American International Group, Inc. 2008 Annual Report To Our Shareholders hile I can offer little time, many of these securities were INVESTMENT FROM THE U.S. GOV- comfort to those of you rated AAA, the highest rating pos- ERNMENT. Because of its size and who suffered severe sible. However, in late 2007, as the substantial interconnection with losses as AIG share- U.S. residential mortgage market fi nancial markets and institutions Wholders during 2008, I can assure began to deteriorate, the valuation around the world, the government you that everyone at AIG is working of these securities declined severely. recognized that a failure of AIG hard to preserve as much value as As a result, AIG recorded substantial would have had severe ramifi ca- possible while maximizing the future unrealized market valuation losses, tions. In addition to being one of potential of AIG’s businesses around especially on AIGFP’s credit default the world’s largest insurers, AIG was the world. swap portfolio, which led to signifi - providing more than $400 billion of Last year’s economic cataclysm cant cash requirements. credit protection to banks and other was unprecedented. Less than At the same time, AIG reported clients around the world through 12 months after reporting record large unrealized losses in its securi- its credit default swap business. AIG results, AIG found itself on the ties lending program. Through this also is a major participant in foreign brink of collapse. On September program, AIG made short-term exchange and interest rate markets. 18, when I consented to the U.S. loans of certain securities it owned To stabilize AIG and prevent re- government’s request to lead AIG, I to generate revenues by investing verberations throughout the econo- found an organization full of proud, in high-grade residential mortgage- my, the government extended to talented and dedicated people who backed securities. These and other AIG a two-year emergency loan of were stunned and bewildered to see AIG real estate-related investments $85 billion on September 16, 2008. their life’s work—and in many cases suffered sharp losses in value as well. The facility carried a rate of LIBOR their life’s savings—a shambles. The It is important to reiterate that (the London Interbank Offered swift decline of AIG seemed all the throughout the crisis, AIG’s insur- Rate—a widely used benchmark to more incongruous because most ance businesses were—and continue set short-term interest rates) plus of our businesses were healthy and to be—healthy and well capitalized. 8.5 percent, a commitment fee of 2 operating normally—as they are The losses that occurred as a result percent on the loan principal and a today. But the implosion of the U.S. of AIGFP’s actions have no direct fee on the undrawn portion of housing market exposed AIG’s risk impact on AIG policyholders. AIG’s 8.5 percent. Additionally, the gov- concentration in mortgage-backed insurance companies are closely ernment would be entitled to 79.9 securities. That concentration, com- regulated, and their reserves are pro- percent equity ownership of the bined with tumbling asset values and tected with adequate assets to meet company through preferred stock. dysfunctional credit markets, led to policyholder obligations. With the loan in place, the a sudden and severe cash crisis. The collapse of respected fi nan- management team developed a plan WHAT HAPPENED? Over the years, cial institutions such as Bear Stearns to enable AIG to sell many of its AIG built upon its premier global and Lehman Brothers sent shock leading businesses around the world franchises in life and general insur- waves throughout the world econo- to pay back the government loan ance by expanding into a range of my. The crisis at the U.S.-sponsored with interest. However, with this fi nancial services businesses. One mortgage companies Fannie Mae divestiture and restructuring plan in of these, created in 1987, was AIG and Freddie Mac added to the place, AIG still had to address its two Financial Products Corp. (AIGFP), fi nancial disruption. Credit markets principal liquidity issues: the multi- a company that engaged as principal deteriorated rapidly, making it virtu- sector credit default swap portfolio in a wide variety of fi nancial trans- ally impossible to access capital. In and the securities lending program. actions for a global client base. In September, AIG’s credit ratings were On November 10, 2008, AIG 1998, AIGFP began to sell credit downgraded once again, triggering and the Federal Reserve Bank default swaps to other fi nancial additional collateral calls and cash of New York (NY Fed) announced institutions to protect against the requirements in excess of $20 billion. a comprehensive plan to address default of certain