American International Group (2005)

ASSIGNMENT SUBMITTED TO ADMAS UNIVERSITY UNIVERSIT AS A

REQUIREMENT OF THE COURSE ACCOUNTING INFORMATION
SYSTEM POST GRADUATE PROGRAM DEPARTEMENT OF
ACCOUNTING AND FINANCE
BY

NAME OF PARTICIPANT ID ROLE

1. ASCHALEW MARISHET PGMKA/2004/20 DOCUMENT ORGANIZER

2. GETACHEW MULU PGMKA/2008/20 SECRETARY

3. ABIRHA TIKUE PGMKA/2035/20

4.ABIYOT LIMENEW PGMKA/2004/20

5.TEKALIGN MEGERSA PGMKA/2080/20

COURSE INSTRUCTOR: MUSE BEYENE ( ASST. PROFESSOR)

JULY, 2021

ADDIS ABABA, ETHIOPIA

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Contents
ABSTRACT...........................................................................................................................................3
INTRODUCTION..................................................................................................................................3
PROGRESSION....................................................................................................................................4
ACCOUNTING SCANDAL.....................................................................................................................5
CAMPAIGNSIN THE SPOTLIGHT.....................................................................................................6
CONCLUSION......................................................................................................................................9
REFERENCES.......................................................................................................................................9

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 ABSTRACT
American International Group, (AIG) has recently been charged with reporting bogus
transactions that hid losses and inflated its net worth. The New York State Attorney General
Eliot Spitzer alleges that AIG inflated reserves used for paying claims by millions of dollars
and that AIG's CEO Maurice Greenberg repeatedly directed AIG traders late in the day to buy
AIG shares to prop up its price, among other allegations. We examine the accounting errors
for which AIG and Greenberg are being charged and analyze the opportunities missed by the
auditors to detect problems, within the framework of corporate governance. That is, we
evaluate the corporate environment that supported these lapses and provided an environment
conducive to the perpetration and acceptance of fradulent reporting. We discuss how
corporate governance not only promotes better financial reporting, but provides a level of
scrutiny that encourages more ethical behavior at all levels of the corporate hierarchy, and we
discuss the imperative for accounting education.

INTRODUCTION

American International Group, Inc., also known as AIG, is an American multinational

finance and insurance corporation with operations in more than 80 countries and
jurisdictions. As of January 1, 2019, AIG companies employed 49,600 people.The company
operates through three core businesses: General Insurance, Life & Retirement, and a
standalone technology-enabled subsidiary. General Insurance includes Commercial, Personal
Insurance, U.S. and International field operations. Life & Retirement includes Group
Retirement, Individual Retirement, Life, and Institutional Markets. AIG is a sponsor of AIG
Women’s Open (golf) and of New Zealand Rugby (AIG All blacks)

AIG’s accounting scandal is one of the biggest accounting scandals in the first decade of 21st
century. In 2004, SEC discovered that AIG rewrote its financial reports for years from 2000 to
2004, with support from Gen Re, one of the biggest reinsurers in the world. This scandal led to

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reduction of AIG’s net income in 2004 of $1.32B, and total settlement of $1.6B from
government. AIG was also accused of violating 16 counts of the criminal code.

AIG is the world’s largest insurance and financial services company. AIG, through its
subsidiaries, is engaged in a broad range of insurance and insurance-related activities
worldwide. In 2007, AIG has 93,000 employees, business in 130 countries, $6.2 billion net
income, and $59.8 billion premium written.

Gen Re Corporation, established in 1921, is a Connecticut corporation with its principal

corporate offices located in Stamford, Connecticut. Gen Re became a wholly-owned
subsidiary of Berkshire Hathaway Inc. on December 21, 1998. It is one of the largest
reinsurers in the world. In 2007, Gen Re has $6.0 billion premium written.

Hank Greenburg, CEO of AIG, was born in 1925. He admitted to NY Bar in 1953, and joined
AIG 1962. In 1968, he was named CEO. He has led AIG for 38 years, until he stepped down
in on March 21, 2005.

