AIG 2015 Annual Report Download - page 149

ITEM 7 / INSURANCE RESERVES / LIFE INSURANCE COMPANIES
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term care products primarily due to updated future premium assumptions, and an additional net negative adjustment from the
update of estimated gross profit assumptions primarily due to lower investment spread assumptions. These negative
adjustments were partially offset by a decrease in certain Group Benefit claim reserves based on updated experience data.
A net negative adjustment of $119 million in the Life operating segment in 2014 was primarily due to loss recognition expense,
as discussed below, and also included additions to reserves for universal life with secondary guarantees, primarily due to lower
investment spread and mortality assumptions which, while higher than previously assumed, were still within pricing
assumptions.
A negative adjustment of $80 million in the Life operating segment in 2013 resulted primarily from the update of mortality
assumptions.
The Life operating segment recorded loss recognition expense of $28 million and $87 million to increase reserves for certain
long-term care business in 2015 and 2014, respectively, which reduced pre-tax operating income in those periods. Loss
recognition expense is included in Other reserve changes in the rollforward table presented in Life Insurance Companies
Reserves. The Life loss recognition for both periods was primarily a result of lower future premium increase assumptions and,
in 2014, lower yield assumptions. Assumptions related to investment yields, mortality experience and expenses are reviewed
periodically and updated as appropriate, which could result in additional loss recognition reserves. While the U.S. Life
Insurance Companies do not currently offer standalone long-term care products, these needs are addressed with various
benefits and riders in the existing portfolio, such as chronic illness riders.
Variable Annuity Guaranteed Benefit Features and Hedging Program
Our Retirement Income Solutions and Group Retirement businesses offer variable annuity products with riders that provide
guaranteed living benefit features, which include GMWB and GMAB. The liabilities for GMWB and GMAB are accounted for as
embedded derivatives measured at fair value. The fair value of the embedded derivatives may fluctuate significantly based on
market interest rates, equity prices, credit spreads and market volatility.
In addition to risk-mitigating features in our variable annuity product design, we have an economic hedging program designed
to manage market risk from GMWB and GMAB, including exposures to changes in interest rates, equity prices, credit spreads
and volatilities. The hedging program utilizes derivative instruments, including but not limited to equity options, futures
contracts and interest rate swap and swaption contracts, as well as fixed maturity securities with a fair value election. See
Enterprise Risk Management – Life Insurance Companies Key Insurance Risks – Variable Annuity Risk Management and
Hedging Program for additional discussion of market risk management related to these product features.
Impact on Pre-tax Income
Changes in the fair value of the GMWB and GMAB embedded derivatives, and changes in the fair value of related derivative
hedging instruments, are recorded in Other realized capital gains (losses). Realized capital gains (losses), as well as net
investment income from changes in the fair value of the fixed maturity securities used in the variable annuity hedging program,
for which the fair value option has been elected, are excluded from pre-tax operating income of the Retirement operating
segment.