AIG 2011 Annual Report Download - page 197

Periodically, AIG evaluates estimates used in establishing liabilities for Future policy benefits for life and
accident and health insurance contracts, which include liabilities for certain payout annuities. AIG also evaluates
estimates used in amortizing Deferred Policy Acquisition Costs (DAC), Value of Business Acquired (VOBA) and
Sales Inducement Assets (SIA) for these products. These estimates are evaluated against actual experience and
adjusted based on management judgment regarding mortality, morbidity, persistency, maintenance expenses, and
investment returns. For long duration traditional business, a ‘‘lock-in’’ principle applies, whereby the assumptions
used to calculate the benefit liabilities and DAC are set when a policy is issued and do not change with changes in
actual experience, unless a loss recognition event occurs. These assumptions include margins for adverse deviation
in the event that actual experience might deviate from these assumptions. The key assumptions used in estimating
future policy benefit reserves are:
•Investment returns: which vary by year of issuance and products.
•Mortality, morbidity and surrender rates: based upon actual experience modified to allow for variation in
policy form, risk classification and distribution channel.
As AIG experience changes over time, the assumptions are updated to reflect observed changes. Because of the
long term nature of many of AIG’s liabilities subject to the ‘‘lock-in’’ principle, small changes in certain
assumptions may cause large changes in the degree of reserve adequacy. In particular, changes in estimates of
future invested asset returns have a large effect on the degree of reserve deficiency. If observed changes in actual
experience or estimates result in projected future losses under loss recognition testing, DAC is adjusted through
amortization expense, and additional liabilities are recorded through a charge to policyholder benefit expense.
Loss recognition testing is performed at an aggregate SunAmerica reporting segment level. Once loss recognition
has been recorded for a block of business, the old assumption set is replaced (i.e., a DAC unlocking), and the
assumption set used for the loss recognition would then be subject to the lock-in principle. See Note 2(g) to the
Consolidated Financial Statements for additional information.
These estimates are also used to determine whether to adjust DAC and record additional liabilities when
unrealized gains or losses on fixed maturity and equity securities available for sale are recognized through
accumulated other comprehensive income, at each balance sheet date, as if the securities had been sold at their
stated aggregate fair value and the proceeds reinvested at current yields. Significant unrealized appreciation on
investments in a prolonged low interest rate environment may cause DAC to be adjusted and additional future
policy benefit liabilities to be recorded through a charge directly to accumulated other comprehensive income,
which is included, net of tax, with the change in net unrealized appreciation (depreciation) of investments.
AIG’s future policy benefits include guaranteed minimum death benefits (GMDB). The GMDB liability is
determined each period end by estimating the expected value of death benefits in excess of the projected account
balance and recognizing the excess ratably over the accumulation period based on total expected fees. The
estimates incorporate assumptions including interest rates, mortality rates, lapse rates and stochastically generated
investment returns. In addition to GMDB, AIG’s future policy benefits include, to a lesser extent, guaranteed
minimum income benefits (GMIB). The GMIB liability is determined each period end by estimating the expected
value of the annuitization benefits in excess of the projected account balance at the date of annuitization and
recognizing the excess ratably over the accumulation period based on total expected assessments. AIG periodically
evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefit
expense, if actual experience or other evidence suggests that earlier assumptions should be revised.
AIG also issues certain variable annuity products that offer optional guaranteed minimum withdrawal benefits
(GMWB) and guaranteed minimum account value benefits (GMAV). These living benefits are embedded
derivatives that are required to be bifurcated from the host contract and carried at fair value. The fair value
estimates of the living benefit guarantees include assumptions such as equity market returns, interest rates, market
volatility and policyholder behavior. AIG also incorporates its own risk of non-performance in the valuation of the
embedded policy derivatives. See Note 6 to the Consolidated Financial Statements for information on how AIG
incorporates its own non-performance risk.
AIG 2011 Form 10-K 183
FUTURE POLICY BENEFITS FOR LIFE AND ACCIDENT AND HEALTH
INSURANCE CONTRACTS (SUNAMERICA COMPANIES):