AIG: What Went Wrong

A look at how the icon of insurance got itself in such a mess -- and where all the probes
are headed

Investors in embattled American International Group Inc. (AIG ) may have breathed a
sigh of relief at the Mar. 28 announcement that Chairman Maurice R. "Hank" Greenberg
would step aside two weeks after being pressured to give up the chief executive's role.
But the complex $99 billion insurance and financial empire he leaves behind remains
mired in turmoil.

What began as an investigation into two reinsurance transactions has mushroomed into a
growing scandal that has tarnished the reputation of one of America's premier
corporations. On Mar. 30, AIG acknowledged that it had improperly accounted for the
reinsurance transaction to bolster reserves, and detailed numerous other examples of
problematic accounting. It also announced the delay of its annual 10-K filing, and said
the moves may have inflated its net worth by up to $1.7 billion. While AIG says it does
not yet know if the review will force a restatement of prior results, its stock dropped 2.1%
on the news; all together, AIG shares have dropped 22%, to $57 apiece, since the
company was served with subpoenas by state and federal regulators six weeks ago. The
announcement also caused Standard & Poor's (MHP ) to downgrade AIG's debt rating
from AAA to AA+. Here's a look at where the AIG mess stands and where the probes are
headed:

What is it that has regulators up in arms?

Investigators believe that AIG may have goosed its financial performance with dubious
transactions and improper accounting. Last fall, the insurer paid $126 million in fines to
the Securities & Exchange Commission and Justice Dept. for deals it structured for
outside clients that allegedly violated insurance accounting rules, although AIG admitted
no wrongdoing. The company also came under the glare of New York Attorney General
Eliot Spitzer for its role in bid-rigging with broker Marsh & McLennan Cos. (MMC ),
which led to the ouster of Hank's son Jeffrey as CEO there. AIG admitted no wrongdoing,
but two of its executives plead guilty and left the company.

This time, investigators initially focused on two transactions involving Berkshire

Hathaway's (BRK ) General Re Corp. unit. The deals essentially amounted to a $500
million loan that was dressed up on the books as premium revenue. That allowed AIG to
boost its sagging reserves at a time when investors thought they were too low. The
problem: AIG never assumed any of the risk associated with insurance underwriting. On
Mar. 30, the company acknowledged that "the transaction documentation was improper"
and should never have been classified as insurance premiums.

Since then, AIG 's problems have escalated. In its Mar. 30 release, the company itself
identified several problem areas. They include transactions with supposedly independent
companies that were in fact controlled by AIG; bond transactions that may have allowed
it to claim gains without actually selling the bonds; misclassified losses; and questionable
estimates on deferred acquisition costs. Investigators and state regulators are looking into
some 60 transactions involving these and other possible accounting shenanigans.
"Greenberg strived for a steadily rising stock price," says a source in Spitzer's office. "He
used mechanisms now being revealed as deceptive and improper."

What is the company doing at this point?

It has installed longtime AIG exec Martin J. Sullivan, 50, as the new CEO, and named
independent director Frank G. Zarb as chairman. In addition, it has launched its own
internal investigation, which has so far revealed several arrangements and deals that were
not properly accounted for. The company says that its review is not yet complete.
Moreover, AIG has pledged to change how it accounts for deferred compensation that's
now paid to senior executives through Starr International Co. (SICO) -- one of several
controversial private entities that also are under investigation.

What are these private entities and why are they under scrutiny?

AIG has a highly unusual arrangement with three private entities, governed and
controlled by Greenberg and other AIG executives. Each serves a different purpose and
raises unique concerns. SICO is a holding company that owns about 12% of AIG stock --
making it the company's largest shareholder -- and pays out some of that stock to an elite
group of AIG managers as deferred compensation. Greenberg and other AIG directors sit
on the board, have large personal stakes, and decide who gets paid what. Regulators
believe SICO hides executive pay and takes away powers that should rightly lie with the
compensation committee of the board.

