AIG 2014 Annual Report Download - page 282

ITEM 8 / NOTE 8. REINSURANCE
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Reinsurance Security
Our third-party reinsurance arrangements do not relieve us from our direct obligations to our beneficiaries. Thus, a credit
exposure exists with respect to both short-duration and long-duration reinsurance ceded to the extent that any reinsurer fails to
meet the obligations assumed under any reinsurance agreement. We hold substantial collateral as security under related
reinsurance agreements in the form of funds, securities, and/or letters of credit. A provision has been recorded for estimated
unrecoverable reinsurance. We believe that no exposure to a single reinsurer represents an inappropriate concentration of
credit risk to AIG. Gross reinsurance assets with our three largest reinsurers aggregate to approximately $6.2 billion and $6.0
billion at December 31, 2014 and 2013, respectively, of which approximately $3.3 billion was not secured by collateral in both
years.
9. DEFERRED POLICY ACQUISITION COSTS
Deferred policy acquisition costs (DAC) represent those costs that are incremental and directly related to the successful
acquisition of new or renewal of existing insurance contracts. We defer incremental costs that result directly from, and are
essential to, the acquisition or renewal of an insurance contract. Such deferred policy acquisition costs generally include agent
or broker commissions and bonuses, premium taxes, and medical and inspection fees that would not have been incurred if the
insurance contract had not been acquired or renewed. Each cost is analyzed to assess whether it is fully deferrable. We
partially defer costs, including certain commissions, when we do not believe that the entire cost is directly related to the
acquisition or renewal of insurance contracts.
We also defer a portion of employee total compensation and payroll-related fringe benefits directly related to time spent
performing specific acquisition or renewal activities, including costs associated with the time spent on underwriting, policy
issuance and processing, and sales force contract selling. The amounts deferred are derived based on successful efforts for
each distribution channel and/or cost center from which the cost originates.
Short-duration insurance contracts: Policy acquisition costs are deferred and amortized over the period in which the related
premiums written are earned, generally 12 months. DAC is grouped consistent with the manner in which the insurance
contracts are acquired, serviced and measured for profitability and is reviewed for recoverability based on the profitability of
the underlying insurance contracts. Investment income is anticipated in assessing the recoverability of DAC. We assess the
recoverability of DAC on an annual basis or more frequently if circumstances indicate an impairment may have occurred. This
assessment is performed by comparing recorded net unearned premiums and anticipated investment income on in-force
business to the sum of expected losses and loss adjustment expenses incurred, unamortized DAC and maintenance costs. If
the sum of these costs exceeds the amount of recorded net unearned premiums and anticipated investment income, the
excess is recognized as an offset against the asset established for DAC. This offset is referred to as a premium deficiency
charge. Increases in expected losses and loss adjustment expenses incurred can have a significant impact on the likelihood
and amount of a premium deficiency charge.
Long-duration insurance contracts: Policy acquisition costs for participating life, traditional life and accident and health
insurance products are generally deferred and amortized, with interest, over the premium paying period. The assumptions
used to calculate the benefit liabilities and DAC for these traditional products are set when a policy is issued and do not
change with changes in actual experience, unless a loss recognition event occurs. These “locked-in” assumptions include
mortality, morbidity, persistency, maintenance expenses and investment returns, and include margins for adverse deviation to
reflect uncertainty given that actual experience might deviate from these assumptions. A loss recognition event occurs when
there is a shortfall between the carrying amounts of future policy benefit liabilities net of DAC and the amount the future policy
benefit liabilities net of DAC would be when applying updated current assumptions. When we determine a loss recognition
event has occurred, we first reduce any DAC related to that block of business through amortization of acquisition expense, and
after DAC is depleted, we record additional liabilities through a charge to Policyholder benefits and losses incurred. Groupings
for loss recognition testing are consistent with our manner of acquiring and servicing the business and applied by product
groupings. We perform separate loss recognition tests for traditional life products, payout annuities and long-term care
products. Once loss recognition has been recorded for a block of business, the old assumption set is replaced and the
assumption set used for the loss recognition would then be subject to the lock-in principle.