AIG / Gen Re 2004 ACCOUNTING SCANDAL
Table of Contents
I. Introduction 3
II. The Companies and Participants 4
III. The Setting 5
IV. Aftermath 9
V. Conclusion 10
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 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.
II. The Companies and Participants
AIG is the ...view middle of the document...
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
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...