C.V. Starr & Co., on the other hand, is a group of agencies that develops business and
issues specialized policies for AIG. It's owned and operated by AIG executives -- many of
whom perform functions similar to what they do at AIG -- and controls 1.8% of AIG
shares. Critics worry that the opaque nature of its transactions, for example, could allow
C.V. Starr to become a convenient tool for managing earnings at AIG, which has been a
model of earnings consistency in a notoriously volatile industry. The arrangement also
creates endless possibilities for conflicts of interest. Says North Carolina State Treasurer
Richard H. Moore, who oversees a stake in AIG worth more than $300 million: "I don't
think you can have a publicly traded company that allows board members to own a
private entity that does business with the publicly traded company. [It's] impossible to
know if shareholders are being taken advantage of."

Finally, there's the Starr Foundation, a charitable entity which Greenberg also chairs and
which has a 2% share in AIG. It has come under fire for doling out money for political
causes and for giving $36.5 million to the American Museum of Natural History shortly
after museum President Ellen V. Futter joined AIG 's board.

What pressure does Sullivan now face?

Insiders say the new chief, who began his AIG career at the age of 16, is aggressively
leading the charge for changes necessary to create a more transparent organization. But
the longtime AIG manager -- formerly a vice-chairman and co-chief operating officer -- is
also under scrutiny by regulators. A close confidante of Greenberg, who essentially hand-
picked Sullivan as his replacement, he also serves as a director in C.V. Starr and SICO.
Sullivan has not been accused of any wrongdoing, but regulators are looking for signs
that he knew of or oversaw the dubious transactions. Any hint of that and he, too, could
be forced out. An AIG spokesman says Sullivan has no comment on his future or the
company's direction while AIG cooperates with investigators.

Is Greenberg out of the picture?

The 79-year-old insurance legend is due to appear before Spitzer for a deposition on Apr.
12 and may face continued scrutiny for his actions, sources say. But Greenberg still
retains significant control of AIG through his 1.7% personal shareholding and stakes in
the private entities that together own another 15.7%. Although the full extent of his
influence is unknown, Greenberg controls 8.3% of SICO's voting stock, is president and
CEO of C.V. Starr, where he owns 16.4% of the common stock, and is chairman of the
Starr Foundation. The structure of SICO, in particular, has also given Greenberg
enormous control because anyone who left the company -- or was fired -- prior to
retirement often forfeited lucrative payments. "It was like joining some elite brotherhood
where, if you toed the line, you were set for life," says one insider. Investigators and
directors may be hard-pressed to force Greenberg out of a private company, and he could
continue to exert influence from the background.

Where was the board through this mess?

For years, AIG had a board that was notoriously clubby and close to Greenberg. Says
Patrick McGurn of Institutional Shareholder Services: "Was there a reform Hank ever put
in place that he liked?" But, thanks to shareholder pressure and new governance
regulations, the board has become more independent in recent years. More important,
perhaps, the investigations have made directors nervous about their own liability -- and
determined to take proactive action to distance themselves from any scandal, insiders say.
They even demanded Greenberg's resignation -- an unthinkable act just months ago.

How do regulators or other critics propose to fix these conflicts of interest?

One answer is to disband the entities, ban business dealings with the public company, or
force AIG executives to end any direct roles in those companies. While a source familiar
with the federal probe says regulators haven't yet demanded any specific action, he notes
that "none of this is stuff I've seen in other walks of life."

Is AIG doomed?
Sources close to the investigation are quick to point out that this is no "Enron situation,
[although] there were a lot of shenanigans going on. "The insurer sells real products and
produces real earnings. The main allegation is that managers went to extreme lengths to
smooth those earnings and boost the stock price. Strip out those machinations, and AIG
may turn out to be a typical insurer, with big earnings swings up and down, rather than
the superior underwriter it appeared to be.

But AIG remains a powerhouse in the industry. It has a diverse mix of industry-leading
insurance and financial-services businesses. Moreover, it's a global force with a
particularly strong foothold in fast-growing Asian markets, especially China.

At the very least, the company's shares may no longer command the kind of premium that
they did during the glory days. Despite the crisis, AIG's stock has been trading at an
average multiple of 16.6, vs. 15.1 for the S&P 500 Insurance Industry index. Investors,
already irate over losing more than $40 billion since the scandal broke, may have to come
to terms with the fact that AIG is just a normal insurer -- subject to the same lousy years
and volatility as others. That means more air may still come out of AIG's shares.

