Updated from 11:02 a.m. EST
American International Group
conceded Wednesday that a five-year-old contract with Warren Buffett's
did not encompass enough risk-transfer to be considered an insurance transaction, and will be reclassified as a loan as part of a broad financial restatement.
Formal recognition of that accounting mistake and several others, including a concession that AIG had effective control over two offshore insurance vehicles with which it did ostensibly arm's-length transactions, was contained in a press release in which the insurance company said it would delay filing its 10-K with the
AIG, whose business practices are being probed by the SEC, the New York attorney general, the Justice Department and the New York insurance commissioner, said it remained unable to codify the full effect of the restatement. It said, however, that preliminary estimates suggest its previously reported shareholder equity of $82.87 billion as of Dec. 31 will fall by about 2%, or $1.66 billion.
AIG hopes to file its 10-K by April 30. The stock, which has given up about one-third of its value this year, was down $1.29, or 2.2%, to $56.91.
The news cost AIG its coveted triple-A credit rating at Standard & Poor's. The agency cut AIG's long-term counterparty and senior debt rating to double-A-plus Wednesday afternoon.
Of most significance is the admission regarding General Re, which Berkshire acquired in 1998. Investigators are currently preparing to interview Buffett, one of the most admired businessmen in the world, over what he knew about the 2000 deal, which had the effect of bolstering AIG's reserves by several hundred million dollars.
"Based on its review to date, AIG has concluded that the Gen Re transaction documentation was improper and, in light of the lack of evidence of risk transfer, these transactions should not have been recorded as insurance," AIG said Wednesday. The company will adjust its financial statements to recharacterize the deals as deposits rather than as consolidated net premiums, reducing the reserve for losses and loss expenses by $250 million and increasing other liabilities by $245 million.
The General Re transactions were carried out in two tranches in the fourth quarter of 2000 and the first quarter of 2001. The first tranche was closed out in November 2004, with a corresponding reduction in premiums and loss reserves totaling about $250 million. The other tranche remains on AIG's books as previously recorded.
To see a column about Buffett's defense of the transactions by
AIG also came clean about a number of offshore entities with which it has done business over the past decade, most notably Union Excess Reinsurance Co. and Richmond Insurance Co. Again, the issue is the use of favorable reinsurance accounting afforded transactions in which one insurer sells liabilities to another with the putative goal of diluting risk. Investigators suspect AIG exerted undue influence on a handful of smaller, mostly Caribbean-based companies to cut such deals simply to lighten its reserve balance.
The key issues are economic risk-transfer to the reinsurer and negotiation, two elements that must be present for the favorable accounting -- and which presumably wouldn't be if AIG controlled the counterparty. (For a story about what probably piqued investigators' interest in the offshore companies by
"AIG has no direct equity interest in Union Excess," the company said. "However, based upon AIG's review to date, including consideration of previously undisclosed facts, AIG now believes that a significant portion of the ownership interests of Union Excess shareholders are protected under financial arrangements with Starr International Company, a private holding company, which owns approximately 12% of AIG's outstanding common stock and whose board of directors consists of current and former members of AIG management."
AIG said that if Union Excess is required to be treated as a consolidated entity by AIG, it would result in a maximum reduction of approximately $1.1 billion in AIG's consolidated shareholders' equity as of Dec. 31, 2004.
Regarding Richmond Insurance Co., AIG said: "Although AIG owns only a minority ownership interest in Richmond, the review of the operations of the Richmond subsidiaries has shown significant previously undisclosed evidence of AIG control."
AIG will treat Richmond as a consolidated entity on its financial statements, a move that will result in a small increase in consolidated assets with a similar increase in consolidated liabilities and a minimal impact on AIG's consolidated shareholders' equity as of Dec. 31, 2004.
In cutting its credit rating, S&P said Wednesday's disclosures raise questions about the company and its culture.
"The number and scope of inappropriate financial transactions -- some characteristic of aggressive financial management -- have diminished our assessment of management and its internal controls, corporate governance, and aggressive culture," S&P said. "In addition, the potential breadth of management involvement in these transactions raises broader enterprise risk-management concerns."