American international group was world's largest insurance company in 2007.
Number of employees were 93 thousand and business was spread across 130
countries. Head of the organization was Maurice Greenburg. AIG had 95.8 billion
outstanding equity shareholders to whom premium paid was 59.8 billion.
General Re was world's largest reinsurance company. Genre was established 1921 ,
was owned by Warren Hathaway but led by Ronald Ferguson.
AIG Came under Scrutiny when SEC discovered that AIG helped one of his client to
manipulate its financials through a non-existing transaction
In !998 one of a leading cell phone distributor was in financial crunch. Distributor
incurred huge losses, it looked at AIG for help to minimize the loss on its financial
statement. AIG entered into a retroactive insurance contract with distributor. To get the
special insurance distributor was asked to pay huge premiums for next 3 years .AIG
paid the amount of losses in form of claims. Distributor was able to defer the losses
for 3 years in equal instalments in form of premium payment which did not dig into net
income immediately but through course of years. AIG got good money in fee.
AIG did not stop here and history’s biggest fraud in insurance sector started when
Greenburg asked CEO of GenRe to transfer loss reserves of $500 Million to AIG
temporarily in a riskless deal.
AIG’s business was to sell plans to business – corporations, sole proprietors and
individual. AIG use to cover financial risk resulting due to a particular events from set
of events covered in lieu of premiums. As per regulation set for insurance companies
AIG has to maintain cash reserves (just like banks) to cover expected claims filed in
given period of time. Investors of company always kept close eye on level of this cash
reserves because lower reserves were signal that AIG will be in financial cruch/crisis
if all or majority of expected claims are filled in small duration. In last quarter of 2000
these reserves shrinked to a very low amount which was a big problem. To deal with
it AIG asked GenRE for help. GenRe’s trade was to insure insurance companies like
AIG. GenRE use to sell plans to insurance companies in order to reduce their risk of
probable losses in return of premiums.
In this particular deal both companies interchanged their roles. Both companies entered
into a intentional fraud contract where reinsurer company paid the insurance company a
hefty amount of $500 million as transfer in loss reserve in form of premiums. Genre got
$5 Million for the deal which had 24 month duration. In Return AIG took responsibility of
risk associated with policies/plans GenRe sold to its clients.
Till now nothing was illegal in eyes of law. The policies AIG covered under the contract
were least risky. Total claims possible arising from those contract were not more than
$500 million – amount paid by GenRe as premium. Result of this transaction was AIG
was in possession of $500 million paid by GenRe, which it will later payback to GenRe
without any risk of paying extra and GenRe big amount in cash as fee. According to
accounting rules these kind of transaction come under loans in company’s balance
sheet. But repayment of loan plus interest accrued will reduce company’s net income
for the year in which repayment is done- one thing AIG was not willing to do in any
case. Keeping all accounting rules aside AIG recorded transaction as normal contract
and entered $500 million as company’s income which later went to retained earnings
through net profits.
Accounting problem with the deal were:-
• AIG used re-insurance accounting while Gen Re- deposit accounting
• A whole bunch of proof were required to show that it was Genre who proposed
• As per statutory requirement