten in prior years, primarily to policies issued in 1984 and prior.
The gross and net IBNR included in the reserve for losses and loss expenses, relating to asbestos and environmental claims separately and combined, were estimated as follows:
                                 
 
    Six Months
    Ended June 30,
     
    2007   2006
         
(in millions)   Gross   Net   Gross   Net
 
Asbestos
  $ 3,011     $ 1,279     $ 3,100     $ 1,351  
Environmental
    316       148       562       241  
 
Combined
  $ 3,327     $ 1,427     $ 3,662     $ 1,592  
 

45


Table of Contents

American International Group, Inc. and Subsidiaries
A summary of asbestos and environmental claims count activity was as follows:
                                                   
 
    Six Months Ended June 30,
     
    2007   2006
         
    Asbestos   Environmental   Combined   Asbestos   Environmental   Combined
 
Claims at beginning of year
    6,878       9,442       16,320       7,293       9,873       17,166  
Claims during year:
                                               
 
Opened
    300       695       995       453       900       1,353  
 
Settled
    (66 )     (59 )     (125 )     (73 )     (83 )     (156 )
 
Dismissed or otherwise resolved
    (544 )     (899 )     (1,443 )     (493 )     (893 )     (1,386 )
 
Claims at end of period
    6,568       9,179       15,747       7,180       9,797       16,977  
 
Survival Ratios — Asbestos and Environmental
The table below presents AIG’s survival ratios for asbestos and environmental claims at June 30, 2007 and 2006. The survival ratio is derived by dividing the current carried loss reserve by the average payments for the three most recent calendar years for these claims. Therefore, the survival ratio is a simplistic measure estimating the number of years it would be before the current ending loss reserves for these claims would be paid off using recent year average payments. The June 30, 2007 survival ratio is lower than the ratio at June 30, 2006 because the more recent periods included in the rolling average reflect higher claims payments. In addition, AIG’s survival ratio for asbestos claims was negatively affected by the favorable settlements described above, which reduced gross and net asbestos survival ratios at June 30, 2007 by approximately 1.7 years and 4.1 years, respectively. Many factors, such as aggressive settlement procedures, mix of business and level of coverage provided, have a significant effect on the amount of asbestos and environmental reserves and payments and the resultant survival ratio. Thus, caution should be exercised in attempting to determine reserve adequacy for these claims based simply on this survival ratio.
AIG’s survival ratios for asbestos and environmental claims, separately and combined were based upon a three-year average payment. These ratios at June 30, 2007 and 2006 were as follows:
           
 
(number of years)   Gross   Net
 
2007
       
Survival ratios:
       
 
Asbestos
  8.5   7.4
 
Environmental
  5.0   4.0
 
Combined
  7.8   6.6
 
2006        
Survival ratios:
       
 
Asbestos
  13.2   15.9
 
Environmental
  6.3   5.5
 
Combined
  11.1   11.9
 
Life Insurance & Retirement Services Operations
AIG’s Life Insurance & Retirement Services subsidiaries offer a wide range of insurance and retirement savings products both domestically and abroad.
     Domestically, AIG’s Life Insurance & Retirement Services operations offer a broad range of protection products, such as life insurance and group life and health products, including disability income products and payout annuities, which include single premium immediate annuities, structured settlements and terminal funding annuities. Home service operations include an array of life insurance, accident and health and annuity products sold primarily through career agents. Retirement services include group retirement products, individual fixed and variable annuities sold through banks, broker-dealers and exclusive sales representatives, and annuity runoff operations, which include previously acquired “closed blocks” and other fixed and variable annuities largely sold through distribution relationships that have been discontinued.
     Overseas, AIG’s Life Insurance & Retirement Services operations include insurance and investment-oriented products such as whole and term life, investment linked, universal life and endowments, personal accident and health products, group products including pension, life and health, and fixed and variable annuities.
     AIG’s Life Insurance & Retirement Services subsidiaries report their operations through the following major internal reporting units and business units:
Foreign Life Insurance & Retirement Services
         Japan and Other
  •  American Life Insurance Company (ALICO)
  •  AIG Star Life Insurance Co., Ltd. (AIG Star Life)
  •  AIG Edison Life Insurance Company (AIG Edison Life)
     Asia
  •  American International Assurance Company, Limited, together with American International Assurance Company (Bermuda) Limited (AIA)
  •  Nan Shan Life Insurance Company, Ltd. (Nan Shan)
  •  American International Reinsurance Company Limited (AIRCO)
  •  The Philippine American Life and General Insurance Company (Philamlife)

