AIG Scandal 2005

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  • Topic: Actuarial science, Insurance, Reinsurance
  • Pages : 6 (1736 words )
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  • Published : December 19, 2014
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Introduction
AIG, American International Group Inc., is one of the top multinational insurance corporations. AIG, with asset of 556 billion, provides insurance service for more than 150 different countries and it has over 630, 000 employees over the world. Even though AIG is such a giant corporation, it has encountered financial problems in the early 2000s.   Under financial pressure and a lack of internal control, AIG have committed frauds resulting in several scandals. One of the accounting scandals was disclosed during 2005 which involved a material mis-statement due to false transactions during 2000. This scandal set to prelude leading the downfall of AIG in 2008. In this paper, I will analyze the cause, the transactions and finally effects of the scandal. The Accounting Scandal 

The Players
The CEO of AIG was Maurice “Hank” Greenberg. Greenberg joined AIG in 1962 and led AIG for thirty eight years until his retirement in March 2005.   Greenberg was not only the CEO, but also the chairman of the board of AIG. AIG also have several subsidiaries, which include National Union Fire Insurance Company of Pittsburgh (NUFIC) and Hartford Steam Boiler Inspection (HSB). Their financial information are consolidated in AIG’s financial statements.    The scandal also involves another corporation General Re Corporation. General Re is a subsidiary of Berkshire Hathaway, Inc., an investment group run by the billionaire Warren Buffet. General Re also has subsidiaries all over the world and together and it is one of the biggest reinsurance companies in the World. Reinsurance companies are entities that insure the insurance companies. They help insurance companies share risk by selling reinsurance plans that would help pay off a share of a claim from the insurance companies. The CEO of General Re was Ron Ferguson when the fraud was committed. General’s RE subsidiary in Dublin, Ireland, known as Cologne Re Dublin (CRD) was also heavily involved in the fraud. The Deal

On October, 26, 2000, AIG released its third quarter earnings. It showed that there was an increase of premium, but a decrease in loss reserves by 59 million. Loss reserve is a liability account which represents the estimate of loss future claims. Loss reserve is an important indicator for whether management of company is sufficiently anticipating for future claims. Since the premiums has increased, AIG’s loss premium should be increased as well. A decline could imply that AIG had cash or reserve problems. Because of the decline in loss reserves, analysts have downgraded AIG two days after release of earnings. Hence, the stock price of AIG dropped 6% from $99.6 to $93.3 on NYSE. It was then that Greenberg called Ferguson. Greenberg wanted to increase AIG loss reserves. Therefore, he and Greenberg had drafted a deal. By using both the subsidiaries of AIG and General RE, NUFIC and CRD.   NUFIC (AIG) would assume the risk of losses from CRD’s policies for about $600 million for $500 million of premium. The $500 million represented two contracts where each contract was paid in different times. Of that $500 million, 10 million would be paid to NUFIC (AIG) and $490 million would be withheld in CRD. The transaction itself is called Loss Portfolio Transfer and it is legal. However, AIG actually did not want to assume any risk. The contracts that CRD transferred were in fact risk-free. The claim would eventually be paid out by AIG for exactly $500 million. Also, AIG secretly agreed to AIG NUFIC Asset

+ 10M Premium Paid by CDR
+ 490M Premium Receivable (withheld by CDR) 
Liability 
+ 500M Loss Reserve

Transection recorded by AIG:
AIG NUFIC
Asset
+ 10M Premium Paid by CDR
+ 490M Premium Receivable (withheld by CDR) 
Liability 
+ 500M Loss Reserve

Transaction recorded by AIG:
Pay General Re 5 million as a fee for doing the deal. Following GAAP (general accepted accounting principle), the nature of the transaction could not be classified as Loss Portfolio Transfer as...
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