But that's without factoring in the substantial hurdles that AIG faces. Transforming a
culture as secretive and ingrained as the one that Greenberg built over four decades
would be a monumental task for any CEO -- and perhaps an impossible one for a leader
who forged his entire career there, as Sullivan did. Moreover, the extent of the company's
liability is unknown. There may be huge fines; there could even be more serious charges.
Investors can only guess how much that will batter AIG from here.

American International Group, Inc.

(AIG:NYSE)
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AIG Details

American International Group, Inc., through its subsidiaries, provides insurance and
financial services in the United States and internationally. It operates in four segments:
General Insurance, Life Insurance and Retirement Services, Financial Services, and Asset
Management. The General Insurance segment underwrites various business insurance
products, including large commercial or industrial property insurance, excess liability,
inland marine, environmental, workers compensation, and excess and umbrella
coverages. This segment also offers various specialized forms of insurance, such as
aviation, accident and health, equipment breakdown, directors and officers liability,
difference-in-condi...
Detailed Description...
www.aig.com
116,000 Employees
Founded in 1967
Latest 10-K Latest 10-K
Latest 10-Q Latest 10-Q
More SEC Filings...
Top Compensated Officers
Mr. Edmund S.W. Tse
Senior Vice Chairman of Life Insurance, Direc...
Age: 70
Total Annual Compensation: $2.7M
Mr. Jay S. Wintrob
Executive Vice President of Retirement Servic...
Age: 50
Total Annual Compensation: $2.5M
Mr. Win Jay Neuger CFA
Chief Investment Officer and Executive Vice P...
Age: 58
Total Annual Compensation: $2.2M
Mr. Robert M. Sandler
Consultant
Age: 65
Total Annual Compensation: $1.5M
People Page

Executives, Board Directors

Compensation as of Fiscal Year 2007.
Key developments
AIG May Reveal Sale Details By October End
10/16/2008

American International Group Inc. (AIG) reportedly plans to reveal its intentions of
selling AIG Edison Life Insurance Co. and AIG Star Life Insurance Co. by end of
October. AIG might plan to merge them in January and then sell them as one. AIG may
consider revealing details to potential suitors next month, and decide on a buyer by the
end of December. The two firms may fetch a few hundred billion yen. AIG also plans to
sell American Life Insurance Company (Japan) together with its U.S. headquarters.
Foreign life and casualty insurers might be interested in buying these operations.
American International Group Inc. Announces Management Changes
10/16/2008

American International Group Inc. announced that David L. Herzog has been named
Executive Vice President and Chief Financial Officer. Mr. Herzog will assume
responsibilities for financial operations across all AIG business units, reporting to Edward
Liddy, Chairman and Chief Executive Officer of AIG. Mr. Herzog will also assume a
central role in overseeing AIG's plan to address its capital structure and pay down the
credit facility from the Federal Reserve Bank of New York. In addition, Mr. Herzog will
work closely with AIG's Chief Administrative Officer in an enterprise-wide review of
expenses and practices. Steven J. Bensinger, who had served since May as Vice
Chairman-Financial Services and acting Chief Financial Officer, has left AIG to pursue
other opportunities. Mr. Herzog, 48, has served as AIG Senior Vice President and
Comptroller since June 2005. He joined American General Corporation in February 2000
and, following the AIG acquisition of American General in 2001, was named Chief
Operating Officer for the combined domestic life insurance companies.
AIG May Sell Hawaiian Unit
10/14/2008

American International Group (AIG) could sell its Hawaii unit to help repay the $85
billion federal loan it got from the government. The unit is part of the AIG Personal Auto
Group, which was listed for sale by AIG. Hawaii Insurance Commissioner J.P. Schmidt
said any company interested in purchasing would have to prove that it is stable enough to
carry on the business.

Three months into his new assignment, Insurance Regulatory and Development Authority
(Irda) Chairman J Hari Narayan is charting the road map for strengthening the regulatory
framework and also dealing with the turmoil in the US.

