Table of Contents
1. Company Background.................................................................................................................2
2. Scandal Introduction....................................................................................................................2
3. Timeline of the Scandal...............................................................................................................2
4. Detailed Scandal Analysis...........................................................................................................4
A. Sham Reinsurance Transactions...........................................................................................................4
B. Use of Special Purpose Entities (SPEs)................................................................................................4
C. Earnings Management & Reserve Manipulation..................................................................................5
5. Accounting violations..................................................................................................................5
Violation of IFRS / IAS standards.............................................................................................................5
Violation of GAAP....................................................................................................................................6
6. Violation of Ethical Principles.....................................................................................................6
7. Consequence of the scandal.........................................................................................................7
1. Financial Consequences:........................................................................................................................7
2. Leadership Shake-up and Personal Fallout:...........................................................................................8
3. Legal and Regulatory Impact:................................................................................................................8
4. Long-Term Impact on AIG’s Trajectory:..............................................................................................8
8. Recommendation.........................................................................................................................8
For AIG and Similar Companies (Corporate-Level Reforms)..................................................................8
Recommendations for Regulators..............................................................................................................9
References......................................................................................................................................10
1 | AIG
1. Company Background
The American International Group (AIG) founded in 1919 by Cornelius Vander Starr in Shanghai is one
of the largest global insurance and financial services company. AIG transformed over the years into a
financial powerhouse with operations in more than 130 countries dealing in products through major
subsidiary such as Chartis, SunAmerica Financial Group and AIG Financial Services. By late 90s to early
2000s, AIG became a market leader with market capitalizations above $180b, and asset sizes above
$800b.
The company touched almost all insurance niches including general insurance, life insurance and
retirement services and positioned itself as one of the global financial powerhouses. AIG was praised for
great strategy of risk management and unmatched worldwide coverage during peak time. But its success
also hid the existing malaise at its financial practices that would later culminate into a big accounting
scandal.026+-
2. Scandal Introduction
The scandal the AIG accounting caused was revealed starting from the beginning of 2000s and peaked in
2005. It was a deliberate accounting corruption and fraudulent financial reporting to puff up the
company’s financial position. The point was to deceive investors, keep the stock of AIG where it was at,
and ensure AIG’s sought-after AAA credit status.
The most prominent fraudulent activity was a $500 million reinsurance deal with General Reclamation
Corporation (Gen Re) in 2000, which appeared to have moved liability to balloon the reserve at AIG. In
fact, no transfer of risk occurred at all, the inflated reserves were only an illusion of financial strength.
Big names in the scandal were Maurice “Hank” Greenberg, the CEO of AIG and Howard Smith, the AIG
CFO. Acused of misleading financial figures by recording loans as sales he also had instructed traders on
inflating stock prices, Greenberg who served the company for almost four decades, faced allegations.
Their doings deceived the investors, the regulators and the public and finally left the company on the
brink of a big crisis.
3. Timeline of the Scandal
2000–2004: AIG engages in numerous transactions of reinsurance to create a false sense of reserves
while failing to operate actual risk, a component of the scheme of inflating the figures in one’s financials.
March, 2005: Martin Sullivan succeeds Maurice “Hank” Greenberg as CEO as Greenberg is sacked by
the board for his part in pumping up the financials of AIG. On Sullivan’s first day a Credit agency takes
away AIG’s AAA rating. AIG admits that it has misrepresented its net income for the past five years by $
3.9 billion, following an internal review that was prompted after United States regulatory pressure.
November 1, 2006: Bob Willumstad takes up the post of Chairman of AIG, a year after having quit
Citigroup over internal differences.
August 8, 2007: AIG reports a 34% recovery of its quarterly profits and this puts the jaw of the
investors of its exposure to the subprime mort latest market to the ground.
2 | AIG
November 2007: Greenberg alludes to AIG’s corporate change, the firm’s third-quarter earnings
dropping to 27% below the estimates. Sullivan accepts the fact that the U.S. mortgage and credit market
environment has been contributing to and lowering the exposure but says that the risk management
processes of AIG helped control the exposure.
December 5, 2007: AIG warns that it may have to write down by up to $1 billion of unrealized losses
on its credit default swap portfolio. Sullivan gives investors some reassuring information regarding AIG’s
exposure, which is small and diversified.
February, 2008: AIG admits an $5 billion drop in value of mortgage-related instruments hardly half of
the former estimate. Auditors of PwC find an “a material weakness” regarding AIG's internal financial
reporting controls. AIG discloses a fourth-quarter net loss of more than $5 billion.
May 8, 2008: AIG flashes its biggest ever quarterly net loss of $7.8 billion and states the necessity to
obtain $12.5 billion of additional capital to balance the balance sheet.
