AIG 2011 Annual Report Download - page 86

under Chartis U.S. and Chartis International. Prior period amounts have been reclassified to conform to the
current year presentation.
As previously noted, AIG presents and discusses its financial information in a manner it believes is most
meaningful to its financial statement users. AIG analyzes the operating performance of Chartis using underwriting
profit (loss) and pre-tax income (loss). Underwriting profit (loss) is derived by reducing net premiums earned by
claims and claims adjustment expenses incurred and underwriting expenses. Net premiums written are initially
deferred and earned based upon the terms of the underlying policies for short duration contracts. The unearned
premium reserve constitutes deferred revenues which are generally recognized in earnings ratably over the policy
period. Net premiums written for long duration contracts are earned when due from the policyholder. Net
premiums written reflect the premiums retained after purchasing reinsurance protection.
Chartis, along with most property and casualty insurance companies, uses the loss ratio, the expense ratio and
the combined ratio as measures of underwriting performance. The loss ratio is the sum of claims and claims
adjustment expenses incurred divided by net premiums earned. The expense ratio is underwriting expenses, which
consist of acquisition costs plus other insurance expenses, divided by net premiums earned. The combined ratio is
the sum of the loss ratio and the expense ratio. These ratios are relative measurements that describe, for every
$100 of net premiums earned, the amount of claims and claims adjustment expenses, and other underwriting
expenses that would be incurred. A combined ratio of less than 100 indicates an underwriting profit and over 100
indicates an underwriting loss.
The underwriting environment varies across countries and products, as does the degree of litigation activity, all
of which affect such ratios. In addition, investment returns, local taxes, cost of capital, regulation, product type
and competition can have an effect on pricing and consequently on profitability as reflected in underwriting profit
and associated ratios.
Chartis will continue to assess the performance of its operating segments based in part on underwriting profit,
loss ratio, expense ratio and combined ratio. Chartis believes these metrics provide long-term measures of the
performance of the business compared to historical results and peer companies. In addition, Chartis is developing
new value based metrics that provide management shorter-term measures to evaluate its performance across
multiple lines and various countries. As an example, Chartis has implemented a risk-adjusted profitability model as
a business performance measure, which it will continue to refine. Along with underwriting results, this
risk-adjusted profitability model incorporates elements of capital allocations, costs of capital and net investment
income. Chartis believes that such performance measures will allow it to manage changes in its business mix.
Investment income is allocated to the Commercial Insurance and Consumer Insurance segments based on an
internal investment income allocation model. The model estimates investable funds based upon the loss reserves,
unearned premium and a capital allocation for each segment. The investment income allocation is calculated
based on the estimated investable funds and risk-free yields (plus an illiquidity premium) consistent with the
approximate duration of the liabilities. The actual yields in excess of the allocated amounts and the investment
income from the assets not attributable to the Commercial Insurance and Consumer Insurance segments are
assigned to Chartis Other.
For the year ended December 31, 2011, results reflect the effects of the full year of Fuji operations, while the
corresponding 2010 period reflects the effects of Fuji for only two quarters, because Chartis began consolidating
Fuji’s operating results on July 1, 2010. Fuji operations primarily relate to Consumer Insurance.
72 AIG 2011 Form 10-K