AIG 2006 Annual Report Download - page 118

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
2006 and 2005 Comparison management, and the associated fee revenue, along with strong
realized gains on sales of real estate investments and per form-
Asset Management operating income increased 4 percent in 2006 ance fees earned on various private equity investments. The
compared to 2005 on revenues that increased 9 percent. increase in operating income was achieved despite the runoff of
Operating income related to the Spread-Based Investment the existing GIC portfolio and the delay in the MIP. The decline in
Business declined 20 percent in 2006 compared to 2005 due GIC operating income compared to 2004 reflects tighter spreads
primarily to the continued runoff of GIC balances and spread in the GIC portfolio, partially offset by improved partnership
compression related to increases in short-term interest rates. A returns. Spread compression occurred as the base portfolio yield
significant portion of the remaining GIC portfolio consists of declined due to an increase in the cost of funds in the short-term
floating rate obligations. AIG has entered into hedges to manage floating rate portion of the GIC portfolio, only partially offset by
against increases in short-term interest rates. AIG believes these increased investment income from the floating rate assets
hedges are economically effective, but they did not qualify for backing the portfolio.
hedge accounting treatment under FAS 133. Income or loss from
these hedges are classified as realized capital gains or losses Other Operations
and are included in AIG’s Other category. The decline in operating
income was partially offset by improved partnership income, The operating loss of AIG’s Other category for the years ended
particularly during the fourth quarter of 2006. Partnership income December 31, 2006, 2005 and 2004 was as follows:
is primarily derived from alternative investments and is affected
by performance in the equity markets. Thus, revenues, operating (in millions) 2006 2005 2004
income and cash flow attributable to GICs will vary among Other Operating Income
reporting periods. Commencing with transactions initiated in the (Loss):
first quarter of 2007, AIG is reinstituting hedge accounting for Equity earnings in
derivative transactions related to the MIP. unconsolidated entities $ 193 $ (124) $ 157
During 2005, the MIP replaced the GIC program as AIG’s Interest expense (859) (541) (435)
principal spread-based investment activity. While the MIP showed Unallocated corporate
strong growth in operating income, AIG does not expect that the expenses (555) (413) (316)
income growth in the MIP will offset the runoff in the GIC portfolio Compensation expense —
for the foreseeable future, because the asset mix under the MIP SICO Plans (108) (205) (62)
Compensation expense —
does not include the alternative investments utilized in the GIC
Starr tender offer (54) ——
program.
Realized capital gains (losses) (295) 505 94
The MIP was initially launched in the Euromarkets in
Regulatory settlement costs —(1,644) —
September 2005 through AIG’s $10 billion Euro medium term
Other miscellaneous, net (23) (113) —
note program. Through December 31, 2006, AIG has issued the
equivalent of $5.3 billion for the MIP in the Euromarkets and the Total Other $(1,701) $(2,535) $ (562)
U.S. public and private markets.
Operating income related to Institutional Asset Management 2006 and 2005 Comparison
increased 50 percent in 2006 to $1.0 billion compared to 2005,
primarily due to an increase of $337 million in gains on certain Operating loss for AIG’s Other category declined to $1.7 billion in
VIEs and partnerships. These gains are offset in minority interest 2006 compared to $2.5 billion in 2005, largely due to regulatory
expense, which is not a component of operating income. AIG’s settlement costs of $1.6 billion in 2005 as described under
unaffiliated client assets under management, including both retail Item 3. Legal Proceedings. Interest expense grew in 2006 as a
mutual funds and institutional accounts, increased 21 percent result of increased borrowings by the parent holding company.
from year-end 2005 to $75 billion, resulting in higher manage- Unallocated corporate expenses increased $142 million due to
ment fee income. Increased realized capital gains on real estate increases in general corporate expenses primarily resulting from
investments from 2005 also contributed to the increase in ongoing efforts to improve internal controls, higher stock compen-
operating income. The growth in Institutional Asset Management sation expenses and expenses relating to executive departures in
revenues and operating income were driven by contributions from 2005 and 2006. AIG expects these compensation expenses to
all asset classes globally. Partially offsetting this growth were continue to increase as these improvement efforts progress.
lower performance-based fees on private equity investments, and Operating income in 2006 also includes realized capital losses of
higher expenses related to the planned expansion of marketing $295 million, primarily reflecting the effect of hedging activities in
and distribution capabilities, combined with technology and opera- the Financial Services and Asset Management segments that did
tional infrastructure-related enhancements. not qualify for hedge accounting treatment under FAS 133. Also
reflected in Other operating loss in 2006 is an out of period
charge of $61 million with respect to the SICO Plans and a one-
2005 and 2004 Comparison
time charge related to the Starr tender offer of $54 million. For a
Asset Management operating income increased in 2005 compared further discussion of these items, see Note 16 of Notes to
to 2004 as a result of growth in institutional assets under Consolidated Financial Statements. These declines were partially
68 AIG 2006 Form 10-K