May 12, 2008: Greenberg’s criticism of current management becomes more radical, “AIG is “in crisis”.
May 14, 2008: Bob Willumstad, Chairman of AIG, is overtly backing his CEO, Sullivan claiming that
he is “the right guy” to steer the business through its financial problems. AIG informs that it will mobilize
$20 billion, 60% increase over the initial projections, to cushion its balance sheet.
June, 2008: AIG admits it is being investigated by authorities on its valuation of subprime related
derivatives. After an emergency board meeting, AIG will be replacing Martin Sullivan and appointing
Bob Willumstad to succeed him with the title of Chairman.
Figure: Time-line of the AIG scandal (self-made)
3 | AIG
4. Detailed Scandal Analysis
A. Sham Reinsurance Transactions
The American International Group (AIG) & General Reinsurance Corporation (Gen Re) had a
disputed reinsurance transaction between 2000 & 2001. In a normal reinsurance arrangement, a firm of
insurance transfers the risk to a third party in order to minimize its liabilities in return for premiums paid.
But in this case, there was no bona fide, transfer of risk under the agreement between AIG & Gen Re.
Instead, it had been designed simply to give the impression that AIG had achieved valid reinsurance
coverage.
This false transaction was used by AIG to inflate its financial accounts. The business boosted its loss
reserves by the same ($500 million), on top of the fake premiums it had already documented. AIG
appeared more conservative and financially sound after this move, which is particularly attractive to
investors & credit agencies. The market was misled as to AIG’s dependability and financial stability
because of the deceptive accounting.
The transaction breached both International Financial Reporting Standards (IFRS) & US Generally
Accepted Accounting Principles (GAAP), and that is because reinsurance arrangements are required to
have significant risk to be transferred. AIG was involved in conducting dishonest financial reporting
through entering a transaction with no economic substance.
B. Use of Special Purpose Entities (SPEs)
Such legal entities referred to as Special Purpose Entities (SPEs) are supposed to separate financial risk
from the parent business. Using them appropriately, entities can finance big projects without incurring
associated risks. These organizations may actually play a useful role in financial management in complex
transactions that require the need of risk control or minimal exposure.
Misuse of Special Purpose Entities (SPE’s) by AIG:
While created SPEs to move exposures to risky assets and debt to the balance sheet.
Prevented artificial reduction of the value of reported liabilities through consolidation of these
entities.
Anonymous exposure to credit default swaps & collateralized debt obligations (CDOs).
Distorted financial statements provide a false illusion of solvency in a company.
Pretended to mislead investors & regulators re. the firm’s true level of risk.
AIG’s strategies mirrored very much Enron in their abuse of SPEs. Below is a chart comparing some
similarities & consequences.
Key Similarities Between AIG & Enron
Off-Balance Sheet Risk Transfer: SPE were used by both AIG & Enron to shift financial risk
from their balance sheet.
Avoidance of Consolidation: Every company intentionally did not consolidate SPEs and thus
understated the liabilities.
4 | AIG
Deceptive Risk Exposure: Both by understating exposure to high-risk financial instruments
misled the investors & regulators.
Systemic Impact: Such fraudulent approaches played a large role in larger financial instability.
Because of AIG’s deceit, significant financial risk was hidden, its exposure to large credit default swap
defaults. It was during 2008 financial crisis when these hiding obligations were uncovered the crisis got
worse. The context of this scandal became a combination of serious weaknesses in regulation & a serious
detriment to public faith in financial institutions.
C. Earnings Management & Reserve Manipulation
Insurance reserves, or the money held aside to help to pay
future claims are integral to an insurer’s financial stability.
Because these reserves do directly impact on solvency &
profitability, an exact estimate is of high importance. Even
though minor changes are normal due to judgment &
estimation, a company’s financial picture may be seriously
skewed by deliberate manipulation.
AIG illegally manipulated its reserves to regulate its
claimed profits. Excessive reserving during booms helped the business accumulate a reserve margin. It
would then release these reserves to inflate profits in bad times. Through this strategy, “cookie jar
accounting,” AIG could smooth swings & give a steady, but misleading picture, over time.
This kind of manipulation weakens the reliability of financial reporting. By hiding the true generative &
risk exposure of the company, it cheats analysts, investors, & power figures. This strategy is particularly
deplorable because it replaces undefined, timely maneuvers with the attempt to influence the direction of
market sentiment, instead of objective financial data that has little meaning in the economy’s context.
