NEW YORK (Reuters) - American International Group Inc yesterday disclosed new detail about a series of accounting errors it committed over the past five years. The changes reduced net worth by $2.26 billion or 2.7 percent, and slashed aggregate net income by $3.9 billion, or 10 percent.

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The following is an outline of some of the accounting errors and their impact on restated results:

NET INVESTMENT INCOME - AIG in some transactions improperly treated capital gains as net investment income, which is inconsistent with Generally Accepted Accounting Principles. The most significant of these transactions were:

+ Covered Calls - From 2001 through 2003, AIG subsidiaries entered into transactions with third parties whereby they sold in-the-money calls, principally on municipal bonds in their investment portfolios, that had unrealised appreciation associated with them. AIG recognised net investment income rather than realised capital gains.

Adjustments required to correct these errors reduced previously reported net investment income by an aggregate $332 million. Realised capital gains from these transactions, over the three-year period, were increased by $234 million.

+ Synthetic Fuel Investment - AIG invested in companies that invest in synthetic fuel facilities that generate income tax credits. AIG recorded these credits as net investment income or other revenues rather than as a reduction of tax expense. Changes to 2004 results included a $203 million reduction in investment income and cut other revenue by $143 million.

+ Hedge Fund Accounting - AIG subsidiaries invest in hedge funds. As part of investment agreements, the AIG units have the right to redeem their interests at defined times.

AIG has found that in certain cases, redemptions resulted in inappropriate gain recognition because the proceeds were immediately reinvested in the funds, pursuant to agreements. The restatement of these items had “virtually no effect” on shareholder equity last year and boosted profit by $2 million.

INSUFFICIENT RISK TRANSFER - AIG concluded that there was insufficient risk transfer to qualify for insurance accounting for several transactions where AIG subsidiaries either wrote direct insurance or assumed or ceded reinsurance. These transactions will now be recorded as deposits rather than as premiums and associated loss reserves.

This category included reinsurance transactions with Union Excess Reinsurance Co.

The restatement of these matters reduced net income last year by $78 million and slashed shareholder equity by $951 million. Adjustments to transactions involving General Re Corp., a unit of Berkshire Hathaway Inc., last year increased liabilities by $250 million and reduced loss reserves by the same amount.

In other risk transfer matters, AIG found that results of Richmond Insurance Co., a Bermuda-based reinsurer in which AIG owns 19.9 percent, should be consolidated into AIG's financial statements. This change had little impact on AIG net income or shareholders' equity. AIG said it also received notice of the exercise of a put option, requiring AIG to acquire 49.9 percent of Richmond shares by June 30.

TOP-LEVEL ADJUSTMENTS - As part of its internal review, AIG has analysed and assessed “top level” journal entries since 2000 and determined certain entries appear to have been made at the direction of former members of senior management without appropriate support. The restatement reversed all such unsupported entries, reducing shareholders' equity at the end of 2004 by $206 million.

LOSS RESERVES - AIG restated the amounts of carried reserves. As a result the fourth quarter 2002 charge related to the General Insurance reserve for losses and loss expenses was reduced to $2.1 billion from $2.8 billion.

That means the charge to pretax earnings is about $700 million less than previously reported.

Last year, though, the restated reserves had the effect of reducing net income by $196 million and pared shareholders' equity by $572 million.

CONVERSION OF UNDERWRITING LOSSES TO CAPITAL LOSSES - This category includes entries that improperly characterised underwriting losses as capital losses. Transactions reviewed included various transaction with Capco Reinsurance Co., AIRCO Reinsurance and The Robert Plan Corp.

Last year adjustments in these matters increased net income by $79 million, including $116 million in realised gains, but reduced shareholders' equity by $30 million.

OTHER CHANGES:

+ Derivatives - AIG, which hedges interest rate and foreign currency risk for its own accounts, said its internal review concluded that in many cases it did not meet requirements that hedges be matched with underlying exposures to an outside party.

Adjustments and restatements for derivatives reduced AIG's net income by $783 million in 2003 while boosting profit by $252 million last year. The changes increased shareholders' equity by $1.02 billion last year.

+ Foreign Currency Translation - Some transactions did not comply with foreign currency translation standards, forcing the insurer to reclassify gains and losses into income. Last year these adjustments reduced net income by $124 million.

+ Life Settlements - Life settlements are designed to assist life insurance policy-holders monetising the value of their policies.

AIG determined that certain aspects of its prior accounting for this business were incorrect, resulting in a decrease of $129 million to shareholders' equity at the end of last year.

+ Deferred Acquisition Costs - AIG's internal review identified the incorrect application of accounting principles with respect to certain general insurance DAC. As a result, AIG determined it was necessary to reduce the DAC asset. The effect of the adjustments was a $344 million reduction in shareholder equity and a $33 million cut to net income last year.

+ Starr International Co. Deferred Compensation - AIG included in restated results expenses attributable to a deferred compensation plan granted to certain AIG executives by SICO, a private holding company that owns about 12 percent of AIG's common shares. Expenses attributable to the SICO compensation plans reduced 2004 net income by $56 million.

ASSET VALUE REALISATION - AIG said adjustments should be made to the value of certain assets included on its consolidated balance sheet. The most significant items were:

Allowances for doubtful accounts - A review of allowances for doubtful accounts and other accruals led AIG to conclude allowances related to certain premiums receivable, reinsurance recoverables and other assets were not properly analysed in prior periods and the appropriate allowances were not properly recorded. Various accounts also were not properly reconciled.

AIG restated consolidated financial statements will reflect the recording of appropriate allowances for the time periods affected. The effect of this restatement on shareholders' equity at December 31, 2004 was $290 million.