AIG Accounting Scandal
By: Ghazanfar Ali Zafar Rahmat
Introduction
AIG, American International Group Inc., is one of the top multinational insurance corporations. Its primary activities include General Insurance and Life Insurance & Retirement Services AIG, with asset of 556 illion, provides insurance service for more than !5" different countries and it has over 6#", """ employees over the world. According to the 2008 Forbes Global 2000 list, AIG was once the 18th-largest public company in the world. $ven thou%h AIG is such a %iant corporation, it has encountered financial prolems in the early """s. 'nder financial pressure and a lac( of internal control, AIG have committed frauds resultin% in several scandals. )ne of the accountin% scandals was disclosed durin% ""5 which involved a material mis*statement due to false transactions durin% """. +his scandal set to prelude leadin% the downfall of AIG in "".
The Accounting Scandal The Players
+he -$) of AIG was aurice /0an(1 Greener%. Greener% 2oined AIG in !36 and led AIG for thirty ei%ht years until his retirement in arch ""5. Greener% was not only the -$), ut also the chairman of the oard of AIG. AIG also have several susidiaries, which include 4ational 'nion ire Insurance -ompany of ittsur%h 74'I-8 and 0artford Steam 9oiler Inspection 70S98. +heir financial information are consolidated in AIG:s financial statements. +he scandal also involves another corporation General Re -orporation. General Re is a susidiary of 9er(shire 0athaway, Inc., an investment %roup run y the illionaire ;arren 9uffet. General Re also has susidiaries all over the world and to%ether and it is one of the i%%est reinsurance companies in the ;orld. Reinsurance companies are entities that insure the insurance companies. +hey help insurance companies share ris( y sellin% reinsurance plans that would help pay off a share of a claim from the insurance companies. +he -$) of General Re was Ron er%uson when the fraud was committed. General:s R$ susidiary in
The Deal
)n )ctoer, 6, """, AIG released its third =uarter earnin%s. It showed that there was an increase of premium, ut a decrease in loss reserves y 53 million. Loss reserve is a liaility account which represents the estimate of loss future claims. Loss reserve is an important indicator for whether mana%ement of company is sufficiently anticipatin% for future claims. A decline could imply that AIG had cash or reserve prolems. 9ecause of the decline in loss reserves, analysts have down%raded AIG two days after release of earnin%s. 0ence, the stoc( price of AIG dropped 6> from ?33.6 to ?3#.# on 4@S$. It was then that Greener% called er%uson. Greener% wanted to increase AIG loss reserves. +herefore, he and Greener% plotted to draft a deal. AIG bought insurance from General Re and accounted for it in a way that overstated revenue. ransactions with General Re were im!ro!erly recorded as a reinsurance deal. At the time, some AIG shareholders were "uestioning whether the insurance com!any had enough money set aside to cover !otential claims, #nown as reserves. $nder the transaction, AIG shifted %&00 million of e'!ected claims to itself from General Re, along with %&00 million of !remiums. AIG boo#ed the !remiums as revenue, and then added %&00 million to its reserves to reflect its obligation to !ay the claims. If AIG was receiving the !remiums to ensure that it didn(t lose anything in the deal, then it faced no ris#. In that case, it wasn(t really insuring anything and the %&00 million shouldn(t have been treated as !remium revenue. General Re received a %& million commission for the deal. For its !art, General Re did not treat the transaction as an insurance !olicy) instead, it boo#ed it as a finance deal.
Other Accounting frauds
AIG also admitted to* using insurers in +ermuda and +arbados that were secretly controlled by AIG to bolster its financial results, including shifting some liabilities off its boo#s a broad range of im!ro!er accounting that could slash its net worth by %.-billion, im!ro!erly accounting for a reinsurance transaction with +er#shire athaway Inc./s General Re in 2000200.