He spoke to Falaknaaz Syed about his plans for the sector and his impression about how
the financial crisis will impact the insurance sector in India. Excerpts:

Have the Tatas and AIG submitted their reports and do you see AIG selling its stake in
life and non-life insurance firms to the Tatas?

No, AIG India has not yet submitted the report. However, we do not see the situation
arising, where AIG has to sell the stake in Tata AIG Life and Tata AIG General.

If AIG had to sell its assets, it would have done that before it approached the US Federal
Reserve.

The loan that AIG has received from the US Fed, compared to their assets, is small. AIG
may have a cash-flow problem, but they are not that stressed out and so I do not
anticipate AIG selling stakes in the two insurance companies in India.

Life Insurance Corporation (LIC [Get Quote]) wants a higher limit on equity investment
and has also sought other flexibilities. What have you decided?

The new investment norms will apply to future investments of LIC and will not apply
retrospectively.
The LIC chairman and his team met us to tell us about the constraints they will face,
given the volume of investment lined up. Maintaining the prudential norms for exposure
is very important.

We do not want our insurance firms to be over-exposed. We want to take a conservative

line and prefer stability. We are in dialogue with LIC.

When can non-life insurance companies decide the policy wordings on their own?

We need to build a consensus before freeing the wordings and, by December, we hope to
do that. One, we need to get a consensus on certain wordings as a number of these terms
carry specific meanings.

For instance, in India, the word fire as used in insurance includes a whole lot of other
perils and not just fire. Two, there are concerns that over time, we have used certain
words, which have been examined by courts.

Now, if we change them and bring in a new word, again there may be some judicial lack
of clarity. So it is also important that the meaning of a word is as given by the court so
that it reduces disputes later.

We can see how other countries have done it. Besides, Indian documents are written in a
stylised, archaic manner.

So while we are releasing wordings, we have to work on making the style simpler.

Do you think banks should be allowed to sell products of multiple insurance companies?

At the moment, I am evaluating both the options (sale of single and multiple products). In
the bancassurance model, as it stands today, 70-75 per cent of the transactions are with
five banks.

We also need evidence, which so far is not so forthcoming that the bancassurance model
improves service. In case a bank wishes to move to a multi-product, multi-insurance
company system, it can do so by setting up a broking company. Broking will come under
the (purview of the) insurance regulator.

But whether a bank can set up a broking company or not is an issue dealt with by the
banking regulator (RBI).

How are you simplifying the wordings of health insurance policies?

We have managed to get a consensus on what pre-existing diseases should mean and that
will be a standard across the industry.
Another issue is on calculating age, as different companies do it differently. Now, we
have a common platform on age.

There are some other issues that still need to be sorted out. What is supposed to be
covered and what are the circumstances in which a cover is unavailable have to be clearly
spelt out. These are the two main elements and the rest is standard stuff.

Is Irda asking life insurers to reinsure more?

At present, in life, reinsurance is of the order of 2 per cent. It will be healthy for the
industry if it is pushed up to 10 per cent.

We are talking to life insurers and are suggesting they reinsure more.

There are certain advantages you get. One, you get access to useful international
expertise. It will enable the development of new products and, to that extent, the risk may
be more widely shared.

This may be important, especially if you have catastrophic events. It will also provide
clarity.

Insurance companies hardly disclose any business figures other than the new business
premium. What is Irda doing about it?

We consider it a priority area. We are looking at the governance issues of insurance

companies very closely and we will be coming out with appropriate regulations.

Also, we are in dialogue with experts such as the Institute of Actuaries of India, chartered
accountants, the industry, the (life and general insurance) councils to figure out the range
of indices or figures that we would like to publish on a systematic basis, not just premium
figures.

AIG to Get $85 Billion Loan, Give Up 80% Stake

Topics:Federal Reserve | Banking
Sectors:Insurance | Financial Services | Banks
Companies:American International Group Inc
| 16 Sep 2008 | 07:43 PM ET
Text Size

American International Group will get an $85 billion bridge loan from the federal
government in exchange for an 80 percent stake in itself, sources have told CNBC.

