AIG 2005 Annual Report Download - page 99

AMERICAN INTERNATIONAL GROUP, INC. AND SUBSIDIARIES
The contribution of Life Insurance & Retirement Services AIG’s domestic Life Insurance & Retirement Services
operating income to AIG’s consolidated income before income operations utilize internal and third-party reinsurance relation-
taxes, minority interest and cumulative effect of accounting ships to manage insurance risks and to facilitate capital
changes amounted to 58 percent in 2005, compared to management strategies. Pools of highly-rated third-party rein-
53 percent in 2004 and 57 percent in 2003. surers are utilized to manage net amounts at risk in excess of
retention limits. AIG’s domestic life insurance companies also
cede excess, non-economic reserves carried on a statutory-basis
Underwriting and Investment Risk
only on certain term and universal life insurance policies and
The risks associated with the life and accident & health certain fixed annuities to AIG Life of Bermuda Ltd., a wholly
products are underwriting risk and investment risk. The risk owned Bermuda reinsurer.
associated with the financial and investment contract products AIG generally obtains letters of credit in order to obtain
is primarily investment risk. statutory recognition of these intercompany reinsurance trans-
Underwriting risk represents the exposure to loss resulting actions. For this purpose, AIG entered into a $2.5 billion
from the actual policy experience adversely emerging in syndicated letter of credit facility in December 2004. Letters of
comparison to the assumptions made in the product pricing credit totaling $2.17 billion were outstanding as of Decem-
associated with mortality, morbidity, termination and expenses. ber 31, 2004, and letters of credit for all $2.5 billion were
The emergence of significant adverse experience would require outstanding as of December 31, 2005, all of which relate to life
an adjustment to DAC and benefit reserves that could have a intercompany reinsurance transactions. The letter of credit
substantial effect on AIG’s results of operations. facility has a ten-year term, but the facility can be reduced or
Natural disasters such as hurricanes, earthquakes and other terminated by the lenders beginning after seven years.
catastrophes have the potential to adversely affect AIG’s In November 2005, AIG entered into a revolving credit
operating results. Other risks, such as an outbreak of a facility for an aggregate amount of $3 billion. The facility can
pandemic disease, such as the Avian Influenza A Virus be drawn in the form of letters of credit with terms of up to
(H5N1), could adversely affect AIG’s business and operating ten years. As of December 31, 2005 and as of the date hereof,
results to an extent that may be only minimally offset by $1.86 billion principal amount of letters of credit are outstand-
reinsurance programs. ing under this facility, of which approximately $494 million
While to date, outbreaks of the Avian Flu continue to relates to life intercompany reinsurance transactions. AIG also
occur among poultry or wild birds in a number of countries in obtained approximately $212 million letters of credit on a
Asia, parts of Europe, and recently in Africa, transmission to bilateral basis.
humans has been rare. If the virus mutates to a form that can The investment risk represents the exposure to loss resulting
be transmitted from human to human, it has the potential to from the cash flows from the invested assets, primarily long-
spread rapidly worldwide. If such an outbreak were to take term fixed rate investments, being less than the cash flows
place, early quarantine and vaccination could be critical to required to meet the obligations of the expected policy and
containment. contract liabilities and the necessary return on investments.
Both the contagion and mortality rate of any mutated See also the discussion under ‘‘Liquidity’’ herein.
H5N1 virus that can be transmitted from human to human are To minimize its exposure to investment risk, AIG tests the
highly speculative. AIG continues to monitor the developing cash flows from invested assets and policy and contract
facts. A significant global outbreak could have a material liabilities using various interest rate scenarios to evaluate
adverse effect on Life Insurance & Retirement Services investment risk and to confirm that assets are sufficient to pay
operating results and liquidity from increased mortality and these liabilities.
morbidity rates. AIG actively manages the asset-liability relationship in its
AIG’s Foreign Life Insurance & Retirement Services compa- foreign operations, as it has been doing throughout AIG’s
nies generally limit their maximum underwriting exposure on history, even though certain territories lack qualified long-term
life insurance of a single life to approximately $1.7 million of investments or certain local regulatory authorities may impose
coverage. AIG’s Domestic Life Insurance & Retirement Ser- investment restrictions. For example, in several Asian coun-
vices companies limit their maximum underwriting exposure on tries, the duration of the investments is shorter than the
life insurance of a single life to $10 million of coverage in effective maturity of the related policy liabilities. Therefore,
certain circumstances by using yearly renewable term reinsur- there is a risk that the reinvestment of the proceeds at the
ance. See the discussion under ‘‘Liquidity’’ herein and Note 6 maturity of the initial investments may be at a yield below
of Notes to Consolidated Financial Statements. that of the interest required for the accretion of the policy
AIRCO acts primarily as an internal reinsurance company liabilities. Additionally, there exists a future investment risk
for AIG’s foreign life operations. This facilitates insurance risk associated with certain policies currently in force which will
management (retention, volatility, concentrations) and capital have premium receipts in the future. That is, the investment of
planning locally (branch and subsidiary). It also allows AIG to these future premium receipts may be at a yield below that
pool its insurance risks and purchase reinsurance more effi- required to meet future policy liabilities.
ciently at a consolidated level, manage global counterparty risk In 2005, new money investment yields increased in some
and relationships and manage global life catastrophe risks. markets and continued to decrease in others, leading to more
frequent adjustments in new business premium rates, credited
AIG m Form 10-K 47