AIG Sham Reinsurance and Accounting Case: Reserves Without the Risk

AIG agreed to pay $800 million to settle the Securities and Exchange Commission’s sham reinsurance and accounting case over transactions that allegedly made its financial results look stronger. The alleged reinsurance added reserves to the balance sheet without transferring the risk the accounting claimed. If you worked on the contracts, reserve schedules or accounting review, you may recognize the distance between what a transaction did and what the company told investors it did.

The Securities and Exchange Commission’s February 2006 settlement announcement described transactions involving American International Group, Gen Re, Capco and Union Excess. This page follows those transactions and the records behind AIG’s reported results. Our page on accounting restatements explains the wider connection between a correction and the decisions that produced the original number.

AIG and Gen Re Created Reserves Without Transferring Risk

The SEC alleged that AIG used two sham reinsurance transactions with General Re Corporation, known as Gen Re, to add $500 million in false loss reserves. The transactions occurred in December 2000 and March 2001 and affected the fourth quarter of 2000 and the first quarter of 2001. Their purpose, according to the agency, was to answer analysts who had criticized AIG’s declining reserves.

The contracts ran between Cologne Re Dublin, a Gen Re subsidiary in Dublin, Ireland, and an AIG subsidiary. In its separate civil action against former executives, the Securities and Exchange Commission alleged that participants at both companies knew the transactions did not transfer risk. AIG nevertheless accounted for them as though Gen Re had transferred risk to it.

That accounting reached the market through AIG’s quarterly earnings releases. The Commission said AIG promoted the reserve increases, while its reserves would have shown further declines without the false additions. We see better reserves, on paper. The deal did not get real.

The executive-action announcement described recorded conversations about planning and carrying out the transaction. It explained why the documents themselves were part of the allegation:

For someone reviewing the reinsurance file, that allegation goes directly to the relationship between the contract and the accounting entry. The agency described paperwork created to support a result the participants allegedly understood was false. An explanation of how that paperwork was prepared can matter as much as the signed document.

Capco Changed the Loss Category, Union Excess Hid the Control

The Capco transaction allegedly moved approximately $200 million in underwriting losses into capital or investment losses. The Securities and Exchange Commission said AIG used the transaction in 2000 to make losses in its general insurance business less embarrassing. The alleged maneuver changed how the losses appeared in the accounts, giving someone familiar with their origin a direct comparison with the reported classification.

An accountant who knows why an underwriting loss was assigned to an investment category can connect the business result to the entry that changed its presentation. The losses had not found a better business, just a different heading.

Union Excess involved control over an offshore reinsurer. The agency alleged that AIG established Union Excess in 1991, ultimately ceded approximately 50 reinsurance contracts to it for AIG’s own benefit, and controlled it while failing to consolidate its financial results. The agency also alleged that AIG concealed that control from auditors and regulators.

For a person who worked on those accounts, the relevant comparison reaches beyond the name on the contract. It concerns who controlled the reinsurer and whether its results appeared in AIG’s consolidated financial statements. Gen Re, Capco and Union Excess changed different parts of the accounting story, but the Commission alleged that each helped improve the financial results investors saw.

AIG’s Restatement Reached the Purpose Behind the Entries

AIG’s internal investigation led it to restate its accounting for approximately 66 transactions or items, according to the Securities and Exchange Commission’s corporate settlement announcement. The investigation began after federal and state regulators contacted AIG about the Gen Re transaction. The correction reached Gen Re, Capco and Union Excess as well as other accounting issues.

The agency reported that AIG admitted in its restatement that some accounting had been improper and that some transactions were intended to improve financial results the company considered important to the market. It also reported AIG’s concession that certain transactions may have involved inaccurate documentation and misrepresentations to management, regulators and independent auditors.

The Gen Re correction was particularly concrete. The Commission’s executive-action announcement said AIG reclassified those transactions as deposits rather than reinsurance in its financial statements. The overall restatement reduced shareholders’ equity at December 31, 2004 by approximately $2.26 billion, or 2.7%.

AIG’s SEC Settlement Included Money for Investors

The Securities and Exchange Commission settlement announced on February 9, 2006 called for $700 million in disgorgement, the surrender of ill-gotten gains, and a $100 million civil penalty. The agency said it would seek to distribute both to injured investors.

How to Catch Accounting Fraud?

Catching accounting fraud in a reinsurance transaction means connecting the reported result to the risk the parties actually agreed to assume. We examine that connection with the person who understands the transaction, including how the documents reached accounting and what reviewers understood them to mean. A reserve schedule shows the number. The underlying arrangements explain whether the entry belongs there.

Public-company reporting runs from transaction records through accounting entries, estimates, the close, financial statements and disclosure review. Management and accounting personnel hold entries and reconciliations, while audit workpapers, committee minutes and auditor communications can show how the same transaction was examined. Our work on the records behind a reported number connects those separate views.

For a reinsurance accountant or actuarial analyst who sees comparable conduct, the AIG allegations suggest several precise comparisons:

• Risk and the reserve. We connect the contract’s obligations and the analysis supporting risk transfer with the reserve entry and the result presented to investors. Payment records and any side terms help explain the arrangement the accounting is supposed to represent.
• The loss and its classification. We trace where the loss arose in the business and how it reached the reported account. Capco’s alleged conversion of underwriting losses into investment losses makes that comparison concrete.
• Control and consolidation. We compare who directed the reinsurer with the treatment of its results in the company’s accounts. The Union Excess allegations also make communications with auditors and regulators part of that comparison.

This is where accounting expertise and investigative work meet. Accounting Fraud: A Literature Review, published in Risk Governance and Control: Financial Markets & Institutions in 2019, describes forensic accounting as combining accounting and investigative knowledge. Applied here, the task is to explain how a contract, an entry and an earnings release came to describe the same arrangement differently.

The same gap between paperwork and the economic bargain appears in supplier rebate accounting. In its Kraft Heinz order, the Securities and Exchange Commission alleged that future commitments appeared as earned rebates, upfront receipts carried hidden repayment obligations and temporary price reductions were offset later. In both settings, a person who knows the obligations behind the document can explain why the apparent accounting benefit tells an incomplete story.

What Is Whistleblowing in Accounting?

Whistleblowing in accounting can bring forward the terms, instructions and decisions behind the figures investors received. In a reinsurance matter, that may be the difference between the risk described in the accounting analysis and the arrangement the participants actually made. If your knowledge came through an audit or compliance role, how you learned about the conduct is something we work through with you and securities fraud whistleblower lawyers.

Do Corporate Whistleblower Laws Deter Accounting Fraud?, a March 2019 working paper hosted by MIT Sloan, studied companies held by state pension funds and their exposure to state False Claims Acts. It found a 5% to 9% reduction in estimated accounting-fraud probability, measured through financial-statement risk scores.

Eligible SEC whistleblowers under the Securities Exchange Act can share 10% to 30% of qualifying sanctions collected when the covered action exceeds $1 million in monetary sanctions. Fraud against government money has a separate route: a whistleblower case under the False Claims Act can pay 15% to 30% of what the government recovers. We assess the connection your information makes and the securities reporting decision with you.

You Know What the Reinsurance Contract Was Meant to Do

If you know why a reinsurance entry reached the books despite what the deal actually required, speak with our whistleblower experts. We build the case around your understanding of the transaction and bring in securities fraud whistleblower lawyers who can work through the insurance accounting with you. We stay beside you through the process, turning the contract, the reported number and the decisions behind them into your strongest securities fraud whistleblower case.