AIG 2005 Annual Report Download - page 89

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
unreported losses, or other factors affecting the particular class
In response to the continuing loss development, an additional of business.
study was conducted for the 2005 year-end actuarial reserve
analysis for DBG pertaining to the selection of loss development Long-Tail Reserves
factors for this class of business. Claims for excess workers
Estimation of ultimate net losses and loss expenses (net
compensation exhibit an exceptionally long tail of loss develop-
losses) for long-tail casualty lines of business is a complex
ment, running for decades from the date the loss is incurred. Thus,
process and depends on a number of factors, including the line
the adequacy of loss reserves for this class is sensitive to the
and volume of the business involved. Experience in the more
estimated loss development factors, as such factors may be applied
to many years of loss experience. In order to better estimate the recent accident years of long-tail casualty lines shows limited
tail development for this class, AIG claims staff conducted a claim statistical credibility in reported net losses because a relatively
by claim projection of the expected ultimate paid loss for each low proportion of net losses would be reported claims and
open claim for 1998 and prior accident years as these are the expenses and an even smaller proportion would be net losses
primary years that drive the tail factors. The objective of the study paid. Therefore, IBNR would constitute a relatively high propor-
was to provide a benchmark against which loss development tion of net losses.
factors in the tail could be evaluated. AIG’s carried net long-tail loss reserves are tested using loss
For a discussion of the adverse development in asbestos and trend factors that AIG considers most appropriate for each
environmental exposures, see ‘‘Asbestos and Environmental class of business. A variety of actuarial methods and assump-
Reserves’’ below. tions is normally employed to estimate net losses for long-tail
The favorable development in 2005 referred to above was casualty lines. These methods ordinarily involve the use of loss
principally the result of the following: Most classes of business, trend factors intended to reflect the estimated annual growth
with the notable exception of D&O, experienced favorable loss in loss costs from one accident year to the next. For the
development for accident year 2003, and nearly all classes majority of long-tail casualty lines, net loss trend factors
experienced favorable development for accident year 2004. These approximated five percent. Loss trend factors reflect many
accident years are benefiting from the actions AIG has taken in items including changes in claims handling, exposure and
response to the significant improvement in market conditions that policy forms; current and future estimates of monetary inflation
occurred beginning in 2001 and that accelerated thereafter. Rates and social inflation and increases in litigation and awards.
increased sharply for most classes of business, and policy terms and
These factors are periodically reviewed and subsequently
conditions were also improved significantly. In connection with
adjusted, as appropriate, to reflect emerging trends which are
AIG’s 2005 year-end actuarial reserve analysis and after consider-
based upon past loss experience. Thus, many factors are
ing the results of the Milliman review, AIG has recognized the
implicitly considered in estimating the year to year growth in
improving results to the extent they are credible, evidenced by up
to five years of favorable loss experience across many lines of loss costs recognized.
business since the market conditions improved. In addition, AIG A number of actuarial assumptions are made in the review
has taken this information into consideration in determining the of reserves for each line of business. For longer tail lines of
expected loss ratios for the 2005 accident year. business, actuarial assumptions generally are made with respect
to the following:
Overview of Loss Reserving Process mLoss trend factors which are used to establish expected loss
The General Insurance loss reserves can generally be ratios for subsequent accident years based on the projected
categorized into two distinct groups. One group is long-tail loss ratio for prior accident years.
casualty lines of business which include excess and umbrella mExpected loss ratios for the latest accident year (i.e.,
liability, D&O, professional liability, medical malpractice, accident year 2005 for the year end 2005 loss reserve
workers compensation, general liability, products liability, and analysis) and, in some cases, for accident years prior to the
related classes. The other group is short-tail lines of business latest accident year. The expected loss ratio generally
consisting principally of property lines, personal lines and reflects the projected loss ratio from prior accident years,
certain classes of casualty lines. adjusted for the loss trend (see above) and the effect of rate
changes and other quantifiable factors. For low-frequency,
high-severity classes such as excess casualty and D&O,
Short-Tail Reserves
expected loss ratios generally are utilized for at least the
For operations writing short-tail coverages, such as property
three most recent accident years.
coverages, the process of recording quarterly loss reserve
mLoss development factors which are used to project the
changes is geared toward maintaining an appropriate reserve
reported losses for each accident year to an ultimate basis.
level for the outstanding exposure, rather than determining an
AIG records quarterly changes in loss reserves for each of
expected loss ratio for current business. For example, the IBNR
its many General Insurance profit centers. The overall change
reserve required for a class of property business might be
in AIG’s loss reserves is based on the sum of these profit center
expected to approximate 20 percent of the latest year’s earned
level changes. For most profit centers which write longer tail
premiums, and this level of reserve would generally be
classes of casualty coverage, the process of recording quarterly
maintained regardless of the loss ratio emerging in the current
loss reserve changes involves determining the estimated current
quarter. The 20 percent factor is adjusted to reflect changes in
loss ratio for each class of coverage. This loss ratio is
rate levels, loss reporting patterns, known exposures to large
multiplied by the current quarter’s net earned premium for that
AIG m Form 10-K 37