AIG 2005 Annual Report Download - page 85

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
2004, net investment income increased when compared to tion. Additionally, with the approval of its domiciliary insurance
2003. See also the discussion under ‘‘Liquidity’’ herein and regulators, AIG posted approximately $1.5 billion of letters of
Note 8 of Notes to Consolidated Financial Statements. credit issued by several commercial banks in favor of certain
Realized capital gains and losses resulted from the ongoing Domestic General Insurance companies to permit statutory
investment management of the General Insurance portfolios recognition of balances otherwise uncollateralized at Decem-
within the overall objectives of the General Insurance operations. ber 31, 2005. The remaining 52 percent of the general
See the discussion on ‘‘Valuation of Invested Assets’’ herein. reinsurance assets were from authorized reinsurers. The terms
The contribution of General Insurance operating income to authorized and unauthorized pertain to regulatory categories, not
AIG’s consolidated income before income taxes, minority creditworthiness. At December 31, 2005, approximately 88 per-
interest and cumulative effect of accounting changes was cent of the balances with respect to authorized reinsurers are
15 percent in 2005, compared to 21 percent in 2004 and from reinsurers rated A (excellent) or better, as rated by A.M.
38 percent in 2003. The decrease in contribution percentages Best, or A (strong) or better, as rated by S&P. These ratings are
in both 2005 and 2004 was largely the result of reserve measures of financial strength.
increases and the effects of catastrophe losses. AIG maintains a reserve for estimated unrecoverable
reinsurance. While AIG has been largely successful in its
previous recovery efforts, at December 31, 2005, AIG had a
Reinsurance
reserve for unrecoverable reinsurance approximating
AIG is a major purchaser of reinsurance for its General $992 million. At that date, AIG had no significant reinsurance
Insurance operations. AIG insures risks globally, and its recoverables due from any individual reinsurer that was
reinsurance programs must be coordinated in order to provide financially troubled (e.g., liquidated, insolvent, in receivership
AIG the level of reinsurance protection that AIG desires. or otherwise subject to formal or informal regulatory
Reinsurance is an important risk management tool to manage restriction).
transaction and insurance line risk retention at prudent levels AIG’s Reinsurance Security Department conducts ongoing
set by management. AIG also purchases reinsurance to mitigate detailed assessments of the reinsurance markets and current
its catastrophic exposure. AIG is cognizant of the need to and potential reinsurers, both foreign and domestic. Such
exercise good judgment in the selection and approval of both assessments include, but are not limited to, identifying if a
domestic and foreign companies participating in its reinsurance reinsurer is appropriately licensed and has sufficient financial
programs because one or more catastrophe losses could capacity, and evaluating the local economic environment in
negatively affect AIG’s reinsurers and result in an inability of which a foreign reinsurer operates. This department also
AIG to collect reinsurance recoverables. AIG’s reinsurance reviews the nature of the risks ceded and the requirements for
department evaluates catastrophic events and assesses the credit risk mitigants. For example, in AIG’s treaty reinsurance
probability of occurrence and magnitude of catastrophic events contracts, AIG includes provisions that frequently require a
through the use of state-of-the-art industry recognized program reinsurer to post collateral when a referenced event occurs.
models among other techniques. AIG supplements these Furthermore, AIG limits its unsecured exposure to reinsurers
models through continually monitoring the risk exposure of through the use of credit triggers, which include, but are not
AIG’s worldwide General Insurance operations and adjusting limited to, insurer financial strength rating downgrades, policy-
such models accordingly. Although reinsurance arrangements do holder surplus declines at or below a certain predetermined
not relieve AIG from its direct obligations to its insureds, an level or a certain predetermined level of a reinsurance
efficient and effective reinsurance program substantially limits recoverable being reached. In addition, AIG’s Credit Risk
AIG’s exposure to potentially significant losses. With respect to Committee reviews the credit limits for and concentrations
its property business, AIG has either renewed existing coverage with any one reinsurer.
or purchased new coverage that, in the opinion of management, AIG enters into intercompany reinsurance transactions,
is adequate to limit AIG’s exposures. primarily through AIRCO, for its General Insurance and Life
AIG’s consolidated general reinsurance assets amounted to Insurance operations. AIG enters into these transactions as a
$23.59 billion at December 31, 2005 and resulted from AIG’s sound and prudent business practice in order to maintain
reinsurance arrangements. Thus, a credit exposure existed at underwriting control and spread insurance risk among AIG’s
December 31, 2005 with respect to reinsurance recoverable to various legal entities. These reinsurance agreements have been
the extent that any reinsurer may not be able to reimburse AIG approved by the appropriate regulatory authorities. All material
under the terms of these reinsurance arrangements. AIG intercompany transactions have been eliminated in consolida-
manages its credit risk in its reinsurance relationships by tion. AIG generally obtains letters of credit in order to obtain
transacting with reinsurers that it considers financially sound, statutory recognition of these intercompany reinsurance trans-
and when necessary AIG holds substantial collateral in the form actions. At December 31, 2005, approximately $3.6 billion of
of funds, securities and/or irrevocable letters of credit. This letters of credit were outstanding to cover intercompany
collateral can be drawn on for amounts that remain unpaid reinsurance transactions with AIRCO or other General Insur-
beyond specified time periods on an individual reinsurer basis. ance subsidiaries.
At December 31, 2005, approximately 48 percent of the general At December 31, 2005, the consolidated general reinsurance
reinsurance assets were from unauthorized reinsurers. Many of assets of $23.59 billion include reinsurance recoverables for
these balances were collateralized, permitting statutory recogni- paid losses and loss expenses of $829 million and $19.69 bil-
AIG m Form 10-K 33