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AIG Adds Derivatives Blunder

The insurer was undervaluing its book by $2.4 billion.

Updated from 9:52 a.m. EDT

American International Group

(AIG) - Get Report

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

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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.

"We now know that there were serious issues with our internal controls, and that it is necessary for us to address those issues and strengthen our controls," he said.

Manhattan-based AIG, under investigation by New York Attorney General Eliot Spitzer over how it accounted for some transactions with some subsidiaries, said it will restate its fiscal 2000, 2001, 2002 and 2003 statements and the March, June and September quarters for 2004.

The investigation of AIG over its business with reinsurance firms has led to the dismissal of a number of executives, including the forced resignation of Maurice "Hank" Greenberg, who ruled the firm with an iron hand for nearly four decades.

AIG has lost $58 billion in market value since its troubles came to light in February. Shares closed Friday in NYSE trading at $50.85, down 29 cents.