5. Accounting violations
Violation of IFRS / IAS standards
Substance over form and faithful presentation: According to the IFRS Conceptual Framework, the
substance of a transaction is “faithfully represented” in the financial statements. AIG went against this
major point by placing non-risk-transfer deals under reinsurance.
IAS 1, “Presentation of Financial Statements,” requires neutrality and prudence. Participants’ withdrawal
of real losses did not correspond to the requirements for presenting the trustee's financial state, following
the truth, and the view of truth.
Failing the IFRS 17 risk-transfer test: Though the IFRS 17 was effective only from 2023, the
risk transfer criteria are similar to those expected under IFRS 4 and the Conceptual Framework. A
reinsurance contract is eligible under IFRS 17 and 19 only when there is a situation with
commercial substance in which the reinsurer has a possibility of a loss on a present value basis.
AIG’s deals would not have survived that test and should not have been treated as reinsurance—
losses have to be recognized precisely when they accrue.
5 | AIG
Improper liability measurement: IFRS 4 and IFRS 17 require that insurance contract liabilities
be measured as the present value of future cash flows, inclusive of an explicit risk and contractual
service margin, both for IFRS 4 and IFRS 17. Through these contrived treaties, it became
possible to defer losses, thus breaking these requirements of measurement, and overstate reserves
of the AIG.
Violation of GAAP
ASC 944 “Financial Services—Insurance” is the topic of ‘Risk-transfer criteria’ support. According to
ASC 944, “Financial Services—Insurance” is, as a topic, the ‘Risk-transfer criteria. A reinsurance
contract, according to ASC 944-20-15-41, a short-duration reinsurance contract, is only met if both of the
following exist as of inception:
There is a high insurance risk for the reinsurer. Such is a very good chance of material loss for the
reinsurer.
The AIG GRC transactions failed both tests – no real risk ceded – so they should have been
booked as deposit liabilities (not reinsurance recoverable).
Matching principle & loss recognition:
Under GAAP, probable and reasonably estimable losses should be recognized in the period that they
occur. The offsetting of the losses to future periods resulted in AIG's violation of the matching concept
and the requirement under ASC 450 to accrue contingent losses.
Full-disclosure & transparency: GAAP also requires specified revelations about the transactions of
related parties as well as reinsurance. AIG prevented the other shareholders from knowing what real
natural and economic effectiveness these transactions had; thus, the disclosure failure was a clear
violation of the transparency requirements of ASC 235.
6. Violation of Ethical Principles
Integrity: When it came to building “sham” reinsurance transactions that concealed real losses, AIG
management not only deceived investors, regulators, and the public but did so deliberately. It is necessary
that financial reporting be in accordance with integrity. The destruction of integrity destroys the
foundation upon which the capital market functions, such as trust.
Objectivity & Independence: Lead executives allowed their close relationships with counterparties to
set their accounting decisions instead of relying on neutral professional standards. Objectivity contributes
to reducing the conflict of interest. Once the compromise happened for some returns, it was just abused
by financial professionals, then the entire reporting process is compromised.
Competence & Due Care: The AIGs did not show the criteria for risk-transfer according to the
accounting standards, but accepted face value, contrived documents. IFRS/GAAP execution is necessary.
Lack of technical requirements affects financial statements in terms of quality and reliability.
6 | AIG
Compliance: To inflate its short-term results for ASC 235, AIG did everything in its power to drive back
both the letter and the spirit of disclosure rules under IAS 1 and IFRS 7. Fair ethics require total following
of laws and regulations. Regulatory exploitation of loopholes for concealing losses goes against our social
contract of the relationship between business and society.
When the sham reinsurance was realized, AIG’s stock price plunged, crashing billions into the throats of
shareholders, and a major government bailout was created. Honest reporting will help investors channel
the capital effectively. AIG has breached the vow of fair and reliable information.
The concealment of losses threatened solvency to cover the consumers' insurance with decent coverage
and decent reserves. Insurers are the policyholders’ violating their duty, which causes real financial and
psychological trauma to ordinary citizens, businesses. The scandal had made the smaller insurance
companies fearful for fear that such aggressive moves might be able to fly under the radar or become the
norm. It may become a big failure to ruin the whole industry image and instill suspicion, from regulators
to the public, vacuum all the players have.
AIG’s ethical issues fueled the public’s phobia regarding the financial system as a basis of the credit-
crunch panic during 2008 – 2009. Corporate ethics are not meant for merely balance sheets; they shape
social stability. Wild accounting degrades the confidence in markets and government watchdogs.
Finally, we can say that AIG’s case is not just about the accounting standard violation, but the moral
failure of the professional principles at the core of this firm.