securities. At the Although solvent, AIG suddenly faced an acute liquidity crisis. AIG 2008 Annual Report 1 AIG’s liquidity issues and provide net loss for the fourth quarter of Reserve, agreements in principle more time and greater fl exibility $61.7 billion, or $22.95 per diluted were reached to develop a new set of to sell assets and repay the govern- share, compared to a 2007 fourth tools to strengthen AIG’s capital base ment. Among the provisions was the quarter net loss of $5.3 billion, or and allow us time to benefi t from creation of two fi nancing entities, $2.08 per diluted share. AIG’s re- future improvements in market and Maiden Lane II and Maiden Lane ported net loss for full year 2008 was industry conditions. III, to acquire AIG’s securities lend- $99.3 billion, or $37.84 per diluted Under the new plan, the terms of ing assets and the multi-sector share, compared to net income of the U.S. Treasury’s preferred stock collateralized debt obligations that $6.2 billion, or $2.39 per diluted investment in AIG will be modifi ed were guaranteed by AIGFP’s credit share, for full year 2007. to make these preferred securities default swaps. The entities were Despite the challenging condi- more closely resemble common eq- funded primarily by the government, tions in 2008, insurance premiums uity, improving AIG’s capital struc- with a subordinated capital contri- and other considerations declined ture. The U.S. Treasury also agreed bution by AIG. Under the terms only modestly by 1.9 percent for to provide AIG with a new fi ve-year of the agreements, the majority of the fourth quarter, compared to the standby equity capital facility, any appreciation in the securities same period of 2007. For the year, which will allow AIG to raise up to held by the entities would go to the premiums and other considerations $30 billion of capital by issuing non- government, but a portion would be grew by 5.3 percent. cumulative preferred stock to the retained by AIG. A NEW RESTRUCTURING PLAN. U.S. Treasury from time to time. In addition, the U.S. Department Although the divestiture and busi- AIG will transfer to the NY Fed, of the Treasury (U.S. Treasury) ness sale process had some successes or to a trust for its benefi t, preferred purchased, through the Troubled with several announced transactions, interests in American Life Insurance Asset Relief Program (TARP), the worldwide economy continued Company (ALICO) and American $40 billion of newly issued AIG to worsen at an alarming pace, and International Assurance Company, perpetual preferred shares. The potential buyers of AIG businesses Limited (AIA) in return for a reduc- proceeds were used to pay down a faced growing challenges of their tion in the outstanding balance of up portion of the government loan. own, including a lack of access to to $26 billion of the senior secured The perpetual preferred shares capital. The life insurance sec- credit facility. carried a 10 percent coupon with tor has seen enormous declines in In addition, AIG announced that cumulative dividends. stock market value. Life insurance it expects to transfer to the NY Fed Although Maiden Lane II and company stocks, as measured by embedded value of up to $8.5 billion, III and the government’s equity indices published by A.M. Best, have representing securitization notes of injection signifi cantly relieved AIG’s declined 51 percent globally and 60 certain of its U.S. life insurance busi- liquidity pressures, the world percent in the United States since nesses, in return for a further reduc- economy in general and the fi nancial October 1, 2008. Standard & Poor’s tion in its outstanding senior secured industry in particular continued to recently downgraded many major credit facility balance. This capital falter. AIG’s losses mounted through- life insurance companies in the U.S. management strategy—securitiza- out the end of the year, taking a The same trend is seen among life tion—will not affect the day-to-day heavy toll on fourth quarter results. insurers throughout Europe with the operations, sales activities or custom- 2008 RESULTS. AIG reported that rating agencies Fitch and Moody’s. ers of these businesses. the continued severe credit market Against this backdrop, on March Also, under the terms of the new deterioration, particularly in mort- 2, 2009, AIG made important adjust- plan, the NY Fed will remove the gage-backed securities, and charges ments in our plan to assure the sta- LIBOR fl oor on the senior secured related to ongoing restructuring bility and vitality of our businesses, credit facility. This will save AIG an activities, contributed to a record protect policyholders and repay the estimated $1 billion in interest costs government. In cooperation with per year, based on current levels.