)n )ctoer, 6, """, AIG released its third =uarter earnin%s. It showed that there was an increase of premium, ut a decrease in loss reserves y 53 million. Loss reserve is a liaility account which represents the estimate of loss future claims. Loss reserve is an important indicator for whether mana%ement of company is sufficiently anticipatin% for future claims. Since the premiums has increased, AIG:s loss premium should e increased as well. A decline could imply that AIG had cash or reserve prolems. 9ecause of the decline in loss reserves, analysts have down%raded AIG two days after release of earnin%s. 0ence, the stoc( price of AIG dropped 6> from ?33.6 to ?3#.# on 4@S$. It was then that Greener% called er%uson. Greener% wanted to increase AIG loss reserves. +herefore, he and Greener% had drafted a deal. 9y usin% oth the susidiaries of AIG and General R$, 4'I- and -R<. 4'I- 7AIG8 would assume the ris( of losses from -R<:s policies for aout ?6"" million for ?5"" million of premium. +he ?5"" million represented two contracts where each contract was paid in different times. )f that ?5"" million, !" million would e paid to 4'I- 7AIG8 and ?3" million would e withheld in -R<. +he transaction itself is called Loss ortfolio +ransfer and it is le%al. 0owever, AIG actually did not want to assume any ris(. +he contracts that -R< transferred were in fact ris(*free. +he claim would eventually e paid out y AIG for eBactly ?5"" million. Also, AIG secretly a%reed to AIG 4'I-
Asset
C !" remium aid y -
C 5"" Loss Reserve Transection recorded by AIG:
AIG 4'I-
Transaction recorded by AIG:
ay General Re 5 million as a fee for doin% the deal. ollowin% GAA 7%eneral accepted accountin% principle8, the nature of the transaction could not e classified as Loss ortfolio +ransfer as there was no transfer of ris(. 0owever, senior mana%ements of AIG and General R$ a%reed to en%a%e in /non*mirror ima%e accountin%1, which 4'I- recorded the transaction as a Loss ortfolio
+ransfer, while -
-ommute ?E.5 Loss ayment ?!# -
;ith the reserves set up and a lac( of transparency, AIG was ale to manipulate numers and added ?!"6 million of loss reserves in """ and ?6# million ! ""! to the alance sheet mas(in% the actually decline of loss reserves of ?! million and ?!Emillion. ;ith the additional premium and loss reserve, analysts thou%ht that the earnin%s of AIG in those two =uarters were %reat. In the release of earnin%s in ! ""!, Greener% even wrote /JAIG had a solid first =uarter... ;e added ?6# million to AIGKs %eneral insurance net loss and loss ad2ustment reserves for the =uarter, rin%in% the total of those reserves to ?5." illion at arch #!, ""!.J What went wrong?
+he Securities and $Bchan%e -ommission 7S$-8 had already een proin% into AIG durin% early """ due to a various misconducts of AIG. +hey were already suspicious of the inte%rity of the financial information provided y AIG. In anuary ""5, the counsel of General R$ phoned S$- representatives to disclose the entirety L+ transaction. )n eruary ! ""5, AIG received a supoena from S$- relatin% to finite reinsurance accountin%. And # days later, AIG disclosed the L+ scheme to the pulic. In arch ""5, Greener% stepped down from the -$) position. In ay ""5, AIG issued a restated financial statement for fiscal years from """ throu%h ""#, which reduced the income for "" for !.# illion. Also $liot SpliMer, the 4ew @or( Attorney General filed a civil case a%ainst AIG. Responsiility of the Auditors ;ith liti%ation %oin% on for AIG, its auditor ricewaterhouse-oopers LL were also under scrutiny ecause they si%ned off the financial statements of AIG. any criticiMed w- that it did not detect the unusual transactions. +he AIG shareholders filed several complaints on w- to have violated the securities laws in providin% AIG auditin% services and %ivin% un=ualified opinions on AIG financial statements and demanded dama%es. )n nd
the AIG shareholders. w- has a lon% usiness relationship with AIG for over #" years, ut it appeared that w- has not een eBertin% full professional efforts. +he investi%ation of the char%es a%ainst w- revealed that the Audit -ommittee of AIG:s own oard of directors had repeated stated that it could not verify the AIG:s accountin% methods, ut w- i%nored the Nred fla%s: re%ardin% AIG:s poor accountin% practices. If w- was on hi%h alert, it mi%ht have wor(ed closely with AIG and prohiited AIG from classifyin% the ? 5"" million as revenue.