7. Consequence of the scandal
The 2005 crisis of the AIG had wide spread destructive influences on finances, law, and reputation. The
consequences of the scandal on AIG and other parties are:
1. Financial Consequences:
More than $1.6 Billion in Penalties: AIG was forced to pay $1.64 billion to settle civil fraud
allegations against SEC and New York Attorney General among other authorities. By then, it was
one of the biggest business settlements.
Restated Financials: For quite a few years AIG had to correct its financial figures. This showed
that the royalties it had previously declared were highly exaggerated. Suddenly analysts and
investors faced with an entirely different, much less spectacular corporation.
Stock Price Decline: After the scandal, AIG’s stock plummeted. Within seconds, the investors
saw billions of dollars of market wealth evaporate. Improvement of trust reduced negatively the
company’s credits rating and capability to access finance.
2. Leadership Shake-up and Personal Fallout:
Maurice “Hank” Greenberg Expelled: Longtime chief of AIG, Hank Greenberg, who had
turned the company into a multinational behemoth, was forced to quit. His legacy suffered
greatly even if he did not admit any sort of participation.
Additional Executives Charged: Several AIG and General Re executives were implicated and a
number of them were indicted for their positions. The court cases took on for years.
7 | AIG
Permanent Reputational Damage: The controversy rendered careers of persons affected
useless. Even those who were not indicted were accused or banned from upgrading and
membership in the important boards of businesses.
3. Legal and Regulatory Impact:
Tighter Reinsurance Rules: In a bid to identify authentic risk transfer, regulators began reading
reinsurance contracts with great care. This strife revealed how such complex devices might be
used to manipulate financial results.
SOX Enforcement Increased: After Enron, Sarbanes-Oxley received a boost. The case example
of AIG showed that there was still unethical activity following SOX. Companies were
pressurized to mandate SOX in their internal controls and enforcement by regulators. Even after
SOX wheel came, unethical behaviour even existed, which was evident in the case of AIG.
4. Long-Term Impact on AIG’s Trajectory:
A few years before the 2008 financial crisis, when the business was much more sharply affected, the
scandal had already hobbled AIG. Some say, the affair exposed internal weaknesses that made AIG more
vulnerable to the world financial crisis.
The U.S. government has to bail AIG out of $180 billion in 2008. The former fraud had compromised the
company’s confidence, stability, internal controls even though it was not the immediate consequence of
the 2005 fraud.
The AIG crisis was far more than just accounting fraud; it also involved a culture of preference of image
to integrity, breaking of trust, and abuse of complexity. The repercussions go beyond money.
Reputations of destroyed, careers were ended, and an entire profession had to look at its risk accounting
practices.
8. Recommendation
For AIG and Similar Companies (Corporate-Level Reforms)
1. Strengthen Internal Controls:
Implement rigorous internal auditing and compliance systems to monitor financial reporting,
especially for reinsurance and complex transactions.
2. Appoint Independent Board Members:
Ensure the board includes qualified, independent directors with expertise in accounting, risk
management, and corporate governance.
3. Ensure Transparent Financial Disclosures:
Clearly report all reinsurance arrangements, off-balance-sheet activities, and related-party
transactions in financial statements.
4. Implement Whistleblower Protections:
Create secure, anonymous reporting systems for employees to flag unethical or illegal activity
without fear of retaliation.
8 | AIG
Recommendations for Regulators
1. Tighten Oversight on Risk Transfer Transactions:
Closely monitor reinsurance and derivatives deals to ensure genuine risk is transferred and not
merely structured for accounting purposes.
2. Enforce Full Compliance with IFRS/GAAP Standards:
Apply strict enforcement of accounting rules related to insurance liabilities, asset transfers, and
consolidation of entities.
3. Strengthen Sarbanes-Oxley Enforcement:
Hold CEOs and CFOs personally accountable for certifying the accuracy and completeness of
financial reports and internal controls.
4. Monitor Off-Balance-Sheet Activities:
Require companies to disclose the economic substance of transactions and consolidate entities
where risk exposure remains.
5. Promote Ethical Corporate Culture:
Encourage ethical leadership through regulatory guidance and industry-wide governance
benchmarks.
References
AMERICAN INTERNATIONAL GROUP (AIG) ACCOUNTING SCANDAL
A.I.G.: Whiter Shade of Enron - The New York Times
Case Study on Business Ethics: The AIG Scandal - MBA Knowledge Base
AIG’s Spiral Downward: A Timeline — ProPublica
Falling Giant: A Case Study of AIG
9 | AIG
The Fall of AIG: The Untold Story | Institutional Investor
What Went Wrong at AIG?
AIG: The Accounting Scandal Unfurls Case Study | Finance Accounting and Control
Case Study
10 | AIG