46


Table of Contents

American International Group, Inc. and Subsidiaries
Domestic Life Insurance
  •  American General Life Insurance Company (AIG American General)
  •  The United States Life Insurance Company in the City of New York (USLIFE)
  •  American General Life and Accident Insurance Company (AGLA)
Domestic Retirement Services
  •  The Variable Annuity Life Insurance Company (VALIC)
  •  AIG Annuity Insurance Company (AIG Annuity)
  •  AIG SunAmerica Life Assurance Company (AIG SunAmerica)
Life Insurance & Retirement Services Results
Life Insurance & Retirement Services results were as follows:
                                             
 
    Premiums   Net   Net Realized    
    and Other   Investment   Capital Gains   Total   Operating
(in millions)   Considerations   Income   (Losses)   Revenues   Income
 
Three months ended June 30, 2007
                                       
 
Foreign Life Insurance & Retirement Services
  $ 6,503     $ 3,361     $ 18     $ 9,882     $ 1,654  
 
Domestic Life Insurance
    1,369       1,006       (16 )     2,359       368  
 
Domestic Retirement Services
    298       1,765       (281 )     1,782       598  
 
   
Total
  $ 8,170     $ 6,132     $ (279 )   $ 14,023     $ 2,620  
 
Three months ended June 30, 2006
                                       
 
Foreign Life Insurance & Retirement Services*
  $ 5,981     $ 1,970     $ 164     $ 8,115     $ 1,739  
 
Domestic Life Insurance
    1,404       893       (75 )     2,222       235  
 
Domestic Retirement Services
    263       1,557       (246 )     1,574       407  
 
   
Total
  $ 7,648     $ 4,420     $ (157 )   $ 11,911     $ 2,381  
 
Percentage Increase/(Decrease) from Prior Year:
                                       
 
Foreign Life Insurance & Retirement Services
    9 %     71 %     %     22 %     (5 )%
 
Domestic Life Insurance
    (2 )     13             6       57  
 
Domestic Retirement Services
    13       13             13       47  
 
   
Total
    7 %     39 %     %     18 %     10 %
 
Six months ended June 30, 2007
                                       
 
Foreign Life Insurance & Retirement Services
  $ 13,116     $ 6,244     $ (217 )   $ 19,143     $ 2,938  
 
Domestic Life Insurance
    2,897       2,011       (28 )     4,880       713  
 
Domestic Retirement Services
    582       3,390       (290 )     3,682       1,250  
 
   
Total
  $ 16,595     $ 11,645     $ (535 )   $ 27,705     $ 4,901  
 
Six months ended June 30, 2006
                                       
 
Foreign Life Insurance & Retirement Services*
  $ 12,098     $ 4,225     $ 516     $ 16,839     $ 3,425  
 
Domestic Life Insurance
    2,830       1,826       (67 )     4,589       601  
 
Domestic Retirement Services
    520       3,203       (390 )     3,333       985  
 
   
Total
  $ 15,448     $ 9,254     $ 59     $ 24,761     $ 5,011  
 
Percentage Increase/(Decrease) from Prior Year:
                                       
 
Foreign Life Insurance & Retirement Services
    8 %     48 %     %     14 %     (14 )%
 
Domestic Life Insurance
    2       10             6       19  
 
Domestic Retirement Services
    12       6             10       27  
 
   
Total
    7 %     26 %     %     12 %     (2 )%
 
Includes the effect of an out of period UCITS adjustment in the second quarter of 2006. For the three and six-month periods ended June 30, 2006, the effect was an increase of $221 million and $203 million, respectively, in net investment income and $144 million and $132 million, respectively, in operating income.
The following table presents the Insurance In-force for Life Insurance & Retirement Services:
                   