Ron Ferguson, CEO of Gen Re, was born in 1995. He is a fellow of CAS. He is a co-
developer of B-F method. In 1966, he joined 1966. He was named CEO in 1987. He retired in
2002.

PROGRESSION
The early 2000s saw a marked period of growth as AIG acquired American General
Corporation, a leading domestic life insurance and annuities provider, and AIG entered new
markets including India. In February 2000, AIG created a strategic advisory venture team
with the Blackstone Group and Kissinger Associates "to provide financial advisory services to
corporations seeking high level independent strategic advice". AIG was an investor in
Blackstone from 1998 to March 2012, when it sold all of its shares in the company.
Blackstone acted as an adviser for AIG during the 2007-2008 financial crisis.

In March 2003 American General merged with Old Line Life Insurance Company.

In the early 2000s, AIG made significant investments in Russia as the country recovered from
its financial crisis. In July 2003, Maurice Greenberg met with Putin to discuss AIG's
investments and improving U.S.-Russia economic ties, in anticipation of Putin's meeting with
U.S. President George W. Bush later that year."

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In November 2004, AIG reached a $126 million settlement with the U.S. Securities and
Exchange Commission and the Justice Department partly resolving a number of regulatory
matters, and the company needed to continue to cooperate with investigators continuing to
probe the sale of a non-traditional insurance product.

During the 1980s, AIG continued expanding its market distribution and worldwide network
by offering a wide range of specialized products, including pollution liability and political
risk. In 1984, AIG listed its shares on the New York Stock Exchange (NYSE). Throughout
the 1990s, AIG developed new sources of income through diverse investments, including the
acquisition of International Lease Finance Corporation (ILFC), a provider of leased aircraft to
the airline industry. In 1992, AIG received the first foreign insurance license granted in over
40 years by the Chinese government. Within the U.S., AIG acquired SunAmerica Inc. a
retirement savings company managed by Eli Broad, in 1999.

ACCOUNTING SCANDAL

In 2005, AIG became embroiled in a series of fraud investigations conducted by the Securities
and Exchange Commission, U.S. Justice Department, and New York State Attorney General's
Office. Greenberg was ousted amid an accounting scandal in February 2005. The New York
Attorney General's investigation led to a $1.6 billion fine for AIG and criminal charges for
some of its executives.

On May 1, 2005, investigations conducted by outside counsel at the request of AIG's Audit
Committee and the consultation with AIG's independent auditors, PricewaterhouseCoopers
LLP resulted in AIG's decision to restate its financial statements for the years ended
December 31, 2003, 2002, 2001 and 2000, the quarters ended March 31, June 30 and
September 30, 2004 and 2003 and the quarter ended December 31, 2003.On November 9,
2005, the company was said to have delayed its third-quarter earnings report because it had to
restate earlier financial results, to correct accounting errors.

. He is a co-developer of B-F method. In 1966, he joined 1966. He was named CEO in 1987. He
retired in 2002.
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 CAMPAIGNSIN THE SPOTLIGHT

