Insurance problem

The American International Group (AIG) joins a list of once illustrious names such as Enron, WorldCom and Parmalat as a commercial giant laid low by improper accounting.

AIG, the world's largest insurance company has admitted its past accounts overstated the business's equity value by the significant margin of $1.6bn.
But AIG's problems are not simple. While the accounting failure arises from errors in the treatment of some re-insurance contracts, in corporate governance terms these are compounded by question marks over the way payments of commissions to brokers were handled and relationships with companies with which AIG shared directors. In a statement, AIG said it: 'cannot presently determine whether additional matters will be discovered or further adjustments will be required'.

The most serious issue is the treatment of finite reinsurance contracts, in particular one with General Re - a subsidiary of Berkshire Hathaway, the group chaired by Warren Buffett. It is now accepted by AIG that this amounted to an undeclared loan of $500m. By treating the deals as reinsurance contracts they were disclosed in the accounts as premium revenue, rather than as liabilities, and assisted AIG in meeting investors' calls for larger reserves. The key fact is that there appears to have been no risk transfer involved alongside the cash handover. While AIG has accepted that the accounts were inaccurate, AIG's domineering former chief executive, Hank Greenberg, strongly asserts that he is not guilty of any impropriety. Greenberg has told the Securities and Exchange Commission, and New York Attorney General Eliot Spitzer, that he will invoke his right to silence under the Fifth Amendment and not answer any questions about his conduct, at least until he has been advised of any allegations against him. Spitzer has suggested that his office will pursue civil proceedings against AIG, through which he expects to reach agreement, and is considering a criminal action against Greenberg.

Greenberg has already resigned, along with the chief finance officer, Howard Smith, and the executive in charge of reinsurance, Chris Martin. Earlier investigations by the New York Attorney's office into the payment of insurance commissions and the relationship between AIG (and other insurers) with the world's largest broker, Marsh & McLennan, led to the resignation of Marsh's chief executive Jeffrey Greenberg - Hank Greenberg's son.

Pressure is now on to untangle other commercial relationships entered into by AIG. In particular, AIG has a major contract with C V Starr, which provides reward packages for AIG executives, deals in niche insurance contracts, and owns 2% of AIG's shares. Starr's president and chairman is Hank Greenberg, while other AIG executives - including the new chief executive, Martin Sullivan - have now resigned as directors of Starr.

Additional AIG directors are also under scrutiny over their relationships with outside organisations, including the Starr Foundation. The Foundation was established in 1955 by Cornelius Vander Starr, the founder of AIG, and the charity continues to make substantial donations to good causes associated with AIG directors. We were unable to contact the Foundation, but it is reported that it denies any impropriety. While the pressure is specifically on AIG, the whole insurance industry is affected. Zurich Financial Services Australia has said that it will restate its results from 2000 to 2003 because of its treatment of reinsurance contracts, including with General Re Australia. The misreporting of an earlier deal with General Re Australia by insurers FAI was a significant factor in the collapse of HIH, after it bought FAI and discovered the full extent of FAI's liabilities. Former chief executives of both HIH and FAI have recently been found guilty of criminal charges relating to the HIH collapse.

The IASB and other standard setters had already stated that insurance was a priority sector for improved standards and the AIG scandal will strengthen their resolve.