 
    June 30,   December 31,
(in millions)   2007   2006
 
Foreign
  $ 1,195,315       $1,162,699  
Domestic
    946,598       907,901  
 
 
Total
  $ 2,141,913       $2,070,600  
 
Life Insurance & Retirement Services total revenues for the three and six-month periods ended June 30, 2007 reflect growth in premiums and other considerations and net investment income offset by realized capital losses. Realized capital losses reduced revenues by $279 million and $535 million in the three and six-month periods ended June 30, 2007, respectively, while net realized capital losses decreased revenues by $157 million in the three months ended June 30, 2006 and net realized capital gains increased revenues by $59 million in the six months ended June 30, 2006. Net realized capital losses in 2007 were primarily related to the decline in value of securities deemed to be other-than-temporary that AIG no longer intends to hold to recovery.

47


Table of Contents

American International Group, Inc. and Subsidiaries
    Operating income for the first six months of 2007 includes a charge of $48 million related to SOP 05-1 which generally requires DAC related to group contracts to be amortized over a shorter duration than in prior periods, and also requires that DAC be expensed at the time a policy is terminated and prohibits recapitalization if that policy is reinstated. The effect of SOP 05-1 was most significant to the group products line in the Domestic Life operations.
    Operating income for the six months ended June 30, 2007 also included a $62 million charge for additional benefit expense resulting from a continuing industry-wide review of claims in Japan and a $50 million charge related to balance sheet reconciliation remediation activities. Operating income for the six months ended June 30, 2006 included an increase of $132 million for an out of period adjustment related to the accounting for UCITS.
    Policyholder trading gains (losses) for the three and six months ended June 30, 2007 increased significantly compared to the same periods in 2006. The three and six months ended June 30, 2007 included policyholder trading gains of $784 million and $1.3 billion, respectively, compared to losses of $321 million and gains of $69 million for the three and six months ended June 30, 2006, respectively. Policyholder trading gains (losses) are offset by an equal charge to incurred policy losses and benefits expense, as these investment returns accrue to the benefit of the policyholder. The trend in policyholder trading gains (losses) generally reflects the trend in equity markets.
    In order to better align financial reporting with the manner in which AIG’s chief operating decision makers have managed their businesses, commencing in the first quarter of 2007, revenues and operating income related to foreign investment contracts, which were historically reported as a component of the Asset Management segment, are now being reported as part of Foreign Life Insurance & Retirement Services. Prior period amounts have been revised to conform to the current presentation.
Foreign Life Insurance & Retirement Services Results
Foreign Life Insurance & Retirement Services results were as follows:
                                             
 
    Premiums and   Net   Net Realized    
    Other   Investment   Capital Gains   Total   Operating
(in millions)   Considerations   Income   (Losses)   Revenues   Income
 
Three months ended June 30, 2007
                                       
Japan and Other:
                                       
 
Life insurance
  $ 1,350     $ 641     $ 33     $ 2,024     $ 438  
 
Personal accident
    1,041       52             1,093       243  
 
Group products
    539       201       1       741       63  
 
Individual fixed annuities
    101       546       (129 )     518       34  
 
Individual variable annuities
    102       385             487       32  
 
   
Total
  $ 3,133     $ 1,825     $ (95 )   $ 4,863     $ 810  
 
Asia:
                                       
 
Life insurance
  $ 2,755     $ 1,451     $ 108     $ 4,314     $ 717  
 
Personal accident
    446       35       2       483       82  
 
Group products
    151       21       (7 )     165       26  
 
Individual fixed annuities
    17       28       9       54       18  
 
Individual variable annuities
    1       1       1       3       1  
 
   
Total
  $ 3,370     $ 1,536     $ 113     $ 5,019     $ 844  
 
Total Foreign Life Insurance & Retirement Services:
                                       