Sources said the loan, which will allow AIG to avoid bankruptcy, will be secured and
include incentives for quick asset-sales by AIG.
Government warrants for most of AIG's equity will severely dilute existing shareholders.

AIG has been racing the clock to avoid a bankruptcy filing on Wednesday, making efforts
to work out a deal with the Federal Reserve to shore up its finances.

Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke met
with Senate and House leadership Tuesday night to discuss how to assist AIG, sources
said.

The Fed's financial aid to the troubled insurer marks a reversal of its decision on Monday
to refuse a bridge loan to AIG.

The Fed met with the company's advisers throughout the day and came to a better
understanding of what is needed to help the company through its current crisis, people
familiar with the negotiations told CNBC.

Bloomberg reported late Tuesday that the Fed was considering some kind of
conservatorship for AIG—which would mean bringing in an outsider to run the company.
But sources told CNBC that no legal authority exists for such an arrangement.

AIG [AIG 2.31 0.21 (+10%) ] shares swung wildly all day Tuesday in heavy volume.

Watch David Faber's report on possible AIG deal.

The shares, which are a component of the Dow Jones Industrial Average, at one point
were down more than 50 percent in the wake of a cut in the insurer's credit rating, which
only served to heighten the concerns that it would file for bankrupcy and further upset the
troubled global financial system.

The plunge in AIG shares has been the biggest drag on the Dow this week.

AIG, one of the world's largest insurers, is the latest company to be convulsed by a
mortgage and credit crisis that this week led to a bankruptcy filing by Lehman Brothers
Holdings [LEH 0.054 --- UNCH (0) ] and the sale of Merrill Lynch [MER 19.32
1.17 (+6.45%) ] to Bank of America [BAC 24.40 1.16 (+4.99%) ].

WALL STREET IN CRISIS - A CNBC SPECIAL REPORT

AIG late Sunday asked the Federal Reserve for help, including a possible "bridge" loan to
tide it over while it pursues asset sales and capital raising. The Fed refused, but pushed
JPMorgan Chase [JPM 40.66 1.33 (+3.38%) ] and Morgan Stanley [MS 19.77 0.53
(+2.75%) ] to try to put together a credit facility of $70 billion to $75 billion for New
York-based AIG, a person familiar with the matter said on Monday.

Paulson View Unchanged

The Fed declinded to comment Tuesday on its willingness to assit AIG.

However, a Treasury official told CNBC that the comments of Treasury Sectary Hank
Paulson on Monday still stand.

CNBC Investor Advice:

* Who Owns AIG Shares?

* What If You're A Client of AIG?
* Cramer: Banks Worth Buying!
* Non-Bank Stock Picks
* Slideshow: Bank Failures of 2008

On Monday, Paulson had said, "We do not take, and I don't take, lightly ever putting the
taxpayer on the line to support an institution ... Don't read it as no more; read it as that it's
important, I think, for us to maintain the stability and orderliness of our financial system.
Moral hazard is something I don't take lightly.''

Time is running short for AIG. The insurer has "a day" to solve its problems, New York
Gov. David Paterson said on CNBC television.

Bankruptcy Poses 'Systemic Risk'

Meanwhile, a company run by former AIG CEO Hank Greenberg said it may try to take
over the insurer in a proxy fight or tender offer, according to a regulatory filing on
Tuesday.

"It's in our national interest that AIG survive," said Greenberg told CNBC. He said there
could be "systemic risks" if AIG's trading partners try to get out of their contracts.

Asked if an AIG bankruptcy were possible, he said if the company doesn't get a bridge
loan, new capital, or relief from rating agencies, "then there's no alternative, and that
would be a disaster."

Greenberg, who has much of his own personal wealth tied up in AIG, said he has written
a letter to the company offering his help, but complained that he has been rebuffed.

Watch Greenberg interview at left.

The former CEO has been at odds with the company since he left in 2005 amid charges of
financial misconduct leveled by then-New York Attorney General Eliot Spitzer and the
Securities and Exchange Commission. Greenberg denied wrongdoing.

