AIG 2015 Annual Report Download - page 150

ITEM 7 / INSURANCE RESERVES / LIFE INSURANCE COMPANIES
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The following table presents the net increase (decrease) to consolidated pre-tax income from changes in the fair
value of the GMWB and GMAB embedded derivatives and related hedges:
Years Ended December 31,
(in millions) 2015 2014 2013
Change in fair value of GMWB and GMAB embedded derivatives $63 $ (759) $ 1,252
Change in fair value of variable annuity hedging portfolio:
Fixed maturity securities (43) 260 (161)
Interest rate derivative contracts 343 742 (468)
Equity derivative contracts (86) (230) (461)
Net impact on pre-tax income $277 $ 13 $ 162
The effect of the changes in the fair value of the GMWB and GMAB embedded derivatives and the related hedging portfolio
had a net positive impact on consolidated pre-tax income in 2015, 2014 and 2013. The change in the fair value of the
embedded derivatives and the change in the value of the hedging portfolio are not expected to be fully offsetting, primarily due
to differences between the U.S. GAAP valuation of the embedded derivatives and the economic hedge target, which include a
non-performance or “own credit” spread adjustment (NPA) to the rate used to discount projected benefit cash flows. When
corporate credit spreads widen, as they did in 2015, the change in the NPA generally reduces the fair value of the embedded
derivative liabilities, resulting in a gain, and when corporate credit spreads narrow or tighten, the change in the NPA generally
increases the fair value of the embedded derivative liabilities, resulting in a loss. See Note 4 to the Consolidated Financial
Statements for additional discussion of the fair value measurement of the embedded derivatives under U.S. GAAP and the
estimation of the NPA, and see Differences in Valuation of Embedded Derivatives and Economic Hedge Target, below.
In 2015, there was a slight gain from a decline in the fair value of the embedded derivative liabilities, as losses from the
decrease in market interest rates were more than offset by gains from a higher NPA, related to widening corporate credit
spreads. The losses from the decrease in market interest rates in 2015 were largely offset by interest rate hedges. In 2014, the
decrease in market interest rates resulted in losses from a significant increase in the fair value of the embedded derivative
liabilities, which was only partially offset by higher equity markets. Since the change in NPA was relatively small in 2014, the
loss on the embedded derivatives was primarily offset by hedging. In 2013, there was a significant decline in the embedded
derivative liabilities, driven by both higher interest rates and higher equity markets, which was only partially offset by a decline
in NPA from spread tightening. The embedded derivative gains due to higher interest rates were offset by interest rate hedging
to a lesser extent in 2013, as we had not elected to fully hedge interest rate risk until the second half of 2014.
These changes in the fair value of the embedded derivatives were offset in part by the following changes in the fair value of the
variable annuity hedging portfolio:
• Changes in the fair value of fixed maturity securities, for which the fair value option has been elected, that are used as a
capital-efficient way to economically hedge interest rate risk. In 2012, we began to use U.S. Treasury bonds in this hedging
program to reduce our interest rate risk exposure over time. Effective June 30, 2015, we discontinued the U.S. Treasury
bond interest rate hedging program and initiated a corporate bond hedging program, which is intended to provide the same
capital efficiency as the previous U.S. Treasury bond hedging program. The 2015 losses from the change in the fair value of
fixed maturity securities were primarily due to the impact on the U.S. Treasury position in the first half of the year from
increasing market interest rates. The gains in 2014 and losses in 2013 from the change in the fair value of the fixed
maturities securities were due to market interest rates, which decreased in 2014 and increased 2013.
• Changes in the fair value of interest rate derivative contracts, which included swaps, swaptions, futures and options,
resulted in gains in 2015 and 2014 due to decreasing market interest rates, and losses in 2013 driven by increasing interest
rates. Prior to 2014, we had elected to only partially hedge GMWB and GMAB interest rate risk.
• Losses from the change in the fair value of equity derivative contracts, which included futures and options, were relatively
smaller in 2015 compared to 2014 and 2013, due to higher equity market returns in those years.