 
Life insurance
  $ 4,105     $ 2,092     $ 141     $ 6,338     $ 1,155  
 
Personal accident
    1,487       87       2       1,576       325  
 
Group products
    690       222       (6 )     906       89  
 
Individual fixed annuities
    118       574       (120 )     572       52  
 
Individual variable annuities
    103       386       1       490       33  
 
   
Total
  $ 6,503     $ 3,361     $ 18     $ 9,882     $ 1,654  
 
Three months ended June 30, 2006
                                       
Japan and Other:
                                       
 
Life insurance
  $ 1,238     $ 343     $ 113     $ 1,694     $ 454  
 
Personal accident
    1,006       42       22       1,070       279  
 
Group products
    410       93       2       505       63  
 
Individual fixed annuities
    78       432       27       537       148  
 
Individual variable annuities
    62       (56 )           6       31  
 
   
Total
  $ 2,794     $ 854     $ 164     $ 3,812     $ 975  
 

48


Table of Contents

Foreign Life Insurance & Retirement Services Results (continued)
American International Group, Inc. and Subsidiaries
                                             
 
    Premiums and   Net   Net Realized    
    Other   Investment   Capital Gains   Total   Operating
(in millions)   Considerations   Income   (Losses)   Revenues   Income
 
Asia:
                                       
 
Life insurance*
  $ 2,700     $ 1,038     $ 26     $ 3,764     $ 688  
 
Personal accident
    374       29       3       406       76  
 
Group products
    97       22       (30 )     89       (7 )
 
Individual fixed annuities
    16       26       1       43       6  
 
Individual variable annuities
          1             1       1  
 
   
Total
  $ 3,187     $ 1,116     $     $ 4,303     $ 764  
 
Total Foreign Life Insurance & Retirement Services:
                                       
 
Life insurance*
  $ 3,938     $ 1,381     $ 139     $ 5,458     $ 1,142  
 
Personal accident
    1,380       71       25       1,476       355  
 
Group products
    507       115       (28 )     594       56  
 
Individual fixed annuities
    94       458       28       580       154  
 
Individual variable annuities
    62       (55 )           7       32  
 
   
Total
  $ 5,981     $ 1,970     $ 164     $ 8,115     $ 1,739  
 
Percentage Increase/(Decrease) from Prior Year:
                                       
 
Japan and Other:
                                       
 
Life insurance
    9 %     87 %     %     19 %     (4 )%
 
Personal accident
    3       24             2       (13 )
 
Group products
    31       116             47        
 
Individual fixed annuities
    29       26             (4 )     (77 )
 
Individual variable annuities
    65                         3  
 
   
Total
    12 %     114 %     %     28 %     (17 )%
 
Asia:
                                       
 
Life insurance
    2 %     40 %     %     15 %     4 %
 
Personal accident
    19       21             19       8  
 
Group products
    56       (5 )           85        
 
Individual fixed annuities
    6       8             26        
 
Individual variable annuities
                             
 
   
Total
    6 %     38 %     %     17 %     10 %
 
Total Foreign Life Insurance & Retirement Services:
                                       
 
Life insurance
    4 %     51 %     %     16 %     1 %
 
Personal accident
    8       23             7       (8 )
 
Group products
    36       93             53       59  
 
Individual fixed annuities
    26       25             (1 )     (66 )
 
Individual variable annuities
    66                         3  
 
   
Total
    9 %     71 %     %     22 %     (5 )%
 
Six months ended June 30, 2007
                                       
Japan and Other:
                                       
 
Life insurance
  $ 2,566     $ 1,191     $ 15     $ 3,772     $ 790  
 
Personal accident
    2,069       102       2       2,173       532  
 
Group products
    1,114       351       6       1,471       136  
 
Individual fixed annuities
    217       1,092       (164 )     1,145       181  
 
Individual variable annuities
    193       879             1,072       84  
 
   
Total
  $ 6,159     $ 3,615     $ (141 )   $ 9,633     $ 1,723  
 
Asia:
                                       
 
Life insurance
  $ 5,706     $ 2,458     $ (42 )   $ 8,122     $ 1,017