AIG 2005 Annual Report Download - page 100

Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
rates, and discontinuance of some products. In regard to the (investment-oriented products) are deferred and amortized, with
inforce business, to maintain an adequate yield to match the interest, as appropriate, in relation to the historical and future
interest necessary to support future policy liabilities, manage- incidence of estimated gross profits to be realized over the
ment focus is required in both the investment and product estimated lives of the contracts. Amortization expense includes
management process. Business strategies continue to evolve to the effects of current period realized capital gains and losses.
maintain profitability of the overall business. As such, in some With respect to universal life and investment-oriented products,
countries, sales growth may slow for some product lines and AIG’s policy, as appropriate, has been to adjust amortization
accelerate for others. assumptions for DAC when estimates of current or future gross
The investment of insurance cash flows and reinvestment of profits to be realized from these contracts are revised. With
the proceeds of matured securities and coupons requires active respect to variable annuities sold domestically (representing the
management of investment yields while maintaining satisfac- vast majority of AIG’s variable annuity business), the assump-
tory investment quality and liquidity. tion for the long-term annual net growth rate of the equity
AIG may use alternative investments in certain foreign markets used in the determination of DAC amortization is
jurisdictions where interest rates remain low and there are approximately ten percent. A methodology referred to as
limited long-dated bond markets, including equities, real estate ‘‘reversion to the mean’’ is used to maintain this long-term net
and foreign currency denominated fixed income instruments to growth rate assumption, while giving consideration to short-term
extend the duration or increase the yield of the investment variations in equity markets. Estimated gross profits include
portfolio to more closely match the requirements of the investment income and gains and losses on investments less
policyholder liabilities and DAC recoverability. This strategy interest required as well as other charges in the contract less
has been effectively used in Japan and more recently by Nan actual mortality and expenses. Current experience and changes
Shan in Taiwan. Foreign assets comprised approximately in the expected future gross profits are analyzed to determine the
33 percent of Nan Shan’s invested assets at December 31, effect on the amortization of DAC. The estimation of projected
2005, slightly below the maximum allowable percentage under gross profits requires significant management judgment. The
current regulation. In response to continued declining interest elements with respect to the current and projected gross profits
rates and the volatile exchange rate of the NT dollar, Nan are reviewed and analyzed quarterly and are adjusted
Shan is emphasizing new products with lower implied guaran- accordingly.
tees, including participating endowments and variable universal AIG’s variable annuity earnings will be affected by changes
life. Although the risks of a continued low interest rate in market returns because separate account revenues, primarily
environment coupled with a volatile NT dollar could increase composed of mortality and expense charges and asset manage-
net liabilities and require additional capital to maintain ment fees, are a function of asset values.
adequate local solvency margins, Nan Shan currently believes DAC for both insurance-oriented and investment-oriented
it has adequate resources to meet all future policy obligations. products as well as retirement services products are reviewed
AIG actively manages the asset-liability relationship in its for recoverability, which involve estimating the future profit-
domestic operations. This relationship is more easily managed ability of current business. This review also involves significant
through the ample supply of appropriate long-term investments. management judgment. If the actual emergence of future
AIG uses asset-liability matching as a management tool profitability were to be substantially different than that
worldwide to determine the composition of the invested assets estimated, AIG’s results of operations could be significantly
and appropriate marketing strategies. As a part of these affected in future periods. See also Note 4 of Notes to
strategies, AIG may determine that it is economically advanta- Consolidated Financial Statements.
geous to be temporarily in an unmatched position due to
anticipated interest rate or other economic changes. In Insurance and Asset Management Invested Assets
addition, the absence of long-dated fixed income instruments AIG’s investment strategy is to invest primarily in high quality
in certain markets may preclude a matched asset-liability securities while maintaining diversification to avoid significant
position in those markets. exposure to issuer, industry and/or country concentrations.
A number of guaranteed benefits, such as living benefits or With respect to Domestic General Insurance, AIG’s strategy is
guaranteed minimum death benefits, are offered on certain to invest in longer duration fixed maturity investments to
variable life and variable annuity products. AIG manages its maximize the yields at the date of purchase. With respect to
exposure resulting from these long-term guarantees through Life Insurance & Retirement Services, AIG’s strategy is to
reinsurance or capital market hedging instruments. See produce cash flows required to meet maturing insurance
Note 21 of Notes to Consolidated Financial Statements for a liabilities. See also the discussion under ‘‘Operating Review:
discussion of new accounting guidance for these benefits. Life Insurance & Retirement Services Operations’’ herein. AIG
DAC for Life Insurance & Retirement Services products invests in equities for various reasons, including diversifying its
arises from the deferral of those costs that vary with, and are overall exposure to interest rate risk. Available for sale bonds
directly related to, the acquisition of new or renewal business. and equity securities are subject to declines in fair value. Such
Policy acquisition costs for life insurance products are generally changes in fair value are presented in unrealized appreciation
deferred and amortized over the premium paying period of the or depreciation of investments, net of taxes, as a component of
policy. Policy acquisition costs which relate to universal life and accumulated other comprehensive income. Generally, insurance
investment-type products, including variable and fixed annuities
48 AIG m Form 10-K