AIG 2015 Annual Report Download - page 285

ITEM 8 / NOTE 8. DEFERRED POLICY ACQUISITION COSTS
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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 amount of future policy benefit liabilities, net of DAC, and what 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, servicing and measuring the profitability of 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.
Investment-oriented contracts: Policy acquisition costs and policy issuance costs related to universal life and investment-
type products (collectively, investment-oriented products) are deferred and amortized, with interest, in relation to the incidence
of estimated gross profits to be realized over the estimated lives of the contracts. Estimated gross profits include net
investment income and spreads, net realized investment gains and losses, fees, surrender charges, expenses, and mortality
gains and losses. In each reporting period, current period amortization expense is adjusted to reflect actual gross profits. If
estimated gross profits change significantly, DAC is recalculated using the new assumptions, and any resulting adjustment is
included in income. If the new assumptions indicate that future estimated gross profits are higher than previously estimated,
DAC will be increased resulting in a decrease in amortization expense and increase in income in the current period; if future
estimated gross profits are lower than previously estimated, DAC will be decreased resulting in an increase in amortization
expense and decrease in income in the current period. Updating such assumptions may result in acceleration of amortization
in some products and deceleration of amortization in other products. 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
current and projected future profitability of the underlying insurance contracts.
To estimate future estimated gross profits for variable annuity products, a long-term annual asset growth assumption is applied
to determine the future growth in assets and related asset-based fees. In determining the asset growth rate, the effect of
short-term fluctuations in the equity markets is partially mitigated through the use of a “reversion to the mean” methodology
whereby short-term asset growth above or below long-term annual rate assumptions impact the growth assumption applied to
the five-year period subsequent to the current balance sheet date. The reversion to the mean methodology allows us to
maintain our long-term growth assumptions, while also giving consideration to the effect of actual investment performance.
When actual performance significantly deviates from the annual long-term growth assumption, as evidenced by growth
assumptions in the five-year reversion to the mean period falling below a certain rate (floor) or above a certain rate (cap) for a
sustained period, judgment may be applied to revise or “unlock” the growth rate assumptions to be used for both the five-year
reversion to the mean period as well as the long-term annual growth assumption applied to subsequent periods.
Shadow DAC and Shadow Loss Recognition: DAC related to investment-oriented products is also adjusted to reflect the
effect of unrealized gains or losses on fixed maturity and equity securities available for sale on estimated gross profits, with
related changes recognized through Other comprehensive income (shadow DAC). The adjustment is made 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.
Similarly, for long-duration traditional insurance contracts, if the assets supporting the liabilities maintain a temporary net
unrealized gain position at the balance sheet date, loss recognition testing assumptions are updated to exclude such gains
from future cash flows by reflecting the impact of reinvestment rates on future yields. If a future loss is anticipated under this
basis, any additional shortfall indicated by loss recognition tests is recognized as a reduction in accumulated other