On Friday American International Group reported its first profit in seven quarters, aided by a whopping accounting gain of $676 million. AIG's shares have risen almost steadily since last Wednesday when the news broke - prematurely - that it would show a profit.
But on closer examination there's an asterisk next to that $676 million: "Reflects the effect of hedging activities (otherwise known as derivatives) that did not qualify for hedge accounting treatment under FAS 133." FAS is short for Financial Accounting Standards, set by the Financial Accounting Standards Board.
Separate that out and AIG doesn't look so good. Its general insurance unit, which handles property and casualty, had a decline in operating income and a rise in losses.
Insurance people in the know were not impressed. "They dress it up with fancy words, but if I see your premium going down, you can't tell me business is good," an insurance consultant told the New York Times.
Now look at MetLife. Last month it reported a rather large second quarter decline, driven by derivative losses of $1.8 billion. Not good, right? No, good. According to the company, the value of the derivatives has gone down because the value of the underlying investments in MetLife's portfolio has gone up. Translation: they are worth more.
And MetLife's operating earnings, which represent real earnings, beat analyst estimates.
So let's do the math. If MetLife's loss on its derivatives means it made money on its investments, does AIG's gain on its derivatives mean it lost money on investments?
There's no accounting for good taste. Some derivatives, which are essentially insurance products, qualify for hedge accounting and go right on the balance sheet. Others, which aren't tied to a specific security, are reported as earnings or losses in the quarterly income statement. Confused? MetLife CEO Rob Henrikson dismissed his company's loss as "accounting noise" on the analysts' conference call.
But it's significant in two respects. First, it's getting harder to trust that the bottom line is really the bottom line. Operating earnings, rather than final net earnings, is now the gold standard, particularly for insurers.
Second, AIG is desperately trying to sell its huge portfolio of investments. This week alone it offloaded $1.9 billion of energy and infrastructure assets from its troubled Financial Products unit. So how do you value all of its investments and derivatives when "accounting noise" drowns out reality?