AIG 2006 Annual Report Download - page 128

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
dividends under AIG’s new dividend policy and repurchases of tial portion of the Life Insurance & Retirement Services operations
common stock. bond portfolio diminished significantly in value and/or defaulted,
AIG might need to liquidate other portions of its Life Insurance &
Retirement Services investment portfolio and/or arrange financ-
Insurance Operations
ing. Potential events causing such a liquidity strain could be the
The liquidity of the combined insurance operations is derived both result of economic collapse of a nation or region in which Life
domestically and abroad. The combined insurance operating cash Insurance & Retirement Services operations exist, nationalization,
flow is derived from two sources, underwriting operations and terrorist acts, or other economic or political upheaval. In addition,
investment operations. Cash flow from underwriting operations a significant rise in interest rates leading to a major increase in
includes periodic premium collections, including policyholders’ policyholder surrenders could also create a liquidity strain.
contract deposits, and paid loss recoveries, less reinsurance
premiums, losses, benefits, and acquisition and operating ex- Financial Services
penses. Generally, there is a time lag from when premiums are
collected and, when as a result of the occurrence of events AIG’s major Financial Services operating subsidiaries consist of
specified in the policy, the losses and benefits are paid. AIGFP, ILFC, AGF and AIGCFG. Sources of funds considered in
Investment cash flow is primarily derived from interest and meeting the liquidity needs of AIGFP’s operations include GIAs,
dividends received and includes realized capital gains net of issuance of long-term and short-term debt, proceeds from maturi-
realized capital losses. ties, sales of securities available for sale and securities and spot
In addition to the combined insurance operating cash flow, commodities leased or sold under repurchase agreements. ILFC,
AIG’s insurance operations held $11.2 billion in cash and short- AGF and AIGCFG utilize the commercial paper markets, bank loans
term investments at December 31, 2006. Operating cash flow and and bank credit facilities as sources of liquidity. ILFC and AGF
the cash and short-term balances held provided AIG’s insurance also fund in the domestic and international capital markets
operations with a significant amount of liquidity. This liquidity is without reliance on any guarantee from AIG. An additional source
available, among other things, to purchase predominately high of liquidity for ILFC is the use of export credit facilities. AIGCFG
quality and diversified fixed income securities and, to a lesser also uses wholesale and retail bank deposits as sources of funds.
extent, marketable equity securities, and to provide mortgage On occasion, AIG has provided equity capital to ILFC, AGF and
loans on real estate, policy loans, and collateral loans. This cash AIGCFG and provides intercompany loans to AIGCFG.
flow coupled with proceeds of approximately $126 billion from the
maturities, sales and redemptions of fixed income securities and Asset Management
from the sale of equity securities was used to purchase Asset Management operating cash flow is derived primarily from
approximately $161 billion of fixed income securities and market- investment income in connection with domestic and foreign GICs
able equity securities during 2006. and from the collection of various forms of investment manage-
See also Operating Review — General Insurance Operations ment fees, brokerage commissions and custody fees earned from
— General Insurance Net Investment Income and Life Insurance & affiliated and unaffiliated clients. Investment management fees
Retirement Services Operations — Life Insurance & Retirement are typically asset-based fees collected on a periodic basis, while
Services Net Investment Income and Realized Capital Gains brokerage commissions and custody fees are more transaction
(Losses) herein. driven and received on a continual basis. Asset Management also
derives cash from the realization of gains earned through its
General Insurance investment partnership holdings and collects various forms of
General Insurance operating cash flow is derived from underwriting incentive management fees. These incentive management fees,
and investment activities. With respect to General Insurance which are typically based on the appreciation and/or realization of
operations, if paid losses accelerated beyond AIG’s ability to fund gains on managed assets, are generally received in the form of
such paid losses from current operating cash flows, AIG might carried interest earned from sponsored funds managed on behalf
need to liquidate a portion of its General Insurance investment of clients. Asset Management’s spread-based investment busi-
portfolio and/or arrange for financing. Potential events causing ness derives cash from the investment income and the sale of
such a liquidity strain could be the result of several significant invested assets backing these contract liabilities.
catastrophic events occurring in a relatively short period of time. AIGGIG incurs expenses with associated cash outflows from
Additional strain on liquidity could occur if the investments the operation of its business, including costs related to portfolio
liquidated to fund such paid losses were sold into a depressed management and related back and middle office costs. In
market place and/or reinsurance recoverable on such paid losses addition, cash is used in association with investment warehousing
became uncollectible or collateral supporting such reinsurance activities wherein AIGGIG funds and holds an investment for the
recoverable significantly decreased in value. benefit of a future investment vehicle.
Cash needs for the spread-based investment business are
principally the result of GIC maturities. Significant blocks of the
Life Insurance & Retirement Services
GIC portfolio will mature over the next five years. AIG utilizes
Life Insurance & Retirement Services operating cash flow is asset liability matching to control liquidity risks associated with
derived from underwriting and investment activities. If a substan-
78 AIG 2006 Form 10-K