AIG 2006 Annual Report Download - page 132

American International Group, Inc. and Subsidiaries
Management’s Discussion and Analysis of
Financial Condition and Results of Operations Continued
the maturity of the initial investments may be at a yield below that AIG actively manages the asset-liability relationship in its
of the interest required for the accretion of the policy liabilities. domestic operations. This relationship is more easily managed
Additionally, there exists a future investment risk associated with through the availability of qualified long-term investments.
certain policies currently in-force which will have premium receipts A number of guaranteed benefits, such as living benefits or
in the future. That is, the investment of these future premium guaranteed minimum death benefits, are offered on certain
receipts may be at a yield below that required to meet future variable life and variable annuity products. AIG manages its
policy liabilities. exposure resulting from these long-term guarantees through
In 2006, new money investment rates generally increased in reinsurance or capital market hedging instruments.
the U.S., Japan and Taiwan, and were generally unchanged in AIG invests in equities for various reasons, including diversify-
Thailand. In regard to in-force business, management focus is ing its overall exposure to interest rate risk. Available for sale
required in both the investment and product management process bonds and equity securities are subject to declines in fair value.
to maintain an adequate yield to match the interest necessary to Such declines in fair value are presented in unrealized apprecia-
support future policy liabilities. Business strategies continue to tion or depreciation of investments, net of taxes, as a component
evolve to maintain profitability of the overall business. In some of Accumulated other comprehensive income. Declines that are
countries, new products are being introduced with minimal determined to be other-than-temporary are reflected in income in
investment guarantees resulting in a shift toward investment the period in which the intent to hold the securities to recovery no
linked savings products and away from traditional savings prod- longer exists. See Valuation of Invested Assets herein. Generally,
ucts with higher guarantees. insurance regulations restrict the types of assets in which an
The investment of insurance cash flows and reinvestment of insurance company may invest. When permitted by regulatory
the proceeds of matured securities and coupons requires active authorities and when deemed necessary to protect insurance
management of investment yields while maintaining satisfactory assets, including invested assets, from adverse movements in
investment quality and liquidity. foreign currency exchange rates, interest rates and equity prices,
AIG may use alternative investments in certain foreign jurisdic- AIG and its insurance subsidiaries may enter into derivative
tions where interest rates remain low and there are limited long- transactions as end users to hedge their exposures. For a further
dated bond markets, including equities, real estate and foreign discussion of AIG’s use of derivatives, see Risk Management —
currency denominated fixed income instruments to extend the Credit Risk Management — Derivatives herein.
duration or increase the yield of the investment portfolio to more In certain jurisdictions, significant regulatory and/or foreign
closely match the requirements of the policyholder liabilities and governmental barriers exist which may not permit the immediate
DAC recoverability. This strategy has been effectively used in free flow of funds between insurance subsidiaries or from the
Japan and more recently by Nan Shan in Taiwan. In Japan, foreign insurance subsidiaries to AIG parent. For a discussion of these
assets, excluding those matched to foreign liabilities, were restrictions, see Item 1. Business — Regulation.
approximately 30 percent of statutory assets, which is below the Life Insurance & Retirement Services invested assets grew by
maximum allowable percentage under current local regulation. $37.0 billion, or 10 percent, during 2006 as bond holdings grew
Foreign assets comprised approximately 32 percent of Nan by $15.1 billion, or 6 percent, and listed equity holdings grew by
Shan’s invested assets at December 31, 2006, slightly below the $6.7 billion, or 41 percent. For a discussion of credit risk
maximum allowable percentage under current local regulation. The exposures, see Risk Management — Credit Risk Management
majority of Nan Shan’s in-force policy portfolio is traditional life herein.
and endowment insurance products with implicit interest rate
guarantees. New business with lower interest rate guarantees are Financial Services Invested Assets
gradually reducing the overall interest requirements, but asset ILFC
portfolio yields have declined faster due to the prolonged low
The cash used for the purchase of flight equipment is derived
interest rate environment. As a result, although the investment
primarily from the proceeds of ILFC’s debt financings. The primary
margins for a large block of in-force policies are negative, the
sources for the repayment of this debt and the related interest
block remains profitable because the mortality and expense
expense are ILFC’s cash flow from operations, proceeds from the
margins presently exceed the negative investment spread. In
sale of flight equipment and the rollover and refinancing of the
response to the low interest rate environment and the volatile
prior debt. During 2006, ILFC acquired flight equipment costing
exchange rate of the NT dollar, Nan Shan is emphasizing new
$6.0 billion. For a further discussion of ILFC’s borrowings, see
products with lower implied guarantees, including participating
Operating Review — Financial Services Operations — Aircraft Leas-
endowments and investment linked products. Although the risks of
ing and Capital Resources — Borrowings herein.
a continued low interest rate environment coupled with a volatile
At December 31, 2006, ILFC had committed to purchase 254
NT dollar could increase net liabilities and require additional
new aircraft deliverable from 2007 through 2015 for an estimated
capital to maintain adequate local solvency margins, Nan Shan
aggregate purchase price of $19.0 billion. As of February 22,
currently believes it has adequate resources to meet all future
2007, ILFC has entered into leases for all of the new aircraft to
policy obligations.
be delivered in 2007, and 64 of 171 of the new aircraft to be
delivered subsequent to 2007. ILFC will be required to find
customers for any aircraft currently on order and any aircraft to be
82 AIG 2006 Form 10-K