AIG Adds Derivatives Blunder

Updated from 9:52 a.m. EDT

American International Group(AIG Quote) expanded the scope of its long-expected earnings revision, saying a four-year restatement of financial results will include reductions to shareholder equity of $2.7 billion, or 3.3%.

That's about $1 billion more than previously estimated. Still, the news led Moody's to cut its rating of AIG's long-term debt to Aa2 from Aa1.

Ironically, the bottom-line impact of AIG's accounting mistakes could be lessened by a newly disclosed blunder involving the insurer's accounting for derivative instruments. AIG said it was undercounting the value of some of its derivative contracts to the tune of $2.4 billion.

The adjustment to the derivatives portfolio will be counted against the bottom-line impact of the rest of the bookkeeping errors, a person familiar with the company said. As such, the net impact of all the accounting changes on shareholder equity will be a decrease of about $300 million.

The discovery that AIG had been underestimating the value of its derivatives was unexpected. Normally, such a development is viewed negatively, regardless of whether it hurts or helps earnings. In AIG's case, however, the derivatives problem may actually reduce the overall impact of the insurer's accounting irregularities.

Shares of AIG were trading higher Monday, rising $2.61, or 5%, to $53.46.

AIG appears to be guilty of errors similar to those committed by mortgage-finance giant Freddie Mac(FRE Quote) a few years ago. Regulators found that Freddie, which has a massive derivatives portfolio, had been undervaluing some of its hedges as way to smooth earnings.

An AIG spokesman declined to comment. It appears the derivatives issue is something that emerged in recent weeks and may be one reason the company has had to delay the filing of its 10-K, or 2004 annual report.

AIG's auditor is PricewatehouseCoopers, the same big accounting firm that handled Freddie Mac's restatement and discovered that the mortgage finance firm had been undervaluing its derivatives. A PWC spokesman declined to comment

Still, the restatement is another indication that AIG's accounting mess is more than just recent history.

The troubled insurance giant expects to file its 10-K annual report, which now has been delayed three times, with the Securities and Exchange Commission by May 31.

"We are disappointed that we have not yet been able to file our Form 10-K," said Martin J. Sullivan, AIG president and chief executive officer. "We are working diligently to complete the filing, at the same time assuring we have accurate financial statements, rigorous accounting, greater transparency and thorough disclosure.