Oct 26, 2000 – AIG announced that premiums increased in Q3, but reserves fell by $59 million
Oct 26, 2000 – AIG share price dropped from $99.37 to $93.31 on NYSE (6%)
October 31, 2000 – Concerned about analysts’ reactions to AIG’s declining reserves and the
resultant negative impact on AIG’s stock price, Hank Greenberg called Ron Ferguson to solicit
Gen Re’s help in structuring a transaction between AIG and Gen Re that would transfer $200
million to $500 million of “loss reserves” to AIG by year end through a reinsurance
arrangement between AIG and Gen Re. In conversations with Gen Re’s CEO, AIG’s chairman
made clear that, while he was looking to increase AIG’s loss reserves, the transaction he was
contemplating was one that would not require AIG to take on any actual risk.
Gen Re and AIG fashioned two contracts between National Union Fire Insurance Company of
Pittsburgh, PA (“National Union”), an AIG subsidiary, and Cologne Re Dublin (“CRD”), a
Dublin, Ireland-based subsidiary of a Gen Re subsidiary. These purportedly were retrocession
contracts, or contracts in which a reinsurer ceded to another reinsurer all or part of a reinsured
risk it previously assumed – in other words, reinsurance of reinsurance.
The contracts ultimately agreed upon showed reinsurance transactions that appeared, falsely, to
transfer risk to AIG. On the face of the contracts National Union appeared to assume $100
million of risk over and above the $500 million in premiums CRD was obligated to pay, but this
extra $100 million of risk was pure fiction added to make it appear that the contracts transferred
risk to National Union. In fact, National Union assumed no risk and CRD incurred no premium
liability. Of the $500 million in premiums set forth in the contracts, $490 million was on a
“fund withheld” basis (i.e., the money was never paid to National Union but was retained by
CRD). CRD was supposed to pay the remaining $10 million to National Union according to the
contracts, but AIG “prefunded” the $10 million to CRD in what amounted to a round trip of
cash in a side deal that was not reflected in the contracts. Gen Re received $5 million for doing
the deal.

How CRD Paid $10M in Premium without Really Paying

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Leverage existing contract, in which Gen Re holds $31.8M payable to AIG * Gen Re pays only
$7.5M to commute an existing contract with AIG’s Hartford Steam Boiler (HSB) * Gen Re
pays National Union $9.1M in premium to reinsure the HSB losses that were just commuted *
CRD pays $0.4M in premiums to Gen Re for a “sham” reinsurance contract and receives a loss
payment of $13M shortly after ink dries * CRD pays LPT “premium” of $10M to AIG * Gen
Re / CRD left with $5.2M to cover the fee * Gen Re: $31.8M - $ 7.5M - $9.1M + $0.4M-
$13.0M = $2.6M * CRD: - $0.4M + $13.0M - $10.0M = $2.6M
The contracts became the vehicle for improperly adding loss reserves to AIG’s financial
statements. By accounting for the contracts as if they were real reinsurance, AIG inflated its loss
reserves by $250 million in 2000 and an additional $250 million in 2001, and its premiums by
$250 in both 2000 and 2011. Without the phony loss reserves added to AIG’s balance sheet,
AIG’s reported loss reserves would have been $250 million less in the fourth quarter of 2000
and $500 million less in the first quarter of 2011. In other words, but for the phony loss
reserves, AIG would have reported declining loss reserves for three consecutive quarters,
including the decline in the third quarter of 2000 that prompted AIG’s CEO to initiate the
transactions with Gen Re.

Impact on AIG’s accounting reports: Assets | Liabilities | +$10M Premium Paid by CRD+
$490M Premium Receivable withheld by CRD | +$500M Additional Reserves |

1 | 2 Reported | 3 LPT Contracts | 4 Actual | 5 4Q 2000 | 6 +$106M | 7 -$250M | 8 -$144M | 9

1Q 2001 | 10 +$63M | 11 -$250M | 12 -$187M |

February 8, 2011 and April 26, 2011 – AIG issued fourth quarter 2000 and first quarter 2001
earnings releases, respectively. These releases reflected the impact of the two Gen Re contracts,
and were materially inaccurate because the transactions that resulted in the reported increase in
reserves did not transfer risk to AIG. The deal AIG and Gen Re struck achieved its intended
purpose when markets analysts reacted favorably to the increased reserves.
March 30, 2005 – AIG issued a press release announcing a delay in the filing of AIG’s 2004
Form 10-K. In the press release, AIG disclosed that an internal review of AIG’s books and
records was being conducted that included issues arising from pending regulatory
investigations. The release also discussed that AIG/Gen Re transactions. It stated that “the
documentation [for the AIG/Gen Re transactions] was improper and, in light of the lack of

