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Breadth of AIG's problems is clear

The troubling things about the $1.7 billion in accounting problems reported Wednesday by American International Group Inc. are their number and variety, accounting and finance experts said.
/ Source: a href="" linktype="External" resizable="true" status="true" scrollbars="true"><p>The Washington Post</p></a

The troubling things about the $1.7 billion in accounting problems reported Wednesday by American International Group Inc. are their number and variety, accounting and finance experts said.

The eight accounting issues revealed by the company range from a transaction with a company closely linked to AIG that could reduce shareholder equity by $1.1 billion to others that were improper but will have little or no effect.

"My initial reaction was 'Wow!' They have about eight different new issues here, and it pretty much covers the waterfront" of improper accounting, said University of Georgia accounting professor Dennis R. Beresford. "It's an indication that a lot of things are messed up."

But Beresford and others also said the insurance giant's overall health and survival do not appear to be in jeopardy. So far, AIG estimates that the total value of the restatement will be about $1.7 billion, about 2 percent of shareholder equity of nearly $83 billion at the end of 2004.

In contrast, by the time WorldCom Inc. finished writing off the company's $11 billion fraud and its overvalued assets and goodwill, the company was broke. Frauds at WorldCom and Enron Corp. disguised large operating losses, while AIG's estimated write-down is less than one-fifth of the $11 billion profit previously reported for 2004.

"This is not the same as Enron. They were trying to look better than they are, but they were not in terrible shape," said Columbia University accounting professor Itzhak Sharav.

AIG announced Wednesday that it was delaying filing its annual report with the Securities and Exchange Commission until April 30 to give executives more time to comb the company's books for improper transactions and accounting issues. The AIG board has already forced out chairman and chief executive Maurice R. "Hank" Greenberg and fired three top executives for invoking their Fifth Amendment right not to incriminate themselves.

Wednesday's report also gave shareholders a first glimpse of the size and kinds of problems that an internal investigation has found, although the review is continuing and more problems could emerge.

First, AIG acknowledged in a news release that two $250 million reinsurance transactions with General Re Corp. -- a subsidiary of Berkshire Hathaway Inc. -- in 2000 and 2001 were "improper" and should not have been characterized as insurance deals because they did not transfer risk from one company to another.

The SEC and New York Attorney General Eliot L. Spitzer's office issued subpoenas to AIG in mid-February, seeking information about the transactions. The company's stock price has slid more than 22 percent since then.

Regulators are scheduled to interview Greenberg and Berkshire Hathaway Chairman Warren E. Buffett, a longtime Washington Post Co. board member, in April. Buffett is being treated as a witness, not a target, in the investigation, according to a spokesman for Spitzer.

The contested transaction had the effect of boosting the reported size of AIG's reserves for insurance claims when investors were asking if the reserves were too small. The transaction was structured to make it appear that General Re was paying AIG to share some of its claim risk, but AIG said in a statement Wednesday that its investigators had found no "evidence of risk transfer."

Essentially, Sharav said, the deal was "economic engineering to prettify the financial statements. This is a big no-no."

AIG stock is part of the Dow Jones industrial average and is widely held by mutual funds and closely watched by investors. The company had a longtime reputation for solid growth and reliable results despite being in an industry that was inherently volatile.

Now the company has warned that at least some of its recent reliability was based on a series of "transactions which appear to have been structured for the sole or primary purpose of accomplishing a desired accounting result."

Three of the issues involve offshore insurance issuers that AIG previously treated as separate companies and may have used to shift liabilities and losses off its books. Regulators have been scrutinizing related entities particularly closely since Enron hid billions of dollars in losses that way.

According to AIG:

  • Barbados-based Union Excess Reinsurance Co. does business almost exclusively with AIG, and its shareholders are entwined with a holding company that owns 12 percent of AIG and has a board made up of current and former AIG executives. If AIG is required to consolidate Union's liabilities with its own, it could cut shareholder equity by $1.1 billion, the firm said.
  • There is "previously undisclosed evidence" that AIG controls Bermuda-based Richmond Insurance Co. Adding Richmond to AIG's results would have a minimal effect on the bottom line, the company said.
  • AIG engaged in improper transactions with Barbados-based Capco Reinsurance Co. Ltd. that had the effect of reclassifying $200 million in operating losses from its automobile insurance business as capital losses. Investors tend to pay more attention to operating losses, analysts said.

The company also said it had improperly boosted its reported investment income by $300 million by selling options on the bonds in its portfolios. The deal, which resulted in a corresponding decrease in realized capital gains, had no effect on shareholder equity.

AIG also revealed that it may not be able collect as much as $300 million in debts owed to its U.S. operations. It also may have to take a $370 million charge relating to the way it accounted for acquisition costs. AIG also plans to reclassify how it accounted for some investment income and some deferred compensation paid to company employees.

The company did not elaborate on the reasons for the accounting changes. AIG's auditor, PricewaterhouseCoopers, did not return calls for comment.

Stock analysts had mixed reactions to the announcements.

Merrill Lynch & Co. analyst Jay A. Cohen called the impact of the restatements "manageable" in his report. He said the stock's 22 percent slide since the regulatory investigation was announced in February an "overreaction."

But Morgan Stanley & Co. analyst William M. Wilt and his team wrote that "the depth and breadth of troubles and apparent lack of accounting controls at AIG is alarming."

AIG has been in and out of regulatory trouble for several years over its sale of insurance products that some public companies used to make their financial results look better, and it was implicated in a bid-rigging scandal last fall.

Staff writer Carrie Johnson contributed to this report.