Greenberg's company C.V. Starr said, in a filing with the SEC, that it is working with its
adviser, investment bank Parella Weinberg Partners, on strategic options, including buing
assets from AIG, taking it private, or trying to buy it in a proxy fight.
In order to take such steps, Greenberg would have to receive approval from the New York
Department of Insurance, given strict laws governing those who hold more than 10
percent of an insurer's stock.

A spokesman for New York Insurance Superintendent Eric Dinallo was not immediately
available for comment.

RELATED LINKS

Current DateTime: 04:08:47 21 Oct 2008

LinksList Documentid: 26737121

* Fed Statement on AIG

* Cramer: AIG Too Big to Fail
* Poll: Should US Bail Out AIG?
* Handicapping AIG's Options
* Rush to Redeem Policies in Asia
* WaMu Surges on Talk of JPMorgan Bid
* BofA Buys Merrill for $29 a Share
* Farrell: Parsing the Faltering Financials

Monday's rating downgrades will make it much more difficult for AIG Chief Executive
Robert Willumstad to raise cash, and could trigger demands that the company come up
with nearly $20 billion.

The insurer has suffered $18 billion of losses in the last three quarters tied to guarantees it
wrote on mortgage-linked derivatives. It ended June with $1.05 trillion of assets. Its
failure would likely be larger than that of Lehman, which said it ended August with about
$600 billion of assets.

Credit Suisse analyst Thomas Gallagher halved his price target on AIG to $3, citing a
"heightened probability" of a bankruptcy filing. "While there is a chance the company
can work its way through its liquidity problems if it can secure substantial bridge
financing, we think this will be challenging to execute in the current onerous credit
environment," he wrote.

AIG ended 2007 with 116,000 employees, more than four times as many as Lehman.

Too Big to Fail?

Late Monday, Standard & Poor's cut AIG's long-term credit rating three notches to "A-
minus" from "AA-minus," citing "reduced flexibility in meeting additional collateral
needs and concerns over increasing residential mortgage-related losses."
Moody's Investors Service on Monday cut AIG's rating two notches to "A2" from "Aa3,"
while Fitch Ratings cut its rating two notches to "A" from "AA-minus."

The far-reaching influence of AIG in American life. Watch video at left.

S&P told CNBC Tuesday that the key consideration in its ratings changes was the
"company's reduced access to the capital markets."

The firm's insurance analyst, Rodney Clark, said AIG has an increasing need to post
collateral at a time of diminishng access to capital. And though it is actively pursuing a
number of financing options, the situation was "reflecting a lot of risk in its abiity to
succeed in putting those solutions in place."

The downgrades mean that AIG's trading partners can require the insurer to post an
additional $14.5 billion of collateral, according to an Aug. 6 regulatory filing. They could
also result in the early termination of some contracts, requiring an additional $5.4 billion
of payments, the filing shows.

"Many people think AIG is too big to fail, but the world will not come to an end if it
fails," said Matt McCormick, portfolio manager and banking analyst at Bahl & Gaynor
Investment Counsel Inc in Cincinnati.

Despite its problems, AIG has many profitable businesses it could sell, including life
insurance, property and casualty insurance, and aircraft leasing. Greenberg estimated the
company could raise $20 billion from asset sales if given the time.

On Monday, Paterson said New York would let AIG essentially loan itself $20 billion by
shifting liquid investments to itself from some of its regulated insurance units.

All About You ...

* Bank Deposits: What's Insured, What's Not

* Six Steps to Restoring Credit
* Dealing with Credit and Debt Problems

AIG's 5.85 percent notes maturing in 2018 fell 11 cents on the dollar to 36 cents, yielding
22.55 percent, the Financial Industry Regulatory Authority bond pricing service Trace
said.

Investors on Tuesday were paying $5.2 million up front plus $500,000 annually to protect
$10 million of AIG debt against default for five years, up from $3.3 million up front on
Monday, according to Phoenix Partners Group.

-Charles Gasparino, On-Air Editor; David Faber, CNBC anchor and reporter; Steve
Liesman, senior economics reporter; and Reuters contributed to this report.