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evidence of risk transfer,” the transactions should not have been accounted for as reinsurance.
As a result, AIG stated it would adjust its financial statements to recharacterize the transactions
as deposits, effectively reversing the reserves that AIG had posted as a result of the AIG/Gen Re
transactions.
May 31, 2005 – AIG announced that it had completed its internal review and filed its 2004
Forms 10-K. The Form 10-K included a restatements of its financial statements for the years
ended December 31, 2000, 2001, 2002 and 2003, and selected quarterly information for the
quarters ended March 31, June 30 and September 30, 2003 and 2004, and the quarter ended
December 31, 2003. As part of the restatement, AIG amended its periodic quarterly filings on
Form 10-Q for the periods ended March 31, 2003 and 2004 in a 10-Q/A filed on June 28, 2005;
for the periods ended June 30, 2003 and 2004 on a 10-Q/A filed on August 9, 2005 and for the
period ended September 30, 2004 in a 10-Q filed on November 14, 2005.
AIG also restated its accounting pertaining to the AIG/Gen Re transactions. AIG concluded in
the 2004 Form 10-K that the transactions were done to accomplish a desired accounting result
and did not entail sufficient qualifying risk transfer. As a result, AIG has determined that the
transactions should not have been recorded as insurance.
AIG’s restated financial statements re characterize the transactions as deposits rather than as
insurance.
Feb 9, 2006 – SEC and Justice Department settlement with AIG * Total settlement in excess of
$1.6 billion * Related to alleged improper accounting, bid rigging and practices involving
workers comp funds * CEO and CFO replaced
Alleged violation of 16 counts of the criminal code
* Conspiracy (1 count)
* Securities fraud (7 counts)
* False statements to SEC (5 counts)
* Mail fraud (3 counts) Hank Greenberg: resign from chairman and CEO of AIG.
RonFerguson:
2yearssupervisedrelease,$200,000fine

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 CONCLUSION

The AIG/Gen Re scandal has put financial reinsurance on the front page of every major
financial news publication and has caused the industry to re-evaluate the accounting of such
contracts. The financial devastation wrought by the scandal is not trivial. On May 31, 2005,
AIG filed its 10-K report, in which it restated its financials for the years 2000, 2001, 2002,
2003, and 2004.

Despite all of the turmoil surrounding the AIG/Gen Re scandal, however, it is important to
realize that it’s not financial reinsurance itself that is scandalous; rather, as Georgia insurance
commissioner John Oxen dine so aptly put it, it is the misuse of it that is wrong.

REFERENCES
 AGREED STATEMENT OF FACTS. (n.d.). Retrieved from justice.gov:
http://www.justice.gov/criminal/pr/documents/01-20-1%20gen-re-
agreedstatement.pdf
 AIG SECURITIES LITIGATION-PwC SETTLEMENT. ( 2010, December 2).
Retrieved from AIG SECURITIES LITIGATION-PwC SETTLEMENT:
http://www.aigsecuritieslitigationpwcsettlement.com/
 AIG: What Went Wrong. (2005, 4 10). Retrieved from businessweek.com:
http://www.businessweek.com/stories/2005-04-10/aig-what-went-wrong
 American International Group. (20, September 2013). Retrieved from Wikipedia:
http://en.wikipedia.org/wiki/American_International_Group
 CALLAHAN, D. (2010, November 8). AIG: Before the Crash, There Was the Fraud.
Retrieved from cheatingculture.com: http://www.cheatingculture.com/accounting-
fraud/2010/11/8/aig-before-the-crash-there-was-the-fraud.html
 Kay, J. (2005, March 24). Top insurance company mired in allegations of accounting
fraud. Retrieved from International Committee of the Fourth International (ICFI):
http://www.wsws.org/en/articles/2005/03/aig-m24.html
 Schonfeld, M. (2005 ). John Houldsworth: Securities and Exchange Commission
Litigation Complaint. New York.
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  Starkman, D. (2005, June 1). AIG Comes Clean on Accounting. Retrieved from The
Washington Post:
http://www.washingtonpost.com/wp-dyn/content/article/2005/05/31/AR20050531015
89.html
 Wilkinson, P. (2009, February 11). PwC Off Hook In AIG Shareholder Fraud Suit.

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