Conclusion
In the end of the civil case trial, eBecutive memers of General Re and AIG were convicted. 0owever, the char%es were all overturned y the federal court of appeal in !st Au%, "!!, includin% Greener% and er%uson. 0owever the dama%e was done. 9ecause of this scheme, it was estimated on )ct #!, "" that shareholders lost around ?5 million to ?53E million. AIG almost went an(rupt at the start of the finical crisis. It is ovious that there were many internal controls prolems for AIG. 9ut can the fraud e prevented in this caseO ;e can analyMe the situation usin% the raud +rian%le. ressure P
RationaliMation P Increase stoc( price P SpliMer file civil suit 2ust for election ressure P
RationaliMation P Increase stoc( price P SpliMer file civil suit 2ust for election ;e can see that that all three elements. ressure, )pportunity and RationaliMation eBist in this case. Also with the lac( of internal control in AIG and the ne%li%ence of its auditor w-, it almost seemed that fraud was inevitale. 0owever, after the financial crisis, we have eBperienced the financial frauds and ille%al acts incurred hu%e costs with far reachin% dama%es affectin% the lives of many people for years Government a%encies all over the world have een wor(in% hard to improve re%ulations for ti%hter controls. In addition, I elieve that lar%e corporations and audit firms ali(e should learn from mista(es and eBercise hi%h professional and ethical principles to prevent frauds and account scandals.
References
AGR$$< S+A+$$4+ ) A-+S. 7n.d.8. Retrieved from 2ustice.%ovD httpDFFwww.2ustice.%ovFcriminalFprFdocumentsF"!*"*!>"%en*re* a%reedstatement.pdf AIG S$-'RI+I$S LI+IGA+I)4*w- S$++L$$4+. 7 "!",
Liti%ation -omplaint. 4ew @or(. Star(man, <. 7""5, une !8. AIG -omes -lean on Accountin%. Retrieved from +he ;ashin%ton ostD httpDFFwww.washin%tonpost.comFwp* dynFcontentFarticleF""5F"5F#!FAR""5"5#!"!53.html ;il(inson, . 7""3, eruary !!8. w- )ff 0oo( In AIG Shareholder raud Suit. Retrieved from law#6".comD httpDFFwww.law#6".comFarticlesFE"#Fpwc* off*hoo(*in*ai%*shareholder*fraud*suit @oun%, <. R. 7""3, ay 68. Actuarial Accountin%DA -autionary Report. Retrieved from casact.or%D httpDFFwww.casact.or%FeducationFsprin%F""3FhandoutsFyoun%.pdf
altu After the admission, Investigators now are e'amining actions of to! AIG officials. he 13 could bring civil fraud charges against the com!any or e'ecutives. AIG/s shares fell .84 continuing to sliden Feb. 5, 200& AIG/s shares are down 224 since closing on Friday, Feb. . 1tandard 6 7oor/s and oody/s downgraded AIG/s longterm bonds and certain other debt by a notch from its to! AAA and Aa rating. A.. +est !ut AIG under review with 9negative: im!lications. Fitch Ratings !ut AIG under 9Rating ;atch by more than 24. AIG 3? 9an#: Greenberg resigns in arch 200& and retired as AIG/s chairman days later. 1hareholders/ e"uity would still be above %80 billion. r. Greenberg had been running AIG for nearly four decades and was res!onsible for moving AIG into 3hina which is now one of its most !romising regions. any say r. Greenberg was the most !owerful e'ecutive in the history of insurance. r. Greenberg too# AIG from %@00 million mar#et value to about %0 billion. owever, 1!itBer !raises AIG for changing some to! management.
In late 2000 and 200, Gen Re shifted %&00 million of e'!ected claims to AIG along with %&00 million of !remiums. Gen Re accounted for this transaction !ro!erly. AIG recorded the !remiums as reveue and added %&00 million to its reserves to show its obligation to !ay claims
